Have you heard of FRTB? Well, you should have

It's only six months until the long delayed Fundamental Review of the Trading Book regulation finally comes into force - but are banks ready for the changes it will bring?

The Fundamental Review of the Trading Book (FRTB) was originally introduced following the aftermath of the 2008 global financial crisis but has since been delayed with an implementation date of January 2023 finally agreed upon.

It provides a global set of rules which specify the minimum regulatory capital requirements that apply to banks’ wholesale trading activities. The rules were created in response to the systemic losses that were seen on trading books during the financial crisis.

The FRTB’s main challenge is differentiating the boundary between the trading book and the banking books, with its rules having the goal of creating a distinction between assets intended for active trading as opposed to those expected to be held to maturity such as customer loans.

In addition, the rules look to combat market illiquidity concerns as well as the use of expected shortfall, as opposed to value at risk, as a method to measure risk under stress – allowing banks to capture tail risk events.

Compared to previous methods used in the past, banks will now be required to calculate a Standardised Approach (SA) that is more complex and risk-sensitive than before.

Delays for implementation

Initial proposals for FRTB were published for consultation in May 2012 and the rules were finalised in January 2016 with an intended implementation date set for January 2019.

To allow enough time for the industry to implement the changes and to absorb higher capital requirements, the date was pushed back until this year. However, due to global pandemic, the implementation date has once again been delayed until January next year.

Impact of FRTB

 When the rules are eventually implemented, the capital that large banks need to hold against trading various products – such as derivatives which are illiquid or have risk profiles that are not easy to benchmark – is expected to increase significantly.

In addition, added costs may result from risks that are not backed by enough data and consequently considered ‘non-modellable’.

FRTB will also introduce new treatments of fund and index exposures which may be of concern to banks. The new regulation will require holdings data to be made regularly by funds to measure fund risk through the Look Through (LT) approach, which uses underlying constituents to assess positions – an approach where accurate and robust fund data is required.

Elsewhere, the FRTB will bring substantial compliance costs as regulators have insisted on receiving metrics reported desk by desk as opposed to in aggregate across an entire organisation.

As with any upcoming regulation, banks should be encouraged to start preparing for implementation as soon as possible. The FRTB’s requirements surrounding reporting, data management and ensuring organisational flows of information are created appropriately, will need enhanced technical processes to be deployed.

To comply to the upcoming rules, ample time and resources are necessary to develop and test models that will incorporate new methodologies and data requirements.