global regulatory issues: tokyo roundtable, february … · 2016-03-29 · global regulatory...

Global Regulatory

Issues: Tokyo

Roundtable, February

2012

Adrian Blundell-Wignall

Special Advisor to the Secretary-General of the OECD on Financial Markets

(The views presented here are my own & do not reflect those of the OECD or any of its member governments.)

February, 2012

The Financial and

Sovereign Crisis in

Europe

Source: OECD

2

• The problem.

• Banking first and sovereign debt crisis second.

• Policies.

Figure 1: EU Bank versus Sov. CDS Spreads

Source: Datastream, OECD

3

0

200

400

600

800

1000

1200 Wtd Sprd BPEU Wtd. Bank CDS Sprd Index

EU Sov. CDS Sprd Index

Figure 2: Bank Exposures to Sovereign Debt

Source: Bank Reports, OECD 4

Banks Sov. Exp.€m Core_Tier_1 €m % Core Tier 1 Banks Sov. Exp.€m Core_Tier_1 €m % Core Tier 1

GR 48376 22819 212% IE 12,844 30,626 42%

CY 4,926 3,804 129% CY 361 3,804 9%

BE 4,267 20,460 21% PT 547 17,386 3%

PT 1,020 17,386 6% BE 376 20,460 2%

LU 82 1,480 6% FI 41 4,945 1%

DE 6,450 120,092 5% FR 1,144 172,357 1%

FR 7,053 172,357 4% DE 751 120,092 1%

IT 1,459 93,410 2% SI 9 1,447 1%

Other 2,659 558,205 0% Other 1,124 616,078 0%

Total 76,292 1,010,014 8% Total 17,197 987,196 2%


PT 22,680 17,386 130% ES 155,175 102,066 152%

BE 1,993 20,460 10% DE 16,895 120,092 14%

LU 143 1,480 10% BE 2,605 20,460 13%

DE 3,760 120,092 3% LU 173 1,480 12%

ES 3,177 102,066 3% IT 3,529 93,410 4%

FR 2,938 172,357 2% FR 5,610 172,357 3%

NL 659 73,609 1% NL 1,238 73,609 2%

GB 1,288 235,367 1% GB 3,371 235,367 1%

Other 464 213,752 0% Other 345 168,354 0%

Total 37,113 987,196 4% Total 188,941 987,196 19%


IT 150,636 93,410 161% FR 84,207 172,357 49%

LU 1,396 1,480 94% NL 21,683 73,609 29%

BE 17,409 20,460 85% SI 268 1,447 19%

DE 26,259 120,092 22% CY 493 3,804 13%

FR 30,775 172,357 18% DE 15,471 120,092 13%

PT 959 17,386 6% BE 2,194 20,460 11%

AT 1,050 19,402 5% GB 20,251 235,367 9%

ES 5,344 102,066 5% SE 2,379 46,290 5%

Other 9,886 440,542 2% Other 3,190 313,769 1%

Total 243,715 987,196 25% Total 150,136 987,196 15%

Sovereign Exposure to Portugal Sovereign Exposure to Spain

Sovereign Exposure to Italy Sovereign Exposure to France

Sovereign Exposure to Greece Sovereign Exposure to Ireland

Figure 3: Bank Exposure & CDS 2011H1

Source: BIS, OECD 5

€m Exposure of banks of the area/country to the financial instruments shown in the column

All Of which……

Countries Euro Area German French Spanish Italian Non-EU US

Banks Banks banks banks banks banks Banks banks

Greece

Sovereign 39,027 36,578 12,411 10,686 462 1,871 2,449 2,321

Banks 9,692 6,696 1,842 1,583 28 191 2,996 2,487

Non bank priv. 82,307 77,439 7,119 43,470 665 1,666 4,868 3,547

Guarantees incl. CDS 48,580 10,057 3,106 4,411 27 355 38,523 38,460

Portugal

Sovereign 32,106 29,896 8,978 6,153 7,138 509 2,210 1,144

Banks 36,306 33,609 12,554 6,170 5,050 1,867 2,697 2,250

Non bank priv. 136,036 133,145 14,320 13,339 76,295 1,556 2,891 1,856

Guarantees incl. CDS 72,838 25,778 15,628 489 5,883 1,076 47,060 46,891

Ireland

Sovereign 16,753 13,522 3,470 2,896 163 584 3,231 1,898

Banks 78,066 63,202 21,532 9,841 1,174 4,402 14,864 11,730

Non bank priv. 371,154 302,268 85,507 19,278 7,874 9,857 68,886 39,960

Guarantees incl. CDS 89,935 41,869 14,852 18,453 560 3,120 48,066 46,062

France

Sovereign 254,979 173,331 31,373 - 6,610 2,420 81,648 24,927

Banks 701,894 456,894 116,084 - 10,906 30,322 245,000 191,557

Non bank priv. 394,583 290,961 75,828 - 15,271 17,821 103,622 55,196

Guarantees incl. CDS 477,036 120,999 35,166 - 3,550 5,349 356,037 347,166

Spain

Sovereign 106,581 86,523 29,454 30,492 - 6,394 20,058 7,633

Banks 227,536 192,471 69,144 38,616 - 6,722 35,065 28,375

Non bank priv. 407,573 363,969 78,867 81,784 - 16,860 43,604 30,765

Guarantees inl. CDS 206,379 56,701 34,757 8,273 - 2,314 149,678 148,848

Italy

Sovereign 288,732 237,322 47,624 106,764 11,173 - 51,410 12,891

Banks 164,087 138,705 48,338 44,657 4,240 - 25,382 19,110

Non bank priv. 485,218 460,433 65,795 264,952 24,351 - 24,785 14,898

Guarantees incl. CDS 329,403 89,001 47,045 23,367 7,092 - 240,402 237,581

Totals for above 6 countries

Sovereign 738,178 577,172 133,310 161,006 50,814

Banks 1,207,889 884,881 267,652 323,008 253,022

Non bank priv. 1,794,564 1,550,776 320,317 243,788 142,675

Guarantees incl. CDS 1,224,171 344,405 150,554 879,766 865,008

Figure 4: The Real Problem of the Euro

Source: OECD.

6

C/A DEFICIT

UNEMPLOYMENT

Real SPA X ITA X

Exchange GRE X Internal

Rate POR X Balance

C/A SURPLUS C/A DEFICIT

UNEMPLOYMENT INFLATION

GER X

C/A SURLUS External BalanceINFLATION

Domestic Absorption

Figure 5: Debt Positions 2010H2

Source: OECD, Federal Reserve, Eurostat.

7

2010 Government Household Corporate TOTAL

USA 93.6 92.1 49.1 234.8

Germany 87.0 61.6 66.5 215.1

France 94.1 55.1 104.7 253.9

Italy 126.8 45.0 81.4 253.2

Spain 66.1 85.7 141.6 293.5

UK 82.2 99.5 112.2 293.9

Greece 147.3 60.0 62.6 269.9

Portugal 103.1 95.4 152.9 351.3

Ireland 102.4 118.9 222.5 443.7NB: Debt figures focus on loans and securities and ignore equity

liabilities, trade credit etc. In the case of Ireland, a financial

centre, the figures for corporate may be misleading in terms of

pressure on the domestic economy. Households are loans only.

Figure 6: Spreads to Bunds: EMU vs Euro

Source: OECD, Datastream.

8

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4

6

8

10

12

14

16

18

20

Fra

Ita

Spa

Ire

Por

Gre

Figure 7: Selected Bank Capital Positions

Source: OECD, Bank Reports.

9

Core Tier 1 Capital Leverage

(EUR million) Ratio

Deutsche Bank DE 30,361 63 26,838 − 64,970 88% − 214%

Societe Generale FR 27,824 41 6,156 − 28,809 22% − 104%

ING Bank NL 30,895 40 6,538 − 31,493 21% − 102%

Allied Irish Banks IE 3,669 40 690 − 3,596 19% − 98%

Barclays GB 46,232 38 6,107 − 41,001 13% − 89%

Credit Agricole FR 46,277 37 5,675 − 40,310 12% − 87%

BNP Paribas FR 55,352 36 4,624 − 44,608 8% − 81%

Dexia BE 17,002 33 0 − 11,349 0% − 67%

Nordea Bank SE 19,103 30 0 − 9,954 1% − 52%

Danske Bank DK 14,576 29 0 − 6,850 0% − 47%

Banco Santander ES 41,998 29 0 − 18,909 0% − 45%

Royal Bank of Scotland GB 58,982 29 0 − 26,139 0% − 44%

Millennium bcp PT 3,521 28 0 − 1,483 0% − 42%

Commerzbank DE 26,728 28 0 − 11,007 0% − 41%

Bayerische Landesbank DE 11,501 28 0 − 4,325 0% − 38%

KBC Bank BE 11,705 27 0 − 4,344 0% − 37%

UniCredit IT 35,702 26 0 − 10,797 0% − 30%

la Caixa ES 11,109 26 0 − 3,185 0% − 29%

SEB SE 9,604 25 0 − 2,553 0% − 27%

Intesa Sanpaolo IT 26,159 25 0 − 6,796 0% − 26%

Lloyds Bank GB 47,984 24 0 − 10,082 0% − 21%

EFG Eurobank GR 4,296 24 0 − 901 0% − 21%

Bank of Ireland IE 7,037 24 0 − 1,341 0% − 19%

Rabobank NL 27,725 24 0 − 4,919 0% − 18%

BBVA ES 24,939 22 0 − 2,712 0% − 11%

HSBC GB 86,900 21 0 − 4,953 0% − 6%

Erste Bank AT 10,507 20 0 − 0 0% − 0%

Caixa Geral de Depositos PT 6,510 19 0 − 0 0% − 0%

Raiffeisen Bank AT 7,641 17 0 − 0 0% − 0%

National Bank of Greece GR 8,153 15 0 − 0 0% − 0%

All Banks 759,991 30 56,637 − 397,387 7% − 52%

Capital Required 3% vs 5% LR Capital Required

(EUR million) (% of Core Tier 1)

Figure 8: EU Policies Cost-Benefit

Source: OECD

10

Policy Advantages Disadvantages

FISCAL CONSOLIDATION, ETC.

1 Fiscal consolidation. Fiscal compact rules Debt reduction/affordability improves. Growth negatives undermines fiscal adjustment.

for deficits and debt burdens in the future. Euro credibility improves. Recession=banking system problems multiply.

2 Richer country transfers/debt haircuts. Helps fund periphery. Euro viability improves. Politically difficult/wrong incentives to adjust.

3 Governments allowed to issue Eurobonds. Reduces costs for problem countries. Increases costs/lower ratings for sound countries

ECB ROLE

4 Lender-of-last-resort funding including Provides banks with term funding & cash for Encourages banks to buy 2yr sovereigns to pledge

LTRO operations & reduced collateral collateral. Supports interbank lending. Avoids as collateral for margin call, etc., pressures. Greater

requirements. bank failures. Maintains orderly markets. concentration on the crisis assets.

5 Operations to put a firm lid on bond rates, or Avoids debt dynamics deteriorating. None. Liquidity can be sterised if need be.

more general QE policies. Supports a growth strategy. (Is some inflation really a cost?)

6 Possible lender to the EFSF/ESM or IMF. See below. See below.

EFSF/ESM ROLES

7 Borrows & lends to governments. Funding/& ability to restructure debt by Credit rating downgrades of the governments

Buying cheap in secondary market. passing on discounted prices to principal cuts. involved. Inability to raise enough funds & the overall

Invests in banks: recapitalisation. Helps recapitalise banks (some can't raise equity). size of funds required is much higher than €500bn.

Buying from the ECB holdings of sovereign Deals with losses from restructuring. Provides Monetary impact if the bank capitalisation part

debt at discounted prices. an ECB exit strategy. No CDS events. No is funded by the ECB (see below).

monetary impact if ECB funding excluded.

POLICIES TO AUGMENT RESOURCES IF EFSF/ESM €500bn IS NOT ENOUGH

8 Bank license for EFSF/ESM plus more More fire power to deal with banks lack of capital None in the short term. Longer-run inflation risks.

leverage. & losses. ECB can be the creditor. Sterilisation of ECB balance sheet required.

9 EFSF capitalises an SPV (EIB spomsor), Increases resources via extra leverage in SPV, Limited private sector interest in investing in SPV.

or acts as a guarantor of 1st loss. or helps sell more bonds as guarantor. Large guarantees=credit rating risk. Resources.

10 IMF funded by loans from the ECB. No pressure on European budgets. IMF already Stigma. Possible monetary impact if not

a bank. Speed. Can lend for $ or € funding. sterilised.

Conditionality/debt restructuring role possible.

Good credit rating. No treaty change required.

11 SWF funds attracted via lending to IMF. No monetary impact/IMF buys euros with $'s. EU credit risk shifted onto the IMF.

12 EURO FRACTURES

Periphery countries forced to leave. Or large Transforms sovereign credit risk into more manage- Inflation rises in some countries. Legal uncertainty

countries choose to leave. able inflation risk. Competitiveness channel. on € contracts. Other countries leave/€ damaged.

STRUCTURAL POLICY NEEDS

13 Structural growth policies: labour markets, Reduces the cost of fiscal consolidation & Political difficulties & civil unrest.

product markets, pensions. improved competitiveness via labour markets.

14 Leverage ratio 5%, based on more transparent Deals with 2 forms of risk: leverage & contagion None, as the approach envisages allowing time to

accounting for hidden losses. Separation of of domestic retail from high-risk globally-priced achieve the leverage ratio.

retail & investment banking activities. products. Risk fully priced/no TBTF. More stable

SME lending.

Figure 9: Policies to Stop the Euro Fracturing?

Source: OECD

11

• The ECB term funding & QE well into the future.

• The „Greece problem‟ needs to be resolved: transfers & guarantees required.

• No destructive fiscal-ism: growth first, compact achievement later. Structural reforms: bank restructuring and recapitalisation; labour and product market competition; and pension system reform.

• Bank recapitalisation based on a proper cleaning up of balance sheets and resolutions. This can only be achieved with transparent accounting. Over €400bn needed (5% leverage ratio) plus some for losses.

• Investment and retail banking have to be separated. Depositor insurance cross-subsidises high-risk-taking businesses. These traditional banking activities should be immune to sudden price shifts in global capital markets. These policies will improve, not diminish, the funding of domestic SME‟s on which growth depends.

• EFSF/ESM resources of €500bn are not enough: more than € 1tn needed (borrowing needs and bank recapitalisation). More paid in capital and leverage ability may be needed—the €500bn limit to the ESM should not be consolidated with the €440bn resources of the EFSF. If these structures as envisaged can‟t raise enough funds from private investors—as seems likely—then other funding sources will need to be brought in: (a) a bank license to the EFSF and credit from the ECB (and increasing leverage); (b) the IMF is a „bank‟ and the ECB could lend to them the appropriate sums; (c) sovereign wealth funds could be cajoled with appropriate guarantees (possibly via the IMF) to provide the funds.

The Financial Crisis, &

Regulation

Source: OECD

12

• Basel.

• Leverage.

• GSIFI‟s, dealing with investment banking and counterparty risk.

Figure 10: Risk and the Crisis

Source: OECD 13

• The fundamental cause of the crisis was the under-pricing of risk.

• There are always 2 basic causes of excess risk: (1) too much leverage; & (2)—for given leverage—increased dealing in high risk products.

• Risk-weighted asset optimisation makes a mockery of the Basel tier 1 rule. Banks model their own risk & anyway can use derivatives to alter the risk characteristics of assets to which the risk weights apply.

• The OECD has consistently argued for (1) a leverage ratio and (2) the separation of retail & investment banking from the outset of the crisis.

Figure 11: Structural Trends & the Current

Crisis

Source: OECD

14

• Once or twice in a career secular trends in innovation & structural change collide with institutional arrangements & regulations creating conflicts in policy objectives & market volatility so great that its is capable of bringing down the system.

• For banking policy has allowed too much leverage & (until now in the UK) has failed to take seriously the need to separate retail from investment banking.

• Securitisation, OTC derivatives, repo financing, & re-hypothecation pyramids, inter alia, have contributed to “complete markets” in bank products. There is more volatility and greater inter-connectedness.

Fig 12: Basel I, II & III??

Source: OECD 15

Figure 13: Comparing US & European Leverage


0.0

10.0

20.0

30.0

40.0

50.0

60.0 RATIO

Leverage to Equity

Leverage to Tier 1

Figure 14: Basel vs RWA/TA & Leverage


10714.29

10

20

30

40

50

60

70

80

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Q2 2011

ratio

Basel II

Deutsche Bank TA/Tier1

BNP Paribas TA/Tier1

RBS TA/Tier1

Barclays TA/Tier1

UBS TA/Tier1

10%

20%

30%

40%

50%

60%

70%

80%

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Q2 2011

%

Basel II

Deutsche Bank RWA/TABNP Paribas RWA/TARBS RWA/TABarclays RWA/TAUBS RWA/TA

Figure 15: Basel III & Time Profile of Max

Leverage for Individual Banks

Source: BCBS, OECD 18

Regulatory Capital Requirements Time Profile

2013 2014 2015 2016 2017 2018 2019

Core T1/RWA 0.035 0.04 0.045 0.045 0.045 0.045 0.045

Core+Buffer/RWA 0.035 0.04 0.045 0.05125 0.0575 0.06375 0.07

T1/RWA 0.045 0.055 0.06 0.06 0.06 0.06 0.06

LR 0.03 0.03 0.03 0.03 0.03 0.03 0.03

Max. Allowed Leverage to the Capital Concept for a Constant RWA/TA Assumption

RBS RWA/TA 0.320

Core+Buffer/RWA 89.3 78.1 69.4 61.0 54.3 49.0 44.6

Barclays RWA/TA 0.267

Core+Buffer/RWA 107.0 93.6 83.2 73.1 65.1 58.8 53.5

DBK RWA/TA 0.182

Core+Buffer/RWA 157.0 137.4 122.1 107.2 95.6 86.2 78.5

BNP RWA/TA 0.301

Core+Buffer/RWA 94.9 83.1 73.8 64.8 57.8 52.1 47.5

Santander RWA/TA 0.497

Core+Buffer/RWA 57.5 50.3 44.7 39.3 35.0 31.6 28.7

HSBC RWA/TA 0.449

Core+Buffer/RWA 63.6 55.7 49.5 43.5 38.7 34.9 31.8

UBS RWA/TA 0.151

Core+Buffer/RWA 189.2 165.6 147.2 129.2 115.2 103.9 94.6

Citi RWA/TA 0.388

Core+Buffer/RWA 73.6 64.4 57.3 50.3 44.8 40.4 36.8

MS RWA/TA 0.199

Core+Buffer/RWA 143.6 125.6 111.7 98.1 87.4 78.8 71.8

JPM RWA/TA 0.329

Core+Buffer/RWA 86.8 76.0 67.5 59.3 52.9 47.7 43.4

GS RWA/TA 0.271

Core+Buffer/RWA 105.4 92.3 82.0 72.0 64.2 57.9 52.7

BAC RWA/TA 0.39

Core+Buffer/RWA 73.3 64.1 57.0 50.0 44.6 40.2 36.6

Figure 16: Primary Assets v Derivatives

Source: BIS, Datastream, World Federation of Stock Exchanges, OECD 19

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0Total

Primary Securities

Derivatives

Figure 17: What Banks Do

Source: Bank Reports, OECD

20

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00 % Deriv/TA

Loans/TA

FV Sec./TA

Deposits/TA

Figure 18: CDS the Atomic Bomb Graph

Source: OECD

21

• One of the most urgent things to do in Europe (& elsewhere) is to introduce NOHC legislation to facilitate the quarantining of risk from different parts of a financial group. Bravo Vickers.

Notional €100m

Probability of Default (& 50% Recovery Rate)

After 4 Periods

0.99 €45.2m

0.76 €33.3m

0.34 €11.7m

0.19 €4.6m

Figure 19: The AIG CDS Payouts

Source: GAO, AIG, OECD

22

Institution

Collateral

postings for credit

default swapsa)

Payments to securities

lending counterpatiesb) Total

As a share

of capitalc) at

end-2008

Goldman Sachs 8.1 4.8 12.9 29.1%

Société Générale 11 0.9 11.9 28.9%

Deutsche Bank 5.4 6.4 11.9 37.4%

Barclays 1.5 7 8.5 20.0%

Merrill Lynch 4.9 1.9 6.8 77.4%

Bank of America 0.7 4.5 5.2 9.1%

UBS 3.3 1.7 5 25.2%

BNP Paribas … 4.9 4.9 8.3%

HSBC 0.2 3.3 3.5 5.3%

[memo: Bank of America after its merger with Merrill Lynch] 12 [18.1%]

In USD billion

Figure 20: The Logic of Separation

Source: Datastream, OECD 23

• A retail bank with a leverage ratio is

safe & boring—boring is good for

unsophisticated investors (but not

good for bankers profits).

• Deposit insurance applies to the

boring retail bank only, and there

should be no TBTF cross

subsidisation of the IB.

• Boring bank goes on lending to

households & SME’s regardless of

what happens in the IB—prices of

products determined in global

markets.

• IB has more limited capital & no

guarantees, & no favoured Basel

status—tough initial & variation

margin requirements & high quality

capital via market pressure. The cost

of capital for high risk activities goes

up.

Figure 21: Firewall NOHC Structure

Source: OECD 24

ALTERNATIVE CONGLOMERATE STRUCTURES

PARENT (C) NOHC (siloed cap.)

Capital market activity Equity 100 Equity 100 Equity 100

SUBSIDIARIES Comm. Bank Invest. Bank Comm. Bank Invest. Bank Comm. Bank Invest. Bank

Equity investment parent, USD bn 30 70 70 30 70 30

Debt, USD bn 480 3 500 1 120 780 1 120 570

Balance sheet total, USD bn 510 3 570 1 190 810 1 190 600

Debt/equity ratio 16 50 16 26 16 19

Leverage ratio (assets/equity) 17 51 17 27 17 20

Profit,c) USD bn 5 36 12 24 12 6

Return on equity, % 17 51 17 81 17 20

max. loss rate, in % assets 2.5 5 2.5 15 2.5 5

max. loss, USD bn 13 178 30 121 30 30

max. loss in % of equity 43 254 43 403 43 100

GROUP

Balance sheet total, USD bn 4 080 2 000 1 790

Leverage ratio (assets/equity) 41 times equity 20 times equity 18 times equity

Unweighted capital ratio (common equity), % 2.5 5.0 5.6

max. loss in % of equity 191 151 60

Return on equity, % 41 36 18

a) A conglomerate "too big to fail" (TBTF), thus with implicit government guarantee; no restrictions on leverage ratio imposed.

b) A conglomerate "too big to fail" (TBTF), thus with implicit government guarantee; but assuming a group leverage restriction of 20 times equity is imposed.

c) Profits are assumed as 1% return on assets (ROA; balance sheet total) for all cases except for the IB in case B where profits are assumed to be 3% ROA activities

(due to riskier IB compensating for the reduction in ROE caused by restrictions on leverage).

(A) TBTFa) (B) TBTF & levg.restr.b)

Figure 22: Firewall NOHC Structure

Source: OECD

25

SIFI EXPOSURE TO LOSS BEFORE SEPARATION

UNEXPECTED TRADITIONAL

VOLATILITY BANKING

EVENT (STD. DEV.'s) (Amortised Cost Accounting)

5

SECURITIES TRADING

PRIME BROKING

4 OTC DERIVATIVES

(Fair Value Accounts)

3

2

1

Loan loss: Traditional Banking

0 Bank Capital 5%

Leverage Ratio

POST SEPARATION

Retail Bank

5

4 Separated IB

Little Capital/Counterparties

Require 100% Collateralisation

3

SECURITIES TRADING

PRIME BROKING

2 OTC DERIVATIVES

(Fair Value Accounts)

1

0

Figure 23: Some Fallacies of Hasty

Generalisation

Source: OECD

26

• „I always give a one word answer when someone tells me it is safer to have stand-alone investment banks—LEHMAN‟.

(A lawyer from London at the recent OECD CMF meeting)

Lehman did not operate in the NOHC separation regime and benefitted from favourable Basel treatment as a bank in its interactions with other banks. No cross subsidisation in the new regime.

• „The removal of Glass-Steagall rules didn’t cause contagion risk. We have had universal banks here in Europe for centuries, and no problems have arisen before the US subprime crisis caused a headache for everyone’.

(A senior European policy maker)

Prior to “complete markets” and greater „interconnectedness‟ universal banking was less dangerous (& Glass-Steagall-like rules less needed) than is the case now. Large scale co-mingling of fair-value-through-profit-or-loss capital market banking products with amortised cost accounting traditional bank products, following decades of innovation & poor regulation has changed all of that.

Figure 24: NOHC Legislation Australia

Source: OECD

27

• March 1997 Wallis Review recommends NOHC: best method to quarantine entities in a group containing an ADI (to protect against creditors of one entity seeking to pursue the other entities of a group).

• 1998 Financial Sector (Shareholdings) Act amends the 1959 Banking Act to permit NOHC‟s.

• No adoption due to regulatory & tax complications (impediments under the Corporations Act 2001, & income tax law), so the Financial Sector Legislation Amendment (Restructures) Bill 2007 was passed.

• Restructure instrument: to grant relief to the specific statutory impediments to NOHC affiliates complying with the requirements of law.

• Internal Transfer Certificates: by APRA, to facilitate the rearrangement of assets & liabilities of the different activities into their separate business lines.

• Income Tax Assessment Act 1997 amendments: to the consolidation rules & capital gains tax aspects that were impediments to restructuring.

• Macquarie Bank adopts NOHC in 2007—it saves the bank in the crisis.

Figure 25: Separation Issue: Which Activities?

Source: Datastream, OECD 28

• Prime broking.

• OTC derivatives?

• Securities trading

( Including origination &

market making)

• Repo funding, re-hypothecation.

• Proprietary trading (directional &

relative value)

• Bank hedge funds, private equity

& SPV’s

• NOHC Structure: Operational

flexibility—can better meet

prudential requirements by

allowing appropriate allocation of

risk between prudentially & non-

prudentially regulated businesses

of a group.

Figure 26. Competition: Barriers • GFC & M&A activity (Merrill‟s, Wachovia, Lehman, Bear

Stearns, Northern Rock, etc)

• TBTF reduces counterparty risk—government back-up.

• Barriers to entry: low agency costs to exploit arbitrage better requires: rapid execution, custody, risk control, cheap funding, HFT.

• Barriers to entry: Higher regulatory costs favour scale and volume. Smaller firms exit.

• Barriers to entry: Basel netting favours GISFI size.

• Barriers to entry: Centralised clearing favours GSIFI platforms (swap clearing LCH.Clearnet & OTC Derivnet owned by the GSIFI‟s).

• Barriers to entry: Global reach needed for complex products, favours size.

Source: OECD. 29

Figure 27: Herfindahl: Interest Rate

Derivatives; Dollar Market; Bank/Bank

Source: BIS, OECD 30

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07

-H1

20

07

-H2

20

08

-H1

20

08

-H2

20

09

-H1

20

09

-H2

20

10

-H1

IndexFwd Rate

Swaps

Options


Derivatives: Dollar Market; Bank/Non-bank


0

500

1000

1500

2000

2500INDEX Forwards

Swaps

Options


Derivatives; Bank/Non-bank


0

2

4

6

8

10

12

14C

$/F

R

C$

/Sw

ap

C$

/Op

tio

n

SwF/

FR

SwF/

Swap

SwF/

Op

tio

n

€/F

R

€/S

wap

€/O

pti

on

£/F

r

£/S

wap

£/O

pti

on

yen

/FR

yen

/sw

ap

yen

/Op

tio

n

SwK

/FR

SwK

/Sw

ap

SwK

/Op

tio

n

US$

/FR

US$

/Sw

ap

US$

/Op

tio

n

No. Dominant Firms


Derivatives; Bank/Bank


0

2

4

6

8

10

12

14

16

18

20

C$

/FR

C$

/Sw

apC

$/O

pti

on

SwF/

FRSw

F/Sw

apSw

F/O

pti

on

€/F

R€

/Sw

ap€

/Op

tio

n

£/F

r£

/Sw

ap£

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n

yen

/FR

yen

/sw

apye

n/O

pti

on

SwK

/FR

SwK

/Sw

apSw

K/O

pti

on

US$

/FR

US$

/Sw

apU

S$/O

pti

on

No. Dominant Firms

Figure 31: Herfindahl: Equity Derivatives;

Dollar market; Bank/Non-Bank


500

700

900

1,100

1,300

1,500

1,700

1,900

2,100

2,300

2,500Index Forwards & Swaps

Options


Dollar Market; Bank/Bank


500

1000

1500

2000

2500

3000

19

98

-H1

19

98

-H2

19

99

-H1

19

99

-H2

20

00

-H1

20

00

-H2

20

01

-H1

20

01

-H2

20

02

-H1

20

02

-H2

20

03

-H1

20

03

-H2

20

04

-H1

20

04

-H2

20

05

-H1

20

05

-H2

20

06

-H1

20

06

-H2

20

07

-H1

20

07

-H2

20

08

-H1

20

08

-H2

20

09

-H1

20

09

-H2

20

10

-H1

Index

Fwds & Swaps

Options


Bank/Non-Bank


0

2

4

6

8

10

12

14

16 No. Dominant Firms


Bank/Bank


0

2

4

6

8

10

12

14No. Dominant

Firms

Figure 35: Netting & Concentration

Source: OECD, Datastream.

38

A. Diverse Counterparties B. Concentration Case

P1: Netting Set 1 One netting Set

IRS up 100 IRS up 100

CDS down -90 CDS down -90

Net 10 IRS up 90

P2: Netting Set 2 CDS down -100

IRS up 90 Net 0

CDS down -100

Net -10

Figure 36: Equity Derivatives & the Next Crisis

Source: OECD 39

• ROE‟s fall mechanically with regulatory reform—other things given.

• GSIFI‟s are unlikely to stand still.

• Equity derivative ROE‟s are highest post financial reform.

• Delta one products are in the lead.

Figure 37: Expected GSIFI ROE’s

Post Regulatory Reform

Source: JP Morgan, OECD. 40

• Mechanically ROE’s halve with all reforms.

• Equity derivatives unexploited.

• Delta One products are booming now; and it will continue.

• Structured products in the EU.

• Convertibles.

• Prop. Trading (especially in EU).

CS UBS DBK GS MS BNP SG BARC BAC Citi Avg.

ROE before reg. Changes 23.5 22.7 19.9 23.4 19 19.2 17.2 17.8 na na 20.3

Post Reg. ROE 13 11.5 10.5 13.8 12.4 13.8 10.2 12 na na 12.1

Equity Derivatives Post Reg ROE's

Structure products 15 13 16 11 5 21 27 15 5 4 14

Flow equity 15 15 15 30 18 19 15 21 20 8 18

Delta one (ETF,s, Swaps, fut. fwds) 38 45 34 32 53 51 55 49 32 23 40

Convertibles 27 36 23 26 42 24 18 42 36 44 30

Prop. Trading 23 36 24 21 37 12 31 29 17 22 24

Total 22 26 21 20 22 24 29 27 17 15 22

Figure 38: ETFs: the Next CDO Type Crisis

Source: OECD 41

CASH ETF & STOCK LENDING/LIQUIDITY

Investor: Invests cash Provider: accepts deposit Stock Borrower,

in ETF lends stock sells stock

Asset Liability Asset Liability Asset Liability

ETF holding Buys stock & lends it Investors deposit Cash on Sale Stock

100 100 Loan 100 100 100

Investor wants to withdraw deposit today, but the stock loan is not due. Borrows from a liquidity provider.

collateralising the stock. What happens in a liquidity crisis? What happens if the borrower fails?

SYNTHETIC ETF, The Risk Is Even Higher

COLLATERAL BASKET

(unrelated to ETF market)

Collateral

Cash Basket

Return

INVESTOR Cash ETF PROVIDER Cash INDEX ETF S&P500

S&P ret S&P ret

Collateral

S&P ret. Basket

Often the same Return

bank.

SWAP COUNTERPARTY

Figure 39: Summary of Financial Reform Process

Source: OECD

42

• At the FSB there has been a strong focus on progress with reform: Basel III compliance; raising more capital; getting more OTC derivatives centrally cleared on platforms; and improving the resolvability of SIFI‟s. Country reviews are going on—recently Canada and Switzerland. In these reviews, they look at what countries are doing individually, in addition to internationally negotiated things like Basel III.

• The US, the EU and Japan are working together on clearing platforms for OTC derivatives. But these products are traded globally, raising questions that some countries in Asia will have banks exposed to platforms over which they have no control.

• Switzerland has focused on holding more capital than required and is dealing with resolvability in a unique way—a capital rebate if its banks can demonstrate resolvability.

• Canada, the United Sates and Switzerland (to be implemented next year) have a leverage ratio (not based on risk weighted assets that runs alongside the Basel risk-weighted approach.

• Separately, the Vickers inquiry in the UK has recommended separation of retail and investment banking and this has been accepted by the government.

• The US Dodd-Frank bill has looked to ban proprietary trading and certain swap transactions must be separated and (by law) will not be bailed out in the event of a problem.

Figure 40: What is lacking

Source: OECD

43

• What is clearly lacking on these crucial issues is international consistency in what countries do and what they might be exposed to. Without this consistency, issues will continue to arise about regulatory arbitrage and business migration from more to less controlled jurisdictions. Non-financial businesses are also concerned about these inconsistencies and what it will mean for them.

• Asia could risk becoming the recipient region for this less regulated search if it is not careful.

• A lot more consistency would come about if countries would begin to focus more on the 2 key proposals that the OECD has backed from the outset of the crisis:

• 1. A leverage ratio, based on more equity, of 5%. The US, Canada and Switzerland are already on board and Europe needs to join. As different accounting systems apply this needs to be resolved, and more transparency generally about hidden losses and the real capital needs of banks have to be solved.

• 2. Formal separation of traditional banking (retail) from investment banking as now accepted by the UK. This helps solve the resolvability issue.

global regulatory issues: tokyo roundtable, february … · 2016-03-29 · global regulatory...

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