HOW THE FUNDAMENTAL REVIEW OF TRADING BOOK IMPACTS THE VOLCKER REGIME TRADING DESK STRUCTURE

FINANCE & RISK

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EXECUTIVE SUMMARYIMPACT OF FUNDAMENTAL REVIEW OF TRADING BOOK (FRTB) ON VOLCKER RULE

Overview

• The FRTB rules have a major impact on the trading activities of the banks and should be implemented considering other relevant regulations (e.g., BCBS239, Volcker, Stress Testing, Credit Value Adjustment framework) which may have an impact on the implementation of FRTB

• Understanding the regulatory impact of FRTB can help banks design a holistic compliance solution; and leverage the existing capabilities developed as part of other strategic regulatory initiatives elsewhere in the organization

Volcker Trading Desk

• Under the Volcker Rule, a Trading Desk is defined as “the smallest discreet unit of an organization of a banking entity that purchases or sells Financial Instruments for the trading account of the banking entity”1

• Trading Desks under the Enhanced Minimum Standards for Programmatic Compliance for example, are required to have: policies and procedures; internal controls; testing; limits; products (e.g., instruments, strategy, risks, and exposure); defined holding period; authorization procedures; compensation arrangements; and counterparty definitions

FRTB Trading Desk

• Under FRTB, a Trading Desk is defined as a “group of traders or trading accounts that implements a well defined business strategy operating within a clear risk management structure” but subject to regulatory approval of the supervisor for capital purposes

• Trading Desks key attributes for example, are a defined group of traders or trading accounts, clear reporting line to senior management and compensation policy linked to pre-established objectives, defined business strategy, clear risk management structure, and supervisory reports (inventory aging, daily limits, intraday limits and respective utilization and breaches, and reports on assessment of market liquidity) and foreign or commodity positions held in banking book

Volcker and FRTB Areas of Impact and Degree of Change

Trading Desk Structure Trading Account Definition Trading Desk Instruments

Low HighMedium

Foreign Banking Entity

US Banking Entity

Low HighMedium Low HighMedium

1 2 3

• Volcker Rule is based on compliance requirements that vary based on size of banking entity resulting in different levels of Trading Desk structure which may not align to FRTB Trading Desk attributes

• The Volcker Rule concept of Trading Account is to identify transactions subject to the rule, and not a strict boundary for Trading vs Banking book as found under FRTB

• The Volcker Rule identifies Financial Instruments that are subject to the rule, while FRTB defines a strict boundary for the definition of instruments that are to reside in the Trading Desk

1. “Proprietary trading and certain interest in and relationships with covered funds,” Access at: http://online.wsj.com/public/resources/documents/1210volckerregtext.pdfSource for all FRTB-specific content: Minimum capital requirements for market risk,” Basel Committee on Banking Supervision. Access at: http://www.bis.org/bcbs/publ/d352.pdf Copyright © 2017 Accenture. All rights reserved.

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FRTB IMPACT ON VOLCKER RULETRADING DESK STRUCTURE

The Volcker final rules provides compliance requirements that vary based on the size of the banking entity and the activities conducted which result in varying degrees of Trading Desk requirements

Trading Desk Component Volcker Rule Degree of Change FRTB

Trading Desk Structure Smallest Discreet Unit

Aligned to Business Strategy

• FRTB is a global regulatory regime as opposed to the US centric Volcker rule. Key asset thresholds under Volcker (US Consolidated Assets, Consolidated Assets and Gross US Trading Assets and Liabilities) govern Foreign Banking Entities and lead to varying degrees of Trading Desk structure against the Volcker Rule (e.g., desks may lack risk management structure, trading strategies, limit monitoring required under FRTB) while US Banking Entities will primarily be subject to “Volcker Enhanced Compliance Requirements”

• This may result in a Low - Medium degree of change for US Banking Entities, as Trading Desks are largely subject to Volcker Trading Desk requirements as part of the Enhanced Minimum Standards for Programmatic Compliance (Volcker Rule Appendix B)

• This may result in a Medium - High degree of change for Foreign Banking Entities, as Trading Desks may not be subject to Volcker Trading Desk requirements and may need to be re-evaluated and enhanced under the FRTB regime

Use Case Scenario

US Bank

Foreign Bank

Low HighMedium

Foreign Banking Entity

U.S. Banking Entity

US Banking Entity

US Banking Entities with Gross Worldwide Trading Assets and Liabilities of at least $10 BN

Volcker Guidance

Subject to Enhanced Compliance Requirements1

1. Given the tiered compliance program timeline based on Asset and Liability all US entities with at least $10 BN of Gross Worldwide Trading Assets and Liabilities will be subject to enhanced compliance by December 2016

2. Volcker Trading Desk Requirements defines specific requirements that must be in place to govern the each Trading Desk (Volcker Rule Appendix B)

Volcker Trading Desk

Volcker Requirements (e.g., Product, Desk Structure, Strategy, Risk Factors)2

Degree of Change

Low - Medium Degree of Change

Foreign Banking EntityVarying degree of compliance

requirements based on Consolidated and US Trading

Assets and Liabilities1

Volcker Guidance

Banking Entity may be subject to varying Volcker requirements from

Simplified to Enhanced2

1. Multiple thresholds to determine required compliance program for Foreign Banking Entities i.e., Total US Consolidated Assets and Gross US Trading Assets and Liabilities as a result Foreign Banking Entities may be subject to varying degrees of compliance requirements under Volcker

2. Volcker implication depends on size of the banking entity and activities conducted3. Ibid

Volcker Trading Desk

Requirements range from guidelines (standard) to prescriptive (enhanced)3

Medium – High Degree of Change

FRTB

FRTB Trading Desk

Desk Assessment to align with FRTB Requirements

FRTB Trading Desk

Desk Assessment to align with FRTB Requirements

Minor degree of change may be assumed as desks will largely have the Trading Desk artifacts as required under Volcker, which may need to be re-calibrated and enhanced under FRTB

Medium - high degree of change as trading desks have to establish the Trading Desk artifacts required under FRTB. However, desks may maintain artifacts at various levels.

Source for all FRTB-specific content: Minimum capital requirements for market risk,” Basel Committee on Banking Supervision. Access at: http://www.bis.org/bcbs/publ/d352.pdf Copyright © 2017 Accenture. All rights reserved.

Degree of Change

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FRTB IMPACT ON VOLCKER RULEINSTRUMENTS IN SCOPE

The Volcker Rule identifies Financial Instruments that are subject to the rule, while FRTB defines a strict boundary for the definition of instruments that are to reside in the Trading Desk

Trading Desk Component Volcker Rule Degree of Change FRTB

Trading Desk Instruments Instruments subject to Permitted Activities

Strict Instrument Boundaries

• Under the FRTB regime, there is a strict boundary to set out guidance on instruments which are to be included in the Trading Book or excluded from the Trading Book, any deviation from guidance requires supervisory oversight. This represents a significant shift from the Volcker Rule as there was no clear delineation on classification of instruments other than what would be subject to Volcker monitoring and reporting or excluded from definition of proprietary trading

• This may result in a Medium-High degree of change as Trading Desk instruments may need to be re-evaluated and enhanced to align with specific Trading Desks under FRTB and consider capital implications

Use Case Scenario

Volcker Trading Desk Instruments FRTB Trading Desk Instruments

• Financial Instrument: • Security (including option on a security) • A derivative (including an option on a derivative)• A contract of sale of a commodity for future delivery, or option on a contract of a sale

of a commodity for future delivery• Excluding: Loan, excluded commodity, and foreign exchange

• Instruments comprise Financial Instruments, foreign exchange, and commodities • Financial Instrument is any contract that gives rise to both a financial asset of one entity and a

financial liability or equity instrument of another entity • Financial instruments include both primary Financial Instruments (or cash instruments) and

derivative Financial Instruments • A financial asset is any asset that is cash, the right to receive cash or another financial asset or

a commodity, or an equity instrument • A financial liability is the contractual obligation to deliver cash or another financial asset or a

commodity • Commodities also include non-tangible (i.e., non-physical) goods

Low HighMedium

Volc

ker

Fina

ncia

l In

stru

men

ts Scope of Volcker identifies instruments that are subject to prohibition on proprietary trading

Market Making

Underwriting

Risk Mitigating HedgingOther Permitted Proprietary

Trading Activities

Market Making

Underwriting

Risk Mitigating HedgingOther Permitted Proprietary

Trading ActivitiesFRTB

Fin

anci

al

Inst

rum

ents

FRTB strictly defines instruments that are required to be classified in the Trading Desk Tr

adin

g Bo

ok

Inst

rum

ents

Strict DefinitionSubject to Volcker

Source for all FRTB-specific content: Minimum capital requirements for market risk,” Basel Committee on Banking Supervision. Access at: http://www.bis.org/bcbs/publ/d352.pdf Copyright © 2017 Accenture. All rights reserved.

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FRTB IMPACT ON VOLCKER RULERECOMMENDATIONS

Volcker and FRTB rules will coexist in the near future and banks will need to establish compliance programs to both set of rules. Having a strategic vision to leverage implementation efforts across programs can help banks stay ahead of the curve and turn these programs into business advantage

Trading Desk Structure

Trading Desk Enhancement

Trading Book Definition

Desk Level Disclosure

Desk Level Key Attributes

Implementation Synergies

• Trading Desk structure to align with FRTB definition with potential isolation of desks used specifically for hedging given Internal Risk Transfers restrictions

• In our view, banks should strive to have a single desk structure which satisfies both Volcker and FRTB requirements

• Potential reconfiguration of Trading Desks and trading strategy may impact the overall business strategy

• Trading desk enhancement if done within the ambit of allowed activities under Volcker rule, should allow banks the flexibility to fine tune their trading desks for attaining improved capitalization

• A revised trading book/banking book boundary with more explicit requirements for inclusions and exclusions of instruments and limitations on reclassifications to reduce potential for regulatory arbitrage

• Volcker rule did not place any restrictions on classification of instruments, just what instruments and activities were permitted. In our view, banks should take a hard look at their trading instruments before classifying them

• Enhanced disclosure requirements require significant infrastructure changes to support public disclosure of capital calculations, profit and loss attribution and back testing results

• Banks would need to augment their reporting infrastructure to be able to report the capital charges and desk information as required under Volcker and FRTB rules

• Trading Desks may need to be enhanced with key attributes defined under FRTB (e.g., defined group of traders or trading accounts, clear reporting lines, compensation policy linked to objectives, strategy)

• While Volcker rules did not explicitly mandate risk policy requirements for all sized banks. FRTB rules have strict governance controls built in which banks will need to codify and implement internally

Impact Summary Key Recommendation

• Volcker and FRTB are strategic regulatory programs in majority of banks with overlapping areas of influence

• In our view these regulatory programs should be viewed as opportunities to drive synergies in both programs to keep costs and timelines manageable

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Copyright © 2017 Accenture. All rights reserved.

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THANK YOUContact us:

Rahim Inoussa: Senior Manager, Accenture Finance & Risk(E): rahim.inoussa@accenture.com (P): +1 917-452-0293

Gaurav Kapoor: Manager, Accenture Finance & Risk(E): gaurav.a.kapoor@accenture.com (P): + 1 917-452-0508

Raj Usman: Manager, Accenture Finance & Risk(E): usman.raj@accenture.com(P): +1 416-641-3588

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Accenture Finance & Risk:https://www.accenture.com/us-en/financial-services-finance-risk

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HOW THE FUNDAMENTAL REVIEW OF TRADING BOOK IMPACTS THE VOLCKER REGIME TRADING DESK STRUCTURE

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