1. Stress and Scenario Testing: CP08/24 ISDA/PRMIA risk seminar, 10 February 2009 Rory Vaughan Wholesale and Prudential Policy Division Financial Services Authority

2. Agenda Outcomes Background Policy proposals in CP08/24 Next steps Discussion

3. Outcomes Better-informed and more timely senior management decision-making Achieved by: Improved stress and scenario testing – firm-wide, more thoughtful, embedded in senior management culture; and Improved senior management engagement

4. Background Concerns about quality of stress and scenario testing Northern Rock internal audit report FSA work Industry reviews International work

5. FSA work FSA has consistently highlighted the importance of stress testing to good risk management –In 2005, two industry workshops, a Discussion Paper and a Feedback statement –2006 thematic stress testing project…leading to Dear CEO letter –BoE / FSA workshops on stress-testing in 2007 –Financial Risk Outlook 2009

6. Industry and international work Industry –Institute of International Finance, July 2008 –Counterparty Risk Management Policy Group III, August 2008 International –Senior Supervisors Group, March 2008 –Basel Committee on Banking Supervision, January 2009

7. Policy proposals in CP 08/24 Reverse-stress testing Capital planning stress Other S&S testing policy clarifications

8. Reverse-stress testing Firms consider scenarios most likely to cause business model to become unviable Increased awareness of vulnerabilities should improve firms’: –Strategic decision-making; –Contingency planning; and –Risk-management arrangements. Not a ‘zero-failure’ policy

9. Scope of reverse-stress testing Applies to Banks, Building Societies, CRD investment firms and insurers BIPRU 50K firms with less than £1bn FUM carved out

10. Capital planning stress Also known as: –1 in 25 stress test –‘Through the cycle’ stress test More comprehensive assessment of material risks and planned mitigating actions: –Combinations of risk –Correlations in times of stress –Impact and feasibility of management actions –1 in 25 economic recession scenario – capital held now to meet stress scenario for BIPRU firms

11. Other S&S testing policy clarifications Pension obligation risk IRB quantification Group risk Market risk Interest rate risk in the banking book Securitisation risk

12. Next steps Continued industry engagement during consultation period High-level industry group Policy Statement – Q3 2009 Policy implementation This presentation is the property of FSA. It may only be downloaded for personal or individual use. It may not be disseminated or otherwise reproduced without the prior consent of the FSA.

13. Stress and Scenario Testing: CP08/24 ISDA/PRMIA presentation, 10 February 2009 Rory Vaughan Wholesale and Prudential Policy Division Financial Services Authority