On 8 January 2014, the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) published a consultation paper on “Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions” (NBNI G-SIFIs). The consultation period closes on 7 April 2014. Continue reading
On 11 November 2013, the Financial Stability Board (FSB) published an updated list of global systemically important banks (G-SIBs) using end-2012 data.
The Basel Committee on Banking Supervision (BCBS) has also separately published the denominators used to calculate G-SIB scores and the Cut-off score and bucket thresholds that were used to allocate G-SIBs to particular buckets. The denominators are to be updated annually, while the cut-off score and bucket thresholds will remain fixed until November 2017, the date when the first three year review of the G-SIB assessment methodology is due to completed. Continue reading
In the context of the continuing industry and regulator discussion regarding CCP resolvability, last week ISDA published a position paper entitled “CCP Loss Allocation at the End of the Waterfall”. The paper addresses two scenarios:
- “Default Losses” – i.e. losses that remain unallocated once the ‘default waterfall’ is exhausted following a clearing member (“CM”) default; and
- “Non-default Losses” – i.e. losses that do not relate to a CM default but exceed the CCP’s financial resources above the minimum regulatory capital requirements.
ISDA recognises the importance of central clearing for standard OTC derivatives, the difficulty of achieving optimal CCP recovery and resolution and the fact that no loss allocation system can avoid allocating losses to CMs. It takes the view that residual CCP losses should be borne not by the taxpayer, nor solely by surviving CMs who as guarantors have no control over losses. Rather, ISDA believes that all CMs with mark-to-market gains since the onset of the CCP default should share the burden of CCP losses. Accordingly, ISDA is an advocate of Variation Margin Gains Haircutting (“VMGH”) being applied at the end of the default waterfall.
Under a VMGH methodology, the CCP would impose a haircut on cumulative variation margin gains which have accumulated since the day of the CM default. In doing so, ISDA believes that:
- losses fall to those best able to control their loss allocation by flattening or changing their trade positions;
- CMs with gains at risk are incentivised to assist in the default management process; and
- in the event that the CCP runs out of resources, VMGH mimics the economics of insolvency.
ISDA believes that a VMGH methodology should not have an adverse impact on the ability of a CM to net exposures or gain the appropriate regulatory capital treatment for client positions held at the CCP. In contrast to contractual tear-up provisions or forced allocation mechanisms, VMGH allows a CM to assume that its portfolio of cleared transactions outstanding as of any given date will be the same as of the point of a CCP’s insolvency (because there is no mechanism by which they can be extinguished prior to any netting process). As such, because it has certainty with respect to its legal rights in the CCP’s insolvency, the CM should be able to conclude that netting sets remain enforceable. In addition, to the extent that VMGH provides incremental resources to the CCP, ISDA believes that it effectively protects initial margin held at a CCP and therefore strengthens segregation.
In theory, VMGH should always be sufficient to cover a defaulting CM’s mark-to-market losses in the same period. However, if in practice this was not the case (e.g. because the CCP was not able to determine a price for the defaulting CM’s portfolio) and in the absence of other CMs voluntarily assuming positions of the defaulting CM, ISDA advocates a full tear-up of all of the CCP’s contracts in the product line that has exhausted its waterfall resources and has reached 100% haircut of VM gains. ISDA contends that there should be no forced allocation of contracts, invoicing back, partial non-voluntary tear-ups, or any other CCP actions that threaten netting. Furthermore, prior to the point of non-viability, ISDA believes that resolution authorities should not be entitled to interfere with the CCP’s loss allocation provisions (as detailed within its rules) unless not doing so would severely increase systemic risk.
An example of Non-default Loss (“NDL”) would be operational failure. ISDA views NDL in a different light to Default Losses believing there to be no justification for reallocating NDL amongst CMs and other CCP participants. Accordingly, it does not believe that VMGH (or similar end-of-the-waterfall options) are appropriate for allocation of NDL. Rather, it considers that NDL should be borne first by the holders of the CCP’s equity and debt.
The ISDA paper is a useful contribution to the ongoing discussion around CCP resolvability. It suggests a sensible CCP default waterfall, but is probably most noteworthy for its opposition to initial margin (“IM”) haircutting as a resolution tool. In ISDA’s view, IM haircutting would distort segregation and “bankruptcy remoteness”. In doing so it would have significant adverse regulatory capital implications and would create disincentives for general participation in the default management process. In this sense, it adopts the opposite position to that detailed by the Committee on Payment and Settlement Systems (“CPSS”) and the International Organization of Securities Commission (“IOSCO”) in their recent consultative report on the Recovery of financial market infrastructures (see this blog post for more detail). CPSS/IOSCO see IM haircutting as an effective tool which may facilitate access to a much larger pool of assets than VMGH.
There is general agreement on the principle that the taxpayer should never again have to pick up the tab following the failure of a systemically important firm. On this basis alone, one suspects that IM haircutting will ultimately be included in the suite of resolution tools, if only to act as additional buffer between derivatives losses and the public purse. In fairness, it’s difficult to see how a general tear-up of contracts is consistent with one of the underlying goals of CCP resolution – to ensure the continuity of critical services. Ultimately, however, we will have to wait to see whether the contagion which may result from ISDA’s tear-ups outweighs the regulatory impact associated with CPSS/IOSCO’s IM haircutting.
On 12 August 2013, the Financial Stability Board published a consultation document regarding the “Application of the Key Attributes of Effective Resolution Regimes to Non-Bank Financial Institutions”, inviting comments by 15 October 2013.
The consultation document proposes draft guidance on how the Key Attributes should be implemented with respect to systemically important non-bank financial institutions. It deals with three main areas:
- The resolution of financial market infrastructure (FMI) and systemically important FMI participants;
- Resolution of insurers; and
- Client asset protection in resolution.
The proposed rules are, to a large extent, little more than the formalisation of existing thought and best practice regarding the resolution of non-bank financial institutions. However, this does not detract from the value of the document. Indeed, it highlights the practical challenge that institutions which are subject to the rules will face in providing the data necessary to facilitate the implementation of resolution measures by regulators.
Both FMIs and insurers will be required to maintain information systems and controls that can promptly produce, both in normal times and during resolution, all data needed for the purposes of timely resolution planning and resolution. In the case of FMIs, this will include:
- Information on direct and indirect stakeholders, such as owners, settlement agents, liquidity providers, linked FMIs and custodians;
- Exposures to each FMI participant (both gross and net);
- Information on the current status of obligations of FMI participants (e.g. whether they have fulfilled their obligations to make default fund contributions);
- FMI participant collateral information, such as:
- holding arrangements; and
- rehypothecation rights; and
- netting arrangements.
Insurers will also be required to generate data regarding:
- sources of funding;
- asset quality and concentration levels; and
- derivatives portfolios.
In addition, any entity holding client money, must have the ability to generate a wide variety of data that would facilitate its speedy return in a resolution scenario. That data must be in a format understandable by an external party such as a resolution authority or an administrator and includes information on:
- the amount, nature and ownership status of client assets held by the firm (directly or indirectly);
- the identity of clients;
- the location of client assets;
- the identity of all relevant depositories;
- the terms and conditions on which client assets are held;
- the applicable type of segregation (e.g. “omnibus” or “individual”);
- the effects of the segregation on client ownership rights;
- applicable client asset protections (particularly where client assets are held in a foreign jurisdictions);
- any waiver, modification or opting out by a client of the client asset protection regime;
- the ownership rights of clients and any potential limitations to those rights;
- the existence and exercise of rehypothecation rights; and
- outstanding loans of client securities arranged by the firm as agent, including details of:
- contract terms; and
- collateral received.
If the experience of banks is anything to go by, the capture, analysis, delivery and updating of this type of data is a significant undertaking. The FSB is clearly laying out its intentions and the direction of travel on this issue. As such, non-bank financial institutions would do well to start analysing their capabilities in these areas, with a view to upgrading their data architectures where necessary.
On 16 July 2013, the Financial Stability Board (FSB) published the following three papers intended to assist authorities and systemically important financial institutions (SIFIs) in implementing the recovery and resolution planning (RRP) requirements set out under the FSB’s key attributes of effective resolution regimes for financial institutions:
This paper describes key considerations and pre-conditions for the development and implementation of effective resolution strategies, dealing with such issues as:
- the sufficiency and location of loss absorbing capacity (LAC);
- the position of LAC in the creditor-hierarchy, particularly with respect to insured and uninsured depositors;
- operational and legal structures most likely to ensure continuity of critical functions;
- resolution powers necessary to deliver chosen resolution strategies;
- enforceability, effectiveness and implementation of “bail-in” regimes;
- treatment of financial contracts in resolution, specifically the use of temporary stays on the exercise of contractual close-out rights;
- funding arrangements;
- cross-border cooperation and coordination;
- coordination in the early intervention phase;
- approvals or authorisations needed to implement chosen resolution strategies;
- fall-back options for maintaining essential functions and services in the event that preferred resolution strategies cannot be implemented;
- information systems and data requirements;
- post-resolution strategies;
- single point of entry (SPE) versus multiple point of entry (MPE) resolution strategies; and
- disclosure of resolution strategies and LAC information.
This guidance is designed to assist authorities and CMGs in their evaluation of the criticality of functions that firms provide to the real economy and financial markets. It aims to promote a common understanding of which functions and shared services are critical by providing shared definitions and evaluation criteria.
After describing the essential elements of a critical function and a critical shared service, the annex to the guidance provides a non-exhaustive list of functions and shared services which could be critical:
- Deposit taking;
- Lending and Loan Servicing;
- Payments, Clearing, Custody & Settlement;
- Wholesale Funding Markets; and
- Capital Markets and Investments activities.
- Finance-related shared services; and
- Operational shared services.
This guidance focuses on two specific aspects of recovery plans:
- criteria triggering senior management consideration of recovery actions (“triggers”), specifically: design and nature, firm’s reactions to breached triggers, and engagement by supervisory and resolution authorities following breached triggers; and
- the severity of hypothetical stress scenarios and the design of stress scenarios generally.
This is a link to an article which appears in yesterday’s FT which describes a bill introduced into Congress by Sherrod Brown (Democrat) and David Vitter (Republican) under which banks with more than USD 500 billion in assets would be required to meet a new capital requirement of 15%. At this stage, it seems that the prospects of the bill becoming law are slim, but ultimately only time will tell.
The Financial Stability Board (FSB) has published a press release regarding the meeting which took place in Zurich on 28 January 2013 to discuss vulnerabilities affecting the global financial system and progress to strengthen global financial regulation.
On the subject of resolving failing financial institutions, the FSB confirmed that, in April, it will publish its final peer review of resolution regimes. Thereafter, the FSB’s work on resolution in 2013 will focus on three main objectives:
addressing remaining obstacles to the implementation of resolution strategies for G-SIFIs;
- launching an effective resolvability assessment process for G-SIFIs; and
- developing guidance for the resolution of non-bank financial institutions.