Too Physical to Fail? Regulators Turn Attention to Commodities Houses

This is a link to an article in Risk Magazine discussing the systemic risk posed by commodity houses such as Cargill, Noble Group, Glencore Xstrata, Trafigura and Vitol.

The FSB has commissioned a study into the potential systemic risk posed by commodity trading houses, citing their involvement in  ‘shadow banking’ activities, such as lending and securitisation, as a cause for concern.  In addition, by the end of 2013, it is also due to publish guidelines for identifying non-bank, non-insurance Global Systemically Important Financial Institutions.

Whilst ‘prepayment transactions’, in which commodities houses pay cash upfront for a commodity to be delivered over time, do act as a source of financing it is generally thought that these deals are designed to provide access to additional commodity flows and do not represent lending for the sake of lending.  In addition, whilst some commodities houses, such as Trafigura, have a programme for the securitisation of trade finance receivables, the scale of these activities is currently very limited compared to those of banks.  Furthermore, in contrast to bank securitisations, it seems that commodity house securitisations tend not to involve a potentially dangerous maturity mismatch, whereby long term assets are financed by short-term money.

The article also makes reference to the joint report issued on 9 July 2013 by the Centre for European Policy Studies and the European Capital Markets Institute (ECMI), which concluded that larger commodity trading houses had grown to the point where their sheer size and importance in physical markets meant that they would have to be bailed out if they went bankrupt in order to avoid widespread disruption to commodity markets.  However, the structure of commodities markets, in which producers can go directly to consumers, would suggest that the failure of a commodity trading house would not have such a significant impact on supply security.  Furthermore, this view is supported by history, with the bankruptcy of Enron and Andre & Cie in 2001, Amaranth Advisors in 2006 and Petroplus in 2012 suggesting that disruption to markets may be limited.

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FSB Issues RRP Guidance

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:

Guidance on developing effective resolution strategies

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.

Guidance on identification of critical functions and critical shared services

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:

Functions

  • Deposit taking;
  • Lending and Loan Servicing;
  • Payments, Clearing, Custody & Settlement;
  • Wholesale Funding Markets; and
  • Capital Markets and Investments activities.

Shared services

  • Finance-related shared services; and
  • Operational shared services.

Guidance on Recovery Triggers and Stress Scenarios

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.

FSB Press Release on RRP Consultation

On 18 December 2012, the Financial Stability Board (FSB) published a press release regarding responses received to its 2 November 2012 consultation on Recovery and Resolution Planning, together with links to the responses of the following institutions:

  • Association of British Insurers
  • Barclays
  • BNP Paribas
  • British Bankers’ Association
  • Credit Suisse
  • Deutsche Bank
  • Federation Bancaire Francaise
  • FirstRand Bank
  • Global Financial Markets Association
  • Institute of International Finance
  • International Banking Federation
  • Investment Management Association
  • Polish Financial Supervision Authority
  • Santander
  • UBS

 

Deadline for G-SIB Resolution Plans Pushed Back

On 5 November 2012, the Financial Stability Board (FSB) published a letter dated 31 October 2012 addressed to the G20 regarding progress made with respect to financial regulatory reforms.

The FSB reported ‘solid but uneven’ progress” in the four priority areas identified by the G20, being:

  • building resilient financial institutions (i.e. Basel III);
  • ending “too big to fail” (i.e. RRP);
  • strengthening the oversight and regulation of shadow banking activities; and
  • completion of OTC derivatives and related reforms.

On the subject on ending “too big to fail”, the FSB noted that a peer review of national actions taken to legislate its “Key Attributes of Effective Resolution Regimes” document will now be published in the first half of 2013.  More importantly, however, on the subject of resolution planning for Globally Systemically Important Financial Institutions (G-SIFIs), the FSB confirmed that the deadline for completion of operational resolution plans for Globally Systemically Important Banks (G-SIBs) has been extended by six months until mid-2013.  Consequently, the FSB’s peer-based resolvability assessment process will now be delayed until the second half of 2013.

Changes to the G-SIFI List

In November 2011, the Financial Stability Board (FSB) published its initial list of Global Systemically Important Banks (G-SIBs).  On 1 November 2012, the list was updated, with BBVA and Standard Chartered being added to the list and Commerzbank, Dexia and Lloyds all being removed.

The significance of being classified as a G-SIB lies in the fact that, under Basel III, any bank identified as a G-SIB in November 2014 will be required to maintain additional loss absorbency.  This requirement will be phased in between January 2016 and January 2019 and ranges between 1% and 2.5% of risk weighted assets depending on the significance of the individual firm.  G-SIBs are also required to meet higher supervisory standards for risk management functions, data aggregation capabilities, risk governance and internal controls.  Any firm newly designated as a G-SIB is required to implement certain resolution planning requirements within specified deadlines.  Furthermore, even where a financial institution is no longer designated as a G-SIB it will continue to be subject to the requirement to prepare an RRP to the extent that it is assessed by its national regulator to be systemically significant or critical in the event of failure.

For the first time, the current list of G-SIBs has been allocated into provisional buckets corresponding to the required level of additional loss absorbency, as set out in more detail in Annex 1 below.  The timetable for implementation of resolution planning requirements for newly designated G-SIFIs is detailed in Annex 2 below.

Annex 1

  

Bucket

G-SIB in alphabetical order within each   bucket

5

(3.5%)

(Empty)

 4

(2.5%)

Citigroup

Deutsche Bank

HSBC

JP Morgan Chase

3

(2.0%)

Barclays

BNP Paribas

 2

(1.5%)

Bank of America

Bank of New York Mellon

Credit Suisse

Goldman Sachs

Mitsubishi UFJ FG

Morgan Stanley

Royal Bank of Scotland

UBS

1

(1.0%)

Bank of China

BBVA

Group BPCE

Group Credit Agricole

ING Bank

Mizuho FG

Nordea

Santander

Societe Generale

Standard Chartered

State Street

Sumitomo Mitsui FG

Unicredit Group

Wells Fargo

Annex 2

G-SIFI Requirement Deadline for completion following date of G-SIFI designation
Establishment of Crisis Management Group (CMG)

6 months

 

Development of recovery plan

12 months

 

Development of resolution strategy and review within CMG

12 months

 

Agreement of institution specific cross-border cooperation agreement

18 months

 

Development of operational resolution plan

18 months

 

Conduct of resolvability assessment by CMG and resolvability assessment process

24 months