Kevin Nixon, Deloitte, February 02, 2017

The challenges for financial institutions conducting wholesale banking business in the region.

Doing business in Asia Pacific (APAC), with its diverse capital markets at varying stages of development, is already a complex proposition for financial institutions.

This challenge is compounded by the large number of international regulations that remain to be implemented over the coming years.

Among these, the Basel Committee’s Fundamental Review of the Trading Book (FRTB), due to come into full force at the end of 2019, is one of the most complex, not just in its implementation but in its strategic impact, particularly as it applies to cross-border business in less liquid or less developed financial markets.

The FRTB revises the way banks calculate the riskiness of their trading portfolios, and therefore directly impacts their capital requirements against these associated businesses. Estimates vary, but all generally agree that for banks active in financial markets there is a substantial increase in capital needed for such portfolios. Importantly, due to the way correlation factors and other aspects are prescribed, the more diverse range of currencies and products the greater the impact. This is especially critical in APAC, where there is neither a single regional currency such as the Euro, or the default to a numeraire such as USD for financial transactions and products.

Although national banking regulators do have some discretion in local implementation of FRTB, as with other Basel reforms these discretions are somewhat limited, and almost always only allow for a more conservative implementation rather than a “watering down”.

FRTB requires banks to implement new or significantly modified risk models for bond, stock, commodity and other exposures, as well as gather a much wider range of data to calculate these. Under FRTB definitions, some exposures will have to be moved from institutions’ trading to banking books, and vice-versa.

It also requires profit and loss to be attributed and assessed against predicted risk metrics. Although the intention of back testing risk estimates against actual outcomes has merit, the implementation of this specific aspect of the reforms is emerging as one of the most challenging.

Finally, internal model approval will only be granted on a desk-by-desk basis. Therefore, the potential for large differences in the calculation methodology for say different currencies but within the same product opens up the challenge of reconciling and managing portfolios of risk.

These challenges also need to be considered in the context of other globally agreed requirements which will have implementation issues in APAC, such as Basel liquidity rules or meeting bail-in liability standards. The complexity of implementing these multiple reforms in aggregate is putting resourcing strains on businesses in the region. This is particularly so for local firms that now have to implement complicated global standards, but in the past adhered to a simpler, more streamlined business model, with a corresponding risk and capital framework. This is certainly the case with the FRTB.

These circumstances are the reason why many in the region have started to become more vocal about the need to pause rule-making, and reconsider a one-size-fits-all approach to regulation. Liquidity rules immediately spring to mind here, with many countries having healthy fiscal positions and no traded government debt, whereas the rules implicitly assume a large supply of bonds, hence very high levels of government debt.

Although we could explore further the implementation, data, and management challenges of the FRTB rules, there are practical challenges for APAC economies and business activities across all sectors that need to be considered.

As noted above, the APAC economy and markets are diverse. From some of the most sophisticated and liquid markets in the world, to those seeking to deepen their capital markets and become more open, international economies. Coupled with the need for infrastructure financing accompanying urbanisation and other demographic shifts underway in the region, there is in APAC a need for greater markets activity, more participants, and more efficient and more active cross-border activity, particularly intra-region. Enhanced capital requirements, the complexity of adding more activity, and the pressure to rationalise (reduce) activity by banks as a result of FRTB therefore takes on a special importance in APAC.

The FRTB rules, liquidity rules and other major, market-focussed regulatory changes such as OTC derivatives reform, are not yet fully implemented, so the full impact (and even a full understanding) is yet to be realised. Further regulatory policy development, and the underlying rulemaking for agreed policies that are yet to be written, need to take many factors into account around the world, but in APAC particularly, the need for economic development, the deepening and expanding of capital markets, and the encouragement of intra-region financing must all be considered and monitored, and the rules adjusted as appropriate, as the reforms become embedded and markets adjust to a new reality.

For more information on FRTB and its impact please see Deloitte’s recently published paper Taking a closer look: Fundamental review of the trading book.

Kevin Nixon is the Global & Asia Pacific Lead for the Deloitte Centre for Regulatory Strategy.

Kevin is a well-known and respected voice globally on regulation of the financial system. Recently he was appointed to the role of Global as well as Asia-Pacific Lead of Deloitte’s Centre for Regulatory Strategy. The focus of the Centre is in assisting senior executives of firms navigate regulatory trends and their strategic implication through deep insight and promoting dialogue.

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