The FRTB challenge: banks brace for further uncertainty

The widely anticipated implementation of the Fundamental Review of the Trading Book (FRTB) hit another obstacle when the Basel Committee on Banking Supervision pushed back the roll-out by another year to January 2023. With different jurisdictions progressing at different paces in their interpretations and setting implementation dates, the enforcement of FRTB now looks likely to be significantly delayed. The lack of clarity from local regulators – which is likely to have different implementation timelines across jurisdictions – is already impacting some banks as they lag behind in the preparatory work needed to be compliant with the rules

The global implementation of FRTB continues to be fraught with challenges as uncertainty in the timeline and regulation looms, despite a deferment of the enforcement date to January 2023.

The Basel Committee pushed back the roll-out date as part of the overall Basel III implementation. While the deadline extension is supposed to provide banks with some measure of relief, banks globally now face more uncertainty as jurisdictions proceed at a different pace in interpreting the rules and setting implementation dates, causing level-playing-field concerns across the industry, says Fausto Marseglia, Refinitiv’s head of product management, FRTB and regulatory propositions.

Europe has made by far the most progress in interpreting the FRTB rules compared with other jurisdictions, but is also significantly delaying FRTB implementation beyond the deadline set by the Basel Committee. The European Union is taking a phased approach to FRTB roll-out, where the reporting requirements were planned to be implemented first, under the Capital Requirements Regulation (CRR) II directive, followed by the capital requirements under the CRR III rules proposed in October.

Marseglia expects the EU to implement the reporting requirements in early 2025, considering they will only take effect three years after the publication of the Regulatory Technical Standards on liquidity horizons, modellability of risk factors, back-testing and profit-and-loss (P&L) requirements in the Official Journal of the European Union, likely by the end of March 2022.

CRR III, issued at the end of October, indicates that the application of the capital requirements is expected on January 1, 2025. The proposal introduces some flexibility to address eventual level-playing-field concerns, as it provides the European Commission with the mandate to monitor the implementation of FRTB in the other major jurisdictions, and empowers it to defer the go-live date by a further two years.

“With CRR III, the implementation of the capital requirements is expected to kick off more or less at the same time as the reporting requirements application, which would make the reporting requirements effectively obsolete,” Marseglia says. “Also, the possibility to push the go-live date back by two years is a clear sign they don’t want to be a frontrunner and create a situation where local banks could be disadvantaged in case other major jurisdictions defer the go-live date even further. There is a clear level-playing-field concern we are seeing across all jurisdictions, as divergences in the timelines and rules will cause distortion and significant additional costs to the implementation.”

Delays in FRTB implementation bring uncertainty to banks

The delay in FRTB implementation in Europe is already having an impact on countries outside the continent. In the Asia-Pacific (Apac) region, although major jurisdictions have consulted on the FRTB framework, only a few have finalised plans and provided go-live dates. Japan’s Financial Services Agency has recently set its go-live to March 2023, while the Australian Prudential Regulation Authority has announced a one-year delay, moving the deadline to 2024. However, there is increasing concern in the region about market fragmentation, which would hinder a level playing field in rule implementation and timelines. To cope with that, the Hong Kong Monetary Authority is expected to go live in July 2023 with transitional arrangements, similar to reporting requirements announced in the EU, and actively monitor what is going to happen in other jurisdictions before setting a go-live date for capital requirements. Other jurisdictions are lagging behind and have yet to publish their market risk frameworks and related go-live dates.

The EU’s delay has led banks in Apac jurisdictions to believe their regulators will follow suit, bringing further uncertainty and raising concerns about market fragmentation, causing those banks to lag behind in their FRTB implementation as they await clarity from local regulators, according to Marseglia.

“Banks decide their investments based on priorities. In countries with delays, banks are putting their investments towards other priorities, rather than the preparation work needed to comply with the FRTB rules,” he says.

Similarly, in the US, banks are lagging in their preparation for FRTB implementation because of an expectation that the rules are unlikely to go live in January 2023. This is despite the US Federal Reserve previously signalling its intention to meet the Basel Committee’s January 2023 deadline for implementing FRTB and Basel III.

The fact the Fed is yet to publish its rule interpretation, and that the Federal Reserve Supervision and Regulation Report, published in April, failed to mention FRTB among its supervisory priorities for large institutions has raised questions about whether it will release its rule interpretation at all, and the possibility of aligning with the Basel Committee’s implementation deadline, Marseglia says.

“Aside from varying local conditions, the Covid-19 pandemic remains one of the threats that could hinder the ambitions to fully implement Basel III by 2023. Flexibility on the final deadline might be needed depending on how the pandemic pans out and the related restrictive measures,” he added.

IMA: a work in progress

Amid the uncertainty, banks must push on with preparations. One of the key priorities – particularly for large global banks – is finalising the decision on desks will take the internal models approach (IMA) and to assess the impact of non-modellable risk factors (NMRFs) on capital charges, Marseglia says.

Desks that want to be eligible for the IMA will have to pass certain onerous quantitative examinations in the form of the P&L attribution test and backtesting. Desks that get the green light will have to undergo another step – the risk factor eligibility test (RFET) – to ensure every risk factor at desk level has sufficient liquidity for inclusion in the desk market risk model for the capital requirements calculation. Risk factors that do not show sufficient trading activity – NMRFs – will be excluded.

“NMRFs are subject to a capital requirement calculation under the stressed expected shortfall [SES] measure, which is much more punitive. Now banks are assessing the impact of NMRFs on capital charges for desks adopting IMA. They do this by first assessing the SES resulting from the pure usage of their internal trades, and then importing data from external vendors. If using a third party enables them to benefit from significant capital charge savings for those NMRFs, it is likely they will buy the data,” Marseglia says.

Extracting internal trade data from their applications for assessing the capital charges for internal models and NMRFs is a complex undertaking if banks lack the necessary data management infrastructure, according to Marseglia.

“Assessing the data to figure out how [it] would minimise the NMRFs and computing the capital charges is not a simple task. In some cases, the money they have to spend on extracting trades is more than what they would spend on buying data from external vendors,” Marseglia says. He expects banks to finalise the work by the second quarter of 2022 at the latest.

In Asia, fewer banks are involved in the work around IMA as most will adopt the standardised approach, considering their less complex trading books and the difficulty to pass NMRFs for certain products with longer tenors, given the limited number of price observations available.

One final challenge that poses further uncertainty is the risk of divergence in the interpretation of the rules, which would bring further complexity and costs in the implementation, such as the the definition of committed quotes for the RFET, which looks significantly different between the Basel Committee text and the EU interpretation.

“Most banks are still unsure on whether they can use committed quotes for the RFET and are waiting for further clarification. It will be interesting to see what the Fed says about this, and other key aspects of the Basel Committee text, if and when it publishes its interpretation,” Marseglia says.

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