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FRTB: Revised Market Risk Framework

Fundamental Review of Trading Book (FRTB)

Speakers

Gurpreet Chhatwal

Kshitij Bhatia

Nageswara Sastry Ganduri

Global Head of Risk & Analytics,


CRISIL Global Research & Analytics

Director, Risk and Analytics,


CRISIL Global Research & Analytics

Director, Risk and Analytics,


CRISIL Global Research & Analytics

April 2016

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Fundamental Review of Trading Book (FRTB)


What is Fundamental Review of Trading Book (FRTB)?
Revised market risk framework by the BASEL Committee for Banking Supervision (BCBS) to
Calculate minimum capital requirements for market risk
Avoid undercapitalized trading book exposure

Plug perceived gaps and reduce regulatory arbitrage between the Trading and the Banking Books
Current Trading Book rules created after the 2008 crisis aim to raise Trading Book capital
requirements
2014

2015

2016

2017/2018

Current framework had overlapping capital charges leading to double and triple counting of risks
Challenging modeling issues such as liquidity and constraining diversification not addressed
Standard Rule calculations were non-risk sensitive and highly conservative
Timeline and Current Status
2012
FRTB
Consultation

2014

2014/2015

Hypothetical QIS III and IV on full portfolio


Portfolio QIS Banks initiating tactical
QIS II on Full
model improvements and
portfolio
Strategic Implementation
Project

2015/2016
Finalization
of rules

2016/2018
Calibration
Phase
(2-3yrs)

2019
Implementation
and Go Live

Evolution of FRTB Rules


Evolution Timeline
May 2012, BCBS 219

December 2014, BCBS 305

Trading-Evidence based boundary vs Valuation based


boundary

Internal risk transfers between the two


regulatory books

Standardized Approach - Partial risk factor approach vs


Fuller risk factor approach

Standardized Approach - development of


Sensitivity Based Approach

Internal Model Approach VaR to ES, Liquidity


horizons, capital add-ons against the risk of jumps in
liquidity premia

Internal Model Approach Simpler


method for liquidity horizons

October 2013, BCBS 265


Decision to develop trading-evidence based boundary
Standardized Approach - Decision to develop Partial Risk
Factor Approach using cash flow based method

January 2016, BCBS 352


Final rules for FRTB

Internal Model Approach additional risk assessment tool


for risk of jumps in liquidity premia

FRTB Components and Implications


Component

Trading & Banking


Book Boundaries

Standardized
Approach to
Market Risk

Description

Implications

Boundaries across the books are


now regulated

Documentation on instruments classification

Clear guidance on instruments

Transfer of instruments between books


subject to regulators approval

Clear listing of presumptions

Removal of capital arbitrage across books

Credible, risk-sensitive fall back to


IMA for:
Smaller Financial Institutions
Desks not approved for IMA

Internal Model
Approach (IMA) to
Market Risk

IMA use is conditional upon


approval by the banks
supervisory authority on a deskby-desk basis

Back-testing and
P&L Attributions

Specific tests to allow


capitalization through IMA on a
desk-by-desk basis

Risk sensitivities as key inputs


Implementation required by all banks

Regular reporting regardless of IMA

Stringent approval process at desk level


ES, liquidity horizons and further prescription
of models
Yearly validation and stress tests
IMA approval contingent on successful backtesting and P&L attribution tests

Yearly P&L and back-testing tests


Quality and reliable data to be ensured

FRTB Standardized Approach


The Standardized Approach to Capital Requirement

Risk Sensitivities Based


Charge

The Default Risk Charge


(Jump to Default)

Securitised
Linear Risk
Charge
(Delta +
Vega)

Non-linear
Risk Charge
(Curvature)

Correlated
Trading
Portfolio
(CTP)

The Residual Add-on


(Notional Method)

Non
Securitised
Exotic
Underlying's

Residual
Risks

Non-CTP

FRTB Internal Model Approach


The Internal Model Approach to Capital Requirement

Market Risk
(Expected Short Fall based)

Default Risk Charge


(Value at Risk based)

Qualitative
Standards
Control
Structure
Back-testing

Stressed Capital Add-on

Initial Monitoring
and Live testing by
supervisors

Stress
Testing

PnL
Attribution

Model Validation

External validation

Implementation Challenges Standardized Approach


Key Challenge: Data and calculation intensive risk sensitivities aggregation
DRC

SBA
Identification of risk factors
for risk classes

Defining DRC sub-bucket


criteria

Risk factor definition

DATA
Data
MANAGEMENT

Maintaining consistency
across desks and
jurisdictions

Add-On
Identification of
instruments with
exotics and other
residual risks

Developing meta data infrastructure

Model
&&
MODELS
CALCULATIONS
Calculation

REPORTING
Reporting

Managing risk data


aggregation

Model development for SA DRC calculations

Increased computational
requirements

Model validation and


frequency

Incorporation of
additional charge for
exotics and non-exotic
instruments

Reporting framework for aggregated capital charge across all desks (irrespective of IMA use)
Governance structure

Implementation Challenges Internal Model Approach


Key Challenge: Intensive nature of calculation of VaR and ES for IMA
DRC

Expected Shortfall
Risk factor classification
(MRFs Vs. NMRFs)

DATA
MANAGEMENT

Liquidity horizons mapping

DRC data integrity to


account for stressed data
period

Sourcing and validation of


historical market data

SES Add-On
Hypothetical PL Full
revaluation
Risk-based PL
Hypothetical Vs. Riskbased database

Developing meta data infrastructure


Historical simulations

MODELS &
CALCULATIONS

Enhancing VaR and SVaR


models to generate ES and
Scaled ES
Model enhancement to
account for revised/scaled
liquidity horizons

Model development for IMA


DRC calculations
DRC validation using stress
tests, sensitivity and
scenario analysis

Historical simulation
based on full revaluation
method

Exception monitoring framework

Reporting
REPORTING

Fall back process for IMA desks, breaching prescribed limit


Reporting framework for disclosure to regulators
Governance and monitoring

A Typical Implementation Charter


A Robust Change Management Plan and Implementation
Stage III
Execution
Target state definition, design and
Implementation

Stage II
Assessment
Stage I
Definition and Planning
Identification of all stakeholders who
would be part of the implementation
charter

Organize workshops and trainings for


all involved parties/employees
Objectives, scope, responsibilities
and approach are defined and
sensitized

Iterative assessment and review of


MR components in light of FRTB
guidelines
Book boundaries, model and data
infrastructure, risk factor
modellability, P&L attribution,
backtesting and reporting
Different analyses Gap analysis,
Impact analysis, Deep dive analysis
Preparation of BRDs and FSDs

Data Models - A robust risk data


infrastructure aligned with pricing
framework, expected shortfall
implementation and risk factor
modellability framework
Desk level Model Risk Management
and performance monitoring
Infrastructure

P&L Attribution and Backtesting


Desk level threshold monitoring
Reporting Model assumptions,
threshold breaches, intra-day desk
level reporting
Desk re-organization or re-alignment

Tactical initiatives towards exploring


technological and operational
innovations

Prepare an agile based modular


approach

10

Assessment Approaches
Approach 1

Implement final rules on different sets of hypothetical/real portfolios


Revised SBA, IMA, P&L attribution, back testing and reporting
Test under different scenarios and portfolio complexities
Linear, non-linear, illiquid
Impact on and assessment of the usability of current processes
Objective: To assess and understand intricacies and effort involved in final implementation at firm-wide
level
Pros: Bottom-up strategy gives a better grip on the rules and processes
Cons: Cannot provide a barometer to understand final efforts that are required in implementation

Approach 2

Implement final rules on a select few desks and scale them up slowly to larger set
Objective: To run eligibility rules, identify failings and strategize on filling the gaps
Pros: Current scenario and gap assessment at desk-level
Cons: Can become complex and tedious with every addition of a new desk to the analyses, can be
repetitive

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FRTB Where things are

Most banks are in definition and planning stage

Some have started on assessments based on tactical and prototype implementations

2016 would to be the year of assessments and SBA

Trading desk re-organizations and realignments being mooted to avoid


stressed capital add-on for non-modellable risk factors

Volcker desk structures may hurt banks in FRTB regime

European banks have had a head start when compared to their US


counterparts

Financial Technology and Operational Innovations, with an objective to


bring down capital investments

Technological innovations to absorb model and data governance overheads

Shared data platforms to largely solve the problem on NMRFs and thereby reducing
stressed capital add-on risk charge for desks

Common reporting frameworks across jurisdictions to


requirements of consistent approach across different banks

help

meet

regulators

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Summary and Way forward

Fundamental overhaul of existing market risk approach

New risk metrics, processes, governance and reporting requirements will change the
way banks trade

Requirement of robust models and process for avoiding large increase in


capital charge

Way forward

Keep standardised approach as an embedded backup

Ensure models are built on granular data

Reorganise trading desk for capital efficiency

Optimise infrastructure

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