Japan regulator: we are racing to finish FRTB in 2018

Japanese banks warn against rushing rules with poor data, and fret over EU delays

Shunsuke Shirakawa, Japan Financial Services Agency

A leading Japanese regulator has warned that the Basel Committee must complete its revamp of the market risk capital framework before the end of 2018, or face a further delay to implementation beyond 2022.

But Japanese banks fear this tight schedule is insufficient to collect the data necessary to calibrate the Fundamental Review of the Trading Book (FRTB) correctly, and also worry about an unlevel playing field if Europe moves more slowly than Japan.

“FRTB is now the single most important factor we have to work on. I would sincerely like this work to be completed by the end of the year. This is my commitment,” said Shunsuke Shirakawa, vice-commissioner for international affairs at the Japan Financial Services Agency (JFSA), speaking at the Risk Japan conference in Tokyo on June 6. “If it is not agreed by then, it would be very difficult for implementation to be achieved by 2022.”

The deadline for member jurisdictions to implement the FRTB has already been pushed back in December last year, from an original start date of 2019. This delay allowed the Basel Committee to consult on modifications to the framework in March 2018.

The possible changes touch on some of the elements that have proved most controversial among dealers. These include defining non-modellable risk factors that will be subject to capital add-ons for banks calculating their capital requirements using the internal modelled approach, and the profit and loss (P&L) attribution test that banks must pass to win supervisory approval for IMA models.

“There have been concerns raised about the implementation of FRTB. The risk sensitivity is too low, or it is too complicated. These [issues] are now being reviewed,” Shirakawa said.

But Japanese market participants at the same conference expressed concern that the tight timeline would make it difficult for them to gather sufficient data to ensure Basel has calibrated the regime accurately.

“The Basel Committee and industry still have a large gap in their understanding [of FRTB] and there is still insufficient data to get Basel to understand what the impact of the challenges and the issues are,” said Taizo Makino, head of the government and regulatory affairs office for Mitsubishi UFJ Financial Group (MUFG), speaking during a separate panel discussion.

Lack of incentives

Sources say the Basel Committee has privately signalled dissatisfaction with the quality of data submitted under quantitative impact studies, which were part of the drafting process for the new rules.

One banker at the conference acknowledged firms have been reluctant to invest heavily in the systems needed to calculate FRTB model outputs until they know if they are likely to derive capital benefits from doing so. From an early stage, banks have fretted that the P&L attribution test would be too difficult to pass, forcing banks onto a standardised approach with more punitive capital requirements, and therefore removing any incentive to invest in IMA capabilities.

“We can’t always submit meaningful data if we haven’t first spent the money to maintain and establish a platform – and we won’t do this unless we can see a clear benefit of doing so,” said Tsuyoshi Hirano, managing director in the group risk management department of Nomura.

We can’t always submit meaningful data if we haven’t first spent the money to maintain and establish a platform – and we won’t do this unless we can see a clear benefit of doing so

Tsuyoshi Hirano, Nomura

Hirano described this as an “eternal circle”, which could only be escaped if banks were given more reassurances over the P&L attribution test. The March consultation included permission to modify data inputs for the bank’s IMA models (known as risk-theoretical P&L) to better match the data from front-office pricing models (known as hypothetical P&L). Banks fail the test if there are too many deviations between the risk-theoretical and hypothetical P&L outputs.

Hirano said the issue of data mismatches could be particularly problematic where the bank lacked historical data and instead had to use proxies for risk models. For example, in the case of recently-listed equities, the front office P&L would use exchange closing prices, but the time series would not be long enough to calculate value-at-risk or expected shortfall figures used in the risk-theoretical P&L models.

“If it is possible to have 100% reproduction of the risks that occur on the front desk then that would be great, but if we don’t have the historical data then this doesn’t make sense,” Hirano said. “Some of the information that needs to be fed into the pass-fail test is difficult if not impossible to collect, so in this kind of situation provisional figures have to become the final figure. [At the moment], it is unlikely we would have a large amount of transactions that could go into the ‘pass’ box.”

Consistency is key

Both the Japanese industry and Japanese regulators are anxious to make sure everyone moves towards FRTB at the same time.

“Any discrepancies between jurisdictions globally could tamper with a level playing field,” said MUFG’s Makino. “Even if we do have the content ready, the timing of the introduction could be different between jurisdictions and this would lead to uncertainty. The regulation in each country should start from 2022.”

Particular concern was raised about the European Union’s approach to FRTB implementation. The EU intended to introduce the market risk framework as part of a revision to the capital requirements regulation (CRR II), due to be adopted before the European Commission’s current mandate ends in April 2019. However, it now appears possible that FRTB could be introduced only as a reporting requirement under CRR II, with the capital requirements to be finalised in a further package under the next commission.

The EU has already proposed a four-year phase-in period, so the added legislative delay could result in the full capital requirements being applied later than 2022. And Makino also pointed out that the proposed phase-in starts with a scalar of just 65% on the capital requirements, which is “far more lenient than international standards”.

JFSA’s Shirakawa promised the audience: “Japan will be observant [and] we will make sure market fragmentation is avoided. It is very important to have a consistent approach, and we will make sure we provide support for other countries’ implementation.”

Editing by Philip Alexander