Metric issue-19-april
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Metric issue-19-april Metric issue-19-april Document Transcript

  • Click here Join Our metric Group CHASE COOPERBasel to price out CDSs?The BCBS released a consultative paper in metric Regulatory capital - solution or problem? In the same week that UK banks were asked to find an extra £60 billion of regulatoryMarch, "Recognizing the cost of credit capital, a report published by the Institute of Economic Affairs (IEA) has questionedprotection purchased" targeting the usage the central tenet of the Basel Capital Accord and suggested that the banksof the banks purchasing of credit default themselves should be allowed to decide how much capital they need to hold.swaps from each other as a way of The IEAs objective is the promotion of free markets and their impact on social andreducing credit-based regulatory capital economic problems. It is a fairly opaque organisation that does not declare itsrequirements, and funding sources although it claims to receive noneproposing that any from governments. Andrew Marr, the politicalpremium for such a journalist, called the Institute "undoubtedly thetransaction carry a most influential think tank in modern Britishheavy risk weighting of history".1,250%. The IEAs report, "Do we need regulation of bankIn December 2011, the capital?" (PDF), says that regulatory capitalBCBS voiced concern requirements simply encourage banks to adoptregarding this practice opaque capital solutions which reinforce the "too(BCBS Newsletter big to fail" conundrum. It recommends that capital obligations set byNo.16) observing regulators should bepotential for regulatory IN THIS ISSUE OF metric dropped, that banksarbitrage through the ● The FSA becomes history should decide on howuse of credit risk ● LIBOR banks sued much capital they need,mitigation instruments. ● JPMOrgan loss report and that attention should concentrate on making it easierInstruments that facilitated a delay in ● Swaps swamp US regulator for banks to fail in such a way as so not to endanger therecognising losses and the costs of ● Regulatory News markets or depositors.protection in earnings, while receiving The authors, Professors Forrest Capie of CASS andimmediate regulatory capital benefit in Geoffrey Wood of the University of Buckingham, agree that banks need to keep boththe form of a lower risk weight on the capital and liquidity against unforeseen events, and that past crises have driven themexposure on which it is nominally to hold what they believe are amounts that balance the need to avoid risks (andtransferring risk. attract depositors) against the requirements of shareholders that they make aThe BCBS questioned the degree of credit sufficient return on capital.risk mitigation or credit risk transfer in What disrupted a working situation was the expectation that the state would step inthese high-cost credit protection to save an insolvent bank. This situation has led governments to try to protecttransactions and observed that the themselves against this expense hence their demanding ever higher levels ofprimary reason for these was to receive capital.favourable risk-based capital treatment in The authors state that the principle of many of the reforms to bankingthe short term and defer recognition of law and regulation currently being proposed or implemented islosses over an extended period, without 19 ISSUE correct, i.e. the Vickers and Volcker separation of investmentany meaningful risk mitigation or transfer banking from the traditional roles of borrowing and lending.of risk. continued on page 2 continued on page 2
  • LIBOR banks sued by Freddie Mac Regulatory capital - solution or problem? Continued from page 1 15 banks have been named in a law That principle, which should be at the heart of regulatory suit being taken out by the US Federal reform, is that banks should be wound up in an orderly way if Home Loan Mortgage Corporation, they fail. commonly known as Freddie Mac, Simultaneously with this report, two relevant happenings both that it suffered substantial damage sides of the Atlantic are serving to bring the above principles into due to the banks illegally fixing the focus. Firstly the Bank of Englands Financial Policy Committee LIBOR US dollar rates. has said it is concerned that the capital held by Britains majorLawyers for Freddie Mac accuse the banks of acting collectively to banks, all probably too big to fail, are insufficient and that theyhold down the rates to "hide their institutions financial problems are expecting these to raise a further £60 billion in capital.and boost their profits" and that the banks "fraudulent and The second has been the ongoing debate in the USs Capitol Hillcollusive conduct caused USD LIBOR to be published at rates that that not only are the top four US banks, holding over 70% of thewere false, dishonest, and artificially low." nations deposits, too big to fail, and getting bigger, but thatThe law suit was filed at a Federal court in Virginia, USA and their executives are "too big to jail".names the British Bankers Association, who managed the setting The US Attorney General, Eric Holder, has been quoted as sayingof the rates, as well as major financial institutions such as Barclays, "I am concerned that the size of some of these institutionsJP Morgan Chase, USB, Royal Bank of Scotland, Royal Bank of becomes so large that it does become difficult for us toCanada, Deutsche Bank, Credit Suisse, Citigroup, Bank of America, prosecute them when we are hit with indications that if you doand Japanese banks Tokyo-Mitsubishi UFJ and Norinchukin. prosecute, if you do bring a criminal charge, it will have aThe defendants are accused of fraud, antitrust violation and breach negative impact on the national economy, perhaps even theof contract. Freddie Mac is seeking damages for financial harm, as world economy".well as punitive damages and treble damages for violations of the There have been other cries in the US that the big banks areSherman Antitrust Act, an act dating from 1890 designed to protect either ignoring or circumventing regulations such as the Volckerconsumers and commonly used in cases involving monopolies or Act designed to halt risky proprietary trading, as well as concerncartels. Freddie Mac says "To the extent that defendants used false in Europe that the "electrified fences" being proposed as anand dishonest USD LIBOR submissions to bolster their respective alternative to breaking up the big banks are simply not working.reputations, they artificially increased their ability to charge higher It looks like the break-up of the big banks is inevitable (but whatunderwriting fees and obtain higher offering prices for financialproducts to the detriment of Freddie Mac and other consumers". of the Chinese banks?) and bankers had better starting planning how they will do this. mLast year an audit report said that Freddie Mac and its sisterorganisation Fannie Mae, the Federal National Mortgage Basel to price out CDSs? Continued from page 1Association, could have lost up to $3 billion in excessive payments In January of 2011, the US Fed had come out heavily against thison their floating rate instruments such as bonds and swaps. practice and had advised all the local US Feds supervisory staff toSo far Barclays, UBS and RBS have admitted LIBOR manipulation to take high-cost credit protection transactions into account in theirthe regulators and have been fined. Another dozen banks are assessment of a banking organizations overall capital adequacy. Inbelieved to be under investigation. Being fined by the regulator particular they were to:does not preclude being sued by clients, and the Freddie Mac case Ÿ Compare the present value of premiums relative tois just one of a number currently going through the US courts. expected losses over a variety of stress scenarios, as well 2However last week a consolidated law suit against 16 LIBOR- as the pricing of the transaction relative to market prices;accused banks was dismissed in part by a Manhatten judge whodismissed antitrust and racketeering charges and partially Ÿ Look at the timing of payments under the transaction, includingdismissed those of commodities manipulation. The defendants, a potential timing differences between the banking organizationsconsortium ranging from bond holders to US city governments, provisioning or write downs and payments by the counterparty,are expected to appeal. m and review of applicable call dates to assess the likely duration of the credit protection relative to the potential timing of futureThe FSA becomes history credit losses;On the 1st April ex-Prime Minister Gordon Browns vision of a unified Ÿ Analyse the impact of reliance on the counterparty at the samefinancial regulator will become a footnote in the history of the City of time that the counterpartys ability to meet its obligations isLondon and will be replaced by a twin-track system of regulation. The weakened, and also whether the organisation can prudentlyPrudential Regulation Authority, incorporated as part of the Bank of afford the transaction premiums;England, becomes responsible for the prudential regulation andsupervision of approximately 1,700 banks, building societies, credit Ÿ Review all memos and records to check the reason for theunions, insurers and major investment firms. The independent transaction and its anticipated costs and benefits.Financial Conduct Authority will have rule-making, investigative and The new BCBS proposal is that banks can continue to use theseenforcement powers with the aim of protecting consumers, the instruments but must reflect the cost of the transactions and take astability of the financial industry and the promotion of competition capital charge on it. Responses to this consultation should be in bybetween financial services providers. m June 21st. m
  • JPMorgan "derivatives risks and abuses" HBOS – “An accident waiting to happen” The US Senate Committee on The UK Government’s Parliamentary Homeland Security and Governmental Commission on Banking Standards has Affairs has published a 307-page finally release the report “An accident document entitled "JPMorgan Chase waiting to happen: The failure of HBOS”. Whale trades: a case history of The Commission, a cross-party group of derivatives risks and abuses" reporting five members of parliament and five on the $6.2 billion that JPMorgan lost peers from the House of Lords, trading in synthetic credit derivatives including the present Archbishop of at its Chief Investment Office (CIO) Canterbury (who worked in finance which managed the banks excess before joining the Church) and Lord Carl Levin Treasury funds of over $300 billion. Lawson (an ex-Chancellor of the Commission member: US Senator This report, chaired by Senator Carl The Archbishop of Canterbury Exchequer), has heavily criticised bothLevin, makes recommendations for changes in JPMorgan as well as the directors and management of HBOS and the regulatorsfor the derivatives market and the US regulators, but does not responsible for ensuring the bank’s prudential management.make any suggestions on charges, which would be up to the The report finds that credit problems at HBOS were largely in theregulators themselves. (The above link also contains a recording of international, corporate and treasury divisions with a combinedthe committees interviewing of JPM executives and the regulating total of £47 billion in impaired loans and that these alone wouldOffice of the Comptroller of the Currency). have bankrupted the bank. Retail lending, although the biggestIn testimony to the committee, Ms Ina Drew, the then Chief division, was relatively healthier although the report points out aInvestment Officer at the CIO and who has now left the bank, funding gap of £111 billion and a deposit to loan ratio of underadmitted that "valuations for many of the books positions were 57%. Regarding the total impairments the report says “Both theinflated and not calculated or reported in good faith; that the relative scale of such large losses and the fact that they wereoriginal version of the second quarter scenario analyses reflected incurred in three separate divisions suggests a systemicmuch higher projected losses and was specifically re-done before management failure across the organisation.”it was sent to me so as to reflect lower projected losses; and that The report comments that the bank’s Group Risk Function wassome members of the London team participated in or condoned inexperienced in the key areas with limited willingness or ability tosuch conduct and hid from me important information regarding challenge, and less wish by the divisions to accept challenge. Thethe true risks in the book." She added that she had since learnt risk function in HBOS was a cardinal area of weakness in the bank,that the VaR model used was flawed and significantly with low status and little hope for career progression. Theseunderstated the true risks in the book." weaknesses “were a matter of design, not accident. ResponsibilityThe reports recommendations to regulators included that banks for this lies with Sir James Crosby, who as Chief Executive untilshould identify all internal portfolios containing derivatives, that 2005 was responsible for that design, with Andy Hornby, whohedging policies and close-down processes be specified, that failed to address the matter, and particularly with Lord Stevensonindependent valuations be used, that they should investigate all as Chairman throughout the period in question.”large limit breaches, that any models that claim materially to But the report also slams the FSA, the then UK banking regulator, sayinglower risk be reviewed, and that the Volcker Act to ban that its regulation was “thoroughly inadequate” and that it failedproprietary trading by banks be implemented and that permitted to ensure that controls were in place to reduce the risks ofderivatives trading should carry an extra capital charge. m aggressive growth and heavy reliance on wholesale funding. 3 “From 2004 until the latter part of 2007 the FSA was not soSwaps trades swamp US regulator much the dog that did not bark as a dog barking up the wrong tree. The requirements of the Basel II framework not only weakenedNew Dodd-Frank rules require all trading firms with US controls on capital adequacy by allowing banks to calculate their ownoperations trading in swaps to report any over-the-counter risk-weightings, but they also distracted supervisors from concernstrades. The new reporting rules specified by the USs Commodity about liquidity and credit; they may also have contributed to theFutures Trading Commission (CFTC), the regulator of these appalling supervisory neglect of asset quality.”trades, required over one thousand data fields of information.But in a glaring technical omission the CFTC failed to specify the Does anyone – HBOS, their directors, the FSA and Basel II – comedata format for the reporting. out of this well? Sadly not. Again to quote the report “The downfall of HBOS provides a cautionary tale. In many ways, theThe result was that, when reporting began in March, with around history of HBOS provides a manual of bad banking which should be75 major swaps dealers, market participants were due to start read alongside accounts of previous bank failures for the futurereporting at a later date, the receiving computers could not handle leaders of banks, and their future regulators, who think they knoweither the volume of the format of the reporting data and crashed. better or that next time it will be different.”Commissioner Scott OMalia of the CFTC has admitted its mistake This report was the fourth such report on the HBOS case. There isand also said that it doesnt really need all this data, even if it a fifth and final report expected where the lessons of HBOS will becould read it! The problem is so bad that CFTC staff currently used to develop recommendations regarding the regulation ofcannot find the London Whale in the current data files. m banks, the usage of ring fencing and the conduct of regulators. m
  • Regulatory ASYMmetricALNEWS The back page, sometimes critical view from the EditorMartin Wheatley, the new head of Where to start? A lot has happened in the last month as the BCBS gets going with aFinancial Conduct Authority, has said they number of reports targeting large G-SIB/G-SIFI institutions but also looking closely at thewill take a more proactive approach to weightings of derivatives, particularly credit default swaps.identifying illegal behaviour than his The LIBOR battle between the banks on one side and an (unholy?) alliance of regulators andpredecessors did, and they will use investors on the other continues with skirmishes and a significant win on the banks side asreports from consumer bodies, the media Manhattens Judge Naomi Buchwald dismissed most of a major case against them.and both social media sites and Twitter,rather than just relying on regulatory An interesting news event was that the US regulators have given Citigroup 60 days toreports back from firms. come up with a remedial plan to fix failures in its AML processes. It is interesting that there were no fines or other punitive action seeing that Citigroup were also castigatedThe BIS has released a number of new for similar AML breaches in 2012 and given "cease and desist" orders. Seeing that HSBCreports - The Markets Committee put out"Central bank collateral frameworks and were fined $1.9 billion and Standard Chartered many hundred of millions for AMLpractices" and the BCBS published a failures, and that Citis failing were at its Mexican subsidiary, as were HSBCs, it looks likeconsultation paper "Supervisory guidance the American bank has got off lightly. JPMorgan recently also received similar processon external audits of banks" along with a change-only orders - is it possible that there is one practice for American banks and"letter to the International Auditing and another for the Brits? How can I think such a thing? We all know the cross-AtlanticAssurance Standards Board (IAASB)" "entente cordiale" brings major benefits to both sides. Like our support for FATCA?(PDF), also "Supervisory framework for On a positive note it is good to see that the UK is relaxing the controls and capitalmeasuring and controlling large requirements for new start-up banks. The time to get approval will be cut from over twoexposures". The BCBS also published a years to 6 months and these banks will have to hold smaller regulatory capital ratios"Report assessing the regulations that than the big banks at 4.5%. In certain cases, capital of only £4.25 million will be neededimplement the Basel capital framework in to start up the bank. However these banks will get no implicit "too big to fail" guaranteeSingapore" (PDF). from the bank - but that is no bad thing and returns us to traditional retail bankingThe Brazilian regulator also reported that practices. So far we have large start-ups such as Metro Bank, and internet bankingit would be implementing Basel III to a providers, Aldermore and Shawbrook - and the small "Bank of Dave", or rather "Bank ontime table starting this October and Dave", the other names for the new Burnley Savings & Loans Limited, whose one branchfinishing in January 2022. has been subject of a recent Channel 4 documentary. We wish them all success andIn updates to the progress of implementing hope their operational risks are under control, that good credit risk practices are inglobal FATCA Intergovernmental place, and that they are not doing proprietary activities or trading in overseasAgreements (IGAs), groups in Canada are transactions which would make them liable to market risk. Their reputational, liquiditythreatening to go to court to have these and systemic risks are probably in our, the publics, hands.declared unconstitutional and the Russian Finally on a issue I have tackled before, let me ask a question: by what rights are youForeign Ministry has said that any suchagreement would break national laws. entitled to call yourself a risk manager? Will the risk managers appointed by the aboveChina and Taiwan have said they have no banks have any qualifications, experience or external support to do their job? Orintention of signing any IGAs but the will these banks simply appoint someone who "has been around a bit" and goesUnited Arab Emirates and Brazil are both on a few courses? 4reported as being about to sign. It is time the banking regulators put their (and our) houses in order and insistedReuters has reported that the US Treasury that anyone operating as a risk manager has the formal professional background to carryDepartment, under instructions from the out the job effectively. That is they should have sufficient academic grounding, haveObama administration as part of anti- studied risk management and passed relevant exams, have some form of external bodyterrorism controls, is drafting plans to give ensuring they maintain good ethical standards, and are committed to regular trainingthe US surveillance agencies complete that keep them up to date with developments.access to the governments database of In other words, put risk managers on the same footing as lawyers, doctors, accountantsfinancial data kept on American citizens and, increasingly, auditors. Given the importance of the subject and the damage thatand foreign persons and organisations failures can cause, I would also put financial compliance officers into the samewho maintain accounts in the USA. requirements bracket for professional status.The UK authorities have announced that it isprepared to relax capital rules for new banking Colin Lawrence, previously Director of Prudential Risk Management at the FSA, and, asstart-ups in the UK. This would allow them to of the beginning of April, now doing the same job at the Bank of Englands Prudentialopen with capital ratios of as little as 4.5% Regulation Authority, has long been a proponent of professional status, that is, deservedcompared to the 10-14% that is being required professional status supported by the above processes, for risk managers. Let us hopeof the large banks. This is to encourage new that, in his current role and with his new masters at thecompetition to the big banks, and, as these BOE, he can persuade them to put their weight behind this metric is published by metric Chase Cooper.start-ups are by definition small, the depositor cause and make risk management in Britain a template for web: www.chasecooper.comrisks are considered manageable. the rest of the world. m email: editor@chasecooper.com