FRTB – Light at the end of the tunnel

Light is beginning to emerge at the end of the tunnel for the Basel Committee on Banking Supervision’s Fundamental Review of the Trading Book (FRTB). 

The first iteration of the revised framework was published in January 2016, with an implementation date of January 2019. However, that go-live date was pushed back to the start of 2022 on completion of the Basel III reforms. 

With industry concerns brewing, the Basel Committee issued a consultation with proposed improvements to the framework, before publishing a final version on January 14.

The changes will likely bring consequences, say market participants. The updated framework reinforces the divide between trading and banking books, shakes up the approval process for the internal models approach (IMA) and provides a more risk-sensitive standardised approach (SA).  

Banks say the revisions make the IMA relatively more attractive than the SA – a reversal from the original version of the rules, which were tougher on in-house approaches.

For example, the 2019 revisions also create paths to reduce the number of costly non-modellable risk factors for banks using the IMA. The changes have made IMAs more popular on foreign exchange desks, where banks in Singapore are eyeing internal methods to reduce the capital impact. 

Forex risk under the 2016 FRTB-SA rules was projected to be 120% greater than the IMA. Under the 2019 rules, this has increased to 220% – perhaps part of the reason banks are increasingly considering the IMA. 

Despite this, the costs associated with implementing the IMA are high and it is a complex process. For banks wishing to use their own models to calculate capital requirements, the framework will be complex and expensive to implement, which could ultimately threaten the viability of certain business lines. 

Concerns centre around such businesses as correlation trading, which may need to rethink hedging methods or close down the business altogether. Some fund-linked trades are also at risk, with some banks having stopped offering products that expire after 2023, when the new Basel Committee rules on market risk are expected to come into force in the European Union, while some are charging more for them.

It has been said restoration of risk weights for equity risk factors, with an increase of 30–60%, impacts not only cash equity trading, but all structured products linked to investment funds.

Implementation is now up to local regulators, with all eyes on the US Federal Reserve, the UK’s Prudential Regulation Authority, the European Banking Authority and Japan’s Financial Services Agency.

Much time and effort was originally focused on meeting the 2019 deadline that never came to pass for the 2016 version of FRTB, so banks are waiting for their respective local regulators to weigh in before taking the plunge again. 

European lawmakers decided in December to put the reporting requirements into effect before the capital requirements, with reporting under the SA to begin in December 2020. UK progress very much depends on the outcome of Brexit, while in the US, Fed officials have said they would like to get rules bottomed out this year. 

Strategic decisions over the best way to implement the new revisions will still be required in advance of 2022, and the industry will watch attentively as banks go about making adjustments to their original implementations. 

Even with a two-and-a-half-year window, a year is likely needed for model approval, and up to another before that for parallel runs, making 2019 the year for banks to decide how they will implement FRTB.

FRTB – Special report 2019
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