FSB reveals shadow banking policy options

Author: Gemma Varriale | Published: 30 Oct 2012
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The chair of the securities lending and repo workstream of the Financial Stability Board’s (FSB’s) shadow banking taskforce has laid out the policy options his team is reviewing, giving a real indication of what form the proposals will take.

David Rule mapped out the potential policy options at the ICMA European Repo Council’s (ERC’s) general meeting, ahead of next month’s meeting between the G20 finance ministers and central bankers.

In its interim report on securities lending and repo, published in April, the FSB described some of the financial stability issues it had identified. The question now is what exactly the Board plans to do about these issues.

At the ERC’s general meeting, Rule first discussed market transparency issues. "The first thing we will do in our report is to set out what we, as authorities, would like to know [about repo and securities financing markets]," he said. "How we then get that information is a practical question that can be addressed jointly with market participants."

The European Central Bank has notably supported the idea of a trade repository for the repo market. According to Rule, the FSB will not seek to duplicate that, but will work with existing initiatives. However, there are difficult issues to sort out.

One is whether the FSB works at the transaction-level and tries to insert reporting into the trade process, or whether it should make institutions report positions to the authorities on a periodic basis.

That, said Rule, is a big decision. There are also practically difficult questions stemming from the fact that the FSB will want to know the type of collateral.

"Defining what the types of collateral are is a very important exercise," he said. "And I don’t think it will be straightforward. One bank was telling me it had a tree of 160 different collateral types which it reviewed weekly - and it changed weekly."

Another issue is improvements in corporate disclosures. The FSB has looked at the accounts of the largest banks and dealers around the world to see what it can find out about their activities in the repo and securities lending markets. "We have found complete lack of consistency and some fairly glaring gaps in what you would want to know if you were a reader of corporate accounts," said Rule.

In particular, he said it’s very difficult to work out what activity financial institutions do in securities versus securities trades. The disclosures bundle derivatives collateral, repo collateral, securities borrowing and lending.

"I think what would be helpful to both regulators and risk analysts is a sources and uses of collateral statement that breaks down where institutions obtain collateral and what they do with it, so that may be one of our recommendations," he said.

The chair of the FSB’s fifth workstream also discussed reporting by fund managers to end investors.

"We have spent a lot of time thinking about the structure of these markets," said Rule. This involved considering whether central clearing played a sufficient role for these markets.

"We haven’t come up with an answer yet, but I don’t think there will be any radical initiatives coming out of the FSB in this area," he added.

Minimum haircuts

Rule also discussed the option of having a requirement underpinning the way market participants use methodology to calculate haircuts. This could take the form of either a certain number of years of data that includes a stress period, or requiring stress testing to be used.

But there are implications in the way that Basel capital requirements are set for banks. "The alternative - and it may be a complement rather than an alternative - is for the regulators to set numerical floors on the haircuts that are used for the markets," said Rule. "That is being considered very seriously."

There are a number of issues to setting numerical floors, including what level and how granular are the type of transactions. What transaction types are in the scope, counterparty type and asset type are also key issues.

"Primary policy in this area [asset type] would be to catch a risky asset whose prices are pro-cyclical because that’s where the pro-cyclicality of the leverage comes so that might make a case for excluding sovereign bonds," said Rule. "On the other hand, we’ve seen that sovereign bonds can themselves have cyclical variation in their prices."

Rule stressed that these regulatory initiatives are designed to address problems that were caused in the boom. "I’m not sure there’s any great rush to introduce measures because we’re not currently in a boom period," he said. "There is a great concern to consult and to understand consequences of any actions taken."

See IFLR’s other bank reform coverage:

'Global regulators to copy UK’s relaxed capital rules’ http://www.iflr.com/Article/3103527/Lending/Global-regulators-to-copy-UKs-relaxed-capital-rules.html

'Liikanen outlines consequences of EU’s bank overhaul’ http://www.iflr.com/Article/3106722/Search/Results/Liikanen-outlines-consequences-of-EUs-bank-overhaul.html

'ECB: how to create a central EU repo database’ http://www.iflr.com/Article/3020649/ECB-how-to-create-a-central-EU-repo-database.html

'Shadow banking rules: AMF MD reveals regulatory agenda’ http://www.iflr.com/Article/3064962/Search/Results/Shadow-banking-rules-AMF-MD-reveals-regulatory-agenda.html