FRTB implementation: How are market participants preparing?
As many global regions look to January 2025 for their FRTB implementation, firms are preparing for what is widely seen as a seismic change to the way they evaluate and measure market risk. With most regulators requiring reporting or parallel run before the final implementation dates, FRTB can no longer remain on the backburner.
While market volatility caused by the pandemic and geopolitical risks create operational risks, key FRTB implementation challenges remain in place:
- fine-tuning Standardized Approach (SA) and Internal Models Approach (IMA) pathways,
- dealing with regulatory timeline uncertainty,
- upgrading data constructs and analytics to run the requisite risk calculations,
- implementing FRTB across the global footprint,
- ensuring front and back-office alignment, and
- sourcing reliable data from third-parties for risk modelling, taxonomies, and more.
Every bank has different operational needs, and it’s important that each FRTB implementation programme reflects the needs and set-up of each individual bank.
At a recent Bloomberg FRTB Summit, industry experts discussed the remaining challenges both regionally and globally around the implementation of FRTB, alongside potential solutions.
Regulatory uncertainty
Despite the long drafting process between authorities and markets over the final rule specifications, a high degree of uncertainty still lingers around the FRTB implementation dates. Both the UK’s consultation on the Basel III.1 package and the US’s NPR (Notice of Proposed Rulemaking) which will include final rules for FRTB, are due later this year. Certainty around FRTB implementation can only be achieved once those documents are released.
While the EU’s draft Capital Requirements Regulation (CRR) calls for a 1st January 2025 implementation date, the language within suggests a degree of flexibility, depending on actions taken by other jurisdictions, particularly the US and the UK. “It’s not really in anyone’s interest to implement these rules materially ahead of other jurisdictions,” said David Phillips, Senior Manager at PRA, Bank of England, during Bloomberg’s Summit.
Since both banks and regulators tend to work back from the final implementation date to chart a course for intermediate steps, timeline uncertainty makes implementation programmes trickier to manage – it also makes it harder to keep all the important pieces streamlined and organized.
In addition, jurisdiction-level technical deviations from the Basel requirements may also provide additional challenges for firms that need to implement their global footprint.
SA or IMA approach?
The question of whether a bank should use SA or IMA is still very much in play.
The highly prescriptive reporting requirements for SA are more complex than they first appear. To ensure compliance in a strategic, streamlined manner, many large banks have expended significantly more effort than initially anticipated. Still, there are gaps to fill. For example, a large bank may run SA on a monthly basis, but a detailed level of oversight is still required for when FRTB dictates the binding capital constraints.
“We still need to build a more robust ecosystem around the operating model, controls, and analytics to ensure the right level of oversight for our reports and calculations,” said Bevan Cowie, Head of Market, Liquidity, Valuation and Model Risk Management at Deutsche Bank, during the summit. While some large banks have now implemented SA for their European operations, their next step is to implement their global footprint, which carries a different set of risks and challenges.
IMA brings its own set of challenges as banks not only need to get approvals from the regulator at the individual desk level, but there are also several requirements around the implementation itself. First, the volume, accuracy, and timeliness of data for booking trades that look through to the relevant component need to have a sufficiently clean lineage and a dynamic framework. Second, firms need perfect alignment between the front office and risk management. Third, firms need to have sufficient computational power, especially for the newly required expected shortfall and diversified and undiversified components.
“FRTB has real consequences in terms of failing the model performance tests and the dynamic interplay between model performance, stressed capital add-ons (SES), non-modellable risk factors (NMRF) and capitalization,” said Amol Tandon, Head of FRTB and Market Risk Governance & Regulatory Solutions at J.P. Morgan. “Therefore, it is key that these processes run in a seamless manner.”
Risk factor management
NMRF brings its own set of challenges, especially in terms of the prescriptive eligibility tests used to determine modellable risk factors. Indeed, NMRF represents a wholesale change to the way firms manage risk today. Sticking with expected shortfall and removing risk factors dynamically – depending on whether they pass or fail the eligibility tests – can lead to issues such as hedge breakages in the expected shortfall models, where one side of the trade passes but the other does not. Once these risk factors become NMRF, the overall capitalization is less economic than it would have been under expected shortfall.
All these challenges point to the underlying importance of the data construct. A successful IMA entails maximizing the number of modellable risk factors so that they can be seamlessly aligned with risk management and passing eligibility tests.
As the implementation dates draw near, firms need to calculate capital charges based on SA approach for all exposures. With approval from their respective regulator, firms will need to choose between the SA or the IMA or a hybrid IMA-SA approach for some desks, depending on which parts of their business they deem suitable for IMA. Determining their IMA scope will influence their approach to NMRF and expected shortfall, and especially how they source their data. It is important to remember that NMRF impacts some trading desks and hedging strategies more than others.
Choosing a suitable vendor partner
Whether SA or IMA, vendors have an important role to play in FRTB implementation programmes. For example, to look through indices and funds to the underlying constituents, firms need to ensure that they have the necessary data and analytics by relying on either their own internal systems or vendors. In addition, NMRF implies an especially important reliance on vendors, particularly around data.
“NMRF is not only adding the data complex for the modelling requirement, but also engaging with vendors are a consideration” said Elena Guz, FRTB Programme Manager at Morgan Stanley.
Whether firms require FRTB-ready market data, a reliable risk analytics engine, or a full end-to-end workflow, Bloomberg can customize a package to meet individual needs, with high-quality, complete, consistent and transparent data to help banks gain approval for their models and minimize add-on capital charges. We offer a complete set of analytics to measure risk and calculate capital requirements for the SA and the IMA.