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Why FRTB matters and why it’s hard

Given the technical and operational challenges that come with this regulation, banks need to prioritize preparations for compliance.


The implementation of certain regulations put on hold during the pandemic is starting to get back on track. Over the last year, regulators in Europe, Asia and Canada have published schedules for implementation of Basel III, including the Fundamental Review of the Trading Book (FRTB), and banks that operate in those regions are racing to implement FRTB and meet those deadlines.

Things are different in the U.S., where the Federal Reserve has not yet set a schedule or drafted a U.S. version of FRTB, so regional banks in this country are not as far along. However, given the many technical and operational challenges that come with this regulation, regional banks need to prioritize preparations for FRTB compliance despite implementation delays and other uncertainties.

Some of the top challenges U.S .banks should have on their radar center around capital models, data availability and data/analytics consistency.

When it comes to the capital models, there are two prescribed methods for calculating market risk capital: the standardized approach (SA), which all banks must calculate, and the internal model approach (IMA), which requires banks to obtain desk-by-desk approval from regulators.

With regard to the SA, risk exposures must be organized into “buckets” that determine risk weights and, ultimately, a capital number. Risk weights differ substantially across buckets, so it is critical that banks have robust data inputs in place to ensure securities are bucketed correctly. Special treatment is required for mortgage-backed securities – agency-backed and otherwise – that regional banks typically have on their books, so these banks will need to ensure they have the required data and analytics.

For banks following the IMA, consistent data is also vital for success. The risk factor eligibility test (RFET) is mandatory for this approach and is used to determine risk-factor modelability. Factors that don’t pass the test accrue a capital add-on, while passing the test requires gathering trade and committed quote data that is hard to find for many asset classes.

Additionally, the IMA mandates that banks compare the risk-theoretical profit and loss statement with the hypothetical and actual P&Ls. This requires aligning various data sources and models for consistent output, which can create many challenges given data formats that can vary between teams within the bank. Devising a strategy to address such internal inconsistencies can take time. Having a reliable data-management infrastructure in place to keep track of all these moving pieces is especially key for FRTB.

As banks engage in the monumental undertaking of FRTB compliance, they should also consider how the investment management landscape has changed.

For example, how banks manage risks related to virtual assets like crypto and environmental, social and governance factors is proving vital to the bottom line. The benefits lie in producing a common data and analytics backbone across every asset class for FRTB regulatory analysis and internal risk management to save time, money and resources down the line.

As banks think through their risk-management protocols, they must assess whether they have the necessary tools in house to get their data in order, or if they need help. For those seeking market data, a risk-analytics engine, or an entire end-to-end solution, it is imperative that solutions meet FRTB compliance needs. FRTB requires banks to have reliable, consistent data as well as analytics solutions that can readily calculate raw risk sensitivities as well as capital and accurately measure risk across their organization.

As with all major technological efforts in the financial world, the key principle is to begin preparations as early as possible to allow adequate time for resolving any foreseen and unforeseen issues. Even global implementation currently coalescing around 2025 for many jurisdictions, there is a lot that needs to be done to prepare for FRTB compliance.

There is a strong possibility that the Fed issues a notice of proposed rulemaking and a compliance schedule as soon as this year, which could mandate being ready for FRTB sooner rather than later. But even in the absence of concrete dates, FRTB requires immediate attention and active preparation from U.S. banks.

Eugene Stern is head of market risk product and Brad Foster is global head of enterprise content, both at Bloomberg