FRTB: laying the foundations

September 20, 2016

The final rules for the Fundamental Review of the Trading Book (FRTB) regulations were published in January and although many questions around the detail remain unknown, we do know the changes are coming and that now is the time to prepare. FRTB, part of the Basel III rules which were finally published in January 2016, will significantly transform the way banks manage their capital requirements and how they are structured and managed internally.

Risk models, liquidity horizons and data for risk calculations, back testing and hedging will all have to be changed to meet the new regulatory guidelines, with a significant component of this change impacting desk structures and their oversight, management and reporting.

The rules are not yet granular enough for banks to implement them with confidence as to their likely interpretation by local regulators. While this makes it difficult to prepare, the deadline of January 2019 is not far off and considering the massive scale of the changes, financial institutions need to do whatever they can now to ensure they are ready to make the changes as soon as the details are clarified.

Below we propose some critical steps to help during this period of uncertainty:

Step one: Understanding the scale of the changes

The implementation of FRTB will be substantial and, if you have not already done so, setting up a programme to ensure good governance and structure is critical. It is important that the FRTB team establish and maintain early communication with impacted stakeholder groups (especially Risk, Finance and Front Office) as they will be looking at potential impacts based on findings presented by the team and as well as those assessed internally. The degree to which the FRTB regulations will change these core functions should not be underestimated.

It is expected to require significant operating model changes, which will prompt substantial culture changes in the front office.

There is a degree of uncertainty around the new rules for desk definition and the need to clarify the book attribution. This is currently being worked through via the International Swaps and Derivatives Association (ISDA) panel and examples include repos for funding and liquidity purposes that should be in the banking book, but are in fact currently managed on a trading desk.

Another complication is the difference between the Volcker and FRTB desk definitions, giving rise to speculation about virtual, or “reporting desks”, versus physical desks. Such an arrangement might be acceptable under Volcker but is unlikely to be valid under FRTB where desk management, P&L attribution, strategy and remuneration – all physical things – need to be clearly and singularly associated with a desk.

Step two: Get Lean Quick

It is estimated that the costs of implementing FRTB will double, triple or quadruple the cost of doing business across the bank. To stay competitive and to ensure that you have the right mix of desks to adequately operate your business, it is important to reduce costs and align procedures and systems. Streamlining and rationalising business and IT processes, implementing automation in areas such as back testing, consolidating systems and reducing your costs per trade are all critical activities. It may be that some desks are no longer viable businesses once the changes have been made, but if you know your structure, at least you will be in a better position to make a decision of which desks should and shouldn’t remain.

Step three: Organise your Data

One of the main concerns the various regulatory programmes have raised for banks relates to the completeness and consistency of their data sourced from multiple systems.

Just like the ‘multiple trading system issue’ encountered in various trade reporting programmes, banks are about to have a ‘multiple risk system issue’.  This is not because those systems are deficient but because, as with the trading systems, they are generally single-purpose, operate in relative isolation, and as a result do not share a common data dictionary. This is exacerbated by the current granularity of the data versus the required degree of granularity (i.e. risk measured at portfolio vs transaction level) under the new regulations.

What is certain, is that risk data will need to be much more granular to provide the correct inputs to calculations with new categorisations for reporting to the regulators. With banks juggling multiple risk systems across asset classes and geographies, there will be a requirement to consolidate risk data in a central repository from which calculations and reporting can be derived. Firms that have already taken steps to create central data repositories – even for non-risk data, such as trade or client data – will be in a much better position than those who have not.

In addition to these initial three steps, firms will need to engage in industry discussions with the regulators on a range of detailed topics. One such topic is the statement made by the Basel Committee on Banking Supervision (BCBS) and the Financial Services Authority (FSA) that ‘the Standard Approach will act as a floor to the Internal Model Approach’. This effectively means that regardless of what your Internal Model calculates as the capital requirement, the minimum capital will be some percentage of the capital calculated under the Standard Model. What remains to be confirmed is the level at which the percentage will be set. The higher the floor is set as a percentage of the Standard Model calculations, the less worthwhile it will be to establish and maintain an Internal Model Approach for certain desks, given the overhead involved.

There will also need to be a much tighter integration of data between the front office and risk and finance functions to ensure consistency of P&L attribution calculations. If these fail three times in any 12-month period, the approved internal model used by the desk will be withdrawn by the regulator, immediately increasing the desk’s capital charge.

There are many other topics to watch out for within FRTB, such as multijurisdictional implementation challenges, hypothetical versus risk theoretical P&L, the move from VaR to Expected Shortfall (ES), the treatment of Non Modellable Risk Factors (NMRF), and the uncertainty around CVA calculations.

Intertwined within all of this are the ‘softer side’ HR impacts of the new guidelines, which appear not to be soft at all. The rearrangement of the trading desks and more stringent requirements for staff job descriptions aligned to those desks and their strategies and business cases will have a significant impact on a company’s organisational structure. Anything that so fundamentally impacts a person’s role, their responsibilities and authority levels, and directly links them to a reportable, regulator-approved business case and strategy is likely to cause a significant shift in where and how businesses are run post FRTB.

This has been a brief look at only some of the critical topics within FRTB. What is known is that it is coming, what is not known is how the banking world will look once all the yet-to-be confirmed regulations are finalised by local regulators.

For more information about FRTB, how it will affect your business, and what Brickendon can do to help you address these issues see our website, or contact

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