Independent audits drive compliance in FRTB data solutions

The European Union and the Basel Committee on Banking Supervision have introduced strict audit standards for data vendors to uphold the Fundamental Review of the Trading Book (FRTB) rules. With deadlines approaching, audited solutions are critical for banks to ensure compliance, minimise non-modellable risk factors (NMRFs) and reduce capital requirements

Fausto Marseglia, LSEG Data & Analytics

The EU and the Basel Committee have established rigorous standards for independent audits of data vendors. These standards focus on ensuring the validity and integrity of real price observations data, which is used for the FRTB and sourced from third-party vendors. This data is critical for banks applying the internal models approach (IMA) to demonstrate compliance with the risk factor eligibility test (RFET) rules. By minimising NMRFs, banks can reduce capital requirements. Consequently, regulators want to ensure that the data sourced from external vendors undergoes an external audit to validate its eligiblity and compliance with RFET rules.

“EU rules are more restrictive than Basel Committee standards,” explains Fausto Marseglia, head of FRTB product management and regulatory propositions at LSEG. “While the Basel Committee requires vendors to undergo an external audit to validate their pricing data, the EU framework goes further. It mandates that audits must also cover governance and processes, ensuring vendors have robust systems and processes in place to validate and maintain the integrity of their FRTB/RFET pricing information. It’s a more comprehensive approach that reflects Europe’s stricter stance on compliance.”

This difference highlights a fundamental shift in how regulatory frameworks are applied globally. While the Basel Committee sets minimum international standards, the EU’s enhanced requirements signal a deeper commitment to ensuring market stability and transparency.

Why independent audits matter

Central to FRTB compliance is the RFET, which determines whether the risk factors in a bank’s trading book have been sufficiently modelled to qualify for inclusion in market risk engines for capital requirement calculations. Passing the RFET significantly impacts a bank’s operations and regulatory capital requirements.

“Risk factors that fail the RFET are classified as non-modellable and are subject to punitive capital charges,” says Marseglia. “This directly impacts a bank’s bottom line. Ensuring compliance and minimising the number of NMRFs is critical for banks, as doing so significantly reduces capital costs.”

Banks rely on data vendors to provide real price observations – records of trades and committed quotes – that are essential for passing the RFET. This is because their internal trading activities often do not generate enough data to meet the test’s requirements. Without proper audits, there is no guarantee this vendor data meets FRTB standards.

“Audit processes confirm the validity of pricing data,” Marseglia elaborates. “For example, trades must occur at arm’s length, meaning between unrelated counterparties. Transactions within the same corporate group, such as between two regional branches of the same bank, wouldn’t qualify under FRTB rules. Similarly, in Europe, committed quotes must include bid and ask prices – a stricter requirement than the Basel Committee rules – which also allow single-sided quotes.”

These stringent checks are vital for ensuring that only high-quality, compliant data is used by banks. As Marseglia puts it: “Audits are designed to create a level playing field, ensuring all vendors meet the same rigorous standards. Without this, the market risks becoming fragmented, with banks unknowingly relying on invalid data.”

Benefits of audited FRTB solutions

For banks, choosing an independently audited FRTB solution is not just a regulatory requirement – it is a necessity. “Regulators now require vendors to undergo external audits. Banks can only buy data from audited vendors, so this is non-negotiable,” Marseglia explains.

Another critical factor is timing. European banks face a January 2026 deadline for FRTB compliance, with other jurisdictions expected to follow. Early adoption of audited solutions is essential for avoiding last-minute operational disruptions.

“European banks are leading the way on FRTB implementation,” Marseglia notes. “They’re already under scrutiny from regulators, who have started pushing back on banks using data from non-audited vendors. We’ve seen this first-hand, with some banks switching to LSEG because their current vendors couldn’t demonstrate compliance.”

Inside LSEG’s audit process

LSEG has positioned itself at the forefront of FRTB compliance through a comprehensive external audit process. Completed in mid-2024, the year-long audit reviewed two key products: DataScope, which provides real price observations for exchange-traded instruments, and Trade Discovery, designed for over-the-counter-traded instruments.

“The process was incredibly rigorous,” Marseglia says. “First, we built a controls matrix, mapping each regulatory requirement to the relevant internal controls. Each regulatory rule – for example, ensuring trades occur at arm’s length – required specific controls to validate the data. Then we implemented all of these controls into our solution. It’s a meticulous and long process that requires extensive coding, system enhancements, and significant involvement and collaboration across multiple teams to ensure compliance.”

Once internal controls were in place, an external auditing firm evaluated their effectiveness. “They scrutinised our controls to ensure they were fit for purpose,” he explains. “If any gaps were identified, we had to go back to the drawing board and refine our design. It’s a long and resource-intensive journey, but one that underscores our commitment to delivering trusted solutions.”

Marseglia emphasises the scale of the investment: “Mobilising teams across two platforms and covering such a wide range of regulatory requirements was no small task. The financial costs alone were significant, but the outcome – being the first audited vendor in this space – has made it worthwhile. This is not a one-off process; it must be repeated on an annual basis, as required by the rules.”

Setting LSEG apart

By completing its audit, LSEG has set itself apart in the crowded FRTB space. “We’re now a trusted provider,” Marseglia says. “Banks can purchase from us with confidence, knowing our data is fully compliant with EU and Basel Committee standards.”

Marseglia also highlights the importance of distinguishing between general certifications and FRTB-specific audits. “Banks need to be aware that the external audit prescribed by the FRTB rules is about the validity of the vendor pricing information for the RFET. Other types of audits, for example, the System and Organisation Controls 2 [SOC 2] certification, which focus on general data security and processing practices rather than FRTB compliance, are not suitable for FRTB/RFET compliance. Our external audit was conducted specifically against the EU and Basel Committee FRTB/RFET rules, focusing on the validity of the data in line with the RFET eligibility requirements – exactly what FRTB mandates.”

Addressing banks’ compliance challenges

FRTB compliance presents significant challenges, particularly for banks adopting the IMA. “Passing the RFET is tough,” Marseglia acknowledges. “Banks often lack sufficient internal trading data to meet the eligibility thresholds, so they must rely on external vendors.

“Finding a vendor that provides full cross-asset class coverage while meeting these stringent compliance requirements isn’t easy. LSEG’s audited data ensures clients can minimise NMRFs, reducing their capital costs.”

This dual focus on data coverage and audit compliance positions LSEG as an essential partner for banks navigating FRTB challenges.

The road ahead

As FRTB deadlines approach, the importance of independent audits will only increase. LSEG’s investment in compliance not only reinforces its position as a market leader but also provides banks with the tools they need to meet regulatory demands confidently.

“For us, the audit is not just a regulatory requirement – it is a commitment to delivering trusted, high-quality data to our clients,” Marseglia concludes.

With regulators intensifying scrutiny and deadlines looming, banks must act swiftly to secure audited solutions. In this high-stakes environment, LSEG’s audited FRTB solution offers a critical advantage, ensuring clients remain compliant and competitive.

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