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Dynamic risk management

Date recorded:

Proposed next steps and indicative timeline (Agenda Paper 4)

The paper provides a short overview of the challenges identified during the outreach and discussed during April 2021 meeting that are key to the viability and operability of the Dynamic Risk Management (DRM) model, a proposal of the next steps and the indicative timeline to address each of the identified challenges.

The staff intend to perform further research and analysis of key elements of the core DRM model and reach out to other stakeholders like prudential regulators or users of financial statements.

Identified challenge (and planned timing)

Assessing the interaction between risk limits and the target profile. The staff will revisit the definition of the target profile and consider incorporation of risk limits into the target profile. (Q3 2021)

Assessing the designation of a proportion of prepayable assets. If risks limits are incorporated into the target profile, changes in prepayment expectations might not result in immediate recognition of gain or loss and the benefits of the layer approach may be achieved. (Q4 2021)

Recognising changes in fair value of derivatives in other comprehensive income (OCI). Engage with prudential regulators to ensure a common understanding of the nature of the DRM reserve in OCI.  An analysis of the implications of the fair value or cash flow hedge mechanism is less significant than the challenges identified above. (Q1 2022)

It is proposed that the Board will decide on the project direction in H1 2022.

The staff was not looking for any decisions based on this paper. Instead they asked only for comments in respect of the proposed next steps and indicative timeline.

Board’s comments on the proposed next steps and indicative timeline

The Board raised the following comments/observations:

  • Risk limits and target profile—one Board member agreed with the basic assertion to explore the risk limits further due to the significance of comments raised during outreach but also offered scepticism with regard to building them into the recognition and measurement requirements. As an example, the provisioning under IAS 37 was used. The Board member commented further that it is hard to understand why different rules should be applied for DRM purposes.
  • Another Board Member suggested to the staff to work in parallel on alternatives in case that solutions to the challenges raised during the outreach cannot be found.
  • One Board member raised a question about the order of addressing the challenges, specifically whether the risk limits should be addressed after the issue of designation of a proportion of prepayable assets. At the same time, another Board Member commented that the order of responding to challenges was well thought through, clear and will bring better results.

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