Fundamental Review of the Trading Book
The Basel Committee released “Fundamental Review of the Trading Book” in January 2016, with the joint aims of addressing the shortcomings of existing market risk capital frameworks (Basel 2.5) and to design a minimum capital standard for market risk that is to be more uniformly applied across jurisdictions.
The clue is in the name – it is a fundamental overhaul of the existing market risk capital rules. Unlike those quick fix rules, the FRTB is intended for the long term, so the industry must strategically plan business, operations and technology roadmaps accordingly. It overhauls the standardised approach to market risk, forcing banks to calculate and report Market Risk Capital for the first time, radically altering the way that model approval is granted and policed, replaces value-at-risk (VAR) with expected shortfall (ES) as the standard risk measure, redefines the boundary between banking and trading books and impacts many other areas that require strong significant transformation of technology and operational infrastructures.
We distilled these challenges into – Strategic, Business and Technology – categories.
- Business – Gaps and impact of new risk and capital management treatments, processes, procedures, control, reporting and organisational structure to facilitate and maintain compliance.
- Strategic – Significant overhaul of Target Operating Models, Optimisation of capital and business re-engineering.
- Technology – How to augment existing ecosystems without impacting “business as usual” so that the firm can support FRTB compliance prep, the migration from current to future steady state and then the ongoing maintenance under a robust, high performing, transparent and efficient technical environment.
At Razor Risk, we provide a comprehensive consultative, technology and risk management solution offering that meets the business and technology challenges facing banks. The Razor™ platform is designed to provide risk measurement, management, control and reporting for Market Risk, Liquidity Risk, Counterparty Credit Risk and Capital Calculations as an integrated risk management platform. The existing infrastructure provides a full suite of sophisticated risk valuation models, a facility to run 3rd party or in-house built models and a flexible rules engine that can be end-user maintained to make changes as needed. We also work with established partners in Management and Business consulting to deliver holistic and comprehensive business and technology solutions.
The current version of Razor™ supports the Standard Model approach (SA) “out-of-the-box” along with all components needed to support Expected Shortfall (ES) under the Internal Model Approach (IMA). We fully support stress and back testing requirements while allowing ES and VaR calculations to be run in parallel. Although our presumption is that the Default Risk Charge (DRC) and Non-Modellable Risk factors (NMRF) will be bank-specific, we provide standardized DRC and NMRF capabilities that are customisable to individual bank specifications during implementation.
In addition to SA and IMA, Razor™ is capable of receiving and storing sensitivities and historical P&L risk factors from external systems, enabling users to compare the numbers to ascertain per desk P&L Attribution results. The powerful Razor™ ‘What-If’ analyser is designed to help business users to assess the impact of alternate desk structures and impacts on capital charges to arrive at an optimal target model and regulatory capital.
Additionally a flexible Limits and Excess management function, including 4-eyes workflow and reporting allows users to set limits for each desk in terms of exposure, trade contributions, modellability, face-value checks, maximum availability checks, pre-deal assessments and risk factor volatilities, that can be maintained by risk managers to provide the rigor needed to ensure compliance.
Overall, from a solution perspective, Razor™ provides a software environment that supports a comprehensive and flexible FRTB solution giving banks the options of:-
- Integrating Razor™ as part of the overall FRTB solution with existing market risk BAU systems and data sources; or
- Replacing existing market risk solutions with the Razor™ Market Risk module, a framework that includes the ‘built-in’ FRTB solution.
From an implementation perspective, we have looked at the complexities of market risk infrastructures within each bank and the challenges FRTB poses. Razor Risk proposes an iterative approach to implementing the Razor™ FRTB solution “out-of-the-box” to enable optimised desk structures under the IM approach. Razor™ will also enable banks to begin early reporting to regulators (“shadow reporting”) to gain regulators’ confidence in the performance of the chosen internal model, which in turn will smooth the regulatory application approvals procedure.