Industry divided on case for European phase-in of FRTB

Isda AGM: transition period may allow time for Basel to recalibrate rules, panellists note

European Commission

Market participants are divided over whether the European Union needs to include a transition period in its proposed implementation of the Basel Committee’s Fundamental review of the trading book (FRTB), given the likelihood of a long legislative timeline to introduce the new rules in any case.

Speaking at the International Swaps and Derivatives Association annual general meeting in Lisbon on May 10, Isda chairman Eric Litvack suggested the European Commission’s proposed 65% scalar on market risk capital requirements over a three-year phase-in period was mainly to allow time for further work on the regime by global regulators.

“This is a recognition that the Basel Committee is still working on the calibration of the trading book regime, and the scalar accordingly aims to attenuate any unnecessary sudden and unwarranted increase in capital that could hurt market liquidity,” said Litvack.

Banks are still anxiously awaiting a document from the Basel Committee on Banking Supervision to clarify one of the vital elements of its market risk standards, which were finalised in January 2016. This is the profit and loss attribution test, which determines whether a bank can use its own internal models to measure market risk capital or must default to the more punitive standardised approach. There is concern among banks that one of the methods proposed by the Basel Committee would cause most trading desks to fail the test.

Speaking at the Isda AGM on May 9, Manoj Bhaskar, head of model risk at HSBC, pointed out the EC had opted to defer the design of the P&L attribution test in its proposal. The EC mandated the European Banking Authority (EBA) to tackle this in the level 2 regulatory technical standards, instead of including it in the draft level 1 legislative text of the revised Capital Requirements Regulation (CRR II) published in November 2016.

“This allows a bit more time for us to look at how it is going to be implemented and gives some discretion to the supervisors… We don’t see that yet coming out from other [jurisdictions], but the best practices are evolving, and I hope other regulators will take on those things and give us a more consistent framework,” said Bhaskar.

I would say that the timing is probably already so long that we don’t need additional time
Karin Dohm, Deutsche Bank

In a recent exclusive interview with, the EBA’s director of regulation, Isabelle Vaillant, indicated the agency planned a relatively flexible approach to defining the P&L attribution test in the level 2 text.

Bhaskar said the transition period was also useful more generally to allow banks time to adjust their balance sheets, and he hoped other jurisdictions would follow the EC’s lead.

“Banks by nature are leveraged institutions, and making changes to the capital requirements in a very short span can have some ripple effects to the way we manage our businesses. Having a clear transition plan that allows us to move from where we are to a newer plateau would certainly help,” he said.

Speaking on the same panel, however, Deutsche Bank’s global head of regulatory affairs, Karin Dohm, suggested the three-year transition period would be eclipsed in any case by the lengthy accompanying legislative process. The European Parliament began discussing CRR II only recently, and the Council of the EU is at a very early stage of its deliberations.

Dohm said she expected a trialogue discussion between the three legislative bodies to begin only in 2018, with CRR II finalised only by late 2020 or early 2021. If the entire package includes a two-year implementation period for consultation on and drafting of regulatory technical standards, she estimated the European version of FRTB might only come into force in 2023, even without the 65% scalar phase-in.

“Specifically [with] project management, you always have a trade-off between how much better does your analysis and therefore your implementation get, versus if the time is too long, it is difficult to get the right room temperature and to make sure you have the progress and people sticking to it to get implementation done. I would say the timing is probably already so long that we don’t need additional time,” said Dohm.

She added that the experience of implementing Basel III suggested a phase-in would “not necessarily make life easier”, because investment analysts tend to look through the regulatory transition period to the final capital numbers, and expect banks to front-load compliance with the new standards.

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