FRTB has borne fruit despite delays

This article is based on a Risk.net podcast with Eugene Stern, Head of Market Risk Product at Bloomberg.

Born out of the 2008 credit crisis, FRTB has taken so long to implement that the next major global market crisis – economic stress caused by the COVID-19 pandemic – arrived before full implementation could take place. That said, banks were already much better prepared and better capitalized in 2020 than they were in 2008.

Having FRTB as a target has motivated banks to improve their risk management tools, meaning the regulation has already borne fruit, even before full implementation.

Although banks are in different places regarding the fine-tuning of FRTB implementation, and many still lack a full FRTB workflow, by and large they responded reasonably well to the market volatility of 2020.

The year ahead: FRTB An interview with Eugene Stern, Global Head of Market Risk Product at Bloomberg

Full implementation remains an ongoing challenge. Although FRTB was meant to incentivize banks to think about the bigger picture, ironically, it has bogged them down in details. Banks often end up getting caught up in overly technical discussions, debating, for example, the scope of credit or vega or which risk bucket to use, or worrying over look through constituents and the details of curves required for calculations for P&L attribution tests. The avalanche of details can be overwhelming and arguably represents one of the weaknesses of the framework. However, many banks - from the biggest global players to the smaller regional banks - have been stepping up to the challenges, and while the process isn’t over yet, surviving 2020 is proof that significant progress has been made.

A mixed picture: banks at different stages

Depending on their size, risk-taking, and risk technology, different banks need to upgrade different parts of the workflow to establish a fully FRTB compliant risk platform. Many midsize banks and smaller multinationals, for example, still need to figure out how to model optionality in their credit portfolios or how to align models and inputs between trading and risk. Meanwhile, many larger multinationals and global banks are working on their approach to fund exposures, unwilling to model them just as miscellaneous equity holdings with a high-risk weight.

No matter where they are, all banks need an accurate, consistent and scalable risk platform that covers every asset class.

Many have grappled with the question of whether to build the platform on their own or in conjunction with a strategic partner. If with a strategic partner, they will need to decide which elements of the platform the partner should help develop.

Bloomberg thinks of FRTB as a component of an overall risk platform – a distinction particularly important for banks that choose to focus on SA (Standardized Approach). For example, although under SA, VaR is no longer required for capital, most banks still expect to keep using VaR for internal risk management. Banks that focus exclusively on FRTB run the risk of neglecting internal risk management and ending up with two separate systems, one for SA and another for VaR, with separate sets of employees managing each one, and possibly a third set of employees trying to align data and models between the two. Such disparity creates an expensive and hard-to-manage mess, both operationally and in terms of risk-decision-making capacity.

Banks that think strategically recognize the value of a single platform and consistent data set, of having access to quality market, reference and classification data, and a single set of pricing models, as the backbone of all risk applications, be they VaR, FRTB, stress testing, or front-office Greeks.

Their budget to build an FRTB solution is seen as an opportunity to upgrade their entire risk platform and fulfil both internal and regulatory risk management needs.

Still, making informed implementation choices is challenging. FRTB is composed of many moving parts, and each choice involves trade-offs from a cost-benefit perspective; whether, for example, banks should adopt SA or IMA, or obtain data from one source or several, remain key decision points. However, it’s hard to estimate costs and benefits without getting part way through an implementation.

Although the global COVID-19 pandemic prompted a one-year global delay for FRTB from the regulatory side, most banks got back up and running with their FRTB implementations fairly quickly, putting their implementation plans on pause for only two or three months as they dealt with more immediate pandemic-related issues. In the EU, the EBA was quick to signal that they expected banks to start reporting FRTB SA capital in September 2021, and so far banks appear to be diligently preparing for that deadline .

In the US, the big global banks are relatively far along in their implementations, with planning guided by global dates, while smaller banks tend to vary more in their levels of progress. In recent months, the US Federal Reserve has started to signal expectations for higher levels of implementation activity, with model approvals potentially starting as early as H2 2021.

Banks, especially regionals, are in different stages with respect to those expectations, with some actively trying to get ahead of the rule, while others take a wait-and-see approach. Less proactive banks may find they have less time than they think to satisfy regulatory demands.

It is important to remember that FRTB is both a regulatory exercise and an opportunity to upgrade overall risk management performance.

In conclusion, Bloomberg has three recommendations for 2021. Firstly, banks should make sure their implementation programs are up and running and in qualified hands. Secondly, banks should locate their main implementation decision points and obtain the information necessary to make those decisions. Finally, once the basic FRTB framework is up and running, banks should integrate it into their overall decision-making process, both in terms of tactical trading decisions and more strategic decisions.

How Bloomberg can help

In order to implement FRTB by 2022, banks must enhance their risk architecture and governance processes and reconsider the ways in which they acquire, align and use their reference and market data. Whether you require FRTB-ready market data, a reliable risk analytics engine or a full end-to-end workflow, Bloomberg can customize a package to meet your needs.

What do you consider to be the main challenges that you will face to deliver FRTB?

Extended regulatory timelines make it difficult to obtain budget / funding for the FRTB implementation
Calculating the cost benefit of IMA vs. SA and deciding whether the bank will pursue IMA
Gaining regulatory approval for IMA due to backtesting and P&L attribution difficulties
Data requirements: cleansing, granularity and capturing historical data such as volatility and curves, static and classification data (for bucketing purposes) and real price observations for IMA RFET
Alignment of Market Risk and Front office pricing models