Key Regulatory Challenges Facing EMEA Risk Professionals

Key Regulatory Challenges Facing EMEA Risk Professionals

Ahead of the Center for Financial Professionals’ upcoming flagship European event, Risk EMEA, 5th Annual Banking Risk And Regulation Summit, we undertook extensive research to find out the key regulatory challenges facing risk professionals over the coming year.

The findings of this year’s research will be illustrated at our 5th Annual Risk EMEA Summit, which is taking place on 24-25 May 2016 in London. The Summit brings together 50+ CROs and Heads of Department from institutions across EMEA, beginning with keynote plenary sessions and CRO panel discussions in the morning before dividing into three concurrent streams across both days; Stream One on The Fundamental Review of The Trading Book (FRTB); Stream Two on Risk & Regulatory Developments; and Stream Three on Liquidity Risk & Capital Management.

The agenda can be viewed at:

This first piece in this series of research reports will focus on the first stream, The Fundamental Review Of The Trading Book and the key challenges that risk professionals highlighted over the next year within the FRTB. These include implementation challenges, timing constraints and the move from VaR to expected shortfall. The upcoming research pieces will then discuss the main focus areas for risk professionals within Banking Risk & Regulatory Developments and Liquidity Risk & Capital Management respectively.

With the FRTB ‘finalisation paper’ released in mid-January and the implementation date pushed back until 2019, the change in the market risk framework is a ‘fundamental’ regulatory development and a huge challenge for market risk professionals across the board. Therefore it is no surprise that during the research one of the main areas that came to the forefront was the overall implementation challenges of the FRTB, particularly in light of the finalisation paper, for example, the computational intensity and infrastructure change that are required under the FRTB framework is a huge undertaking across the industry. Certainly for all banks that will be operating under internal models, this will require upheaval in internal processes and systems going forward, far more so than the original framework. Therefore as a whole organisations will need to optimize not only their IT infrastructural systems, but internal frameworks and processes in preparation for implementation.

In contrast to this, one of the key decisions that will need to be made is whether banks should invest in their own infrastructure or outsource it to third parties, for instance banks could use cloud computing and outsource to big data centres to provide the computer capacity and data requirements in order for compliance with the new standard. This is certainly one potential route to go down for institutions that do not have the capacity and infrastructure in place. Institutions will need to balance the benefits vs. cost of outsourcing these areas, are they better prepared for future changes if they transform infrastructure internally and build up their own capacity, or with the regulatory landscape changing so frequently, will this work be in vein? Institutions will also have to review some of the main drawbacks of this approach, mainly the data protection and security aspects that are frequently publicized, alongside the reputational fallout and the governance and monitoring challenges that such an approach would pose.

Additionally, one such implementation challenge for market risk professionals is that the new FRTB rules have far more stringent model eligibility criteria’s than the original framework. In short model eligibility is what determines whether a bank will be using the Internal Models Approach (IMA) or The Standardardised Approach. With stringent regulatory requirements in place for those operating under IMA, can institutions gain value from building internal models to satisfy regulatory requirements? An area viewed in its entirety as a key focus area for banks is their ability to be able to pass the tests to ensure that the bank is operating under the IMA. This poses the further question, if institutions develop the capacity and approval to operate under IMA, with such stringent regulatory oversight, what would be the fallout if they were to be bumped back down to standardised having built the infrastructure to operate under IMA? This poses further questions to organisations such as their capability in being able to pass these difficult tests, are banks adequately prepared for them? The results of failing them could have a detrimental impact on capital requirements and ultimately the balance sheet, so it is certainly something that is an important area of focus for banks as the industry moves towards implementation.

Finally the subject of timing constraints was highlighted as a particularly pressing issue for market risk professionals and ensuring that the FRTB is implemented in a timely yet effective manner. Numerous professionals highlighted that the regulators have set the bar very high for models, data and process requirements, just some of the tasks that need to fulfilled include the implementation of new standard rules and a number of eligibility tests that require improvements, and overhaul of internal models to pass. To satisfy the regulators, a re-structure in many areas including the real price criteria and P&L attribution tests, and are not something that can be solved and completed overnight, there is a long road ahead which begs the question, can this be fulfilled in the allocated time, and can regulators afford another push back?

This is just one of the many facets of FRTB implementation. There are numerous timing and complexity issues throughout the various stages of implementation for the industry as a whole and professionals were in unanimous agreement that there is a significant amount of work required to be done in a relatively short time scale. The fact that planned implementation has been moved back one year to 2019 may ease some of these concerns, but there is no doubting that there is still much to be done, particularly for the smaller banks who may have further to go and tighter budgetary constraints.

Furthermore, the move from VaR to Expected Shortfall and what this will actually look like in practice is a key challenge. For years financial institutions have dealt with standard VaR calculations, yet the financial crisis raised serious questions about the validity and accuracy of VaR, particularly in the lack of understanding or accountability within the fat tail. This is what expected shortfall calculations hope to address to ensure the industry does not have a repeat of the 2007-2008 situation again. A lot of firms will need to re-engineer their market risk VaR calculations quite significantly, whether it’s complying with the correlation assumptions which are permitted between asset classes or the change to expected shortfall. Therefore the internal infrastructural systems of banks require arguably a near-full overhaul, which not only requires time, but also is a complex process with a huge drain on resources.

These are only a summary of the challenges that different organisations are facing across the industry, as we head into the fine-tuning stage before implementation. To hear industry discussions around the finalisation paper and overcoming the challenges of implementation, join us at The Center for Financial Professionals’ 5th Annual Risk EMEA Summit, taking place in London on May 24-25th. Stream One of will be solely focused on the FRTB and will provide a platform whereby market risk professionals can review and discuss the implementation of the FRTB, and challenges faced across a variety of institutions.

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For further information, please get in touch with a member of the team on +44 (0) 207 164 6582