Industry divided on whether Europe should delay FRTB

The Fundamental Review of the Trading Book is set to take effect at different times in major jurisdictions, with Europe due to adopt the new market risk capital requirements in January 2025 and the US following suit six months later. Yet there remains disagreement in the market about whether starting early is the best way forward for Europe.

The International Swaps and Derivatives Association is in favor of delaying the start date in the EU and the UK, and thereby putting the continent in sync with the US.

Panayiotis Dionysopoulos, Isda’s head of capital, says it would ensure a level playing field and remove an additional layer of complexity for global investment banks, which are currently having to work towards different target dates across multiple jurisdictions. He says a delay would also give the banks extra time to provide information in support of their applications to use the internal models approach (IMA) to calculate their market risk capital requirements.

“The desire for a level playing field is the main reason for wanting alignment, as you ideally want to synchronize those go-live dates,” says Dionysopoulos. However, he notes the difficulties in achieving this in practice, given the differences in the ways jurisdictions will transpose the FRTB into their capital rules.

Yet of the six bank sources whom Risk.net, WatersTechnology’s sibling publication, contacted and who expressed a preference, only two want a delay. The other four prefer an earlier start date, which they say will enable their teams to spread the workload across multiple jurisdictions and prevent them from losing resources they have secured from senior management. They add that any competitive disadvantages during the six-month gap will be short-lived and therefore inconsequential.

By the book

On July 27, US regulators published their long-awaited notice of proposed rulemaking for incorporating the final elements of the post-financial crisis capital regulations, collectively known as Basel III, into law. The NPR, of which the FRTB forms a part, confirmed what many had feared: a different start date between the US on the one hand and the European Union and the UK on the other.

Banks’ trading divisions can operate globally, which makes them more sensitive to different capital requirements having a distorting effect on prices and competition. Estimates vary about how much capital requirements will increase as a result of the FRTB. The most recent quantitative impact study of the Basel III reforms, published in February by the Basel Committee on Banking Supervision, forecast a 56.5% increase in market risk capital requirements for global systemically important banks, based on data submitted by the G-Sibs.

The desire for a level playing field is the main reason for wanting alignment, as you ideally want to synchronize those go-live dates

Panayiotis Dionysopoulos, Isda

Some jurisdictions, such as Canada and Japan, have earlier start dates than both Europe and the US, while others, such as Australia, are due to start later.

The internal models currently used by most banks to calculate risk-based capital requirements have fewer hurdles and smaller capital add-ons than the IMA set out in the FRTB. The steep costs of the IMA are causing many banks, particularly in Europe, to opt for the regulator-defined standardized approach. Trading desks that fail to overcome the new hurdles to eligibility for the IMA must also use the standardized approach.

A market risk manager at a European bank sees an unlevel playing field emerging for equity trading desks, “regardless” of whether EU banks use the IMA or the standardized approach. Under the IMA, there is a capital surcharge for those banks with risk factors for which there are too few real-price observations to overcome the FRTB’s modelability hurdles. The sheer number of possible equity underlyings increases the likelihood of finding non-modelable risk factors, which would mean more risk factors becoming subject to the surcharge. The market risk manager adds that the standardized approach sets high risk weights for equity exposures, particularly for emerging markets.

Don’t delay

Although policymakers in the EU and the UK could delay their start dates, most of the bankers who spoke to Risk.net feel the six-month difference is not long enough to justify them doing so.

A regulatory expert at a second European bank compares the current situation with the state of affairs back in 2018, when the EU only implemented the FRTB as a reporting requirement after the US failed to take action towards implementing it as a capital requirement for banks. The US’s inaction caused the Basel Committee to revise the standard.

“When in 2018 the EU decided to postpone its timeline, there was not enough commitment from the US that it would even transpose the FRTB into law,” says the regulatory expert. “Some more years were deemed necessary to stabilize the standards. But once the commitment is taken by all major regulators, going live a few months ahead or a few months after does not make much difference.”

Staggered is better, rather than a big bang where everybody’s going on the same date. It just makes the operations a lot easier

FRTB implementation manager at a US bank

A senior risk modeler at a third European bank also favors sticking to the current timeframe: “It would have been another issue if we were talking about years, but six months is not something that concerns us at all.”

Two of the bankers with global operations—one at an EU firm and the other at a US institution—say different start dates will help them spread the workload of implementing the FRTB in multiple jurisdictions.

“Staggered is better, rather than a big bang where everybody’s going on the same date,” says an FRTB implementation manager at a US bank. “It just makes the operations a lot easier.” This banker says that once the first go-live date has been met, the team’s limited staff and resources can be redeployed to meet the next one: “We only have so many people.”

The senior risk modeler at the third European bank also cites resources as a reason for not delaying. In this banker’s view, a delay would result in senior management taking away “expensive quant resources” from the risk modeling team. The risk modeler also says the team might finish developing its FRTB model early, and that a delay could then result in it calculating both the new and the current market risk capital requirements for an extended period: “It is a huge task to run two internal models at the same time.”

Not so fast…

Yet sources who favour a delay also say it could ease implementation, as it would give them more time to prepare.

A senior market risk manager at a fourth European bank says a delay would give the firm the chance to iron out any interpretation issues that cropped up during implementation. However, this manager adds that a delay is not a “must”, as most banks in Europe will be implementing the simpler standardized approach—which, unlike the new IMA, is not subject to supervisory approval.

A risk manager at a fifth European bank expects the start dates to be aligned between the EU, the UK and the US to “avoid such level-playing-field issues arising”.

In June, the EU addressed a series of high-level issues, which had caused disagreement among finance ministers, by making revisions to its bank capital laws. These revisions, known as the Capital Requirements Regulation, followed negotiations between the Council of the EU, the European Commission and the European Parliament. All three bodies had a provision in their draft rules that would give the commission the power to delay the start of FRTB capital requirements for up to two years—something that was originally proposed to ensure a level playing field with the EU’s “international peers.” It is understood that this power has been included in the final text of the Capital Requirements Regulation.

A spokesperson for the commission suggests it is too early to delay, and that the NPR is only a proposal that US regulators may amend before issuing a final version.

The UK’s banking supervisor, the Prudential Regulation Authority, has so far released only draft proposals for implementing the FRTB and other elements of Basel III into its capital requirements. Like the US, the PRA—which declined to comment for this article—can also change the proposed start date in its final rules.

A regulatory expert at a second US bank sees no need for delay and believes the EU should stick to its timeline. “However, it is a bit of a game of chicken,” says the expert. “Until the US confirms that timeline, there is going to be a little doubt. Could it slip?”

The expert says the wait-and-see approach makes it awkward for European banks’ preparations. A national supervisor within the EU would not find it an acceptable excuse for a bank to be unprepared for an early start date if the bloc stuck to its plans but the bank was planning on a delay.

“Unless you get confirmation from the EU or the UK regulators that they plan to postpone those dates, you can only work on what those dates are right now,” says the expert.

The NPR is currently out for consultation, and the deadline for responses has been set at November 30. It is not known for how long US regulators will consider those responses before releasing the final rules.

Editing by Daniel Blackburn