Numerix: The FRTB - Key Challenges and Implementation Headaches
Posted: 19 January 2017 | Source: Numerix
The broad implications of the revised capital framework proposed under the Fundamental Review of the Trading Book (FRTB) have begun to crystalize. These gains are the fruit of significant discussion, analyses and impact studies from industry participants and regulatory bodies. Banks are faced with anticipated increases in overall capital requirements, stricter tests for internal model approvals, needs for enhanced data quality, aggregation challenges, and more computationally-burdensome risk metrics. As we near the finalization of the Basel-level standards, and as implementation dates for the new framework grow nearer, banks are analyzing specific details of the FRTB standards with increased vigor.
This white paper provides an assessment of how the new FRTB framework, including both the new FRTB-Market Risk (FRTB-MR) and FRTB-CVA Risk frameworks, deviate from the existing Basel III capital framework, and it seeks to summarize some of the more nuanced issues the industry has raised concerns over throughout the course of 2016. In the context of the FRTB-MR framework, we will dive into some opaque aspects of the P&L attribution test which must be passed to gain internal model approval, and examine the Residual Risk Add-On (RRAO). In the context of the FRTB-CVA framework, we will discuss the calculation of CVA sensitivities and the treatment of initial margin. We will also spend some time on the importance of initial margin and its impact on trading costs at the end of the paper.
To set the stage for the forthcoming discussion consider Diagram A overleaf, which provides a broad overview of the implementation timeline for relevant upcoming regulatory initiatives. These include the FRTB-MR and FRTB-CVA frameworks, the new Standardized Approach to Counterparty Credit Risk (SA-CCR) framework, as well as the expanding Uncleared Margin Requirements (UMR). The rationale for including the SA-CCR in this discussion is that the way we measure counterparty credit risk under the SA-CCR is adopted and utilized under the FRTB-CVA framework (specifically by the new “Basic” CVA approach), and the rational for including the UMR is that the associated increase in initial margin (IM) postings between counterparties will necessarily impact CVA and CVA variability, and thus needs to be accounted for under the FRTB-CVA framework. These details will be discussed further in subsequent sections.