A stress test simulates extreme or unfavourable, yet plausible, economic and financial conditions in order to study the consequences on both the performance of a collective investment undertaking or investment mandate and its ability to honour redemption requests, even at a discounted net asset value.
Primarily, stress tests are tools that help to analyse the strength of the strategies that have been put in place.
They provide periodic scenario analyse in order to address risks arising from potential changes in market
conditions that might adversely impact the portfolios managed.
During normal periods, the stress test identifies the weaknesses of an investment strategy and helps Solution provider to prepare themselves operationally for a crisis;
During crisis periods, the stress test helps to direct crisis management and resolution strategy.
In such a way, stress tests can serve as risk management and decision-making tools both when a fund is created and throughout its life.
The investment services provider shall establish and implement, among other things, follows: 1) risk mapping, taking account of the risks of each position of the collective investment undertaking or individual portfolio it manages, and the interaction between those individual risks; 2) relevant risk indicators and a system of risk limits that is consistent with the risk profile of the collective investment undertaking or individual portfolio under its management; 3) an alert mechanism to prevent and detect any breaches of the limits, and remedial procedures in the event of any actual or anticipated breaches of the limits. It updates them regularly to ensure they are relevant and effective.
Recognizing the increasing importance of stress testing, combined with a significant range of approaches adopted by supervisory authorities and banks, the Committee decided to update the 2009 stress testing principles. The resulting set of principles is set at a high level so that they may be applicable across many banks and jurisdictions, remain relevant as stress testing practices evolve over time, and be used by jurisdictions to guide all elements of a sound stress testing framework.
Stress testing principles 1. Stress testing frameworks should have clearly articulated and formally adopted objectives
2. Stress testing frameworks should include an effective governance structure
3. Stress testing should be used as a risk management tool and to inform business decisions
4. Stress testing frameworks should capture material and relevant risks and apply stresses that are sufficiently severe
5. Resources and organisational structures should be adequate to meet the objectives of the stress testing framework
6. Stress tests should be supported by accurate and sufficiently granular data and by robust IT systems
7. Models and methodologies to assess the impacts of scenarios and sensitivities should be fit for purpose
8. Stress testing models, results and frameworks should be subject to challenge and regular review
9. Stress testing practices and findings should be communicated within and across jurisdictions
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