Regulating and Managing Non-modellable Risk Factors

Sanjay Sharma and John Beckwith

“It is far harder to kill a phantom than a reality” – Virginia Woolf

In the FRTB framework, risk factors that cannot be derived and evidenced from prescribed “real or committed prices” at defined observation periodicity are considered as non-modellable (NMRF). Capital charges for NMRFs must be individually assessed and aggregated on a summative basis across a bank’s risk factors with limited offsets for hedging and diversification. Initial estimates suggest that capital charges for NMRFs will be disproportionately high. This is likely to prompt regulatory trading desks (RTDs) and banks to selectively consider adopting the SA for capital. This could be detrimental to the BCBS motivation for FRTB for complex instruments.

While the concept and applicability of NMRFs is logical and justified, its application and implementation needs considerable planning and effort on the part of banks, data and systems vendors, and supervisors alike. The challenge for data vendors will be to create frameworks for identification and flagging of gaps in market data streams. System platforms and banks must create capabilities for identifying and managing NMRFs, and will have to ensure that these