In the context of the new global crisis due to the COVID-19 pandemic, banks must accelerate trends that have been already reshaping their business. Only flexible and effective organizations will overcome these challenging times.

The Fundamental Review of the Trading Book (FRTB) has been one of the major concerns within capital market firms since 2016. This regulatory framework introduced new methods of measuring Market Risks in order to ensure more accurate risk management. Its implementation resulted in the massive transformation of current practices and tools, along with significant investments made by banks across the globe.

As of today, banks have already made their key technology choices (i.e. Target Functional Architecture, Target Applicative Architecture), the implementation is on track and guidelines of the FRTB strategy are defined by the executive. Now the time has come to focus on a Target Operating model of the whole future Market Risk Department.

Operationalization of the FRTB implementation

The new effective Market Risk Operating Model should be addressing several areas:

• Define ambitions & the orientation of the Market Risk Department and its role in cooperation with other departments of the bank (i.e. Front Office, Finance, ….) → client-facing / instructing party-oriented approach
• Clarify the scope of the work, including new FRTB metrics, firstly for SA, then for IMA (depending of IMA implementation strategy): the most value-added tasks, the low-value added tasks, processes that may be streamlined (i.e. emphasis on strategic activities, analytics & true risk indicators for business decisions, while reducing human efforts in low value-added tasks) → process oriented approach
• Leverage on data-driven decision making with clearly defined governance, data collection and data quality assurance processes → data-oriented approach
• Refine the right personnel skillset and recognize talents → talent-oriented approach

Definition of the Target Operation Model of the New Market Risk Department Should Include:

This integrated approach, that addresses the key considerations of the Market Risk executive, will allow banks to move towards the new generation of Market Risk management. Through intelligent automation, optimized business processes and usage of the right capabilities and skills, banks could manage to balance out their operational costs.

It will allow banks to push transformation even further: retain and attract new talents, anticipate and manage new risks in order to define the new strategic development of the bank. Such a paradigm shift, in general, will help to reinvigorate the financial system and in specific cases, it will help to reassure clients and investors about the resilience and sustainable growth of the firm.

Reminder of the Market Risk Transformation Path

Since the BCBS text was released in 2016, banks have started large FRTB transformation programs in order to tackle complexity and to achieve compliance within aggressive deadlines. Financial institutions devoted significant attention to this subject and allocated substantial budgets to comply with this new regulation.

The first step of a common Market Risk transformation path, driven by FRTB, was a detailed scoping of new requirements. Some articles of the regulatory text were not clear enough and were subject to discussion between the BCBS, national authorities and market participants for several months. As a result, an amended BCBS text was released in early 2019 addressing major market concerns (i.e. P&L attribution text with red, amber & green zones; reduced number of market observations for NMRF…).

Furthermore, banks built their FRTB implementation strategy:

• For the standardised approach (SA), which must be computed and reported by all banks involved in trading activities, there were two options: (1) use a vendor solution, or (2) build an in-house SA calculator. Each option has its advantages and risks, and both are highly impacted by data quality challenges. It makes the SA operational implementation quite complex and time-consuming, but achievable within regulatory deadlines.
• For the internal models approach, each bank may choose whether to implement it or not and to what extent. The operational implementation of the IMA is much more demanding than the SA, and more difficult to achieve within the deadlines. Given the complexity of computations and the significant technology investments required, banks may need to choose what business lines (or trading desks, or asset classes) need to be prioritized in their FRTB IMA implantation roadmap.

Then, banks had to review their technology capacities to address an increased complexity for FRTB computations, because additional capabilities were required to run analytics & reporting. Most commonly, banks decided to take this opportunity and to invest in new technologies in order to enhance Market Risk functions and to address future regulatory requirements (i.e. increased computation grid capacities, big data storage, data driven analytics…). As a result, many banks invested in the revamping of their Market Risk framework in order to build a new scalable ecosystem with effective solutions to meet future business and regulatory needs on demand.

FRTB at a glance

FRTB overhauls the current Market Risk capital framework to enhance the risk measurement and to reduce the variability of risk weighted assets across banks. It includes new quantitative metrics and enhanced governance through business lines.

All banks, implicated in trading activities, must calculate and report the capital requirement values in accordance with the Standardised Approach (SA). In addition, they may choose to apply for Internal Models Approach (IMA) on trading desk level, that will be subject to the approval of the national authorities.

The Basel Committee on Banking Supervision (BCBS) sets out the FRTB requirements to serve as the Pillar 1 minimum capital requirement as of 1 January 2023, while national authorities have not yet announced final binding dates. In Europe, first, the FRTB metrics will be posted for reporting needs only: in 2021 for SA, and in 2023 for IMA; the FRTB capital charge impact is expected not earlier than in 2025 at this stage. Asia and the US have not yet confirmed their commitment to implement FRTB.

If you have any questions or you would like to discuss in more detail regarding the Market Risk management transformation path and its operational implementation that may benefit your firm, please feel free to contact us here.