Timelines and introduction of FRTB with uncertainty on implementation deadline and global disparities

Timelines and introduction of FRTB with uncertainty on implementation deadline and global disparities

By Sebastien Geroult, Head of Non-Credit Stress Testing Execution, Royal Bank of Scotland and Rajiv Arora, Head of Regulatory Change, Mizuho.


Can you please tell the Risk Insights readers a little bit about yourself, your experiences and what your current professional focus is?

Sebastien: At an early age, I developed a passion for Science and it pushed me to study mathematics and computer science, leading to a doctorate. With a PhD in Science and living in London, the financial industry has acted like a magnet on my career path. I started out my career on the trading desk (Structured Credit) at a European investment bank.  Later, I moved to a portfolio management unit; it was very interesting to manage portfolios with a market perspective but also to have the ability to service distressed assets: a very unique experience.

In 2012, I joined the Royal Bank of Scotland Plc as a senior manager in the Group Risk.., Specifically, my mandate involved working with a team that applied oversight for world-wide traded risk activities and to provide monthly reports to the Board Risk Committee. In 2015, I was appointed Head of Stress Testing Execution – Non Credit to run regulatory stress testing activities related to Risk Capital (e.g. BoE/PRA, EBA and ICAAP stress tests).

Currently, my focus has shifted towards the impact of new regulations (FRTB, BCBS 239, IFRS9) with a capital perspective and the development of advanced analytics and platforms to implement them.

Rajiv: I have over 25 years of investment banking experience managing risk, regulatory and technology transformation programmes.  Successfully delivered large change programmes building strong relationships with stakeholders while developing, managing and leading high impact teams across geographies. I have worked on Basel III regulatory framework for capital adequacy, stress testing and liquidity risk including the upcoming regulations for FRTB, SA-CCR, NSFR etc.  More recently, I have been working on Brexit planning to transition the regulatory reporting model across geographies.

How is uncertainty impacting FRTB implementation?

Sebastien: FRTB implementation is not a simple undertaking and the associated uncertainty is real and with potential turmoil. In December 2017, the Basel Committee announced it would consult on revisions to the FRTB with a first consultation on amendments to the framework published on 22 March 2018. This has changed deadlines for jurisdictions to implement FRTB and a revised date was set at 1 January 2022which has led to a knock-on impact on the ECB and EU legislators i.e.ECB has already postponed the deadline by when banks must submit their IMA models for regulatory approval under FRTB market risk framework.

Overall, Market participants face an impact around internal delivery planning and preparation creating more uncertainty. It remains difficult to plan without wasting resource and budget in this uncertain environment. However, awaiting further clarity can be hazardous, as it could put pressure on delivery timelines to be fully compliant.

How are global disparities impacting FRTB implementation?

Rajiv: There are various factors that are delaying the implementation of the FRTB standard which will impact the orderly implementation of the proposed FRTB standard.

Basel committee have extended the FRTB implementation date to 1 January 2022.  They have also issued a consultation paper with a number of revisions that will help reduce the overall capital requirements and align better with the Committee’s expectation.  The revised capital requirement is also expected to provide a more credible floor for the internal model approach.

While the Committee is recalibrating the standard, various jurisdictions are also dragging their feet on adoption.  The US are yet to publish the draft regulation and other jurisdictions such as Japan, China, India etc. have also followed their lead in not taking the first step to publish the draft regulation.   Although European Union has published the regulation, it is under consideration with the legislator.

All these developments will result in a delay in Basel Committee realising their objective of standardising capital treatment for the trading book.

At the Risk EMEA 2018 Summit, you will be speaking on your insight regarding ‘Timelines and introduction of FRTB with uncertainty on implementation deadline and global disparities’. Why is this a key concern right now? And what are the essential things to remember?

Sebastien: In its current form, several important aspects of FRTB remain unclear and some key areas are still subject to debate, including:  P&L Attribution testing, Non Modelable Risk Factors and the boundary between the trading and banking books. This uncertainty creates grey areas in the requirement and subsequently in the implementation deadline and execution timelines.  The positive aspect to remember is the presence of opportunity for the industry to discuss and influence during the consultation period prior to final approval of this regulation.

Rajiv: Delays in publishing the regulation, consultations for revising the framework to align with expected timelines, capital requirements and dis-agreements on applicable capital floors, Non-modelable risk framework, P/L attribution requirements for internal model implementation across the globe will lead to confusion across jurisdictions in adopting the standard.

This will further delay in realising Basel Committee’s objective to address a number of structural shortcomings in the Basel 2.5 market risk framework and working within a common global regulatory standard in response to the global financial crisis.

Why might there be variations of FRTB implementation across Europe?

Sebastien: Some aspects of FRTB are subject to interpretation and it is difficult to find a consensus in the financial industry. In the absence of guidance, the interpretation might not be clearly defined before its implementation at a national level. For example, last year we experienced a difference of interpretation in the provision of NMRF requiring  “clear and apparent relationship” between an observable price and the risk factors being derived from it. It could have been clarified with RTS issued by EBA but in this case the EBA does not have the ability to publish an RTS for Non Modelable Risk Factors (NMRF). In the absence of clarity in the CRR II draft, a clear interpretation will only be available after implementation at a national level. This is typically the case which does not help when you have to plan the delivery of this new Market Risk Capital Framework.

More recently, in December 2017 parliamentary rapporteur Peter Simon published a series of amendments on the FRTB draft (e.g. PLA test so that a failure would not lead to an automatic loss of internal model). This specific amendment could lead to differences in the approval of IMA models across Europe and would make internal model approval dependent on the discretion of each national regulator. Such issues would create variations of FRTB across Europe.  It is a paradox knowing FRTB was designed to create consistency and harmony across the industry.

What are the key considerations on varying stakeholders views and interpretations?

Rajiv: The key issue is the level of capital that is likely to be required based on current specifications.   The likely increase in capital requirements with some of the prescriptive requirements for trading book boundaries is forcing prolonged periods of consultation and business planning cycles.

What are some of the key concerns when adapting back end systems?

Sebastien: FRTB requires significant implementation and operational efforts when adapting back end systems. They are influenced by several aspects, among them: data, speed, elasticity & scale, reduced cost and capabilities.  For example, FRTB presents a significant number of Expected Shortfall calculations and it will lead to an increase in computation time but also aggregation time. A proper assessment of hardware and high speed/scalable computation technologies will help to size the need and reduce concerns. One key concern remains data management and it becomes a crucial point due to the importance of maintaining consistence and standardized data.  Unapproved data sources can be a delicate matter as it could result in regulatory sanctions. Proper governance and controls in the back end system has to be considered to avoid such a scenario. The traceability will have to be considered too, especially when used for capital requirement calculations and this will have to be taken into consideration when adapting back end systems.

A positive aspect balancing these concerns is the fact that FRTB is not the only regulation impacting back end systems. For example, BCBS239 requires data cleansing and lineage documentation and this can be leveraged when adapting back end systems. The potential overlap with regulatory and other programs should be taken in consideration to identify potential synergies.

How do you see risk and regulatory landscape evolving over the next 6-12 months?

Sebastien: Over the next 12 months FRTB and CRR II could be the centre of attention and focus but not only at European level. The current US administration did not show much enthusiasm to implement quickly FRTB as the US transposition had not even started. They view capital and liquidity impacts as a cause of concern and it might create some disparities in the implementation of FRTB in the US. However the Basel Committee proposal to delay FRTB to 2022 will provide more time and opportunity to re-assess PLA and NRMF, knowing all the issues.

The question of Brexit remains a concern and the transition period agreed by the EU and UK will help to smooth the process. However, it will not prevent firms from implementing contingency plans in the event of potential failure of negotiations. Firms with legal entities on both sides of the channel will face significant challenges, especially if UK and EU do not reach a political deal. In this worst-case scenario, regulators might play a pivotal role to ensure certainty and stability. We have to be cognizant there is still a lot of moving parts with potential knock on impacts and creating an environment which is difficult to navigate.

Rajiv: We expect that the more immediate issues, in the next 6 to 12 months, for banks/institutions will be Brexit in Europe.  While the wider economy is more likely to be impacted by the “war of trade tariffs”, since the proposed implementation date FRTB was delayed to 1 January 2022.

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