Implementation pitfalls – Case studies and lessons learned

Implementation pitfalls – Case studies and lessons learned

By Stefan Scheutzow, Expert and Market Risk Team Lead and Hendrik Sumpf, Associate Manager from Finbridge.

Ahead of the Fundamental Review of the Trading Book Summit 2017, Stefan and Hendrik share with us their insight into lessons learned ahead of FRTB implementation. 

Stefan and Hendrik, can you tell the Risk Insights’ readers about yourself and what your current professional focus is?

We both work at Finbridge, a consultancy agency focusing on financial services based in Germany.

Hendrik is Associate Manager at Finbridge. He is specialised in running projects that interface between functional concept work and technical implementation in financial institutions. His recent projects in regulatory reporting and risk controlling encompass implementations of new regulatory requirements in liquidity, credit, and market risk as well as the broader BCBS 239 context. Hendrik has been part of the Finbridge FRTB team since the beginning of the BCBS consultations and has given various presentations and webinars on the subject. He is also one of the lead programmers for the Finbridge FRTB Toolbox used in change-impact studies for Finbridge’s clients.

Stefan is market risk team lead at Finbridge and responsible for the interpretation and implementation of current banking related regulations following Basel III. Stefan worked for several years in financial risk management covering supervisory requirements as well as quantitative risk models across capital markets and banking. Today, he is in charge of conducing impact studies for Finbridge clients on current treasury and capital markets related regulations such as FRTB and SA-CCR and develops achievable recommendations for implementation. He is also helping his clients to embed future supervisory requirements with their business strategies.

Can you provide our audience an insight into implementation difficulties that financial institutions are currently facing?

One of the main issues when implementing FRTB is that the regulatory requirements are still not quite finalised and in some key aspects very unspecific. This includes BCBS draft consultation with various parties working on a compromise that could develop both in favour and against the banks’ interest. On the European legislative level the CRR overhaul is subject to plenary debate, as well. Once the CRR is finalised, further layers might be added by the NCAs’ interpretation. These uncertainties have negative influences on project planning and budgeting. For the worse, the enormous workload creates urgency for a timely adoption of a tight implementation schedule. All of this creates an atmosphere in which far-reaching processes related to IT implementation and organisational restructuring may be initiated based on business requirements that might be subject to further change.

How can professionals best prepare for a draft regulation?

Working with draft regulation demands for flexible implementations. Early impact analyses reveal interpretation issues before they manifest themselves in banks’ infrastructures. Similarly, early adoption leaves room for discussion within the industry and the use of regulatory consultation processes, alike. After interpretation of draft issues is done, business requirements should ensure flexibility for later change. Besides dynamic parameter specification this calls for interchangeable algorithm implementation techniques that reduce the risk for additional effort.
Lastly, a comprehensive understanding of the regulatory history reveals the regulators intention in many cases.

What effect will implementation have on IT infrastructure?

The FRTB standardised approach, which all banks need to implement due to the proposed capital floor, comes along with very data-heavy requirements that demand corresponding computing time. These include but are not limited to the sensitivities themselves which, if the current wording in the draft regulation prevails, need to be calculated with finite differences on basis point or percentage point increments. This is the “elementary numerics” way of approximating sensitivities but not necessarily computationally efficient when compared with more elaborate techniques such as adjoint algorithmic differentiation (AAD). With some front-office (FO) systems that focus on analytical sensitivities, finite differences is currently not even available or has never been used nor been tested by the banks. Further down the process chain, the information required for achieving the correct bucketing and risk factor mapping of these sensitivities includes a long list of base transaction and counterparty information that need to be shuffled together. As the current draft CRR wording goes, sensitivities will likely come from the FO rather than the risk controlling systems and, in case of banking groups, this necessitates a group-wide integration and harmonisation effort for risk factors in the FO systems. We expect to see some consolidation w.r.t. the system arrays currently in use at some of our clients. I.e., trades that are kept in various different FO systems for historical reasons, such as mergers and acquisitions, will be migrated in order to shed off the odd system and reduce the integration burden in due course of the FRTB implementation.

What challenges do you foresee on the horizon for market risk professionals?

Many risk professionals have been occupied with regulatory compliance topics in the aftermath of the financial crisis. With this continuous regulatory pressure over the last decade, many banks now rely on ageing internal risk models and systems. While regulators have intensified restraints on internal models and complexity of standardised approaches simultaneously, work on model enhancements and alignment of established models with common market standards has often been standing still. Likewise, risk management systems have been adapted to BCBS 239 conformity while calculation speed and controlling incentives were of minor importance. To keep up with competitors in the medium-term in a both dense and specialised local market as well as internationally, risk professionals are urged to combine change due to regulatory compliance with the creation of added value. To achieve this ambitious goal, capital market related topics such as FRTB, MiFID II or SA-CCR need to be viewed in a broader context allowing for early identification of synergy leveraging, market influences, and potential advantages from increased risk sensitivity. We at Finbridge are triggering these discussions with our clients and with relevant software developers through various cooperations in order to realise potential synergy effects and make the workload manageable both financially