Boris: Hello ladies and gentlemen and welcome to our meeting. We are speaking today with Richard Moss who is a Product Manager at AxiomSL. As we move from VAR to expected shortfall regulation coupled with the focus on liquidity, I thought of sharing a perspective on one of the hottest regulations around the corner - the Fundamental Review of the Trading Book (FRTB).
You can watch a video recording of the interview here https://www.youtube.com/watch?v=BVcJleqmIbU&t=2s
This has resulted in a lot of effort from banks to prepare systems and processes and at the same time opens up career opportunities for market risk professionals.
Richard, welcome to our meeting and please introduce yourself to our audience at Global Risk Community.
Richard: Thank you. Hi, I am Richard Moss, Product Manager at AxiomSL. Having previously worked at Bank of America Merrill Lynch for 4 years and before that Barclays Capital and EY, I have a keen interest in the banking sector, specifically in relation to market risk.
Boris: Richard, what are the advantages to banks that will be the first movers into the FRTB space?
Richard: As we all know, on December 8th, Basel pushed back the implementation timeline of FRTB which has proven to be one of the most expansive regulations to have been imposed in the last 20 years.
The biggest advantage to the early adopter banks was the ability to focus on their operating models, ensuring that the scaling up of infrastructure, processes and calculation burden is completed an efficient manner.
This then allows banks to look at how they can restructure their systems to comply with the rules and how it may be possible to bring forward any capital savings. The sooner they adopt, the more they can take advantage of that reorganization, and look at risk management and capital management together.
Boris: There's a school of thought suggesting that banks can most easily cope with these demands by simply adding hardware. Do you agree with this?
Richard: FRTB does require an increase in computational power, especially if going down the path of full revaluation. However, it simply isn't enough and it is not sustainable just to increase processing power. The challenge is in having to perform additional calculations while capturing the non-linearity of instruments without sacrificing the BCBS 239 principles of accuracy, completeness and timeliness. Overarching all of this, the solution has to be cost effective.
FRTB puts a great amount of stress on existing infrastructure. The main drivers for demanding higher processing power are; layered expected shortfall (ES) with partial ES for each risk factor class – up to 63 calculations, SA-SBA – sensitivity calculations for each desk, NMRF – stress scenario calculation for each NMRF (significant if a high number of NMRFs).
So, the solution has to be scalable and go beyond purely Regulatory compliance. A sustainable long-term implementation has to be capable to handle future Business growth and be at the heart of Business decisions.
Boris: What do you see as the long-term ramifications of FRTB for banks and financial institutions?
Richard: The long-term effect is increased transparency, ultimately to satisfy regulatory requirements. Looking at internal ramifications, the focus is a paradigm shift towards risk. Currently, within a bank, the Regulatory reporting team and Finance team sit together or work together to complete most, if not all of the returns, Market Risk may send some outputs to these teams; FRTB puts the Risk function at the front and center of Reg. Capital requirements.
This raises the question of organizational and operational change, who will own Capital requirements in the future. I think the answer is yes, it should be owned by the Risk function. I would go as far as saying it could open up a functional gap for a new type of role in the long term, a Business Partner, a role that merges Reg & Risk and augments front office, facilitating business growth in parallel to Capital requirements. Ultimately, one thing it does mean is that the Reg SMEs and the Finance team have to become more educated in modeling and Risk. I say this because FRTB is moving away from Balance Sheet metrics, assets, liabilities, notionals are being replaced or need to be traced right through to risk factors. This doesn’t tend to be the principle domain of Reg. finance in the current world. But in the long term, if they want to remain in that function, they will be required to develop their skills.
Boris: What would you advise to a chief technology officer or CTO who is embarking on this journey?
Richard: The challenge created by FRTB is truly the sheer scale of data that is required. If there are inconsistencies across the bank it has an impact on capital, and it has an impact on the ability to remain profitable.
These issues require a technology and data led solution that can process large volumes of data and enable effective Risk management. I see FRTB as more of an opportunity for CTOs and CDOs to take the lead.
Across the street, estimates suggest that more than USD 7 billion has been spent to date on implementing BCBS 239. The ultimate litmus test for these implementations is to see how seamlessly the banks can roll out FRTB. There is a low return on investment for BCBS 239 however; it may pay dividends to adhere to the best practice guidelines when thinking about the problems FRTB imposes.
Boris: Many banks are headed in the direction of having the front office and risk on the same platform. What are your thoughts on this?
Richard: I think it's true. The front office has always had a larger budget than middle office and finance, for that reason, the front office systems are normally better equipped and more advanced which has partly led to different practices and processes. There are many reasons why these two functions have become siloes. The key game changer that FRTB brings is that non-conformity across practices and processes can lead to penalising Capital. Taking a strategic approach to FRTB implementation will require an examination of traditional operating models and boundaries.
Overall, I think the change imposed by FRTB is good; ultimately, it will lead to processes that are more efficient, drive growth that is more organic and highlight capital savings whilst reducing operational risk.
Boris: Alright, thank you. What are then the challenges of FRTB for the banks with multiple platforms?
Richard: The main challenge of having multiple platforms is one of governance and consistency. Without clear and consistent labelling/taxonomies of risk and financial measures and a consistent definition for calculations of risk measures, avoiding a spike in capital cost leading to a loss of competitive advantage will be increasingly difficult with the more platforms that you have.
The best way to move forward is to have one solution and one platform that can deal with multiple data inputs and hierarchies and harmonise it in a way that allows it to be scalable. That means that you can then run scenarios and what-if analysis, review and challenge policies, desk structure and strategy, whilst maintaining consistency as well as an accurate and complete data lineage/traceability.
Boris: Alright, thank you Richard and maybe last question what are the biggest mistakes you see in the process of implementation of this regulation?
Richard: A number of firms have raced ahead and not thought strategically about how to comply in the long term. Effective compliance with FRTB involves going back to basics and thinking about how to solve the issues from a data perspective.