House of the year, Taiwan: CTBC

Asia Risk Awards 2017

The Fundamental Review of the Trading Book (FRTB) component of the Basel III framework represents, as the name suggests, a radical overhaul of how banks manage this aspect of their business. Originally slated by the Basel Committee for Banking Supervision to come into force in 2019, Asia’s regulators are taking a more relaxed approach.

Australia was first to delay, saying in March that more time was needed to address some of the complexities embedded within the new Basel standard. Hong Kong followed suit in June. Australia has delayed until at least 2021 whilst Hong Kong until 2020. Although the Monetary Authority of Singapore has not announced anything officially, it is understood to have privately told its banks to expect a delay. Malaysia’s regulator is also set to delay FRTB, according to market sources. This means that regional banks might not have to deal with the FRTB regime for the next three or four years, at least.

For now, Taiwan’s banks are only obliged to apply the accounting CVA – or credit valuation adjustment – of IFRS 13, in force on the island since 2015. Since the international FRTB standard has not yet been finalised, the Financial Supervisory Commission has so far not required lenders to make any move toward an FRTB-compliant approach.

But CTBC, Taiwan’s largest derivatives house according to statistics from the central bank, has already started getting to grips with some of the concepts embedded in the international FRTB regime.

Step one was to get a handle on the potential future exposure (PFE) calculation method that is at the heart of the FRTB’s advanced CVA approach. PFE is used to measure credit risk exposure to a counterparty. There are a wide variety of methodologies that can be used to calculate PFE, from simple weight-based calculations to those based on complex simulations. CTBC had to work out which best suited its business.

“First the bank spoke to all the technology vendors, because that is the best way to catch up on the latest thinking in more advanced markets and to understand what the necessary components are for successful PFE calculation,” says Claudia Kuan, vice-president in the bank’s risk management department. “The vendors then suggested clients that we could visit [in order] to understand how they implement the advanced approach and their calculation methods can really solve our current concerns.”

A common problem for markets globally is the unavailability of the volume and type of data required to use the advanced approach of FRTB and it is particularly acute for Taiwan, given the shallowness of large parts of its financial markets. This is an issue that CTBC is keenly aware of as it sets up its internal model infrastructure.

One main driver for CTBC’s enhancement to reach the highest standards of risk management is the lesson learned from the collapse of the target redemption forward (Tarf) market in 2014. Previously it had been the mainstay of Taiwanese banks’ derivatives earnings, accounting for as much as 60% of total turnover. This resulted in a build-up of counterparty credit risk (CCR) and encouraged CTBC to develop their advanced CCR measurement infrastructure. Virtually all Tarf contracts have now run off, with some in the market estimating that the total volumes for August 2017 were a tenth of what they were a year previously.

“Our clients are diversified and CTBC’s most advanced trading desk can compose different kinds of product for various parts of the market,” says Jack Wang, head of global treasury sales division at the bank. “Corporate clients reduce derivatives usage due to previous various restrictions so our front office decided to move toward other client segments, such as financial institutions, to produce products that meet their needs or large syndication hedges – and to do that successfully we needed to upgrade out approach to counterparty credit risk.”

One area where CTBC is diversifying its product suite – in line with a number of other regional banks – is by providing commodities structuring as global banks continue their retreat from the sector.

In early 2017 it provided a coal swap for a local biofuels player that was looking for index hedging against the long-term price of palm kernel shells; coal is typically used as a proxy for the prices of palm oil by-products. The bank provided the coal swap by using its Singapore commodity trading platform and then warehoused the risk on its own balance sheet. The firm says it is the only Taiwan bank able to warehouse such commodity exposures.