By David Scalzetti, CFA - Senior Regulatory Products Director, ICE Data Services

January 14, 2019 brought us the long awaited final FRTB BCBS rule. There are a number of accommodations offered by regulators to ease capital burdens associated with the rule. These include changes to the Standardized Approach (SA), the Internal Model Approach (IMA) (including Profit & Loss Attribution (PLA) tests and back testing requirements) as well as revisions to the Risk Factor Eligibility Test (RFET). Here, I take a deeper dive into the RFET.

Under the final rule, the RFET has seen some notable changes. No more than one price observation per day is eligible and the test itself is broken down into two distinct parts.

  1. First, if there are at least 100 days with observations in the previous year, no further analysis is required and the associated risk factors are modellable.
  2. Second, when 100 days of observations are not available, the original proposal is modified such that there are at least 24 observations in the year and every rolling 90-day period has at least 4 observations (the original proposal required 24 observations with no 30-day period lacking an observation).

This new RFET structure offers significant benefits to the industry. Firstly, for risk factors that are supported by highly liquid and observable sets of market data (i.e. 100 days of observations), this expectedly simplifies the test as is warranted by something that is so transparent. Secondly, the change from a ‘no 30-day period with a gap in observability’ to a ‘rolling 90-day period with at least 4 observations’ addresses a valid industry concern around seasonality. ICE Data Services submitted a comment letter [in June 2018] to the March 22, 2018 consultation paper highlighting some potential unintended consequences of the 30-day gap test (Read here) where certain exchange-traded power contracts that are generally accepted to be fairly liquid would be deemed non-modellable due to seasonality affects. This, along with numerous other such examples, is more intuitively handled under the new test.

Many banks that I have spoken to still expect to engage third parties to assist with the RFET in order to maximize the modellability of their risk factors.

Moreover, the final rule is definitively more accommodative with regards to the capital surcharges associated with non-modellable risk factors. The IMA broadly had higher regulatory capital charges relative to the SA, which has now been addressed. The reduced penalty may lead banks to apply for more trading desks on the IMA.

That being said, many banks that I have spoken to still expect to engage third parties to assist with the RFET in order to maximize the modellability of their risk factors. The final rule addresses this with a partial clarification that banks can indeed utilize third party vendors for RFET data if an independent audit to validate their approach and the underlying market data is performed and subsequently those audit reports are made available to the banks and their regulators.

As banks work towards the 2022 deadline for full implementation of the rule, ICE Data Services remains dedicated to providing the necessary clarity and perspective to customers, partnering closely to help navigate the myriad rules and ensuring timely compliance with our flexible data and technology solutions.

Explore how ICE Data Services can help with FRTB compliance.

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