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Table of contents
• FRTB Overview
• FRTB Indicative Timelines
• FRTB Major Capital Charge Components
• FRTB Key Changes vs. Basel 2.5
• Revised Trading Book and Banking Book Boundary
• Trading Desk Definition
• Standardized Approach: Overview
• Standardized Approach: SBA Capital Charge (Delta & Vega)
• Standardized Approach: SBA Capital Charge (Curvature)
• Standardized Approach: DRC & RRAO
• Internal Model Approval Process
• IMA Approval Process: P&L Attribution And Backtesting
• PLA: Causes of Misalignment
• Expected Shortfall: Overview
• Non-Modellable Risk Factors: Overview
• IMA Default Risk Charge
• Market Risk Capital Charge Calculation: ACR
• FRTB Industry State of Play
• Key Program Challenges
• Key Implementation Challenges
• Many New Processes are Required Under FRTB
Ernst & Young LLP (the “US firm) is part of the global organization of member firms • Illustrative FRTB Program Timeline
(collectively, “EY”) of Ernst & Young Global Limited, separate legal entities that
perform professional services under the “EY” name worldwide. Information in these • EY Presence/Offerings
materials relating to our approach or methodologies is confidential and proprietary
to the India firm and/or EY and may not be disclosed to third parties without our • FRTB SA calculator – Overview
prior written consent.
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FRTB Overview

Why FRTB?
➢ Capital Arbitrage
• Intent based approach: Capital benefits due to switching • TB boundary i.e. moving from Intent based to evidence based
of books approach

➢ Lack Comparability
• Significant difference between IMM and SA
• Standard rule floor (50% - 72.5% over 5 years horizon)
Assuming CS and UBS have absolute same trading
portfolio, with the current methodology their regulatory
(FINMA) VaR and IRC numbers differ by 5%

➢ IMA Approach

• Fail to capture the tail risk (VaR vs ES) • Moving from VaR to ES
• Unable to capture the Liquidity risk (10 VaR across asset • Different LH: ranging from 10 to 120 days across asset
classes) classes
• No check on data quality • Market Data modellability
• One Bank • Desk level calculation and Eligibility

➢ Standard Rules

• Lack of Risk sensitivities (RWA approach does not • Sensitivity Based Approach
capture risk accurately)
• Limited recognition of hedge and diversification • Allowing Correlation benefits
• Insufficiently addressing complex instruments • Comprehensive rules to cater complex instruments.

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FRTB Indicative Timelines

Regulatory timelines are converging on January 1, 2022 with significant lead time required for internal and external model approval
► The Basel Committee (BCBS) issued the final FRTB rule on January 14, 2019 and restated January 1, 2022 as new go live date
► PRA has indicated an FRTB timeline in line with BCBS, with significant pre-go-live engagement and approval processes
► EU would be finalising the CRR 2 legislature by April 2019; CRR2 will expect banks to report based on SA approach by January
2021 and IMA by January 2023
► CRR 3 legislative proposal for FRTB as a binding capital constraint is expected to be drafted by Q2 2020 which would delay the
BCBS timeline for FRTB as a binding capital constraint
► FRB/OCC have not yet issued any official FRTB guidance, but indicated that a draft rule is expected toward the end of 2019

Proposal for CRR 3* Parallel run & approval

*(Q1 – Q4 2022)
EU ECB guidance SA reporting start
released (9/17) Finalization of CRR 2* date Jan 2021*# IMA reporting start date -2023*#

Model methodology reviews by asset class

PRA (H1 2018 – 2019) PRA Parallel Run Model Approval PRA go-live
(1/2022)
(Q1 – Q4 2020) (Q1 – Q4 2021)

FRB Final Rules expected

APAC**
FAQ 2, Final rule BCBS go-live (1/2022) PLA in Pillar 1
BCBS FAQ 1
released
Final consultation
released
PLA in Pillar 2

2017 2018 2019 2020 2021 2022 2023

* Indicative timelines, would be confirmed under CRR III expected in June 2020
** No announced plans in Japan; HKMA has indicated draft rules Q2 2019 closely aligned to BCBS
# Expected to also include a 60-day parallel run in order to enable ECB review

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FRTB Major Capital Charge Components

Below is an illustrative diagram of the major capital charge components and certain other requirements under FRTB.
Population

Trading book Trading desk and risk factor

• Inclusions • Internal risk transfers – Equity and Interest • Definition • Desk level internal model approval
• Exclusions rate risk • Criteria • Risk factor “real-price” criteria

Aggregated capital charge

Capital components

Non-approved trading desks and floor for

Approved trading desks
IMA for approved trading desks
Internal model approach (IMA) Standardized approach (SA)

Non-modellable Default risk Default risk

Expected shortfall Sensitivity-based Residual risk
risk factors charge charge
(ES) risk charge add-on
(NMRF) (DRC) (DRC)
Basel 2.5

VaR1 Partially addressed

Incremental risk Standardized charge 3 No Pillar I charge
+ through RNiVs in
charge (IRC) 2
Stressed VaR1 certain jurisdictions

Additional requirements
Other

• Intraday limit monitoring • Market liquidity • P&L reports

• Stress-testing • Disclosures • Inventory aging reports

1. Securitization positions are included in the value-at-risk and stressed value-at-risk measures under Basel 2.5. FRTB requires that securitization positions are excluded from the IMA
and only included in the SA.
2. Modeled default risk charges for correlation trading positions (CPT) are measured through the comprehensive risk measure under Basel 2.5. FRTB requires CTPs to be capitalized
under the standardized approach.
3. Certain jurisdictions apply Basel 2.5 standardized charges only for products with specific risk. Additionally, certain jurisdictions provided de minimis charges for positions not included
in VaR.

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FRTB Key Changes vs. Basel 2.5

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Revised Trading Book and Banking Book Boundary

➢ What is Trading Book (TB) & Banking Book (BB)

➢ Why these books are required?
For Accounting purpose
For Regulatory purpose: BB assets and TB assets can have very different regulatory treatment

Trading Book Banking Book

Holding period Short-term, Available-for-Sale (AFS) Held-to-Maturity (HTM)
Liquidity Regularly traded Less liquid
Valuation Daily Mark to Market Historical Cost
VaR 99% confidence Level @ 10-day Holding VaR 99.9% confidence Level @ 1 year
Reg. Capital Charge
period (BASEL II) Holding period

➢ Regulatory Arbitrage (Capital benefit due to switching between books)

Trading Book Banking Book

VaR 99% confidence Level @ 10-day VaR 99.9% confidence Level @ 1
Calculation of Reg. Capital Charge Holding period (BASEL II) year Holding period
= N * 2.58 * σ * sqrt (10) = N * 3.3 * σ * sqrt (252)
= N * σ * 8.15 = N * σ * 52.38
Impact : 6.5 times more capital required in BB, this gave banks an “INCENTIVE” to park as many assets as possible in the
TB
Adverse effect on 2008 credit crisis:
• Many banks had placed a lot of assets that looked of a BB-type into the TB, possibly to take advantage of lower capital
requirements
• Leverage, leverage, leverage and leverage
• Billions of losses in subprime CDO tranches

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Revised Trading Book and Banking Book Boundary

Standards for assigning instruments to the Trading book

➢ The regulatory text includes criteria for the definition of TB instruments. Examples include:
a) Short-term resale
b) Profiting from short-term price movements
c) locking in arbitrage profits
d) Hedging risks that arise from instruments meeting criteria (a), (b) or (c)
➢ Any FX (excluding hedge positions) or commodity positions held in the banking book need to be included

List of inclusions (Trading Book) Presumptive (Trading Book) Explicit exclusions (Trading Book)

➢ Instruments in CTP ➢ Listed equities ➢ Unlisted equities

➢ Instrument giving rise to a net short credit or ➢ Positions held as accounting trading assets ➢ Positions in securitization warehouse
equity position in BB or liabilities ➢ Real estate holdings
➢ Instruments resulting from underwriting ➢ Instruments resulting from market making ➢ Retail and SME credit
commitments activity
➢ Equity investments in funds where the bank
➢ Equity investments in funds where the bank ➢ Trading-related repo-style transaction cannot look through the fund or obtain daily
can look through the fund or obtain daily ➢ Options and bifurcated embedded derivative real prices
real prices from instruments issued out of the banking ➢ Derivative & hedging for above instruments
book relate to credit equity risk
Transfers between Trading Book and Banking Book strictly limited

➢ Switching is only allowed in extraordinary circumstances, must be thoroughly documented, approved by the regulator and publicly disclosed
➢ Regulatory penalty surcharge to eliminate capital benefit from switching between TB and BB through the remaining life of a position. The
difference in charges (at the point of the switch) is imposed on the bank as a fixed, additional disclosed Pillar 1 capital surcharge

Key considerations
➢ Covered position identification processes, systems and flags will likely have to be updated to reflect the updated TB/BB eligibility criteria
➢ Intercompany hedge programs may have to be reviewed to confirm the costs/benefits of hedging internally vs. externally (with third parties)
➢ Business processes to trace ‘back to back’ hedge transactions may have to be implemented to recognize hedges executed through an internal
trading desk

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Trading Desk Definition

For the purpose of regulatory capital calculations, a “trading desk” is defined as a group of traders or trading accounts that implement a well-defined business
strategy operating within a clear risk management structure

Four key elements of the ‘Trading Desk Definition’

➢ Individual trader or trading account is an indisputable and unambiguous unit of observation

Defined group of ➢ Can have up to 2 Head Trader; the role can cut across several businesses, with the clear cut accountability
traders or trading ➢ Each trading account must be assigned to only one trading desk
accounts ➢ Must have a clear reporting line to senior management and a formal compensation policy linked to pre-established
objectives

➢ Clear description of the economics of the business strategy for the desk, its primary activities and trading/hedging
Well-defined strategies
business strategy ➢ Management team must have a clear annual plan for the budgeting and staffing of the desk
➢ Regular Management Information reports, covering revenue, costs and RWA attributes for the desk are required

➢ Key groups and personnel responsible for overseeing the risk-taking activities at the desk
Clear risk ➢ Well defined trading limits and trader mandates reviewed at least annually by senior management
management ➢ P&L reports produced at least once a week
structure ➢ Internal and regulatory risk management reports produced once a week (e.g., desk VaR/ES, Backtesting and p-
value)

Proposed by the
➢ Bank must prepare a policy document for each desk it defines
bank but approved
➢ Supervisors will treat the definition of the trading desk as part of the initial model approval for the desk
by supervisors

Key considerations

➢ New desk flags and risk system hierarchies will likely have to be implemented to meet the FRTB trading desk definition
➢ Management, Volcker, and Basel 2.5 sub-portfolio definitions should be assessed and modified for consistency and to reduce the need for
multiple reports and duplicative monitoring

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Standardized Approach: Overview

• The standardized approach is designed to be a simpler approach for banks that do not have sophisticated measurement infrastructure for market risk.
• The approach provides a fall-back in the event of internal model inadequacy, will facilitate consistent and comparable reporting of market risk across
• Banks and jurisdictions, and can potentially be used as a floor or add-on to the internal models-based charge. The Default Risk Charge and Residual Risks
add-ons explicitly capture default and other risks, whereas Basel 2.5 standard calculations did not

The standardized approach requires the calculation of five different charges

The sensitivity data needed for the standardized approach calculations needs to be obtained from the same sources that are used for market risk management reporting

Key considerations

• Each of the above components requires granular bucketing of positions and sensitivities therefore banks will need to dedicate significant resources to
accommodate the complex database structures, which support sourcing and storage of additional data (e.g., bucketed sensitivities, new reference data,
parameter configurations)
• US banks may leverage CCAR infrastructure around sensitivities for 14Q reporting with customization for different bucketing

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Standardized Approach: SBA Capital Charge (Delta & Vega)

• The sensitivities-based risk capital charges for delta and vega are calculated for each risk class (rates, credit, FX, equities, commodities) based on granular
risk factor sensitivities (delta and vega) and allows for diversification benefits within, but not across, risk classes.
• The use of asset class and tenor based risk factor sensitivities is more granular than the notional/market value based method under Basel 2.5, which could
potentially reduce the gap between modelled based and standard approach RWA, subject to final calibration

The following steps could generally be followed

Key considerations

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Standardized Approach: SBA Capital Charge (Curvature)

• The curvature risk capital charge is intended to capture the incremental risk not accounted for by the delta risk of price changes in the value of non-linear
instruments. It therefore measures the higher order risks, including gamma.
• The approach allows banks to leverage the risk weights and bucketing structure already specified in the delta risk standards, thereby trying to achieve a
consistent approach across different standardized approach components

Full revaluation capability is required for curvature risk

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Standardized Approach: DRC & RRAO

The default risk capital charge captures the jump-to-default risk. It is calibrated based on the credit risk treatment in the Banking Book in order to reduce the
potential discrepancy in capital requirements for similar risk exposures across the Banking Book and Trading Book.

The default risk capital charge is composed of the following components:

The following steps could generally be followed:

1. Gross jump-to-default (JTD) risk positions 3. Risk weighted net JTD and bucketing
2. Net JTD risk positions 4. DRC per bucket
5. DRC per component
Certain instruments have risks which cannot be capitalized through the other components of the Standardized Approach. To account for these limitations, the
residual risk add-on establishes a capital charge which is calculated as the product of the notional and a prescribed risk weight with no diversification benefit.
The scope of instruments subject to the residual risk charge does not impact the scope for the other components of the standardized approach.

Residual Risk Addon (RRAO)

Simple summation of the gross notional amounts for all in-scope instruments, multiplied by the applicable risk weight:
Calculation 1% for instruments with exotic underlying's, and 0.1% for all other instruments bearing residual risk

Example of exotic Examples of other Residual Risk Types

underlying exposures
• Gap Risk: risk of a significant change in vega parameters in options due to small movements in the underlying, which results
in hedge slippage.
• Longevity risk • Correlation Risk: risk of a change in a correlation parameter necessary for determination of the value of an instrument with
• Weather multiple underlying's.
• Natural disasters • Behavioral Risk: risk of a change in exercise/prepayment outcomes such as those that arise in fixed rate mortgage products
• Future realized volatility where retail clients may make decisions motivated by factors other than pure financial gain ( such as demographical features
and/or and other social factors.

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Internal Model Approval Process

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Internal Model Approval Process

• To use the internal models approach, a bank is required to conduct and pass an overall model and risk management framework assessment
• Individual trading desks must pass qualitative and quantitative criteria and individual risk factors must be assessed against data quality requirements

The following presents a model approval decision tree and associated regulatory capital indication

Step 1 Step 2 Step 3

Firm-wide level Trading desk-level Risk factor level

Overall assessment of Trading desks Trading desks nominated for IMA Determine whether risk factor is “modellable” based on:
bank’s organizational not nominated • Real price criteria
Model performance assessment
infrastructure for for IMA • Frequency of observations
against desk-level quantitative
trading activities and its Pass Pass • Availability of historical data
requirements:
firm-wide internal risk Banks have the • Quality of the historical data which is determined
capital model discretion to Back- Green based on several factors including source of the
For both general and
applicable specific risk
select trading
desks for IMA
testing + P&L Attribution desks1
+
data, frequency of updates and comparability with
FO and Back offices data
Amber
Not Fail
Fail desks1 Non-
Fail Modellable
Nominated (red desks1) modellable
Capital Charge

Default Capital add-on for

Standardized approach for
Expected
Shortfall
+ Risk + NMRF
Add-On
+ trading desks in amber
Standardized approach Charge zone
• all failed regulatory trading desks
for entire Trading Book
• desks not nominated for model approval application
Floor: 72.5% Standardized Approach

Key Considerations
• Increased and more granular requirements for model approval including trading desk level model review and validation as well as “modellable” risk factor
look-through
• Proper control and mechanism are required to ensure funnelling of positions into internal models (including those subject to DRC) at trading desk level;
identification of the trading desks requiring comparison between IMA vs. SA based capital measures; and removing trading desks from the internal models
approach in case of failure of ongoing Backtesting and P&L attribution testing in addition to monitoring how long those desks have lost approval
1A trading desk is assigned to a red, amber or green zone based on the PLA test results. Generally green desks have passed the PLA test while red desks have failed.
Amber desks are those that have not passed the PLA test but have not performed so poorly as to be classified as red.

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IMA Approval Process: P&L Attribution and Backtesting

In order for banks to pass the firm level model process review, two quantitative metrics need to be assessed at a trading desk level in order to determine model
eligibility. A trading desk will be disqualified from using internal models and must be capitalized under the standardized approach if it fails any of the two criteria

Trading Desk Level Quantitative Tool

Profit and Loss Attribution (PLA) Backtesting (BT)

Assess if risk factors included in the trading desk’s internal models Complementary to P&L attribution and serves similar assessment
capture the material drivers of the actual P&L purpose

Trading Desk Level Backtesting: Key Requirements

• Must be performed using a 99% and a 97.5% 1-day VaR, calibrated to the most recent 12 months’ data
• An exception occurs if either APL or HPL is greater than VaR or if either of the P&L or the risk measure is not available
• SA must be used if more than 12 exceptions occur at the 99th percentile or 30 exceptions occur at the 97.5th percentile

Firm Level Backtesting: Key Requirements

• A 99% 1-day VaR, calibrated to the most recent 12 months’ data

• An exception occurs if either APL or HPL is greater VaR or if either of the P&L or the risk measure is not available
• Exceptions due to Non-Modellable Risk Factors can be disregarded in some cases, subject to the bank’s supervisor’s approval
• Depending on the number of exceptions, the bank’s capital model is assigned to one of the following 3 zones, which determines if IMA is
permitted and also determines the level of the Backtesting add-on to the capital charge multiplier:

• Number of exceptions > 10, Backtesting capital multiplier add-on is increased to the maximum 2 (an increment of 0.5)
Red Zone
• Internal models might not be approved

Amber Zone • 4 < Number of exceptions < 9, Backtesting add-on could be increased within the range of 0.2 to 0.42

• Number of exceptions < 4, no capital multiplier add-on

Green Zone

𝐶𝐴 = 𝑀𝐴𝑋 𝐼𝑀𝐶𝐶𝑡−1 + 𝑆𝐸𝑆𝑡−1 ; 𝑚𝑐 𝑥 𝐼𝑀𝐶𝐶60−𝑑𝑎𝑦 𝑎𝑣𝑔 + 𝑆𝐸𝑆60−𝑑𝑎𝑦 𝑎𝑣𝑔 Where 𝑚𝑐 is set at 1.5

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IMA Approval Process: P&L Attribution and Backtesting

Market data alignment, revised test metrics and thresholds make it easier for banks to pass the PLA eligibility test (PLAET). Although banks are required to
conduct PLAET starting January 1, 2022, capital requirement consequences will begin to apply January 1, 2023

PLAT Metrics: Key Requirements

Metrics: Spearman Rank Correlation (SP): To assess the correlation between RTPL and HPL
Kolmogorov-Smirnov (KS) Test: To assess similarity of the distributions of RTPL and HPL
➢ Data: Banks are allowed to align RTPL input data with the data used in HPL
➢ Frequency: PLAET must be performed on a quarterly basis using the preceding 12 months of data
➢ Penalty Function: A capital surcharge applies to desks in the amber zone as follows: Capital surcharge = k x max{0, SA G,A – IMAG,A}
• Where k is half of the ratio of the SA charge applied to the desk in the amber zone to the SA charge applied to the desk in the green zone

• SP < 0.7 or if KS > 0.12 (p-value=0.055)

Red Zone
• SA applies until the desk is in the green zone for PLA and passes Backtesting for 12 months

Amber Zone • 0.8 > SP > 0.7 or if 0.09 < KS < 0.12
• Eligible to capitalize under IMA with the surcharge capital.
• SP > 0.8 or if KS < 0.09 (p-value=0.264)
Green Zone
• Eligible to capitalize under IMA

P&L Measure Rule definition

The P&L that is predicted by the valuation engines in the trading desk risk management model using all risk
RTPL factors used in the trading desk risk management model (i.e. including all NMRFs) (FRTB p. 12)
The P&L produced by revaluing positions held at the end of the previous data using the market data at the
HPL end of the current day. This is akin to reported daily P&L but removing commissions, fees, the impact of
intraday trading and certain valuation adjustments. (FRTB p. 12)
The daily reported P&L based on the marking to market of the books and records of the bank excluding fees
FRTB Actual P&L and commissions and certain valuation adjustments. (FRTB p. 12)
N/A –generally used by management for monitoring as well as for books and records and limit monitoring;
Reported Daily P&L may include a breakdown into different sources to help management understand the drivers or facilitate
other calculations or processes (e.g. Volcker, tax)

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PLA: Causes of Misalignment

To improve PLA test results, firms need to be able to investigate the root causes of misalignment between HPL and RTPL. Potential causes of misalignment
include:

Market Data Methodology Processes P&L Adjustments

• The Final FRTB rule • Differences in • Since HPL and RTPL are • That March 2018 FRTB
allowed banks to align methodology between outputs from different update clarified that
market data input for official P&L pricing and risk departments and systems, valuation adjustments
RTPL to HPL if the management models could the resulting differences in that have their own
difference is due to cause misalignment these two processes can regulatory capital
different data providers, between HPL and RTPL have a significant impact on treatment, are deducted
different time fixing, or • Methodology PLA test performance from CET1, are not
certain transformations misalignments could • Potential process calculated daily or are not
• Aligning market data may include: misalignments could able to be calculated at
be operationally o Different revaluation include: the trading desk level are
challenging, particularly or calibration o Data quality checks excluded from desk-level
for different regional close approaches o Trading holiday HPL
times and for instances o Omission of risk treatment • Categorizing valuation
where finance and front factors o Process for adjustments for correct
office have different o Insufficient risk operational failures treatment may be
market data factor granularity o Hierarchy challenging
• Despite this relaxation, o Parameter misalignments • There are a number of
there may still be approximations o Population remaining types of
instances where market o Treatment of misalignments adjustments to raw HPL
data cannot be aligned and passage of time that may cause
causes PLA test failures misalignment, such as::
o Model and liquidity
VAs
o IPV adjustments
o Fill forwards
o Error or data quality
adjustments

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Expected Shortfall: Overview

Expected shortfall (ES) has to be determined at a 97.5% confidence level considering the following:

Three Types of ES Holding Period

• Three types of ES calculations are required: • ES is calculated for a base holding period of 10 days
• One ES calculation uses the full set of risk factors calibrated to • Base measure scaled to prescribed liquidity horizons for different
the current period (𝐸𝑆𝐹,𝐶) risk factors
• Remaining two ES calculations use a reduced set of risk factors
LH 1 LH 2 LH 3 LH 4 LH 5
that must meet certain data quality requirements: one calibrated
to the current period (𝐸𝑆R,𝐶) and one calibrated to a stress 10 D 20 D 40 D 60 D 120 D
period (𝐸𝑆R,S)
• LH assigned based on risk factor categories (partial extract only):
• Stress period selected at least monthly based on most severe 12
month period looking back to at least to 2007
• Stressed ES for the full set of risk factors is calculated as:

Constrained Diversification Benefits

• Unconstrained: ES allow diversification effects between risk factor asset classes that leads to the full correlation benefit.
• Constrained: ES without diversification effects between risk factor asset classes that leads to correlation benefit only within the asset class.

• The 3 types of ES (𝐸𝑆𝑅,𝑆, 𝐸𝑆𝑅,𝐶, and 𝐸𝑆𝐹,𝐶) are calculated individually as:

• Based on the liquidity horizons applicable to each risk factor class, calculating the three
types of ES would each require (5 + 3 + 3 + 3+ 3 + 4) = 21 ES calculations
• Total of 63 ES calculations for each scenario to calculate the ES charge (assuming
portfolio with exposure across all risk factor categories and liquidity horizons)

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Non-Modellable Risk Factors: Overview

FRTB introduces a new risk factor eligibility test to determine which risk factors have sufficient observability to be included in the expected shortfall and which
are subject to NMRF capital addon

Risk Factor ➢ A risk factor is considered modellable if it satisfies either of the below criteria:
Eligibility Test 1. At least 24 representative “real” price observations RPOs in the last year and no 90-day period with fewer than 4 RPOs
(RFET) 2. At least 100 RPOs total in the last year

Real Price Observation (“RPO”) definition Principles of risk factor modellability

• A price will be considered “real” if it is: • Risk factors which passed RFET need to be
• A price at which the institution has conducted a transaction; evaluated against 7 data principles to ascertain their
• A verifiable price for an actual transaction between other arms-length parties; suitability for inclusion in the ES model
• Obtained from a committed quote; or • Regulators may deem risk factors which do not meet
• If the price is obtained from a third-party vendor (with specific qualifying criteria) the data principles to be non-modellable, even if they
passed the REFT. These risk factors would need to
• Collateral reconciliations or valuations are not considered “real” prices be capitalized using more punitive stress scenarios
• A “real” price is representative for a risk factor if the value of the risk factor can be
extracted from the real price

Sources of Real Price Observations

• Front Office trade repositories or externally reported data (e.g. TRACE, SDR reporting)
• Data used for IPV or fair value level assessments
• Third party vendor data
➢ Each NMRF is to be capitalised using a stress scenario that is calibrated to be at least as prudent as the expected shortfall
calibration used for modelled risks (i.e. a loss calibrated to a 97.5% confidence threshold over a period of extreme stress)
Treatment of ➢ The bank must determine a common 12 month period of stress across all NMRF in the same risk class
Non- ➢ Bank may be permitted to calculate stress scenario capital requirements at bucket level (subject to supervisory approval), with a
Modellable single stress scenario for all the NMRFs that belongs to the same bucket
Risk Factors ➢ For each NMRF, the LH of the stress scenario must be greater of the LH assigned to the risk factor in and 20 days
➢ A zero correlation assumption may be used when aggregating gain & losses

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Non-Modellable Risk Factors: Overview

The FRTB requires that risk factors that do not meet the real price standards be capitalized using a stress scenario add-on, with no
diversification benefits with other risk factors.

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IMA Default Risk Charge

The Default Risk Charge (DRC) replaces the IRC from the Basel 2.5 framework. FRTB removes the requirement for modelling migration risk within the DRC.
The market risk model approval for the desk is a pre-requisite for DRC approval. The DRC also explicitly includes the requirement to model equities, whereas
equity inclusion in IRC was optional under Basel 2.5. Defaulted debt positions are also explicitly required in-scope

DRC has to be determined at a 99.9% confidence level on a weekly basis considering the following:

➢ Must use a default simulation model with two systemic risk factors
➢ Must use constant positions over one year
• Banks have the discretion to apply a minimum liquidity horizon of 60 days to the determination of default risk
Modelling charges for equity sub-portfolios.
requirements ➢ Prescribed approach for default correlations
• Must be based on credit spreads or listed equity prices
• Must be based on 10 years of data which includes a stress period for the portfolio and be based on a one year
liquidity horizon

Prescribed floor ➢ A PD floor of 0.03% is proposed

for default ➢ Result in higher DRC for products with lower PDs such as highly rated sovereigns and may make these products
probability more expensive for banks

➢ Under the FRTB, equity positions must be included in DRC

Mandatory • Definition and computation of Jump-to-Default for equity products may be complex for multi-underlying non-
inclusion of linear products
equities in DRC • Simplified modelling approaches may be applied
➢ The default of an issuer is interpreted as equity price dropping to zero

Key Considerations

• IRC models, or for banks subject to the CCAR Global Market Shock, Incremental Default Risk models, may be modified to meet the DRC
standards
• Market data time series going back 10 years will be needed

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Market Risk Capital Charge Calculation: ACR

The aggregated capital charge for market risk (ACR) is calculated on a portfolio level and comprised as follows:

If at least one eligible trading desk is in the PLA test amber zone, a capital surcharge is added. The impact of the capital surcharge is
limited by the formula:

Key Considerations

• Daily calculation of market risk regulatory capital may require significant increasing of computational power, personnel, and processes to
review and sign-off on capital figures
• Controls and audit trails for desk-level model approvals over times may need to be established to identify and justify applicable capital charges
for each desk included in the aggregated capital charge

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FRTB Industry State of Play
Previously banks de-emphasized PLA and NMRF given rule uncertainty; these will now be the areas of focus for banks seeking IMA

Below are illustrative indicators for six areas of FRTB programs:

Prototype Methodology/Policy Requirements IT Implementation

Standardized ➢ Banks are updating QIS prototype calculators to incorporate final rule revisions, enhancing capabilities for more frequent runs and
MIS reporting (e.g., Legal entity level runs)
Approach
➢ Banks are addressing data gaps and data quality issues for both FRTB-SA and CVA-SA

➢ Banks are working on establishing JTD methodologies and feeds for new product types not currently in the model (e.g., equities)
Default Risk
➢ Banks are reviewing prototype methodology (e.g., constant position, 2 systematic risk factors) and comparing IMA vs. SA DRC
Charge capital impacts across desks and asset classes

Expected ➢ Banks are implementing VaR enhancements (e.g., full revaluation, risk factor granularity, RNIV, and time series)
Shortfall / VaR ➢ Banks implementation for FRTB specific requirements (e.g., liquidity horizon mapping, diversified and constrained ES calculations,
Enhancements reduced set of risk factors) are still in prototyping stages

➢ Volcker desk structures usually serve as a starting point

Desk Structure
➢ Desk analysis is ongoing. Dependency on more frequent/desk level estimates for SA and IMA capital charge and PLA results

➢ Clarity on RTPL, HPL and revised metrics is leading banks

to ramp up on PLA analysis and development ➢ Enhanced prototypes may leverage existing VaR infrastructure or
new VaR environment for banks further along on enhancements
P&L Attribution ➢ Analysis inflight to assess risk factor coverage,
granularity, and market data alignments ➢ Prototypes often based on FO HPL as a model development tool,
with firms investigating VAs separately
➢ Operating models agreed for some banks

➢ Banks are engaged with vendor pilot testing

Non-Modellable ➢ Initial prototypes implemented at some banks, but often still
Risk Factors ➢ Analysis of internal real price sources inflight relying on significant assumptions and simplifications
➢ Limited real price and NMRF infrastructure build

Majority
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Key Program Challenges

In analyzing the final rule impact and reassessing implementation plans and priorities, banks face
significant program choices and challenges

 Banks with larger market RWA may need to quickly reassess the capital benefits of IMA under the final
rules and engage with stakeholders in FO, capital management, to confirm desk priorities and update
budgets and project plans for IMA
Business case  Overall firmwide assessment of benefits of IMA may consider proposed aggregate 72.5% SA output floor,
analysis and CCAR stressed capital ratios, and potential impact of SCB on binding constraint
prioritization  Firms may consider multiple allocation methods to assist with desk prioritization, impact on desk-level ROE,
broader business strategy, and potential qualitative considerations for likelihood of obtaining approval
 BAU costs are an important consideration in developing business case, particularly considering increased
computational and operational costs of maintaining IMA

 Banks must agree on design principles for strategic enhancements to align front office, risk and finance
data and models, refine risk models and calculations, enhance market and reference data, and implement
Organizational supporting architecture and technology enhancements to meet significant computational uplift
coordination
 Bank programs must coordinate across a large number of stakeholders from front office, risk and finance,
and require clear split of responsibilities for both project implementation and BAU operating model

Resource  Banks seeking IMA may need to significantly ramp-up resources to build PLA and NMRF infrastructures to
mobilization have meaningful test results to support internal model validation and regulatory approval submissions

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Key Implementation Challenges
With the final rule available, banks need to finalize key rule interpretations and progress on several time consuming builds early enough
to meet demanding timelines

 Risk factor to instrument mapping: Banks will need to perform detailed analysis of risk factor mapping to inform
methodology and bucketing decisions and initiate strategic builds in order to optimize NMRF
 Data sourcing: Though analysis of internal sources of real prices may be have been performed, given significant
NMRF incentives to source high quality market risk factor data to pass the RFET, banks should finalize data sourcing
strategies with vendors to source quality data and should develop new infrastructures to store trading data
 Model enhancements: Optimization efforts are required to assess the alignment of risk factors and time series
data given NMRF requirements

 RTPL and HPL: Banks may need to make enhancements to their existing P&L calculations, processes and
systems to increase chances of passing PLA and facilitate root-cause analysis of any misalignments between
RTPL and HPL
PLA  VaR: Though banks may leverage existing VaR infrastructure, significant effort may be needed to enhance Risk
and FO pricing models and assess risk factor coverage, granularity, and market data alignments
 Desk structure: Significant work may be required for banks that choose to re-define desk structures based on
trading desk requirements and the results of the P&L Attribution

 Banks may require significant effort to review existing time series and update them for FRTB specific
requirements, such as reduced risk factor treatment and complete history to 2007, or incorporate changes to
Time series risk factor definitions as a result of PLA, NMRF or other requirements
 The FRTB market data principles may require changes to existing risk factor definitions or additional one-time
implementation efforts or ongoing controls for time series

 Banks will need to perform detailed analysis on available risk measure and reference data and make
interpretations on rule requirements to determine any gaps
SA  Banks will also need to agree on scope and filtering logic for residual risk add-on
 Banks will need to assess options for multi-underlie treatments and plan implementation; complying with the
requirements and minimizing capital impact may take significant implementation effort

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Many New Processes are Required Under FRTB
Internal Models Approach (IMA)
P&L Attribution and Backtesting
► Fallback to Standardized Approach if ongoing tests fail

Population
with Model Non-Modellable Risk Factors
Model Based Capital
Approval ► Real price criteria analysis
Charge
► Undiversified stressed capital add-ons
► Three step Market Risk Capital Charge
Desk-level for
Market Risk Regulatory Capital Charge Calculation

►
process Expected Shortfall Calculation
approved desks
► Desk and ► 3 types with different risk factors sets and lookback periods
► Top of the house ► Must meet capital
risk factor ► Modellable risk factors only
for approved desks requirement on a daily
level ► Varying liquidity horizons
approvals ► Limitations on cross risk factor class correlations basis to maintain model
approval
Default Risk Charge (DRC) ► SA introduced as a floor to
► Two factor; 10-year lookback; stressed correlations
IMA pending further
calibration
Standardized Approach (SA)
Sensitivity Based Charges
Trading Book/
(Delta, Vega, & Curvature)
Banking Book
► Net sensitivities to risk factors x prescribed risk weights
Boundary
► Granular bucketing of risk factors
and Trading
► Prescribed formulas for aggregating within buckets and across
Desk Definition
buckets in same risk class
► No diversification benefit between delta and vega Standardized
► Based on difference between full and sensitivity based revaluation in Approach Capital
prescribed up and down shock scenarios Charge
All Trading ► Prescribed risk weights and aggregation formulas
► Desk-level for all
Book Default Risk Charges desks
Positions ► Function of notional, market value, LGD prescribed by product type ► Top of the house
and risk weight for unapproved
► Offsetting rules within buckets varying based on product desks
characteristics Regulatory Capital
► Separate offsetting and bucketing for non-securitizations, Reporting
securitizations (non-CTP), and CTP
Residual Risk Add-On
► Applies to instruments with risks not otherwise captured in SA
► Product of simple sum of gross notional amounts and prescribed
multiplier
Internal Management
Testing
Stress

Stress Testing Reporting

Internal Scenario Supervisory Scenario

Process, Controls, and Disclosures

Market Risk End-to-End Control Independent Quantitative Qualitative
Model Validation
Governance Process Verification Disclosures Disclosures

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Illustrative FRTB Program Timeline

Depending on home jurisdiction go-live dates and requirements for IMA approval processes, banks will likely have to have high
quality IMA results by mid-2020

► The diagram below illustrates a high level FRTB program timeline based on regulatory go-live of Jan 2022
► Lead times to support collection of results for internal model validation and regulatory approval processes means significant model
development and collection of results (e.g., backtesting, PLA) likely needed by early/mid 2020

2019 2020 2021 2022

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

VaR enhancements
(full reval, RF, RNIV, and time series) Model validation
Collection of results Model approval submission
IMA build & testing
(e.g. PLA, backtesting) packages and results
(ES, DRC, NMRF calculators & reports)

PLA build & testing

(RTPL, HPL, PLAT)

Desk structure analysis

SA build & testing Model

(data, calculator & reports) validation
IMA & SA operating
model, governance & Submission package Reg Go-Live
controls (1/2022)

Regulatory engagement and submissions Regulatory Approval

Internal Go- Application

Page 28 Live Submission
EY Presence/Offerings

Page 29
 FRTB SA calculator – Overview

EY has developed a FRTB standard charge calculator which fully automates the decomposition and capital charge calculation
providing reporting capabilities. It has been used to deliver the basis for their strategic compliance solution.
FRTB SA Approach

Standardized Residual Risk

Sensitivity Based Approach Risk Default Risk
Capital Charge Add-on
FX EQ COMM CSR GIRR
Sec Sec
Non-Sec
CTP Non-CTP

Delta Risk Vega Risk Curvature Risk

Inputs Calculations Outputs

Risk factor sensitivities Reporting

EY FRTB SA Calculator

Asset Classes

Aggregate by Asset
Revaluation ladders Delta Total
• FX Standard ToH
Risk factors
Firm Data

• EQ Rules
Class
Static data Vega • COMM Capital Desk level
• CSR NS Charge
Semi static data Curvature • CSR SEC MI breakdown
• CSR CTP
• GIRR
Market data
Default Risk
Residual Risk
Correlation matrices
BCBS Data

Risk weights

Page 30
Questions and Answers

Page 31
Thank You
Ernst & Young

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