FRTB Whitepaper Explores the Impact of Basic CVA Framework vs FRTB-CVA Framework

January 5, 2017
  • FRTB has forced banks to rethink their risk technology architecture
  • There will be a requirement to monitor SA capital in addition to IMA
  • Test show formula-based BA-CVA is much more punitive than SA-CVA

New York and London, 5th January, 2017 - Quantifi, a provider of risk, analytics and trading solutions, and Kauri Solutions, a specialist financial consultancy firm, today announced the release of their whitepaper titled ‘FRTB: strengthening market risk practices?’.

In July 2015, the Basel Committee proposed the FRTB-CVA framework which replaces the current CVA Risk Capital calculations. Six months later it published the final rule of the FRTB framework designed to address the undercapitalisation of trading book exposures witnessed during the financial crisis. This paper explores how these frameworks affect bank balance sheets.

 


 “FRTB is anticipated to have a huge impact on capital, modelling methodologies and IT
complexity, for instance at desk level there will be a requirement to monitor SA capital in addition
to IMA. There will also be a business and operational impact, for example PnL testing, desks
potentially moving between SA and IMA capital, and IT infrastructure changes to support implementation. 
"

Vlad Ender, Managing Director, Kauri Solutions


 

“FRTB is anticipated to have a huge impact on capital, modelling methodologies and IT complexity, for instance at desk level there will be a requirement to monitor SA capital in addition to IMA,” comments Vlad Ender, Managing Director, Kauri Solutions. “There will also be a business and operational impact, for example PnL testing, desks potentially moving between SA and IMA capital, and IT infrastructure changes to support implementation. The new market standard will influence how banks approach the measurement and reporting of risk and will therefore require most banks to transform their risk architecture.” continues Vlad.

Both FRTB and FRTB-CVA calculations are complex and computationally burdensome, particularly for FRTB-CVA as the number of scenarios in IMA and sensitivities required to be computed have increased. To achieve fast, accurate and consistent calculations banks need a cross-asset class framework that includes uniform models for front-office and risk. For computing the CVA sensitivities necessary for FRTB-CVA banks will require an efficient Monte Carlo engine that reflects various scenarios and time horizons. 

“Tests run by Quantifi illustrate that of the two approaches, formula-based BA-CVA is considerably more punitive than SA-CVA, which is based on real CVA sensitivities. This difference is especially striking for trades with CSA, where BA-CVA capital charge can be 10-15 times higher than SA-CVA”, comments Dmitry Pugachevsky, Research Director, Quantifi. “In anticipation of this development, many regional banks now include trades with CSA into CVA calculations, even though this can lead to one-time significant CVA loss. Banks are also seeking to enhance their CVA models by calibrating to market-implied data as this allows for CVA to be hedged against credit and market risk.” continues Dmitry

As banks prepare for the 2019 FRTB deadline, specialist technology providers like Quantifi have a key role to play in helping banks modernise their risk infrastructure and business processes. Banks with a culture of following a disciplined approach in managing their technology will be at a distinct advantage and better positioned in the post FRTB world in terms of operating costs, ability to manage risk and understand profitability across their organisation.


About Kauri Solutions

Kauri Solutions is a specialist financial consultancy firm. Combining in-depth knowledge of the financial markets with business acumen and IT skill, Kauri Solutions creates bespoke solutions to meet client needs. Services include regulatory advise, advising on derivative and securitization structures, identifying, implanting and delivering standalone derivative products and platforms, and delivering time-critical IT systems that cross the front, middle and back office. 

For further information, please visit www.kaurisolutions.com