The document discusses concerns that led to the Fundamental Review of the Trading Book (FRTB). It summarizes that pre-FRTB there was unclear classification between banking and trading books allowing regulatory capital arbitrage. Risk measures also failed to fully capture risks like procyclicality, model risk for complex products, and comprehensive risks. The FRTB aims to address these issues with changes like standardized approaches, constraints on modeling, and convergence of prudential and accounting rules. It signals a strategic shift towards limiting internal modeling and preventing methodology arbitrage.
(INDIRA) Call Girl Mumbai Call Now 8250077686 Mumbai Escorts 24x7
CH&Cie - Fundamental Review of the Trading Book
1. Arbitrage opportunity Banking book vs Trading book
• The classification of assets between the banking book and trading book
was unclear allowing arbitrage opportunity for RWA optimization
• For instance, the credit risk component in the banking book is more
demanding in terms of RWA in comparison to the trading book
Volatility of capital assigned for trading positions
• Pro-cyclicality of market risk measures has been revealed in the past
few years, especially for banks using the advanced approach
• As a consequence, the volatility in capital assigned for trading positions
is a concern not in line with regulatory expectations
Model risk for structured and complex products
• The models used as well as the underlying assumptions were unable to
capture embedded risks in complex products
• Whether related to the use of historical data or the nature of the
products itself, model risk has been looked upon very closely
Comprehensive risks coverage
• Both regulatory constraints and internal processes failed to ensure a
comprehensive coverage of all embedded risks in trading positions
• The liquidity component of the trades had not been captured nor the
increasing credit risk components embedded in credit derivatives
Granularity, data quality and aggregation
• The level of granularity on which risk factors were monitored seemed
insufficient to fully capture real trends in the trading portfolios
• The aggregation of data (and its quality) introduced imperfections and
myopia in risk measures
Market Risk RWA Variability
• Following investigations led by the Basel Committee market risk RWA
vary significantly across jurisdictions and portfolios
• These variability could be explained (partially) by discrepancies by
modeling methodologies as well as the approaches (STD vs Adv.)
Multiple concerns behind the scenes that led to the FRTB
Obviously the past few years reshaped the convictions that were commonly acknowledged across the industry.
Besides these convictions, some new loopholes were brought to light by the extreme conditions, deemed
impossible, of the past crisis.
The trading book and the underlying instruments of trading portfolios have been subject to multiple
investigations in order to assess “what went wrong” (as mentioned by the Basel Committee).
The Fundamental review of the Trading Book opens a new era on regulatory perception of the embedded risks
in trading positions. More importantly, it shows a strategic reversal and the willingness of regulators for a
convergence between risk measurement methods (standardized approach vs advanced approach), an
integrated assessment of risk types (from a silo risk assessment to a more comprehensive risk identification)
and an alignment between prudential and accounting rules.
Fundamental Review of the
Trading Book
The purpose of the FRTB is to cover the shortcomings that
both regulatory constraints as well as internal risk processes
failed to capture during the crisis
Market Risk RWA / Total RWA
Market Risk RWA / Total trading assets
1
2
3
4
5
6
40%20%
GS
0%
MS
Nomura
CS
Deutsche
Barclays
RBS
60% 80%
JPM
Commerz
SG
Uni
BNP
HSBC
BOA
Citi
WF
Some figures on market
RWA (as of end 2011)
2. These concerns are to be addressed by a redesign of the
trading portfolios and the risk measures…
The Fundamental Review of the Trading Book presents extensive reshape of the treatment of market
risk. Its redesign is multi-dimensional and ranges from operational implementation, to measurement
and methodologies, to documentation and clarifications…
Trading
book vs
banking
book
• Boundary and classification | The FRTB provides a clarification
on instruments classification and assignment between the banking and
the trading book. Besides providing a pre-defined list of instruments to
be assigned, institutions should provide operational criteria on the
intent of the instrument
Description Impact
• Rigidity of the classification:
once assigned the
reclassification is limited
• Operational constraints to
justify the classification
• Alignment between the books| The FRTB shows a clear
intention of a convergence between the treatment of the two books in
both directions. The treatment of default risk in the trading book is to
get closer to the banking book whereas interest rate risk in the banking
is to be measured in Pillar I (on-going) using a fair value measurement
of the balance sheet
• The intention is to
segregate the two books
while homogenizing the
treatment of risks
Risk
measurem
ent
• Standardized approach| Introduces a higher level of granularity
and bucket differentiation. Each bucket is assigned to a specific
formula. The diversification and hedging positions are better captured
via a revised correlation factor. Design of a method to better capture
various risks (interest rate, FX, equity, …). To be used as a floor
• Higher complexity that the
initial method
• However, it enhances the
transparency in measuring
risks at more granular levels
• Advanced approach| Using internal methods will be definied on a
more granular level via a P&L attribution method,etc… Risk
measurement is consequently done desk by desk. The methodology
relies on the Expected Shortfall (to replace the VaR) with a 97.5%
confidence level (vs 99% for the VaR). Calibration of risks in stress
conditions.
• Complexity in comparing
results related to the
attribution of methods by
desk. Some are eligible
other not eligible
• ES models can be complex
(use of EVT,…)
Framing
and
constraints
• Framing | Securitization positions are no more eligible to the
advanced approach. The Basel Committee imposes the use of the
standardized approach for all securitized positions
• Higher transparency at the
cost of higher RWA
• Constraints | Constraints are provided by the FRTB. A methodology
will be provided for choosing the stressed period. Correlation
parameters in the IDR charge might be constrained as well whereas
the horizons for VaR calculation ( 10 ൈ 1 െ ݀ܽ ܴܸܽ ݕ vs 10 െ
݀ܽ) ܴܸܽ ݕ are subject to similar types of guidance and constraints
• Higher impact on RWA
• Limits arbitrage related to
methodology and methods
This reveals a new tendency in regulatory requirements and the reversal in terms of limiting the ability
for banks in using internal approaches as well as framing methodology arbitrage
• Will this tendency be generalized
because of some discrepancies
that still exist between these
regulations ?
• Under this framework, what is
the relevance of using advanced
approaches?
• Are regulators pushing
(indirectly) for the use of the STD
approach?
• What about overlaps between
the various regulations?
• Are we heading for an over-
coverage of risks?
Convergence between
prudential and accounting rules
Integrated risk assessment
framework
Convergence between the
Standardized and the advanced
approach
Fundamental Review of the
Trading Book
3. Our expertise in the field can help you in various ways
CH&Co dedicated team is constituted of a balanced team of experts in Risk Modeling as well as
regulatory and accounting interpretation. The ability to both interpret the regulation (via benchmarks
and lobbying among the industry participants) and dispatch resources that can assist in quantifying
risks, allows to achieve quick results while being in line and compliant with regulatory requirements.
Our team can deliver the following:
1
2
3
4
5
6
Regulatory Watch & Interpretation
CH&Co has invested in dedicated to both follow-up on regulations and
their evolutions as well as to interpret them and provide our clients
with clear guidelines designed for in-house purposes to measure the
impact on banks’ organization, models, processes and businesses
Model Design
CH&Co Global Research & Analytics (GRA) team is constituted of
dedicated experts in risk modeling and quantification. They can support
in-house teams by both providing a higher workforce as well as
feedback on market best practices
Model Validation
We can assist as well on model validation. Our 15-year expertise in the
field allows providing our clients with added-value in terms of
regulators expectations on tests to be performed, standards to be
achieved and documentation to be put in place
Benchmark
CH&Co contributes to discussions across the industry around regulatory
evolutions and their impact on banks’ business models. CH&Co is also
active in responding to QIS as well as EBA discussions papers (for
instance “Future of the IRB Approach). Plus, CH&Co can deliver
benchmarks on the market best practices
Optimization
CH&Co has led multiple assignments and discussions on optimizing
RWAs in an environment with high pressure on ROEs and capital. The
areas for optimization are important but can’t be achieved without
difficulty. Therefore, managing risks in an integrated way (vs silo) is key
Support in strategic decisions
Multiple institutions are adapting their strategies to the evolutions in
regulations and the financial sector. CH&Co can provide decision-
making solutions by simulating impacts, projecting strategic and
business related items and facilitate communication with Senior
Management
CH&Co is also
active in publishing
articles and White
Papers. Our teams
try to answer
questions among
market participants
as well as work on
Research to
continually
enhance risk
measurement
methodologies.
Check out our
publications and
white papers on
our website:
http://www.chapp
uishalder.com/publ
ications/
Stéphane Eyraud, Partner & CEO
Tel UK: + 44 78 34 55 03 98
Tel FR: + 33 6 12 41 64 06
seyraud@chappuishalder.com
Benoit Genest, Partner & head of GRA
Tel FR: + 33 7 87 68 81 77
bgenest@chappuishalder.com
Ziad Fares, Manager GRA, R&D
Tel FR: + 33 6 62 96 25 00
zfares@chappuishalder.com
Fundamental Review of the
Trading Book