Financial institutions would be well advised to start investigating now whether they need to ensure compliance in line with the proposed Fundamental Review of the Trading Book (FRTB). That’s according to a white paper released today by risk and regulatory technology firm Wolters Kluwer Financial Services. In fact, proposed changes may mean firms that currently do not consider they have a trading book actually will do so under the new definition that could come into effect as soon as 2017.
The Basel Committee for Banking Supervision’s (BCBS) proposed FRTB – currently under industry consultation – aims to address the management of risk within financial firms’ trading books. Specifically, it seeks to deal with what it considers to be weaknesses in the current design of the regulatory capital framework as it relates to the trading book, by applying more rigorous qualification requirements for both the trading and banking books and for changes in the constitution of both.
In the current environment firms are effectively encouraged to push non-performing trading book holdings to the banking book, thereby reducing the amount of required capital cover by 80%. The BCBS has concluded that this inconsistency results in trading firms inadequately assessing their risk and capital cover.
To eliminate the temptation to arbitrage between books, the BCBS proposes introducing strict rules around what qualifies for inclusion in the trading book and these changes may mean that firms that currently don’t consider they have a trading book will, in fact, have one.
However, the regulators’ drive to simplify may introduce new levels of complexity. For example, larger, more complex banks are unlikely to forego their proprietary models at the drop of a hat. As a result the marketplace is likely to see a parallel operation of both internal and standardized models for risk calculation among many institutions.
With these complexities in mind banks should be evaluating how they will be impacted based on existing proposals. FRTB potentially affects a broad swathe of institution type and will undoubtedly require significant infrastructure investment if firms are to comply, Wolters Kluwer Financial Services experts say.