FRTB: Why banks must act now

By Christopher Burke | 19 December 2016

The final rules for the Fundamental Review of the Trading Book (FRTB) regulations were published in January and although details of how the regulators in each jurisdiction will implement them still remains ill-defined we 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 transform the way banks manage their capital requirements in addition to how they are structured and managed internally.

Risk models, liquidity horizons and data for risk calculations, back testing and hedging must 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 at a local level are not yet granular enough for banks to implement them with confidence. While this makes preparation difficult, the deadline of January 2020 is not far off considering the massive scale of the changes. Financial institutions need to get lean, streamline efficiencies and ultimately prepare ahead of this change. With this in mind, 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 undoubtedly incur significant costs, so if you haven’t already, 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. There is a degree of uncertainty around the new rules for desk definition and the need to clarify the P&L 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

The estimated costs of implementing FRTB will double or quadruple the cost of doing business across a bank. To stay competitive and ensure you have the right mix of desks to 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. Some desks may no longer be viable businesses once the changes have been made, but if you know your structure, at least you will be in a better position to decide which desks should or 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. Additionally, business desks will potentially need to produce up to 60 times more data than current levels for certain desks. The subsequent increased workload for regulators will be enormous. In preparation, allocating more resources and processes to interpret the data is essential.

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.

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 these are the ‘softer side’ HR impacts of the new guidelines. 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 significantly affect where and how businesses are run post-FRTB.

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

Christopher Burke, CEO, Brickendon Consulting

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