I'd like to be able to make a system like this meet building regulations.

We've done one with a groove in the posts/studs/braces but instead of boards it had hardibacker - a fiber cement sheet product. And yes, it's tough to put in as the frame goes up.

We didn't groove the upper face of any braces, sills, or other horizontal or diagonal members. All of these had a bevel cut in them in the hopes that water would drain away from the panels.

The groove was wider than the panel's thickness and foam backer rod was stuffed in the groove and then a polymer chinking material was used around the perimeter of the panels where the panels met wood. The finish for the rest of the panel was typical stucco.

We didn't design the system and we only took it as far as cutting each panel and installing it as the frame was raised.

I haven't been back to see how it's holding up -- it's about a 12 hour drive from here -- but I hope to someday soon.