In the past two weeks, the EBA has issued several consultation papers on the technical standards under the 4th Capital Requirements Directive (CRD IV). One of the papers concerned an important question: When are firms required to report changes to their rating systems and internal models?
The answer: Pretty much all the time. Between the three categories of changes – material changes requiring permission, changes requiring prior notification, and changes requiring subsequent notification – almost all possible changes to a model are covered. Firms will have to notify regulators whether they are: extending the coverage of their model in any way; changing the underlying methodology, algorithms or definitions; or doing a whole host of other, more routine, actions (e.g. changing the way they balance realism/conservatism in making estimates).
For firms, this not only means greater reporting requirements, but also tighter management controls on changes to models. Firms will need to incorporate regulatory reporting into change workflow in order to meet requirements, whether straightforward notification or seeking express permission. In this respect, firms will be caught between fines, on the one hand, and avoiding costly/risky delays to changes to their models on the other.
Ultimately, it is not hard to see a situation in which firms could be caught in a Catch-22 between correcting time-critical blind spots in their models, while waiting on regulatory permission to make the changes at the same time. This is just one of many ways in which risk models will have to become a priority for firms before the CRD/CRR comes into force in January 2014.
The consultation is open until 11th June 2013.