fundamental review of the trading book - what is frtb and why start now?
TRANSCRIPT
WhatisFRTBandwhystartnow?
KPMGseminarontheFundamentalReviewoftheTradingBookCopenhagen- 9June2016
MortenWeis,Ph.D.Independentriskmanagementexpert
AboutMortenWeis
©MortenWeis2016
• FormerExecutiveDirectoratGroupRiskManagementatNordeaBankAB(1998- 2016)
• 18yearsexperienceinfinancialriskmanagementandvaluationoffinancialinstruments• 11yearsinvariousleadershiproleswithinNordea’sGroupMarketandCounterparty
CreditRiskdivision, including:
• HeadofGroupMarketRiskatNordeaBankAB(2012-2015)• LeadBusinessOwnerforNordea’sFRTB&RiskPlatformproject(2015-2016)
• Intheseroles,Iwasresponsible forNordea’sFRTBpreparationssince2012andforparticipationinseveralBaselCommitteecoordinatedQuantitativeImpactStudies(QIS’s)
• ActivememberofinternationalFRTBworkinggrouparrangedbyISDAandparticipatedinpreparing industry input totheBaselCommitteeonFRTB(2014-2016)
• Ph.D.intheoreticalphysicsfromtheNielsBohrInstitute,UniversityofCopenhagen
Foto• FormerExecutiveDirectoratGroupRiskManagementatNordeaBankAB(1998- 2016)
• 18yearsexperienceinfinancialriskmanagementandvaluationoffinancialinstruments• 11yearsinvariousleadershiproleswithinNordea’sGroupMarketandCounterparty
CreditRiskdivision, including:
• HeadofGroupMarketRiskatNordeaBankAB(2012-2015)• LeadBusinessOwnerforNordea’sFRTB&RiskPlatformproject(2015-2016)
• Intheseroles,Iwasresponsible forNordea’sFRTBpreparationssince2012andforparticipationinseveralBaselCommitteecoordinatedQuantitativeImpactStudies(QIS’s)
• ActivememberofinternationalFRTBworkinggrouparrangedbyISDAandparticipatedinpreparing industry input totheBaselCommitteeonFRTB(2014-2016)
• Ph.D.intheoreticalphysicsfromtheNielsBohrInstitute,UniversityofCopenhagen
Questionsweseektoanswer:
©MortenWeis2016
WhyisFRTBhere?
WhatisFRTB?
Whyarelargebanksconcerned?
Whystartpreparingnow?
FRTB- Anew“standardforminimumcapitalformarketrisk”issuesbytheBaselCommitteeforBankingSupervisioninJanuary2016
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• TheFinancialCrisis(2007-2008) ledtheBaselCommitteetolaunchan“emergencyfix”tomarketriskcapitalrulesin2009
• Knowas“Basel2.5”,Value-at-Riskmodelswastargetedandcapitalchargesincreasedseveralfoldforbanksapplyinginternalmodelsforcapitaladequacyreporting,butstandardruleswerekeptunchangedfromBaselI/II
• Intenselobbyingsavedinternalmodelsforcorrelationtrading• AdoptedbyEUinCRDIIIandeffectiveJanuary2011• TheBaselCommitteeknewruleswasamessandpromisedto
makea“fundamentalreview"
FRTB– Thepathtoanewcapitalstandard
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• NextstepfromtheBaselCommitteewastotargetcounterpartycreditrisk,includingnegativeCreditValuationAdjustments(CVA)thatwasresponsibleformajorlossesininternationalbanksduring2007-2008
• “BaselIII”includedamongseveralelementsanewCVARiskcapitalchargefortheembeddedmarketriskinbanksCVAadjustments:
• AdoptedwithadjustmentsbyEUin2013inCRDIV/CRR• Allowedforbothstandardapproachandinternalmodels• A”hybrid”betweencounterpartycreditriskandmarketrisk,CVA
RiskChargewasnotintegratedwiththegeneralmarketriskcapitalcharge
• CVARiskChargeonlyaddresscreditspreadriskinCVA
FRTB- thepathtoanewcapitalstandard
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Basel Committee: Analysis of RWA for market risk - January 2013
• Benchmarkingofbanksinternalmarketriskmodelsforidenticalportfoliosrevealedmassivedifferences
• Widespreadlackofconfidence inbanksobjectivity incalculationofownRWA/REAfiguresemergedamongpoliticiansandregulators
TheaimoftheFundamentalReviewoftheTradingBook
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Ensuresufficientcapitalformarketriskin“TradingBook”
Avoiddoublecounting,butmeasurerisksrealistically,reflectingmarketliquidity
Ensureobjectiveandfirmdefinitionof“TradingBook”vs.“BankingBook”
Ensurecoherentcapitalisationformarketriskacrossbanks
Establishacrediblealternativetointernalmodelapprovalforlargebanks
ThekeycomponentsofFRTB
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TradingBookdefinition• Purposeofpositiondecisive
• Presumptivelistofinstruments
• InternalRiskTransfersundertightrules
StandardisedApproach• “Mandatory”• SensitivityBasedApproach+
• DefaultRiskCharge+
• ResidualRisk+• Securitisations
InternalModelsApproach• "Optional"• Stressed“ExpectedShortfall”replacesVaR &sVaR +
• DefaultRiskCharge+
• Non-ModellableRisks
TheTradingBook- BankingBookboundary
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Thepurposeofthepositiondecidestheplacement:short-term resale,profitingfromshort-timepricemoves,lockinginarbitrageprofits→ TradingBook
Apresumptive listofTradingBookinstruments:listedequity,bonds,derivatives,optionsincludingembeddedderivativesininstrumentsissuedfromtheBankingBookwithequityorcreditunderlying,FXexposures,correlationtrading,commodities
Non-listed equities,fundswithoutlook-throughordailyprice,real-estate,retailandSMEcredits,areBankingBookperdefinition
BankscandeviatefromthepresumptivelistonlyifexplicitFSAapprovalisgranted
TheTradingBook- BankingBookboundary– Canyoupass?
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FXriskintheBankingBookmustbecapitalisedintheTradingBookasaseparateTradingDesk– FSAmaygrantapprovaltoexclude hedgesofcapitaladequacyratioundercertainconditions
InternalRiskTransferfromTradingBooktotheBankingBookgives nocapitalrecognitionintheTradingBook
Internal RiskTransfersfromBankingBooktoTradingBookmustbeidenticallymatchwithexternaltradesforequityandcreditrisktogivecapitalbenefit
InternalRiskTransfersofinterestrateriskmaybemanagedinseparateTradingBookportfolio,capitalisedonstand-alonebasisintheTradingBook,andincludedinIRRBBexposurecalculation
TheBorderChallengerelatestoALLbanks
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Everypositionmustbesupportedbydocumentationforcapital treatment
Key concerncouldbeliquiditybuffers,oftenplacedinBankingBook,butonthepresumptivelistofTradingBookinstrument
Risk management ofmarketriskofstructuredbondissuancesmaybecomemoreexpensiveduetodemandforidenticalexternalhedgeinTradingBook
ManagementofIRRBBwithderivativestradedwithTradingBookmaybecomemoreexpensiveduetostand-alonetreatment
Allbankswillhavetospendmoreresourcesondocumentationandcontrol
ITsystemsforcapitalcalculationmustbeabletohandleInternalRiskTransferscorrectlyinbothMarketRiskandIRRBBregulatory capital
TheStandardApproachcapitalistheabsolutesumof3elements
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SensitivityBased
Approach(SBA)
DefaultRiskCharge(DRC)
ResidualRisk
add-on(RRAO)
RiskFactorSensitivities• Delta+Vega• Curvatureofoptions
CreditRiskinTradingBook• Bonds,• Equities
NotionalBasedCharge• ComplexInstruments• Complexunderlying• Includespre-payment
risk(e.g.DMB)
FRTBSBAdeltariskinonepage
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Foreachbroadriskclass:GeneralInterestRateRisk(GIIR),Equity,CreditSpreads,FX,andcommodities:assignsensitivitiestodifferent“buckets”
Calculateariskweightedsensitivitybybumping eachsensitivitywith adesignatedriskweight
Withinandacrossbuckets,theweightedsensitivitiesareaggregated accordingtospecifiedformulaeverysimilartoaparametricVaR model
CorrelationswithinbucketsandacrossaregivenbytheBaselCommittee
FRTBSBA– examplesofriskweights
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• GIIRriskweightsincreasedby50%following thelastconsultationpaper
• Theconceptof“DomesticCurrency”willbeofimportance forDKKbanks
InterestRates* 1Y 5Y 10Y 30Y
Risk Weight 2.25% 1.5% 1.5% 1.5%
*EUR,USD,GBP,JPY,AUD,CAD,SEK+“DomesticCurrency”maydivideriskweightwith√2
CreditSpreads RiskWeightInvestmentGrade Sovereigns,CentralBanks,.. 0.5%InvestmentGradeFinancials,alsogovernment-backed 5.0%InvestmentGradeCoveredBonds 4.0%Investment GradeTechnology &Telecom 2.0%High-Yield orNot-RatedSovereigns 3.0%High-Yield orNot-RatedFinancials,alsogov-backed 12.0%
• CreditSpreadchargeappliesforallbonds– alsoAAA-ratedSovereigns
• CoveredBondsareveryexpensivecomparedtomorecorporatedebt
FRTBSBA– examplesofriskweights
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• FXriskbecomesmoreexpensive
• Scandinavianbanksarelikelytobehitbyliquidity classification
RiskWeight FX:RISK – dividedoncurrencycrosses21% USD/EUR,USD/JPY,USD/GBP,USD/AUD,USD/CAR,USD/CHF,USD/MXN,USD/CNY,
USD/RUB,USD/HKD,USD/SGD,USD/TRY,USD/KRW, USD/SEK,USD/ZAR,USD/IND,USD/NOK,USD/BRL,EUR/JPY,EUR/GBP,EUR/CHF,JPY/AUD
30% Restoftheworld…...Including EUR/DKK,EUR/SEK, DKK/SEK,SEK/NOKetc...)
FRTBSBAdeltariskcorrelationsareexposedtostressassumptions
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ForallSBAcalculations,FRTBspecifiesthree
correlationscenarios
Thescenariosaredenoted
"low","medium","high"
Banksmustselecttheonegiving thehighest
capitalcharge
Low: listedcorrelations✕ 0.75
Medium: listedcorrelations✕ 1.00
High: listedcorrelations✕ 1.25
FRTBSBA– addingitallup
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• Alloptionproducts– includingembeddedoptionsasinDanishMortgageBondsmustberevaluedinstressedup/downscenariostoformthe“Curvature”riskcharge
• ForGIIRthisisa+/- 240bp. shift*andyoucannotflooratzerointerestrate
• The“Delta”riskchargeforall1.storderriskfactors sensitivitets(delta+vega) aretobeaddedup
• Foreachriskfactorwithinabroadriskfactorclass,suchasGIIR,youmustapplydifferentcorrelations• E.g.swapswithdifferentfixing rates,
butsamecurrencycannotbenettedfullyatthesamematurity
• Theregulation isveryprescriptiveanddetailed
• Sensitivitycalculationsmustfollowspecifictechnicaldefinitions
• Theclassificationofriskfactorsisverydetailedandresidualbucketsverypunitive
• Requiresfull-suiteriskmanagementITtools
FRTBSA:DefaultRiskCharge– A4stepprocess,(Non-CorrelationTrading)
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IdentifyJump-to-Default(JTD)lossforeachinstrument
Offset longandshortJTDexposurestosameobligorwhenpermissiblegivingnetlongandshorts indistinctobligors
Netshortexposuresarediscountedbyahedgebenefitratio
DefaultRiskWeightsareappliedtoarriveatcapitalcharge*
CreditQuality DefaultRiskWeightAAA 0.5%
AA 2%
A 3%
BBB 6%
BB 15%
B 30%
CCC 50%
Unrated 15%
Defaulted 100%
*Atnationaldiscretionclaimsonsovereigns, publicsector,andmultilateraldevelopment banksmaybesubjecttoazerodefaultriskweight
FRTBSA– fittinginthelastpieces
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• Summing up– wehave• HigherRiskWeights• Largercoverageofriskfactors• Muchhighercomplexity• Expecthighercapital&production
cost
• TheResidualRiskAdd-on (RRAO)isasimplecapitalchargeonthegross-notional* of“complexproducts”withrisksnotcapturedwellbytheSBA• E.g.adigitaloptionorbondwithpre-
paymentrisk• TheRiskWeightis0.1%fornon-exotic
underlying assets,otherwise1.0%
• TheSAisdesigned tobeacrediblealternativetointernalmodels, andtoformbasisformoreobjectivecomparisonofbanksrisks
• TheSAwillbecentralforutilisationoffuturecapitalfloors
• Disclosurerequirementsarestillpending.BCBS356indicateonlyhypotheticalportfolio figures tobepublished forpureIMAbanks
Example:• ADMBwillgiverisetoGIIRdelta+
GIIRvega +GIIRCurvature+CreditSpreaddelta+DefaultRiskCharge+ResidualRiskCharge
*Pureback-to-backpositionsnotincluded
TheInternalModelcapitalchargeistheabsolutesumof3elements
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ExpectedShortfall(ES)
DefaultRiskCharge(DRC)
Non-ModellableRiskfactors
HistoricalStatisticalMetric• Calibratedtostressed
1Y periodduringlast10years
• Liquidityscaling• Highdatarequirements
CreditRiskMonteCarlomodel• Bonds,• Equities
StressTestingCharge• Lackof“realpricedata”• Atleastasconservative
astheESmodel
FRTBIMA– thenewExpectedShortfallModelconcept
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• 97.5%ESfor1Yperiodofstressoverthelast10yearsreplaceVaR +sVaR aspricevolatilityriskmetric
Liquidity bucketexamples:Riskfactorcategory nIR:EUR,USD,GBP,AUD,JPY,SEK,CAD+“domestic" 10IR:allothercurrencies 20IR:volatility 60FX: listofcurrencycrosses 10FX: residualcurrencycrosses 20Equity (largecap) 10
Credit Spreads:CorporateInvestmentGrade 40
• ContrarytoCRDIII,crossasset-classcorrelationsarerestrictedtoavoidtolargediversificationeffects
• Riskfactorsareclassifiedin5liquiditybuckets:10d,20d,40d,60d,120d.Allshocksare10-day
Example:a NOKswapforaDKKbank𝐸𝑆&' = (𝐸𝑆+,). + (𝐸𝑆+,).
• Exposuretoseveralriskfactors⟹thesametradeisrevaluedmultipletimesinthecalculationofES
FRTBIMA– Themainelementtobeawareoff
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• Fullrevaluationisnotaformalrequirementasinconsultationversion,butpassingIMAtestswithoutwillbedifficult
• DifferencesbetweenFOandRiskvaluationmethodswillmakeIMAtestschallenging topass
• JointEquityandBonddefaultstobemodelled inDRC
• Significant increaseinCPU&storagedemands
• Theshift fromVaR &StressedVaR toESisassuchnotdifficult
• Themainproblem isIMAapprovalwillnowbedecidedonTradingDeskLevel
• Hardquantitativeandqualitativerequirementsareset:• P&LexplainalignmentFO– Risk• Backtesting• “Realprices”mustexist
• Thetreatmentofliquidity issimplisticandpenalising formanyexposures
• The“domesticcurrency”willhelpDKKbasedbanks
• ”Brokenhedges”willdrivecapitalchargesup
• Theminimummultiplier isreduced from3.0to1.5
FRTB:Whyarethelargebanksveryconcerned?
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• CapitalplanninghardtopredictduetoautomatedIMAadmission tests
• LargecliffeffectsbetweenSAandIMA• Massiveinvestmentsinpeople,dataandIT
formetricshardtouseinternallyforownriskmanagement
• Negativeeffectson liquidityexpected• Maysignificantlyaffectinvestmentbanks
businesscomposition
• Industryassociationshaveledvoluntarysurveyacross21leadingbankson impactoffinalrules
• Whilethefinalrulesarelesspenalisingthanlatestdraftversion,marketriskcapitalwillstillincrease1.5– 2.5timesonaveragecomparedtotodaysrules
SAtoIMA*Interestraterisk 3.0Creditspreadrisk 2.0Equityrisk 4.1Commodity risk 2.9Foreignexchangerisk 6.6
*SAexcludingRRAO&IMAexcludingNMRF,18th April2016
FRTB– Whatisthetimeline?
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BaselstandardfinalJanuary2016
FurtherBaselrules:CVA,CapitalFloors,IRRBB,… during2016
EU process2016- 2018
BCBS:localregulationinforce01-01-19
BCBS:firstreporting31-12-19
Unknowns areplenty….DG-FISMA(EU)havejustlaunched consultation
considering lesserSAdemandsonthesmallestbanks
Unknowns areplenty..CVARiskChargeseemstobecomepartofFRTBSAwithnoIMAoption
FRTB– Whystartpreparingnow?
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• Largeincreaseindataandcalculations
• SBArequirefullcapitalmarketsITplatform
• Highneedforautomation
• IMArequire fullsetofnewmarketriskmodels
• SArequiresfull-revaluationforoptionsincludingDMB's
• Highresourcedemands
• SAnolongerajobforFinance
• Hardtogetspecialistresources
• Cross-firmcollaborationtakestimetoestablish
• Marketdata• “realprices”• Tradeclassification
• Staticdata
data people
ITmodels
Anddonotforgettimeformodelvalidation,auditandFSAdialogueandapproval
FRTB– Whystartpreparingnow?
©MortenWeis2016
data people
ITmodels
• TwomainscenariosforDanishbanks:1) OwnITsystemdevelopment2) SectorbasedsharedITprovider
• Inbothscenarios,planning, fundingandexecutionwilltakeconsiderabletimeandrequire full-timeattentionbyownriskspecialistsaswellasyour ITprovider
CaseA:• InbothSAandIMAyouneedtohave
completecontroloftheclassificationofallpositions intheTradingBooktoknowwhatcalculationsarerequired• Highdemandondataprocessing
forhigh-volume products• Datamodelsmostlikelyneedto
beextendedtosupportFRTBclassificationoftrades
CaseC:• Riskfactorsensitivitycalculationsare
required forproductswherenotcommonlyused– e.g.forcreditspreadsensitivityofgovernment bonds
• Configuration ofriskcalculationstakeslong timedue tonumericalcomplexityandneedfornewdataloads
CaseB:• Cleverriskdataaggregation techniques
mayincreasethecapacityofyourITsolutionsignificantly
• Manyleadingbanksandvendorsapplyin-memory“cube”technologyasitiswell-suitedfornon-linearmeasuresasinIMA
• Highdimensionalityandlargenumberofnumericalcomputations
FRTB– Whystartpreparingnow?
©MortenWeis2016
data people
ITmodels
• ForbothSAandIMAbanks,datademandswillbeveryhigh• Positiondata• Instrumentdata• Marketdata• StaticData• Reportingdimensions
Marketdata:• SAandIMAbankswillneedthesamelevelof
detailedmarketdatatocalculateriskfactorsensitivities
• IMAbankswillneed toprovethathistoricalpricesare“real”tobeinESmodel
• SAbankswillneedmarketdatatheypreviouslymaynothaveseenneedfor,e.g.creditspreadcurvesforgovernmentbonds
Staticdata:• SAandIMAbothhavehigh riskfactor
dimensionality thatsethighdemandsonstaticdata
• E.g.marketcapofequitiesandsectorclassificationfittingFRTBrules
• E.g.issuerratingsonallbondsandequitiesandabilitytolinkequityandbond issuers
Reportingdimensions:• Disclosurerequirementsarestillnotfinal,
butBCBS356inhearingtill10th Junesethighdemands
• TheFSAmaysetadditional requirements• Expect:tradingdeskstructure,tradingdesk
strategies(detailed),granularriskfactorcontribution tofinalcapitalcharge,hypotheticalportfolio capitalcharges,….
SomepersonalexperiencetosharefromNordea
©MortenWeis2016
Key tohaveseniorFrontOfficemanagementinvolvement inFRTBproject- businessmodelsmaychangewithFRTB.Tradinginvolvement iskeyinmostofthedatawork:marketdata– instrumentdata– staticdata
UncertaintiesinfinalrulesfavouragilemodelandITdevelopmentapproach
IMArequirecloseintegrationofFrontOffice,FinanceandRiskIT
Thelargeinternationalbanksarenowrunning bigFRTBprojects,mostwithtwo-digitmillion EURbudgets
Youarenotaloneaboutthischallenge- sectorcollaboration,externaladviseandbenchmarking wasveryhelpful forgettingNordea'sprojectoffonagoodstart
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Questions&
ThankYou