FUNDAMENTAL REVIEW OF THE TRADING BOOK FRTB (BCBS 362) is a major n gulaton that impacts the Market Risk Reporting FRTB - Fundamental Review of the Trading Book FRTB has a major impact on the way MARKET RISK is calculated and reported Cony Commo bse cargo ie da ks for fouce trading activity and management of risk. Trading book is ‘marked to market daly and value at risk for assets measured ona ten day horizon under Bas! Ila 99% confidencs lev Ranking book refers assets on banks balance-sheet that are ESE expected to beheld til maturity. Assets in the banking book are held at historic cost. The value at rik Is measured ata 99.9% confidence level ona one year horizon. Banks would bold assets in wading book to incu lower tsk charge, Additionally, the new banking book / wading book boundary and its limited permeability in terms of intemal risk transfers may put entre ‘rading suategies and business lines a sk due to higher capital cost, Structure and working of Trading desk, ‘A Trading desk must be approved by supervisors, It must have a Head Trader and cach trader must be assigned 1 only one Trad Desk, It must havea clear organization with reporting to senior management, must outline business stategy, authorized instruments and produetsf management structure, risk kimits and allocation, managensent reports covering cost, revere and clearly defined compensation policy lined up x rading, cading/hedging stratepes, clearly defined trading limits reviewed annually, customers and counterparties, risk to the desk objectives. ‘Trading desks have to do weekly PAL reporting and internal and rogulatory risk measure reports (including desk VaR / ES desi VaR / ES sensitivities orsk Fetors and backtesting) tobe eligible for internal modelling ‘The regulation touches the following arcas sting from the trading flor. A high level vow of the trading lor, desk structure and key functions ofthe traders is illustrated below,{pisuaencrs DESK STRUCTURE Pal attribution Pal. = Value of portfolio as of today - Value of Portflio as of yesterday. PP attibuton gives you that information on what generated that Pl. Its done to factrs, 100% of Pais explned to the fact ‘whatever remains unattributed is assigned to "Unexplained" ‘Sensitivities are computed tothe factors whichis used to predict she Pat. ‘P&L. atribution reporting is based on :wo metrics and is reported prot fo end of every oath: 1, Mean unexplained daily P&L (ie riskthcortial P&L - ‘bypotheical PRL) standard deviation of hypothetical daily PAL. Value outside the range of -10% to 10% isa breach 2. Variances of unexplained daily P&L / hypothetical da P&L. Value above 20% is considered a breach. Ifthe desk experiences four or more breaches within the prior 12 ‘months then itmust be capitalised under the standardised approach Jpivisunc nice Backtesting Actual pal is compared tothe hypothetical pl caleulased using the fron: office pricing models which contains more eaTRRTCAL risk factors and is more precise, Risk models should closely track the Ee actual performance vis backtesting and the Pa tebution test. [Risk theoretical pl fr a des is based on the firms risk management ‘models and ae not based on font office pricing models, ‘Backtestng quires comparing each desk'sI-tay static vara both ‘the 97 5th percentile andthe 9th percentile, using atleast one year ‘of eurent observations ofthe desk's one-day P&L experiences wither more then 12 exceptions atthe 9th percentile oF 30 exceptions at the 97th percent in the most recent 12-month peti, al ofits postions must be capitalised using the standardised approach util the desk no longer exceeds the sbove thresholds aver the prior 12 months, IFany given dese eof nadd uc cu premsck ‘The revised Standardised approach (SA) fundamentally overhauls the calculation ofa rsk charge to make the banks suficiently risk-sesitive while stil providing an epproprate standard for banks that do not require a sophisticated treatment for market rink, Risk charge is the amount of capital tha bank should hold as a consequence of the risks i takes. ‘The capital charge under Standardized approach = ‘Capital Risk charges for Delta,Vega and curvature under sensitivities based method +Default risk charge + ‘Residual risk add-on ‘on presribed Risk classes. [Risk charge calculated on each risk class Delta Risk measure + Vega Risk measure + Curvature Risk measure, Delta ie risk measure based on sensitivities ofa bank's trading book to regulatory delta risk factors ‘Vega isa risk measure tat is also based on sensitivities o regulatory vega risk factors Curvature is rsk measure which captures the incremental risk not captured bythe delta rsk of price changes in the value of an option. ‘Curvature risk is based on two stress senaris involving an upward shock and a downward shock toa given rik factor. The Worst loss of the ‘to scenarios isthe risk position tobe used as an input int the aggregation formula which delivers the capital charge. ‘Vega and curvature measures ae only caleulated fr instraments subject to optionality “Three rgk charges must be calculate for eac sk class based on thre different scenarios s the correlations (correlation between risk factors ‘within a bucket) and (correlation across buckets within a risk class) may inereaseor decrease in period of financial stress. Risk Charge ealeulation is an aggregation of risk positions fist atthe bucket lve, and then across buckets within ask class, The caleulaton of Risk charges must used the same pring model used in actual profit and loss reporting “The seven risk classes are: Goneal interest rat isk, Credit spreed risk: non-securitstion, (Credit spread risk: securitsations (non-corrlaton trading portfolio), (Credit spread risk: secuitisatons(corcltion trading portfotio), Equity isk, Commodity isk and Foreign Exchange rise 2, Risk factors are mapped io a rsk cass, Risk factors ae variables (eg given vertex ofa given interest rate curve or an ecity price). Risk actors are mapped toa risk clas. 3. Net Sensitivities (delta vega, curvature) are calelated to risk factors. The nt sensitivities foreach isk factor within a risk class is ‘ultplied by a respective risk weight, Rsk charge is calculated foreach bucket, at wel across bucks, foreach risk class under the data and vepa risk framework. 4, Positions are bucketod by common characterisis int risk buckets within each ofthe is classes. Examples of isk buckets - Curreney, (Currency pir, Market Cap, Sector, Credit Quality buckets, et. Risk positions ae fed into the rsk charge computation. Por delta and vega risks its a sensitivity toa risk factor. For curvature rs, it is the worst loss of two stress scenarios, 5. Applicable wisk weights are applied to net sensitivities. These weighted sensitivities are then agaregated using comcatios, 6, Correlations between risk factors within a bucket and seross bucks within a risk class are applied 17. Risk charges are aggregated after application of rik weighs and correlations. “Two stosssccnatos ate to be computed per tsk factor (an upward shock and «downward shock) withthe dela effect, already captured by the ela risk charge, being removed, The two scenarios are shocked by rsk weights and the worst lss is agaregated by correlations “The Default risk charge caprues the jump-to-default isk for non-securtisations,securitisations(non-coreation trading portfolio) and seourtstion correlation trading portfolio, Finally a residual risk addon is used to capture ll market risks that can be captured inthe standardised approach. Banks must calculate the standardised capital charge for each trading desk which willbe used as fallback capital charge for those desks that fail the eligibility under internal model approach.STANDARDIZED APPROACH KEY COMPONENTS = BESIOUAL Sk ADD-ON ry so pred oh she mayb ofan DEFAULT RISK (Stine oC Spd ek ls s ‘Sr nomen nrg San eens se aa INDER FRB STANDARDIZED APPROACH get Boaige cone ode rbctoadated + PLVISuAL aricKs TacsRISK BUCKETS MAPPING PVISUAL BRICKS RISK CLASS BUCKETS (ase rosmons crouren ey sian cHARACTERSTICSINA BUCKET) NS, GOV BAAD ENERGY ACR MING, SOVEREIGN, GOV BRED ENERGY, AGL MINN, Bsus UM, COVERED BON ET tks ar OVERICNS. GOV ACKED, ENERGY AGAL INNS, SOVEREGNS, COW RACED, ENERGY, AGRL MING, ‘Suck GOO TRANSPORTATION, TECH. CONSUMER GOGO TRANSPORTATION. Eat Fey Gets BS Pen MP Sub Pin, ABS Suse a rade, Aa SEES WEES eAUIcaRe Unum INANCALS ERGY, HEALINCARE TUT NANCIAS EERE, cee 57 CORRELATION TRADING Ce Reet} ea: EQUITY Wary rd Poca arn) que, igup Ati wear anvérc Sh LcUerED ore Ine Matt ypc 6] Oni perl nn tb esperar wwe weil ode ph he deem [Stringent mdr bcesing npn) asa toe Th a pers Sealine wing ‘Expected shortfall must be computed on a daily basis at 8 97.Sth Brwun. ees perv cones eve fecha Se nied te ‘op oh Tear e ar P&L RESULT Selig trim of 10 sand soe 2050 an 12 Seta dip vi, T her ok cso Ts ES start tte eee oh pride oe ts deh ich ort Cpt nga ng ee ako ods mat pial eva or ay sl chon markt orthe cormposiion of the potolio, Hl Theda re ec ii het 2 ont hs et eae ete edd ch Bokmal edad ail ce or oh ing escuchar lock capt cp ron se hal Rly ern ma peach Default Risk under IMA, Defalrskis thers of direct loss due to counterparty defaelt and any potential indirect lossce tht may arise from a defblt event. A separate internal VaR mode! is requied t9 measure the default risk. The model must use two types of systematic risk factors. Default risk must be measured for each counterparty. Due to the unique relationship berween credit spread and default sk, banks mus: seek approval for each desk with exposure to these risks, both for credit spread risk and default risk A bank must assume constnt positions ove the one-year horizon,‘or 60 days in the context of designated equity sub-portfolios. Stress Testing A rigorous and comprehensive stress testing program at both the trading desk and bankwide level is required for banks that use the internal ‘models approach for mesting market ik capital requirements, “The stress scenarios need to cover «range of factors tha ean erate extordinsry losses or enins in trading portfolios, These factors include low-probability evens in all major types of risk, including te various components of market, credit, and operational risks, Banks shoul subject ther portfolios to series of simulated stress scenarios and provide supervisory authorities with he results, A second typeof scenario would evaluate the sensitivity othe bank's market risk exposure to changes inthe assumptions about volailites and correlations.