The document analyzes different hedging strategies to manage capital charges for an interest rate portfolio under the Fundamental Review of the Trading Book (FRTB) regulations. It finds that the most efficient strategy is to consider pairs of related trades and unwind the pair that reduces capital charges the most at each step, taking into account that positions are often managed together. Analyzing the portfolio this way more closely matches how traders actually manage risk. The analysis is intended to help trading desks efficiently reduce their capital charges under FRTB. Proceeds from interested trading desks running their own portfolios through the analysis will support the suicide prevention charity C.A.L.M.

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E: risk@kerrshearer.co.uk
T: +4477 0326 2195
Hedging FRTB SBA
David K Kelly
November 2017

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We consider a number of strategies on a typical IR portfolio:-
• GBP portfolio referencing a couple of benchmarks and gilt curve, gilt futures, typical strategies across the
curve such as spreads and butterflies
• Smaller EUR portfolio across a couple of benchmarks
• Three legs of a AUD/GBP cross currency position in AUD 3M Libor, GBP 3M Libor and the AUD/GBP xccy
basis
• UK RPI inflation long-dated position hedged in the short-end
• USD isolated 3s 6s Libor position in the long-end
Kerr Shearer and C.A.L.M. are teaming up to raise money to support prevention of male suicide
If trading desks are interested in running this analysis on their own portfolio, they can make a one-off donation
to support C.A.L.M. (www.calmzone.net)
Managing FRTB Sensitivity Based Approach
The purpose of this analysis is to consider different hedging strategies to manage down the capital charge of an interest
rate portfolio.
THE ANALYSIS PROVIDES EVIDENCE ON HOW TO CREATE AN EFFICIENT HEDGING STRATEGY

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The Portfolio
The portfolio has been designed to provide some insight on which positions carry a high capital cost to run.
There are 50 positions across a number of currencies, curves and maturity buckets (”Vertex”)

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First Strategy – Linear Approach
First strategy is to start unwinding each holding in blocks of 1,000 DV01 until position is zeroed out
The curve against a straight line suggest a reasonable linear link between shaving off risk and the reduction in capital
charge. With less positions in the latter half there is a drop in efficiency
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Second Strategy – Waterfall Approach
Alternative approach is to netralise each position and re-cacalulate the smaller portfolio. Pick out the position that reduces
the capital the most and execute that trade. After that, repeat the exercise with a smaller portfolio until all have been
closed out.
This might suggest a better approach where at each step, the exercise above is repeated where the position that
generates the most benefit is neutralised

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Waterfall Approach vs Linear Approach
The waterfall approach initially is much more efficient, however after a few iterations, the benefits flat-line and at the end
go into reverse.
The results suggest the second strategy works well, but eventually flatlines.
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Detailed Look at the Waterfall approach
The Waterfall approach unwinds large positions at the start, but also at the end. These have been shaded. Note that all
the large basis trades – USD 3s 6s, AUD xccy, Euribor 3s 6s are left to the end, forcing the capital charge to treat water.
This strategy fails as it does not take into account that many positions are traded as a pair so unwinding one leg will
increase the capital charge. The next approach addresses the dynamic of trading in pairs.

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Third Strategy – Pair-wise Waterfall
The final approach takes all combination of pairs and calculates the impact of neutralising the risk. The pair that creates
the largest drop in capital is chosen and the exercise is then repeated with the smaller population.
This analysis suggest that all hedging strategies for FRTB need to view the portfolio as a collection of pairs of trades and
execute remediation along those lines.
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Detailed look at the Pair-wise Waterfall approach
The first pairs of trades executed are either large curve differentials, large basis positions or positions in lowly correlated
curve
The pair-wise waterfall is computationally intense – this portfolio of 50 positions required over 10,000 different capital
calculations – however the results are much more closely aligned to how the trader manages the risk.

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Quant Aid
For trading groups that are interested in running their portfolio through this analysis, please get in contact via
email and we will be happy send the data input template for you to fill in and will send you back the results.
We will send you a link to a Justgiving page for you to make a donation to C.A.L,M
The code is in Mathematica
The code was written on a Mathematica as a home project and not intended to be a commercial product
Kerr Shearer and C.A.L.M.
Who we are
Kerr Shearer is an independent risk consultancy that focuses on risk assurance, risk regulatory change and
capital markets training. David Kelly has written a number of thought leadership pieces on FRTB.
Kerr Shearer is delighted to support C.A.L.M (Campaign Against Living Miserably) that does fantastic work
preventing suicide amongst men. Suicide is the largest killer for men and in our industry, quants are the
most at risk.
THANK YOU FOR YOUR INTEREST AND SUPPPORT
David K Kelly
Director
E: risk@kerrshearer.co.uk

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Shearer Limited.
This document has been compiled by Kerr Shearer Limited and
includes material which may have been obtained from information
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responsibility or liability is or will be accepted by or on behalf of Kerr
David K Kelly
Director
E: risk@kerrshearer.co.uk
T: +4477 0326 2195
W: www.kerrshearer.co.uk
V: appear.in/kerr-shearer