Reviewing the data and system requirements associated with NMRF and the ability to mitigate impacts

Reviewing the data and system requirements associated with NMRF and the ability to mitigate impacts

By Luca Lopez, Financial Risk Quantitative Analyst, UniCredit

Could you please tell the risk insights readers a little bit about yourself, your experience and what your current professional focus is?

As many quantitative risk managers, I’m a physicist. I got my PhD degree in Theoretical Physics with a focus on String Theory from Scuola Normale Superiore in Pisa. After that, I moved to finance, first as a market risk quantitative analyst in Intesa Sanpaolo and then to UniCredit, where I work on both market and counterparty models development. IN particular, my focus is currently on the implementation of FRTB and of the ISDA Standard Initial Margin Model.

Without giving too much away, what are some of the implications of PLA and BT?

I fear that many of the implications of the desk’s level PLA and BT are still far to be understood and can be seen only in real life. What is sure at the moment is that we (Risk and Business) will be all hit by a new cumbersome process which will make many activities (such as capital optimization, hedging strategies,…) much more difficult and less intuitive than today.

The managing of a desk under IMA or SA is in general very different, that means that a trader should be ready to promptly adjust his strategy (if he wants to mitigate RWA implications) as soon as its desk drops out of the IMA. These jumps of desk between IMA and SA also reflect in an instable firm’s capital charge from quarter to quarter whose evolution is very hard to predict.

Besides that, the impression is that the desk structure will be heavily reshaped by the necessity of passing these eligibility tests, often in an unintended way. An example is the incentive to create directional (more risky) desks that are more likely to pass PLA.

Why is stress scenario definition and SES charge a key talking point?

NMRF is at the moment the main concern of the industry given the uncertainty surrounding its impact on IMA charge that could impair the incentive for IMA. The last exercises produced by ISDA suggest that NMRF charge  is extremely high, this being due to the numbers of NMRF that result from the RFET, the scenario calibration and the aggregation formula. The scenario calibration methodology is not defined at Basel level, while in EU it is still under discussion by EBA.

The main  concerns about that are:

·         The approach proposed by EBA seems unmanageable

·         The wrong association NMRF = Risk Not in VaR, which in turn leads to the belief that NMRF time series are of too poor quality to allow for a scenario calibration based a direct approach (ie relying on the historical distribution) and needs instead some more complicated procedure.

·         The scenario is calibrated independently for each risk factor as if all of them experience their worst losses at the same time. This in practice will never materialize and leads to an extremely punitive outcome.

How can using vendor data be beneficial for FRTB implementation?

Vendor data, thanks to pooling, will allow to increase the number of modellable risk factors the banks can carve out from the SES charge leading to a consistent capital charge relief. This will of course affect  the level playing field between larger and smaller banks, the former turning to vendors while the latter most probably relying just on their own data.

How do you see FRTB landscape progressing over the next 12 months?

In the next 4/5 months nothing new is expected , banks possibly will continue to implement those parts of the reform that have been more or less stabilized (SA and IMCC). The crucial event will be the finalization and publication of the final FRTB document expected at the beginning of the next year. This will possibly clarify many aspects and shad some lights to proceed with the implementation of the other parts of the rules in 2019.  However, most of the uncertainty stays in Europe where the Trilogue should clarify a bit more the process.

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