Courtesy of Mete Feridun
Disclaimer: The views and opinions expressed in this blog are those of the author and do not necessarily reflect the official views and opinions of PwC.
In response to the global financial crisis, the Basel Committee initiated an overhaul of the market risk capital rules to address shortcomings in the current framework with a more coherent and risk-sensitive regime, known as the Fundamental Review of the Trading Book (FRTB). The Committee initially published the FRTB framework in the beginning of 2016 with a view to be implemented by 1 January 2019. However, the framework was met by opposition due to some issues related to the calibration and the structure of the Standardized Approach to market risk. This prompted the Committee to publish a revised version and to push back the go-live date to 2022.
Implementing the FRTB Globally
The FRTB introduces fundamental changes to the market risk framework. For instance, to enhance consistency and risk-weight comparability across banks, it revises the Internal Models Approach (IMA). This revision introduces both a capital add-on for non-modellable risk factors and rigorous trading desk-level model approval processes with a profit and loss attribution test. It also introduces a Standardized Approach (SA) that is sufficiently risk-sensitive to serve as a credible fallback to the IMA. The revisions will require firms to develop the necessary systems infrastructure to meet substantial new data requirements, as well as additional risk sensitivity and complexity in the related risk models.
Given these fundamental changes and the associated implementation challenges, a consistent and simultaneous implementation of the FRTB across all jurisdictions is crucial. However, this will depend on how quickly regulators transpose the new regime into their respective domestic regulations, given that the Basel standards are not directly applicable by member state regulators. Although Basel Committee members have already agreed to full, timely and consistent implementation of all elements of the Basel reform package by a deadline of 1 January 2022, progress towards the implementation of the FRTB in member jurisdictions is moving slowly, with the EU being one exception. Still, the FRTB has been one of the contentious points during negotiations on the revised EU Capital Requirements Regulation (CRR II), which was published in June 2019.
Implementing the FRTB in Europe
For now, the CRR II includes the FRTB for reporting purposes only for firms whose trading book exceeds the threshold of €500 million or 10% of their total assets. By the end of 2020, these firms will have to begin reporting FRTB market risk capital using the new SA. This is two years ahead of the Basel Committee’s implementation target. Firms authorized to use the revised IMA, on the other hand, will be required to report the calculation under this approach starting from Q3 2023. However, capital requirements would still be based on the current regime until the next Capital Requirements Regulation (CRR III) makes FRTB fully binding. This is expected to be finalized around mid-2022.
In June 2019, the European Banking Authority (EBA) published a roadmap for implementing the FRTB in the EU. This is expected to be followed by a legislative proposal by the European Commission around mid-2020 to fully implement the FRTB and the remaining elements of Basel III. To ensure compliance with the Basel implementation deadline, the EU is expected to fast-track the FRTB. For the industry, clarity from the regulators on the implementation steps is essential The increased operational complexity of the FRTB requires the industry to act fast, making a significant investment in technology, risk modelling, and new staff, with a subsequent increase in costs. To some extent, the June 2019 EBA roadmap serves as a rough timeline for the FRTB deliverables.
Implementing the FRTB in the US and the UK
While concrete steps have already been taken to implement the new market risk regime in the EU, this is not the case elsewhere. In the US, for instance, the policy-makers have not committed themselves to the Basel Committee’s timeline, but they are thought to be working towards full compliance before the January 2022 deadline. However, there is little in the public domain to allow us to track progress. Moreover, given American banks’ lobbying power, it is highly likely that the implementation of the FRTB will be delayed.
Needless to say, the likelihood of a no-deal Brexit adds a layer of uncertainty in terms of the timelines in the UK. But the UK Government’s Statutory Instrument onshores the provisions of CRR II into UK law, so the UK is expected to implement at least the initial phase of the FRTB in line with the EU implementation timeframe. Of course, uncertainty still remains as to whether the UK would follow the same timelines for CRR III, which would make the FRTB fully binding in terms of a new market risk capital regime.
Implementing the FRTB in Asia and Australia
A number of other jurisdictions in Asia and Oceania—Hong Kong, Singapore, China, India, and Australia—intend to comply with the Basel Committee’s 2022 timeline. But, in the absence of adequate public information from the respective national regulators, it remains equally challenging to track their progress. The situation is more uncertain for the jurisdictions where it is unknown if the rules would be transposed into the national law at all, and whether they would do so in line with the Basel implementation target.
The benefits of timely and consistent regulatory action are clear. From a financial stability standpoint, in particular, it is imperative the all national authorities remain aligned with the Basel Committee’s implementation timeline and aim for a framework as close as possible to the Basel framework to avoid the risk of regulatory arbitrage, pricing distortions, and an unlevel playing field across jurisdictions. Given that the EU was the first to implement the FRTB, it is equally important for all jurisdictions to mirror the EU-level adoption of certain FRTB rules as much as possible to ensure consistency in cross-border regulations. Globally consistent and simultaneous completion of the FRTB requires a concerted effort from all those involved. Delays or failure could put the Basel Committee’s post-crisis efforts to enhance the regulatory framework for market risks in jeopardy.