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2022 – A market risk odyssey

2022 – A market risk odyssey

Though January’s final version of FRTB offered no great surprises to those who have followed the regulation since its inception, banks now have a greater idea of what is required of them. Bloomberg explores the importance for banks to have FRTB infrastructure in place and models approved by supervisors in time for the deadline

A great way to stake a claim on the future is to lead with a date: think 1984 or 2001: A Space Odyssey. The January 2019 edition of the Basel Committee on Banking Supervision’s Document 457, Minimum capital requirements for market risk, leads with a date in the very first sentence: “This document sets out the amended minimum capital requirements for market risk that will serve as the Pillar 1 minimum capital requirement as of 1 January 2022, replacing the current minimum capital requirements for market risk as set out in Basel II and its subsequent amendments.”

What follows is the final version of FRTB, and while the Basel Committee is less famous as a futurologist than George Orwell, Arthur C Clarke and Stanley Kubrick, emphasising the go-live date after years of delays reinforces regulators’ commitment to timely adoption of the new standard.

For those who followed the rule through the initial draft (2016), two sets of frequently asked questions (2017/2018) and a consultation document (2018), January’s final version offered no major surprises. A mild shake-up in the standardised approach (SA) is a lighter look-through requirement for index exposures. For indexes and their derivatives, the initial draft mandated looking through to constituents for both the sensitivities-based method (SBM) and the default risk charge (DRC). The final rule lets banks calculate the SBM for common well-diversified indexes without looking through to constituents, using new equity and credit index buckets. However, the rule states that it is possible to look through to constituents and still requires look-through for the DRC to enable bucketing by credit rating.

Consequently, banks still need constituent data and ratings for index exposures even if they skip calculating constituent-level sensitivities.

Index constituents bucketed by rating
Index constituents bucketed by rating

Beyond look-through and some changes to SA risk weights, the final rule largely confirms the changes proposed in the 2018 consultation document, while revising the internal models approach (IMA) based on industry concerns. Those changes fall into two categories: modellability and profit-and-loss attribution. 

 

Modellability

Responding to concerns around seasonality and new issues, the final rule makes it easier to show enough ‘real’ price observations – trades and/or committed quotes – to pass the risk factor eligibility test (RFET) for modellability. Factors with month-long gaps between observations can be modellable if they have at least four price observations per quarter and 24 total observations in the past year. In addition, factors become modellable after 100 observations, even before accumulating a year of history. 

Bloomberg analysed the impact of the changes, concluding that:

  • The ‘4 in 90’ rule – a minimum of four observations in any 90 day period – increases the number of bonds and factors that pass the RFET noticeably
  • Admitting factors with at least 100 observations helps only marginally
  • Including committed quotes makes a big difference for many risk factors.

 

Profit-and-loss attribution

Banks liked the traffic-light approach in the 2018 consultation, but feared the amber and red zones would be triggered too frequently. The final rule has wider green and amber zones, especially for the Kolmogorov-Smirnov test. It also maintains a capital surcharge – effectively interpolating between SA and IMA capital – for desks in the amber zone.

Along with the amber-zone capital surcharge, the IMA and SA are also related through the capital floor. The original rule established that a fractional multiple of SA capital should act as a floor for total capital. While floors are not mentioned explicitly in the final rule, the concept remains, limiting the capital relief coming from IMA. Banks will therefore need to weigh potential capital relief coming from IMA against implementation costs.

This brings us back to 2022, but also to 2019. Regardless of whether
2022 is a deadline for reporting only or full capital implementation, banks must have FRTB infrastructure in place and models approved by supervisors by then. With a year likely needed for model approval, and up to another before that for parallel runs, 2019 is the year for banks to decide how they will implement FRTB.

Learn more

Visit www.bloomberg.com/FRTB

 

FRTB – Special report 2019
Read more
 

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