EBA consults on standards for supervisors assessing the new market risk internal models under the Fundamental Review of the Trading Book

The European Banking Authority (EBA) has released its draft Regulatory Technical Standards (RTS) for public consultation regarding the assessment methodology under which competent authorities verify institutions’ compliance with the requirements applicable to their internal models under the Fundamental Review of the Trading Book (FRTB) rules. The RTS are part of phase four of the EBA’s roadmap for new market and counterparty credit risk approaches. For an institution to use the internal model approach (IMA) for market risk calculation, approval from the competent authority is a prerequisite, the approval requires a thorough assessment of the institution’s internal model to ensure compliance with relevant regulatory provisions.
The draft RTS sets out a framework for competent authorities to assess institutions‘ compliance with FRTB rules. The draft RTS focuses on governance, the internal risk-measurement model, the expected shortfall, and the stress scenario risk measure, and the internal default risk model. The RTS addresses competent authorities rather than institutions, and they provide a set of assessment techniques to verify that the Capital Requirement Regulation (CRR) requirements and relevant RTS are met. The competent authorities must apply some assessment techniques, while they may decide to apply others based on the situation of the institution. As a result, the RTS provide clarity on the type of requests institutions can expect from competent authorities during the investigation phase.
The RTS’s chapter on governance is based on the Basel II initial CRR equivalent of the RTS, mirroring the requirements in the old final draft RTS on assessment methodology. However, the governance requirements need to consider some FRTB-specific features, such as assessing the adequacy of trading desk set-up accompanying the approval of trading desk levels. As a result, the RTS require competent authorities to assess all governance-related aspects, including organisational structure, risk management policies, and procedures. The RTS also require that institutions consider risks stemming from climate change and broader environmental issues in their stress testing programs for internal models.