Executive Summary: The US Implementation of FRTB (Basel III Endgame)

OverviewThe United States is currently in the process of implementing the Fundamental Review of the Trading Book (FRTB) as part of the broader "Basel III Endgame." On July 27, 2023, the Federal Reserve (FRB), the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) issued a joint Notice of Proposed Rulemaking (NPR) to revise capital requirements for large banking organizations.

The proposal applies primarily to banking organizations with total assets of $100 billion or more and those with significant trading activity (defined as $5 billion in trading assets/liabilities or exceeding 10% of total assets). The stated goal is to standardize capital requirements, reduce regulatory arbitrage, and better capture tail risks exposed during the Global Financial Crisis.

Key Technical ShiftsThe US proposal replaces the current market risk framework with a "revised approach" that aligns with the core mechanics of the international Basel standards:

1. Risk Measurement: The framework shifts from Value-at-Risk (VaR) to Expected Shortfall (ES) at a 97.5% confidence level to better capture tail risk during periods of stress.
2. Approaches:
   • Standardized Approach (SA): A new, highly risk-sensitive sensitivity-based method serves as a credible fallback and floor for internal models. It includes specific charges for default risk (DRC) and residual risks (RRAO).
   • Internal Models Approach (IMA): Banks may still use internal models for market risk, subject to rigorous desk-level approval and profit and loss (P&L) attribution tests. However, the proposal eliminates the use of internal models for credit and operational risk entirely, a significant departure from global standards.
3. Liquidity Horizons: The static 10-day horizon is replaced by varying liquidity horizons to account for market illiquidity during stress events.

US-Specific Deviations ("Gold-Plating")The US implementation introduces stricter requirements than the international Basel agreement, often referred to as "gold-plating". Key deviations include:

• The Dual-Stack Requirement: Unlike the international standard which sets a floor of 72.5% of standardized risk-weighted assets (RWA), US banks must calculate capital under the new "Expanded Risk-Based Approach" and the existing standardized approach, binding them to whichever is higher. This renders the international floor moot for many US institutions.
• Minimum Haircut Floors: The US proposal introduces minimum haircut floors for Securities Financing Transactions (SFTs) with unregulated entities, a provision the EU and UK declined to implement due to fears of driving activity into shadow banking.
• Public Listing Requirement: Lower risk weights (65%) for investment-grade corporate exposures are restricted to companies with publicly traded securities, disadvantaging private firms and pension funds.

Economic Impact and ControversyRegulators estimate the proposal will increase Common Equity Tier 1 (CET1) capital requirements by approximately 16% for large holding companies, with G-SIBs facing increases up to 19%. Industry analysis suggests the increase for trading activities specifically could be nearly 60% to 80%.

Critics argue that the FRTB overlaps with the Global Market Shock (GMS) component of US supervisory stress tests, effectively double-counting market risk. Furthermore, there are concerns that increased capital costs will reduce market liquidity, increase hedging costs for end-users (such as farmers and pension funds), and accelerate the migration of activity to the non-bank financial sector.

TimelineThe proposed transition period is scheduled to begin on July 1, 2025, with full compliance required by July 1, 2028.