The Fundamental Review of the Trading Book is another major piece of regulatory improvement following on from the financial crisis.  In summary it aims;

• The approval of internal models for the computation of a firm’s market risk capital requirement will become more rigorous with approval at an individual desk level.
• Value at Risk and Stressed Value at Risk will be replaced by an Expected Shortfall which gives a better measure of the size and shape of the loss tail in the distribution whereas VaR identified the 99% tail point.  Better estimation of the potential impact of market illiquidity for both Standardised Rules and Internal Models replacing the previous standard ten day exit period assumption.
• The rules on the use of the Trading Book and the Banking Book will be much more prescriptive with certain activities and products required to be in the Trading Book and others only in the Banking Book.  The operation of a trading desk within the Trading Book will be subject to much tighter control and documentation.  Transfers of positions between TB and BB which had been made to reduce capital costs will be much harder to achieve and will not result in any reduction of capital with a specific capital add-on preventing this.

BCBS want these rules to be implemented in 2019 but this is now looking difficult, particularly around the detailed rules for model compliance and P&L testing.  As one might expect the major regulatory groups have not finalised their versions of these rules.

A diagram showing how the new rules will determine what can be permitted to be trading book as the default position will be banking book for many products.

Links to the BCBS’s new Market Risk Capital requirement document, and a short summary they also published in 2016.