Including updates on OTC derivative reform, recovery and resolution plans and G-SIFIs


FSB sees progress on OTC derivatives

The Financial Stability Board’s (FSB) fourth progress report on OTC Derivatives Market Reforms found that the status of market infrastructure is not creating an impediment to meeting the G20 OTC derivative reforms. Most G20 countries have robust market infrastructures which can be ramped-up sufficiently to meet the increasing numbers of products and participants that will be subject to clearing, reporting and execution requirements in the future. But regulatory uncertainty still remains the most significant impediment to further progress.

International policy work setting the standards for global clearing is substantially completed and implementation is proceeding at the national level. At a recent British Banking Association Conference, ESMA noted that the clearing obligation will probably not come into force until early 2014. ESMA is unable to develop technical standards which identify contracts subject to the clearing requirements until the CCP regime commences next year. Once those standards are available, ESMA will undertake its usual consultation process, and EU legislative endorsement should follow.

Uncertainty about the detail and timing of regulatory change is having a knock-on impact on trading. The FSB noted that CCPs use has plateaued with clearing rates of approximately 40% for interest rate derivatives and 12% for credit derivatives. Neither the percentage nor the notional value has increased significantly since 2010. CCPs believe that regulatory uncertainty is responsible for this plateau, and that volumes will increase when regulators have completed the rules that identify the scope of products and participants who will be subject to mandatory clearing. Many CCPs plan to expand their clearing services soon, particularly for interest rate derivatives.

Transaction reporting figures were more encouraging. The FSB estimates that over 90% of interest rate and credit derivative contracts are reported to TRs, with foreign exchange derivatives reaching 50%. Estimates are not yet available for equity and commodity transaction reporting. But it found that there is still no standardisation of reporting formats between jurisdictions. Standardisation is critical because it allows regulators to view counterparty exposures on an aggregated basis. The FSB believes that legal impediments, such as confidentiality and other rules which prohibit non-disclosure of information to third parties, will also hinder aggregation.

Organised Trading Facilities (OTFs) are now available for all five asset classes of OTC derivatives: interest rate, credit, equity, FX and commodities. Until the scope of clearing, trading and reporting requirements are finalised, it is difficult for market participants to develop platforms further. Trading platform providers are also uncertain about the extra-territorial impact of many national OTC reform rules.

The FSB plans to publish its fifth progress report in spring 2013, focussing on the readiness of market participants and providing updated data and information on international policy and national legislative implementation developments.

Jurisdictions need to implement their rules promptly and in a form flexible enough to respond to cross-border consistency and other issues that may arise. The FSB wants regulators to act by year end to identify conflicts, gaps and inconsistencies in their national frameworks, including the cross-border application of rules.


FSB consults on Recovery and Resolution Plans

The FSB published a consultation document on guidance for recovery and resolution planning (RRP) for globally systemically important financial institutions (G-SIFIs) on 2 November 2012. The guidance covers:
  • recovery triggers and stress scenarios to be used by firms in their recovery planning
  • resolution strategies and associated operational plans tailored to different group structures
  • identification of the critical functions and supporting services that would need to be maintained in a crisis for reasons of systemic stability.
The proposed guidance sets out the key elements that regulators may include in their resolution strategies and plans. It draws on two stylised approaches to resolution: a ‘single point of entry’ approach by which group resolution takes place primarily through action by the home supervisor mainly at the level of the parent or holding company; and a ‘multiple point of entry’ approach whereby resolution actions are taken by multiple authorities along national, regional or functional lines. There is no one-size-fit all approach here - resolution authorities will need to adapt the strategies and plans to fit individual G-SIFIs. In practice, some combination of approaches is likely.

The proposed guidance also provides a framework for the identification of the critical functions and shared services that would need to be continued in resolution for reasons of systemic stability with the objective of assisting convergence of approaches between Crisis Management Groups.

The contents of this report will assist national authorities in implementing the recovery and resolution planning requirements set out in the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions G-SIFIs and other firms working on RRPs will want to consider the report’s findings, to prepare for discussions on RRPs with their supervisors


FSB outlines progress in implementing G-SIFIs framework

Solid progress is being made in financial reforms, particularly in terms of ending the spectra of financial intuitions being “too big to fail”. On 2 November2012, the FSB published three reports outlining the progress made in implementing the framework for SIFIs.

The first report looks at the resolution of G-SIFIs. Overall, progress made in reforming national resolution regimes and advancing recovery and resolution planning is encouraging. But reforms to align resolution regimes with the FSB's key attributes of effective resolution regimes for financial institutions are still ongoing in several jurisdictions. The FSB focuses particularly on:
  • Crisis Management Groups (CMGs) - CMGs have been established for nearly all of the 29 G-SIFIs designated in November 2011. CMG membership includes the prudential supervisor, central bank and, where it is a separate authority, the resolution authority of the home and key host countries. Senior level engagement, with meetings at the level of Heads of Supervision and General Counsel, has proved critical in advancing CMGs’ recovery and resolution planning work .
  • Recovery plans - Initial reviews of recovery plans have taken place for most G-SIFIs, but in-depth reviews are still in progress. These reviews have highlighted a need for greater severity in the hypothetical stress scenarios and for a more exhaustive analysis with regard to impediments to the implementation of recovery measures, taking into account interconnections between group entities and constraints arising from the legal framework.
  • Resolution strategies and operational plans, resolvability assessments and cooperation agreements - CMGs have been focusing more recently on developing a clearly articulated "resolution strategy" for their respective G-SIFIs. These strategies outline, at a high level, the strategic approach to resolution that is likely to be adopted should the need arise. They do not prescribe the precise course of action that the authorities will pursue or preclude the development of fall-back options, given the need to consider the circumstances existing at the time of a resolution.
The FSB suggests that each G-SIFI’s home country resolution authority should propose the basic resolution strategy to the other host countries of that institution, by year-end 2012.The FSB is studying further how client assets can be better protected in the event of institutional failure, and also looking at how regulators in different countries exchange information, especially during times of crisis. We can expect more communication on their recommendations during 2013.

The second progress report looked at the intensity and effectiveness of G-SIFI supervision. The FSB noted there is still evidence of weak risk controls at financial institutions in certain countries--which raises the spectre of regulatory arbitrage in the future. As a result, regulators need to take further steps to make supervision more proactive and effective. The report makes a number of recommendations to support continued improvements in SIFI supervision, in particular of G-SIFIs. The recommendations include the Basel Committee on Banking Supervision (BCBS) updating its capital requirements for operational risk by the end of 2014.

Finally, the FSB updated the list of G-SIFIs, based on end-2011 data. The FSB has reduced the number of G-SIFIs from 29 to 28: three firms are out (Dexia, Lloyds and Commerzbank), and two new firms joined the list (Standard Chartered and BBVA).

The 28 G-SIB's have been allocated/grouped into "buckets" with different required level of additional loss absorbency capacity. The G-SIFIs will be required to have additional loss absorption capacity ranging from 1% to 2.5% of risk-weighted assets (with an empty bucket of 3.5% to discourage firms from increasing their systemic significance), to be met with common equity. These rates are fluid and will change as firms shrink or expand their balance sheets. The G-SIFI list will be reviewed every November to add and delete firms.

Each G-SIFI will be subjected to more intensive surveillance. Specifically, the FSB warned that these firms will face stronger supervisory mandates and higher supervisory expectations for risk management functions in the future. Several of the largest global banks by assets, such as Industrial and Commercial Bank of China, were excluded from the list because their businesses were viewed as being less complex and less risky than their peers. Also, some major European banks were omitted, such as Intesa Sanpaolo – apparently because they concentrate their activities in their respective domestic economies. This approach may drive other G-SIFI’s to consider retrenching to their core domestic businesses in the future, to avoid additional capital surcharges.