FRTB is here – now it’s up to local regulators

Each jurisdiction must produce its own version of FRTB; until then, banks are hanging back

FRTB hatched

  • The Fundamental Review of the Trading Book is at various embryonic stages at the four big regulators – the Federal Reserve, the UK’s Prudential Regulation Authority, the European Banking Authority and Japan’s Financial Services Agency.
  • European lawmakers decided in December to put the reporting requirements into effect before the capital requirements. Sources expect reporting under the standardised approach to begin in December 2020.
  • In the UK, FRTB’s progress will depend on Brexit. Fed officials have previously said they hoped to nail down rules “2019-ish”.

The Basel Committee on Banking Supervision has finished with its Fundamental Review of the Trading Book, and local regulators must now give it their own national slants.

So banks are watching and waiting. And they say they have reasons to be gun-shy.

“The Basel Committee has put out this text, but it is really now for domestic regulators to start to make noise about implementation, because we have been here before,” says one market risk manager at an Australian bank, referring to the expensive commotion that followed the 2016 version of FRTB, only for a 2019 deadline to be junked the following year.

“Regulators at the domestic level need to come out with a message to say: ‘This is the final version of the FRTB and the timelines are set for 2022’.”

It has been only a month since the committee issued its final amendments to FRTB, and its effective date is not until January 2022, giving national regulators some time. But having been burned in the past, banks seem to be waiting for their local authorities rather than taking up the new standard with both hands.

The first iteration of FRTB appeared in January 2016, and was met by vociferous opposition, prompting the committee in December 2017 to say it would amend the rules. In the interim, banks trimmed back FRTB projects to their bare essentials.

But even with the final version in hand, banks are cautious. Besides regulators, some also wonder whether local legislators might try to further amend the standard or set aside the committee’s timeline.

“If we get a bit more certainty from the Federal Reserve and the EU on the timelines,” says a modelling expert at a European bank, it will help people “start to implement this for real”.

FRTB is in various embryonic phases at the four big regulators.  

The Federal Reserve declined to comment on the issue.

In the UK, Brexit will determine what happens with FRTB. If prime minister Theresa May’s deal is agreed, the UK will be tied to the European Union’s single market and its laws until at least December 2020, keeping it on the EU’s schedule for FRTB. If not, the UK’s Prudential Regulation Authority will be free to draft the rules as it wishes.

Regulators at the domestic level need to come out with a message to say: ‘This is the final version of the FRTB and the timelines are set for 2022’
Market risk manager at an Australian bank

A PRA spokesperson commented, “Our current assumption is that we will proceed with implementation according to the Basel timeline.”

In Japan, two sources say the country’s Financial Services Agency has indicated it plans to enforce FRTB in March 2022. The agency, however, sidestepped the issue, saying that, keeping in mind the Basel timetable, it aimed for a “smooth introduction of the regulation after a sufficient consultation with relevant parties”.

Europe may be the furthest ahead in the process.

Europe moves ahead on reporting

Of the largest regulators, the Europeans have a small bit of momentum. On February 15, the Council of the European Union published a draft of the final version of updates to the EU’s capital requirements regulation (CRR II). The document reiterated that the EU will first put FRTB into effect as a reporting requirement, leaving the capital rules for later – a decision taken in December 2018.  

Reporting is likely to begin under the regulator-set sensitivities-based, or standardised approach (SBA) by December 2020. First, the European Commission must pass secondary legislation putting the Basel Committee’s latest changes on the standardised approach into effect by December 31 this year; reporting would start a year later.

Less certain is when banks will be allowed to report under the internal models approach. The draft text states internal modelling could begin three years after the EC passes the four secondary pieces of legislation drafted by the European Banking Authority. Those pieces of secondary legislation will also transpose the recent changes made by the committee on internal modelling into EU law.

The EBA says it has begun discussions with the industry and will begin collecting data on non-modellable risk factors (NMRFs) soon.

“We are likely to initiate a limited-scope data collection exercise at some point, assessing banks’ non-modellable risk factors shortly after the publication of CRR II,” a spokesperson says. “We are, however, still at a development stage, but given the complexity of the topic, have started informal discussions with the industry.”

It is very early days, but the uncertainty around the local regulators will remain at least for another year
Azar Khurshid, Mizuho

The EBA must draft that legislation on internal modelling within nine months after CRR II comes into force. However, it is unknown whether the EBA will make changes to the legislation or how long the EU’s legislative process will delay the pieces of secondary legislation.

An industry source close to FRTB lobbying efforts in Europe says he expects the final version of FRTB to become EU law in April, just before the European Parliament breaks for elections in May.

On that timeline, the EBA would need to complete its work by January 2020. But there is no timeframe on how long the EC and EU legislators will take to adopt the EBA’s standards.

The EBA may also have to make clarifications or changes to the standards published by the Basel Committee before implementing them as a reporting requirement.

“If what you have already implemented in the [Basel] rules changes, then it will, of course, have an implementation cost,” says a market risk expert at a second European bank.

A senior risk manager at a third European bank believes FRTB may go through another series of amendments in Europe once reporting begins and regulators get a clearer idea of how the capital requirements will work in the market

They point to the calibration of parameters for a key test in using internal models – the profit-and-loss attribution test, which compares the alignment between trading desks’ risk and pricing models – potentially changing once reporting on IMA begins.

The committee relaxed the thresholds for trading desks to pass the P&L attribution test by introducing an amber zone between the thresholds for passing and failing the test, though not as far as bankers wanted. As the test has not been tried on real portfolios, banks remain concerned that the redrawing of the parameters did not go far enough. If the reporting period confirms the banks’ position, they feel regulators might give them the slack they want.

Until banks start to hear anything from their regulator, getting projects signed off is difficult when competing for resources with other implementation projects we are undertaking
Market risk manager at an Australian bank

“I don’t think it is the final word,” says the senior risk manager.  “We have maybe a bit less concern compared to somebody that has the final rules on the points between the three thresholds in the P&L attribution test.”

And according to the draft final version of CRR II, FRTB will be converted into a capital standard within the next package of reforms to the EU banking laws – a process that could take until 2025.

In the US, the Fed’s initial diffidence toward FRTB has given way to acceptance, despite early Trumpian rhetoric on foreign standards bodies.

The Fed has not unequivocally committed to the Basel Committee’s timeline, but it has given indications it might. Norah Barger, a senior policy adviser at the Fed, said at an International Swaps and Derivatives Association conference held last June that the US might use the EU’s timeline on FRTB to avoid pricing distortions between EU and US markets.

David Lynch, a deputy associate director at the Fed, estimated at another Isda conference last April that US FRTB rules would be nailed down “2019-ish” to give banks time to align with the standard for 2022.

And now we wait

Azar Khurshid, a director in global risk management at Mizuho in London, believes the general uncertainty around local regulators in implementing FRTB could drag on for another year as they come to grips with how the new FRTB will play out on their local markets.

“It is very early days, but the uncertainty around the local regulators will remain at least for another year,” says Khurshid. “The local regulators are now expected to conduct a QIS [quantitative impact study] and consult with the industry to figure out the impact on their markets.”

The EBA is preparing to collect data on NMRFs that will be subject to a capital surcharge under FRTB, sources say. The data-gathering would begin shortly after CRR II becomes law, according to sources.

Without firm timelines, it’s tough to get the budget for FRTB projects, the market risk manager at the Australian bank says.

“Until banks start to hear anything from their regulator, getting projects signed off is difficult when competing for resources with other implementation projects we are undertaking,” says the market risk manager.

Due to the cloudiness around the rules, banks have been selectively adopting parts of FRTB that are either beneficial to the bank or unlikely to change significantly.

Some smaller institutions have gone ahead and implemented the standardised approach because they didn’t expect the Basel Committee to alter the methodology, and instead anticipated only minor changes to the risk-weights, which would raise costs slightly.

“We decided we wanted to be very early in implementing the FRTB SBA,” says Hjalmar Schröder, head of market risk at Swiss regional bank, Zürcher Kantonalbank.

“Starting with the first version and going through the subsequent changes was probably not the optimal decision when you look at cost alone,” he says, “but in terms of learning what was important and being confident we can deliver FRTB in time – without needing to search for everybody with expertise at the same time as other banks do – it was overall a very good decision.”

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