This comes up when a trading unit is about to start dealing in a new product or market and the institution checks, before launch, that it can measure and manage the risk.
What a new-product review is for
A new-product review exists to check, before the institution starts to deal in a new product, that it has the arrangements to measure, monitor and manage the product's risk. The US Federal Reserve Board's examination manual (Section 2000.1, February 1998) says that, in general, a bank should not trade a product until a condition is met. The condition is that senior management and the relevant personnel in risk management, internal control, legal, accounting and audit understand the product and can build it into the institution's risk measurement and control systems1. Examiners check whether the institution has a formal process for reviewing new products1.
The Basel Committee on Banking Supervision's "Principles for enhancing corporate governance" (October 2010) says that a bank should have a new-product approval process2. These principles were superseded by the Committee's corporate governance principles for banks of July 20153.
What is reviewed as a new product
The review is not limited to new products. The Basel Committee on Banking Supervision's 2010 principles say that the risks assessed in the approval process should cover not only those of new products but also those of significant changes to existing products, the creation of a new business line and entry into a new market2.
In the legal section of the examination manual (September 2002), the covered products include products offered for the first time in a new jurisdiction and products offered to a new type of counterparty. An example of the latter is offering a product designed for institutional investors to retail clients. Existing products that have been significantly modified are also covered4. The definition of a new product should fit the size, complexity and sophistication of the institution, and even a small change to a condition such as a payment formula is a reason to treat the product as new if it changes the nature of the risk significantly4.
The overview section of the examination manual (February 1998) points out that institutions that are active in derivatives create many new products that are variants of existing ones. For option products in particular, it says that a significant change in structure should go through some form of new-product review even if the institution already deals in similar products5.
Flow from review to the check after launch
If the items that the sources ask for are put in order, the flow is review and approval, launch, and a check after launch.
Figure description
This figure shows the flow from the review before a new product is launched to the check after launch. After the review, the decision is to approve or to postpone until the arrangements are ready, and the approval is recorded before launch. After launch, risk and performance are compared with expectations and the risk management treatment is adjusted. The sources do not set a fixed form for the review procedure.
The business units affected by the product take part in the review and approval. The examination manual says that a new-product policy should require review and approval by all affected business units (February 1998). The units are, for example, risk management, credit administration, trading, accounting, regulatory reporting, back office, audit, compliance and legal6. The approval should be supported by a record of approval (an audit trail) before the new product is introduced6.
If the arrangements are not in place, the launch is postponed. The Basel Committee's 2010 principles say that, when adequate risk management processes are not yet in place, the offering of a new product should be postponed until the systems and risk management needed to support the related activity are ready2.
The sources also address how the product is launched. In the examination manual, examiners check whether new products are introduced in a manner that adequately limits potential losses1.
What the review checks
The review checks the following, area by area. Only items that the sources list are included. The sources do not set how the areas are divided or which units take part for each area.
| Area | What the sources list |
|---|---|
| Risk management (assessment input) | The risk management function feeds into the review a full and frank assessment of risk under various scenarios2 |
| Risk management (capacity) | The same function also feeds in an assessment of whether the risk management and internal control functions can manage the related risks2 |
| Risk management (measurement tools) | Whether the current risk measurement and monitoring tools can quantify and monitor the range of related exposures7 |
| Valuation methods | When there is no model that reasonably reproduces market prices, the risk management, control and audit units are responsible for developing an appropriate valuation method7 |
| Systems | Software is tested in the institution's in-house development process before it is used in actual business, and is verified and approved by the relevant functional units7 |
| Legal (participation) | Whether legal counsel (in-house or external) takes part in the review4 |
| Legal (authority and restrictions) | Whether the institution has the authority to trade or sell in every relevant jurisdiction, and what restrictions apply4 |
| Legal (agreements) | Whether the review covers the types of agreements that document the trades and changes to standard documentation4 |
| Operating procedures (coverage) | Whether the policy and procedures documents cover the whole of back office operations (from the manual's questionnaire, February 1998)8 |
| Operating procedures (updates) | Whether they are updated in a timely manner when a new product is introduced or an existing product is changed8 |
| Accounting, regulatory reporting, back office, compliance, audit and credit administration | These units are listed among those that take part in review and approval. What each should check is not stated in the same passage6 |
After launch, and the risk management framework
Checks continue after launch. The Basel Committee's 2010 principles say that a bank should have a process to assess risk and performance against the initial expectations and to adjust the risk management treatment as the business matures2.
New exposures are brought into the current risk management framework. The duties that management and the board give to risk management include identifying and assessing risk, and setting policies, procedures and limits, as well as developing guidelines for new products and bringing new exposures into the current framework (February 1998)11. The types of limits and the procedures for breaches are covered in Limit Frameworks. Whether the market risk management unit takes part in discussions of new products is also a point that examiners check12.
What is not set, and what is not covered
The sources do not fix how roles are divided among the units that take part in the review, who has approval authority, or exactly what counts as a new product. How to think about who carries out the review is covered in The Three Lines Model.
The contents of individual products, the sales procedure for clients, the choice of the entity that books a trade and the system architecture are not covered on this page.
Notes
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2000.1 "Overview of Risk Management in Trading Activities" (February 1998), page 2. PDF page 40. ↩ ↩2 ↩3
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Basel Committee on Banking Supervision, "Principles for enhancing corporate governance" (October 2010; the Japanese provisional translation by the Financial Services Agency is linked in the sources, in Japanese), paragraph 88 (printed page 31 of the translation, PDF page 33). ↩ ↩2 ↩3 ↩4 ↩5 ↩6
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Basel Committee on Banking Supervision, press release on the revision of the corporate governance principles for banks (July 8, 2015; the Japanese provisional translation by the Financial Services Agency is linked in the sources, in Japanese), second paragraph. ↩
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2070.1 "Legal Risk" (September 2002), page 7, "New-Product Approval". PDF page 137. ↩ ↩2 ↩3 ↩4 ↩5
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2000.1 (February 1998), page 2. PDF page 40. ↩
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2000.1 (February 1998), page 6, the item "Every organization should have a new-product policy". PDF page 44. ↩ ↩2 ↩3
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2040.1 "Operations and Systems Risk (Management Information Systems)" (April 2003), page 3, "NEW PRODUCTS". PDF page 94. ↩ ↩2 ↩3
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2060.4 "Internal Control Questionnaire" (February 1998), questions 5 and 6 under "Policies and Procedures" (page 1). PDF page 126. ↩ ↩2
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Financial Services Agency, "主要行等向けの総合的な監督指針" (Comprehensive Guidelines for Supervision of Major Banks, etc.) (October 2026), III-3-7-1-2 (3) ③ (printed page 263, PDF page 279) (in Japanese). ↩
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2040.4 "Internal Control Questionnaire" (February 1998), question 3 (page 1). PDF page 99. ↩
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2000.1 (February 1998), page 2. PDF page 40. ↩
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Board of Governors of the Federal Reserve System, "Trading and Capital-Markets Activities Manual", Section 2010.3 "Examination Procedures" (February 1998; market risk), step 1 c (page 1). PDF page 53. ↩