Fundamental Review of the Trading Book

Fundamental Review
of the Trading Book
Minimum Capital Requirements Regulatory Evolution
April 2016

Fundamental Review of the Trading Book
Executive summary
In January 2016, the Basel Committee on Banking Supervision (BCBS) published the final and revised standards for
minimum capital requirements for market risk. Over the next few slides we will compare the latest standards to
those from the BCBS’s July 2015 Paper and their August 2015 impact study. Among the major changes to the
existing regulatory framework, we find:
Goal This document highlights:
 Guideline updates in respect to the July 2015 BCBS paper on market risk framework
 New definitions and content
 Amendments to formulas and financial indicators/coefficients
Copyright © 2016 Accenture All rights reserved.
 Revised boundary between the trading book and the banking book
A more objective boundary will serve to reduce incentives to arbitrage between the regulatory banking
and the trading book, while still being aligned with a bank’s risk management practices. The market
making activity is subject to change by the Basel Committee and not fully defined in the last document
 Standardized Approach (SA)
Most of the risk factors have been revised in their buckets, risk weights and correlations, distinguishing
between the delta, vega and the curvature risk charges. In particular, delta Credit Spread Risk (CSR) risk
weights and liquidity horizons have been significantly reduced. Other changes touch on the extension of
the Default Risk Charge concept and the Residual Risk Add-on (RRAO).
 Internal Model Approach (IMA)
The regulator has addressed some areas such as the capitalization of risk factors, backtesting, liquidity
horizon, quality of the data used to compute the IMA. The regulator has also updated the capital
requirements and the default risk formulas.
 Supervisory Review Process – the Second Pillar
The regulator has conducted an in-depth analysis of the internal risk transfer and the trading book
eligibility and provided a minimum set of risk management policies and procedures to be thoroughly
documented by financial institutions.
1
Key
Enhancements

2
Industry and regulatory reactions: Pros and Cons
The last version of the Fundamental Review of the Trading Book (FRTB) created much discussion within the Industry. While the final
version of the standards tried to soften some of the strict requirements of the July 2015 version, others rules have been reinforced. An
overview of how the Industry has responded to the new changes is outlined below.
ConsPros
 Capital requirements have
been reduced. (1)
 The estimate of an average
variation is softened to +40%
in the current capital for
trading book positions,
instead of +74%.(2)
 Distinction made between
exotic options (subject to a
punitive 1% and «others»
softened to 0.01%) in the
RRAO’s calculation. The
definition of exotic options
has been reduced to a certain
set of instruments. (1)
Standardized Approach
 Increasing the underwriting
and funding costs and
reducing liquidity in the
secondary market due to
higher capital charges.(5,6)
 Poor distinction between
different rating classes due to
the lack of granularity among
risk weights.(1)
 Double counting due to the
overlap between historical
credit spread and widening
default expectations.(6)
ConsPros
Internal Model Approach
 As “continuous” and “real
data” is not always available,
the treatment of many risk
factors as non-modelable risk
factors could lead to higher
charges. (1,6)
 Intra-day basis measurement
required. Banks may need
new infrastructures and
operational tools.(1)
 More aggressive ES multiplier
(increased to 1.5, (1)) and a
higher multiplier may
diminish positive effects of
LH reduction.(7)
 IMA is preferred to the
standard-based approach
(SBA) in certain cases due to
the more expensive standard
approach.(4)
 The liquidity horizon days
used for the Expected
Shortfall (ES) formula have
been reduced.(1)
 Liquidity horizons have been
reduced for Credit Spread,
Equity and FX.(1)
 Introduction of backtesting
exceptions on very limited
occasions.(1)
With the changes to the market risk standards, the industry should reconsider its overall business strategy in the following areas:
• A possible reallocation of the portfolios with the aim of eliminating/reducing products strongly affected by the updated rules (e.g. bond
markets, SME credit, securitizations as the residential mortgage-backed securities, emerging markets, small cap equities and FX hedges). (1,6)
• As the standard approach for capital charge calculation is mandatory for securitization, making it costly for banks and thus encouraging them
to review their securitization business strategy. (3)

Regulatory evolution: Standardized Approach (1 of 4)
Copyright © 2016 Accenture All rights reserved. 3
The new Market Risk Framework published in January 2016 includes a number of changes related to the definition of Curvature risk
exposure, RRAO formula and cross currency basis definition
January 2016July 2015
Curvature risk
Charge
Instructions: Impact study on the proposed frameworks for
market risk and credit valuation adjustment (CVA) risk
New Market Risk Framework
StandardizedApproach
 The curvature risk charge formula states that
upward/downward shock sensitivity should be
subtracted from the curvature risk charge (CVR).
(8)
 The positive curvature risk exposures should be
ignored, unless they hedge a negative curvature
risk exposure. If there is no negative curvature
risk exposure, the CRV should be zero. (8)
 As previously outlined in the “FAQ: Impact study on the
proposed framework frameworks for market risk and
CVA risk” the curvature risk charge formula has been
modified. Risk-weighted sensitivity for the down shock is
added. (10)
 The negative curvature risk exposures should be ignored,
unless they hedge a positive curvature risk exposure. The
curvature risk charge would be zero for negative
exposures. (10)
Residual Risks
Add-on
 The RRAO is to be calculated for any instrument
which is subject to vega and curvature risk capital
charges and whose payoff cannot be written as a
linear combination of plain vanilla options. (8)
 The RRAO is defined as a sum of the notional
value of instruments bearing residual risks
multiplied by a factor of “x” (yet to be
confirmed). (8)
 In addition to the criteria outlined in the July paper,
instruments concerning correlation trading portfolios
(except for eligible hedges) are subject to RRAO.
Back-to-back transactions, listed instruments or
instruments eligible for central clearing are excluded from
the RRAO. (10)
 The RRAO is a sum of the notional value for instruments
with non-linear payoff or for exotic option, multiplied by a
risk weight of 1.0% and a risk weight of 0.1% for
instruments bearing other residual risks. (10)
August 2015
FAQ: Impact study
on the proposed
framework
Highlighted
issue (9)
Cross Currency
Basis Risk
Factor (1/2)
 For general interest rate risk (GIRR), the BCBS
added two cross currency basis risk factors (EUR
and USD) that have to be considered. (8)
 The GIRR should include one of two possible cross
currency basis risk factors (over EUR or over USD but not
both). (10)

The new Market Risk Framework published in January 2016 includes a number of changes related to the definition of cross currency basis
risk, delta CSR bucket scales and delta risk weights reproportioning
Instructions: Impact study on the proposed
frameworks for market risk and CVA risk
August 2015
FAQ: Impact study
on the proposed
framework
Cross Currency
Basis Risk
Factor (2/2)
 Two cross currency basis risk factors are included
for each currency (i.e. each GIRR bucket). (8)
 The final release of the regulation specifies that term
structure is not recognized as a cross currency basis risk
factor (cross currency basis curves are flat) in the GIRR
risk. (10)
Highlighted
issue (9)
Delta CSR
Buckets
 New release provides 16 buckets due to a split of some
sectors and the introduction of the sector “Covered
bonds”. (10)
 Regulation provides 13 buckets both for CSR non-
securitizations and securitization (CTP). Buckets
assigned based upon credit quality and sector. (8)
Delta Risk
Weights
 Delta GIRR risk weights have experienced a general
increase among all vertex (from 2.4% to 1.5%). (10)
 A risk weight of 2.25% is set for inflation and the cross
currency basis risk factors. (10)
 Delta CSR Non-securitizations in correspondence to the
new buckets’ weights range from 0.5% to 12%. (10)
 Delta CSR Securitizations (CTP) in correspondence to the
new buckets’ weights range from 2% to 16%. (10)
 Delta CSR Securitizations (non-CTP), weights have been
decreased: for senior investment grades the weights range
from 0.8% to 2%, for non-senior Investment grade and
high-yield and non-rated multiplication factors are
reduced to 1.25 and 1.75. Finally, other sector’s weight
has been changed for 3.5%. (10)
 For Foreign Exchange Risk a unique risk weight has been
set to 30%, except specified currency pairs. (10)
 Delta GIRR risk weights vary from 1.6% for lower
tenors to 1% for higher tenors. (8)
 A risk weight of 1.5% is attributed to inflation and
the cross currency basis risk factors. (8)
 Delta CSR Non-securitizations, weights range from
2% to 12%. (8)
 Delta CSR Securitizations (CTP), weights range
from 3% to 17%. (8)
 Delta CSR Securitizations (non-CTP), weights have
the following scale: for senior investment grades –
from 3.5% to 8.5% for non-senior Investment
grade and high-yield and non-rated, multiplication
factors are 2 and 4; while other sector’s weight is
set to 34%. (8)
 Foreign Exchange Risk a unique risk weight is set
to 15%, except specified currency pairs. (8)

The new Market Risk Framework published in January 2016 also includes changes related to the Standardized Approach framework
August 2015
FAQ: Impact study
on the proposed
framework
Delta
Correlations
 Delta CSR Non-securitizations: The delta risk
correlation ρkl is set at 99.90% / 65.00% / 35.00%
(for non-securitizations) and 99.90% / 80.00% /
40% for securitizations (non-CTP) or a product of
the above multipliers depending on the
combination between tenors, curves and issuer
names. (8)
 Correlation parameters across different buckets for
Delta CSR Non-securitization are defined by the
table for each bucket combination. (8)
 Commodity risk: Correlation parameter is set for
each bucket and is multiplied by a factor of 99.9%
in the case of different vertices or different
contract grade or delivery location. (8)
 Delta CSR Non-securitizations and Delta CSR
securitizations (non-CTP): The same concept of delta risk
correlation is applied, except for «other sector» bucket.
Capital requirement for this bucket would be equal to the
sum of weighted sensitivities. (10)
 The calculation procedure of correlation parameters
across different buckets for Delta CSR Non-securitization
has been modified. (10)
 Commodity risk: Correlation parameter is set for each
bucket (remain unchanged) and is multiplied by a factor
of 99.00% in the case of different vertices or/and by a
factor of 99.90% in the case of different contract grade or
delivery location. (10)
Vega Risk
Sensitivities
 The regulation provides insights on vega risk sensitivities for
exotic options and excludes from vega calculation CTP
securitization tranches which do not have implied volatility.
(10)
 The regulation provides details only for non-
exotic options vega calculation. (8)
Highlighted
issue (9)
 The correlation parameter between two vega
sensitivities is determined by correlation parameter
related to similar delta sensitivities, option maturity
correlations and underlying maturity correlation. (8)
 Correlation parameters related to delta sensitivities are
excluded from calculations of vega correlations. (10)
Highlighted
issue (9)
Vega Risk
Correlations

The new Market Risk Framework published in January 2016 includes changes pertaining to risk weights of vega and curvature risks and
redefines the concept of default risk charge
August 2015
FAQ: Impact study
on the proposed
framework
Vega Risk
Weights
 Vega risk weight is calculated by using a formula that
considers liquidity horizons for each vega risk factor
and weights of 0.0032 for GIRR and CSR and 55% for
other risks.(8)
 Vega risk weight formula has been modified and now
takes into account lower liquidity horizons for some
risk classes and a unique weight of 55% for each risk
factor. (10)
Highlighted
issue (9)
 The curvature risk weights are equal to the delta
risk weights.
 For GIRR, the parallel shift of the curve should be
based on the highest risk weights across all the
tenors.(8)
 For FX and Equity the curvature risk weights are equal to
the delta risk weights.
 For GIRR, CSR and Commodity curvature risk factors, the
parallel shift of the curve should be based on the highest
delta risk weights for each risk class. (10)
Curvature Risk
Weights
Default Risk
Charge
 The Default Risk Charge (DRC) methodology provides more
details on the calculation procedure.
 For traded non-securitization credit and equity derivatives,
Jump to Default (JTD) amounts should be determined by
applying a look-through approach. (10)
 Under the DRC for non-securitizations, if the contractual
terms of the derivative allow for the unwinding of the
instrument with no exposure to default risk, then the JTD is
equal to 0. (10)
 When the price of an instrument is not linked to the
recovery rate of the defaulter, there should be no
multiplication of the notional by the Loss Given Default
(LGD). (10)
Highlighted
issue(9)

Regulatory evolution: Internal Model (1 of 2)
The new Market Risk Framework publication includes updates to liquidity horizon, risk factor capitalization and model validation process
under the Internal Model Approach
InternalModelApproach
August 2015
FAQ: Impact study
on the proposed
framework
Liquidity
Horizon
 The liquidity horizon are set to 10, 20, 60, 120, and
250 days. (8)
 The liquidity horizon are set to 10, 20, 60, 120, and 250
days. (8)
Observation
Horizon for
Stressed ES
 For measurements based on stressed
observations, banks must identify the most
stressful 12 months over an horizon period back to
2005. (8)
 For measurements based on stressed observations, banks
must identify the most stressful 12 months over an horizon
period back to 2007. (10)
Model
Validation
Standards
 Regulator may require additional tests for the
model validation using LH, other than those
applicable to the risk factors or without using
overlapping periods. (8)
 Testing with LH other than those applicable is no longer
required.
 Bank may be required to provide additional model
validation information for each day of a 3-year period: VAR
at 99% and 97% level, P&L and its p-value. (10)
Capitalization
of Risk Factors
 The relative weight assigned to the firm’s internal
model is not specified.
 In the formula for aggregated charge the
multiplication factor applies only to the modelable
capital charge and is set at the minimum of 1 and
may be raised by the Supervisor (by a maximum
of 0.33 points) in order to penalize for the
negative outcomes of a backtesting. (8)
 The relative weight assigned to the firm’s internal model is
set to a value of 0.5.
 In the formula for aggregated charge the multiplication
factor applies only to the modelable capital charge and is
set at the minimum of 1.5 and may be raised by the
Supervisor (by maximum of 0.5 points) in order to penalize
for the negative outcomes of a backtesting. (10)

Regulatory evolution: Internal Model (2 of 2)
The new Market Risk Framework published in January 2016 includes changes related to the Standardized Approach framework
InternalModelApproach
August 2015
FAQ: Impact study
on the proposed
framework
Non-
modelable
Risk Factors
 The aggregated regulatory capital for unmodelable
risk factors is the sum of stress scenarios capital
charge for non-modelable risk factors in model-
eligible desks. (8)
 The concept of non-modelable risk factors arising from
idiosyncratic credit spread risk is introduced and is a
separated treatment in the capital charge calculation. (10)
“Real” Price
 The regulator has added a new requirement to define
“real prices”:
• Prices obtained from a third-party vendor when
it matches certain requirements listed by the
regulator
 Moreover, real prices criteria should be assessed on a
monthly basis. (10)
Default Risk
 Default risk must be measured using VaR model
with:
• Weekly calculation frequency
• One year LH
• One-year time horizon
• 99.9 % confidence level (8)
 The regulator has introduced a discretion for banks to
apply a minimum LH of 60 days to the determination of
default risk charges for equity sub-portfolios.
 The model must account for the risk in the timing of
defaults to capture the relative risk from maturity
mismatch of long and short positions. (10)
Backtesting
Highlighted
issue (9)
Highlighted
issue (9)
 There may on very rare occasions be a valid reason why a
series of accurate desk level models across different
banks will produce backtesting exceptions and
inadequately track P&L attribution to the front office
pricing model. (10)
 Trading desks that do not satisfy the minimum
backtesting and P&L attribution requirements are
ineligible for capitalization under the internal model
approach. (8)
 A price is considered “real” if:
• It arises from a transaction
• It is a verifiable price of an actual
transaction
• The price is obtained from a committed
quote (8)

Regulatory evolution: Other issues
The new Market Risk Framework partially modifies concepts such as Trading Book and Banking Book boundary and Supervisory Review
Process and settled the regulatory deadlines
TradingBook
Boundary
August 2015
FAQ: Impact study
on the proposed
framework
Market
Making
 The market maker/dealer exemption set out in this
paragraph is subject to change by Basel Committee. (10)
 Where a bank demonstrates that it is an active
market maker, then a national supervisor may
establish a dealer exception for holdings of the
other banks, securities firms, and other financial
entities capital instruments in the trading book. (8)
Trading Book
 Trading book instruments are defined as financial
instruments and commodities. (8)
 Trading book instruments include financial instruments,
foreign exchange and commodities. (10)
 To be determined. (8)  1 January 2019: Deadline for the revised market risk
framework implementation.
 31 December 2019: Deadline for the regulatory reporting
by banks based on revised market risk framework. (10)
 The Regulator has specified a minimum set of policies and
procedures that should be thoroughly documented and
that relate to:
 Trading book eligibility
 Internal risk transfers from bank book to trading
book (10)
DeadlinesSecondPillar
Supervisory
Review
Process
Transitional
Arrangements
 The Regulator states that banks have to define
clear policies and procedures to determine if an
instrument has to be included in the trading book
 The Supervisor will require a bank to change its
policies and procedures if they prove to be
inappropriate/insufficient for preventing a booking
in the trading book not compliant with the
principles envisaged by the new regulation. (8)

New
Model
Parallel
Running
1
Workflow
10
Timeline
Systems and
Infrastructures
Business Model
Strategy
Methodologies and
Processes
Go Live
Starting
Point
2016
2017
2018
2019
What’s next?
The FRTB is expected to impact all functions within a financial institution. To efficiently cope with these impacts, we suggest firms take
prompt actions at an overall level so they are ready for the go live
 Banks should
actively manage
the upcoming
changes and strike
a new balance
between
profitability and
capital
absorption,
through a
restructuring of
their business
model..
 Banks face
complex
implementation
of the capital
charge calculation
both within the
SA and the IMA
(above all the
switch from VaR
to ES).
 New desk level
approach for
reporting
purposes and
validation imposes
a change to all the
related processes
and procedures.
 Banks should
focus and commit
to updating and
integrating their
systems and
infrastructure in
order to support
the expected
calculation and
operational
burden (e.g.
availability of
sensitivities,
market data,
implementation of
most sophisticated
simulation…).
Hot Topics
 Closing implementation of the revised
market risk standards by January 2019.
 First reporting under the new
standards by the end of the year.
 Assessment to identify changes in
terms of strategy and technical
implementation by the end of June.
 Overall planning and detailed activities
by the end of the year.
 Daily parallel running between risk
measures (e.g.: VaR vs. ES) for the
entire year.
 Backtesting activities and what if
simulation at the desk level for the
entire year.
 Implementation of the new investment
strategy by the end of the year.
 Implementation of a new architecture
in terms of data provision, model
creation/maintenance and reporting by
the end of the year.

Abulenta Librazhdi
Manager
Email:
abulenta.librazhdi@
accenture.com
Tel: +39 327 5790806
Paolo Brognara
Managing Director
Email:
paolo.brognara@
accenture.com
Tel: +39 335 8735387
Contacts
Italy, Central Europe and Greece Spain, Portugal, Africa and Israel
Gimenez Martinez
Senior Manager
Email:
s.martinez.gimeno@
accenture.com
Tel: +34 608 033 438
Markus Tentler
Senior Manager
Email:
markus..tentler@
accenture.com
Tel: +49 6173-94-
67391
Austria, Germany and
Switzerland
Email: tales.s.lopes@
accenture.com
Tel: +55 11-5188-1883
Norway, Sweden, Denmark,
Finland and Latvia
Tales Lopes
Managing Director
Takis Sironis
Senior Principal
United Kingdom and Ireland
Email:
kim.tran@accenture.
com
Tel: +33 1-56526833
France, Netherlands, Belgium
and Luxembourg
Kim Tran
Senior Manager
Email:
takis.sironis@
accenture.com
Tel: +44 20
3335 0457
Peter Beardshaw
Managing Director
Email:
peter.beardshaw@
accenture.com
Tel: +44 20-7844-7550

Fundamental Review of the Trading Book - Regulations:
https://www.accenture.com/us-en/service-address-challenges-
fundamental-trading-regulations
Accenture Finance & Risk – Regulatory Insights Blog Series:
https://www.accenture.com/RegulatoryInsights
Accenture Finance & Risk Services:
https://www.accenture.com/FinanceandRisk
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For more information, visit:

References
1. Analysis and comparison of Basel Committee on Banking Supervision documents.
– “Instructions: Impact study on the proposed frameworks for market risk and CVA risk.” Access at:
http://www.bis.org/bcbs/qis/instr_impact_study_jul15.pdf
– “Minimum capital requirements for market risk.” Access at: http://www.bis.org/bcbs/publ/d352.htm
– “Frequently asked questions: Impact study on the proposed frameworks for market risk and CVA risk.” Access at:
https://www.bis.org/bcbs/qis/FAQs_impact_study.pdf
2. “Basel Committee softens new rules in bank capital,” Financial Times, January 14, 2016. Access at:
http://www.ft.com/intl/cms/s/0/619c95c4-ba1f-11e5-bf7e-8a339b6f2164.html#axzz423vJ5oqu
3. “FRTB―The final rules: What has changed, what has not, and what the BIS does not talk about,” Thomas Orbitz, FRM
blog, January 20, 2016. Access at: https://www.linkedin.com/pulse/frtb-final-rules-what-has-changed-bis-does-talk-thomas-
obitz-frm
4. “Explanatory note on the revised minimum capital requirements for market risk,” Basel Committee on Banking
Supervision, January 2016. Access at: http://www.bis.org/bcbs/publ/d352_note.pdf
5. “Market risk framework could reduce liquidity,” Bloomberg for Enterprise, February 9, 2016. Access at:.
http://www.bloomberg.com/enterprise/blog/market-risk-framework-could-reduce-liquidity/
6. “Fundamental Review of Trading Book,” ISDA Briefing Notes. April 2015. Access at:
https://www2.isda.org/attachment/NzU1MQ==/FRTB%20Briefing%20Notes%20FINAL.pdf
7. “Final FRTB is a game of give-and-take, say dealers,” Risk.net, January 18, 2016. Access at:
http://www.risk.net/risk-magazine/news/2442076/basel-frtb-is-a-game-of-give-and-take-say-dealers
8. “Instructions: Impact study on the proposed frameworks for market risk and CVA risk,” Basel Committee on Banking
Supervision, July 2015. Access at: http://www.bis.org/bcbs/qis/instr_impact_study_jul15.pdf
9. “Frequently Asked Questions: Impact study on the proposed frameworks for market risk and CVA risks”, Banking
Supervision, July 2015. Access at: https://www.bis.org/bcbs/qis/FAQs_impact_study.pdf
10. “Minimum capital requirements for market risk,” Basel Committee on Banking Supervision, January 2016. Access at:
http://www.bis.org/bcbs/publ/d352.htm
14Copyright © 2016 Accenture All rights reserved.

Minimum Capital Requirements Regulatory Evolution
15
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