Including updates on systemic risk, balance sheet repair and short selling


ESRB issue first risk dashboard

The European Systemic Risk Board (ESRB) released its first dashboard on 20 September 2012. The dashboard brings together a series of data on risk categories comprising the interlinkages and composite measures of systemic risk, macroeconomic risk, credit risk, and market risk as well as risks associated with liquidity, funding, solvency and profitability.

The dashboard’s composite indicator of systemic stress showed a steady increase during the first half of 2011. But from July the trend reversed and it is now well below the peak values it reached at end-2008 and end-2011. In turn, banks’ profitability improved marginally in the first quarter of 2012, compared with the second half of 2011, but is still low by historical standards.

A number of indicators point to challenges ahead for financial institutions:
  • the EU economy shows no signs of a recovery with unemployment remaining stubbornly high
  • liquidity in the financial system is weak
  • credit standards have tightened in the past 6 months
  • bank lending is well below its historical averages and in some cases is in negative territory
  • dependence on central bank funding is high
  • banks’ loan-to-deposit ratios remain flat despite efforts to attract further deposits
Insurance companies’ balance sheets have also been affected by the adverse environment. Gross premium growth was slow in 2011 although some improvements have been noted in the first half of 2012 both in life and non-life insurance business.

The dashboard provides a good snapshot of the current state of the European financial system. It should help identify and measure systemic risk in the EU financial system and will be an important input to the ESRB’s discussions on risks and vulnerabilities.


ESRB calls on banks to repair their balance sheets

On 20 September 2012, the ESRB released a press release outlining the areas of discussion at the seventh regular meeting of its General Board. The General Board expressed concerns about the ongoing uncertainty associated with the fragility of the EU financial system. The General Board want EU authorities to implement agreed regulatory reforms fully, consistently and in accordance with agreed timetables.

From a macro-prudential perspective, banks need to move forward with their balance sheet repair to help mitigate some of the uncertainties surrounding markets. Banks also need to consider the implications of the ongoing balance sheet adjustments to the provision of credit to the economy.

In addition to banks’ ongoing restructuring efforts, the ESRB propose the following activities:
  • arrears management and provisioning
  • assessments of loan classification
  • disclosure of public information, including more disclosure on loan loss provisioning and availability of collateral.
In the case of systemic events, the Board notes that banks may need to adopt exceptional measures where necessary, e.g. setting up asset management companies to deal with poor quality assets, and involving third parties in asset evaluation.

In the context of its medium-term work programme, the ESRB is focusing on the following three projects:
  • the treatment of long-term guarantees in insurance: due to concerns of the future legal treatment of long-term guarantees in the insurance industry, stemming from certain provisions of the draft Omnibus II Directive
  • vulnerabilities linked to bank funding: in light of the impairment of credit and interbank markets and
  • interconnectedness and contagion: due to concerns about the way in which risks could propagate in credit default swap markets and in the interbank market.
On the proposed Eurozone banking union, the ESRB believes that the macro-prudential benefits of the SSM would be optimised if adequate resolution procedures for banks were implemented in parallel, for countries adhering to the banking union. The ESRB will examine further the possible implications of the establishment of the SSM for macro-prudential oversight in the EU and where appropriate, will liaise with the relevant authorities in the forthcoming legislative process.


Disclosure requirements in the Islamic capital market

Harmonising disclosure requirements in the Islamic capital markets with global standards can help stimulate greater cross-border activity according to global regulators. On 18 September, the International Organization of Securities Commissions (IOSCO) held a roundtable meeting with the Islamic Financial Services Board (IFSB) and the Securities Commission Malaysia to discuss disclosure practices in Islamic capital market activities. At the meeting, the regulators analysed the risks and challenges arising from inadequate disclosures in the area of sukuk and Islamic collective investment schemes and identified potential approaches that standard-setters, regulators and market participants could adopt. IOSCO and the IFSB believe the meeting represents a significant step towards the development of international regulatory standards and best practices relating to disclosure requirements for Islamic capital market products.


ESMA consults on short selling exemptions

The European Securities and Markets Authority (ESMA) published one of the final pieces to the Short Selling Regulation (SSR) (236/2012) jig-saw on 17 September 2012.The publication relates to guidelines on notification requirements for market makers and primary dealers, who are exempt from certain requirements under the SSR so as not to impede the important liquidity roles they provide to the real economy.

Article 17(1) of the SSR exempts entities undertaking market making activities from net short position transparency requirements and the restrictions on uncovered short sales. Primary dealers are not required to notify net short positions in sovereign debt, are not subject to the restriction on uncovered short sales in sovereign debt instruments and are not prohibited from entering into an uncovered sovereign CDS transaction.

However, these exemptions can only be relied on if the market maker has given its supervisor notice at least 30 calendar days before the date it first intends to rely on the exemption.

The guidelines are intended to assist the notifying entity, by specifying and describing the content of the written notification and providing a template notification form. The guidelines also introduce a common approach to submitting the notification form, assessing eligibility of the notifying entity’s activities and monitoring the whether the entity continues to meet the conditions of eligibility for the exemption.

ESMA alerted the market and regulators, on 30 August 2012, to the opening of the notification period for the use of the exemptions on 1 September 2012. It wants market participants and regulators to use the draft guidelines as an interim benchmark for the application and assessment process, until the finalised guidelines are published.

The consultation closes on 5 October 2012.