Executive Summary

The revised market risk framework for capital calculation, commonly known as the Fundamental Review of the Trading Book (FRTB), allows banking organisations to use either the standardised approach or internal model approach (IMA).

The IMA involves risk factor modellability tests, desk-level approvals, multiple liquidity horizons (LHs), the replacement of value-at-risk (VaR) with expected shortfall (ES), and non-modellable risk factors (NMRFs).

To compute ES and stressed expected shortfall (SES) for NMRFs, the first step is to get the profit and loss (P&L) distribution. One of the common approaches is to use a sensitivity/ Greeks-based framework. However, this approach fails to effectively capture all the non-linearities in valuation.

To address this, banks uses the full-revaluation (FR) approach. FR involves shocking the inputs and then revaluing the products in the portfolio using the corresponding pricing/ valuation functions.

This paper summarises the challenges that banks may encounter, including the complexity involved in FR calculations, impact of using proxies in FR calculations, importance of standardising risk factors to align with reference data, and effect of distinct valuation methodologies for front-office (FO) and risk purposes.