Decoding FRTB: Navigating Regulation, Data Compliance, and Future-Proofing

Just after the European Union announced a delay in the fundamental review of the trading book (FRTB) implementation, last Risk Live Europe panel discussion, sponsored by ActiveViam, discussed the challenges banks face with these new regulatory standards

The experts discussed whether FRTB will achieve its regulatory goals, with a widely expected decline in the number of banks using the internal models approach (IMA). Given recent regulatory announcements, the panel also considered the future course of FRTB. This article presents the key findings from that discussion.

Low IMA adoption

Panelists said that in theory, the more detailed and rigorous market risk capital standards in the FRTB meet the Basel Committee on Banking Supervision’s policy objectives and represent a step forward from value-at-risk (VAR) calculations, which were intended to address shortcomings exposed by the financial crisis that began in 2007-08.

However, very few banks apply for IMA; most adopt the Standardised Approach (SA) to calculating Pillar 1 capital requirements. When asked to predict how many banks will adopt IMA under FRTB, panelists’ responses ranged from five to twelve, with major US banks expected to follow this route, compared with a small number of European banks.

The panelists touched on practical issues in several areas. Katherine Wolicki, global head of engagement and outreach, global benchmarking initiative at Garp, emphasized the complexity of putting together FRTB components and running them day-to-day. “That complexity is reflected in the small number of companies that are taking the IMA route,” she said. “It’s really expensive, really complicated, and ultimately quite uncertain.”

However, Xavier Bellouard, managing director and co-founder of ActiveViam, warned that if banks adopted only SA, it could prove to be a step backward in risk management. “SA is nothing more than a pretty good parametric VAR, which means we will fall into the same problems we had under Basel II. Despite the benefits of IMA, with so few banks using it, there will be no improvement.”

Risks of disconnection

The panel discussed the risks of SA banks adopting Pillar 1 capital requirements and IMAs for Pillar 2. Bellouard explained: “There is a huge risk of misalignment between what banks report to the regulator and what they use as metrics for trading decisions or day-to-day risk checks. For the last 10 years, many banks have tried to use a single gold standard for trading and risk management. If we move away from that, I think it will be a huge step backwards.”

Fabio Lania, market risk manager at Intesa Sanpaolo, one of the few banks in the EU that has applied for internal models, stressed: “Separating the strong link between market risk management and the calculation of capital requirements at commercial level carries a big risk that I believe regulators are not taking into account.”

NMRF and Profit and Loss Attribution Tests

Non-modellable risk factors (NMRFs) and profit and loss (P&L) attribution tests have been identified as particular challenges for FRTB.

Bellouard noted that the NMRF constraints are an extremely difficult issue, while Lania warned: “The modelability criteria are too strict, especially in Europe. Furthermore, the aggregation formula is based on very strong assumptions, leading to amounts of capital that are disproportionate to the real risk of the instruments behind them.”

Bellouard and Wolicki also highlighted the serious data challenges that banks face: lack of data and poor data quality. However, third-party solutions could help, Wolicki emphasized: “It’s become a chicken-or-the-egg situation. There’s been a lot of discussion about the potential of vendor solutions. But because so few banks are adopting IMA, there’s no market for it and it’s not interesting for vendors.”

Panelists discussed the importance of building a common taxonomy of risk factors across finance and risk that aligns with the P&L, ensuring risk models align with exposure. Bellouard emphasized that cleaning data and ensuring consistency across systems are important first steps in P&L attribution. “Having the same taxonomy and maintaining a unique, golden source of data would play a big role in improving P&L attribution data, as most errors can be corrected in these cases,” he noted.

Uncertainty of the future

While regulators did not express a strong desire to increase IMA adoption, the panel agreed that the more complicated elements of the FRTB package would require reconsideration. Bellouard said: “Refining or loosening some of the restrictions would go a long way to increasing IMA adoption.”

Lania insisted that this does not mean rewriting the regulations from scratch. “There are two or three parameters, such as NMRF and P&L attribution, that they could adjust,” he said.

There are some signs that the goalposts are moving. The EU’s decision to delay FRTB implementation until January 2026 was driven by the need to ensure a global level playing field. After strong opposition from US banks, the Federal Reserve has indicated that significant changes to FRTB are likely, and it is widely expected that the US will not be able to meet the July 2025 start date.

Lania noted: “We are watching the US very closely to see if it will encourage European institutions to relax some of the FRTB restrictions. We hope that whatever happens, regulators will respond quickly. If too much time passes, it will be very difficult for some banks to return to IMA because they will have to rebuild teams and infrastructure.”

In summary

Although FRTB is well underway, uncertainty remains over its timing and final content, particularly in the US. IMA adoption is expected to be very low due to the cost and complexity of these new standards, particularly with the NMRF and P&L attribution tests as obstacles. Banks are also struggling with data, and there is currently a lack of willingness from vendors to fill the gap. Without some easing of regulatory constraints, this picture is unlikely to change. However, banks will be closely monitoring further moves in the US to assess any likely implications for the EU and UK markets.