In 2021, banks in the US must be setting the groundwork for meeting the January 2023 deadline for the Fundamental Review of the Trading Book (FRTB). This year, US regulatory agencies are expected to issue a notice of proposed rulemaking (NPR) that will include finalized rules for FRTB. This will be followed by a hypothetical portfolio exercise and comment period. Because of uncertainty arising from the COVID-19 pandemic, the exact timing of the publication date will be difficult to predict. However, the goal of meeting the 2023 deadline is viewed as a high priority given the need for consistency across jurisdictions in terms of both implementation timing and the capital framework.
US banks intending to use the internal models approach (IMA) will need to have systems in place for the profit and loss (PLA) and backtesting requirements, which are needed for determining which desks qualify. Both tests require an accumulation of data over a 12-month period that requires having processes in place for modeling, data collection and testing well ahead of time. In the US, there is the added requirement of aligning desk structures in accordance with both FRTB and the Volcker Rule. Even with the delay of the deadline by a year due to the pandemic, banks will be under a tight schedule, as the Fed review will start in the second half of 2021.
Discussions continue as to the pros and cons of IMA vs. the Standardized approach. With IMA, the technical challenges are well known by now. In addition to the model tests, existing market risk systems need to be re-tooled to support the greatly increased number of simulations required for the expected shortfall. Risk Factor Eligibility Tests must be performed to determine which risk factors qualify for IMA treatment. For IMA Default Risk Charge (DRC), there is both complex modeling and significant simulation requirements. While the IMA approach may lead to lower capital charges, banks are weighing whether this justifies the added complexity when compared to the relatively simpler Standardized approach. To add to this, it’s unclear whether the US will adopt the Basel III Standardized floor (currently set at 72.5%). The decision about the floor may lead banks to question whether it’s worth investing in internal models.
With all the uncertainty around FRTB, implementation of the framework doesn’t end with performing model tests and producing the capital numbers. Robust and flexible systems will be required to test all aspects and implications of moving to the new framework. For example, it requires the ability not only to calculate PLA metrics and perform the backtesting but also to have tools in place that explain the source of backtesting and P&L Attribution (PLA) failures. Banks will also need to test the implication of using different desk structures and ensuring regulatory compliance. The market volatility from the pandemic has shown the need to test the potential for cliff effects from moving from IMA to the Standardized Approach. Banks will also need dynamic analysis and reporting tools, with what-if capability allowing decision-makers to test any modeling assumption, and re-run analysis with any model input.
The next two years will be busy for US banks preparing for the 2023 Basel deadline. Flexibility will be key to adapting to all possible scenarios as the FRTB rules are finalized.
SS&C Algorithmics FRTB solution has been available since 2016. Our modular solution leverages the same core data and analytics architecture as our market risk, counterparty credit risk and ALM/Liquidity solutions. With this architecture comes extensive model coverage, high performance and scalability, as well as extendibility through APIs. In addition to this, many features and optimizations were added to support FRTB specific calculations and workflow. The SS&C Algorithmics Workspace Analyzer (AWA) works with our FRTB solution to provide aggregation, sandboxing and what-if capabilities.
To learn more about preparing for FRTB and managing implementation challenges please download our "FRTB in 2021: Meeting Implementation Challenges" webinar.
Written by Jeff Aziz
Product Manager FRTB, SS&C Algorithmics