1. Institutions shall have processes in place to ensure that any internal risk-measurement models used for the purposes of this Chapter have been adequately validated by suitably qualified parties that are independent of the development process, in order to ensure that any such models are conceptually sound and adequately capture all material risks.
2. Institutions shall conduct the validation referred to in paragraph 1 in the following circumstances:
(a) when any internal risk-measurement model is initially developed and when any significant changes are made to that model;
(b) on a periodic basis, and where there have been significant structural changes in the market or changes to the composition of the portfolio which might lead to the internal risk-measurement model no longer being adequate.
3. The validation of the internal risk-measurement models of an institution shall not be limited to back-testing and P&L attribution requirements, but shall, at a minimum, include the following:
(a) tests to verify whether the assumptions made in the internal model are appropriate and do not underestimate or overestimate the risk;
(b) own internal model validation tests, including back-testing in addition to the regulatory back-testing programmes, in relation to the risks and structures of their portfolios;
(c) the use of hypothetical portfolios to ensure that the internal risk-measurement model is able to account for particular structural features that may arise, for example, material basis risks and concentration risk, or the risks associated with the use of proxies.