FRTB in APAC: Challenges, Solutions, and Strategic Implementation 

Despite its challenges, FRTB presents an opportunity for banks to modernise and for the industry to enhance stability and sophistication, says Yingqi Zhu.

In the dynamic realm of the APAC financial sector, the looming implementation of the Fundamental Review of the Trading Book (FRTB) is taking center stage. FRTB was initiated by the Basel Committee on Banking Supervision and represents a global set of rules that specify the minimum capital requirements that apply to banks’ trading activities. The rules are designed to prevent the losses that occurred on trading books in the wake of the 2008 global financial crisis.

FRTB represents the most significant market risk regulatory change in at least the last decade and is intended to better capture the risk of a bank’s trading book positions and thereby fortify the APAC region against potential financial calamities.

As implementation nears, the monumental nature of this regulatory shift is becoming increasingly apparent, and adherence is laden with challenges unique within the APAC context.

Implementation Deadlines 

Deadlines across the APAC region vary greatly from country to country. For instance, South Korea has been live since January 2023, showcasing early adoption. In contrast, China and Indonesia’s effective dates commence in 2024. Australia, however, follows a more extended timeline, with consultations slated for this year and the go-live not scheduled until tentatively 2026.

Numerous other regions converge on 2024 dates; India is proposed for April 2024, while Japan’s global banks are set to go live in March 2024, with their domestic banks following behind one year later. Hong Kong SAR and Singapore introduce an added layer of complexity. Hong Kong SAR initiates a reporting-only requirement in July 2024, followed by a full go-live in January 2025. Meanwhile, Singapore’s supervisory reporting is set to take effect in July 2024, with Capital Adequacy & disclosure slated for January 2025.

Standardised Model Approach or the Internal Model Approach

There are two model approaches for determining the appropriate level of capital for the risk a bank is taking: the Standardised Model Approach (SA) or the Internal Model Approach (IMA). The choice between the two comes down to which one gives the most sufficient capital to absorb losses, and each bank will need to evaluate the pros and cons of each approach.

Navigating risk modelling proves more intricate for the IMA than the SA. IMA demands meticulous internal models for market risk and obligor default and is subject to rigorous validation and regulatory approval. Despite the challenges, IMA often yields efficient, cost-saving capital requirements compared to the conservative SA. In the APAC region, SA also encounters modelling hurdles. Some banks lack essential pricing models for trading book products, while others grapple with insufficiently sophisticated models, hindering sensitivity calculations. The diversity of structures traded in APAC underscores the need for robust pricing models.

IMA complexities extend to aligning models with trading strategies, balancing basis risks, and handling outlier scenarios. Additionally, IMA faces challenges in generating SES, modelling default correlations and managing the significant computational load for Expected Shortfalls across various scenarios. Resource constraints exacerbate the challenges, hindering banks from running models and explaining results comprehensively. The journey through risk modelling complexities requires precision, efficiency, and strategic resource optimisation.

Addressing this complexity necessitates tapping into the expertise of middle and front-office talents and involving them in the implementation process. Seeking internal and external resources and exploring vendor solutions are viable avenues to alleviating modelling challenges.

Role of Data

Accurate market and trade data play a pivotal role in pricing trades and calculating sensitivities. Legacy systems often struggle to capture the full complexity of trades, leading to inaccuracies. SA requires categorising risk factors and trades into specified buckets, a task complicated by the absence of necessary data items in existing systems. Meanwhile, IMA faces a significant hurdle in obtaining real price observations for the Risk Factor Eligibility Test (RFET), which is particularly challenging in the less liquid markets of the APAC region.

A potential solution lies in enhancing front office systems, as they serve as the starting point for trade data. Front office traders who have intimate knowledge of trade categories can contribute to more accurate data for SA’s Residual Risk Add-On (RRAO) calculations and bucketing. Data vendors offer support for risk factor bucketing, but maintaining mappings to their data IDs remains a bank responsibility. Improved trade capturing and collaboration with front office teams can enhance the accuracy of data crucial for successful FRTB implementation.

As FRTB implementation is still new to the market, there is not much experience in managing the implementation project. Banks encounter unforeseen issues, such as missing data items and evolving models during the project, while the business workflow for capital requirement calculations demands extensive collaboration and consideration of ongoing validation and fallback plans, particularly for the IMA. Additionally, concurrent regulations, like for counterparty credit risk and CVA risk, impact project plans.

A viable solution involves a well-planned, phased approach to FRTB implementation. It is preferable for training to be provided, as needed, to senior managers, project managers, and any relevant key function members. Ideally, they already possess a background in FRTB, related regulations, well as pricing and risk modelling. Involving the Front Office and Middle Office is crucial for addressing modelling and data challenges. Emphasising to the Front Office that FRTB implementation not only calculates capital requirements but also enhances trading business efficiency and risk management is key. Effective communication among stakeholders is essential as their numbers increase.

The suggested pathway to FRTB implementation is to take the Standardised Model Approach first to meet go-live dates and gain valuable modelling and data experience, a prerequisite for IMA adoption. Subsequently, IMA implementation is recommended desk by desk, with desk-level model validations determining eligibility. Leveraging FRTB calculations for risk management and communication further enhances the strategic value of the implementation, emphasising the potential dual role of FRTB solutions in both regulatory compliance and risk management.

FRTB Represents an Opportunity 

In conclusion, the challenges of FRTB implementation in the APAC region are substantial but not insurmountable. Additionally, it should be considered that FRTB is not just capital regulation but a strategic opportunity for banks to modernise their business and systems with advanced technologies. By successfully implementing FRTB, the APAC financial sector can achieve more stability and sophistication in front-office trading and middle-office risk management systems.

The road ahead demands proactive collaboration among financial institutions, significant investments in technology, and the development of strategies to navigate the complexities of FRTB in the APAC context. Embracing this challenge will undoubtedly pave the way for an even more resilient and sophisticated financial sector in the APAC region.

Yingqi Zhu is Director of Pre-Sales and Business Development for APAC at Numerix Japan.

 

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