Market Risk: Basel 2.5 Final Rules-US

Regulatory Updates Rima Consulting.

The Board of Governors of the Federal Reserve System voted to publish final rules (June 7th, 2012) on market risk capital. For Banks with a high proportion of trading assets and liabilities, the final market risk capital rule prescribes methods for calculating the market risk capital requirement (Basel 2.5) for FX and commodities positions and certain trading assets and liabilities. Those rules have been delayed in the US as regulators sought to adjust their rules to comply with the Dodd-frank Act Section 939A requiring from the Agencies to remove all references to and requirements of reliance on credit ratings from their regulations and replace them with alternative standards of creditworthiness.

The Agencies’ final proposals are largely designed to implement Basel 2.5 in which the United States is consistent with the current Market Risk Capital Rule. The final Market Risk Rule (MRR) will apply to any banking organizations with aggregate trading assets and liabilities that exceed either 10 percent of its total assets or $1 billion. This action has generally been welcomed for reflecting industry feedback, albeit some concerns remain.

Basel 2.5 implementation in the US

Subject to certain changes described below, the Market Risk Amendments (MRAs) are largely unchanged from the Agencies’ December 2011 proposals: The rules include a market risk charge based on value-at-risk (VaR), a stressed VaR charge, an incremental risk charge to capture default and credit migration risk, a standardised charge for securitisations and a comprehensive risk measure for correlation trading portfolios - a measure that is also subject to a minimum floor.

The Market Risk Amendments will become effective January 1, 2013, although the Agencies note that they are “committed to continued improvement of the market risk framework”. The Federal Reserve requests comments on the “Risk-Based Capital Guidelines: Market Risk” by September 7, 2012.

What to do next?

1-      Start a Gap-Analysis highlighting the current status of your firm and the changes proposed by the Agency; this exercise should include: 

• A detailed review of existing policies, measurement framework, procedures, reports, etc.
• Review of the data available to assess completeness of the information required to comply with the regulatory requirements.

2-      Review the business impact

3-      Don’t forget to consider in your analysis the impacts of the Fundamental Review of the Trading Book Published in May 2012.