FRTB: A New Market Risk and Capital Requirement Framework for Global Banks

Earlier this year, the Basel Committee on Banking Supervision published final rules related to the Fundamental Review of the Trading Book (FRTB). By January 2019, each member country, including the United States are expected to finalize implementation of the FRTB framework, with reporting by global banks under the new framework to commence by the end of 2019.

The new standards are focused on creating a more resilient banking sector as well as strengthening capital standards for market risk. This will include a more prescriptive boundary between trading book and banking book to reduce the scope of arbitrage, the introduction of highly prescriptive and standardized risk metrics, and trading desk-level model approval process for internal model approaches.

Overview of the proposed solution

An integrated service comprised of four key solutions, combining expertise and infrastructure from across ICE.

Data Service
Modellable Risk Factor Service
User Interface
Data Pooling

HISTORICAL VALUATIONS AND INPUT PRICING DATA FOR REQUIRED BACK-TESTING AND MODELS

Entities will need at least 10 years of historical prices and associated metadata to comply with the back-testing requirements as well as for populating historical Expected Shortfall (ES) models. Results will be disclosed to national supervisors using a three-zone approach for the classification of their back-testing results (i.e. green, yellow or red). ICE Data Services is a leading providers of OTC Derivatives valuations, Fixed Income evaluated pricing, pricing for Equity markets and transparency data. For example, data sets such as granular implied volatility surfaces, forward curves, dividends, correlations, etc. are available both ongoing and up to 10 years of history across all major derivatives asset classes.

Our data is collected from a multitude of sources such as exchanges, interdealer brokers, market-making dealers, data aggregators, and trading venues to name a few. Our processes include quality assurance measures prior to the delivery of the data to customers.

“REAL PRICE” EVIDENTIARY SUPPORT

The process for determining the eligibility of a trading desk for the internal models-based approach is based on, among other things, a risk factor analysis. For a bank to classify a risk factor as modellable, there must be continuously available “real prices” for a sufficient set of representative transactions. This is defined as having at least 24 observable real prices over a rolling 12-month period with a maximum period of one month between any two consecutive observations. Real prices are further defined as a price at which the institution has conducted a transaction, a verifiable price of an arms-length trade at other institutions, or prices obtained from committed quotes.

For certain asset classes (e.g. Equities and most Fixed Income), ICE Data Services is considering creating a flag that will identify which instruments have market data that would meet the criteria for a “real price”. We consider making supporting information to this flag also available, including the count of eligible observations in the last 12-months, the longest gap between two consecutive eligible observations, and the time period necessary to get the most recent 24 eligible observations into scope. In addition, we plan on creating the aforementioned statistics both on the target instrument in isolation, as well as for a cohort group or cluster. We are currently working with industry participants and experts to see what evidentiary support we can generate for other asset classes to help entities support this classification.

STANDARDIZED RISK METRIC INPUTS

The standardized formulae coming out of the FRTB requirements will require a wide range of prescribed inputs to be utilized. ICE Data Services plans to develop new instrument-level attributes that will help identify these values where appropriate. For example, we plan to develop FRTB-specific attributes for asset sector classifications, risk-weighting assignments, correlation parameters, applicable vertices or maturities, liquidity horizons, jump-to-default (JTD) inputs for securitizations.

LIQUIDITY INDICATORS SERVICE

For each of the bank’s trading desks, the bank must prepare, evaluate and have available for supervisors certain reports including reports on the assessment of market liquidity. ICE Liquidity Indicators service calculates instrument-level liquidity indicators that can be a useful input in the bank’s assessment of market liquidity. For certain asset classes, our Liquidity Indicators service includes metrics such as sector-level scores, portfolio-level scores, projected volumes and volatilities, as well as liquidity stress-testing capabilities.

INDEPENDENT PRICE VERIFICATION

FRTB reiterates the necessity for banks to perform independent verification of its daily mark-to-market activities, and suggests that verification of market prices is performed at least monthly, from a unit independent of the trading/dealing room. ICE Data Services offers various transparency tools and portals that can serve as inputs into the verification workflow.

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