While some spent the winter hiding under the covers trying to keep warm, regulators clearly had a busy and productive season. This regulatory roundup provides highlights of new and revisited regulatory conversations on global financial stability, stress testing of CCPs and some big picture ideas from the Bank of England. If you would like to read this article and are not a Finadium research subscriber, please visit Finadium.com/site/finreports.php to get access.
Asset Managers as SIFIs. The Financial Stability Board and IOSCO have published Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions. This is the second public consultation on this topic and is meant to figure out when, how and where asset managers should be considered a SIFI. The idea is to have a consistent methodology globally. Good luck with that. But its a start at least. Some criteria to define an asset manager SIFI are: size, interconnectedness, substitutability, complexity (including holdings of less-liquid assets) and global or cross-jurisdictional activities. The minimum AUM for even evaluating an asset manager is:
(i) Option 1: A particular value (e.g. USD 100 billion) in “balance sheet total assets” for determining the entities that will be assessed in detail by the assessment methodology.
(ii) Option 2: A particular value (e.g. USD 1 trillion) in AUM for determining the entities that will be assessed in detail by the relevant assessment methodology.
This assessment methodology will result in some asset managers being declared SIFIs, in which case they will be subject to a new level of regulatory scrutiny and oversight. The outcome here is pretty inevitable; the uncertain parts are how many firms get caught in this net.
CCP stress tests. IOSCO has announced it is beginning a review of stress tests by CCPs. This is all fine and good but misses an important point: individual CCP stress tests that evaluate Cover 1, Cover 2 or Cover All methodologies are great, but they do not consider what might happen if multiple large CCPs were suffering a default at once. Our concern with the IOSCO approach is that they are missing the boat by focusing on each individual CCP in isolation. For more on this, see our February 2015 research report, “CCP Recovery and Resolution Plans: Players, Regulations and Ideas“. There will need to be some element of the CCP stress test review process that captures this interconnectedness of the global financial system.
Liquidity and Volatility. The Bank of England’s Chris Salmon gave a talk last week on liquidity and market volatility. There are two main conclusions here: market makers are reluctant to commit capital (or have disappeared altogether due to low profitability) and the increased use of electronic platforms can contribute to even greater volatility (no backstop liquidity). These two points are pretty well known, but its good to see a Central Banker take them seriously enough to give a warning to financial market participants and, implicitly, to policy makers as well. The full speech is available here: Financial Market Volatility and Liquidity – a cautionary note.
What’s Next for Bank Capital Rules. David Rule of the Bank of England (and many Financial Stability Board working groups and policy committees) gave a speech earlier this month, What is left to do on the post-crisis bank capital framework? He had four main areas to look out for:
1) The overall calibration of Total Loss Absorbing Capital (TLAC). This should get clearer over the next year.
2) The appropriate level of capital buffers, including how and by how much they increase as banks are more systemically important. This is up for review in 2017.
3) The location of capital buffers, requirements and loss absorbing capacity within international banking groups. “An important question then is to what extent and on what terms that equity and debt is downstreamed from the top-level holding company to any intermediate holding companies and the operating subsidiaries.” This is tricky stuff to figure out.
4) How to measure a bank’s risk exposures in order to set TLAC and buffers – or, in other words, determining the denominator of the capital ratio. This is an ongoing challenge that may never have a final answer. As we’re already seen, adjusting the denominator may be a process of trial and error with pressure and easing happening after each new swing of the regulatory pendulum and ability of banks to fund the real economy.
These are busy days for regulators and those who are working to figure out what their new directions mean for financial markets. Finadium has been focusing a good part of 2015 on evaluating the regulatory agenda, now that much is known and we are already seeing market-based responses to proposals made right after the Global Financial Crisis of 2007-2009. There will be more to come.