Through our “FRTB Accelerator” offering, ActivePivot has been in production since Spring 2017 running calculations and analytics in compliance with the FRTB rules – as they are defined now – at several banks in North America, Europe and Asia. We now have enough experience to start drawing some lessons and draft a few best practices.
Lesson 1: The application of FRTB rules varies between jurisdictions
As we deployed the FRTB accelerator on three continents and tailored it for each client, one thing became clear after a while: various jurisdictions already apply slightly different rules, processes and parameters to the FRTB calculations compared to the Basel standard in BCBS 352, and will likely continue to do so as FRTB becomes the norm.
In banks that operate legal entities in multiple countries, some portfolios are subject to two or more jurisdictions concurrently. Therefore, FRTB solutions have to provide substantial flexibility not just to adapt from one client to another, but also to report against multiple concurrent jurisdictions within the same company and to correctly to apply the right parameter sets when looking at historic data retrospectively.
Like the rest of ActivePivot, the FRTB Accelerator was built from the ground up with flexibility and customization in mind. It was fairly easy therefore to develop similar-but-different versions of our post-processors to deliver results to the exact specification of each jurisdiction, in a way that is completely transparent for end-users.
Lesson 2: The requirements of regulators will not be set in stone
Earlier this summer, the European Banking Authority adjusted its requirements with regard to FRTB: it demanded that banks send the details of each step of their risk charge calculations instead of just the results of those calculations, as was the case until now.
Once again, the format of the FRTB Accelerator allowed us to react quickly. When the new requirements came down from the EBA, we updated the Accelerator in a matter of days to deliver exactly the report that the EBA asked for. The update was made by ActiveViam’s team, it was faster and cheaper than the alternative of having each client make the update themselves, as our own team has the most familiarity with the product, and our clients are also able to share the cost. Since our clients have full access to the source code of the FRTB Accelerator, their compliance department was able to check and validate our work, and can provide proof of conformity to the regulators if asked.
Lesson 3: How FRTB impacts Capital Allocation methods
Once the risk charge for an organization has been established according to FRTB rules, new needs arise in banks that are not defined by the regulatory rules. That is the need to set capital allocations to individual desks in a way that is fair and transparent. This demands the provision of linear decomposition of the top-level risk charges and, mathematically, this can be complex. Some of the capital charges lend themselves to an analytical approach (based on Euler) but others introduce complexity that causes discontinuities that cannot be differentiated. When the analytical methods break down, alternative methodologies such as scaling and pro-rata allocation need to be provided.
The FRTB Accelerator once more proved up to the task. Since ActivePivot stores all data unaggregated and aggregates on-the-fly according to the end-user’s input, switching from one analytical methodology to another is really just a matter of loading a new bookmark.
These stories emphasize an important trap to avoid when designing your risk architecture for FRTB. Most people see FRTB as a matter of regulatory compliance, and therefore there is the temptation to build in rigidity, to enforce compliance at all levels to prevent the bank/organization from any breach.
However, such a view appears short-sighted. While the outline of the FRTB rules have become clear, we are still in a process of evolution where both regulators and banks are looking for the best way to enforce the letter and the spirit of the new rules. Building in too much rigidity at this stage (or, really, at all) is to risk having even minor changes in the rules and how they’re enforced requiring a large rework of the solution.
Instead, what you want is a solution that conforms exactly to FRTB guidelines, but that is also able, on demand, to ensure continued compliance with a slightly (or dramatically) revised set of rules, or simply with different processes for enforcing them.
We believe this is one of the main strengths of the FRTB Accelerator we designed. On the one hand it integrates the calculations and metrics required by the FRTB rules, a compliance that all clients can verify for themselves, as they have unlimited access to review the source code. On the other hand, it features the trademark ActivePivot adaptability, meaning that it can iterate during the test phase, before the FRTB rules become mandatory, as well as be customized easily to comply with the marginally different ways in which regulators from different countries might enforce FRTB rules.