Fundamental Review of the Trading Book

3 days
Prague, NH Hotel Prague
    How you will benefit:
  • An understanding of the rationale for the regulatory initiatives under FRTB and the implementation challenges
  • Understand some of the weaknesses in the current proposals and the need for further regulatory change
  • Understand the divergences between BCBS proposals and EU proposed implementation
  • Understand implications of greater model permission uncertainty and ways to minimise uncertainty
  • Understand the capital impacts of the new rules prescribed by regulators
  • Consider ways to optimise allocation of capital across trading desks to mitigate the impact of higher capital requirements
A comprehensive overview of the proposed new minimum capital requirements for market risk, the changes required for internal models and the new standard rules approach.

The Fundamental Review of the Trading Book (FRTB), which began following the 2008 financial crisis, was 'finalised' by BCBS with the publication of paper D352 in January 2016. The EU commission published a first revised draft of CRD and CRR in November 2016. Many issues are still outstanding and further work is being undertaken by BCBS in parallel to the EBA, which has been charged with introducing a number of regulatory technical standards (RTS) to settle outstanding issues for the EU. Implementation of the new rules is due by end 2019 according to the BCBS timetable although regulatory jurisdictions may not keep to this timeframe and the revised CRR proposes a phased introduction.

The revised framework does indeed fundamentally overhaul the way banks are required to capitalise market risk on the Trading Book and has implications for the management of risk on the banking book as well. Some of the more significant revisions to the internal model approach (IMA) include a move from 'VaR + stressed VaR' to a single stressed expected shortfall measure (ES), with restrictions on diversification benefits and a capital penalty for less liquid risks; the incremental risk charge (IRC) replaced by a version of its simpler predecessor the default risk charge (DRC) but with equity exposures now included; and the abolition of the comprehensive risk measure (CRM). Also the standard rules calculations for market risk have been replaced by a new sensitivity based approach (SBA) combined with a standardised default risk charge. Banks using internal models will also be required to compute the standardised charges, as a benchmark, and the standard rules charge may be used to create a floor to the capital requirements based on internal models. New rules are also proposed to restrict movement of positions and the transfer of risk between the banking book and the trading book.

This course will provide a comprehensive overview of the proposed new market risk regulations and will discuss in detail technical issues that have been debated between regulators and the industry, outstanding issues and challenges banks face. It will also take a look at the draft revised CRD and CRR and discuss divergences between these and the BCBS paper D352.

09.15 - 12.00


  • Regulatory concerns with Basel 2.5
  • Group discussion - want went wrong in 2008 - did VaR fail?
  • Solutions provided by the FRTB
  • BCBS timelines/EU timelines - some of the challenges

Trading Book/Banking book

  • Definition of the Trading Book
    • Trading Book instruments: standards and presumptive list
  • Risk management Policies, reporting requirements
  • Definition of trading desks
    • Regulatory requirements
    • Model approval will be given at desk level so firms should consider optimal desk structures:
      • Minimise P&L volatility relative to VaR at regulatory desk level
      • Impact of model withdrawal for a regulatory desk
      • Make use of sub-desk structures
      • Optimise allocation of capital across desks
  • Restrictions on moving instruments between banking book and trading book
  • Internal risk transfer
    • Credit risk
    • Equity risk
    • Interest rate risk
  • Comparison between FRTB and current rules

12.15 - 13.15 Lunch

13.15 - 17.00

Introduction to Internal Models Approach

  • Elements of the internal model
  • The Approval Process
  • Identifying eligible desks

Expected Shortfall implementation under FRTB

  • Overview of requirements (D352)
  • A review of 1-day VaR and 1-day Expected Shortfall calculations
  • Some simple examples to work through
  • Introducing liquidity horizons
    • Preliminary discussion on time-scaling
    • The original proposal by regulators - problem with retaining correlation structure
    • The industry responses
    • Final proposals by BCBS (D352)
  • Exercise/Example: Computing Expected shortfall with different liquidity horizons
  • Restriction on diversification benefits
    • Preliminary discussion on correlation and stressed periods
    • The original proposal by regulators
    • The industry response
    • Final proposal by BCBS (D352)
  • Identifying Modellable and Non-Modellable Risk Factors (NMRFs)
    • Industry initiatives: Bloomberg; Markit
  • Computing Stressed Expected Shortfall

Day Two

09.00 - 12.15

Model Validation Standards

  • Regulatory requirements (D352)

Back testing VaR

  • Actual P+L, Hypothetical P+L and Risk Theoretical P+L
  • Exception counting - traffic lights - binomial tests
  • What does it tell us?

Problems with back testing ES

  • Non - elicitable functions, so what?
  • What is the right question?
  • P-values, the right answer?
  • The regulatory answer - back test VaR at 97.5th and 99th percentiles
  • What does that tell us?

P+L Attribution

  • Discussion of the requirements
  • Issues and ambiguities
    • Basis risk between Theoretical P+L and Hypothetical P+L
    • The regulatory tests - likelihood of failure?
    • P-Values again!
  • Example/Exercises: Computing the regulatory P+L attribution tests and p-values

12.15 - 13.15 Lunch

13.15 - 17.00


  • Copula models
  • Migration risk dropped
    • Is migration risk adequately captured in VaR and ES?
    • If so, is default risk adequately captured?
  • Equities introduced
    • Why? Why not before?
  • Computing correlations
    • Equity correlations or CDS?
  • Sovereign default
    • What do you do about sovereign correlations?
    • PD floors - how material are they?
  • Example/Exercise - exploring a spread sheet implementation of a DRC model

Standard Rules

  • SBA - sensitivity based approach
    • Overview
    • Some practical examples
  • Standard Rules for default risk
  • Residual Risk
  • Do the proposed new standard rules meet the regulatory objectives and are they practical for small firms?
  • Requirements for desks with internal model approval
  • Exercise/example calculations

Day Three

09.00 - 12.15


  • Capitalisation requirements derived from internal models
  • Adding in unapproved desks
  • Estimates of capital impact of FRTB on banks

EU Implementation of FRTB

  • Scope of draft revisions to CRD and CRR - much more than just FRTB
  • Guide to CRR revisions for FRTB
  • Divergence between draft CRR and FRTB
  • EU timetable and phase in

Role Play Exercise - Meet the Regulator

  • Prepare for and play out a review meeting with the regulator

12.15 - 13.15 Lunch

13.15 - 17.00

Stress Testing

  • Supervisory scenarios
  • Bank scenarios

Related Topics

  • Counterparty risk
  • CVA
  • Illiquid Positions
  • SREP and Pillar 2

Evaluation and Termination of the Seminar

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