By Shannon Harris, Senior Research Executive, CeFPro.
The fundamental review of the trading book (FRTB) has historically been a challenge for the financial industry. The proposal sets out to largely overhaul industry practices and set new guidelines. However the path to implementation has thus far been uncertain. The FRTB project has experienced several delays and set-backs, as a result the final implementation date is currently scheduled for 2022. By the end of this year we should receive the vitally important final standard from the Basel Committee. This will hopefully provide more clarity and carve out a clear path towards implementation. In the calm before the storm the industry has the opportunity to ready itself and prepare for upcoming changes. Therefore this phase of planning is exceptionally important as many industry professionals plan for the journey ahead.
In preparation for this The Center for Financial Professionals conducted extensive primary research into the top opportunities and challenges surrounding FRTB. Conducting interviews with over 80 market risk and FRTB, professionals highlighted the most critical areas of focus over the coming six to twelve months. This also provided a glimpse into multiple financial institutions and how they are preparing for implementation. Below are the top three areas highlighted from our research…
Final Basel release
As mentioned the industry is highly anticipating the final standard being released by the Basel Committee which is expected to be made public by the end of the year. Arguably this will be the last document from the Committee, hopefully this should create a roadmap towards implementation. However research suggested there are some large concerns over what is expected in the final version. Of course a majority of the industry is hoping for increased clarity and detail on the standard, but will this meet up to expectation? We asked multiple industry professionals their thoughts around this topic, below are just some of the comments;
“The next biggest topic is the finalisation of the standard by Basel, they re-opened the FRTB standard and some pieces are in consultation mode. So pieces are clear but there is one big open factor around NMRF. And I think we are anxiously awaiting the final Basel standard to start working out what that means for our capital.”
“The final standard is still a topic which is a cause for concern, and we are waiting like a lot of banks to see if Basel make any material changes. It could cost us a lot if they decide to change a lot of things that we have already built out.”
“Of course we have experienced delays in the past, so what’s to say the final standard will come out by the end of December. Everyone is gearing up for the final piece but we could be waiting until February or March to get it.”
In addition it became very clear early on that one of the largest areas of concern surrounding the final Basel standard was non modellable risk factors (NMRF). It seems that there is still a lack of clarity around what constitutes as a NMRF, and this is causing wide debate across the industry. Plus NMRF has large data requirements and several professionals raised concerns over access to data, data quality and management. Highlighted below are some of the remarks we received relating to NMRF;
“In most of the discussion there is a strong disagreement taking place. This is around determining whether a risk factor is modellable, does it have to be capitalised as a non modellable risk factor. There is a lot of uncertainty around the test for modellability.”
“There is a huge discrepancy between what a regulator thinks the impact of the NMRF is and what the banks think the impact of NMRF is. I expect the rules will change as they will not be able to maintain the current rules and the current framework.”
“I suppose a top question; how banks are interpreting the requirement and how they plan to mitigate the impacts. Are firms using vendor data when doing NMRF calculations, it would be very interesting to get more perspective.”
“And then you have the point on data pooling, what are the industry wide initiatives? Can we use data providers, and if so which data providers are the best in the market?”
P&L attribution was also mentioned multiple times as a key area of focus over the coming six months. Of course, in the previous Basel release the P&L attribution test was overhauled to make way for new testing methods. Since then, questions have been raised over the calibrations and ability to pass the tests. Again this is an area which will hopefully be clarified in the final consultation paper. Below are a few of the comments noted down during our interviews;
“It would be good to look at what’s happened since March and the P&L attribution tests, so the question would be on how the industry has moved on and if they have found a stable implementation.”
“There has been a lot of talk around the P&L attribution tests and whether those tests are effective or too stringent. Also it would be interesting to find out whether any of the participants have done any calculations based on the new tests and can say whether it’s going to be easier or harder to pass.”
“There are still some areas of concern on P&L attribution that has completely changed from the early version, it’s a positive change but with calibrations there are some concerns. I think everyone agrees the calibration of the tests will have to change.”
In summary our research suggests that the top concerns surrounding FRTB include the final Basel release, NMRF and P&L attribution. As we await the all-important final paper to come out we can only speculate on what the final standard will look like. Hopefully with the release, areas of ambiguity within NMRF and P&L attribution will be clarified. It will be very exciting to see what the FRTB landscape will look like in January 2019 as firms begin to gear up for full and final implementation.