Including updates on resolution regimes; FX transactions and Libor


FSB starts its peer review on resolution regimes

While August has been relatively quiet from a regulatory perspective, the ground work on some key initiatives continues. This month the Financial Stability Board (FSB) issued a detailed Questionnaire on resolution regimes. Findings from the questionnaire will feed into the FSB’s first peer review which will evaluate its members’ existing resolution regimes and any upcoming changes.

The FSB will be using the “Key Attributes of Effective Resolution Regimes for Financial Institutions” it developed in November 2011 as the benchmark to evaluation the relative progress of its members. The Key Attributes delineates what the FSB considers best practice in designing and framing resolution regimes. Issues covered include scope, safeguards, segregation of client assets, powers, institutional structure, resolution plans, the legal framework, information sharing etc. The FSB believe their implementation should enable authorities to resolve financial institutions in an orderly manner without resorting to public support, while maintaining continuity of their vital financial intermediation activities.

The Questionnaire will attempt to assess members’ progress in aligning their resolution regimes to these agreed international standards. The FSB will not be checking for compliance against the Key Attributes at this stage as it recognises that this area is complex and significant legislative preparation is required.

The FSB will continue to work with its members to develop further guidance, taking into account the need for implementation to accommodate different national legal systems and market environments and sector-specific considerations (e.g., insurance, financial market infrastructures).

The findings from this Questionnaire and peer-review will be interesting. The newly empowered FSB is in a unique position to align resolution policy across its members. If successful, it will go a long way in validating its position as a global regulator, but more importantly, it should help reduce moral hazard in the financial system and the need for the transfer of billions of euros in public funds to prop-up distressed/failed financial institutions.


Settlement of FX transactions

The Basel Committee on Bank Supervision (Basel Committee) wants banks to consider all risks associated with the settlement of FX transactions, including principal risk and replacement cost risk, and ensure sufficient capital is held against these potential exposures.

In its consultation document, Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions, the Basel Committee called on banks to ensure their risk management techniques for FX transactions are in line with comparable counterparty exposures.

The guidance addresses governance, principal risk, replacement cost risk, liquidity risk, operational risk, legal risk and capital for FX transactions. It also includes a new section on PVP settlement mechanisms, which were almost non-existent when the original guidance was published in 2000.

On PVP settlement mechanisms, the Basel Committee believes that banks should reduce their principal risk as much as practicable by settling FX transactions through the use of financial market infrastructures that provide PVP arrangements. Where PVP settlement is not practicable, a bank should properly identify measure, control and reduce the size and duration of its remaining principal risk.

The updated guidance only relates trades that consist of two settlement payment flows so it includes FX spot transactions, FX forwards, FX swaps, deliverable FX options and currency swaps involving exchange of principal.

The guidance outlines the key risks that arise from a foreign exchange trade during the period between trade execution and final settlement. The Basel Committee notes that the structure of the FX market has been radically altered in the last decade. The advent of new alternative trading venues, together with the development of prime brokerage credit sponsorship, has helped support the rapid growth of high-frequency trading. While this has increased market efficiency and compressed spreads, it has resulted in the exit of many traditional market-makers, and the remaining ones changing how and where they provide liquidity. As a result, the FX market is much more concentrated and sensitive to risk.

The consultation period on this paper closes on 12 October 2012.


ECON seeks input into ‘fixing’ Libor

As we reported in our last update, the EC adopted two amended proposals on market manipulation on 25 July 2012 to prohibit benchmark manipulation, making these criminal offences in light of the Libor scandal. These proposals would widen the scope of the revised Market Abuse Directive (MAD II) and Regulation (MAR), respectively, to include benchmarks. Specifically, the proposals would amend the definition of the offence of market manipulation to capture benchmark manipulation and amend the criminal offence of “inciting, aiding and abetting and attempting” to include it.

To help inform the European Parliament’s (EP) Economic and Monetary Affairs Committee (ECON) response, lead rapporteur Arlene McCarthy MEP, is seeking stakeholder input and has published a short questionnaire in light of the reforms.

The questionnaire attempts to canvas opinion on what measures should be taken to ensure integrity and quality of all benchmarks; to improve investor confidence in light of the scandal; and to increase transparency around the operation and governance of benchmarks.

Stakeholders are requested to send their comments to ECON by 17 September 2012 at 12.00.

In terms of next steps, the current MAD II/MAR revisions, as they stand, should be passed with relative ease. However, the extension of the proposals to include benchmarks will impact the timetable. The vote in ECON, which had been scheduled for 20 September, is likely to be postponed.