FRTB – part of a global regulatory strategy
From a regulatory perspective, market risk affecting a given company can lead to cascading events across multiple companies that cause systemic challenges. Connection and the threat of infection keep regulators up at night and drive the global regulatory strategy. Contradictory political statements aside, this strategy is clear and will move inexorably forward.
FRTB should be seen as a measure in the context of a wider, global regulatory program. We already know that this program will include firewalls and additional capital buffers as well as ring fences that will force business areas to stand on their own. These requirements and the cost of implementation will cause banks to reassess capital allocation and possibly shift selected business areas. In the future, business processes, workflows and technology will be further influenced by increasingly frequent regulatory spot checks by assessors that require firm market risk assessments within minutes.
The danger of a wait-and-see approach
As these two waves inevitably converge, it turns out to be risky and expensive to wait to see what happens.
Risks because failure to manage market risk intraday will put companies at a competitive disadvantage while being exposed to an unacceptable level of risk. Expensive, because responding to each new regulation without a coherent plan has resulted in regulatory costs (as a percentage of operating expenses) of 4-6 percent. Continuing a reactive path for new rules will double this to 8-12 percent.
From a risk or cost management perspective, this is clearly not a sustainable model. Instead, plans to implement the FRTB must proceed now, while laying the foundations for tackling current and imminent regulations.
FRTB next step – remember the gaps and assess the impact
Banks should begin by identifying gaps in current versus required capabilities as well as the potential impact of FRTB on the firm’s business model. They also need to consider requirements such as ringfencing and samples that you will definitely follow. Conversations with our clients reveal the following as some of their biggest concerns about gaps in their capacity and the potential impact of FRTB on their business:
Holes that cause concern with the FRTB implementation:
- Processing data for overnight data will have to migrate to near real time, enabling analysis and reporting as needed.
- Existing systems may not be scaled. FRTB scenarios with longer liquidity horizons may require up to 15,000 simulations per year. Trade.
- Model risk management may need improvements, including centralized governance, a view on interconnection and modeling of external parameters, including counterparty, economic and political risk. Testing and checking holes for new models can result in significant losses.
- Can you close the data gap with a data management solution that meets FRTB requirements as well as other accounting or regulatory requirements such as expected credit loss or stress testing?
Evaluation of the impact of FRTB on each desktop and industry:
- What analytical risk / funding environment allows the bank to deal with what-if-questions?
- How will new FRTB Standard Approach (SA) and Internal Model Input (IMA) market risk modeling scenarios affect capital?
- Is there a critical mass of desks that justify investing against costs that can be moved to an IMA?
- Will separating the banking and trading book affect margins, credit ratings or liquidity? Should any form of dismissal be considered?
- Should the company assess the potential costs / benefits of migrating toward cloud-based compliance-as-a-service?
One last word – competition
A handful of leading international banks and investment managers who have proactively addressed the challenges of assessing intraday market risk – including JPMorgan Chase, Goldman Sachs and Blackrock – cite benefits such as improved risk management, capital optimization and balance immunization.
To compete with these best-in-class companies, a wait-and-see reactive approach to new rules will prove to be too little, too late. Financial institutions need to proactively improve business risk and capital management, automate their workflow to provide intelligence as needed and address compliance with a lower cost structure. Along the way, they will derive data and information to create new revenue streams and achieve their business goals.