FRTB


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Four user interfaces:

  • Data API.
  • Excel Add-ins.
  • Model Analytic API.
  • GUI APP.
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FRTB Standardized Approach Introduction


1. FRTB Introduction

The Fundamental Review of the Trading Book (FRTB) is a new Basel committee framework for the next generation market risk regulatory capital rules. It is inspired by the undercapitalisation of trading book exposures witnessed during the financial crisis. FRTB aims to address shortcoming of the current Basel 2.5 market risk capital framework.

FRTB provides a clear definition of the boundary between the trading book and the banking book. It consists of an overhaul of the internal model approach (IMA) to focus on tail risk and an overhaul of the standardized approach (SA) to make it more risk sensitive. Each approach also explicitly captures default risk and other residual risks. Liquidity risk is explicitly included for different asset classes via liquidity horizons. This presentation provides an overview of the standardised approach.

A Snapshot of FRTB Report
FRTB Standardized Approach Calculation Results

Banking Book vs Trading Book

Banking books normally hold assets to maturity while Trading Books need to mark to market and compute fair values daily in order to recognize any value change (Profit & Loss).

FRTB trading book and banking book comparison in FinPricing

FRTB vs Basel 2.5

The FRTB initiative seeks to address the shortcomings of Basel II.5 with a more coordinated, risk-sensitive and consistent market risk capital framework.

FRTB and Basel 2.5 comparison in FinPricing

2. FRTB Standardized Approach Overview

FRTB Standardized Approach consists of three risk changes:

2.1. Sensitivity Based Risk Charge

Risk Measurements

Three risk measures are defined:

  • Delta – the first order derivative with respect to underlying price
  • Vega – the first order derivative with respect to implied volatility
  • Curvature – the shocked value change minus Delta.

Seven risk classes are specified:

  • General interest rate (GII) risk
  • Credit spread risk
  • Credit spread risk: non-correlated secularization
  • Credit spread risk: correlated secularization
  • Equity
  • Commodity
  • Foreign exchange

FRTB further introduces buckets and risk factors within each risk class and each measure. A risk weight is definied for each risk factor. Furthermore, Risk correlations are specified between risk factor and between buckets.

Sensitivity based risk charge should be calculated separately for each risk class and each risk measure. FRTB reporting hierarchies from low to high are portfolio, desk, and bank.

Total risk charge = sensitivity-based risk charge + default risk charge +residual add-on.

For example, assuming that an equity portfolio has equity and interest rate risks only. The FRTB standardized risk chages are reported as

FRTB sample results in FinPricing

Sensitivity Notes

  • All trading products have Deltas
  • Only non-linear products (e.g., options) have Vegas and Curvatures
  • Regulator clearly defines all Delta and Curvature calculation but not Vega
  • Interest rate deltas are computed on yield rates (or zero coupon rates) rather than instrument quotes (e.g., swap rates , futures)
  • Curvature is a new measurement that is equal to value change minus Delta

Standardized Approach Calculation Guide

  • Compute Sensitivities (Delta, Vega, Curvature) for each position.
  • Sum all sensitivities belonging to the same risk factor and then multiply by the risk weight to get the risk charge  per risk factor
  • Within one bucket, two risk factor charges can be added as
  • Within each class and each measure, two bucket charges can be added as (for example, the GII Delta only has two bucket).
  • The final standardized risk charge is the sum of all risk charges for each class and each measure.

2.2. FRTB Calculation Tool

FinPricing offers build-in tool for computing advanced risk measures, including initial margin.

2.3. Default Risk Charge

The following assets are subject to default risk: debt instruments, equity products and securitization.

Default risk charge calculation procedure:

  • Determine jump-to-default (JTD) loss amount for each position subject to default risk.
  • Offset the JTD amounts of long and short exposures with respect to the same obligor.
  • Discount the net short exposures by a hedge benefit ratio
  • Apply default risk weights to exposures to arrive at the DRC
2.4. Residual Add-on Risk Charge

The following trade types bear residual risk

  • Products traded in incomplete markets
  • Products having gap risk, such as path dependent options (barrier, Asian, digital, Bermudan, etc.
  • Products having correlation risk, such as multiple underlying options (basket, best, spread, basis, quote, etc.)
  • Products having behavioral risk: such as mortgage

Residual add-on risk charge calculation procedure:

  • Calculate the residual add-on (RAD) risk charge for each related position.RAD = notional * factor (1% or 0.1%)
  • The total RAD is the sum of all individual RADs.
3. Related Topics