FRTB in Brazil – Objectives, Challenges and Impacts for Risk Teams

Unlike regulators in other countries, the Central Bank of Brazil opted to implement the FRTB (Fundamental Review of the Trading Book) in phases. The standardized model rule was partially defined and only included the DRC (Default Risk Capital) component in Resolution 313 on April 2023.

On August 20, 2024, the Central Bank of Brazil published public consultation 102/2024 [1] with the proposed rules for the two missing components of the standardized FRTB model: "Sensitivities-Based Method" and "Residual Risk Add-on." This public consultation has a duration of 90 days, and the target date for the application of the rules is January 1, 2026, which aligns with the implementation deadline set by the European Banking Authority (EBA).

The Objectives: Simplicity and Comparability

The standardized model has two fundamental objectives. The first is that it should be easy for any institution to implement, and the second is comparability. The adoption of FRTB by various jurisdictions will improve consistency and alignment between the market risk reports provided by financial institutions worldwide.

The impact of the new regulation on observed capital has been different for each jurisdiction, mainly due to the heterogeneity of the current regulatory frameworks. The EBA estimates a 35% increase in bank capital [2]. Recently, an ISDA study estimated an additional impact of between 73% and 101% for US banks [3].

Impacts of FRTB on Financial Institutions in Brazil

In Brazil, the Central Bank has stated at some events that it estimates a neutral impact on the market risk capital of local financial institutions, based on the biannual Quantitative Impact Study (QIS) studies carried out with S1 and S2 banks.

The standardized FRTB model has a class of risks not covered by the current market risk framework-the Credit Spread Risk (CSR) component. Non-linear instruments, such as options and other derivatives, will have the Vega and Curvature component capturing risks in addition to the Delta component addressed by the current standardized model. The neutral impact estimated by Bacen occurs because Brazil has a more conservative framework than Basel 2.5, mainly due to the calibration of the weights and multipliers adopted locally.

With regard to the adoption of internal models, the increase in capital expected from the adoption of the standardized FRTB model has not been enough to encourage the adoption of IMA-FRTB by global banks. Many intend to leave their current internal models and migrate to the standardized FRTB model, while others will adopt the internal FRTB model in a manner restricted to a few trading desks [4].

In Brazil, phase 4 of the IMA-FRTB model has not yet been scheduled; nor is it expected to be widely adopted by local banks. The main reasons for this are the output floor, which limits the capital allocated by the internal model to a percentage of the capital of the standardized model, the backtesting and P&L attribution tests (PLAT) that the desks must carry out regularly to prove the effectiveness of the models, and the operational challenges of developing and maintaining the internal models.

In addition, banks will have the technological challenge of improving systems and processes. Bacen Resolution 111 requires banks to control the limits of their trading desks on an intraday basis. To comply with this requirement, institutions must have robust systems for simulating and managing market risks.

The Path Forward

SS&C Algorithmics has extensive experience in FRTB implementations in all jurisdictions, including Brazil's S1 and S2 banks. Our solutions support banks in the calculation of both standardized and internal models and have received many awards and recognitions.

Contact us to discuss how we can support your strategy for FRTB.

Bibliography

[1]	"Consulta Publica 104/2024," 30 August 2024. [Online]. Available: https://www3.bcb.gov.br/audpub/DetalharAudienciaPage?5&audienciaId=664.
[2]	EBA, "BASEL III Reforms: Impact Study and Keu Recomendations," 30 August 2024. [Online]. Available: https://www.eba.europa.eu/sites/default/files/Basel%20III%20reforms%20-%20Impact%20study%20and%20key%20reccomendations.pdf.
[3]	ISDA, "US BASEL III ENDGAME: TRADING AND CAPITAL MARKETS IMPACT," 30 August 2024. [Online]. Available: https://www.isda.org/a/I21gE/US-Basel-III-Endgame-Trading-and-Capital-Markets-Impact.pdf.
[4]	ISDA, "Fundamental Review of the Trading Book: Internal Models Approach Adoption," 30 August 2024. [Online]. Available: https://www.isda.org/2024/07/18/fundamental-review-of-the-trading-book-internal-models-approach-adoption/.

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