Introduction: Sifma: Keep a global perspective

Author: | Published: 1 Oct 2009
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In the 12 months since the financial crisis first flared up, the morning headlines have lost the capacity to shock, or even surprise. While much of the drama has abated and the sense of imminent collapse has receded, global regulatory reform continues in the background. The pace of change – slower than some might prefer, faster than others deem prudent – reflects the exceedingly complex and technical nature of the project: global, regional, and national policy makers are fashioning comprehensive overhauls of individual regulatory frameworks in the middle of a global recession.

From the outset, the Securities Industry and Financial Markets Association (Sifma) has acknowledged the need for reform and supported the efforts of policy makers to address the causes of the financial crisis and has played a constructive role in the ensuing debate. The resulting framework will have profound implications not only for our members, but also for the global economy. A key to effective and durable regulatory reform will therefore be the extent to which the resulting regulatory landscape features an integrated global system with the fewest unintended consequences. This is not to say that regional variation is unnecessary or undesirable, but that global coordination is paramount to ensure that policy makers have considered the collective global impact of regional and national reform.

Against this background of regional action requiring global coordination, Sifma has embarked on a reorganisation to function more efficiently and to represent its members more effectively as the work moves forward. On November 1, the European operations of Sifma will be spun off into an independent, self-funded organisation that will merge with the London Investment Banking Association (Liba). The resulting entity, the Association for Financial Markets in Europe (AFME) will represent a broader array of global and European participants in the wholesale financial markets, bring together a group of professionals with expertise in the most important issues facing our members, and communicate the industry perspective to regulators, policy makers, and the general public. In the meantime, AFME will continue to offer traditional activities in support of the day-to-day commercial activities of our members, including promulgating market practice and industry standards.

On the global level, AFME will be a participant in a global alliance with its partners in the US (Sifma), and Asia (the Asian Securities Industry and Financial Markets Association), through their representation on the Global Financial Markets Association (GFMA). The GFMA will provide a framework for each of these organisations to stay abreast of regional developments and to consider their collective global impact. We expect that the coming year will bring us abundant opportunity to feed constructively into a debate on reform. We highlight several major themes below.

Macro-prudential supervision

The need to focus on financial stability and systemic risks in addition to micro-prudential supervision – which focuses on the safety and soundness of individual firms – has been agreed at G20/FSB as a source of weakness in the regulatory framework. Macro prudential supervision is likely to take any one or a combination of the following forms.

Monitoring and assessment of systemic risks – at the global, regional and national level. The most appropriate level at which systemic risk might be monitored has not yet been agreed upon at global level. Global bodies (IMF, the World Bank and the FSB) are poised to take an enhanced role. At the regional and national levels the role of central banks and of new bodies (as has been proposed by the EU), is still under debate. A likely consequence of these measures is an increased burden on firms in data and information reports and an as yet uncertain effect on the day-to-day supervision of firms.

Introduction of counter-cyclical measures. To date there has been no consensus on the tools that authorities might use to dampen cyclical effects. Regulation of leverage ratios, through-the-cycle provisioning, capital buffers, and core funding ratios have all been mooted alone or in combination as possible measures. Any of the measures that might be adopted are likely to lead to increased capital requirements and restrictions on the volume of business firms can undertake. Policy makers should act not out of urgency, but calibrate these measures carefully to the needs of a well-functioning global economy.

A more focused treatment of firms that are deemed systemically important. The G20 has agreed that systemically important firms should be supervised with care. The IMF and the FSB have been asked to produce a guideline to identify these entities. There are no agreements so far on how such entities should be treated, but the recent UK Treasury White Paper suggests that higher capital requirements and more intense supervisory focus is probable. The problems with setting a boundary for systemic firms are considerable. There is difficulty with creating a clear definition, not least that contagion can spread quickly from non-systemic to systemic and render the boundary meaningless.

Revisions to the prudential framework

Although some aspects of the prudential framework were due to be reviewed even prior to the financial crisis (liquidity, trading book capital requirements and definition of capital), this has given way in the EU to a more wide ranging review to strengthen the safety and soundness of banks and investment firms.

The transposition of the Capital Requirements Directive (CRD II). This will likely occur at the end of 2010. The CRD III directive proposal is going through the Council and Parliamentary processes with a view to adoption early next year and implementation at the end of 2010. (In general terms the CRD texts reflect the negotiations in Basel.) Changes to the prudential framework will increase the capital required to be held, the systems employed by the firms, and the intensity of the supervisory relationship.

Trading Book and Market Risk capital requirements (Basel and CRD III). Introduction of stressed scenario VAR in addition to the ordinary VAR calculation. Introduction of incremental risk capital charge in the trading book to capture default and migration risks for unsecuritised credit products.

Securitisation capital requirements (CRD III). Requirements in the trading book will be aligned with those of the banking book, increased capital requirements for re-securitisation transactions, complex re-securitisations, amended treatment of positions held that have unfunded support from the firm itself ("self-guarantees").

Securitisation capital requirements (CRD II). Implementation of retention and due diligence requirements, Commission review of level of retention and methodologies.

Liquidity (CRD II and FSA UK). CRD II will introduce more robust liquidity management guidelines. The FSA will finalise its domestic liquidity regime, which will introduce the Individual Liquidity Adequacy Standards framework under which each firm will have to hold a liquidity buffer.

Large exposures (CRD II). Implementation of the revised framework.

EU Systemic Risk Board

The Commission is expected to make formal proposals in late September to establish a European Systemic Risk Board (to monitor and make recommendations on systemic risk issues in the EU); and a European System of Financial Supervisors, consisting of a network of new EU authorities (developing out of the existing Cebs, Cesr, and Ceiops Level 3 committees) and existing national authorities. In our view, the authorities should proceed with ensuring that the governance and staffing of the new EU authorities enhance the quality of regulation and supervision, the allocation of tasks and powers between EU and national authorities is appropriate and clearly set out in legislation, the respects in which the new EU authorities have rule-making and adjudicatory powers are clearly and appropriately specified, the bodies do not undermine or limit firms' discretion or supervisory judgements that national authorities are specifically charged with by EU law, and EU coordination arrangements (such as for colleges of supervisors) are not so rigid or exclusive that they undermine or cut across supervisory cooperation at a global level in relation to global firms.

OTC derivatives

In late July, the European Commission (EC) issued a consultation paper on possible reform of the OTC derivatives market in Europe, which suggests the following improvements.

Promotion of central clearing via increased standardisation.

The EC would like to see eligibility of derivatives contracts for clearing by central clearing counterparties (CCP is defined in terms of any one CCP being willing to clear it via the EC) and standardisation of the documentation and the products themselves in the majority of cases.

Enhance bilateral counterparty risk management techniques.

The EC recognises that some contracts will be inappropriate for clearing in CCPs, but would like to see bilateral clearing, collateral management and valuation techniques enhanced.

Increase transparency and promote use of public trading venues.

The EC would like to encourage the development and use of central data repositories. The consultation implies that new trade reporting requirements for OTC derivatives (and non-equity products generally) will be required, with trade price information made publicly available and with more reporting of derivatives positions to regulators. The EC sees trading on exchanges or e-trading platforms (MTF) as the next logical step after central clearing. It recognises that there may be a trade-off between liquidity and transparency, but argues there is a societal preference for transparent trading markets.

We (along with our sister trade association Isda) broadly support the EC's objectives. At the same time, we caution against a one size fits all approach that fails to take account of different types of derivatives and the varied practical purposes they serve, and does not provide for global consistency. We also caution against viewing standardisation as an automatic route to clearing and exchange trading. Our position on transparency is broadly supportive, but we urge the EC to avoid fragmentation of repositories, and carefully assess the impact of public dissemination of trade price information on liquidity.

Alternative investment funds regulation

We are commenting on the Alternative Investment Funds Managers Directive as it works through the EU legislative process. Member firms generally agree that fund managers should be regulated and subject to capital adequacy and conduct of business rules (as indeed they are in the UK today), but the scope of the proposal should be carefully tailored to avoid overbreadth. Members are concerned about the adverse impact on major institutional investors, such as pension funds and insurance companies, which use non-Ucits collective investment schemes routinely.

The most critical issue is the extraterritorial custodial provisions that severely restrict the class of those that can provide custody to EU credit institutions and the liability regime is also problematic. Custodians should be held to a high standard, but an absolute standard is likely to make the business very unprofitable or the cost to investors very high.

Emerging issues in 2010

Looking ahead to 2010, we have identified a number of issues that we expect will take on a higher profile and to which we intend to devote much of our attention. Many of them are natural extensions of the areas that are already under review. We expect the most important to be: the development of resolution regimes (including the concept of living wills) for banks and investment firms, the integration of post-trading systems, and a comprehensive review of EU financial services legislation (including the Market Abuse, Transparency, and the Markets in Financial Instruments Directive).

About the author

Lorraine Charlton will be Managing Director of the Equity Capital Markets Division and General Counsel of Sifma. She came to Sifma  from the Office of the Legal Advisor in Eritrea, where she represented it before the Eritrea-Ethiopia Claims Commission in The Hague. Charlton has also practiced in the London office of Latham & Watkins LLP, and in the Brussels and New York offices of Cleary Gottlieb Steen & Hamilton. She graduated from New York University School of Law in 1995.
Contact information

Lorraine Charlton

St. Michael's House
One George Yard
London EC3V 9DH
Tel: +44 (0)20 7743 9300