February 25, 2022
Provisional model approvals would be granted for urgent business purposes or in other words, emergency situations to address unaccounted for elements in the current-use model. The provisional model approval is granted for 6 months, in which time the official MRM validation process should take place.
The proposed rule change clearly states the reason for extension, up to 1 year total of provisional model use, is in the clearing agencies delay in finalizing the model itself rather than the MRM validation process. NSCC deflects this delay onto third-party developers of the model, however the responsibility of the model falls under NSCC. It would be reasonable to assume that a provisional model implemented under an emergency situation would take high priority in finalization. It does not appear reasonable that a party implementing an emergency use protocol would in turn have such a significant delay in finalizing said protocol.
Since circumstances may arise and cause delay in NSCC producing a finalized model for MRM validation (note, this should not be indicated as delay in MRM validation (itself), as stated in the proposed rule change), it is logical to include provisions for immediate-model-use under emergency conditions, in which a timeframe is established for official MRM validation and the integrity of the model is maintained under provisional use conditions.
In order to mitigate concerns with prolonged provisional model use and to maintain the risk-protection intent of the model during provisional model use, the rule should include running the current MRM-validated model in parallel with the provisional use model, during the provisional use period. The model which renders the greatest risk indicators should be used as the basis for risk mitigation action during the provisional use period. The comparison of the risk indicators of the current MRM-validated model and the provisional use model should be used in the analysis for MRM validation and final approval.
The definition of risk, to include the differentiation of greatest risk between model outputs, must be considered. Credit risk, liquidity risk, and margin risk are all listed as risk categories evaluated in a model. The categories are interrelated to an extent, and can have a greater correlation depending on the particular market conditions. Generally, credit risk and margin risk should be mitigated by the indicator showing the higher requirement of credit and margin funds. Liquidity risk overlaps the credit and margin risk categories. Liquidity is important for the fluid operation of the markets, however reduced liquidity should not be considered a risk such that actions are taken in which credit and/or margin risks are increased as a result. Said actions would mean a reduction in capital requirements, as required based on credit exposure or margin requirements, to increase liquidity (reduce liquidity risk). There are ways in improve liquidity that are easily foreseen by market participants, which do not include creating greater market risk. Liquidity risk should never be reduced in exchange for increased credit or margin risks.
Overall, the risk to be considered is the risk a partys actions imposes on the greater market. Other risks are mentioned in the framework such as operational, general business, and investments risks. While these are all risks for an individual party to consider to be successful and/or profitable in their operation, self preservation or any derivation thereof should not be considered a factor above wholistic market risk. If self preservation of an entity itself becomes a wholistic market risk, then the checks and balances of the SRO have failed, in which the SRO is responsible for the outcome.