Dealers 'getting very creative' ahead of FRTB implementation

FRTB will force banks to rethink the structure of their businesses

In order to use their own internal models under the Basel Committee on Banking Supervision's Fundamental review of the trading book (FRTB), major dealers are going to have to work hard to interpret the rules and up their game when it comes to modelling.

But in addition to this, they are also expected to make some more fundamental changes.

Because of differences in the way trading desks and products are treated under the FRTB, banks say they will need to rethink the structure of their businesses, including their trading desks and hedging strategies.

According to the FRTB text, "a trading desk is a group of traders or trading accounts that implements a well-defined business strategy operating within a clear risk management structure". At the largest banks, the number of trading desks is expected to be in the high double digits, but firms have some flexibility in terms of how these desks are delineated.

In some cases, banks are expected to start with the trading desks they use to comply with the Volcker rule, part of the US Dodd-Frank Act that limits proprietary trading. Firms may then pull out products for which they are unlikely to obtain modelling approval.

"It is a very personal and firm-specific choice," explains a source at a major UK bank. "We have heard banks that are more interested in going in that direction, because you already have [Volcker desks] as a benchmark – so it's attractive for some but it doesn't necessarily make sense for others."

A key factor many banks are thinking about is how regulators in different jurisdictions might implement the FRTB's more rigorous model approval process. With hedging desks situated in different locations across the globe, banks are eager to get some idea of how local regulators will approach trickier issues, such as non-modellable risk factors, and the irksome profit-and-loss attribution test.

Differences between jurisdictions would be a cause for concern, says one source at a major US bank. It would be problematic if, for instance, a trading desk based in the UK were hedging exposures in the US and one of the two countries' regulators denied model approval. "What if we have similar infrastructure and governance around our desk? What if one is approved and one is not? Then we have broken hedges, according to the rules," says the source.

This cuts both ways, however. There is already speculation that dealers may draw up contingency plans to hastily move a trading desk to a different, more favourable jurisdiction in the event that it loses model approval. One London-based consultant raises the possibility that banks could start relocating trading desks based on the capital impact from regulators' interpretations of the FRTB. "People are getting very creative," he says. "A lot of interesting things are happening."