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Turning the IMA into a competitive advantage

Turning the IMA into a competitive advantage

Following the clarification of the FRTB rules in January 2019, financial institutions are now working towards a 2022 implementation deadline, finalising how their trading books will operate under this demanding regulation. Eoin Ó Ceallacháin, head of product marketing at Murex, examines how some banks are starting to assess differentiating profit-generating opportunities now that the regulatory fog is lifting

The Basel Committee on Banking Supervision’s finalisation of the FRTB rules last January brought welcome clarity to banks, which face the challenging task of revising business plans to cope with FRTB. With the January 2022 deadline looming, strategic decisions are needed soon. The expanded red, amber and green zones have been broadly welcomed by the industry and regulators alike – as have the relaxation and simplification of the risk factor eligibility test. Until recently, the perceived wisdom appeared to suggest that the internal models approach (IMA) was simply a non-starter for all but the largest global banks. But this story has evolved since January in two significant ways.

First, capital charge increases were confirmed under the standardised approach (SA) – also known as the sensitivities-based approach – which affect several important business lines. For example, foreign exchange risk under the 2016 FRTBSA rules was projected to be 120% greater than the IMA. Under the 2019 rules, this has increased to 220%.  

A further punishing example is the restoration of risk weights for equity risk factors, with an increase of 30–60%, which impacts not only cash equity trading, but all structured products linked to investment funds.

Second, the attractiveness of the IMA at desk level may be increasing for some players. Some banks – especially those in emerging markets with extensive trading operations in non‑dollar currencies – are understood to be considering the IMA for their forex cash desks. For credit markets, the final version of the SA text prevents banks from offsetting the widely used credit default swap indexes – such as CDX or iTraxx – against their single-name constituents for correlation trading portfolios.

More generally, an increasing number of banks seem keen not to close the door on new profit-making opportunities to which FRTB structural disruption may give rise. With the regulatory picture now clearer – though not completely, due to the required jurisdictional adoption of global FRTB rules – cost-benefit analyses with higher predictability are now possible. Learning from the first adopters supports the view that revamping the enterprise market risk framework goes a long way towards being FRTBIMA ready. 

The transformation journey involves the three Ps: people, processes and supporting technology platforms – with the last often being the most straightforward. The remaining effort required for IMA approval revolves largely around risk factor classification and modellability, which drive the required global expected shortfall and stressed expected shortfall capital add-on. Feasible within only a few additional project months, this incremental investment equips senior management with valuable ‘what-if’ analysis capabilities to quickly exploit new desk-level business opportunities as they emerge.

All told, the competitive manoeuvrings around the IMA will make for interesting watching.


FRTB – Special report 2019
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