FRTB regulation threatens trading desk closures

Banks are estimated to spend more than $200 million to implement the new capital requirements.

Certain trading desks at banks could face the threat of closure if they are unable to adhere to incoming market risk capital rules.

The Fundamental Review of the Trading Book (FRTB) regulation requires banks to completely overhaul the way their trading desks manage and monitor market risk.

Banks will have to choose which capital calculation model to adopt to reflect the risk of each desk independently. If they are unable to adopt an internal model approach (IMA), it would have to default to an imposed standard approach.

If banks are forced to adopt the standard approach and fail to comply, it could result in several trading desks facing closure.

“Clarity aids risk management in monitoring and encouraging productive trading strategies and to penalise those who have not adhered to an IMA. The subsequent risk for non-adherence being that regulators impose a more punitive standardised approach on the institution,” said Dan Marcus, global head of strategy and business development, Tradition.

“Desks, which do not adhere to efficiency standards will inevitably incur costs which could ultimately see them being closed down.”

A recent study from Oliver Wyman estimated that banks are set to spend more than $200 million each to implement the requirements. In addition market experts believe risk capital requirements could rise by anything between 1.5 to 2.4 times more than they are now as a result of implementation.

One solution for banks is to restructure and align their trading desks to offset capital calculations and gain approval to adopt the IMA model. 

“For internal models approval, a desk needs to pass stringent rules around back-testing and P&L (profit and loss) attribution,” said Anthony Pereira, founder and CEO of Percentile.

“Desks can be restructured based on trading frequency which affects the ability to model actual and hypothetical P&L for back-testing. The inability to closely model risk and trading P&L might cause a desk to fail the P&L attribution test and influence a restructuring.”