Exploring FRTB's Fragmented Implementation Across Jurisdictions

The Fundamental Review of the Trading Book (FRTB) is now live in some countries and is on track to go live in 2025 and 2026 in the other major financial markets where local regulators have provided near-final rules. However, there remain discrepancies in how and when the rules are being implemented in each jurisdiction.

In a recent Numerix webinar, presenter, Franck Rossi, Vice President of Product Management, unpacked the effects of the Fundamental Review of the Trading Book (FRTB) implementation, including the challenges associated with the varied timelines and rules for implementation across different jurisdictions. In today’s blog, we give key highlights of the topics covered in our latest FRTB webinar.  

Understanding FRTB Timelines

FRTB is a comprehensive set of regulations aimed at overhauling the capital requirements for market risks, which has different go-live dates across the impacted jurisdictions. Many market practitioners are concerned that FRTB implementation could cause major problems in the industry, as it becomes challenging for banks to manage the complexity associated with the differing timelines and fragmented rules.  

The staggered implementation schedule is as follows:

• Korea, China, Canada, and India: Already live
• Hong Kong: Reporting goes live in July 2024, capital requirements in January 2025
• UK: January 2025
• Japan: Already live for global banks; March 2025 for domestic banks
• USA: July 2025
• Eurozone: January 2026 (new date announced on June 18, 2024)  

In his presentation, Franck noted that while the UK is considering aligning its timeline with the USA, the final decision is still pending. After Franck’s webinar, the EU announced it was delaying its implementation to January 2026, due to possible delays in the USA’s implementation.

Impact of Different Rules Across Jurisdictions

The key differences in FRTB rules across jurisdictions often pertain to risk weights or specific regulatory provisions. For instance, in the UK, the Prudential Regulation Authority (PRA) introduced a new bucket for carbon trading, demonstrating that the PRA is actively considering the impact of carbon trading within the FRTB framework. In the US, the Notice of Proposed Rulemaking (NPR) has mandated that the Standardized Approach be used for credit risk, prohibiting use of the Internal Model Approach (IMA) for this category of risk.  

These discrepancies raise significant challenges in areas such as comparing results across jurisdictions, as variations in rules complicate the supervision and comparison of results. Another area of concern is bringing together results for global banks, as institutions operating globally may face difficulties in aggregating numbers due to inconsistent regulations.

One potential solution to these challenges is the use of Common Risk Interchange Format (CRIF) files. This standard format facilitates the aggregation of trade-related data consumed by a bank’s FRTB aggregation engine, allowing both the bank and supervisors to gain a holistic view of risk and capital requirements. However, differences in CRIF formats from country to country may still make cross-jurisdiction comparisons and aggregation complex.

Benefits of Staggered Implementation

Despite these challenges, the staggered implementation dates provide certain benefits. For global banks, it enables them to avoid a "Big Bang" scenario, allowing for a phased rollout and the opportunity to reuse trained staff across regions. Another advantage is that jurisdictions such as the EU have the flexibility to postpone FRTB adoption to align with others, ensuring smoother transitions.

Potential for Regulatory Arbitrage

In the webinar, Franck discussed the concept of regulatory arbitrage, where differences in rules might incentivize businesses to relocate operations to jurisdictions with more favorable regulations. He used the example of the look-through approach for index-linked products which have slightly different approaches across regions:

• EU: Allows using sensitivities from third parties such as administrators or asset managers to look-through the products on the bank’s behalf, but the bank is still accountable for the numbers from the external provider.
• USA: Offers a similar option as the EU, but provides a second option of using the most recent quarterly index holdings and weights as disclosed by the index provider.
• UK: Allows treating the index as a single exposure if banks can show the PRA that the results would be similar to looking-through to all the index constituents, subject to annual validation.

However, Franck noted that with major jurisdictions implementing FRTB within a six-month period, and with relatively minor rule differences between jurisdictions, the odds of significant regulatory arbitrage are low.

Few Banks Using Internal Model Approach (IMA)

The IMA, once viewed as a more favorable approach by many banks, is now less popular than the Standardized Approach due to its demanding nature. In fact, only a few European banks, such as BNP Paribas, Deutsche Bank, and Intesa Sanpaolo, plan to adopt it. The Eurozone, USA, and UK all have stringent requirements for IMA, making it a costly and risky choice. Factors contributing to this include intensive calculation requirements for daily monitoring; requirements for the completion of the risk factor eligibility test (RFET) to ensure banks have sufficient real price data to accurately model risks; and additional Expected Shortfall (ES) backtesting requirements in the EU, but without much guidance on acceptable methodologies.  

Standardized Approach (SA) to be Broadly Adopted

While the SA method requires comprehensive risk sensitivities and is computationally intensive, it is simpler to implement due to its exemption from the stringent P&L attribution, backtesting, and non-modellable risk factor requirements of the IMA. Most banks are now leaning towards the Standardized Approach, which, despite greater capital requirements, is seen as more manageable and less risky compared to the IMA. Moreover, many banks are planning to implement the Standardized Approach first, and then may apply for the IMA in the future. One drawback is that the SA's design may not fully capture all market dynamics and related risks.

Want Additional FRTB Insights?

The fragmented implementation of FRTB across jurisdictions presents both challenges and opportunities to capital markets participants. By understanding these nuances, institutions can better navigate the complexities of the global regulatory landscape. For a more detailed look at FRTB’s impacts on the capital markets, including an extensive Q&A session with Numerix’s FRTB expert, Franck Rossi, watch our on-demand webinar, Impacts of FRTB’s Fragmented Implementation.