The Fundamental Review of the Trading Book (FRTB) is a new Basel committee framework for the next generation market risk regulatory capital rules. It is inspired by the undercapitalisation of trading book exposures witnessed during the financial crisis. FRTB aims to address shortcoming of the current Basel 2.5 market risk capital framework.

Value at Risk (VaR) is the regulatory measurement for assessing market risk. It reports the maximum likely loss on a portfolio for a given probability defined as x% confidence level over N days. VaR is vital in market risk management and control. Also regulatory and economic capital computation is based on VaR results. Although VaR measure is objective and intuitive, it doesn’t capture tail risk. There are three commonly used methodologies to calculate VaR – parametric, historical simulation and Monte Carlo simulation. This presentation focuses on historical VaR.

Initial Margin (IM) is the amount of collateral required to open a position with a broker or an exchange or a bank. The Standard Initial Margin Model (SIMM) is very likely to become the market standard. It is designed to provide a common methodology for calculating initial margin for uncleared OTC derivatives. Initial margin calculation is counterparty-portfolio-based. Given this standardized approach, counterparties can easily reconcile the results.

The incremental risk charge (IRC) is a regulatory requirement from the Basel Committee in response to the financial crisis. It supplements existing Value-at-Risk (VaR) and captures the loss due to default and migration events at a 99.9% confidence level over a one-year capital horizon.