FRTB

by

The FRTB will tighten Desk Management Standards, Trading/Banking book Position Transfers and Banking Book hedging

As well as upgrading the market risk capital rules the FRTB will set much higher standards over the governance, management and operation of trading desks.  Desks must be defined in detail with traders assigned to a single desk which must have a designated desk head.  As previously covered the FRTB is prescriptive about what instruments and activities should be part of the trading book and what should not.  Further moving positions from trading book to banking book will be much harder, banks need to document the reason, receive senior management and regulatory approval and then publish the fact and adjust their capital calculations  to prevent any capital benefit.

Using the trading book to hedge banking book risks will still be possible but different risks require different approaches;
1) Equity and Credit risk need an external trade that exactly matches the internal risk transfer trade.
2) Interest rate risk needs the internal risk transfer trade to be dealt by a specific desk set up for that process, this desk can then trade hedges with third parties.
3) FX and Commodity risk will only require an internal risk transfer to a standard trading desk.

Trading book risks cannot be moved to the banking book for regulatory capital purposes.

The EU published a proposal to amend the existing CRR rules to meet the new BCBS standard in November 2016.  Here is an analysis of the governance, position transfer and risk transfer provisions, comparing the existing EU rules with the BCBS standard and EU’s proposal.  As one would expect the proposal follows the BCBS standard very closely and at this stage the EU does not seem to be intending to “gold plate” or add any extra rules.

 

by

FRTB Model Approval and P&L Attribution

The FRTB has much tougher criteria a firm must meet for it to gain internal model approval to use its models to compute its market risk capital requirement.  One very significant component of the new rules are tests on the firm’s official market risk figures.  The tests use the risk figures to compute a “Theoretical P&L” at a trading desk level which then gets tested for accuracy using two statistical measures.  Daily data is tested monthly and if the firm fails either of the tests in four months out of the previous twelve months the desk in question has to use the standardised approach which could at the very least double its capital requirement.  A more detailed explanation of the tests may be found here.

by

FRTB Banking Book / Trading Book Boundary

Previously banks had considerable discretion is designating positions as “held for trading” to gain Trading Book treatment for market risk capital.  This changes under the FRTB where certain activities and products are automatically deemed trading while others are automatically deemed banking and certain products are presumed trading but firms can apply to their regulator for permission to deviate from this.  Anything not covered above is banking under the new rules.  Here’s a diagram describing the new designations.