Market risk capital (FRTB) and CVA

Trading book governance

Ketterby Bank plc (invented) is a UK bank with £9,000m of assets and three trading desks: Rates, Equity derivatives and Credit. Ahead of the FRTB standardised approach, which UK banks use from 1 January 2027 (PRA PS1/26, para 1.23), the team reviews the boundary between its books at 31 December 2025.

First, four positions the desks have asked to hold (part a). Second, the treasury wants to buy £30m of five-year CDS protection on a corporate to which the banking book has lent £20m (part b).

Third, in a publicly announced restructuring Ketterby permanently closes the part of its Credit desk that trades sterling corporate bonds. The PRA approves moving the remaining £40m of BBB-rated bonds to the banking book, where they take the standardised weight for a BBB corporate. Capital on the trading book, in £ millions:

Lessons: L4.3.01: The trading book boundary

Market risk, standardised approach

Ketterby's Equity derivatives desk holds two large-cap UK shares and has sold FTSE 100 futures against them. The risk system gives the P&L for a 1% rise in each price, in £ millions:

MAR21 defines an equity delta sensitivity as the change for a 1% rise divided by 0.01. Bucket 8 (large cap, advanced economy, financials, real estate and technology) has a spot weight of 50%; bucket 12 (large-cap advanced-economy indices) 15%. Two names in bucket 8 correlate at 25%, and buckets 8 and 12 at γ = 45%. The desk has no other equity delta.

Lessons: L4.3.02: The sensitivities-based method: delta and vega

Market risk, standardised approach

The same desk has sold FTSE 100 calls and bought FTSE 100 puts, all with six months to run. The pricing team revalues the options in full, in £ millions:

The index is in equity bucket 12, where the curvature shock is the delta weight, 15% (MAR21.98). Vega on a large-cap index has a liquidity horizon of 20 days, so its weight is min(55% × √(20/10), 100%) (MAR21.92). The options have one vega risk factor.

Lessons: L4.3.02: The sensitivities-based method: delta and vega · L4.3.03: The curvature charge

Market risk, standardised approach

The Credit desk's positions in the corporate DRC bucket, in £ millions. Notional is signed (negative for protection bought); the CDS were bought today at market, so their value is zero. Every position has more than a year to run.

Default weights by rating are A 3%, BBB 6% and BB 15% (MAR22.24). The desk also holds two positions that the SBM and DRC cannot see, gross notional in £ millions:

Lessons: L4.3.04: Default risk charge and residual risk add-on

Market risk, internal model (illustrative)

Ketterby plans to put its Rates and Equity derivatives desks on the internal model approach. This is illustrative: the UK IMA starts on 1 January 2028 (PRA PS1/26, para 1.24), and Ketterby has no permission. On 250 ten-day scenarios of the current 12 months, with every risk factor shocked, the ten worst losses are, in £ millions:

9.8, 8.6, 7.9, 7.1, 6.6, 6.2, 5.9, 5.5, 5.3, 5.0

The same scenarios shocking only the factors with longer liquidity horizons give ES_T(P, j) of 4.0 (LH ≥ 20 days), 2.5 (LH ≥ 40 days), 1.0 (LH ≥ 60 days), 0.0 (LH ≥ 120 days). For the stress calibration, the reduced set of factors gives a liquidity-adjusted ES of £9.80m on the current 12 months and £15.40m in the stress period. The partial charges IMCC(C_i), already scaled to the stress period, are:

Lessons: L4.3.05: Internal models: expected shortfall

Model validation (illustrative)

Over the last 250 business days, the one-day 99% VaR of the desks in the model's scope was exceeded 6 times by actual P&L and 7 times by hypothetical P&L. Desk by desk:

For the PLA test, here are ten days of the Equity derivatives desk's hypothetical P&L (HPL) and risk-theoretical P&L (RTPL), in £ thousands. As a drill, treat them as the test window and apply the MAR32 thresholds to them (the real test uses 250 days).

Lessons: L4.3.07: Backtesting and the P&L attribution test

Capital planning (illustrative)

Three risk factors on the model desks have these records of real prices over the past 12 months:

Issuer D's spread has a CS01 of £5,000 per bp, and its stress scenario over max(LH, 20 days) moves it 80bp. The desks have one more issuer spread NMRF, with a stress loss of £0.30m, and two NMRFs that are not idiosyncratic, with stress losses of £0.50m and £0.20m.

Rates is green and Equity derivatives amber in the PLA test; Credit is on the standardised approach. With Problems 5 and 6 (IMCC £18.10m, m_c 1.83), in £ millions:

Lessons: L4.3.06: Non-modellable risk factors and the internal DRC · L4.3.08: Total market risk capital

Counterparty risk and CVA

Ketterby has three non-cleared netting sets, one per counterparty, and uses the reduced basic approach (BA-CVA), part of the UK's new CVA framework from 1 January 2027 (PS1/26, para 1.23). Ratings are external. EAD is SA-CCR's and M is the netting set's effective maturity, in £ millions and years:

The CVA desk then buys £10m of four-year CDS protection on C3 itself, moving to full BA-CVA. C1's CDS spread is flat at 120bp, and the market LGD is 60%.

Lessons: L4.3.09: CVA capital: the basic approach · L4.3.10: CVA capital: the standardised approach · L4.3.11: Market risk and CVA capital: what changes from 2027