OFR FSOC – 2014 Annual Conference
At
Jan. 23rd’s Office of Financial Research (OFR) and Financial Stability
Oversight Council (FSOC) Annual Conference, regulators, industry participants,
and experts discussed “Mapping and Monitoring the Financial System,” and
focused on swap data reporting as well as funding and operations risks.
Opening
Remarks – Mary Miller
In
opening remarks, Mary Miller, Undersecretary for Domestic Finance at the U.S.
Treasury, said that regulators “need to stay vigilant” in watching emerging
areas of risk in the financial system because the next crisis “will not
look like the last one.”
Miller
stressed that more work needs to be done to “fill the gaps” of financial data,
especially the “missing piece” of data on over-the-counter (OTC)
derivatives. She noted that data is “still fragmented” in different swap
data repositories (SDR) located in different jurisdictions and that they are
all collecting data in different ways, making it difficult for regulators to
aggregate and analyze the information they contain. She concluded that “a
great deal of work” still needs to be done to ensure that the swap data is as
“useful as possible” and allows for good research to be conducted on the
marketplace.
Session
1 – Liquidity and Funding Maps: Analytics and Funding Risks
The
first session “Liquidity and Funding Maps: Analytics and Funding Risks”
included presentations from panelists Tom Wipf of Morgan Stanley; Hyun Shin from
Princeton University; and Nellie Liang, Board of Governors of the Federal
Reserve System.
Wipf
gave brief remarks which focused on measuring durability in funding. He
presented a map following the movement of securities and cash between entities,
and argued that the map needed to be paired with a durability index. The
durability index Wipf proposed is a hierarchy of funding sources and the risks
associated with them.
Shin’s
presentation discussed the relationship between complexity and leverage, specifically
dealing with core and non-core liabilities. According to Shin, when there is an
increase in intermediaries in the process, complexity rises alongside
leverage. Shin went on to state that the ratio of core to non-core
liabilities can be used as an indicator for impending problems in the system.
However, he noted, what counts as “non-core” depends on the financial system
and context.
Lang
presented on short term funding and the collapse of the asset backed commercial
paper (ABCP) market. She presented on the growth of shadow banking over the
years, particularly on its sharp rise since the late 1990’s. Lang’s data
showcased the very fast rise and just as rapid fall of ABCP. She showed
that in 2007, the ABCP market was approximately $1.2 trillion, which then
dropped by $350 billion in a matter of months and kept falling thereafter.
She
described the ways ABCP programs are similar to banks by saying “ABCP programs
issue short-term debt to finance assets such as receivables, loans, and
securities.” That liquidity support may reduce rollover risk, she added. Lang
described the ways ABCP programs vary by assets and liquidity support, and by
the type of sponsors they have. The good news, according to Lang, is that the
research showed that the runs felt in the ABCP markets were not random, nor are
they simply investor panic.
Lang
was asked if Fed will focus on the shadow banking sector moving forward, to
which she replied that it will be an area of interest but not the main focus.
When
asked if regulators have responded appropriately in terms of policy response,
Lang felt it was appropriate that a lot of programs did end up back on to bank
balance sheets, though “it clearly raises the cost of financing.” Lang also
commented that there is a trade-off , in which in order to reduce the
disruptiveness of a crisis, you have to raise the cost of financing.
Session
2 – Mapping Financial System Plumbing: Operations Risk and Counterparty Risk
The
second session, “Mapping Financial System Plumbing: Operations Risk and
Counterparty Risk” included Paul Glasserman of Columbia University, and Caryl
Athanasiu of Wells Fargo. Athanasiu, who is Chief Operational Risk Officer at
Wells Fargo, gave her perspective on the world of operational and systemic
risk.
Athanasiu
defined the primary systemic players as financial market utilities (FMUs)
involved in clearing and settlement for payments and securities, and financial
institutions with dollar and/or transaction volume concentration. The three
factors, according to Athanasiu, that influence the extent of systemic
disruption are 1) which players are impacted and their roles in the system; 2)
how long it takes to restore “business as usual”, and 3) the extent of
asymmetry created by the disruption. Also, the most relevant operational risks,
she noted, are cybersecurity, technology changes, resilience, third-party
management of data, and orderly recovery.
She
went on to describe the problems that lead to the biggest systemic disruptions.
First, she said, the impact of a failure increases as the amount the player is
relied upon in the system increases. Secondly, the longer the disruption goes
on the more “downstream” impacts it will have. Athanasiu described the
potential causes for disruptions, such as cybersecurity breaches. Market actors
now, she commented, “are no longer driven by fraud, there are folks interested
in disruption and chaos… It is easier to disrupt and destroy then perpetuate
fraud,” she said. Technology failures, insufficient resiliency, third-party
failures, and a poorly executed recovery plans were other possible causes, she
said.
Glasserman’s
presentation delved into counterparty risk. Developments in counterparty risk,
he noted, are from recent regulations, such as Dodd-Frank which mandated
clearing of most derivatives, and Basel III which added a Credit Valuation
Adjustment (CVA) capital charge for counterparty risk. Glasserman also
discussed the magnitude of “wrong-way risk,” or “an adverse dependence between
the market value of exposure to a counterparty and the counterparty’s default
risk.” The Basel standardized formula for CVA, he explained, assumes
independence and then multiples by 1.4.
Glasserman
went on to discuss automated analysis programs that search the system for destabilizing
feedback between counterparties. In closing, Glasserman noted that
“counterparty risk looks very different than it did a few years ago.” However,
there is still much left unseen including the total cost of increased
collateral use, implications for legitimate hedging by end users, and the
impact of responses like collateral transformation.
Keynote
Address – Paul Tucker
Paul
Tucker, Professor at the Harvard Kennedy School and former Deputy Governor of
the Bank of England, focused his remarks on macro-prudential economic policies.
He noted that in response to the 2008 crisis, the leaders of the G20 set up two
reform work streams. One work stream was to reform the financial system,
which Tucker felt has gone well, while the other work stream was set up to
reform the international monetary system, which Tucker felt has not gone so
well.
According
to Tucker, the interesting thing to come out of international monetary policy
reform is that many large emerging market economies have taken solutions from
the financial reform program and applied them to their international monetary
policies. Tucker went on to note that two things have changed. First, there has
been a large amount of research into cross-border carry trade that shows it
does exist and is profitable. He pointed to three threats to this trade
including: 1) problems in the “home country”; 2) problems in the country
receiving the capital; and 3) money returning home or moving somewhere else
simply because relative interests rates can change.
The
second thing that has changed is the “advent of macro-prudential policy,” he
said. Macro-prudential policy, Tucker noted, presents three new questions: 1)
can this use of macro-prudential policy work?; 2) can it be abused?; and 3)
what kind of framework should be employed to guide the policy?
In
answering his own questions, Tucker said that research has so far said that
policy can work “in the sense of insulating the economy” from some risk the
economy may be exposed to, when faced with massive inflows of short-term
capital.
“Policy
makers want the ability to raise capital requirements for banks… so that if the
bubble bursts, the banks have more capital to absorb the bust,” Tucker said.
The
research also showed that countries that required financial systems to build-up
resilience managed to insulate themselves from the effects of “hot capital”
flowing in and out of the country. However, Tucker also mentioned that policy
can be subjected to abuse in that “macro-prudential polices can slide all too easily
to capital flow management,” he said.
As
to the policy framework, Tucker noted that capital controls distinguish between
residents and non-residents while macro-policies do not; and a typical
macro-prudential measure is one applied by central banks to regulate financial
institutions, which Tucker felt to be flawed.
In
closing, Tucker suggested the importance of national balance sheets has been
overlooked for too long, and stressed that the Treasury Department should
develop one for the United States. He also commented that it is not just a flow
of funds that is needed for national balance sheets, but also a flow of risk.
Questioned
on his view regarding the proliferation of trade data repositories, Tucker said
a “drift” in their purpose would be his biggest concern.
On
risks related to national balance sheets, Tucker noted that the most important
lesson out of the Lehman Brothers failure was that “we live in democracies and
democracies are unpredictable. So banks cannot rely on government
bailouts.” Tucker closed by saying the lesson from Lehman Brothers now
applies worldwide.
Session
3 – Swap and Trade Repositories: Data Standards and Data Gaps
The
third session, entitled “Swap and Trade Repositories: Data Standards and Data
Gaps,” included Linda Powell, OFR, Scott O’Malia, Commissioner at the Commodity
Futures Trading Commission (CFTC); Colin HW Pou, Hong Kong Monetary Authority;
and Andrew Lo, Massachusetts Institute of Technology.
Commissioner
O’Malia gave his standard disclaimer that his remarks reflect only his own
views, but said that “as a Commission” the CFTC “believes strongly in the value
of data” and that it is “foundational to all the work we are going to be
doing.” He said that good data should be used in Commission decisions on
position limits, made-available to trade (MAT) determinations, and made
available to clear decisions, but noted that the CFTC is “struggling a bit”
when it comes to analyzing the data they receive.
O’Malia
said that there are four SDRs currently operating in the U.S. and that they
each have different “architectures.” These differences, he continued,
make it difficult for CFTC staff to “put the pieces together” and said it takes
“considerable effort to clean and sort” the information and aggregate data
across the marketplace.
Reflecting
on the goals of swaps market reform set by the International Organization of
Securities Commissions (IOSCO), O’Malia said there is a “long way to go” in
assessing systemic risk and marrying cleared and uncleared data to get a view
of bilateral portfolio exposure, assets concentration and contagion, and
correlated risk exposure. He also noted a need to focus on resolution
authorities in the case of a firm or clearing house failure.
O’Malia
said the CFTC will cooperate with Hong Kong and the EU in order to share data
across borders, but that regulators are a “long way from doing that.” He
expressed concern that the CFTC has a staff with the “wrong skill mix” and is
in need of more people to “integrate data.”
The
Commissioner also stressed the need to create an “asset taxonomy,” because
efforts to create a global product identifier may take too long and said that
packaged trades and related products “need to have markers” so that the data
can be followed throughout the reporting and aggregation process.
O’Malia
mentioned that the EU has a system of “collateral IDs” to identify which
counterparty is relying on certain collateral, and said that the CFTC “may want
to build this out down the road” through rule revisions.
He
concluded that there is a need for international harmonization of data
reporting standards and indemnification problems, that hamper the sharing of
information, must be addressed.
Pou,
in his remarks, explained that the swap market infrastructure in Hong Kong is
different from that of its international peers because the infrastructure is
provided by the government, rather than being created by the market. He said
Hong Kong chose this route so that they could deliver the greatest amount of
certainty to market participants and “create gravity” in attracting more of the
Chinese derivatives market to Hong Kong.
Pou
stated that it is a common belief that data held by trade repositories (TR) are
good, but said in practice TRs are “not very capable” of ensuring data quality,
as they “may not have all the tools to do so.” He noted that TRs are
“helpless” in identifying missing data and also expressed concern about
problems arising due to the lack of location information contained in legal
entity identifiers (LEI). He concluded that a “mechanism” is needed to
resolve data errors and that the swap data infrastructure should be looked at
“under a microscope.”
Lo,
in his remarks, discussed systemically important financial institutions (SIFI)
and said that their importance depends on a number of factors, including: 1)
relation to other market participants; 2) the state of the overall system; and
3) rules that are in place. He said that importance “can change quickly”
and that it is “dynamic over time and circumstances.”
Lo
briefly described a research paper that mapped out the interconnections and
“credit network” of the sovereigns and financial institutions, noting that the
results “can be counterintuitive at times.” He said this complexity
illustrates a need gather more data on the actual swaps network of the market
place. He said that this data exists right now but that “accessing it is
complex.” He concluded that the lack of progress in data collection is
“troubling” given the amount of time that has passed since the crisis and the
importance of the swaps marketplace.
In
the question and answer segment, when asked about the next steps for the CFTC,
O’Malia stated that “now is the time to come back” to “really drill down” and
address SDR concerns. He added that SDRs should be “high quality, low
cost utilities.”
When
asked about budget constraints and the possibility of leveraging other entities
to help in data reporting, O’Malia said that SDRs can be “the first line of
compliance” by validating the data they receive. He also said there is a need
for an advisory group within the economics division of the CFTC to think about
challenges and that regulators “need to unleash academia on this data” to
figure out how to “get it right.”
Session
4 – Policy Panel: Risk in CCPs
The
final session entitled, “Risk in CCPs,” included Benoît Coeuré, European
Central Bank and the Committee on Payment and Settlement Systems; David
Weisbrod, LCH.Clearnet Group; and Marcus Stanley, Americans for Financial
Reform.
In
introductory remarks, Peter Curley, Securities and Exchange Commission (SEC),
stated that there are “still foundational questions” about central counter
parties (CCP), including: 1) is increased reliance on CCPs always a good
thing?; 2) are there limits to public interest goals?; 3) can CCPs contribute
to systemic risk?; 4) should CCPs be regulated like financial entities?; and 5)
are there ways of comparing risk and reward characteristics of CCPs with more
specific data?
Coeuré,
in his remarks, said that CCPs are “already of systemic importance” and that
the discussion of potential risks in, with, and of CCPs to markets starts with
looking at clearing members. He said the benefits of CCPs are: 1) efficiency
gains by overcoming information asymmetries and reducing transaction costs; 2)
a level playing field through risk management and margining methods; 3) making
losses more predictable; and 4) netting of exposures to allow less collateral
to provide better risk protection.
Coeuré
said that possible unintended consequences of more concentration in CCPs are
that they are now systemic institutions and their failure to could lead to
serious disruptions and contagion. He also said there is a need for
better cross-border consistency in requirements to avoid regulatory arbitrage
and a “race to the bottom” in terms of standards.
Stanley,
in his remarks, said that clearing houses do not change the fundamental close
out and resolution risks inherent in the system, but noted they do offer the
“right kind of workshop” for managing these types of risk. He said that
even with “forceful regulation” there will be “tail risks” in the derivatives
markets and that the cost of derivatives should be increased to reflect
this. He suggested that CCPs regulation “be integrated with bank
regulation” and avoid an “implicit reliance” on a “public backstop.” He
also said that a resolution process like the one in Title II of Dodd-Frank will
not work for CCPs because they have little debt or equity to draw on in the
event of a failure.
He
agreed that CCPs provide more opportunities for netting and compression and
that these advantages are “the only thing that can be a free lunch” and shrink
the market.
Stanley
then said that the SEC and CFTC can make rules for brokers to encourage
standardization of swaps to facilitate central clearing and increase
transparency.
Weisbrod,
in his remarks, responded to concerns raised by pointing out the successful
track record of clearing houses in the past. He admitted that CCPs are a
source of systemic risk and that it is “inherent in concept” that they
concentrate market risks in one place. He noted, however, that clearing houses
reduce bi-lateral risk; “play a helpful role” in collateral segregation; and
facilitate regulatory oversight. He concluded that clearing houses should be
seen as agents of regulators and systemic risk managers.
For
more information on this event, please click here.
,Blog Tags:,Blog Categories:,Blog TrackBack:,Blog Pingback:No,Hearing Summaries Issues:Derivatives,Hearing Summaries Agency:FSOC,Publish Year:2014
At
Jan. 23rd’s Office of Financial Research (OFR) and Financial Stability
Oversight Council (FSOC) Annual Conference, regulators, industry participants,
and experts discussed “Mapping and Monitoring the Financial System,” and
focused on swap data reporting as well as funding and operations risks.
Opening
Remarks – Mary Miller
In
opening remarks, Mary Miller, Undersecretary for Domestic Finance at the U.S.
Treasury, said that regulators “need to stay vigilant” in watching emerging
areas of risk in the financial system because the next crisis “will not
look like the last one.”
Miller
stressed that more work needs to be done to “fill the gaps” of financial data,
especially the “missing piece” of data on over-the-counter (OTC)
derivatives. She noted that data is “still fragmented” in different swap
data repositories (SDR) located in different jurisdictions and that they are
all collecting data in different ways, making it difficult for regulators to
aggregate and analyze the information they contain. She concluded that “a
great deal of work” still needs to be done to ensure that the swap data is as
“useful as possible” and allows for good research to be conducted on the
marketplace.
Session
1 – Liquidity and Funding Maps: Analytics and Funding Risks
The
first session “Liquidity and Funding Maps: Analytics and Funding Risks”
included presentations from panelists Tom Wipf of Morgan Stanley; Hyun Shin from
Princeton University; and Nellie Liang, Board of Governors of the Federal
Reserve System.
Wipf
gave brief remarks which focused on measuring durability in funding. He
presented a map following the movement of securities and cash between entities,
and argued that the map needed to be paired with a durability index. The
durability index Wipf proposed is a hierarchy of funding sources and the risks
associated with them.
Shin’s
presentation discussed the relationship between complexity and leverage, specifically
dealing with core and non-core liabilities. According to Shin, when there is an
increase in intermediaries in the process, complexity rises alongside
leverage. Shin went on to state that the ratio of core to non-core
liabilities can be used as an indicator for impending problems in the system.
However, he noted, what counts as “non-core” depends on the financial system
and context.
Lang
presented on short term funding and the collapse of the asset backed commercial
paper (ABCP) market. She presented on the growth of shadow banking over the
years, particularly on its sharp rise since the late 1990’s. Lang’s data
showcased the very fast rise and just as rapid fall of ABCP. She showed
that in 2007, the ABCP market was approximately $1.2 trillion, which then
dropped by $350 billion in a matter of months and kept falling thereafter.
She
described the ways ABCP programs are similar to banks by saying “ABCP programs
issue short-term debt to finance assets such as receivables, loans, and
securities.” That liquidity support may reduce rollover risk, she added. Lang
described the ways ABCP programs vary by assets and liquidity support, and by
the type of sponsors they have. The good news, according to Lang, is that the
research showed that the runs felt in the ABCP markets were not random, nor are
they simply investor panic.
Lang
was asked if Fed will focus on the shadow banking sector moving forward, to
which she replied that it will be an area of interest but not the main focus.
When
asked if regulators have responded appropriately in terms of policy response,
Lang felt it was appropriate that a lot of programs did end up back on to bank
balance sheets, though “it clearly raises the cost of financing.” Lang also
commented that there is a trade-off , in which in order to reduce the
disruptiveness of a crisis, you have to raise the cost of financing.
Session
2 – Mapping Financial System Plumbing: Operations Risk and Counterparty Risk
The
second session, “Mapping Financial System Plumbing: Operations Risk and
Counterparty Risk” included Paul Glasserman of Columbia University, and Caryl
Athanasiu of Wells Fargo. Athanasiu, who is Chief Operational Risk Officer at
Wells Fargo, gave her perspective on the world of operational and systemic
risk.
Athanasiu
defined the primary systemic players as financial market utilities (FMUs)
involved in clearing and settlement for payments and securities, and financial
institutions with dollar and/or transaction volume concentration. The three
factors, according to Athanasiu, that influence the extent of systemic
disruption are 1) which players are impacted and their roles in the system; 2)
how long it takes to restore “business as usual”, and 3) the extent of
asymmetry created by the disruption. Also, the most relevant operational risks,
she noted, are cybersecurity, technology changes, resilience, third-party
management of data, and orderly recovery.
She
went on to describe the problems that lead to the biggest systemic disruptions.
First, she said, the impact of a failure increases as the amount the player is
relied upon in the system increases. Secondly, the longer the disruption goes
on the more “downstream” impacts it will have. Athanasiu described the
potential causes for disruptions, such as cybersecurity breaches. Market actors
now, she commented, “are no longer driven by fraud, there are folks interested
in disruption and chaos… It is easier to disrupt and destroy then perpetuate
fraud,” she said. Technology failures, insufficient resiliency, third-party
failures, and a poorly executed recovery plans were other possible causes, she
said.
Glasserman’s
presentation delved into counterparty risk. Developments in counterparty risk,
he noted, are from recent regulations, such as Dodd-Frank which mandated
clearing of most derivatives, and Basel III which added a Credit Valuation
Adjustment (CVA) capital charge for counterparty risk. Glasserman also
discussed the magnitude of “wrong-way risk,” or “an adverse dependence between
the market value of exposure to a counterparty and the counterparty’s default
risk.” The Basel standardized formula for CVA, he explained, assumes
independence and then multiples by 1.4.
Glasserman
went on to discuss automated analysis programs that search the system for destabilizing
feedback between counterparties. In closing, Glasserman noted that
“counterparty risk looks very different than it did a few years ago.” However,
there is still much left unseen including the total cost of increased
collateral use, implications for legitimate hedging by end users, and the
impact of responses like collateral transformation.
Keynote
Address – Paul Tucker
Paul
Tucker, Professor at the Harvard Kennedy School and former Deputy Governor of
the Bank of England, focused his remarks on macro-prudential economic policies.
He noted that in response to the 2008 crisis, the leaders of the G20 set up two
reform work streams. One work stream was to reform the financial system,
which Tucker felt has gone well, while the other work stream was set up to
reform the international monetary system, which Tucker felt has not gone so
well.
According
to Tucker, the interesting thing to come out of international monetary policy
reform is that many large emerging market economies have taken solutions from
the financial reform program and applied them to their international monetary
policies. Tucker went on to note that two things have changed. First, there has
been a large amount of research into cross-border carry trade that shows it
does exist and is profitable. He pointed to three threats to this trade
including: 1) problems in the “home country”; 2) problems in the country
receiving the capital; and 3) money returning home or moving somewhere else
simply because relative interests rates can change.
The
second thing that has changed is the “advent of macro-prudential policy,” he
said. Macro-prudential policy, Tucker noted, presents three new questions: 1)
can this use of macro-prudential policy work?; 2) can it be abused?; and 3)
what kind of framework should be employed to guide the policy?
In
answering his own questions, Tucker said that research has so far said that
policy can work “in the sense of insulating the economy” from some risk the
economy may be exposed to, when faced with massive inflows of short-term
capital.
“Policy
makers want the ability to raise capital requirements for banks… so that if the
bubble bursts, the banks have more capital to absorb the bust,” Tucker said.
The
research also showed that countries that required financial systems to build-up
resilience managed to insulate themselves from the effects of “hot capital”
flowing in and out of the country. However, Tucker also mentioned that policy
can be subjected to abuse in that “macro-prudential polices can slide all too easily
to capital flow management,” he said.
As
to the policy framework, Tucker noted that capital controls distinguish between
residents and non-residents while macro-policies do not; and a typical
macro-prudential measure is one applied by central banks to regulate financial
institutions, which Tucker felt to be flawed.
In
closing, Tucker suggested the importance of national balance sheets has been
overlooked for too long, and stressed that the Treasury Department should
develop one for the United States. He also commented that it is not just a flow
of funds that is needed for national balance sheets, but also a flow of risk.
Questioned
on his view regarding the proliferation of trade data repositories, Tucker said
a “drift” in their purpose would be his biggest concern.
On
risks related to national balance sheets, Tucker noted that the most important
lesson out of the Lehman Brothers failure was that “we live in democracies and
democracies are unpredictable. So banks cannot rely on government
bailouts.” Tucker closed by saying the lesson from Lehman Brothers now
applies worldwide.
Session
3 – Swap and Trade Repositories: Data Standards and Data Gaps
The
third session, entitled “Swap and Trade Repositories: Data Standards and Data
Gaps,” included Linda Powell, OFR, Scott O’Malia, Commissioner at the Commodity
Futures Trading Commission (CFTC); Colin HW Pou, Hong Kong Monetary Authority;
and Andrew Lo, Massachusetts Institute of Technology.
Commissioner
O’Malia gave his standard disclaimer that his remarks reflect only his own
views, but said that “as a Commission” the CFTC “believes strongly in the value
of data” and that it is “foundational to all the work we are going to be
doing.” He said that good data should be used in Commission decisions on
position limits, made-available to trade (MAT) determinations, and made
available to clear decisions, but noted that the CFTC is “struggling a bit”
when it comes to analyzing the data they receive.
O’Malia
said that there are four SDRs currently operating in the U.S. and that they
each have different “architectures.” These differences, he continued,
make it difficult for CFTC staff to “put the pieces together” and said it takes
“considerable effort to clean and sort” the information and aggregate data
across the marketplace.
Reflecting
on the goals of swaps market reform set by the International Organization of
Securities Commissions (IOSCO), O’Malia said there is a “long way to go” in
assessing systemic risk and marrying cleared and uncleared data to get a view
of bilateral portfolio exposure, assets concentration and contagion, and
correlated risk exposure. He also noted a need to focus on resolution
authorities in the case of a firm or clearing house failure.
O’Malia
said the CFTC will cooperate with Hong Kong and the EU in order to share data
across borders, but that regulators are a “long way from doing that.” He
expressed concern that the CFTC has a staff with the “wrong skill mix” and is
in need of more people to “integrate data.”
The
Commissioner also stressed the need to create an “asset taxonomy,” because
efforts to create a global product identifier may take too long and said that
packaged trades and related products “need to have markers” so that the data
can be followed throughout the reporting and aggregation process.
O’Malia
mentioned that the EU has a system of “collateral IDs” to identify which
counterparty is relying on certain collateral, and said that the CFTC “may want
to build this out down the road” through rule revisions.
He
concluded that there is a need for international harmonization of data
reporting standards and indemnification problems, that hamper the sharing of
information, must be addressed.
Pou,
in his remarks, explained that the swap market infrastructure in Hong Kong is
different from that of its international peers because the infrastructure is
provided by the government, rather than being created by the market. He said
Hong Kong chose this route so that they could deliver the greatest amount of
certainty to market participants and “create gravity” in attracting more of the
Chinese derivatives market to Hong Kong.
Pou
stated that it is a common belief that data held by trade repositories (TR) are
good, but said in practice TRs are “not very capable” of ensuring data quality,
as they “may not have all the tools to do so.” He noted that TRs are
“helpless” in identifying missing data and also expressed concern about
problems arising due to the lack of location information contained in legal
entity identifiers (LEI). He concluded that a “mechanism” is needed to
resolve data errors and that the swap data infrastructure should be looked at
“under a microscope.”
Lo,
in his remarks, discussed systemically important financial institutions (SIFI)
and said that their importance depends on a number of factors, including: 1)
relation to other market participants; 2) the state of the overall system; and
3) rules that are in place. He said that importance “can change quickly”
and that it is “dynamic over time and circumstances.”
Lo
briefly described a research paper that mapped out the interconnections and
“credit network” of the sovereigns and financial institutions, noting that the
results “can be counterintuitive at times.” He said this complexity
illustrates a need gather more data on the actual swaps network of the market
place. He said that this data exists right now but that “accessing it is
complex.” He concluded that the lack of progress in data collection is
“troubling” given the amount of time that has passed since the crisis and the
importance of the swaps marketplace.
In
the question and answer segment, when asked about the next steps for the CFTC,
O’Malia stated that “now is the time to come back” to “really drill down” and
address SDR concerns. He added that SDRs should be “high quality, low
cost utilities.”
When
asked about budget constraints and the possibility of leveraging other entities
to help in data reporting, O’Malia said that SDRs can be “the first line of
compliance” by validating the data they receive. He also said there is a need
for an advisory group within the economics division of the CFTC to think about
challenges and that regulators “need to unleash academia on this data” to
figure out how to “get it right.”
Session
4 – Policy Panel: Risk in CCPs
The
final session entitled, “Risk in CCPs,” included Benoît Coeuré, European
Central Bank and the Committee on Payment and Settlement Systems; David
Weisbrod, LCH.Clearnet Group; and Marcus Stanley, Americans for Financial
Reform.
In
introductory remarks, Peter Curley, Securities and Exchange Commission (SEC),
stated that there are “still foundational questions” about central counter
parties (CCP), including: 1) is increased reliance on CCPs always a good
thing?; 2) are there limits to public interest goals?; 3) can CCPs contribute
to systemic risk?; 4) should CCPs be regulated like financial entities?; and 5)
are there ways of comparing risk and reward characteristics of CCPs with more
specific data?
Coeuré,
in his remarks, said that CCPs are “already of systemic importance” and that
the discussion of potential risks in, with, and of CCPs to markets starts with
looking at clearing members. He said the benefits of CCPs are: 1) efficiency
gains by overcoming information asymmetries and reducing transaction costs; 2)
a level playing field through risk management and margining methods; 3) making
losses more predictable; and 4) netting of exposures to allow less collateral
to provide better risk protection.
Coeuré
said that possible unintended consequences of more concentration in CCPs are
that they are now systemic institutions and their failure to could lead to
serious disruptions and contagion. He also said there is a need for
better cross-border consistency in requirements to avoid regulatory arbitrage
and a “race to the bottom” in terms of standards.
Stanley,
in his remarks, said that clearing houses do not change the fundamental close
out and resolution risks inherent in the system, but noted they do offer the
“right kind of workshop” for managing these types of risk. He said that
even with “forceful regulation” there will be “tail risks” in the derivatives
markets and that the cost of derivatives should be increased to reflect
this. He suggested that CCPs regulation “be integrated with bank
regulation” and avoid an “implicit reliance” on a “public backstop.” He
also said that a resolution process like the one in Title II of Dodd-Frank will
not work for CCPs because they have little debt or equity to draw on in the
event of a failure.
He
agreed that CCPs provide more opportunities for netting and compression and
that these advantages are “the only thing that can be a free lunch” and shrink
the market.
Stanley
then said that the SEC and CFTC can make rules for brokers to encourage
standardization of swaps to facilitate central clearing and increase
transparency.
Weisbrod,
in his remarks, responded to concerns raised by pointing out the successful
track record of clearing houses in the past. He admitted that CCPs are a
source of systemic risk and that it is “inherent in concept” that they
concentrate market risks in one place. He noted, however, that clearing houses
reduce bi-lateral risk; “play a helpful role” in collateral segregation; and
facilitate regulatory oversight. He concluded that clearing houses should be
seen as agents of regulators and systemic risk managers.
For
more information on this event, please click here.