Independent Price Verification is an increasingly important process requirement to support finance and risk functions across a wide range of financial institutions. The core IPV process demands that internal prices are verified against independent third party sources.
Basel II Prudent Valuation Guidance defines Independent Price Verification as “the process by which market prices or model inputs are regularly verified for accuracy. While daily marking-to-market may be performed by dealers, verification of market prices or model inputs should be performed by a unit independent of the dealing room, at least monthly (or, depending on the nature of the market/trading activity, more frequently)”.
Significant discrepancies between the internal and independent prices above a certain threshold then trigger an investigation. It is important to note that this threshold is typically set in relation to the exposure that a firm has to a given asset (or liability). That means as part of the price verification process, firms need to collect up to date information relating to exposures (delta, vega and cash positions).
Any ensuing price investigation typically requires a controller to research circumstances that might have legitimately caused the discrepancy (for example – a distressed sale in the market causing a temporary blip in the ‘independent source’). The independent nature of price verification refers to more than just the independence of the pricing source. For example, under the EU’s Capital Requirements Regulation (CRR) it also refers to the individual in charge of the process, specifying that the verification process “shall be performed by a person or unit independent from persons or units that benefit from the trading book.”
In order to meet these requirements it is important that firms maintain strict role-based access control over the verification process, as well as process auditability and maker-checker controls to help safeguard and demonstrate compliance.