FRTB: What makes a price real?

Modellability data standards for FRTB

The Fundamental Review of the Trading Book (FRTB) standards published by the Basel Committee on Banking Supervision (BCBS) earlier this year require banks to differentiate between risk factors that are "modellable" and those that are "non-modellable". The latter carry a hefty capital add-on that could account for some 29% of total market risk capital[1]. The modellability classification comes down to whether the firm has access to sufficient data to model the position - that is whether it can demonstrate that there are continuously available "real" prices for a sufficient set of representative transactions.

The final BCBS standards provide some guidance on "real prices". A price will be considered "real" if: "it is a price from an actual transaction conducted by the bank; it is a price from an actual transaction between other parties (e.g. at an exchange); or it is a price taken from a firm quote, (i.e. a price at which the bank could transact)."[2]

Nevertheless, there is still much debate as to what should and should not be classified as a real transaction price. We asked participants at our recent FRTB roundtables in London, Sydney and Frankfurt whether they believe repo transactions can be used in demonstrating modellability.

Overall, the feedback illustrated that even some of the largest banks are still figuring out what data can be used for real prices under FRTB and therefore which risk factors are modellable.

As Markit works with the industry to source the relevant data that qualifies for use under FRTB, we have been considering how best to identify whether prices are "real" and transactions relevant. Most firms agree that, in accordance with the policy intent, only trades which are "price forming" should be used. Specifically, only if the transaction plays a part in setting the prevailing market price for a particular instrument and results in a risk transfer between the parties, is it "real".

This principle should be applied to filter transaction data so that the FRTB risk factors derived will automatically include only trades that fall into the price-forming categories.

Based on this principle, the following types of transactions should be included:

- Price-forming transactions, such as new trades, terminations, amendments and novations

- For derivative transactions that are centrally-cleared, only one of the two transactions that results from the clearing process will be considered.

On the other hand, the following would not qualify:

- Non price-forming transactions, such as compression trades, internal trades, internal novations, error correction trades and trades amended same day or next day

- Swaption parent trades

There has been an increasing amount of pressure on data management from banking regulators in recent years. FRTB only increases the stakes. While debate within the industry will undoubtedly continue about what should be classified as a real transaction price, it's important that firms have the capabilities to clean and intelligently manage transaction data to meet the FRTB standards.

Yaacov Mutnikas, Executive Vice President-Financial Market Technologies, IHS Markit

[1] Industry FRTB Quantitative Impact Study Executive Summary, October 2015

[2]BCBS Standards, Minimum capital requirements for market risk, January 2016

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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.