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Brussels Nov 09

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speech on OTC derivatives regulation and regulatory arbitrage

speech on OTC derivatives regulation and regulatory arbitrage


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  • 1. Financial Future Forum Barbara C. Matthews BCM International Regulatory Analytics LLC www.bcmstrategy.com November 2009 BCM International Regulatory Analytics LLC
  • 2. Conclusions
    • Merriam-Webster definition of arbitrage :
      • Etymology: French, from Middle French, arbitration, from Old French, from arbitrer to render judgment, from Latin arbitrari, from arbitr-, arbiter
      • Date: 1875
      • 1 : the nearly simultaneous purchase and sale of securities or foreign exchange in different markets in order to profit from price discrepancies 2 : the purchase of the stock of a takeover target especially with a view to selling it profitably to the raider
    • Economist.com definition of regulatory arbitrage
      • Exploiting loopholes in REGULATION , and perhaps making the regulation useless in the process. This is often done by international investors that use DERIVATIVES to find ways around a country’s financial regulations.
    Regulatory Arbitrage: Definitions www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  • 3.
    • Dynamic Innovation & Evolution
    Experimentation Market growth Customization Regulatory Inquiry, cautious standards 1908 1929 1974 1987 1991 1997 2007-08 Standardization Legislation Regulation Mind the Gap ©BCM International Regulatory Analytics LLC all rights reserved www.bcmstrategy.com BCM International Regulatory Analytics LLC
  • 4. Conclusions
    • Even with directional normative consistency at the global level, prospects for divergent outcomes remain
    • National priorities to cover liabilities generates significant centrifugal forces in both normative & enforcement areas.
    • Arbitrage hits BOTH sides of the balance sheet and all sides of the intermediation framework.
    • Incentives to arbitrage differences in regulatory frameworks are not limited to specific asset classes or financial institutions and can apply to governments and corporations.
    • The classic debate: regulating products v. regulating actors (or both)
    Regulatory Arbitrage? www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  • 5. Conclusions Regulatory Arbitrage?: The Intermediaries www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  • 6. Data, Data, Data…and sharing www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved
    • Data Providers
    • Financial firms
    • Regulators
    • Governments
    • Individuals
    • Exchanges
    • Corporates?
    • Data Collectors
    • Regulators
    • CCPs
    • Risk Managers
    • IMF
    • Exchanges
    • Dark Pools
    • Central banks
    BCM International Regulatory Analytics LLC What happens when information flows from central points across borders? Data Provider 8 Data Provider 7 Data Provider 6 Data Provider 5 Data Provider 4 Data Provider 3 Data Provider 2 Data Provider 1 Data Provider 9 Central data
  • 7. Conclusions www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
    • Initial Margin requirements/capital
    • Variation margin: marking to market credit exposures?!
    • Presumption of lower risk in CCP transactions: expressed how?
    • Changes in operational risk capital charges on banks for transactions within CCPs
    • Transaction data and other reporting requirements: substance & IT issues
    • Governance (restrictions on board memberships/ownership)
    • Operational reliability requirements
    • Contract continuity in the event of CCP default
    • Role of government fisc in the event of CCP default: domestic & cross-border
    • Which government entities have access to which data?
    • What information is available to non-government entities/the trading public?
    • Who approves contract issuance? Who sets position limits?
    • Asset segregation requirements
    • Who is authorized to be a transacting member of a CCP or exchange?
    • Cross-border information sharing by CCPs and/or regulators?
    • Geography of oversight authority, of course
    The Pressure Points
  • 8. Conclusions 1. Expectations Management : Will cross-border policy harmonization of OTC policy eliminate regulatory arbitrage, make the derivatives marketplace safer for “legitimate” hedging, generate financial system stability, and still provide corporate end-users with flexible financing options? www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC Two Questions 2. Link to the Real Economy : What incentives and impacts will increased regulation of the derivatives markets create for governments and corporate end-users?
  • 9. Conclusions Regulatory Arbitrage?: European Banks www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  • 10. “ The US dollar shortage in global banking and the international policy response ,” BIS Working Paper no. 291 (Oct. 2009)
    • Growth in European and Japanese banks’ USD assets produced structural USD funding requirements that could not be met when money, interbank & swap markets shut down.
    • Figure 5: “the major European banks’ US dollar funding gap had reached $1.0-1.2 trillion by mid-2007. Until the onset of the crisis, European banks had met this need by tapping the interbank market ($432 billion) and by borrowing from central banks ($386 billion) and used FX swaps ($315 billion) to convert (primarily) domestic currency funding into dollars.”
    • Currency & maturity mismatches “can be understood only by looking at banks’ worldwide positions consolidated across all office locations.”
    • Counterparty sector breakdown in BIS banking stats “can serve as a proxy for maturity transformation and, hence, funding risk, since the maturity of positions is likely to vary systematically with the type of counterparty.”
    • “ Demand deposits held by households, for instance, are a stable source of funding with a long effective maturity.” footnote 16
    BCM International Regulatory Analytics LLC www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved
  • 11. Conclusions Regulatory Arbitrage?: Corporates www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  • 12. External Loans to non-banking sector Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD) estimated exchange rate adjusted changes
  • 13. External Deposits non-banking sector Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD) estimated exchange rate adjusted changes
  • 14. AA asset-backed
    • FRB Volume Statistics for Commercial Paper Issuance (as of October 21, 2009)
    • All values in USD millions
    BCM International Regulatory Analytics LLC ©BCM International Regulatory Analytics LLC all rights reserved www.bcmstrategy.com AA nonfinancial
  • 15. International Commercial Paper Issues Source: BIS Quarterly Review, Sept. 09, Table 13A NET values, in billions USD BCM International Regulatory Analytics LLC www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved
  • 16. International Debt Securities Corporate Issuers, NET values in billions of dollars Data Source: BIS Quarterly Review Table 12C, Sept. 2009 BCM International Regulatory Analytics LLC www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved
  • 17. Implications
    • Shifting maturity transformation function = f(survival, not necessarily arbitrage). Permanent?
    • Targeted but volatile short-term use of financial trading markets as alternative to credit markets.
    • Decreased funding flexibility for foreign expansion, trade, sourcing, and R&D. Will flow through to jobs and economic growth.
    BCM International Regulatory Analytics LLC www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved
  • 18. Conclusions Regulatory Arbitrage?: Derivatives Markets www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  • 19. Amounts Outstanding: OTC derivatives Source: BIS Quarterly Review, Table 13 (in billions USD, gross market value) BCM International Regulatory Analytics LLC www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved
  • 20. Derivative Financial Instruments Traded on Organized Exchanges Contracts Outstanding (all futures) Source: BIS Quarterly Review, Sept. 2009, Table 23B www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  • 21. Consolidated foreign claims and other exposures of reporting banks: Ultimate risk basis Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD) www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved