As the Basel III capital reforms are finalized for implementation in key jurisdictions, ISDA is maintaining a laser focus on making sure the rules are robust and risk-appropriate. Simply put, if capital requirements are set disproportionately high, this will have serious consequences for the thousands of companies that rely on banks for financing and hedging solutions.

When it comes to the Basel III market risk framework, known as the Fundamental Review of the Trading Book (FRTB), most regulators have deviated from the global standards when drafting their rules, which suggests there may be flaws in the original calibration. Rectifying those flaws is a step in the right direction, which is why we welcome the European Commission’s (EC) consultation, launched this week, to gather feedback on possible changes to the FRTB.

The FRTB is currently due to be implemented in the EU from January 1, 2026, but that’s a year earlier than the current deadline in the UK and there is no clarity at this stage on when US policymakers will finalize and implement the rules. Citing the need to avoid penalizing internationally active EU banks and preserve their ability to compete with third-country banks, the EC is consulting on three possible options – implement the FRTB as planned, delay by one year until the start of 2027, or apply a set of targeted amendments for a three-year period.

Those targeted amendments comprise 10 possible changes that could be made to the FRTB’s standardized and internal models approaches. Although designed to be temporary, many of these changes address issues that ISDA has long advocated to resolve. They would improve the risk sensitivity of the framework and result in more appropriate capital requirements.

For example, the EC has proposed that the profit-and-loss attribution test under the internal models approach could be used as a monitoring tool until the start of 2029. ISDA had previously highlighted the difficulties posed by this test and the instability of the resulting capital requirements. The proposed reprieve would allow data to be collected initially so the impact can be carefully monitored over time.

The EC has also recognized the punitive impact of the additional capital charge for non-modellable risk factors and proposed the application of a discount factor over a three-year period. Further analysis will be needed to determine if the discount is appropriately calibrated or whether alternative solutions are warranted, but this measure would certainly reduce the punitive capital impact of NMRFs.

Another welcome change is the proposal to assign a 0% risk weight to sovereigns in the default risk charge for both the standardized and internal models approaches, subject to supervisory approval. This would remove the disproportionate treatment of sovereigns when using internal models and reduce one of the impediments for banks to use their own models for market risk capital. This is a simple solution to a longstanding issue.

The proposed amendments also include improved recognition of diversification in the standardized approach and a more pragmatic approach to the capitalization of equity investments in funds, an issue ISDA has been working with members to address for some time.

ISDA commends the EC for its willingness to revisit the standards, and we hope it will lead to an improved regulatory framework for market risk capital in the EU. As we work with our members to respond to the consultation, we’ll also continue to engage with regulators in other jurisdictions. We must maintain our focus on a global capital framework that is risk-appropriate for both standardized and internal models.