Financial Future Forum Barbara C. Matthews BCM International Regulatory Analytics LLC www.bcmstrategy.com November 2009 BC...
Conclusions <ul><li>Merriam-Webster definition of arbitrage :  </li></ul><ul><ul><li>Etymology: French, from Middle French...
<ul><li>Dynamic Innovation & Evolution </li></ul>Experimentation Market growth Customization Regulatory  Inquiry, cautious...
Conclusions <ul><li>Even with directional normative consistency at the global level, prospects for divergent outcomes rema...
Conclusions Regulatory Arbitrage?: The Intermediaries www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all ...
Data, Data, Data…and sharing www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved <ul><li>D...
Conclusions www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulato...
Conclusions 1. Expectations Management :  Will cross-border policy harmonization of OTC policy eliminate regulatory arbitr...
Conclusions Regulatory Arbitrage?: European Banks www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all righ...
“ The US dollar shortage in global banking and the international policy response ,”  BIS Working Paper no. 291 (Oct. 2009)...
Conclusions Regulatory Arbitrage?: Corporates www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights r...
External Loans  to non-banking sector Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in m...
External Deposits  non-banking sector Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in m...
AA asset-backed <ul><li>FRB Volume Statistics for Commercial Paper Issuance  (as of October 21, 2009) </li></ul><ul><li>Al...
International Commercial Paper Issues Source:  BIS Quarterly Review, Sept. 09, Table 13A NET values, in billions USD BCM I...
International Debt Securities Corporate Issuers, NET values in billions of dollars Data Source:  BIS Quarterly Review Tabl...
Implications <ul><li>Shifting maturity transformation function = f(survival, not necessarily arbitrage).  Permanent? </li>...
Conclusions Regulatory Arbitrage?: Derivatives Markets www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all...
Amounts Outstanding: OTC derivatives Source:  BIS Quarterly Review, Table 13 (in billions USD, gross market value)  BCM In...
Derivative Financial Instruments Traded on Organized Exchanges Contracts Outstanding (all futures) Source:  BIS Quarterly ...
Consolidated foreign claims and other exposures of reporting banks:  Ultimate risk basis Source: BIS, preliminary Internat...
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Brussels Nov 09

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speech on OTC derivatives regulation and regulatory arbitrage

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Brussels Nov 09

  1. 1. Financial Future Forum Barbara C. Matthews BCM International Regulatory Analytics LLC www.bcmstrategy.com November 2009 BCM International Regulatory Analytics LLC
  2. 2. Conclusions <ul><li>Merriam-Webster definition of arbitrage : </li></ul><ul><ul><li>Etymology: French, from Middle French, arbitration, from Old French, from arbitrer to render judgment, from Latin arbitrari, from arbitr-, arbiter </li></ul></ul><ul><ul><li>Date: 1875 </li></ul></ul><ul><ul><li>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 </li></ul></ul><ul><li>Economist.com definition of regulatory arbitrage </li></ul><ul><ul><li>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. </li></ul></ul>Regulatory Arbitrage: Definitions www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  3. 3. <ul><li>Dynamic Innovation & Evolution </li></ul>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. 4. Conclusions <ul><li>Even with directional normative consistency at the global level, prospects for divergent outcomes remain </li></ul><ul><li>National priorities to cover liabilities generates significant centrifugal forces in both normative & enforcement areas. </li></ul><ul><li>Arbitrage hits BOTH sides of the balance sheet and all sides of the intermediation framework. </li></ul><ul><li>Incentives to arbitrage differences in regulatory frameworks are not limited to specific asset classes or financial institutions and can apply to governments and corporations. </li></ul><ul><li>The classic debate: regulating products v. regulating actors (or both) </li></ul>Regulatory Arbitrage? www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  5. 5. Conclusions Regulatory Arbitrage?: The Intermediaries www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  6. 6. Data, Data, Data…and sharing www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved <ul><li>Data Providers </li></ul><ul><li>Financial firms </li></ul><ul><li>Regulators </li></ul><ul><li>Governments </li></ul><ul><li>Individuals </li></ul><ul><li>Exchanges </li></ul><ul><li>Corporates? </li></ul><ul><li>Data Collectors </li></ul><ul><li>Regulators </li></ul><ul><li>CCPs </li></ul><ul><li>Risk Managers </li></ul><ul><li>IMF </li></ul><ul><li>Exchanges </li></ul><ul><li>Dark Pools </li></ul><ul><li>Central banks </li></ul>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. 7. Conclusions www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC <ul><li>Initial Margin requirements/capital </li></ul><ul><li>Variation margin: marking to market credit exposures?! </li></ul><ul><li>Presumption of lower risk in CCP transactions: expressed how? </li></ul><ul><li>Changes in operational risk capital charges on banks for transactions within CCPs </li></ul><ul><li>Transaction data and other reporting requirements: substance & IT issues </li></ul><ul><li>Governance (restrictions on board memberships/ownership) </li></ul><ul><li>Operational reliability requirements </li></ul><ul><li>Contract continuity in the event of CCP default </li></ul><ul><li>Role of government fisc in the event of CCP default: domestic & cross-border </li></ul><ul><li>Which government entities have access to which data? </li></ul><ul><li>What information is available to non-government entities/the trading public? </li></ul><ul><li>Who approves contract issuance? Who sets position limits? </li></ul><ul><li>Asset segregation requirements </li></ul><ul><li>Who is authorized to be a transacting member of a CCP or exchange? </li></ul><ul><li>Cross-border information sharing by CCPs and/or regulators? </li></ul><ul><li>Geography of oversight authority, of course </li></ul>The Pressure Points
  8. 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. 9. Conclusions Regulatory Arbitrage?: European Banks www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  10. 10. “ The US dollar shortage in global banking and the international policy response ,” BIS Working Paper no. 291 (Oct. 2009) <ul><li>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. </li></ul><ul><li>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.” </li></ul><ul><li>Currency & maturity mismatches “can be understood only by looking at banks’ worldwide positions consolidated across all office locations.” </li></ul><ul><li>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.” </li></ul><ul><li>“ Demand deposits held by households, for instance, are a stable source of funding with a long effective maturity.” footnote 16 </li></ul>BCM International Regulatory Analytics LLC www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved
  11. 11. Conclusions Regulatory Arbitrage?: Corporates www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  12. 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. 13. External Deposits non-banking sector Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD) estimated exchange rate adjusted changes
  14. 14. AA asset-backed <ul><li>FRB Volume Statistics for Commercial Paper Issuance (as of October 21, 2009) </li></ul><ul><li>All values in USD millions </li></ul>BCM International Regulatory Analytics LLC ©BCM International Regulatory Analytics LLC all rights reserved www.bcmstrategy.com AA nonfinancial
  15. 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. 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. 17. Implications <ul><li>Shifting maturity transformation function = f(survival, not necessarily arbitrage). Permanent? </li></ul><ul><li>Targeted but volatile short-term use of financial trading markets as alternative to credit markets. </li></ul><ul><li>Decreased funding flexibility for foreign expansion, trade, sourcing, and R&D. Will flow through to jobs and economic growth. </li></ul>BCM International Regulatory Analytics LLC www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved
  18. 18. Conclusions Regulatory Arbitrage?: Derivatives Markets www.bcmstrategy.com ©BCM International Regulatory Analytics LLC all rights reserved BCM International Regulatory Analytics LLC
  19. 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. 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. 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

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