Forming FRTB action plans: Tactical vs. Transformational

The formal phase of consultations between banks and regulators on FRTB has ended, and the biggest change to market risk capital requirements in over a decade has been finalized. Now banks are in a race against the regulatory deadline, and must choose the most efficient path to overhaul their risk management infrastructure and adapt their business strategies.

Over 100 banks worldwide were surveyed and interviewed by Chartis; many are uncertain that current efforts to meet these challenges are enough. 35% of banks surveyed believe that FRTB will have a high transformational impact on operations and will significantly increase regulatory capital. 90% of these firms expect to further increase resources in 2017. Yet over 50% of the respondents surveyed do not know if their bank will meet the January 2019 deadline.

The Fundamental Review of Trading Book (FRTB) defines new minimum capital requirements and behaviors for market risk management. The controversial reforms, released by the Bank for International Settlements (BIS), were finalized in January of this year.

FRTB has faced heavy resistance from the banking industry, which had repeatedly confronted regulators with results from Quantitative Impact Studies that showed the severity of higher capital requirements on their trading books. In response, regulators adjusted calculations in the final rules of FRTB to partially lighten the capital burden. Uncertainty remains on how banks interpret these rules, which continues to attract lobbying from the banking industry.
There is a consensus that adhering to the new methodologies will require a costly and time-consuming overhaul of the risk systems at many banks, however, there is not much time for banks to implement. The FRTB reforms impact every bank with a trading book, which according to the new definition is virtually every bank.

Chartis’s 2016 survey has identified the following key FRTB challenges, namely:

  • Implementing P&L attribution as a desk level performance metric.
  • Managing the increased volume of model outputs arising from both the internal model and revised standardized calculations.
  • Tracking and managing trading desk-level model approval and testing.
  • Sourcing data for ‘non-modelable’ risk factors.
  • Defining trading desks for the purposes of FRTB.
  • Delivering the sensitivities-based approach.
  • Calibrating correlations in the incremental default risk charge to price data.
  • Handling the massive increase in computation needed to run Expected Shortfall calculations with variable liquidity horizons. Full revaluation could be particularly demanding.
  • Back-testing Expected Shortfall.

Banks are looking for the most efficient path to meeting FRTB requirements, with the largest banks allocating large budgets and resources to focus on sizing alternatives for transforming their existing risk management infrastructure. The alternative models being explored can be characterized in three different ways:

  1. Adopt new reporting, strain existing systems: Banks that are confident their existing risk infrastructure is equipped to handle the incremental volume and variety of data and risk analytics under FRTB, and see the only gap is how to effectively aggregate these in demonstrating new behavior and presenting new reporting on FRTB to regulators.
  2. Adopt new reporting, and extend risk data management: Banks that have identified bottlenecks in their existing risk data management and market risk infrastructures and need to add ‘point’ solutions to improve overall system performance.
  3. Rethink the entire risk infrastructure: Banks that see FRTB and other new regulatory and operational demands as the catalyst to question their current risk and data infrastructure. This approach involves a phased implementation of infrastructure reforms built largely upon new technologies. Adopting new reporting methods, and improving the performance of existing systems are often interim steps within a long-term transformation.

Only 15% of banks surveyed expected to implement a revised market risk framework within the next 12 months in advance of the January 1 2019 deadline, allowing time to build up relevant data to qualify for the internal model across more desks and scenario capital arbitrage and optimization.

These banks described their experiences and the ‘lessons learned’, examples of which are summarized below:

  • Conduct comprehensive impact analyses as early as possible to identify business line impact and gaps in existing infrastructure to highlight the volume of work to be undertaken.
  • Frame data aggregation and reporting as a competitive advantage as most banks were already investing in BCBS 239.
  • Several respondents have been able to broaden on-going projects to leverage these systems to support FRTB’s risk data and analytics requirements.
  • Identify technological obsolescence and leverage existing assets where appropriate.

This report, in collaboration with IBM, examines what banks are doing to achieve FRTB compliance and shares examples of best practice from banks who are leading the way. It looks at the operational impacts of implementing new measures and new technologies, and the expected impact on regulatory capital requirements.