In January 2013, the BCBS published its Principles for Effective Risk Data Aggregation (RDA), with a threat that regulators would be checking up on implementation throughout Q1. But banks have flinched at the size of the task ahead of them and few have made committed steps towards compliance.
However, within the opening paragraphs of the Principles, the BCBS has conceded ground to banks struggling to break down into bite-sized pieces what could otherwise, in some cases, amount to a total systems overhaul. At paragraph 16, the draftsmen introduce the theme of ‘critical data’. Based on this threshold, it is possible to exclude some of the bank’s data from the scope of the Principles. Therefore, asking the question of ‘what is critical data?’ upfront can significantly reduce the workload demanded by the principles, and help to focus work.
‘Critical data’ is defined in the Principles as ‘data that is critical to enabling the bank to manage the risks it faces’. These exemptions may seem like small comfort, and many institutions probably take such exemptions for granted. However, banks are given the discretion to exclude data which is irrelevant to the risks the banks faces or simply non-critical. As a result, firms who want to take advantage of this discretion will have to find their critical data threshold. But interpreting this threshold with adequate certainty is not an easy task, and will differ from institution to institution.
However, the Principles do give two distinct clues as to how high this bar is set: Under exceptional circumstances data may be exempt from the requirements in the Principles on the basis that it is either, one, non-material or, two, that it has been sacrificed as part of an unavoidable trade-off to achieve a priority objective. The second of these, the trade-off exemption, will be covered in another article . But the first, the materiality threshold, is dealt with below.
Materiality is a well-defined concept elsewhere, but possibly one less familiar to the industry. In this instance, the BCBS defines material information as information that would affect the decision-making process. Let’s take a scenario: The board wants to make a decision on the firm’s risk appetite and so they call up a report of the bank’s exposure to the Spanish economy. The report is prepared but, due to mis-aggregation, an unknown piece of information is omitted. The board decides to increase risk appetite.
In this scenario, a breach of the Principles only occurs where the information should have been included and would have changed the decision. If the missing information was a minor commodity trade on the Spanish market, for example, or a sign of long-term Spanish growth (e.g. a new infrastructure project) then the materiality threshold is not met. In other words, if the information is de minimis, or would have supported the decision to increase risk appetite, then the firm remains compliant.
Many firms may decide that implementing this threshold carries greater cost/risk than taking the broad-brush approach, and simply apply the Principles to their risk data as a whole. However, there is a clear opportunity here for firms to gain a competitive advantage, by considerably reducing the cost and effort involved in implementing these Principles, but only if the implementation is managed well.