This blog post by Xenomorph CEO Brian Sentance is entitled FRTB and MiFID II: Light at the End of the Tunnel and was originally published via the Tabb Forum.
The onslaught of new regulations impacting the financial services industry in recent years has been relentless. So the thought that one set of regulatory requirements (MiFID II transparency) may actually help with meeting another (FRTB market risk capital framework) could be a welcome tonic.
The Basel Committee’s Fundamental Review of the Trading Book (FRTB) and the European Commission’s update to its Markets in Financial Instruments Directive (MiFID II) are two regulatory initiatives that are rarely mentioned in the same breath. Perhaps that’s to be expected. After all, these are entirely distinct sets of rules; they differ in scope, objectives, timelines, and, perhaps most importantly, they have been devised by entirely different bodies. Which is why attempting to link the two could, quite understandably, be seen as tenuous.
That said, I think there are aspects of the two regulations that could genuinely dovetail. So let me elaborate. The link between the FRTB and MiFID II is simple: it’s about data. More specifically, there are elements of FRTB and MiFID II (specifically relating to non-equities transparency requirements and the initiative to expand the consolidated tape coverage) that could be seen as complementary. The table below explains what those elements are.
FRTB and MiFID II side by side
|FRTB||MiFID II Transparency and Non Equities Consolidated Tape|
|FRTB spurs the need for more data||MiFID II spurs the supply of more data|
|The requirement for more data is particularly acute in less liquid asset classes.||The non-equities consolidated tape (or tapes) will cover less liquid asset classes.|
|To meet the FRTB criteria for ‘modellability’, a risk factor needs at least 24 ‘real’ prices per year (with no more than a month between pricing events). There are many OTC-traded securities and derivatives that would struggle to meet this criteria – particularly as model-based or evaluated prices are not considered ‘real’.||The non-equities tape will include bonds, exchange traded certificates and notes, structured finance products, securitised derivatives, interest derivatives, foreign exchange derivatives, equity derivatives, commodity derivatives, credit derivatives, contracts for difference, C10 derivatives, emission allowances and their derivatives.|
|‘Real’ prices need to be actual trades or committed quotes||The consolidated tape will provide a time-and-sales feed of actual trades|
|FRTB is scheduled for implementation at the end of 2019||The non-equities tape is scheduled for implementation in September 2019|
|Gathering the data required for FRTB can be can be complex and expensive (many sources to aggregate)||Pricing for the non-equities consolidated tape is still TBD but it should at a minimum be made available on ‘reasonable’ commercial terms|
Although the non-equities consolidated tape won’t solve all data management challenges posed by FRTB (for more information see my earlier blog), it could certainly serve as a step in the right direction. Currently, sourcing data for illiquid instruments can be a real challenge, with many data sources and complex licensing terms and conditions to navigate. Although data aggregators can help address part of the problem, the completeness, accuracy and cost of data can all be of concern.
Having a regulated source of time-and-sales data will help solve one piece of the puzzle. It will make it easier (and more cost effective) to identify instruments that do not trade frequently enough to be deemed ‘modellable’ (based purely on data for executed trades). However, it is important to note that the Basel Committee’s definition of a ‘real’ price includes both executed trades as well as committed quotes.
That means certain instruments may not trade frequently enough to be deemed modellable, but banks will still have an opportunity to augment trade data with ‘committed quotes’ to help meet the criteria for modellability. This could be done in a variety of ways, but the most obvious would be to capture data from a request-for-quote (RFQ) trading platform.
Being able to incorporate this kind of workflow into routine data management operations could be a key factor in keeping capital costs under control. Previous quantitative impact studies have suggested most banks will face increased capital requirements as a result of FRTB, with a significant portion of this charge (at least for those adopting an internal models approach) coming from non-modellable risk factors (NMRFs). Being able to improve access to high quality data, and in turn, improve the modellability of risk factors – could therefore be of great economic benefit.
Unfortunately, the arrival of the non-equities consolidated tape may just be a little late to the party. Although the tape is currently set to implemented a few months ahead of FRTB, the current implementation roadmap suggests banks will need to start the FRTB model approval process by the beginning of 2019 (whereas the tape will only be available in September of that year). Even so, if the non-equities tape succeeds in making data for illiquid assets more easily accessible, it will be a case of better late than never. In the meantime, firms will need to start identifying their FRTB data management challenges and come up with a solution that doesn’t rely on non-equities tape data from day one.