Implementing FRTB in the U.S.: What to Expect

Blog Financial Services Technology

By the time the Fundamental Review of the Trading Book (FRTB) regulation finally takes effect in the U.S. in January 2023, it will be close to a decade from when it was introduced by the Basel Committee on Banking Supervision (BCBS) in 2016.

Banks can opt to adopt the Standardized Approach “SA” and some will try for or keep their Internal Models Approach “IMA” status. While the IMA is less costly from a capital perspective, it requires more effort in sourcing data as well as larger volumes of data. In order to model risk of individual financial instruments, banks need to perform the Risk Factor Eligibility Test which means in order to be deemed “modellable” a risk factor must have a certain number of real price observations for that particular instrument over a defined period to feed the calculation.

ActiveViam has worked with the DTCC Real Price Observation Service to provide this data. If a bank fails to meet or maintain the requirements of the IMA, it defaults to the SA.  Either way, the size and complexity of the regulation is matched only by the massive volumes of data that banks will need to sift through, manage, analyze and report.

Banks in Europe and Canada are already running their books under FRTB rules. European banks in particular have already begun implementing the FRTB regulation under the European Banking Authority’s Capital Requirements Regulation (CRR2). The U.S. Federal Reserve is expected to provide guidance on the FRTB release some time this year and then open up the draft regulation for public comment. 

Here are five things U.S. banks need to know as they develop a plan to choose an FRTB solution:

  1. The data volume challenge is real. Backtesting alone can require hundreds of thousands of datapoints to create risk scenarios and prove to regulators that your desk falls within regulatory guidelines. As briefly mentioned above, the IMA requires a bank to prove it has the mettle to maintain that status (often trading desk by trading desk). Falling within the “amber” zone of capital requirements under the FRTB Profit and Loss Attribution Test is not ideal since the bank might be doubly penalized. ActiveViam’s FRTB Accelerator facilitates backtesting whether at the desk or trade level as clients can use “What-If” scenarios which allow users to see where a faulty piece of data may lie and rectify any shortfalls to meet the requirement and quell regulatory concern.

  2. A “black box” is the absolute wrong way to go. Apart from reporting the numbers, a bank analyst truly needs to explain to regulators how they arrived at the number they are reporting. A “black box” approach is not what the regulators are after. A software solution that provides a transparent thread from trade inception to capital charge and that demonstrates a clean analysis promotes confidence in both the bank’s senior management and its supervisors. Internal risk departments need to manage this way irrespective of Basel capital rules. 

  3. One size does NOT fit all (jurisdictions). Reporting across jurisdictions and in line with other regions and regional regulators is key to a sane balance sheet. Cross border trading can and will go quickly awry without holding the proper capital across currencies leading to mismatches in risk and putting the bank in jeopardy of not meeting requirements.

  4. Turn a requirement into an opportunity. While searching for an FRTB solution, best practices dictate that you combine what you need to do with what you have to do anyway. So a “crisis” becomes an opportunity when you choose a flexible solution that allows you to solve for the regulation while meeting internal risk management protocols that need to be performed daily anyway.

  5. The right solution can increase your revenue rather than cost you. The “ideal” platform that solves all of your problems – the one that you’ve been thinking about for years has arrived, now. It may have looked cost prohibitive a couple of years ago but things have changed.  An agile software platform that quickly consumes your P&L and sensitivities from the risk engine across jurisdictions, geographies and any dimension you choose and performs complex calculations in real-time with results viewable on flexible dashboards with state-of-the-art front-end graphics is already here. Costs have dropped as technology has become more scalable and the goal of meeting complex government regulations while deftly managing your own internal risk is very much achievable.