Some jurisdictions, like Hong Kong, are going full steam ahead with the adoption of FRTB, while others require more time to implement. Timing inconsistencies pose challenges to globally active FIs as they will need to adapt to work under different local regulatory rules.
In January 2019, the Basel Committee on Banking Supervision (BCBS) issued its revised Minimum capital requirements for market risk, commonly referred to as the “Fundamental Review of the Trading Book” (FRTB).
The framework aims at addressing the structural shortcomings of the market risk framework under the Basel 2.5 regime and it follows up on an original version published in January 2016.
Across the globe, Financial institutions and local regulators are in the process of analyzing the impact of the new FRTB framework without clear commitments for implementation timelines until those impacts are better understood, while other jurisdictions, like Hong Kong, are full steam ahead. Inconsistencies in implementation timelines poses different challenges for FI’s globally.
Impact on Capital and Trading Strategies Unclear but Material
Firstly, the impact on RWA of the FRTB framework is not clear. This poses banks with large trading books in a difficult position, since the rules might have a larger than expected impact on capital requirements.
In January, the Basel Committee on Banking Supervision estimated the new FRTB regime would result in a 22% weighted average increase in capital requirements when compared to the previous Market Risk Capital Requirements. However, the ISDA has conducted more detailed research on the impact and found that the BCBS’ numbers could be a large underestimation.
Secondly, the impact of FRTB on FIs trading strategies and organization are equally likely to be large. It seems that a strategic re-alignment of the trading strategy will need to happen in a context where the timing of global roll out of the rules is uncertain.
In April this year, ISDA had pointed out the challenges that some jurisdictions in emerging markets would face when introducing the new market risk rules since ‘[…] it is also acknowledged that the framework has been primarily developed and calibrated for large, globally active banks in advanced economies. As a result, there are questions about which approach might be best for smaller banks, and to what extent the framework will impact those institutions in emerging markets’.
Impact of Geography
As most smaller banks or local banks with smaller trading books would use the (Simplified) Standardized Approach, the risk weights for sovereign bonds, which are mostly used as collateral for trading activities, are high relative to the credit risk Standardized Approach, which allows 0% risk weights for sovereign bonds issued in domestic currency under national discretion.
Since South East Asian country ratings are in the BBB (e.g. Thailand, Indonesia) -BB (Vietnam) range, Risk weights under the Market Risk SA approach are set at 6 or 15% respectively, which seems especially punitive for trading activities collateralized by those government bonds.
Generally, a lack of infrastructure, data and/or legal framework would need to be addressed prior to the implementation date. However, even those jurisdictions having to deal with such impediments to a far lesser degree are still keeping their hands close to their chest (EU, US, SG, AU).
What Does the Eu Say?
The EU will implement the FRTB in a 2-step approach, with only the reporting requirement as part of step 1 and included in the CCR2. The capital requirements in step 2 will be handled in a separate proposal, of which no details have yet been published except that the proposal of the European Commission is scheduled for 30 June 2020.
The two main reasons for the delayed implementation of FRTB are:
- A full and clear understanding of the impact through QIS.
- Awaiting ‘developments on International level’. Regarding QIS, the European Banking Authority is scheduled to publish a report on the impact of FRTB on European Institutions at the end of September 2019.
Hong Kong Full Steam Ahead
In contrast, Hong-Kong’s HKMA published plans to steam ahead with the local adoption having published its proposal for the local FRTB implementation the form of a consultative paper back in June this year. Many global FIs are watching the progress of HKMA closely, since the impact of FRTB on both their regulatory capital as on their organization is potentially large.
Moreover, large global banks could find themselves unprepared for abiding to the new rules just for their HK trading desks, given that the timing of the FRTB rules to come into effect in other jurisdictions is still debated. HKMA seems to surprise many industry players by its stated intention to stick to the BCBS FRTB framework in scope, methodology and timing and is seeking to move ahead with the implementation of the new Market Risk regime by 1st of January 2022.
HKMA states that ‘As the revised market risk capital framework in effect represents a significant overhaul of the current market risk capital framework, it is likely to have impacts on, among other things, the capital charges, systems, data and resources of AIs, particularly for those with material market risk exposures. All relevant AIs are therefore strongly recommended to consider the implications of implementation for their institutions and start preparing for the local implementation of the revised framework in 2019’.
It is clear that most countries are taking a wait-and-see approach to see if the overall objective of rolling out the FRTB rules globally in a consistent manner will be met. Both in time as in substance, FRTB maintaining a geographical level playing field seems paramount. The uncertainty around the direction of the new market risk rules now seem to have shifted to more pragmatic concerns of strategic, financial and organizational impact of the implementation of the finalized rules.
In this context, it is likely that more time will be needed for the rules to come into effect in Europe and the US, both of which have not committed timelines to date. In the meantime, banks with global trading strategies are facing a period of uncertainty in absence of unified global regulation and will incur increased overhead and uncertainty.