Designing a best-in-class fund transfer pricing (FTP) framework
How banking CFOs and their treasurers can evolve their FTP mechanisms to support strategic decision-making
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Increasing market volatility, inflation, cost of funding, and market illiquidity have placed banking CFOs and their treasurers under growing pressure to reassess the effectiveness of their FTP mechanisms, and the accuracy with which they are evaluating, managing, and charging the various business units.
Compounding this challenge are also several emerging factors impacting FTP base rates, such as the transition from Interbank Offered Rates (IBOR) to alternative risk-free rates (RFRs) that do not reflect term structures, as well as inherent uncertainties surrounding the maturity timelines and volume development of non-maturing deposits (NMDs), which are growing in importance as a cost-efficient source of funding for many banks.
While there are no one-size-fits-all FTP approaches, a best-in-class framework is one that is fundamentally commensurate with the bank’s activities and size, in terms of its complexity, methodology, and processes.
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Compounding this challenge are also several emerging factors impacting FTP base rates, such as the transition from Interbank Offered Rates (IBOR) to alternative risk-free rates (RFRs) that do not reflect term structures, as well as inherent uncertainties surrounding the maturity timelines and volume development of non-maturing deposits (NMDs), which are growing in importance as a cost-efficient source of funding for many banks.
While there are no one-size-fits-all FTP approaches, a best-in-class framework is one that is fundamentally commensurate with the bank’s activities and size, in terms of its complexity, methodology, and processes.
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Three design themes for a best-in-class FTP framework
All things considered, we believe that a best-in-class FTP framework should broadly adhere to three design themes:
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Strategic alignment
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- To ensure that the FTP mechanism serves its purpose in driving balance sheet objectives, there needs to be strategic alignment between the FTP mechanism overseen by the treasury and the bank’s overarching financial resource management objectives under the purview of the CFO.
- In line with this, there needs to be a review of the business model and balance sheet objectives and the definition of economic performance units (EPUs); an analysis of liquidity portfolio optimisation and risk management strategies under realistic but stressed scenarios; and tailoring of hedging structures to the bank’s business model for treasury risk management.
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Consistency and feasibility
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- The FTP framework needs to be clearly articulated, transparent, and easily understood by business units. Furthermore, it should be effective across both the banking book and trading book, and be applied at the group level with consistent pricing of similar currencies across different markets.
- At the same time, however, there needs to be sufficient built-in flexibility to accommodate market-specific features that could vary significantly by geography.
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Technical soundness and feasibility
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- There needs to be conceptually sound and feasible approaches to establishing base rates and liquidity premiums, as well as allocating costs, in order for the bank to derive a true view of the product or portfolio’s economic value against prescribed minimum performance returns on allocated or risk-based capital.
- Other technical considerations also include ensuring a clear differentiation between stock and flow components, where appropriate, and accounting for the implications of the transition to alternative RFRs.
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Five dimensions of a comprehensive FTP mechanism
Leveraging our extensive experience supporting banking CFOs and their treasurers in evolving their FTP mechanisms, we have developed a granular maturity model to facilitate structured benchmarking discussions on FTP capabilities along five dimensions.
Mature, best-in-class FTP governance frameworks should possess at least two key characteristics in common. Firstly, they clearly define the policies, as well as roles and responsibilities, at the bank’s group, regional, and divisional levels along the three lines of defence (3-LoD).
Secondly, these FTP governance frameworks should also have received the endorsement and buy-in of senior stakeholders. This is necessary to ensure the alignment of responsibilities, risk appetite, and mandates at all levels of the organisation, given that risk-adjusted returns on capital (RAROC) performance measurement and management are fundamental components of a bank’s governance framework and the way in which it considers risk in its strategic decision-making.
Secondly, these FTP governance frameworks should also have received the endorsement and buy-in of senior stakeholders. This is necessary to ensure the alignment of responsibilities, risk appetite, and mandates at all levels of the organisation, given that risk-adjusted returns on capital (RAROC) performance measurement and management are fundamental components of a bank’s governance framework and the way in which it considers risk in its strategic decision-making.
Mature FTP frameworks and asset and liability (ALM) mandates should be supported by robust processes and a comprehensive set of internal controls that are effective, efficient, and fully documented along the 3-LoD.
It must be emphasised that it is also critical that FTP processes are seamlessly integrated into the bank’s key business decision-making capabilities, and that stakeholders possess a sound understanding not only of the impacts that the FTP framework will have on these capabilities, but also the impacts that material decisions taken within these capabilities will have on the FTP framework.
It must be emphasised that it is also critical that FTP processes are seamlessly integrated into the bank’s key business decision-making capabilities, and that stakeholders possess a sound understanding not only of the impacts that the FTP framework will have on these capabilities, but also the impacts that material decisions taken within these capabilities will have on the FTP framework.
Mature FTP models should be able to withstand the necessary stress-testing and scenario modelling as mandated by business and regulatory requirements. The model strategy must also be fully documented, and be subject to comprehensive controls and validation to ensure that there is a clear delineation between LoD 1 and LoD 2.
In addition, many banks are increasingly taking into consideration several emerging factors impacting FTP base rates, such as the transition from IBOR to alternative RFRs.
In addition, many banks are increasingly taking into consideration several emerging factors impacting FTP base rates, such as the transition from IBOR to alternative RFRs.
In a mature setup, a comprehensive architecture of IT systems should be in place to support the mandate of FTP functions. These should, in turn, be accompanied by robust data quality controls and service-level agreements covering data flow and system functionality aspects.
Typically, best-in-class systems are characterised by the use of a consistent data taxonomy, centralised management of IT systems, as well as continual strategic IT renewal and recurring review of service-level agreements with internal and external providers by the ALM function with oversight by the CFO and CIO/COO/CTO.
Typically, best-in-class systems are characterised by the use of a consistent data taxonomy, centralised management of IT systems, as well as continual strategic IT renewal and recurring review of service-level agreements with internal and external providers by the ALM function with oversight by the CFO and CIO/COO/CTO.
FTP frameworks are intrinsically linked to the way in which a bank manages its funding risks, including its interest rate and liquidity risks.
It therefore follows that given the importance of interest rate and liquidity risk metrics in both regulatory reporting and management information, the MIS should incorporate key funding risk metrics, which include but are not limited to cashflow reporting, interest rate risk, and foreign exchange risk, as well as stress/scenario/sensitivity analyses and exposures against approved risk appetites.
It therefore follows that given the importance of interest rate and liquidity risk metrics in both regulatory reporting and management information, the MIS should incorporate key funding risk metrics, which include but are not limited to cashflow reporting, interest rate risk, and foreign exchange risk, as well as stress/scenario/sensitivity analyses and exposures against approved risk appetites.
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