The Basel Committee has been conducting a fundamental review of its "Trading Book" rules as part of the Basel III overhaul of the capital and liquidity framework, and is now following up an initial consultation released in May 2012 with a second Consultation Document which represents the Basel Committee's latest thinking on the changes required to the Basel III market risk framework to improve trading book capital requirements. The distinction between the trading book and banking book is important because capital charges for banking book assets have historically been much higher than for trading book assets (something which the Basel Committee has already addressed in Basel 'II.5' with regard to securitisation, by aligning banks' trading book and banking book treatment of securitisations, thus preventing banks holding securitisation positions in trading books with no real trading intent but which attract very low capital charges). The Basel Committee proposes a revised boundary between the banking book and trading book that is less based purely on the subjective notion of "trading intent" but seeks to reduce the possibility for arbitrage, and would allow a common understanding to develop about the types of instrument the regulators expects to see in each book. Further, the Basel Committee has decided to move from the "value-at-risk" measurement of trading book assets/risk to an "expected shortfall" measurement, to more effectively capture "tail risk", and to calibrate the measurement based on a period of significant financial stress. The risk of "market illiquidity" will also be factored into the framework, through the use of "liquidity horizons" (defined as "the time required to execute transactions that extinguish an exposure to a risk factor, without moving the price of the hedging instruments, in stressed market conditions") in the market risk metric, and through the use of an additional risk assessment tool for trading desks with exposure to illiquid, complex products. A revised Standardised Approach to measuring market risk will use increased risk-sensitivity and ensure it is truly a fall-back option, while the revised internal models-based approach will encompass a more rigorous model-approvals process and will feature a more consistent identification of material risk factors. Both the Standardised and internal model approaches will be more closely calibrated to ensure a closer alignment of capital charges between the two, reducing the scope for arbitrage and allowing "internal model" banks to use the Standardised Approach as a fall-back. In addition, the treatment of credit risk will be more closely aligned in the trading and banking books, leading to (amongst other things) a differential approach to securitisation and non-securitisation exposures that, broadly, will mean that capital charges for securitisation positions in the trading book will be based on the revised Standardised Approach, but charges for non-securitisation exposures may be based on internal models, subject to an Incremental Default Risk (IDR) charge. Credit Valuation Adjustment (CVA) charges are not being incorporated into the market risk framework at this time. Comments on the Consultative Document are requested by 31 January 2014, following which the Basel Committee expects to conduct a Quantitative Impact Study (QIS) before releasing the final framework during 2014.
Basel Committee Consultative Document