EBA Issues Final Draft Standards on Internal Model Approach Under FRTB

These recently published technical standards specify essential aspects of the internal model approach under FRTB and represent an important contribution to a smooth and harmonized implementation of FRTB in EU. Under CRR2, the adoption of these regulatory technical standards is expected to trigger a three-year period after which institutions with the permission to use the FRTB internal models are required, for reporting purposes only, to calculate their own funds requirements for market risk with those internal models. Thus, in light of the current situation linked to COVID-19, these regulatory technical standards will not impose a burden on the industry. On the contrary, EBA trusts that providing early information to all market participants about key aspects for the EU implementation of the FRTB framework will be beneficial to ensure a smooth and harmonized process. The final draft technical standards cover 11 mandates and have been grouped in three different documents:

• The final draft regulatory technical standards on liquidity horizons for the internal model approach clarify how institutions are expected to map the risk factors to the relevant category and subcategory, along with specifications with respect to the list of currencies and currency pairs that can be mapped to a ten-day liquidity horizon under the interest rate and the foreign-exchange risk category. The standards also provide a definition of large and small capitalization reflecting the specificities of the EU equity market.
• The final draft regulatory technical standards on back-testing and P&L attribution requirements specify the elements to be included for the purpose of the tests in the hypothetical, actual, and risk-theoretical P&L (HPL, APL, and RTPL respectively). Furthermore, they set all key elements characterizing the P&L attribution requirements: the tests ensuring that HPL and RTPL are sufficiently close, the consequences for institutions with desks where those changes are not close, and the frequency at which the assessment of the P&L attribution requirement has to be performed. These standards also set the aggregation formula that institutions are expected to use for aggregating the own funds requirements.
• The final draft regulatory technical standards on criteria for assessing the modelability of risk factors under the internal model approach set out the criteria for identifying the risk factors that are modelable and that institutions are, therefore, allowed to include in their expected shortfall calculations. The modelability assessment is intended to ensure that only risk factors that are sufficiently liquid and observable are included into expected shortfall calculations so that reliable risk measures are calculated. The technical standards also set the frequency under which the modelability assessment should be performed by institutions.

Related Links

• Press Release
• Final Draft Standards on Liquidity Horizons (PDF) 
• Final Draft Standards on Back-Testing and P&L Attribution (PDF)
• Final Draft Standards on Risk Factor Modelability (PDF)
• EBA Roadmap (PDF)

Keywords: Europe, EU, Banking, Securities, Market Risk, CRR2, Data Collection, COVID-19, Regulatory Technical Standards, FRTB, Internal Model Approach, Counterparty Credit Risk, Credit Risk, Basel III, EBA