UK regulator provides further insight on AMA use test

Regulators are continuing to hammer home their expectations surrounding the use test for the advanced measurement approach (AMA) for operational risk under Basel II. The UK Financial Services Authority has been a particular proponent of the test and it forms a key part in its AMA approval process.

Andrew Sheen, manager of operational risk policy at the UK regulator, provided further insight into the FSA's expectations during a recent presentation a conference in Rome on June 12 and 13. He said: "Firms often experience difficulties in determining whether they meet the use test as they fail to develop a robust structure against which they might measure their performance and effectiveness."

Sheen proposed that AMA firms could assess the way in which they have integrated their op risk measurement system using three components: the model inputs; the model outputs; and the various linkages connecting these elements, including governance, management reporting and risk tolerance. This approach can be easily adapted by firms using one of the simpler methodologies. Sheen added: "Even in instances where firms have succeeded in specifying the extent of the challenge, many have failed to fully judge how successful they have been. In some cases the assessment has been completed by the operational risk function itself, and it might be possible that sometimes the area is insufficiently independent to evaluate the true position."

In the FSA's view, compliance with the use test should be considered an ongoing requirement and one that firms will need to review and assess on a regular basis, particularly in view of changes to a number of variables including personnel, structure, products, processes and systems. As the firm strives to meet the use test by supporting and enhancing the management of operational risk within the organisation, it will need to be constantly revising its assessment of the way in which the operational risk framework is integrated into its day-today risk management process to keep pace with this evolution. Tony De Quintal, senior associate for operational risk policy in the FSA's wholesale and institutional markets division, said: "Firms with a dynamic, continually evolving framework, will be better placed for use test discussions with their regulator."