Question
Shall a delta of 1 according to Art. 29 (6) IFR be used for the calculation of the effective notional A) if no option price model has been approved at all or B) where a model for a specific instrument type has not been approved by the competent authorities, while for models of other instrument types there is an approval?
Background on the question
In order to calculate K-TCD, the effective notional is necessary to determine the potential future exposure and exposure value. The effective notional consists, among others, of the supervisory delta. To determine the supervisory delta, Art. 29 (6) IFR states, that „The supervisory delta of options and swaptions may be calculated by the investment firm itself, using an appropriate model subject to the approval of competent authorities. The model shall estimate the rate of change of the value of the option with respect to small changes in the market value of the underlying. For transactions other than options and swaptions or where no model has been approved by the competent authorities, the delta shall be 1.” Since different option instrument types usually require different option price models to derive the delta, each instrument type model needs to be approved separately. This leads to two possible interpretations of Art. 29 (6) IFR: A delta of 1 has to be used when no option price model at all has been approved by competent authorities. A delta of 1 has to be used where no option price model for a specific instrument type has been approved by competent authorities. Interpretation A would induce the question how to handle the situation where some models have been approved while others are not, i.e. what delta to use for the models not approved (or prohibit their use altogether).
Answer
This question has been rejected because the issue it deals with is already explained or addressed in the regulatory framework. In particular, please see Article 29(6) of Regulation (EU) 2019/2033 (IFR).For further information on the purpose of this tool and on how to submit questions, please see “Additional background and guidance for asking questions”.