In previous blogs, we have looked at potential changes to trading desk structure and definition under the Fundamental Review of the Trading Book (FRTB) in comparison to the Volcker Rule.  FRTB also has a significant impact on trading accounts for trading desks.

Under the Volcker Rule, the trading account is defined as a statutory concept to identify transitions that are subject to the final rule’s restrictions on proprietary trading.  Under Volcker, therefore, trading accounts are not identified as such if the account aligns with the trading book or banking book within the bank.1 FRTB, however, clearly defines a boundary that governs trading book instruments as well as their purpose and interaction (for example, for internal risk transfer) between a regulatory trading account and the banking book.2

This may result in a medium-to-high degree of change for trading desks, as the Volcker Rule does not define a strict boundary for trading and/or banking books.3  Under FRTB, however, the trading account and trading desks would need to be re-evaluated against the guidelines, with instruments that are required to be classified within the trading desk – such as those used for market making, underwriting, risk mitigating hedging, and other permitted proprietary trading activities –strictly defined.4

In addition, Volcker and FRTB define financial instruments differently.  The Volcker definition of financial instrument encompasses securities (including options), derivatives (including options), a contract for sale of a commodity on future delivery or options on such a contract, but excludes loans, specific commodities, and foreign exchange.5  In comparison, FRTB defines financial instruments to include foreign exchange and commodities as well as any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Financial instruments include both primary Financial Instruments (or cash instruments) and derivative Financial Instruments.6

Under FRTB, a financial asset is any asset that is cash, the right to receive cash or another financial asset or a commodity, or an equity instrument, and a financial liability is the contractual obligation to deliver cash or another financial asset or a commodity.  Commodities under FRTB also include non-tangible (that is, non-physical) goods.7

Volcker and FRTB rules will coexist in the near future and banks should enhance their compliance programs to address both sets of rules.  In the next two blogs in this series we will look at actions banks can take to achieve this objective.

For more information, see our presentation “How the Fundamental Review of Trading Book Impacts the Volcker Regime Trading Desk Structure.

References:

  1. “Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds and Private Equity Funds,” Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Securities and Exchange Commission, April 1, 2014. Access at: https://www.sec.gov/rules/final/2013/bhca-1.pdf
  2. “Minimum capital requirements for market risk,” Basel Committee on Banking Supervision, January 2016. Access at: http://www.bis.org/bcbs/publ/d352.htm
  3. “Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds and Private Equity Funds,” Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Securities and Exchange Commission, April 1, 2014. Access at: https://www.sec.gov/rules/final/2013/bhca-1.pdf
  4. “Minimum capital requirements for market risk,” Basel Committee on Banking Supervision, January 2016. Access at: http://www.bis.org/bcbs/publ/d352.htm
  5. “Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds and Private Equity Funds,” Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Securities and Exchange Commission, April 1, 2014. Access at: https://www.sec.gov/rules/final/2013/bhca-1.pdf
  6. “Minimum capital requirements for market risk,” Basel Committee on Banking Supervision, January 2016. Access at: http://www.bis.org/bcbs/publ/d352.htm
  7. Ibid

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