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International Association of Risk and Compliance
Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.risk-compliance-association.com
Top 10 risk and compliance management related news stories
and world events that (for better or for worse) shaped the
week's agenda, and what is next
Dear Member,
The laws of supply and demand are in play
in any market, wherever people are buying
and selling goods and services, and the
labor market is no different.
High wages or compensation can persist in
any occupation as long as many potential
employees or contractors can’t or won’t
enter it to drive down the wage.
It is so interesting to read about these very well paid jobs for employees and
contractor, especially when new skills are required and where there are very
few skilled professionals to fill these great positions.
Today we will start with a really interesting job description. I was very
surprised to read the perfect employee should have “Broad knowledge of
Basel III, CRD IV, Solvency II and BRRD”.
BRRD stands for the Bank Recovery and Resolution Directive (BRRD) that
applies in all EU Member States. Let’s read the job description:
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Regulatory Policy, ICAAP, Basel III
London - £400 - £500 per day
Contract
Posted: Friday, 24 April 2015
My client, a leading international bank, has a new opening for a senior
regulatory analyst within their Regulatory Division.
The ideal candidate will have 5+ years experience within a regulatory
function at a leading FS company, with particular focus on ICAAP and Basel
III.
Description/Comment:
-
Aide business area in assessing and providing interpretative guidance to
support the implementation of regulatory requirements for new
business initiatives, closely with subject matter experts from other key
functions, such as treasury, risk and compliance.
-
Review proposed regulatory requirements, perform impact assessment
and help develop the corporation's views on these requirements,
including the FCA and PRA's adoption of EU directives.
-
Review legal entity regulatory reporting interpretation of relevant rule
text to support the team in delivering accurate and timely reports to the
FCA and PRA.
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Participation in the analysis, design and execution of training covering
new and existing technical regulatory requirements.
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Responsible for the maintenance and development of all regulatory
policy documentation.
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Continuously broaden and deepen expertise in the FCA, PRA and EBA's
regulatory rules via self-directed research and training.
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Assist with internal audit issues and queries.
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Liaise with compliance/risk and escalate any regulatory breaches.
Essential Products/Systems/Experience
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Broad knowledge of Basel III, CRD IV, Solvency II and BRRD
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Detailed understanding of the FCA and PRA's implementation of
relevant directives, their supervisory approaches for banks, investment
firms, asset management firms and life insurance entity.
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An advanced knowledge of CRD IV Own Funds, Leverage Ratio, Large
Exposures and Liquidity standards, as well as an understanding of the
COREP reporting in these areas.
-
Knowledge or working experience in ICAAP and Pillar 3 will be an
advantage.
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An advanced knowledge of investment types and products.
Desirable Products/Systems/Experience
-
Ability to apply technical understanding to real world business
events/transactions.
-
Flexible when solving problems and making decisions; taking into
account a broad range of internal and external factors; understanding
and working effectively with senior management; adjusts actions and
decisions for focus on critical issues; accepts accountability for impact
of decisions made.
-
Ability to identify and cultivate relationships with key stakeholders;
gain the cooperation of peers and customers, persuade others; mobilise
people to take action.
-
Ability to set a strategic vision, inspire and motivate others.
Location: London, UK
Industry: Finance
Rate: £400 - £500 per day
This is a very interesting job description!
According to EU Commissioner for Financial Stability, Financial Services
and Capital Markets Union, Jonathan Hill, the Bank Recovery and
Resolution Directive equips public authorities for the first time across
Europe with a broad range of powers and tools to deal with failing banks,
while preserving financial stability. From now on, it will be the bank's
shareholders and their creditors who will bear the related costs and losses
of a failure rather than the taxpayer.
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{And it will be the bank’s employees and contractors that have to explain
the requirements to the board and senior management, and to ensure that
the organization complies enterprise-wide, I would add}.
Welcome to the Top 10 list.
Ms Sabine Lautenschläger, Member of the Executive Board of the European
Central Bank and Vice-Chair of the Supervisory Board of the Single
Supervisory Mechanism, covers the importance of the Bank Recovery and
Resolution Directive at Number 5 below.
Best Regards,
George Lekatis
President of the IARCP
General Manager, Compliance LLC
1200 G Street NW Suite 800,
Washington DC 20005, USA
Tel: (202) 449-9750
Email: [email protected]
Web: www.risk-compliance-association.com
HQ: 1220 N. Market Street Suite 804,
Wilmington DE 19801, USA
Tel: (302) 342-8828
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International Association of Risk and Compliance Professionals (IARCP)
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The Basel Committee removes selected national
discretions and replies to frequently asked
question on funding valuation adjustment
The Basel Committee has agreed to remove certain
national discretions from the Basel capital framework.
National discretion allows countries to adapt the Basel standards to reflect
differences in local financial systems.
However, the use of national discretions can also impair comparability
across jurisdictions and increase variability in risk-weighted assets.
European Securities and Markets Authority (ESMA)
ESMA is seeking information on new developments
in virtual currency investment
The European Securities and Markets Authority (ESMA) has launched a
call for evidence on investments using virtual currency or distributed ledger
technology.
ESMA is seeking information and views from stakeholders on new
developments in how virtual currency technology is used to issue, buy and
sell and record ownership of securities.
Remarks at University of South Carolina and
UNC-Charlotte 4th Annual Fixed Income
Conference
Commissioner Michael S. Piwowar
Charlotte, NC
Although I spent my early career producing academic research, my
intervening years in Washington, DC probably make it more accurate to call
me a “reformed academic.”
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Eighth progress report on adoption of the Basel
regulatory framework
April 2015
This report sets out the adoption status of Basel II, Basel
2.5 and Basel III regulations for each Basel Committee
member jurisdiction as of end-March 2015.
It updates the Committee’s previous progress reports, which have been
published on a semi-annual basis since October 2011.
Regarding the consistency of regulatory implementation, the Committee
has published its assessment reports on 19 members, including nine
members of the European Union (Australia, Brazil, Canada, China,
European Union, Hong Kong SAR, Japan, Mexico, Singapore, Switzerland
and United States of America) regarding their implementation of Basel III
risk-based capital regulations, which are available on its website.
Monitoring, regulation and self-regulation in the
European banking sector
Speech by Ms Sabine Lautenschläger, Member of the
Executive Board of the European Central Bank and
Vice-Chair of the Supervisory Board of the Single
Supervisory Mechanism, at the evening reception at the Deutsche
Aktieninstitut, Frankfurt am Main
“Do we need to do more to make sure that we never have to experience
another financial market and banking crisis like that in 2008-09, or have
we done too much and thus prevented the European banking industry from
being able to offer financial services to the real economy?
After a long phase of deregulation, a comprehensive re-regulation has been
in vogue since 2009.”
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Community Bank Regulations
Maryann F. Hunter, Deputy Director, Division of
Banking Supervision and Regulation, before the
Subcommittee on Financial Institutions and
Consumer Credit, Committee on Financial Services, U.S. House of
Representatives, Washington, D.C.
“Community banks are a critical component of our financial system and
economy.
They reduce the number of underbanked citizens by providing banking
services that may otherwise go unmet, particularly in rural areas.”
The IFSB Announces the Release of
Prudential and Structural Islamic Financial
Indicators (PSIFIs) for 15 Member Countries
The Islamic Financial Services Board (IFSB) is
pleased to announce the release of a set of indicators
on the financial soundness and growth of the Islamic banking systems in 15
member countries.
This initiative is in line with Article 4 of the IFSB Articles of Agreement,
which mandates the IFSB to establish a global database of the Islamic
financial services industry.
The indicators, called Prudential and Structural Islamic Financial
Indicators (PSIFIs), are the first set of internationally comparable measures
of the soundness of Islamic banking systems.
The PSIFIs capture information on the size, growth and structural features
of Islamic banking systems and on their macroprudential condition by
looking at measures of their capital, earnings, liquidity, and exposures to
various types of risks.
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International Association of Risk and Compliance Professionals (IARCP)
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Policies and governance framework required to
ensure Europe's prosperity
Opening address by Mr Carlos da Silva Costa, Governor
of the Bank of Portugal, at the Seminar on "Governance
and Policies for Prosperity in Europe", Lisbon
“Recent years have seen deep changes in Europe.
In many cases, such changes went beyond what was thought possible not
long ago.”
Getting Better All the Time: JILA
Strontium Atomic Clock Sets New
Records
In another advance at the far frontiers of
timekeeping by National Institute of Standards and Technology (NIST)
researchers, the latest modification of a record-setting strontium atomic
clock has achieved precision and stability levels that now mean the clock
would neither gain nor lose one second in some 15 billion years*—roughly
the age of the universe.
Einstein predicted these effects in his theories of relativity, which mean,
among other things, that clocks tick faster at higher elevations.
Basel Committee on Banking Supervision
Board of the International Organization of
Securities Commissions
Margin requirements for non-centrally cleared derivatives
The final policy framework that establishes minimum standards for margin
requirements for non-centrally cleared derivatives as agreed by the Basel
Committee on Banking Supervision (BCBS) and the International
Organization of Securities Commissions (IOSCO).
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International Association of Risk and Compliance Professionals (IARCP)
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The Basel Committee removes selected
national discretions and replies to frequently
asked question on funding valuation
adjustment
The Basel Committee has agreed to remove certain
national discretions from the Basel capital framework.
National discretion allows countries to adapt the Basel standards to reflect
differences in local financial systems.
However, the use of national discretions can also impair comparability
across jurisdictions and increase variability in risk-weighted assets.
The Committee has agreed to remove the following national discretions
from the Basel II (note: Yes, Basel II not Basel III) capital framework:
-
Treatment of past-due loans: footnote 31 of paragraph 76: "There will be
a transitional period of three years during which a wider range of
collateral may be recognised, subject to national discretion".
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Definition of retail exposures: the following sentence in paragraph 232:
"Supervisors may choose to set a minimum number of exposures within
a pool for exposures in that pool to be treated as retail".
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Transitional arrangements for corporate, sovereign, bank and retail
exposures: the following sentence in paragraph 264: "During the
transition period, the following minimum requirements can be relaxed,
subject to discretion of the national supervisor" and the related
transitional arrangements in that paragraph.
-
Rating structure standards for wholesale exposures: the following
sentence in paragraph 404: "supervisors may require banks, which lend
to borrowers of diverse credit quality, to have a greater number of
borrower grades".
-
Internal and external audit: the following sentence in paragraph 443:
"Some national supervisors may also require an external audit of the
bank's rating assignment process and estimation of loss
characteristics".
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Re-ageing: the following sentence in paragraph 458: "Some supervisors
may choose to establish more specific requirements on re-ageing for
banks in their jurisdiction".
In addition, the Committee notes that the national discretion related to the
internal ratings-based (IRB) approach treatment of equity exposures
(paragraph 267) will expire in 2016, as the discretion was to apply for a
maximum of 10 years from the publication of the Basel II framework.
The Basel Committee has also issued today a response to a frequently asked
question (FAQ) on funding valuation adjustment, as discussed below.
The FAQ notes that a bank should continue to derecognise its debit
valuation adjustment in full, whether or not it has adopted a funding
valuation-type adjustment.
Paragraph 75 of the Basel III capital framework requires banks to
"derecognise in the calculation of Common Equity Tier 1, all unrealised
gains and losses that have resulted from changes in the fair value of
liabilities that are due to changes in the bank's own credit risk."
Therefore, with regard to derivative liabilities, banks are required to
derecognise all accounting valuation adjustments arising from the bank's
own credit risk.
Offsetting between valuation adjustments arising from the bank's own
credit risk and those arising from its counterparties' credit risk is not
allowed.
Where a bank adopts a funding valuation adjustment (FVA), how should
the capital adjustment for a firm's own credit be calculated?
A bank's adoption of FVA should not have the effect of offsetting or
reducing its "own credit" adjustment according to paragraph 75 of the Basel
III capital framework.
The Committee recognises that derivative valuation practices and
accounting adjustments continue to evolve.
However, a bank should continue to derecognise its debit valuation
adjustment in full, whether or not it has adopted a funding valuation-type
adjustment.
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Notes
The removal of these national discretions builds on the Committee's earlier
work on identifying national discretions in the Basel capital framework.
The Committee will continue to monitor national discretions and consider
further removals from the framework.
To promote consistent global implementation of the Basel framework, the
Committee periodically reviews FAQs and publishes answers along with
any technical elaboration of the rules text and interpretative guidance that
may be necessary.
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European Securities and Markets Authority (ESMA)
ESMA is seeking information on new developments
in virtual currency investment
The European Securities and Markets Authority (ESMA) has launched a
call for evidence on investments using virtual currency or distributed ledger
technology.
ESMA is seeking information and views from stakeholders on new
developments in how virtual currency technology is used to issue, buy and
sell and record ownership of securities.
ESMA would like to hear from all those involved: whether from existing
financial institutions, new start-ups or their technological advisers, and
issuers and investors.
ESMA is interested in how different virtual currencies and the associated
blockchain, or distributed ledger, can be used in investments.
There are now facilities available to use the blockchain infrastructure as a
means of issuing, transacting in and transferring ownership of securities in
a way that bypasses the traditional infrastructure for public offer and
issuance of securities, trading venues like exchanges and central securities
depositaries or other typical means of recording ownership.
ESMA would like to find out more about these market developments and in
particular to know to what extent the use of the blockchain could enter the
financial mainstream, and how it could be used.
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Remarks at University of South Carolina and
UNC-Charlotte 4th Annual Fixed Income
Conference
Commissioner Michael S. Piwowar
Charlotte, NC
Thank you, Jean [Helwege] and Dolly [King], for inviting me to speak at
this great conference.
I always enjoy getting back to college campuses and spending time with
students and fellow academics.
Of course, I am using the term “fellow academics” a bit loosely.
Although I spent my early career producing academic research, my
intervening years in Washington, DC probably make it more accurate to call
me a “reformed academic.”
The reality is that I am now strictly a consumer of your scholarly work. In
my current role, I am constantly reminded of the value of quality academic
research to our financial markets, and more specifically the great insights it
can provide to financial regulators.
Research is particularly important in the area that is the focus of this
conference: fixed income markets.
Before I get too far along, I need to give the standard disclaimer that the
views I express today are my own and do not necessarily reflect those of the
Commission or my fellow Commissioners.
With that out of the way, let me get back to my prepared remarks, which
serve partly as a speech and partly as a call to action.
This conference is one stop on a bit of a tour I have been on lately, speaking
with academics around the country.
In each of those conferences, meetings, and other events I have been
encouraging increased dialogue between academic researchers and the
SEC.
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Just last month, I spoke to a group of equity market microstructure
researchers at the University of Notre Dame, with a message similar to what
I intend to share with you today.
That message is simple: your work is vital to helping the SEC accomplish its
core mission to protect investors, maintain fair, orderly, and efficient
markets, and facilitate capital formation.
Given the talent and collective focus of the people in this room, I do not
need to recite statistics about the size of the fixed income markets, the
degree to which issuers rely on bonds for debt financing, or the
pervasiveness of fixed income products from the largest institutional
investor portfolios to the smallest retail investor accounts.
Suffice it to say that well-functioning fixed income markets are a concern of
nearly all participants in our securities markets.
However, compared to equity markets, the SEC has historically taken a
more hands-off approach to the municipal and corporate bond markets.
I mention this not to imply that the Commission has been absent from fixed
income oversight, or that I am advocating for a more interventionist
approach.
In fact, over the past few years we have boosted the staffing level in our
Office of Municipal Securities, which was created by the Dodd-Frank Act,
and now consists of a team of experts handling a variety of issues in that
area.
And although we have not seen a similar increase in staffing related to the
corporate bond market, talented individuals in our Division of Trading and
Markets have been focusing on that topic as well.
While the Commission to date has dedicated relatively limited resources
and attention to fixed income markets, the same cannot be said about the
academic community.
Having been involved in fixed income market microstructure research since
I started my first tour of duty at the SEC in 2002, I am well aware of the
quality work undertaken by academics on fixed income issues, including by
many of you in this room.
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That is why I believe the Commission must leverage the talents of the
academic community as we seek to advance our core mission in the fixed
income markets.
Recent Progress
Before discussing some of these challenges in greater depth, let me first
spend a few minutes addressing the progress that has been made recently in
the fixed income space.
Shortly after assuming my role as a commissioner at the SEC, I gave a
speech calling for common-sense reforms to the municipal and corporate
bond markets, including the disclosure of markups and markdowns on
riskless principal transactions.
In August of last year I reiterated that call and also suggested that a best
execution standard, which already exists for corporate bond transactions,
also be applied to municipal bond transactions.
Thanks to the hard work of staff in the SEC’s Office of Municipal Securities,
as well as at the Municipal Securities Rulemaking Board (“MSRB”) and the
Financial Industry Regulatory Authority (“FINRA”), we have made great
strides on these issues.
After much discussion, the MSRB and FINRA moved forward in November
with a proposal to require the disclosure of markups and markdowns on
riskless principal transactions on both municipal and corporate bonds.
The MSRB also adopted a best execution rule for the municipal securities
market in December, and I understand that the MSRB and FINRA are
collaborating to develop much-needed guidance for the application of the
best execution standard for fixed income securities.
I am pleased about the progress over the past year on these important
reforms, but there is much to be done on initiatives to improve the fixed
income markets that are already underway.
First, I encourage the MSRB and FINRA to keep up their momentum
toward adopting a final rule on disclosure of markups and markdowns on
riskless principal transactions. Second, we must take steps to incrementally
increase pre-trade transparency for municipal bonds.
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I know that SEC staff is working hard on this project, and I urge them to
continue their dialogue with market participants in order to develop an
approach that balances the goal of improving pre-trade transparency with
the risk of pushing transactions further into the dark by taking overly
aggressive or burdensome action.
I also continue to meet with various market participants to discuss issues
related to instrument complexity in the municipal securities market. As I
noted in August, the high degree of complexity seen in many municipal
bond offerings puzzles me.
At a time when liquidity and standardization in the fixed income markets
generally are frequent topics of conversation, we must keep questioning
whether the complex nature of many municipal bonds is truly in the best
interests of issuers and investors.
In addition to these developments in the regulation of fixed income
markets, our Division of Enforcement has done an excellent job tackling the
issue of disclosure in the municipal securities market through the SEC’s
Municipalities Continuing Disclosure Cooperation Initiative (“MCDC
Initiative”).
The MCDC Initiative’s goal is to address potentially widespread violations
of the federal securities laws by municipal issuers and underwriters of
municipal securities in connection with certain representations about
continuing disclosures in bond offering documents.
The Commission received a number of voluntary submissions from both
issuers and underwriters in response to this program, and it is my
understanding that there will be settlements stemming from the MCDC
Initiative in the near future.
More importantly, however, we are already seeing the fruits of the MCDC
Initiative in the area of improved disclosure.
The MSRB has recently seen an uptick in submissions of continuing
disclosures on its Electronic Municipal Market Access (“EMMA”) system,
which is an extremely positive sign for investors.
Current Challenges
Despite these recent developments in the oversight of the fixed income
markets, the number of active work streams in this space remains relatively
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small when compared to the size and importance of these markets,
particularly with respect to corporate bonds.
This fact may not be all that surprising given the SEC’s staffing limitations
that I mentioned earlier.
But I do not believe that resource allocation alone, or any sort of regulatory
neglect, explains our lack of action in the fixed income space.
Instead, the more likely answer is the dearth of straightforward issues to
tackle or clear regulatory actions to take with respect to many of the key
issues concerning the bond markets.
Both the corporate and municipal bond markets present unique challenges
from a regulatory perspective given their overwhelmingly over-the-counter
nature, which leaves us with fewer of our traditional regulatory
responsibilities than we have for the equity markets.
As a result, I must confess that we encounter more questions than solutions
when it comes to potential problems in the fixed income markets.
This, of course, is where each of you and your colleagues come in.
At this point, I will repeat the message that I have given — and will continue
to give — to academic audiences.
As someone intimately engaged in the Washington, DC policymaking
process, I can assure you that academic research can have real, measurable
influence.
In order to achieve this influence, however, I urge you to use policy
implications as an ex ante motivation for new research ideas, rather than as
an ex post justification for an already-completed working paper.
This is especially true with respect to the municipal and corporate bond
markets, where both market participants and regulators alike have a
pressing need for rigorous analysis of current market concerns, possible
solutions, and the potential consequences to our financial markets.
Market Concerns
Without a doubt, the primary challenge I hear about from participants in
the bond markets is liquidity.
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Market participants have traditionally sourced bond liquidity directly from
dealers in the over-the-counter market.
Bond dealers under this traditional model hold inventories of bonds that
are used to make markets.
When dealer inventories are high, liquid bond markets typically follow and
everyone is happy.
When dealer inventories are low, market participants get worried and my
schedule fills up with meetings and calls from reporters.
You can probably guess what my outlook calendar looks like right now.
It is well-documented that bond dealer inventories are down since the
financial crisis.
This reduction is forcing market participants to rethink where they will find
liquidity when they need it, and causing regulators to examine what impact
this reduction may have on the markets as a whole.
Lately, the potential for a bond market liquidity crisis has been receiving a
lot of attention. Much of the discussion involves market stability issues
related to the markets and the issuers that rely on them.
At the SEC, we certainly have a strong interest in how a liquidity crisis
would affect the functioning of our markets, its effect on capital formation,
and its impact on investors.
Our interests are particularly heightened with respect to retail investors
that could be uniquely harmed by a bond market dislocation, as they may
be less able to navigate illiquid markets than more sophisticated
participants.
The SEC, and other financial regulators, can certainly use your help in
better understanding a number of issues related to these key concerns.
The first issue is the proper baseline against which to measure current
dealer inventories.
Some have suggested using 2006 or 2007 data as the baseline because they
provide the most recent pre-crisis data.
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Others have suggested that those years are not appropriate because there
may have been “too much liquidity” in the run-up to the crisis.
Unless we know the appropriate baseline to serve as a point of comparison,
we will not be able to properly understand the magnitude of the change.
The second issue is the underlying causes of the reduction. Recent actions
by prudential regulators have undoubtedly added to the risks and costs of
holding large inventories of bonds.
For example, Section 619 of the Dodd-Frank Act — the so-called Volcker
Rule — prohibits proprietary trading by banks, which makes it riskier for
banks to hold less-liquid assets like bonds and increases compliance costs
related to justifying legitimate market-making activity for these securities.
Basel III’s higher risk-weighted asset requirements and supplementary
leverage ratio also have raised costs associated with holding fixed income
securities by making certain assets, such as corporate bonds, more
expensive than under previous capital rules, and setting a higher threshold
for capital to be held against gross assets, respectively.
I share the concerns recently expressed by former Treasury Secretary Larry
Summers that prudential regulators have not been properly considering the
unintended consequences of their actions when he said, “I thought
regulatory authorities made a mistake when they looked at each institution,
and said, ‘You’ll be safer if you withdraw from the markets a bit,’ and then
forget that if all institutions withdraw from the markets a bit, the markets
would be less liquid. The markets themselves would be less safe.
That would, in the end, hurt all institutions.… Frankly, a lot of the effort
that’s going into macroprudential [regulation] should be into making sure
we have liquidity.”
In addition to regulatory pressures, which may make dealers less able to
provide bond market liquidity, in the current environment dealers may be
less willing to provide it.
For example, some have suggested that the Federal Reserve’s current zero
interest-rate policy makes dealer market-making less profitable.
Others have posited that, in the wake of the financial crisis, many dealers
reappraised their risk tolerance and are raising the risk premia they
demand in exchange for their services.
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Unless we fully understand the underlying causes of the reductions in
dealer inventories, we cannot assess whether the reductions are likely to be
permanent or temporary, or whether dealer market-making capacity is
likely to improve, stay the same, or decline in response to changes in
regulatory policies, interest rates, etc.
As a result, more work needs to be done before we can determine whether a
regulatory response is even necessary, and, if so, what type of response may
be appropriate.
These are the types of issues that merit further study by academic
researchers, and which would be of enormous value to the SEC and other
financial regulators.
Possible Solutions
One of the strengths of our markets is the ability of participants to adapt to
changes in the financial system.
This is strikingly evident in the fixed income markets.
As market participants reevaluate how they will find stable sources of
liquidity in a world of decreasing dealer inventories, a whole host of
market-based solutions are being developed.
I have met with numerous groups of talented individuals working on
creative solutions to bond market liquidity issues.
Some are looking to alleviate the reliance on dealer inventories by creating
exchange-like platforms for bonds, while others have been developing
alternative trading systems to allow buy-side firms to directly interact with
one another to satisfy their liquidity needs.
Still others are seeking to improve liquidity in the future by standardizing
the terms of bond issuances.
Many of these proposed solutions overlap and reinforce one another, and
yet each contains its own unique characteristics.
As a firm believer in the power of competition and market-based solutions,
I applaud this innovation. Some have called for the SEC to “do more” to
enhance the market structure of municipal and corporate bonds.
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However, at this point, given all the innovation that is moving forward, I
view my role as quite straightforward: stay out of the way.
We should let market participants, not regulators, determine which ideas
succeed.
It is interesting to note that while groups are proposing to address the
liquidity shortfall in any number of ways, they each face one challenge that
is the same: the complexity of the fixed income markets.
Although corporate bond issuances for the most part are not as complex as
municipal bond issuances, their unique characteristics still present barriers
that must be overcome if any new market structure initiatives are going to
succeed.
As each of these new approaches to increasing liquidity in the bond markets
vies for market share, there will be ample opportunity for academics to
examine their strengths and weaknesses — including any knock-on effects
of restructuring in this market — as well as broader questions surrounding
complexity and standardization.
Potential Consequences
As market participants seek out new ways to operate efficiently in today’s
fixed income markets, regulators are still left questioning what could occur
if efforts to address liquidity shortfalls are ineffective in a time of severe
market stress.
Academic research in this area could provide invaluable assistance to the
SEC and other financial regulators as we try to better understand the types
of events that could cause market instability, as well as the potential
magnitude of such events.
Two recent incidents provide excellent case studies for this type of analysis.
The first is the October 15, 2014 liquidity event or so-called “flash crash” in
the Treasury market.
On that day, the yield on the benchmark 10-year U.S. Treasury bond
suddenly plunged more than 30 basis points to 1.86 percent.
Later that afternoon, yields rebounded to 2.13 percent.
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I continue to be surprised that so few U.S. market participants have drawn
attention to this exceptional event.
I say “U.S.” because I have found that contrary to the somewhat muted
response to the event in our country, it drew an enormous amount of
scrutiny abroad.
On a trip late last year to Australia, New Zealand, and Singapore, I had
numerous meetings with international market participants and regulators.
Without fail, the topic of the October 15th event in the Treasury market
came up in each conversation.
Those meetings revealed a great amount of concern that what is viewed as
the most liquid market in the world could experience this type of instability.
Some wondered aloud whether it reflected the proverbial “canary in the
coal mine” and portends future liquidity shocks in the rest of the world’s
fixed income markets.
While the Treasury market has key differences from the rest of the bond
markets, the October 15th liquidity event still seems ripe for study to
determine its causes and what it can teach us about liquidity in other debt
markets.
The second event seems like the perfect test case for a common narrative
regarding potential contagion risks in the bond market.
Questions continually arise regarding how the market will react to
significant outflows from a single large financial firm, and whether such an
event could pose risks to the financial system as a whole.
This hypothetical scenario became a reality in September of last year when
a well-known fund manager abruptly resigned from one of the world’s
largest asset managers.
That firm experienced billions of dollars of outflows from multiple
fixed-income funds in the days after the announcement, which is precisely
the type of event some suggest could cause market-wide impacts.
Despite these unprecedented outflows, I have seen no evidence to suggest
that they posed any measurable threat to the stability of the bond markets.
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I look forward to reading analyses of this event to see what we can learn
about how our markets function in times of stress at individual financial
firms.
Despite its challenges, the fixed income market remains a vital part of our
nation’s financial system.
I appreciate all of your work in this field, and I encourage you to take up
these issues as topics of research and share the results with us at the SEC.
Thank you. Enjoy the rest of this great conference.
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Eighth progress report on adoption of the
Basel regulatory framework
April 2015
Introduction
This report sets out the adoption status of Basel II,
Basel 2.5 and Basel III regulations for each Basel
Committee member jurisdiction as of end-March 2015.
It updates the Committee’s previous progress reports, which have been
published on a semi-annual basis since October 2011.
In 2012, the Basel Committee started the Regulatory Consistency
Assessment Programme (RCAP) to monitor progress in introducing
regulations, assess their consistency and analyse regulatory outcomes.
As part of this programme, the Committee periodically monitors the
adoption status of the risk-based capital requirements (since October 2011)
and (since October 2013) the requirements for global and domestic
systemically important banks, the liquidity coverage ratio (LCR) and the
leverage ratio.
Regarding the consistency of regulatory implementation, the Committee
has published its assessment reports on 19 members, including nine
members of the European Union (Australia, Brazil, Canada, China,
European Union, Hong Kong SAR, Japan, Mexico, Singapore, Switzerland
and United States of America) regarding their implementation of Basel III
risk-based capital regulations, which are available on its website.
This includes all members who are home jurisdictions of global systemically
important banks (G-SIBs).
The Committee has also published its assessment reports on the domestic
adoption of the Basel LCR standards in Hong Kong SAR and Mexico in
March 2015.
The assessments of India, Saudi Arabia and South Africa have begun, and
include consistency of implementation of both risk-based capital standards
and the Basel III LCR standards.
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By September 2016, the Committee aims to have assessed the consistency
of risk-based capital standards of all 27 member jurisdictions.
Regarding the analysis of consistency of regulatory outcomes, the
Committee is conducting additional analytical work on risk-weighted asset
(RWA) variation in the banking and trading books, which is envisaged to be
published during the second quarter of 2015.
In addition, measures to address excessive variation are under
development, and the Basel Committee expects to publish its progress later
this year.
The Committee is also considering a proposal for ongoing monitoring of
RWA variation from 2015.
Status of adoption of Basel III standards
Scope
The Basel III framework builds on and enhances the regulatory framework
set out under Basel II and Basel 2.5.
The table attached therefore reviews members’ regulatory adoption of Basel
II, Basel 2.5 and Basel III.
•
Basel II: Basel II, which improved the measurement of credit risk and
included capture of operational risk, was released in 2004 and was due to
be implemented from year-end 2006.
The Framework consists of three pillars: Pillar 1 contains the minimum
capital requirements; Pillar 2 sets out the supervisory review process; and
Pillar 3 corresponds to market discipline.
•
Basel 2.5: Basel 2.5, published in July 2009, enhanced the
measurements of risks related to securitisation and trading book exposures.
Basel 2.5 was due to be implemented no later than 31 December 2011.
•
Basel III: In December 2010, the Committee released Basel III, which
set higher levels for capital requirements and introduced a new global
liquidity framework.
Committee members agreed to implement Basel III from 1 January 2013,
subject to transitional and phase-in arrangements.
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•
G-SIB framework: In July 2013, the Committee published the
framework on the assessment methodology and the higher loss absorbency
for global systemically important banks (G-SIBs).
The requirements will be introduced on 1 January 2016 and become fully
effective on 1 January 2019.
To enable their timely implementation, national jurisdictions agreed to
implement by 1 January 2014 the official regulations/legislations that
establish the reporting and disclosure requirements.
•
D-SIB framework: In October 2012, the Basel Committee issued a set
of principles on the assessment methodology and the higher loss
absorbency requirement for domestic systemically important banks
(D-SIBs).
Given that the D-SIB framework complements the G-SIB framework, the
Committee believes it would be appropriate if banks identified as D-SIBs by
their national authorities are required to comply with the principles in line
with the phase-in arrangements for the G-SIB framework, ie from January
2016.
•
Liquidity coverage ratio: In January 2013, the Basel Committee
issued the revised liquidity coverage ratio (LCR).
The LCR underpins the short-term resilience of a bank’s liquidity risk
profile.
The LCR came into effect on 1 January 2015 and is subject to a transitional
arrangement before reaching full implementation on 1 January 2019.
•
Leverage ratio: In January 2014, the Basel Committee issued the
Basel III leverage ratio framework and disclosure requirements following
endorsement by its governing body, the Group of Central Bank Governors
and Heads of Supervision (GHOS).
Implementation of the leverage ratio requirements has begun with
bank-level reporting to national supervisors and public disclosure on 1
January 2015.
•
Net stable funding ratio: In October 2014, the Basel Committee
issued the final standard for the net stable funding ratio (NSFR).
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In line with the timeline specified in the 2010 publication of the liquidity
risk framework, the NSFR will become a minimum standard by 1 January
2018. The monitoring of the status of adoption of the NSFR is planned to
start with the next progress report in October 2015.
Methodology
The information contained in the following table is based on responses
from Basel Committee member jurisdictions, and reports the status as of
end-March 2015.
The following classification is used for the adoption status of Basel
regulatory rules:
1.
Draft regulation not published: no draft law, regulation or other
official document has been made public to detail the planned content of the
domestic regulatory rules.
This status includes cases where a jurisdiction has communicated
high-level information about its implementation plans but not detailed
rules.
2.
Draft regulation published: a draft law, regulation or other official
document is already publicly available, for example, for public consultation
or legislative deliberations.
The content of the document has to be specific enough to be implemented
when adopted.
3.
Final rule published: the domestic legal or regulatory framework has
been finalised and approved but is still not applicable to banks.
4.
Final rule in force: the domestic legal and regulatory framework is
applied to banks.
In order to support and supplement the status reported, summary
information about the next steps and the adoption plans being considered
are also provided for each jurisdiction.
In addition to the status classification, a colour code is used to indicate the
adoption status of each jurisdiction.
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The colour code is used for those Basel components for which the agreed
adoption deadline has passed.
To read more:
http://www.bis.org/bcbs/publ/d318.pdf
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Monitoring, regulation and self-regulation in
the European banking sector
Speech by Ms Sabine Lautenschläger, Member of the
Executive Board of the European Central Bank and
Vice-Chair of the Supervisory Board of the Single
Supervisory Mechanism, at the evening reception at
the Deutsche Aktieninstitut, Frankfurt am Main
1. Introduction
Dear Mr Baumann, dear Mr Engels, ladies and gentlemen,
My topic today, "Monitoring, regulation and self-regulation in the
European banking sector", cannot currently be discussed without asking
ourselves the following questions.
Do we need to do more to make sure that we never have to experience
another financial market and banking crisis like that in 2008-09, or have
we done too much and thus prevented the European banking industry from
being able to offer financial services to the real economy?
After a long phase of deregulation, a comprehensive re-regulation has been
in vogue since 2009.
At the global, European and national level, we have tackled almost
everything that can limit, reduce or prevent risks to and risks caused by
banks.
The general public, politicians, academics, supervisors and even bankers simply everyone - called for comprehensive and tough rules for banks and
for their close supervision.
But the mood seems to have changed over the past year. In Germany and
Europe, more and more people are complaining of overregulation.
In the rest of Europe, a connection is being made between the words "credit
crunch" and "regulation".
Many people yearn for a pause in regulation, would perhaps rather leave
the market to regulate itself - rely on self-regulation.
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At the moment in Europe, we are a long way off from self-regulation.
And I hope that it will stay like this, even if people like to quickly forget bad
memories.
I do not believe in self-regulation, at least not in financial markets.
You cannot have stable and functional banks without comprehensive
regulation and energetic supervision.
A sustainably stable banking sector demands a set of regulations which can
keep up with the innovativeness of the financial sector and progress in
banking, but which sets adequate limits in order to uncover and correct
abnormal trends and excessive risks in their business activities.
To this end, the rules have to be adaptable and both leave room for
discretion and provide leeway for a clever supervisor with good judgement
skills.
2. A retrospective
The past speaks for itself.
A light touch in regulation and supervision, or even self-regulation, has not
proven to be a convincing solution.
Over the last two decades, global financial markets have been characterised
by a high level of volatility, a series of rapid booms, major upheavals and
severe slumps.
The Asian financial crisis of 1997, the dotcom bubble of 1997-2000, the US
subprime crisis as from 2007 and the European debt crisis are merely the
most prominent examples.
Looking at all these events, there is a recurrent pattern: innovation in the
real or financial economy and deregulation measures are followed by
accelerated growth, which is accompanied by a very expansive lending
policy on the part of banks.
Sooner or later, the boom comes to an end and price corrections take place
that often end in a recession.
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As a rule, the stronger the boom is at the start of the cycle, the larger is the
subsequent harm to the economy and to society.
This pattern is often complemented by another factor.
Particularly, but not exclusively, in the financial sector - a sector with fierce
competition between regulated and non-regulated financial market
participants - regulatory loopholes are actively exploited in order to gain
competitive or other advantages.
This is particularly well illustrated by the example of asset-backed
securities (ABSs).
From the middle of the 1990s, the originate-to-distribute model, i.e. the
securitisation and resale of loans, was seen by many as the financing model
of the future, not just in the United States, but also in Europe and Germany.
Many saw it as a solution to economic and socio-political problems and
took measures in favour of ABS financing in terms of regulatory
requirements.
Accordingly, banks were able, for example, to finance their ABS-based
special-purpose vehicles solely through short-term credit lines, credit lines
that are in place "until further notice".
The "loans" to the special-purpose vehicle did not have to be backed by
equity as long as the maturity of the loan commitments remained under one
year.
So it soon became standard practice among banks to limit the maturity of
such credit lines to 364 days and to prolong them accordingly at maturity.
The consequences of this practice became clear at the start of the subprime
crisis in 2007 when German banks were among the first to run into
difficulties because of these credit lines.
The past thus shows that financial markets do not always behave rationally.
In fact, markets tend towards exaggerations even more than individuals;
crowd psychology plays a significant role in pricing.
Given the potential for damage as a result of undesirable developments and
the incentives to which participants are exposed, it is obvious that
self-regulation alone is not sufficient in financial markets.
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3. Requirements to be met by regulation and supervision
Against this background, the question is which regulatory or supervisory
approach is the right one for a modern financial system.
Should financial markets be subject to all-encompassing regulation in
which every single activity is regulated down to the smallest detail?
My answer is "no" - because this would not have a satisfactory outcome,
either.
Depending on its design, such a rule book would either be permanently
outdated and incomplete, because legislators cannot keep up with the rapid
pace of innovation within the financial sector with meticulous regulation, or
would have to regulate so rigidly that it would impose excessive restrictions
on the functioning of the financial system.
As is often the case, the most sensible option is in the middle.
We need regulation based on principles which adapts to changes in banking
and we need a supervisory authority that is capable taking action.
Allow me to elaborate.
Good regulations must be adaptable.
They must be just as applicable to different business models as they are to
different sizes of institution - they must fit large and small institutions
alike.
Good regulations must adapt to changing circumstances without legislators
having continually to improve on them.
Accordingly, the rules must provide room for discretion in individual cases.
Good regulations must, however, also ensure a minimum level of planning
and legal certainty for banks; that is the only way in which banks operate
properly and provide their financial services over the long term.
This holds particularly true of Europe, where banks play a greater role in
financing the real economy than the capital markets.
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At the same time, there has to be a global understanding of what regulation
means, since regulations could otherwise, given the global
interconnectedness of financial markets, be easily leveraged and since fair
competition can only be assured when the rules of the game are the same.
I remain convinced that regulation and supervision must be sensitive to
risks.
This means that the bank that takes greater risks and poses a greater threat
to financial stability must also be subject to stricter rules and/or limitations
on its business activities.
If our set of rules was to treat different risk profiles in the same way, then
we would subject conservative, low-risk banking business with low yields to
the same requirements as high-risk business activities, thereby making the
former uneconomical.
In my view, that would be creating the wrong incentive.
We need a shrewd supervisory authority that monitors compliance with the
rules and supervises banks in a consistent and tough but fair way.
It needs to be shrewd because it must be able to use its discretionary powers
correctly when regulating matters and weigh different arguments on a
case-by-case basis.
In this role, supervision must be able to act across national borders,
because that is the only way to ensure that large, internationally active
institutions, too, are subject to consistent and comprehensive control.
These are stringent requirements which we can only honour with a
consistent focus on the ultimate goal of regulation and supervision, namely
a stable financial system.
I would therefore like to end my list of requirements with a warning.
Under no circumstances should regulation be misused to support economic
development.
That would blur responsibilities and shift tasks from the political domain to
supervision.
New rules for the banking industry go hand in hand with burdens.
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With a multitude of new rules, the sum of those burdens can impair the
banking industry's ability to function properly.
This must be taken into account and solutions must be found, but this
cannot be done by ignoring risks.
The past has shown us far too often that there is no point in ignoring risks
to banks - in the medium and long term, they always come back like a
boomerang.
4. Current status and further need for improvement
Where do we currently stand in Europe in this respect? Do we need more
regulation, or do we need less?
Since 2009, the regulatory framework has undergone further extensive
development and has been decisively improved upon at both the
international and the European level.
Let me mention just a few elements by way of a reminder:
-
considerably more and higher-quality capital for banks;
-
new standards for liquidity reserves and indebtedness in banks;
-
considerably stricter risk management and governance requirements;
-
the Bank Recovery and Resolution Directive (BRRD) that marks
significant progress in dealing with distressed institutions.
Thanks to these reforms, the regulatory network within Europe has become
considerably tighter and more balanced in recent years.
It has developed from a purely capital-based system into a set of diversified
standards.
This has made it more difficult to circumvent individual regulations.
It requires banks to give due consideration to a broad range of relevant
factors (capital, liquidity, leverage, interconnectedness/systemic
significance and structure) when designing their business models.
Despite this progress, there is still work to be done here and there.
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We must convincingly weaken the connections between a country and its
banks in the long run.
Government bonds continue to be considered by regulators as largely
risk-free: there is neither an obligation to have capital available that is
commensurate with the risks, nor are there rules that address
concentration risks.
This cannot be allowed.
We must also improve the calculation of equity in individual banks.
A great deal of confidence has been lost in this respect over recent years.
Internal bank models are today seen by many to be a means for risky capital
optimisation and not as a useful tool for bank management and risk-based
supervision.
To restore confidence, we need less complexity and more transparency.
Not every portfolio or risk can be modelled.
For these portfolios, we must use simple, standardised approaches.
We must reduce the complexity of the model-based approaches to a level
which allows both the banks' supervisory bodies and the supervisory
authorities to understand and review them within a reasonable period of
time.
Standard approaches should also be used here as a control variable and
indicator for capital savings.
Given the great number of regulatory measures, it is important not to lose
sight of the bigger picture.
We will therefore carry out a comprehensive analysis of the overall effect of
regulatory measures.
This project is already being planned and prepared by the Basel Committee.
Such an exercise will do us good and will also be beneficial to the general
debate on regulation, helping objectify it.
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I hope that this work will not only result a list of overlaps, duplication and
other inefficiencies which we would subsequently clear up.
I also expect that we will address unintended consequences of the new
rules.
In supervision, too, much needs to be changed.
The crises of recent years did not come about solely because there were
weaknesses in the regulatory framework.
The supervision of banks did not function optimally, either.
The consequence of the crisis is therefore not only that the supervision of
banks has shifted from the national level in the euro area to a European
level, but also that supervision has changed in its basic approach and in
what is expected of it and the supervised entities.
The SSM has allowed us to start afresh in our relationship with banks.
It has broken with traditions and customs that were often no longer being
questioned.
Supervisory teams from different countries see the banks with fresh eyes
and on the basis of their common experience.
This creates the necessary critical distance for sensible supervision.
Banking supervision in Europe should take tough but fair action (the
emphasis being on "action").
European supervision, the SSM, sees itself as a supervisor which identifies
and addresses risks at an early stage, and thus contributes to ensuring that
the banking system is able to function properly.
A light touch and reactive supervision should belong to the past.
European supervision should create a level playing field.
That is why the first thing that we developed in the SSM was a consistent
supervisory approach with a consistent methodology for assessing banks'
risks and governance structures, as well as their equity capital and liquidity
positions.
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For the supervision of systemically relevant and large, internationally active
banks in particular, the SSM represents a quantum leap forward.
The SSM allows us to compare and adapt supervision across 19 countries, to
identify best practices and to ensure that they are implemented consistently
through effective quality assurance.
There are now completely new possibilities for comparative and
cross-sectoral analysis than were available at the national level.
For our tasks, we can use information and insights from banks with very
different business models.
This enables us to identify risks and undesirable developments more clearly
and at an earlier stage, and to take suitable countermeasures.
We can also put work on banks' internal models, which have a significant
influence on a bank's capital requirements, on a new footing.
We will use the opportunity, given the improved level of data and insight, to
implement strict rules for the approval and ongoing supervision of internal
models.
Despite this progress, there is still a lot to do in the further development of
supervision.
The effectiveness and efficiency of supervision is dependent on the legal
framework it applies, although this is not the sole determinant.
Soft European standards or diverging national rules impair the SSM's
ability to take action and its effectiveness.
And this does not just concern national rules that affect the quality of
banks' equity.
The SSM applies 19 different national legal frameworks and not only when,
for example, we examine the professional suitability of managers in large,
internationally active banks.
Detailed rules on governance in banks and deliberations on transposing
extensive rules on banks' internal control systems into national law
complicate or even prevent the desired level playing field of consistent
supervision - they increase fragmentation.
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Moreover, European supervisory legislation provides more than 150
options to choose from, options which have so far been exercised along
highly different lines at the national level.
Some are justified by local features - in this respect, the principle is that
similar things should be treated similarly and dissimilar things should be
treated dissimilarly.
Many of the options are based rather more on tradition, and are in conflict
with the principle of "same business, same risk, same rules".
The smaller proportion of these options remains national in character.
Competence for the majority of the options - for over 100 - has been vested
in the SSM since 4 November 2014.
The ECB, together with the national supervisory authorities, has now begun
to arrange for their consistent application.
This process and the resulting adaptations will not always be simple or
convenient, but the benefits of the outcome should outweigh the cost of
adaption - not just in terms of financial stability, but also through more
balanced competition and lower transaction costs.
In some respects, we are still at the beginning of the road, but I am
confident that the SSM has put us are on the right path towards achieving
these objectives.
5. Conclusions
I don't think that you were much surprised by my saying that I don't think
much of lax regulation.
Given the obvious tendency towards exaggeration and erroneous
developments in financial markets, and the potential damage for the
economy and society, good regulations are an indispensable prerequisite
for ensuring that the financial sector is able to function properly in the long
term.
This does not mean that the consequences of regulation and supervision for
the banking industry's ability to function should not be considered.
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The desire of some to make up for the rigour of the rules with less stringent
supervision is something I reject.
That would be the wrong approach.
But what are required are not only good regulations, but also a
well-functioning supervisor that exercises tough but fair control to help
ensure a stable banking system and a level cross-border playing field.
A decisive factor for the success of the SSM will not just rest on banks in the
euro area being subject to a consistent supervisory approach.
Rather, both supervisory legislation and the powers of European
supervision must take further steps in the direction of harmonisation.
Finally, it is not possible for every conceivable situation to be covered by
regulations, nor can every crisis be anticipated from a supervisory point of
view.
Although regulation and supervision can ensure a certain measure of
protection, or build a line of defence, as it were, they cannot and should not
eliminate every risk.
In this respect, banks and financial market participants that act
independently, and take responsibility for their actions, remain a
prerequisite for a stable and secure system, even if it is well-regulated and
supervised.
Thank you for your attention.
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International Association of Risk and Compliance Professionals (IARCP)
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Community Bank Regulations
Maryann F. Hunter, Deputy Director, Division of
Banking Supervision and Regulation, before the
Subcommittee on Financial Institutions and
Consumer Credit, Committee on Financial Services, U.S. House of
Representatives, Washington, D.C.
Introduction
Chairman Neugebauer, Ranking Member Clay, and other members of the
subcommittee, I appreciate the opportunity to testify on the important
topic of community financial institutions and regulatory relief for these
institutions.
Community banks are a critical component of our financial system and
economy.
They reduce the number of underbanked citizens by providing banking
services that may otherwise go unmet, particularly in rural areas.
They also are especially effective at meeting the credit needs of their
surrounding communities.
Because of their firsthand knowledge of the local economic landscape, they
are better prepared to look beyond traditional credit factors to consider
unique borrower characteristics when making credit decisions.
Having begun my career more than 30 years ago as a community bank
examiner at the Federal Reserve Bank of Kansas City and eventually
becoming the officer in charge of bank supervision at the Reserve Bank, I
have seen firsthand how critical it is that we balance effective supervision
and regulation to ensure that community banks operate in a safe and sound
manner, while not subjecting these institutions to unnecessary regulatory
requirements that could constrain their capacity to lend to the communities
they serve.
In my testimony, I will discuss measures taken by the Federal Reserve to
calibrate regulations, policies, and supervisory activities to the risks at
community banking organizations.
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Condition of Community Banks
The Federal Reserve supervises approximately 860 state-chartered
community banks that have chosen to be members of the Federal Reserve
System (referred to as state member banks).
In addition, the Federal Reserve supervises approximately 4,400 top-tier
bank holding companies and approximately 300 top-tier savings and loan
holding companies, most of which operate small community thrifts.
The overall condition of community banks has improved significantly in the
time since the recent financial crisis.
The number of banks on the Federal Deposit Insurance Corporation's
(FDIC) "Problem List" fell from a peak of 888 at the end of the first quarter
of 2011, to 291 at year-end 2014.
Despite that significant decline, the number of problem banks compares
unfavorably with historical numbers of less than 100, on average, in the
years prior to the crisis.
Overall capital levels and asset quality at community banks have improved
since the financial crisis.
At year-end 2014, the aggregate tier 1 risk-based capital ratio for
community banks was 14.5 percent, up from a low of 12.0 percent at
year-end 2008, and the aggregate leverage ratio was 10.5 percent, up from a
low of 9.2 percent at year-end 2009.
Noncurrent loans represented 1.4 percent of total loans at year-end 2014,
down significantly from 4.1 percent at year-end 2009, while net charge-offs
as a percent of total loans were down to 0.3 percent at year-end 2014 from a
high of 1.6 percent at year-end 2009.
Moreover, community banks saw an uptick in lending in 2014, with annual
loan growth of 6.5 percent at year-end 2014.
This is in stark contrast to the period from 2009 through 2011, when total
loans declined each year.
Banks' earnings have benefited in the past couple of years from reductions
in provision expenses for loan and lease losses.
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Yet, community bank earnings continue to experience considerable
pressure from historically low net interest margins, and many community
banks report concerns about their prospects for continued growth and
profitability.
The Federal Reserve's Approach to Supervising and Regulating
Community Banks
The Federal Reserve uses a risk-focused approach to supervision, with
activities directed toward identifying the areas of greatest risk to banking
organizations or consumers and assessing the ability of the organizations'
management processes to identify, measure, monitor, and control those
risks.
Under our risk-focused supervision framework, bank examination and
holding company inspection procedures are tailored to each banking
organization's asset size, complexity, risk profile, and condition.
The supervisory program for all institutions, regardless of size and
complexity, entails both off-site and on-site work, including development of
supervisory plans, review of financial data, transaction testing,
documentation of examination results, assignment of supervisory ratings,
and communication of examination findings to the bank and its board of
directors.
There are distinct differences between the supervision program of a large,
complex banking organization and a small, non-complex bank.
For one, a large banking organization generally has a dedicated supervisory
team, supported by risk specialists, whereas a small bank is generally
visited by examiners only every 12 to 18 months.
Furthermore, if a bank is engaging in nontraditional or higher-risk
activities, our supervision program typically requires greater scrutiny and a
higher level of review of specific transactions and risk areas.
Conversely, if a well-managed bank's activities are lower risk, we adjust our
expectations for examiners to a lower level of review. In this way, we
alleviate examination burden on community banks with histories of sound
performance and modest risk profiles.
Consistent with the Federal Reserve's risk-focused approach to supervision
and when permitted by law, the Federal Reserve scales supervisory rules
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and guidance in a way that applies the most stringent requirements to the
largest, most complex banking organizations that pose the greatest risk to
the financial system.
We work within the constraints of the law to draft rules and guidance so as
not to subject community banks to requirements that are not
commensurate with their risks and that would be unduly burdensome for
these institutions to implement.
We recognize that the cost of compliance can be disproportionally greater
on smaller institutions versus larger institutions, as community banks have
fewer staff available to help comply with additional regulations.
Therefore, we carefully consider the need to establish new requirements to
safeguard the safety and soundness of the financial system against the
burden on banks to implement new requirements.
Many recently established rules have been tailored to apply the strictest
requirements to only the largest, most complex banking organizations.
One such example is the capital rule, issued in 2013, where many of the
requirements do not apply to community banks.
These requirements include the countercyclical capital buffer,
supplementary leverage ratio, trading book reforms, capital requirements
for credit valuation adjustments, and disclosure requirements.
Community banks also are not subject to additional enhanced standards
that large banking organizations face related to capital plans, stress testing,
liquidity and risk management requirements, and the systemically
important financial institution surcharge.
The Federal Reserve has made a concerted effort to communicate clearly to
both community bankers and examiners about new requirements that are
applicable to community banks.
We provide a statement at the top of each Supervision and Regulation letter
and each Consumer Affairs letter that clearly indicates which banking entity
types are subject to the guidance.
These letters are the primary means by which the Federal Reserve issues
supervisory and consumer compliance guidance to bankers and examiners,
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and this additional clarity allows community bankers to focus efforts only
on the supervisory policies that are applicable to their banks.
Also, to assist community banks in understanding how new complex rules
could possibly affect their business operations, the federal banking agencies
have issued supplemental guides that focus on rule requirements that are
most applicable to community banks.
For example, the federal banking agencies issued supplemental guides for
the 2013 capital rule, as well as the Volcker rule issued in December 2013.
Coordination with the Other Banking Agencies
In order to help ensure that its supervision program is not unduly
burdensome, the Federal Reserve also works closely with its colleagues at
the other federal banking agencies and the state banking agencies to ensure
that our supervisory approaches and methodologies are consistent and
complementary.
The agencies also work cooperatively to coordinate the examination of
institutions subject to the supervision of more than one agency.
For instance, on the resolution of a problem bank or thrift, the FDIC, as the
insurer of depository institutions, has backup examination authority and
coordinates with the primary federal bank regulator (either the Federal
Reserve for state member banks or the Office of the Comptroller of the
Currency (OCC) for national banks and federal thrifts) and as applicable
with the state banking department on its participation on an examination.
The Federal Reserve and the FDIC also coordinate the examination of state
banks with the responsible state banking department.
As the supervisor for holding companies, the Federal Reserve coordinates
its examination activities with the OCC and the FDIC when the holding
company and the bank or thrift subsidiary share risk-management
functions.
The Dodd-Frank Act requires that the Federal Reserve and the Consumer
Financial Protection Bureau (CFPB) coordinate aspects of their consumer
compliance supervision of insured depository institutions and their
affiliates, including scheduling of examinations, providing reciprocal
opportunities to comment upon reports of examination prior to issuance,
and reciprocally providing final reports of examination after issuance.
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In May 2012, the Federal Reserve and the other federal banking agencies
entered into a Memorandum of Understanding on Supervisory
Coordination (MOU) with the CFPB.
The MOU establishes arrangements for coordination and information
sharing among the parties.
The Dodd-Frank Act also requires the CFPB to consult with the appropriate
federal banking agencies before proposing rules and during the comment
process.
Through the work of the various Federal Financial Institutions
Examination Council's (FFIEC) task forces and subcommittees, staffs of the
agencies meet to discuss the implementation of supervisory guidance and
to develop common examination approaches and regulatory reports.
For example, the FFIEC member agencies are coordinating various work
streams on cybersecurity to improve collaboration with law enforcement
and intelligence agencies and to communicate the importance of
cybersecurity awareness and best practices among the financial industry
and regulators.
Also, to foster consistency in the examination of state community banks,
the Federal Reserve, the FDIC, and the FFIEC State Liaison Committee
have adopted common examination procedures (referred to as the
Examination Documentation (ED) modules) and have an ongoing,
interagency process for the review and updating of the ED modules to
reflect current regulatory and policy mandates.
Moreover, all of the FFIEC member agencies collaborate on the
development of common consumer compliance examination procedures to
support consistent supervision related to consumer protection statutes and
regulations.
Through the FFIEC, the agencies are considering ways to reduce burden
associated with quarterly filing of the Consolidated Reports of Condition
and Income (commonly called the Call Report), including collecting less
data from banks.
As part of this effort, agency staff are planning on-site visits to several
community banks to better understand aspects of their Call Report
preparation processes that could be sources of reporting burden.
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This would include having the banks show where manual intervention is
necessary to report particular Call Report items.
Also, agency staff have enhanced training on upcoming reporting changes,
such as recently holding teleconferences to provide guidance on changes to
regulatory capital reporting requirements.
Federal Reserve Efforts to Provide Regulatory Relief to
Community Banks
The Federal Reserve has several internal efforts underway aimed at
providing regulatory relief for community banks.
For instance, the Federal Reserve periodically reviews its existing
supervisory guidance to assess whether the guidance is still relevant and
effective.
We recently completed a policy review of the supervision programs for
community and regional banking organizations to make sure the programs
and related supervisory guidance are appropriately aligned with current
banking practices and risks.
The project entailed an assessment of all existing supervisory guidance that
applies to community and regional banks to determine whether the
guidance is still appropriate.
As a result of this review, we are likely to eliminate some guidance that is no
longer relevant and to update other guidance for appropriateness to current
supervisory and banking industry practices and relevance to the risks to
these institutions.
Additionally, we are continually working to calibrate examination
expectations so that they are commensurate with the risks at these
institutions.
For example, the Federal Reserve has an initiative currently underway to
use Call Report data and forward-looking risk analytics to identify high-risk
community and regional banks, which would allow us to focus our
supervisory response on the areas of highest risk and reduce the regulatory
burden on low-risk community and regional banks.
Along these lines, the Federal Reserve adopted a new consumer compliance
examination framework for community banks in January 2014.
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While we have traditionally applied a risk-focused approach to consumer
compliance examinations, the new program more explicitly bases
examination intensity on the individual community bank's risk profile,
weighed against the effectiveness of the bank's compliance controls.
This should increase the efficiency of our supervision and reduce regulatory
burden on many community banks.
In addition, we revised our consumer compliance examination frequency
policy to lengthen the time frame between on-site consumer compliance
and Community Reinvestment Act examinations for many community
banks with less than $1 billion in total consolidated assets.
We have also been investigating ways that would allow for more
supervisory activities to be conducted off-site, which can improve efficiency
and reduce burden on community banks.
For example, we can conduct some aspects of the loan review process
off-site for banks that maintain electronic loan records and have invested in
technologies that would allow us to do so.
While off-site loan review has benefits for both bankers and examiners,
some bankers have expressed concerns that increasing off-site supervisory
activities could potentially reduce the ability of banks to have face-to-face
discussions with examiners regarding asset quality or risk-management
issues.
In that regard, we will continue to work with community banks that may
prefer their loan reviews to be conducted on-site.
In short, the Federal Reserve is trying to strike an appropriate balance of
off-site and on-site supervisory activities to ensure that resources are used
more efficiently while maintaining high-quality supervision of community
banks.
The Federal Reserve has invested significant resources in developing
various technological tools for examiners to improve the efficiency of both
off-site and on-site supervisory activities, while ensuring the quality of
supervision is not compromised.
For instance, the Federal Reserve has automated various parts of the
community bank examination process, including a set of tools used among
all Reserve Banks to assist in the pre-examination planning and scoping.
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This automation can save examiners and bank management time, as a bank
can submit requested pre-examination information electronically rather
than mailing paper copies to the Federal Reserve Bank.
These tools also assist examiners in the off-site monitoring of community
banks, enabling examiners to determine whether a particular community
bank's financial condition has deteriorated and warrants supervisory
attention between on-site examinations.
As we develop supervisory policies and examination practices, we are
mindful of community bankers' concerns that new requirements for large
banking organizations could become viewed as "best practices" that trickle
down to community banks in a way that is inappropriate.
To address this concern, the Federal Reserve is enhancing communications
with and training for examinations staff about expectations for community
banks versus large banking organizations to ensure that expectations are
calibrated appropriately.
Specifically, we are modernizing our longstanding examiner commissioning
training program for community bank examiners, and a key part of this
effort is ensuring that examiners are trained on the different supervisory
programs and requirements for community banks and large banking
organizations.
In addition, when new supervisory policies are issued, we typically arrange
a teleconference to explain the new policy to examiners, including whether
and to what extent the policy is applicable to community banks.
By effectively training our examination staff and providing channels to keep
them informed of newly issued policies in a timely manner, examiners are
better equipped to understand the supervisory goals of regulations and
guidance for community banks and to provide appropriate guidance to
community banks.
Small Bank Holding Company Policy Statement and Resulting
Changes in Regulatory Reporting Requirements
More recently, the Federal Reserve Board has taken regulatory action to
reduce the burden on community banking organizations with the issuance
of a final rule that expands the applicability of its Small Bank Holding
Company Policy Statement and also applies the statement to certain
savings and loan holding companies.
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The policy statement facilitates the transfer of ownership of small
community banks and savings associations by allowing their holding
companies to operate with higher levels of debt than would normally be
permitted.
While holding companies that qualify for the policy statement are excluded
from consolidated capital requirements, their depository institution
subsidiaries continue to be subject to minimum capital requirements.
The final rule raises the asset threshold of the policy statement from $500
million to $1 billion in total consolidated assets.
It also expands the application of the policy statement to savings and loan
holding companies.
All firms must still meet certain qualitative requirements, including those
pertaining to nonbanking activities, off-balance sheet activities, and
publicly registered debt and equity.
The scope of the previous policy statement has been expanded to cover
approximately 440 additional bank holding companies and 280 savings
and loan holding companies.
Going forward, this means that 89 percent of all bank holding companies
and 81 percent of all savings and loan holding companies will be covered
under the policy statement.
This expansion follows a revision to the Dodd-Frank Act recently passed by
Congress.
In an action related to the expansion of the policy statement's scope, the
Board took steps to relieve regulatory reporting burden for bank holding
companies and savings and loan holding companies that have less than $1
billion in total consolidated assets and meet the qualitative requirements of
the policy statement.
Specifically, the Board eliminated quarterly and more complex
consolidated financial reporting requirements (FR Y-9C) for approximately
470 of these institutions, and instead required parent-only financial
statements (FR Y-9SP) semiannually.
The Board also eliminated all regulatory capital data items that were to be
reported on the FR Y-9SP for approximately 240 savings and loan holding
companies with less than $500 million in total consolidated assets.
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The Board made these changes effective on March 31, 2015, and
immediately notified the affected institutions, so they would not continue to
invest in system changes to report revised regulatory capital data for only a
short period of time.
Economic Growth and Regulatory Paperwork Reduction Act of
1996 Review
In addition to the Federal Reserve efforts mentioned earlier, the federal
banking agencies and the FFIEC have launched a review to identify banking
regulations that are outdated, unnecessary, or unduly burdensome, as
required by the Economic Growth and Regulatory Paperwork Reduction
Act of 1996 (EGRPRA).
The major categories of regulations covered in the review include
applications and reporting; powers and activities; international operations;
banking operations; capital; the Community Reinvestment Act; consumer
protection; directors, officers, and employees; money laundering; rules of
procedure; safety and soundness; and securities.
This review will cover all agency rules in these categories, including rules
recently adopted or proposed in the implementation of the Dodd-Frank
Act.
The agencies are soliciting comments on their regulations through notices
in the Federal Register.
As part of the EGRPRA review process, the agencies are holding several
outreach meetings with bankers, consumer groups, and other interested
parties to engage individuals in a public discussion about the agencies'
regulations.
The agencies have conducted two outreach meetings to date in Los Angeles
and Dallas, respectively.
Additional outreach meetings are scheduled for the coming months,
including Boston on May 4, 2015; Kansas City on August 4, 2015; Chicago
on October 19, 2015; and Washington, D.C., on December 2, 2015.
The Kansas City outreach meeting will focus more specifically on issues
affecting rural institutions.
Several themes have arisen so far from discussions at the outreach
meetings.
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A recurring theme has been the question of whether the agencies could
reevaluate the various thresholds and limits imposed in regulations that
may constrain community banks and their lending activities.
For example, community bankers in rural areas have noted that it can be
difficult to find an appraiser with knowledge about the local market at a
reasonable fee.
Bankers have asked the agencies to consider increasing the dollar threshold
in the appraisal regulations for transactions below which an appraisal
would not be required, which could allow them to use a less-formal
valuation of collateral for a larger number of loans.
Bankers have also asked whether the agencies could review the statutorily
mandated safety-and-soundness examination frequency for banks, which
varies based on a bank's asset size and condition, as a way to ease burden
from frequent on-site examinations.
Other bankers have commented that some longstanding interagency
guidance may now be outdated and warrant a fresh look and revision.
Some of the relief that bankers have asked for and suggestions developed
through the EGRPRA process may require legislative action.
We will work with the other federal banking agencies as appropriate to
consider and assess the impact of potential changes identified through the
EGRPRA review process.
Gathering the Views of Community Bankers
Outside of the EGRPRA review process, the Federal Reserve uses multiple
channels to gather the views of community bankers on economic and
banking topics, including regulatory burden.
For instance, when a proposed rule or policy is issued to the public for
comment, we gather information from banking organizations that assists us
in assessing implementation complexity or cost, especially for the smallest
institutions.
The feedback received has been instrumental in helping us scale rules and
policies to appropriately reflect the risks at these institutions without
subjecting them to unnecessary burden.
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This was evident in the final capital rule that was issued in July 2013.
The final rule reflected several changes to respond to comments and reduce
the regulatory burden on community banks.
Also, in 2010, the Federal Reserve Board formed the Community
Depository Institutions Advisory Council (CDIAC) to provide input to the
Board of Governors on the economy, lending conditions, and other issues of
interest to community depository institutions.
CDIAC members are selected from representatives of banks, thrift
institutions, and credit unions serving on local advisory councils at the 12
Federal Reserve Banks.
One member of each of the Reserve Bank councils is selected to serve on the
national CDIAC, which meets twice a year with the Board of Governors in
Washington, D.C., to discuss topics of interest to community depository
institutions.
In order to better understand and respond to concerns raised by these
institutions through the various channels, the Federal Reserve Board has
established a community and regional bank subcommittee of its Committee
on Bank Supervision.
The governors on this subcommittee help the Board as a whole to weigh the
costs associated with regulation against the safety-and-soundness benefits
of new supervisory policies for smaller institutions.
The subcommittee also meets with Federal Reserve staff to hear about key
supervisory initiatives at community banks and ongoing research in the
community banking area.
Additionally, members of the Board of Governors routinely meet with
representatives from banks of all sizes to discuss banking conditions and
the regulatory landscape.
Conclusion
The Federal Reserve is committed to taking a balanced supervisory
approach that fosters safe and sound community banks and fair treatment
of consumers, and encourages the flow of credit to consumers and
businesses.
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To achieve that goal, we will continue to work to make sure that regulations,
policies, and supervisory activities are appropriately tailored to the level of
risks at these institutions.
In doing so, we will solicit and assess the views of bankers on supervisory
issues and regulatory burden through the EGRPRA process and other
communication channels.
Thank you for inviting me to share the Federal Reserve's views on
regulatory relief for community financial institutions. I would be pleased to
answer any questions you may have.
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The IFSB Announces the Release of
Prudential and Structural Islamic
Financial Indicators (PSIFIs) for 15
Member Countries
The Islamic Financial Services Board (IFSB) is
pleased to announce the release of a set of indicators on the financial
soundness and growth of the Islamic banking systems in 15 member
countries.
This initiative is in line with Article 4 of the IFSB Articles of Agreement,
which mandates the IFSB to establish a global database of the Islamic
financial services industry.
The indicators, called Prudential and Structural Islamic Financial
Indicators (PSIFIs), are the first set of internationally comparable measures
of the soundness of Islamic banking systems.
The PSIFIs capture information on the size, growth and structural features
of Islamic banking systems and on their macroprudential condition by
looking at measures of their capital, earnings, liquidity, and exposures to
various types of risks.
They also cover the indicators on capital adequacy and liquidity based on
newly issued IFSB Standards to complement international regulatory
reforms under the Basel III regime.
The indicators are part of an international effort involving the IFSB and
other organisations to construct a comprehensive picture of activity in the
Islamic financial services industry.
Due to rapid growth and significance of Islamic finance in many
jurisdictions, such information is increasingly needed to understand the
structure, soundness, and growth of the Islamic finance component within
the entire financial systems.
The PSIFIs thus provide statistics that are useful to financial sector
supervisors and policy-makers; fund providers and investors; academics
and researchers; international financial press and media as well as the
general public. Many of the PSIFIs are parallel to the widely used IMF
Financial Soundness Indicators (FSIs) on the strength or vulnerabilities of
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financial systems, but are customised to the specific characteristics of
Islamic banking.
As such, they will serve to highlight the role of Islamic banking within
national economies and permit comparisons between the conventional and
Islamic banking systems.
PSIFIs cover aggregated data of Islamic banking institutions at the country
level, compiled by the regulatory and supervisory authorities (RSAs) of the
participating countries.
The data are separately provided on stand-alone Islamic banks and Islamic
windows of conventional banks in jurisdictions where available.
The PSIFIs will be regularly collected on a quarterly basis from the
participating countries.
This press release covers data from 15 of the 16 countries that have agreed
to participate in the data compilation exercise.
These countries are: Afghanistan, Bahrain, Bangladesh, Brunei, Egypt,
Indonesia, Jordan, Kuwait, Malaysia, Nigeria, Oman, Pakistan, Saudi
Arabia, Sudan, and Turkey.
The PSIFI Database currently represents PSIFI data as of December 2013.
Data are provided for various types of “prudential indicators” (PIFI)
covering capital adequacy, leverage, nonperforming financing, earnings,
liquidity, and foreign currency exposure as well as “structural indicators”
(SIFI) focusing on items such as number of branches, employees, and size
of total assets, funding and financing portfolios.
The database also includes “metadata” which provides information on the
design and specifications of data elements.
“The launching of the IFSB database represents an important milestone in
the ongoing transformation of Islamic finance into a globally significant
undertaking”, said the Secretary General of the IFSB, Mr. Jaseem Ahmed.
He further added, “I am pleased to acknowledge that the IFSB PSIFIs
project has benefitted from the Technical Assistance from both the Islamic
Development Bank and Asian Development Bank (ADB) over the years”.
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The current phase of the project is being undertaken with a Technical
Assistance from the ADB.
The PSIFI Database (full set of data with metadata) is available on the
PSIFIs portal at the IFSB website http://psifi.ifsb.org
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Policies and governance framework
required to ensure Europe's prosperity
Opening address by Mr Carlos da Silva Costa,
Governor of the Bank of Portugal, at the Seminar
on "Governance and Policies for Prosperity in
Europe", Lisbon
Minister of State and Finance, Ladies and
gentlemen,
First of all, I would like to thank the Minister for her invitation to deliver
the opening address in this seminar, in which we reflect on the policies and
governance framework required to ensure Europe's prosperity.
I hardly need to highlight how opportune this is.
Recent years have seen deep changes in Europe.
In many cases, such changes went beyond what was thought possible not
long ago.
Developments so far, however, are not enough to sustainably ensure the
prosperity of the economy in Europe and all its Member States.
In my opinion, this is the appropriate time to consider long-term issues,
and to discuss what is missing in the Economic and Monetary Union
(EMU), so that it may function smoothly.
The EMU is the result of shared sovereignty among Member States.
It is built on ongoing negotiations and on catching up from different
starting positions, safeguarding national cultures and identities, while at
the same time ensuring the sense of belonging within a group.
This involves an institutional framework with a large capacity to
understand and manage the differences and link the interest of the whole
with the specificities of the parts, in order to ensure that the whole is
greater than the sum of the parts.
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Opening this seminar, I would like to convey to you five messages regarding
the reflection on the policy and governance framework required to ensure
prosperity in Europe.
The first message is that, most of the time, the European response during
the crisis has been reactive, delayed and built from national perceptions of
the problems faced by the Union and, in particular, the euro area.
In effect, two types of bias in the Monetary Union decision-making process
have come to the fore during the crisis:
-
A reactive bias of the decision-making process: the problems were not
foreseen and initially there was even a tendency to deny them.
As a result, the problems were only acknowledged belatedly and the
willingness to reflect jointly on the causes and necessary answers was
delayed.
For instance, in 2010, at the start of the sovereign debt crisis, it was
extremely difficult to recognise that we were facing a common problem;
-
A national bias in the characterisation and evaluation of the problems: a
tendency to perceive others' problems and their solutions based on
one's own situation, i.e. on the individual country's specific situation.
In other words, the evaluation of the whole is based on an evaluation of
its parts, instead of, as would be desired, evaluating the whole situation
and its interaction with each of its parts.
As is known, the whole is greater than the sum of the parts.
For this reason, considering the whole from the viewpoint of one of the
parts is necessarily simplistic and biased.
The crisis has highlighted the tendency of all Member States to bring
their own ways of facing the problems and their own a priori
considerations to group discussions.
In this context, the particular problems and the specificity of the
viewpoints tend to take precedence over the vision of the whole.
Therefore, inter-Member State balance has been contaminated by the
rationale of relative size, which runs counter to the rationale underlying
the European Union.
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We cannot have an EMU with an institutional framework that, instead of
promoting the resolution of the problems, exacerbates them and, in some
cases, makes them self-fulfilling.
In this instance, the adjustment costs are considerably worsened, from the
point of view both of each part and of the whole group, either the euro area
or the European Union.
The second message is that the constitutional rules contained in the
Treaties are the basis for mutual trust among the Member States
composing the European Union.
The rules forming the basis for mutual trust in the EMU are enshrined in
the Treaties, ranging from the Maastricht convergence criteria and
European Central Bank Statutes, with regard to monetary policy and
financial stability objectives, to the ceilings on fiscal deficits and public debt
set out in the Treaty on Stability, Coordination and Governance.
Facing such diverse economic, social, cultural and political situations,
European countries have had to base their notion of belonging and
therefore mutual trust on rules that ensured the relationship among group
members was balanced, eliminating both hegemony/dominance risk and
moral hazard (the attraction of free riding).
Thus, shared sovereignty, aggravated by different preferences and different
institutional frameworks and cultures, has imposed the need to identify the
required minimum conditions for the functioning of the Monetary Union.
This means that the group had to adopt rules not deriving from market
sustainability principles, but rather from the need to install and operate
self-imposed mutual-trust mechanisms.
The observance of these rules, which I will call constituent rules, is key for
the survival and development of the whole, i.e. of the group.
Therefore, these rules can only be changed by a decision of the same nature.
Compliance with them is fundamental in order not to jeopardise the group.
The nature of derivative rules, such as, for instance, those in the Stability
and Growth Pact or the Macroeconomic Imbalance Procedure, is different
from that of constituent rules, given that they are not cornerstones for the
survival of the group.
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These rules are instrumental for the resilience of the group when, due to
endogenous or exogenous circumstances, the whole or the parts deviate
from compliance with the rules supporting the group aggregation and, in
particular, underlying mutual trust among its members.
Even though they are also the result of a group decision, they may take
different forms, depending on the specific circumstances faced by the whole
and/or its parts, provided that they are consistent with the key or
constituent rules.
Derivative rules may also be somewhat flexible, provided that they do not
jeopardise compliance over time with the group's key rules.
They can therefore change according to the social and economic
environment of the whole and its parts, namely when considering a shorter
or longer deadline for convergence towards compliance with the rules of
belonging to the group.
This decision must be taken by the group, in terms of the need to ensure
convergence of the parts towards compliance with the principles underlying
the levels of shared effort achieved so far and, as a result, mutual trust
requirements.
In my opinion, this clarification is very important. It is not the market that
disciplines EMU, but rather its members, based on the rules to which they
are committed.
Until 2010, Europe was indulgent regarding the implementation of the
rules, and considered that the markets would monitor and discipline; the
markets, in turn, were indulgent in their evaluation of Member States'
economic situations, precisely because they considered that the rules would
be complied with.
These positions led to a misconception: that it would be possible for the
whole to function, disregarding compliance by its parts with the constituent
rules. This situation of mutual deception cannot be repeated.
The third message I would like to convey is that the rules and operational
procedures must promote the resilience of sustainability trends in reply to
shocks.
It is clear for all of us today that the stability and prosperity in the euro area
as a whole depend on the stability and prosperity of its individual members.
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Therefore, at national level, it is fundamental that Member States adopt
policies supporting medium-term sustained economic growth.
This means ensuring the:
(i) Sustainability of external accounts;
(ii) Sustainability of public debt;
(iii) Sustainability of private debt;
(iv) Socio-economic cohesion expressed in employment levels aligned with
the size of the labour force, in productivity and income levels aligned with
public and private consumption prospects, and in the capacity to provide
support to dependents and those excluded from the labour market, either
temporarily or permanently.
In order to reach these goals, it is necessary to implement counter-cyclical
fiscal policies, macro-prudential policies limiting the indebtedness of
private economic agents, and income policies safeguarding the economy's
competitiveness.
This means it will be necessary to create an institutional framework
ensuring that wage and price formation simultaneously take into account
the objective of nominal monetary policy stability, the safeguarding of
business competitiveness in the tradable sectors, and investment
attractiveness.
This investment attractiveness is very important because, on the one hand,
it increases productivity and, on the other, it widens the productive base,
and, as a result, the opportunities to create further employment and
employment with higher value added per asset.
Virtuous dynamics such as these require:
i) the implementation of an institutional framework ensuring, in the
context of sectoral and corporate business, the alignment of real wage
growth in the tradable sector with a rise in the sector's productivity; and
ii) growing regulatory competitive pressure ensuring efficiency gains and,
therefore, cost reduction in the non-tradable sectors and, in particular, in
sectors with low competition.
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In this vein, it is also necessary to carry on structural reforms removing
obstacles to competition, creating a more favourable environment to
business development, and promoting the absorption of know-how and
corporate investment in research and development.
Moreover, it is crucial to ensure that the allocation of internal savings,
especially via bank credit and public nature instruments, is based on
efficiency principles and therefore on the economic and financial return of
the investment projects.
This condition is essential for promoting an efficient allocation of resources
and optimisation of potential growth associated with the volume of
disposable savings.
At European level, a framework for the monitoring and surveillance of
national policy sustainability (most notably, fiscal and wage and
price-setting policies) must be implemented and equipped with effective
corrective instruments.
As part of this, steps must be taken to safeguard the resilience of national
adjustments, ensuring that the economy - through its macroeconomic
fundamentals - is able to return to a sustainable path following deviations
resulting from (internal and external) exogenous shocks or erroneous
economic policy decisions.
This is a particularly important point in the ongoing discussion about the
flexibility of fiscal objectives for a given Member State.
Indeed, what truly matters is whether the sustainability plan/path is
resilient, in other words, whether its mechanisms can return it to a path
complying with the constituent rules, which serve as the basis for the group
and its activities.
Naturally, resilience increases proportionally to the better quality of
growth.
As such, the sustainability of a given country's financial consolidation and
maximum growth are not mutually exclusive.
On occasion, means are confused with goals, such as confusing structural
reforms, which are a means, with the goal of ensuring potential growth
compatible with increased resilience in the economic and financial path of a
given economy.
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Structural reforms leading to increased resilience in economies as a
response to shocks are those that guarantee:
(i) employment growth compatible with social cohesion in the long run;
(ii) sustainable public finances; and
(iii) a response to population developments.
A Monetary Union with sustainability mechanisms favours economic
growth, but does not guarantee the aggregate's maximum and sustainable
growth.
It ensures sustainable public finances, but not a growth path consistent
with the natural rate of unemployment, which means that it can coexist
with a suboptimal equilibrium.
The nature of national economic policies and the coordination of such
policies at aggregate level are inextricably linked to the sustainability and
quality of the development model for each economy participating in the
euro area.
Therefore, it is crucial to define, put in place and legitimate a power centre
that works on the premise that the whole is greater than the sum of its
parts.
This means that it is necessary to guarantee the set-up and proper
functioning of a coordinating power for national economic policies bearing
in mind not only the parts but also the path of potential output and
employment in the euro area as a whole and, for that purpose, has its own
means as well as indirect means to manage aggregate demand, investment
and potential output.
In the EU institutional framework, this role should be played by the
Eurogroup.
It is responsible for acting as a coordination centre and ensuring the
consistency of national policies, making use of the entire range of
instruments created by the EU, such as centralising the optimisation of the
aggregate's path by monitoring spillover effects on its constituent parts.
This is, unsurprisingly, a paradigm shift: it entails moving the focus from
financial or regulatory instruments to policies.
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Until now, the EU tended to believe that it was enough to create
instruments, as they would induce policies, as was the case of the European
Social Fund and the European Regional Development Fund.
However, those same instruments served/induced different policies and
consequently, different efficiency levels for both the parts and the whole.
This should be viewed from the opposite perspective: instruments do not
induce policy optimisation; policies require and warrant the use of
instruments and, as such, they should be employed according to the
policies' level of consistency with the general interest.
The fourth message that I would like to convey is that responsibility for
compliance with fiscal rules should lie with an independent entity.
National budgets are a matter of common interest, given that the debt
sustainability principle is an integral part of the institutional principles
enshrined in the Treaties.
As a constituent rule in the EU, it must be safeguarded while ensuring its
independence, technicality and neutrality.
I therefore believe it is crucial to establish a central independent entity
capable of assessing and issuing reasoned opinions on the fiscal adjustment
path followed by Member States - a European "Public Finance Council".
This "Public Finance Council" would gauge national policies' compliance
with the EMU's self-imposed rules, but it would not interfere with political
choices, provided that they were compatible with long-term sustainability.
This means that if a country prefers to adopt an approach that favours
equality over efficiency - defining efficiency as public expenditure yielding
returns - it would not be bound by an obligation to follow a sustainability
path.
However, we must bear in mind that the sustainability path would not be
the same.
It is crucial to reach a balance between two situations at opposite ends of
the spectrum, both of which unfeasible:
(i) to grow in the future without creating conditions for consensus in the
present; and
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(ii) creating conditions for consensus now, but neglecting future economic
growth.
The nature and quality of national policies affect a country's potential
output and, consequently, the political room for manoeuvre within the
rules.
Any policy measure identified as necessary in the scope of the "Public
Finance Council" would have to be decided by the Eurogroup, which, as I
have mentioned before, should be responsible for the aggregate's economic
policy and its consistency with national policies.
The fifth message that I would like to convey is that, in order to act quickly
and decisively in times of crisis, we must establish a European Monetary
Fund.
We must take an institutional leap and turn the European Stability
Mechanism into a European Monetary Fund, so as to put in place a
specialised entity to manage imbalance situations that a Member State may
have to overcome.
Imbalances may occur following the adoption of national policies that are
unsustainable in the long run, due to asymmetric effects of common shocks
or specific shocks resulting from circumstances outside the scope of
economic policy-makers.
In such cases, there must be an institution independent from Member
States, empowered and qualified to negotiate with the country in question
on matters of financial assistance with associated conditionality.
Empowered, in the sense that it cannot depend on the approval, by national
parliaments, of conditions and amounts needed for that purpose; and
qualified, in the sense of having the technological and technical means that
make it possible to act in a quick and informed manner.
The adjustment programme should be defined on the basis of a contractual
approach (and not by imposition) to ensure the policy's ownership by the
beneficiary country.
The existence of a European Monetary Fund would help turn conditionality
into the joint adoption of a programme of internally consistent adjustment
policies that are also consistent with the restoration of a resilient
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convergence path towards compliance with the group's underlying
rationale, which I previously called constituent rules.
The creation of a European Monetary Fund, with a clear mandate, means
and independence of action from Member States and removed from the
concept of guardianship, will put in place the necessary conditions for the
development of win-win solutions, which is a pillar for the aggregate's
cohesion.
Final remarks
In conclusion, I would like to stress that, when reflecting on the policies and
the governance framework that are crucial to guarantee Europe's
prosperity, we must separate what is possible from what is desirable.
I have focused my speech on what is possible, but I would like to approach
an issue that falls within the scope of what is desirable, in other words of
what is impossible right now but indispensable in the medium run.
I mean the need to reflect on faster responsiveness and the political
upgrading of the European Commission, while safeguarding its specificity:
the monopoly initiative, the coexistence between its political-lawmaking
and executive functions and - the cornerstone of its institutional role - the
equal representation of Member States in its collegiate managing body.
These days, the European Commission is a key body for ensuring the
existence and functioning of the European Union as a whole and crucial in
terms of thinking and projecting this aggregate in the future.
Indeed, as European integration progresses further, the European
Commission has evolved from being a fundamentally lawmaking body to
being an entity that today combines executive and legislative functions.
Given the European Commission's current architecture, it is very difficult to
combine both functions.
In my opinion, the Commission should, in the long run, adopt an internal
organisation model similar to that of the European Central Bank.
This means establishing a Board of Commissioners comprising a
commissioner from each Member State, who, in the scope of a collegiate
body, will participate in the decision of policy guidelines and associated
legislative proposals, and an Executive Board that will manage the
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day-to-day business and the implementation of policies defined by the
Board of Commissioners.
The Executive Board would consist of a small group of commissioners, in
proportion to the scope of executive powers entrusted to the Commission,
appointed on a rotational basis amongst Member States.
For instance, the definition of an energy policy or the European digital
policy should be a task for all commissioners (and not only the
commissioner in charge of such areas), but decisions on the purchase of a
building or on staff policy could be delegated to the Executive Board.
In this context, we should revisit the concept of subsidiarity, but in contrast
to what was used in the past (when it only gave powers back to local
authorities).
We must develop on a bidirectional concept, locating at aggregate level
issues that are being handled in a disperse and uncoordinated manner by
the parts, to the detriment of optimisation.
The principle of equality between Member States tends to be sacrificed to
the principle of "who moves first" or "who weighs more", as was the case,
for instance, in energy policy.
This is something we should ponder on, even though this falls within the
scope of what is desirable, and, therefore, for the medium run.
Thank you very much.
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Getting Better All the Time:
JILA Strontium Atomic Clock
Sets New Records
In another advance at the far
frontiers of timekeeping by National
Institute of Standards and
Technology (NIST) researchers, the latest modification of a record-setting
strontium atomic clock has achieved precision and stability levels that now
mean the clock would neither gain nor lose one second in some 15 billion
years*—roughly the age of the universe.
Precision timekeeping has broad potential impacts on advanced
communications, positioning technologies (such as GPS) and many other
technologies.
Besides keeping future technologies on schedule, the clock has potential
applications that go well beyond simply marking time.
Examples include a sensitive altimeter based on changes in gravity and
experiments that explore quantum correlations between atoms.
As described in Nature Communications,** the experimental strontium
lattice clock at JILA, a joint institute of NIST and the University of Colorado
Boulder, is now more than three times as precise as it was last year, when it
set the previous world record.***
Precision refers to how closely the clock approaches the true resonant
frequency at which the strontium atoms oscillate between two electronic
energy levels.
The clock's stability—how closely each tick matches every other tick—also
has been improved by almost 50 percent, another world record.
The JILA clock is now good enough to measure tiny changes in the passage
of time and the force of gravity at slightly different heights.
Einstein predicted these effects in his theories of relativity, which mean,
among other things, that clocks tick faster at higher elevations.
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Many scientists have demonstrated this, but with less sensitive
techniques.****
"Our performance means that we can measure the gravitational shift when
you raise the clock just 2 centimeters on the Earth's surface," JILA/NIST
Fellow Jun Ye says. "I think we are getting really close to being useful for
relativistic geodesy."
Relativistic geodesy is the idea of using a network of clocks as gravity
sensors to make precise 3D measurements of the shape of the Earth.
Ye agrees with other experts that, when clocks can detect a gravitational
shift at 1 centimeter differences in height—just a tad better than current
performance—they could be used to achieve more frequent geodetic
updates than are possible with conventional technologies such as tidal
gauges and gravimeters.
In the JILA/NIST clock, a few thousand atoms of strontium are held in an
"optical lattice," a 30-by-30 micrometer column of about 400 pancake shaped regions formed by intense laser light.
JILA and NIST scientists detect strontium's "ticks" (430 trillion per second)
by bathing the atoms in very stable red laser light at the exact frequency
that prompts the switch between energy levels.
The JILA group made the latest improvements with the help of researchers
at NIST's Maryland headquarters and the Joint Quantum Institute (JQI).
Those researchers contributed improved measurements and calculations to
reduce clock errors related to heat from the surrounding environment,
called blackbody radiation.
The electric field associated with the blackbody radiation alters the atoms'
response to laser light, adding uncertainty to the measurement if not
controlled.
To help measure and maintain the atoms' thermal environment, NIST's
Wes Tew and Greg Strouse calibrated two platinum resistance
thermometers, which were installed in the clock's vacuum chamber in
Colorado.
Researchers also built a radiation shield to surround the atom chamber,
which allowed clock operation at room temperature rather than much
colder, cryogenic temperatures.
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"The clock operates at normal room temperature," Ye notes.
"This is actually one of the strongest points of our approach, in that we can
operate the clock in a simple and normal configuration while keeping the
blackbody radiation shift uncertainty at a minimum."
In addition, JQI theorist Marianna Safronova used the quantum theory of
atomic structure to calculate the frequency shift due to blackbody radiation,
enabling the JILA team to better correct for the error.
Overall, the clock's improved performance tracks NIST scientists'
expectations for this area of research, as described in "A New Era in Atomic
Clocks" at
www.nist.gov/pml/div688/2013_1_17_newera_atomicclocks.cfm
The JILA research is supported by NIST, the Defense Advanced Research
Projects Agency and the National Science Foundation.
Notes
* For this figure, NIST converts an atomic clock's systematic or fractional
total uncertainty to an error expressed as 1 second accumulated over a
certain minimum length of time.
That is calculated by dividing 1 by the clock's systematic uncertainty, and
then dividing that result by the number of seconds in a year (31.5 million) to
find the approximate minimum number of years it would take to
accumulate 1 full second of error.
The JILA clock has reached a higher level of precision (smaller uncertainty)
than any other clock.
** T.L. Nicholson, S.L. Campbell, R.B. Hutson, G.E. Marti, B.J. Bloom, R.L.
McNally, W. Zhang, M.D. Barrett, M.S. Safronova, G.F. Strouse, W.L. Tew
and J. Ye. Nature Communications. Systematic evaluation of an atomic
clock at 2 × 10-18 total uncertainty. April 21, 2015.
*** See 2014 NIST Tech Beat article, "JILA Strontium Atomic Clock Sets
New Records in Both Precision and Stability," at
www.nist.gov/pml/div689/20140122_strontium.cfm
**** Another NIST group demonstrated this effect by raising the quantum
logic clock, based on a single aluminum ion, about 1 foot.
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See 2010 NIST news release, "NIST Pair of Aluminum Atomic Clocks
Reveal Einstein's Relativity at a Personal Scale," at
www.nist.gov/public_affairs/releases/aluminum-atomic-clock_092310.cf
m.
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Basel Committee on Banking Supervision
Board of the International Organization of
Securities Commissions
Margin requirements for non-centrally cleared derivatives
Part A: Executive summary
This document presents the final policy framework that establishes
minimum standards for margin requirements for non-centrally cleared
derivatives as agreed by the Basel Committee on Banking Supervision
(BCBS) and the International Organization of Securities Commissions
(IOSCO).
This final framework was developed in consultation with the Committee on
Payment and Settlement Systems (CPSS) and the Committee on the Global
Financial System (CGFS).
Background
The economic and financial crisis that began in 2007 exposed significant
weaknesses in the resiliency of banks and other market participants to
financial and economic shocks.
In the context of over-the-counter (OTC) derivatives in particular, the
recent financial crisis demonstrated that improved transparency in the OTC
derivatives markets and further regulation of OTC derivatives and market
participants would be necessary to limit excessive and opaque risk-taking
through OTC derivatives and to mitigate the systemic risk posed by OTC
derivatives transactions, markets, and practices.
In response, the Group of Twenty (G20) initiated a reform programme in
2009 to reduce the systemic risk from OTC derivatives.
As initially agreed in 2009, the G20’s reform programme comprised four
elements:
• All standardised OTC derivatives should be traded on exchanges or
electronic platforms, where appropriate.
• All standardised OTC derivatives should be cleared through central
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counterparties (CCPs).
• OTC derivatives contracts should be reported to trade repositories.
• Non-centrally cleared derivatives contracts should be subject to higher
capital requirements.
In 2011, the G20 agreed to add margin requirements on non-centrally
cleared derivatives to the reform programme and called upon the BCBS and
IOSCO to develop, for consultation, consistent global standards for these
margin requirements.
To this end, the BCBS and IOSCO, in consultation with the CPSS and CGFS,
formed the Working Group on Margining Requirements (WGMR) in
October 2011 to develop a proposal on margin requirements for
non-centrally cleared derivatives for consultation by mid-2012.
In July 2012, an initial proposal was released for consultation.
The initial proposal was followed by an invitation to comment on the
proposal by 28 September 2012.
Additionally, a quantitative impact study (QIS) was conducted to assess the
potential liquidity and other quantitative impacts associated with
mandatory margining requirements.
In February 2013, the BCBS and IOSCO released a second consultative
document that reflected the near-final policy framework after careful
consideration of the responses to the first consultative document as well as
the QIS results.
The consultative document sought comment on four questions relating to
certain specific aspects of the near-final margin framework.
A large number of comments were received on the near-final margin
framework.
These comments have been considered in updating the proposal and
specifying a final global framework for margining requirements on
non-centrally cleared derivatives.
Taking into account the operational and legal complexities of implementing
the final framework, the BCBS and IOSCO have agreed to delay the
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implementation of the margin requirements.
The requirement to collect and post initial margin will be delayed by nine
months.
The requirement to exchange variation margin will also be delayed by nine
months, and will be subject to a six month phase-in period.
The following document lays out the key objectives, elements and principles
of the final margining framework for non-centrally cleared derivatives.
Objectives of margin requirements for non-centrally cleared derivatives
Margin requirements for non-centrally cleared derivatives have two main
benefits:
Reduction of systemic risk
Only standardised derivatives are suitable for central clearing.
A substantial fraction of derivatives are not standardised and cannot be
centrally cleared.
These non-centrally cleared derivatives, totalling hundreds of trillions of
dollars in notional amounts, pose the same type of systemic contagion and
spill over risks that materialised in the recent financial crisis.
Margin requirements for non-centrally cleared derivatives would be
expected to reduce contagion and spill over effects by ensuring that
collateral is available to offset losses caused by the default of a derivatives
counterparty.
Margin requirements can also have broader macroprudential benefits, by
reducing the financial system’s vulnerability to potentially destabilising
procyclicality and limiting the build-up of uncollateralised exposures within
the financial system.
Promotion of central clearing
In many jurisdictions, central clearing will be mandatory for most
standardised derivatives.
But clearing imposes costs, in part because CCPs require margin to be
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posted.
Margin requirements on non-centrally cleared derivatives, by reflecting the
generally higher risk associated with these derivatives, will promote central
clearing, making the G20’s original 2009 reform programme more
effective.
This could, in turn, contribute to the reduction of systemic risk.
The effectiveness of margin requirements could be undermined if the
requirements were not consistent internationally.
Activity could move to locations with lower margin requirements, raising
two concerns:
• The effectiveness of the margin requirements could be undermined (ie
regulatory arbitrage).
• Financial institutions that operate in the low-margin locations could gain
a competitive advantage (ie unlevel playing field).
Margin and capital
Both capital and margin perform important and complementary risk
mitigation functions but are distinct in a number of ways.
First, margin is “defaulter-pay”.
In the event of a counterparty default, margin protects the surviving party
by absorbing losses using the collateral provided by the defaulting entity.
In contrast, while capital adds loss absorbency to the system, because it is
“survivor-pay”, using capital to meet such losses consumes the surviving
entity’s own financial resources.
The shift towards greater reliance on margin will have a useful influence on
incentives.
Greater reliance on margin will help market participants to better
internalise the cost of their risk-taking, because they will have to post
collateral when they enter into a derivatives contract.
It will also promote resilient markets in times of stress, when a market
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participant who has not received margin could be under pressure to
withdraw from trading to preserve its capital.
Second, margin is more “targeted” and dynamic, with each portfolio having
its own designated margin for absorbing the potential losses in relation to
that particular portfolio, and with such margin being adjusted over time to
reflect changes in that portfolio’s risk.
In contrast, capital is shared collectively by all the entity’s activities and
may thus be more easily depleted at a time of stress.
It is also difficult to rapidly adjust capital in response to changing risk
exposures.
Capital requirements against each exposure are not designed to cover the
loss on the default of the counterparty but rather the probability-weighted
loss given such default.
For these reasons, margin can be seen as offering enhanced protection
against counterparty credit risk provided that it is effectively implemented.
In order for margin to act as an effective risk mitigant, it must be
(i) accessible when needed and
(ii) provided in a form that can be liquidated rapidly and at a predictable
price even in a time of financial stress.
Impact of margin requirements on liquidity
The potential benefits of margin requirements must be weighed against the
liquidity impact that would result from derivatives counterparties’ need to
provide liquid high-quality collateral to meet those requirements, including
potential changes to market functioning as a result of an increased
aggregate demand for such collateral.
Financial institutions may need to obtain and deploy additional liquidity
resources to meet margin requirements that exceed current practice.
Moreover, the liquidity impact of margin requirements cannot be
considered in isolation.
Rather, it is important to recognise ongoing and parallel regulatory
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initiatives that will also have significant liquidity impacts; examples of such
initiatives include the BCBS’s Liquidity Coverage Ratio (LCR), Net Stable
Funding Ratio (NSFR) and global mandates for central clearing of
standardised derivatives.
The BCBS and IOSCO conducted a QIS in order to gauge the impact of the
margin proposals.
In particular, the QIS assessed the amount of margin required on
non-centrally cleared derivatives as well as the amount of available
collateral that could be used to satisfy these requirements.
The results of the QIS, as well as comments that were received on the initial
proposal and near-final framework were carefully considered in arriving at
the margin framework that is described in this document.
The overall liquidity burden resulting from initial margin requirements, as
well as the availability of eligible collateral to satisfy such requirements, has
been carefully assessed in designing the margin framework.
The use of permitted initial margin thresholds, which are discussed in
detail in Element 2, the eligibility of a broad range of eligible collateral,
which is discussed in detail in Element 4, the ability to re-hypothecate some
initial margin collateral under strict conditions, which is discussed in
Element 5, as well as the triggers that provide for a gradual phase-in of the
requirements, which are discussed in detail in Element 8, have been
included as key elements of the margin framework to directly address the
liquidity demands associated with the requirements.
Key principles and requirements
As described in more detail in Part B, this paper presents the BCBS’s and
IOSCO’s final policy for margin requirements for non-centrally cleared
derivatives, as articulated through key principles addressing eight main
elements:
1. Appropriate margining practices should be in place with respect to all
derivatives transactions that are not cleared by CCPs.
2. All financial firms and systemically important non-financial entities
(“covered entities”) that engage in non-centrally cleared derivatives must
exchange initial and variation margin as appropriate to the counterparty
risks posed by such transactions.
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3. The methodologies for calculating initial and variation margin that serve
as the baseline for margin collected from a counterparty should:
(i) be consistent across entities covered by the requirements and reflect the
potential future exposure (initial margin) and current exposure (variation
margin) associated with the portfolio of non-centrally cleared derivatives in
question and
(ii) ensure that all counterparty risk exposures are fully covered with a high
degree of confidence.
4. To ensure that assets collected as collateral for initial and variation
margin purposes can be liquidated in a reasonable amount of time to
generate proceeds that could sufficiently protect collecting entities covered
by the requirements from losses on non-centrally cleared derivatives in the
event of a counterparty default, these assets should be highly liquid and
should, after accounting for an appropriate haircut, be able to hold their
value in a time of financial stress.
5. Initial margin should be exchanged by both parties, without netting of
amounts collected by each party (ie on a gross basis), and held in such a way
as to ensure that:
(i) the margin collected is immediately available to the collecting party in
the event of the counterparty’s default; and
(ii) the collected margin must be subject to arrangements that fully protect
the posting party to the extent possible under applicable law in the event
that the collecting party enters bankruptcy.
6. Transactions between a firm and its affiliates should be subject to
appropriate regulation in a manner consistent with each jurisdiction’s legal
and regulatory framework.
7. Regulatory regimes should interact so as to result in sufficiently
consistent and non-duplicative regulatory margin requirements for
non-centrally cleared derivatives across jurisdictions.
8. Margin requirements should be phased in over an appropriate period of
time to ensure that the transition costs associated with the new framework
can be appropriately managed.
Regulators should undertake a coordinated review of the margin standards
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once the requirements are in place and functioning to assess the overall
efficacy of the standards and to ensure harmonisation across national
jurisdictions as well as across related regulatory initiatives.
Monitoring and evaluation
The actual impact of margin requirements is subject to various factors and
uncertainties, including, among others, the ratio of cleared to non-centrally
cleared derivatives and changes in market volatility over time.
Moreover, a number of the framework’s design elements could have
impacts that may change over time depending on changes in market
structure and market conditions.
The BCBS and IOSCO will set up a monitoring group to evaluate these
margin standards in 2014.
The evaluation will focus on the relation and consistency of the margin
standards with related regulatory initiatives such as changes to
standardised approaches for trading book and counterparty credit risk
capital, potential minimum haircuts on repurchase and reverse repurchase
transactions, implementation of the LCR, and capital requirements on
centrally cleared derivatives that may develop alongside these requirements
between now and 2014.
The monitoring group will consider any initiatives to conduct further
analysis of the costs and benefits, and of the impact on competition of rules
setting margin requirements for non-centrally cleared derivatives.
It will consider the overall efficacy and appropriateness of the margin
methodologies and standards.
It will explore the possible alignment of the model and standardised
schedule approaches for calculating initial margin, and assess the potential
procyclicality of the margin requirements.
The monitoring group will consider the results of various studies that are
being conducted, such as the study being conducted by the Bank for
International Settlements Macroeconomic Assessment Group on
Derivatives on the macroeconomic impact of OTC derivatives market
reforms and the OTC Derivatives Assessment Team’s assessment of
incentives for central clearing, and will further monitor and evaluate the
liquidity impact of these margin requirements on different types of covered
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entities.
Where appropriate, the monitoring group will conduct a quantitative study
to assess the impact of the margin framework or certain specific aspects of
the margin framework.
The monitoring group will consider providing more guidance on the
validation and back testing of models for margining.
It will also evaluate the risks of not subjecting the fixed physically settled
foreign exchange (FX) transactions associated with the exchange of
principal of cross-currency swaps to the initial margin requirements, and
consider whether any modifications to such arrangement are appropriate.
The monitoring group will consider developments in the effort to establish
a global framework for cross-border interactions across an array of
regulatory initiatives including margin.
These developments will be reviewed to ensure that the interactions
between differing jurisdictions in the context of margin requirements are
compatible with the goals of this framework.
Finally, the monitoring group will gather data relevant to the extent to
which collateral is re-hypothecated under the limited re-hypothecation
conditions identified in Element 5, where and how such collateral is held,
any implementation issues and the benefits and risks of such
re-hypothecation, in order to formulate recommendations to BCBS and
IOSCO on whether to continue to permit re-hypothecation of collateral
under these conditions, permit re-hypothecation for only a subset of
non-centrally cleared derivatives products, prohibit re-hypothecation
altogether, or whether to otherwise modify the conditions.
Certain elements of the margin standards may need to be re-evaluated or
modified if forthcoming additional data and further analyses reveal that the
incentives and impacts of them substantially deviate from the results
reflected in the QIS, or are inconsistent with the goals expressed in this
framework, or do not effectively balance the costs and benefits of the
requirements.
Based on the findings of the monitoring group, the BCBS and IOSCO will
jointly determine whether any additional work needs to be undertaken or
whether any modifications to the margin requirements are necessary or
appropriate.
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This monitoring and evaluation process is not intended to deter individual
regulatory authorities from proceeding with rules pertaining to margin
requirements for non-centrally cleared derivatives consistent with this
paper while the monitoring group is conducting its work.
The BCBS and IOSCO will also continue working to monitor and assess how
consistently the requirements are implemented across products,
jurisdictions and market participants.
Part B: Key principles and requirements
Element 1: Scope of coverage – instruments subject to the
requirements
Background discussion
1(a) A primary threshold question that must be addressed in the design of
margin requirements for non-centrally cleared derivatives is the scope of
derivatives instruments to which the requirements will apply.
Consistent with the G20 mandate, the BCBS and IOSCO have focused their
attention on all derivatives that are not cleared by a CCP, regardless of type.
At the same time, some consideration has been given to whether certain
types of transactions (eg FX forwards and swaps) may merit exclusion from
the scope of the margin requirements because of their unique
characteristics or particular market practices.
Key principle 1
Appropriate margining practices should be in place with respect to all
derivatives transactions that are not cleared by CCPs.
Requirement 1
1.1 Except for physically settled FX forwards and swaps, the margin
requirements apply to all non-centrally cleared derivatives.
The margin requirements described in this paper do not apply to physically
settled FX forwards and swaps.
However, the BCBS and IOSCO recognise that variation margining of such
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derivatives is a common and established practice among significant market
participants.
The BCBS and IOSCO recognise that the exchange of variation margin is a
prudent risk management tool that limits the build-up of systemic risk.
Accordingly, the BCBS and IOSCO agree that standards apply for variation
margin to be exchanged on physically settled FX forwards and swaps in a
manner consistent with the final policy framework set out in this document
and that those variation margin standards are implemented either by way
of supervisory guidance or national regulation.
The BCBS and IOSCO note that the BCBS has updated the supervisory
guidance for managing settlement risk in FX transactions.
The update to the supervisory guidance covers margin requirements for
physically settled FX forwards and swaps.
In developing variation margin standards for physically settled FX forwards
and swaps, national supervisors should consider the recommendations in
the BCBS supervisory guidance.
1.2 Initial margin requirements for cross-currency swaps do not apply to
the fixed physically settled FX transactions associated with the exchange of
principal of cross-currency swaps.
In practice, the margin requirements for cross-currency swaps may be
computed in one of two ways.
Initial margin may be computed by reference to the “interest rate” portion
of the standardised initial margin schedule that is discussed below and
presented in the appendix.
Alternatively, if initial margin is being calculated pursuant to an approved
initial margin model, the initial margin model need not incorporate the risk
associated with the fixed physically settled FX transactions associated with
the exchange of principal.
All other risks that affect cross-currency swaps, however, must be
considered in the calculation of the initial margin amount.
Finally, the variation margin requirements that are described below apply
to all components of cross-currency swaps.
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Element 2: Scope of coverage – scope of applicability
Background discussion
2(a) Another important element of the margin requirements is their general
scope of applicability – that is, to which firms do the requirements apply,
and what do the requirements oblige those firms to do.
In particular, the scope of the margin requirements’ applicability has an
important effect on each of the following:
• The extent to which the requirements reduce systemic risk – here the
BCBS and IOSCO have considered the extent to which potential approaches
would capture all or substantially all systemic risk arising from
non-centrally cleared derivatives, the risk of which is generally
concentrated among the activities of the largest key market participants
transacting in a significant amount of non-centrally cleared derivatives (eg
through dealing or other activities), subject to certain exceptions in specific
asset classes, such as commodities;
• The extent to which the requirements promote central clearing – here the
BCBS and IOSCO have considered the extent to which potential approaches
would parallel the central clearing mandate, which generally applies to all
financial institutions and those non-financial institutions that pose
significant systemic risk; and
• The liquidity impact of the requirements – here the BCBS and IOSCO
have considered the fact that increased scope of applicability would entail a
correspondingly greater liquidity impact.
2(b) In evaluating this fundamental element of the margin requirements
and its implications with respect to systemic risk reduction, incentives
relative to central clearing and impact on liquidity, the BCBS and IOSCO
have focused on two principal questions:
• Whether the margin requirements should apply to all parties to
non-centrally cleared derivatives, only to financial firms, or only to key
market participants; and
• Whether the margin requirements should require a bilateral exchange of
margin between all entities covered by the requirements, or only the
unilateral collection of margin by certain types of firms (eg key market
participants).
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2(c) The BCBS and IOSCO believe that the margin requirements need not
apply to non-centrally cleared derivatives to which non-financial entities
that are not systemically important are a party, given that:
(i) such transactions are viewed as posing little or no systemic risk and
(ii) such transactions are exempted from central clearing mandates under
most national regimes.
Similarly, the BCBS and IOSCO advocate that margin requirements are not
applied in such a way that would require sovereigns, central banks,
multilateral development banks (MDBs) or the Bank for International
Settlements to either collect or post margin.
Both of these views are reflected in the exclusion of such transactions from
the scope of margin requirements.
As a result, a transaction between a covered entity and one of the
aforementioned entities is not covered by the requirements set out in this
document.
2(d) With respect to other non-centrally cleared derivatives; the BCBS and
IOSCO support margin requirements that, in principle, would involve the
mandatory exchange of both initial and variation margin among parties to
non-centrally cleared derivatives (“universal two-way margin”).
2(e) In the case of variation margin, the BCBS and IOSCO recognise that
the regular and timely exchange of variation margin represents the
settlement of the running profit/loss of a derivative and has no net liquidity
costs given that variation margin represents a transfer of resources from
one party to another.
The BCBS and IOSCO also recognise that the regular and timely exchange
of variation margin is a widely adopted best practice that promotes effective
and sound risk management.
2(f) In the case of initial margin, the BCBS and IOSCO recognise that initial
margin requirements will have a measurable impact on market liquidity, as
assets that are provided for collateral purposes cannot be readily deployed
for other uses over the life of the non-centrally cleared derivatives contract.
It is also recognised that such requirements will represent a significant
change in market practice and will present certain operational and logistical
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challenges that will need to be managed as the new requirements come into
effect.
2(g) These operational and logistical challenges will be dealt with as the
requirements are implemented in a manner consistent with the phase-in
timeline described earlier and discussed in detail under Element 8.
Following the end of the phase-in period, there will be a minimum level of
non-centrally cleared OTC derivatives activity (€8 billion in gross notional
outstanding amounts) necessary for covered entities to be subject to initial
margin requirements described in this paper.
2(h) One method for managing the liquidity impact associated with initial
margin requirements – and one that has received broad support – is to
provide for an initial margin threshold (threshold) that would specify an
amount under which a firm would have the option of not collecting initial
margin.
In cases where the initial margin requirement for the portfolio exceeded the
threshold, the firm would be obliged to collect initial margin from its
counterparty in an amount that is at least as large as the difference between
the initial margin requirement and the threshold.
For example, if the threshold amount were 10 and the initial margin
requirement for a particular non-centrally cleared derivatives portfolio was
15, then a firm would be obliged to collect at least 5 from its counterparty in
initial margin (15–10=5), or more if it so chose pursuant to its risk
management guidelines and principles.
Such an approach, if applied in a manner consistent with sound risk
management practices, could help ameliorate the costs associated with a
universal two-way margin regime.
Key principle 2
All covered entities (ie financial firms and systemically important
non-financial entities) that engage in non-centrally cleared derivatives
must exchange initial and variation margin as appropriate to the
counterparty risks posed by such transactions.9
Requirement 2
2.1 All covered entities that engage in non-centrally cleared derivatives
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must exchange, on a bilateral basis, the full amount of variation margin (ie
a zero threshold) on a regular basis (eg daily).
2.2 All covered entities must exchange, on a bilateral basis, initial margin
with a threshold not to exceed €50 million.
The threshold is applied at the level of the consolidated group to which the
threshold is being extended and is based on all non-centrally cleared
derivatives between the two consolidated groups.
2.3 All margin transfers between parties may be subject to a de-minimis
minimum transfer amount not to exceed €500,000.
2.4 Covered entities include all financial firms and systemically important
non-financial firms.
Central banks, sovereigns, multilateral development banks, the Bank for
International Settlements, and non-systemic, non-financial firms are not
covered entities.
2.5 Initial margin requirements will be phased-in, but at the end of the
phase-in period there will be a minimum level of non-centrally cleared
derivatives activity (€8 billion of gross notional outstanding amount)
necessary for covered entities to be subject to initial margin requirements
described in this paper.
2.6 The precise definition of financial firms, non-financial firms and
systemically important non-financial firms will be determined by
appropriate national regulation.
Only non-centrally cleared derivatives transactions between two covered
entities are governed by the requirements in this paper.
Commentary
2(i) All covered entities engaging in non-centrally cleared derivatives must
exchange initial and variation margin as appropriate to the counterparty
risk posed by such transactions.
2(ii) The requirement that the threshold be applied on a consolidated group
basis is intended to prevent the proliferation of affiliates and other legal
entities within larger entities for the sole purpose of circumventing the
margin requirements.
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The following example describes how the threshold would be applied by an
entity that is facing three distinct legal entities within a larger consolidated
group.
2(iii) Suppose that a firm engages in separate derivatives transactions,
executed under separate legally enforceable netting agreements, with three
counterparties, A1, A2, A3. A1, A2 and A3, all belong to the same larger
consolidated group such as a bank holding company.
Suppose further that the initial margin requirement (as described in
Element 3) is €100 million for each of the firm’s netting sets with A1, A2
and A3.
Then the firm dealing with these three affiliates must collect at least €250
million (250=100+100+100–50) from the consolidated group.
Exactly how the firm allocates the €50 million threshold among the three
netting sets is subject to agreement between the firm and its counterparties.
The firm may not extend a €50 million threshold to each netting set with,
A1, A2, A3, so that the total amount of initial margin collected is only €150
million (150=100-50+100-50+100–50).
2(iv) Furthermore, the requirement to apply the threshold on a fully
consolidated basis applies to both the counterparty to which the threshold
is being extended and the counterparty that is extending the threshold.
As a specific example, suppose that in the example above the firm (as
referenced above) is itself organised into, say, three subsidiaries F1, F2 and
F3 and that each of these subsidiaries engages in non-centrally cleared
derivatives transactions with A1, A2 and A3.
In this case, the extension of the €50 million threshold by the firm to A1, A2
and A3 is considered across the entirety of the firm, ie F1, F2, and F3, so
that all subsidiaries of the firm extend in the aggregate no more than €50
million in an initial margin threshold to all of A1, A2 and A3.
2(v) The implementation of this approach requires appropriate cooperation
between home and host supervisors.
As the threshold is applied on a consolidated basis, only the home
supervisor of the consolidated group will necessarily be able to verify that
the group does not exceed this threshold with all of its counterparties.
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The host supervisors of subsidiaries of a group would not be able to assess
whether the local subsidiaries under their responsibility comply with the
threshold allocated by the group to each of its subsidiaries.
Communication between the home consolidated supervisors and host
supervisors is therefore necessary to ensure that the latter have access to
information on the threshold allocated to the local subsidiary under their
responsibility.
Element 3: Baseline minimum amounts and methodologies for
initial and variation margin
Background discussion
3(a) A third key element of the margin requirements is the minimum
baseline amount of initial and variation margin that would need to be
collected for a non-centrally cleared derivatives and the methodologies by
which that baseline amount would be calculated.
The BCBS and IOSCO have evaluated the calculation of these baseline
margin amounts by reference to the two underlying benefits of the margin
requirements described in Part A – systemic risk reduction and promotion
of central clearing.
From the perspective of systemic risk reduction, the BCBS and IOSCO have
considered the extent to which baseline margin amounts would be
sufficient to offset any loss caused by the default of a counterparty with a
high degree of confidence; this line of analysis involves calibrating baseline
margin amounts relative to the current and potential exposure posed by
particular derivatives transactions.
From the perspective of promoting central clearing, the BCBS and IOSCO
have considered the costs associated with complying with the baseline
margin requirements; this line of analysis involves calibrating baseline
margin amounts relative to the costs of executing the same or similar
transactions on a centrally cleared basis.
This paper establishes a general framework for calculating baseline
variation and initial margin that is intended to realise both benefits of
margin requirements.
3(b) In terms of distinguishing baseline requirements for initial margin and
variation margin, the BCBS and IOSCO have taken into account the
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differing form and purpose of each type of margin and their typical use in
market practice.
3(c) Variation margin protects the transacting parties from the current
exposure that has already been incurred by one of the parties from changes
in the mark-to-market value of the contract after the transaction has been
executed.
The amount of variation margin reflects the size of this current exposure.
It depends on the mark-to-market value of the derivatives at any point in
time, and can therefore change over time.
3(d) Initial margin protects the transacting parties from the potential future
exposure that could arise from future changes in the mark-to-market value
of the contract during the time it takes to close out and replace the position
in the event that one or more counterparties default.
The amount of initial margin reflects the size of the potential future
exposure.
It depends on a variety of factors, including how often the contract is
revalued and variation margin exchanged, the volatility of the underlying
instrument, and the expected duration of the contract closeout and
replacement period, and can change over time, particularly where it is
calculated on a portfolio basis and transactions are added to or removed
from the portfolio on a continuous basis.
Key principle 3
The methodologies for calculating initial and variation margin that serve as
the baseline for margin collected from a counterparty should
(i) be consistent across entities covered by the requirements and reflect the
potential future exposure (initial margin) and current exposure (variation
margin) associated with the particular portfolio of non-centrally cleared
derivatives at issue and
(ii) ensure that all counterparty risk exposures are covered fully with a high
degree of confidence.
Requirement 3 – Initial margin
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3.1 For the purpose of informing the initial margin baseline, the potential
future exposure of a non-centrally cleared derivatives should reflect an
extreme but plausible estimate of an increase in the value of the instrument
that is consistent with a one-tailed 99 per cent confidence interval over a
10-day horizon, based on historical data that incorporates a period of
significant financial stress.
The initial margin amount must be calibrated to a period that includes
financial stress to ensure that sufficient margin will be available when it is
most needed and to limit the extent to which the margin can be procyclical.
The required amount of initial margin may be calculated by reference to
either
(i) a quantitative portfolio margin model or
(ii) a standardised margin schedule.
When initial margin is calculated by reference to an initial margin model,
the period of financial stress used for calibration should be identified and
applied separately for each broad asset class for which portfolio margining
is allowed, as set out below.
In addition, the identified period must include a period of financial stress
and should cover a historical period not to exceed five years.
Additionally, the data within the identified period should be equally
weighted for calibration purposes.
3.2 Non-centrally cleared derivatives will often be exposed to a number of
complex and interrelated risks.
Internal or third-party quantitative models that assess these risks in a
granular form can be useful for ensuring that the relevant initial margin
amounts are calculated in an appropriately risk-sensitive manner.
Moreover, current practice among a number of large and active CCPs is to
use internal quantitative models when determining initial margin amounts.
3.3 Notwithstanding the utility of quantitative models, the use of such
models is predicated on the satisfaction of several prerequisite conditions.
First, any quantitative model that is used for initial margin purposes must
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be approved by the relevant supervisory authority.
Models that have not been granted explicit approval may not be used for
initial margin purposes.
Models may be either internally developed or sourced from the
counterparties or third-party vendors but in all such cases these models
must be approved by the appropriate supervisory authority.
Moreover, in the event that a third party-provided model is used for initial
margin purposes, the model must be approved for use within each
jurisdiction and by each institution seeking to use the model.
Similarly, an unregulated counterparty that wishes to use a quantitative
model for initial margin purposes may use an approved initial margin
model.
There will be no presumption that approval by one supervisor in the case of
one or more institutions will imply approval for a wider set of jurisdictions
and/or institutions.
Second, quantitative initial margin models must be subject to an internal
governance process that continuously assesses the value of the model’s risk
assessments, tests the model’s assessments against realised data and
experience, and validates the applicability of the model to the derivatives
for which it is being used.
The process must take into account the complexity of the products covered
(eg barrier options and other more complex structures).
These additional requirements are intended to ensure that the use of
models does not lead to a lowering of margin standards.
The use of models is also not intended to lower margin standards that may
already exist in the context of some non-centrally cleared derivatives.
Rather, the use of models is intended to produce appropriately
risk-sensitive assessments of potential future exposure so as to promote
robust margin requirements.
3.4 Quantitative initial margin models may account for risk on a portfolio
basis.
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More specifically, the initial margin model may consider all of the
derivatives that are approved for model use that are subject to a single
legally enforceable netting agreement.
Derivatives between counterparties that are not subject to the same legally
enforceable netting agreement must not be considered in the same initial
margin model calculation.
Derivative portfolios are often exposed to a number of offsetting risks that
can and should be reliably quantified for the purposes of calculating initial
margin requirements.
At the same time, a distinction must be made between offsetting risks that
can be reliably quantified and those that are more difficult to quantify.
In particular, inter-relationships between derivatives in distinct asset
classes, such as equities and commodities, are difficult to model and
validate.
Moreover, this type of relationship is prone to instability and may be more
likely to break down in a period of financial stress.
Accordingly, initial margin models may account for diversification, hedging
and risk offsets within well defined asset classes such as
currency/rates,15,16 equity, credit, or commodities, but not across such
asset classes and provided these instruments are covered by the same
legally enforceable netting agreement.
However, any such incorporation of diversification, hedging and risk offsets
by an initial margin model will require approval by the relevant supervisory
authority.
Initial margin calculations for derivatives in distinct asset classes must be
performed without regard to derivatives in other asset classes.
As a specific example, for a derivatives portfolio consisting of a single credit
derivative and a single commodity derivative, an initial margin calculation
that uses an internal model would proceed by first calculating the initial
margin requirement on the credit derivatives and then calculating the
initial margin requirement on the commodity derivative.
The total initial margin requirement for the portfolio would be the sum of
the two individual initial margin amounts because they are in two different
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asset classes (commodities and credit).
Finally, derivatives for which a firm faces no (ie zero) counterparty risk
require no initial margin to be collected and may be excluded from the
initial margin calculation.
3.5 While quantitative, portfolio-based initial margin models can be a good
risk management tool if monitored and governed appropriately; there are
some instances in which a simpler and less risk-sensitive approach to initial
margin calculations may be warranted.
In particular, smaller market participants may not wish or may be unable to
develop and maintain a quantitative model and may be unwilling to rely on
counterparty’s model.
In addition, some market participants may value simplicity and
transparency in initial margin calculations, without resorting to a complex
quantitative model.
Further, an appropriately conservative alternative for calculating initial
margin is needed in the event that no approved initial margin model exists
to cover a specific transaction.
Accordingly, the BCBS and IOSCO have provided an initial margin
schedule, included as Appendix A, which may be used to compute the
amount of initial margin required on a set of derivatives transactions.
3.6 The required initial margin will be computed by referencing the
standardised margin rates in Appendix A and by adjusting the gross initial
margin amount by an amount that relates to the net-to-gross ratio (NGR)
pertaining to all derivatives in the legally enforceable netting set.
The use of the net-to-gross ratio is an accepted practice in the context of
bank capital regulation and recognises important offsets that would not be
recognised by strict application of a standardised margin schedule.
The required initial margin amount would be calculated in two steps.
First, the margin rate in the provided schedule would be multiplied by the
gross notional size of the derivatives contract, and then this calculation
would be repeated for each derivatives contract.
This amount may be referred to as the gross standardised initial margin.
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Second, the gross initial margin amount is adjusted by the ratio of the net
current replacement cost to gross current replacement cost (NGR).
This is expressed through the following formula:
Net standardised initial margin = 0.4 * Gross initial margin + 0.6 * NGR *
Gross initial margin
where NGR is defined as the level of net replacement cost over the level of
gross replacement cost for transactions subject to legally enforceable
netting agreements.
The total amount of initial margin required on a portfolio according to the
standardised margin schedule would be the net standardised initial margin
amount.
However, if a regulated entity is already using a schedule-based margin to
satisfy requirements under its required capital regime, the appropriate
supervisory authority may permit the use of the same schedule for initial
margin purposes, provided that it is at least as conservative.
3.7 As in the case where firms use quantitative models to calculate initial
margin, derivatives for which a firm faces no (ie zero) counterparty risk
require no initial margin to be collected and may be excluded from the
standardised initial margin calculation.
3.8 Derivatives market participants should not be allowed to switch
between model- and schedule- based margin calculations in an effort to
“cherry pick” the most favourable initial margin terms.
Accordingly, the choice between model- and schedule-based initial margin
calculations should be made consistently over time for all transactions
within the same well defined asset class and, if applicable, it should comply
with any other requirements imposed by the entity’s supervisory authority.
3.9 At the same time, it is quite possible that a market participant may use a
model-based initial margin calculation for one class of derivatives in which
it commonly deals and a schedule-based initial margin in the case of some
derivatives that are less routinely employed in its trading activities.
A firm need not restrict itself to a model-based approach or to a
schedule-based approach for the entirety of its derivatives activities.
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Rather, this requirement is meant to ensure that market participants do not
use model-based margin calculations in those instances in which such
calculations are more favourable than schedule-based requirements and
schedule-based margin calculations when those requirements are more
favourable than model-based margin requirements.
3.10 Initial margin should be collected at the outset of a transaction, and
collected thereafter on a routine and consistent basis upon changes in
measured potential future exposure, such as when trades are added to or
subtracted from the portfolio.
To mitigate procyclicality impacts, large discrete calls for (additional) initial
margin due to “cliff-edge” triggers should be discouraged.
3.11 The build-up of additional initial margin should be gradual so that it
can be managed over time.
Moreover, margin levels should be sufficiently conservative, even during
periods of low market volatility, to avoid procyclicality.
The specific requirement that initial margin be set consistent with a period
that includes stress is meant to limit procyclical changes in the amount of
initial margin required.
3.12 Parties to derivatives contracts should have rigorous and robust
dispute resolution procedures in place with their counterparty before the
onset of a transaction.
In particular, the amount of initial margin to be collected from one party by
another will be the result of either an approved model calculation or the
standardised schedule.
The specific method and parameters that will be used by each party to
calculate initial margin should be agreed and recorded at the onset of the
transaction to reduce potential disputes.
Moreover, parties may agree to use a single model for the purposes of such
margin model calculations subject to bilateral agreement and appropriate
regulatory approval.
In the event that a margin dispute arises, both parties should make all
necessary and appropriate efforts, including timely initiation of dispute
resolution protocols, to resolve the dispute and exchange the required
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amount of initial margin in a timely fashion.
Requirement 3 – Variation margin
3.13 For variation margin, the full amount necessary to fully collateralise
the mark-to-market exposure of the non-centrally cleared derivatives must
be exchanged.
3.14 To reduce adverse liquidity shocks and in order to effectively mitigate
counterparty credit risk, variation margin should be calculated and
exchanged for non-centrally cleared derivatives subject to a single, legally
enforceable netting agreement with sufficient frequency (eg daily).
3.15 The valuation of a derivative’s current exposure can be complex and, at
times, become subject to question or dispute by one or both parties. In the
case of non-centrally cleared derivatives, these instruments are likely to be
relatively illiquid.
The associated lack of price transparency further complicates the process of
agreeing on current exposure amounts for variation margin purposes.
Accordingly, parties to derivatives contracts should have rigorous and
robust dispute resolution procedures in place with their counterparty
before the onset of a transaction.
In the event that a margin dispute arises, both parties should make all
necessary and appropriate efforts, including timely initiation of dispute
resolution protocols, to resolve the dispute and exchange the required
amount of variation margin in a timely fashion.
Commentary
3(i) The existence of both a model-based and schedule-based initial margin
standard allows derivative users to opt for either approach.
Derivatives market participants should be able to choose between a more
risk-sensitive but potentially less transparent quantitative model and a less
risk-sensitive but more transparent initial margin schedule for calculating
initial margin amounts.
At the same time, derivatives market participants should not be allowed to
switch between model- and schedule-based margin calculations in an effort
to cherry pick the most favourable initial margin terms.
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Accordingly, the choice between a model- and a schedule-based initial
margin calculation should be made consistently over time.
3(ii) The applicable netting agreements used by market participants will
need to be effective under the laws of the relevant jurisdictions and
supported by periodically updated legal opinions.
Supervisory authorities and relevant market participants should consider
how those requirements could best be complied with in practice.
3(iii) The BCBS and IOSCO also recognise that national supervisors may
wish to alter margin requirements to achieve macroprudential outcomes,
such as limiting the build-up of leverage and the expansion of balance
sheets.
One method for achieving this may be for the relevant authority to impose a
macroprudential “add-on” or buffer on top of baseline (or minimum)
margin levels.
Although no conclusions have been reached on this issue, the BCBS and
IOSCO continue to give further consideration to the coordination issues
that may arise in this respect.
3(iv) As discussed above, derivatives transactions between covered entities
with zero counterparty risk require zero initial margin and may be excluded
from the initial margin calculation.
As an example, consider a European call option on a single stock.
Suppose that one party, the option writer, agrees to sell a fixed number of
shares to another party, the option purchaser, at a predetermined price at
some specific future date, the contract’s expiry, if the option purchaser
wishes to do so.
Suppose further that the option purchaser makes a payment to the option
writer at the outset of the transaction that fully compensates the option
writer for the possibility that it will have to sell shares at contract expiry at
the predetermined price.
In this case, the option writer faces zero counterparty risk while the option
purchaser faces counterparty risk.
The option writer has received the full value of the option at the outset of
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the transaction.
The option purchaser, on the other hand, faces counterparty risk since the
option writer may not be willing or able to sell shares to the option
purchaser at the predetermined price at the expiry of the contract.
In this case, the option writer would not be obliged to collect any initial
margin from the option purchaser and the call option could be excluded
from the initial margin calculation.
Since the option purchaser faces counterparty risk, the option purchaser
must collect initial margin from the option writer in a manner consistent
with the requirements of this paper.
Element 4: Eligible collateral for margin
Background discussion
4(a) Even in cases where margin is collected in an amount sufficient to fully
protect a firm in the event of the default of a derivatives counterparty, the
firm may nonetheless be exposed to loss if that margin is not in a form that
can be readily liquidated at full value at the time of default, particularly
during a period of financial stress.
4(b) Accordingly, the BCBS and IOSCO have considered the types of
collateral that should be deemed eligible for use in meeting the margin
requirements, evaluating several different approaches.
One approach would be to restrict eligible collateral to the most liquid
top-quality assets, such as cash and high-quality sovereign debt, on the
grounds that doing so would best ensure that the value of collateral held as
margin could be fully realised in a period of financial stress.
Another approach would be to permit a broader set of eligible collateral,
including assets such as liquid equity securities and corporate bonds, and
address the potential volatility of such assets through the application of
appropriate haircuts to their valuation for margin purposes.
Potential advantages of the latter approach would include
(i) a reduction of the potential liquidity impact of the margin requirements
by permitting firms to use a broader array of assets to meet margin
requirements and
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(ii) better alignment with central clearing practices, in which CCPs
frequently accept a broader array of collateral, subject to collateral haircuts.
After evaluating each of these alternatives, the BCBS and IOSCO have opted
for the second approach (broader eligible collateral).
Key principle 4
To ensure that assets collected as collateral for initial and variation margin
purposes can be liquidated in a reasonable amount of time to generate
proceeds that could sufficiently protect collecting entities covered by the
requirements from losses on non-centrally cleared derivatives in the event
of a counterparty default, these assets should be highly liquid and should,
after accounting for an appropriate haircut, be able to hold their value in a
time of financial stress.
The set of eligible collateral should take into account that assets which are
liquid in normal market conditions may rapidly become illiquid in times of
financial stress.
In addition to having good liquidity, eligible collateral should not be
exposed to excessive credit, market and FX risk (including through
differences between the currency of the collateral asset and the currency of
settlement).
To the extent that the value of the collateral is exposed to these risks,
appropriately risk-sensitive haircuts should be applied.
More importantly, the value of the collateral should not exhibit a significant
correlation with the creditworthiness of the counterparty or the value of the
underlying non-centrally cleared derivatives portfolio in such a way that
would undermine the effectiveness of the protection offered by the margin
collected (ie the so-called “wrong way risk”).
Accordingly, securities issued by the counterparty or its related entities
should not be accepted as collateral.
Accepted collateral should also be reasonably diversified.
Requirement 4
4.1 National supervisors should develop their own list of eligible collateral
assets based on the key principle, taking into account the conditions of their
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own markets.
As a guide, examples of the types of eligible collateral that satisfy the key
principle would generally include:
• Cash;
• High-quality government and central bank securities;
• High-quality corporate bonds;
• High-quality covered bonds;
• Equities included in major stock indices; and
• Gold.
The illustrative list above should not be viewed as being exhaustive.
Additional assets and instruments that satisfy the key principle may also
serve as eligible collateral.
Also, in different jurisdictions, some particular forms of collateral may be
more abundant or generally available due to institutional market practices
or norms.
Eligible collateral can be denominated in any currency in which payment
obligations under the non-centrally cleared derivatives may be made, or in
highly liquid foreign currencies subject to appropriate haircuts to reflect the
inherent FX risk involved.
4.2 Potential methods for determining appropriate haircuts could include
either internal or third-party quantitative model-based haircuts or
schedule-based haircuts.
Each alternative is briefly discussed below.
4.3 As in the case of initial margin models, risk-sensitive quantitative
models, both internal or third-party, could be used to establish haircuts
provided that the model is approved by supervisors and is subject to
appropriate internal governance standards.
As in the case of initial margin models, an unregulated derivatives
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counterparty may use an approved quantitative model.
In addition to the points regarding the use of internal models discussed in
the context of initial margin, the BCBS and IOSCO also note that eligible
collateral may vary across national jurisdictions owing to differences in the
availability and liquidity of certain types of collateral.
As a result, it may be difficult to establish a standardised set of haircuts
that would apply to all types of collateral across all jurisdictions that are
consistent with the key principle.
4.4 In addition to haircuts based on quantitative models, as in the case of
initial margin, derivatives counterparties should also have the option of
using standardised haircuts that would provide transparency and limit
procyclical effects.
The BCBS and IOSCO have established a standardised schedule of haircuts
for the list of assets appearing above.
The haircut levels are derived from the standard supervisory haircuts
adopted in the Basel Accord’s comprehensive approach to collateralised
transactions framework, and can be found in Appendix B.19
In the event that the BCBS chooses to make changes to these haircuts for
regulatory capital purposes, the BCBS and IOSCO would expect to adopt
these changes in the context of the margin requirements for non-centrally
cleared derivatives absent a compelling policy reason not to do so.
However, if a regulated entity is subject to an existing standardised
haircut-based approach under its required capital regime, the appropriate
supervisory authority may permit the use of the same haircuts for initial
margin purposes, provided that they are at least as conservative.
While haircuts serve a critical risk management function in ensuring that
pledged collateral is sufficient to cover margin needs in a time of financial
stress, other risk mitigants should also be considered when accepting
non-cash collateral.
In particular, entities covered by the requirements should ensure that the
collateral collected is not overly concentrated in terms of an individual
issuer, issuer type and asset type.
4.5 In the event that a dispute arises over the value of eligible collateral,
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both parties should make all necessary and appropriate efforts, including
timely initiation of dispute resolution protocols, to resolve the dispute and
exchange any required margin in a timely fashion.
Commentary
4(i) Market conditions and asset availability differ across jurisdictions.
National supervisors should develop their own list of eligible collateral
assets based on the key principle, taking into account the conditions of their
own markets and making reference to the list of examples of eligible
collateral under the requirement section.
4(ii) Haircut requirements should be transparent and easy to calculate, so
as to facilitate payments between counterparties, avoid disputes and reduce
overall operational risk.
Haircut levels should be risk-based and should be calibrated appropriately
to reflect the underlying risks that affect the value of eligible collateral, such
as market price volatility, liquidity, credit risk and FX volatility, during both
normal and stressed market conditions.
Haircuts should be set conservatively to avoid procyclicality.
For example, haircuts should be set at a sufficiently high level during “good
times” to avoid the need for sharp and sudden increases in times of stress.
4(iii) Some firms may be unable or unwilling to develop internal haircut
calculation models that meet regulators’ requirements. It may also be
desirable to make available a simpler, conservative and transparent
approach to calculating haircuts.
The BCBS and IOSCO have established a set of standardised haircuts that
can be used in lieu of model-based haircuts.
4(iv) Schedule-based haircuts should be stringent enough to give firms an
incentive to develop internal models.
To prevent firms from selectively applying the standardised tables where
this would produce a lower haircut, firms would have to consistently adopt
either the standardised tables approach or the internal/third-party models
approach for all the collateral assets within the same well defined asset
class.
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4(v) Collateral that is posted by a counterparty to satisfy margin
requirements may, at some point in time before the end of the derivatives
contract, be needed by the counterparty for some particular reason or
purpose.
Alternative collateral may be substituted or exchanged for the collateral
that was originally posted provided that both parties agree to the
substitution and that the substitution or exchange is made on the terms
applicable to their agreement.
When collateral is substituted, the alternative collateral must meet all the
requirements outlined above.
Further, the value of the alternative collateral, after the application of
haircuts, must be sufficient to meet the margin requirement.
Element 5: Treatment of provided initial margin
Background discussion
5(a) The legal capacity in which initial margin is held or exchanged can
have a significant influence on how effective margin is in protecting a firm
from loss in the event of the default of a derivatives counterparty.
In particular, when two parties to a derivatives transaction exchange initial
margin on a net or commingled basis, there can be little or no actual
increase in the extent to which either firm is protected from the default of
the other.
Although one firm has received initial margin as collateral, the firm also
now bears the risk of additional loss on the initial margin that it has
provided to the counterparty if the counterparty defaults, which may offset
some or all of the benefits of initial margin received.
The risk would be exacerbated if the counterparty re-hypothecates,
re-pledges or re-uses the provided margin, which could result in third
parties having legal or beneficial title over the margin, or a merging or
pooling of the margin with assets belonging to the others as a result of
which the firm’s claim to the margin becomes entangled in legal
complications, thus delaying or even denying the return of re-hypothecated
/ re-used assets in the event that the counterparty defaults.
5(b) Under current market practices, the exchange of two-way initial
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margin in bilateral trades is not universal.
Accordingly, requiring the segregation or other protection of initial margin
collateral may create material incremental liquidity demands and trading
costs relative to current practices, as
(i) firms would be required to divert significantly more liquid assets to
provide initial margin to counterparties on a gross, rather than net, basis,
and
(ii) firms would no longer retain the unlimited ability to use initial margin
collected as a source of funding, for re-hypothecation, re-pledge or re-use,
or for other discretionary purposes.
5(c) Given the potential for the net treatment of provided margin to
undermine the general benefits of the margin requirements, there was
broad consensus in the BCBS and IOSCO that the requirements should
address these risks by requiring the gross exchange and the segregation or
other effective protection of provided initial margin, so as to preserve its
capacity to fully offset the risk of loss in the event of the default of a
derivatives counterparty.
Key principle 5
Because the exchange of initial margin on a net basis may be insufficient to
protect two market participants with large gross derivatives exposures to
each other in the case of one firm’s failure, the gross initial margin between
such firms should be exchanged.
Initial margin collected should be held in such a way as to ensure that
(i) the margin collected is immediately available to the collecting party in
the event of the counterparty’s default, and
(ii) the collected margin must be subject to arrangements that protect the
posting party to the extent possible under applicable law in the event that
the collecting party enters bankruptcy.
Jurisdictions are encouraged to review the relevant local laws to ensure that
collateral can be sufficiently protected in the event of bankruptcy.
Requirement 5
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5.1 Initial margin should be exchanged on a gross basis and held in a
manner consistent with the key principle above.
Commentary
5(i) There are many different ways to protect provided margin, but each
carries its own risk.
For example, the use of third-party custodians is generally considered to
offer the most robust protection, but there have been cases where access to
assets held by third-party custodians has been limited or practically
difficult.
The level of protection would also be affected by the local bankruptcy
regime, and would vary across jurisdictions.
5(ii) The collateral arrangements used will need to be effective under the
relevant laws and supported by periodically updated legal opinions.
5(iii) Cash and non-cash collateral collected as variation margin may be
re-hypothecated, re-pledged or re-used.
5(iv) Except where re-hypothecated, re-pledged or re-used in accordance
with paragraph 5(v), cash and non-cash collateral collected as initial margin
should not be re-hypothecated, re-pledged or re-used.
A jurisdiction may allow the initial margin collector (initial margin
collector) to re-hypothecate, re-pledge or re-use certain initial margin
collected from a customer (customer) provided that the strict
circumstances provided in 5(v) below are fully adhered to and that the
jurisdiction determines that appropriate controls are in place to ensure that
such collateral use would only allow a one-time re-hypothecation, re-pledge
or re-use in the global financial system; that is, once initial margin
collateral has been re-hypothecated, re-pledged or re-used to a third party
(third party) in accordance with 5(v), no further re-hypothecation,
re-pledging or re-use of such initial margin collateral by the third party is
permitted.
Moreover, collected collateral must be segregated from the initial margin
collector’s proprietary assets.
In addition, the initial margin collector must give the customer the option
to segregate the collateral that it posts from the assets of all the initial
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margin collector’s other customers and counterparties (ie individual
segregation).
5(v) Cash and non-cash collateral collected as initial margin from a
customer may be re-hypothecated, re-pledged or re-used (henceforth
re-hypothecated) to a third party only for purposes of hedging the initial
margin collector’s derivatives position arising out of transactions with
customers for which initial margin was collected and it must be subject to
conditions that protect the customer’s rights in the collateral, to the extent
permitted by applicable national law.
In this context, customers should only include “buy-side” financial firms as
well as non-financial entities, but shall not include entities that regularly
hold themselves out as making a market in derivatives, routinely quote bid
and offer prices on derivative contracts and routinely respond to requests
for bid or offer prices on derivative contracts.
In any event, the customer’s collateral may be re-hypothecated only if the
conditions described below are met:
1. The customer, as part of its contractual agreement with the initial margin
collector and after disclosure by the initial margin collector of
(i) its right not to permit re-hypothecation and
(ii) the risks associated with the nature of the customer’s claim to the
re-hypothecated collateral in the event of the insolvency of the initial
margin collector or the third party, gives express consent in writing to the
re-hypothecation of its collateral.
In addition, the initial margin collector must give the customer the option
to individually segregate the collateral that it posts.
2. The initial margin collector is subject to regulation of liquidity risk.
3. Collateral collected as initial margin from the customer is treated as a
customer asset, and is segregated from the initial margin collector’s
proprietary assets until re-hypothecated.
Once re-hypothecated, the third party must treat the collateral as a
customer asset, and must segregate it from the third party’s proprietary
assets.
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Assets returned to the initial margin collector after re-hypothecation must
also be treated as customer assets and must be segregated from the initial
margin collector’s proprietary assets.
4. The collateral of customers that have consented to the re-hypothecation
of their collateral must be segregated from that of customers that have not
so consented.
5. Where initial margin has been individually segregated, the collateral
must only be re-hypothecated for the purpose of hedging the initial margin
collector’s derivatives position arising out of transactions with the customer
in relation to which the collateral was provided.
6. Where initial margin has been individually segregated and subsequently
re-hypothecated, the initial margin collector must require the third party
similarly to segregate the collateral from the assets of the third party’s other
customers, counterparties and its proprietary assets.
7. Protection is given to the customer from the risk of loss of initial margin
in circumstances where either the initial margin collector or the third party
becomes insolvent and where both the initial margin collector and the third
party become insolvent.
8. Where the initial margin collector re-hypothecates initial margin, the
agreement with the recipient of the collateral (ie the third party) must
prohibit the third party from further re-hypothecating the collateral.
9. Where collateral is re-hypothecated, the initial margin collector must
notify the customer of that fact.
Upon request by the customer and where the customer has opted for
individual segregation, the initial margin collector must notify the customer
of the amount of cash collateral and the value of non-cash collateral that
has been re-hypothecated.
10. Collateral must only be re-hypothecated to, and held by, an entity that is
regulated in a jurisdiction that meets all of the specific conditions contained
in this section and in which the specific conditions can be enforced by the
initial margin collector.
11. The customer and the third party may not be within the same group.
12. The initial margin collector and the third party must keep appropriate
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records to show that all the above conditions have been met.
5(vi) The level and volume of re-hypothecation should be disclosed to
authorities so that they can monitor any resulting risk.
5(vii) In addition, the monitoring group will review the extent to which
initial margin collateral is re-hypothecated, which entities are electing to
have their initial margin collateral re-hypothecated, which entities have
been allowed to re-hypothecate the initial margin collateral that they
collect, how jurisdictions and market participants are implementing the
above conditions and giving protection to assets re-hypothecated, how
re-hypothecation works in practice, whether the above conditions have
created level playing field issues, and how reporting on re-hypothecation
can be enhanced to formulate recommendations to the BCBS and IOSCO as
to whether to continue to permit re-hypothecation of collateral under these
conditions, permit re-hypothecation for only a subset of non-centrally
cleared derivative products, prohibit re-hypothecation altogether, or
whether to otherwise modify the conditions.
Finally, the monitoring group will review the definition of customer and
consider whether the definition should be revised or new conditions should
be added.
Element 6: Treatment of transactions with affiliates
Background discussion
6(a) Although current market practices on this point vary, the exchange of
initial or variation margin by affiliated parties to a non-centrally cleared
derivative is not customary.
Accordingly, extending the initial margin requirements to such transactions
would likely create additional liquidity demands for firms engaging in such
transactions.
In addition, the specific legal and regulatory environment in which such
transactions are regulated varies considerably across jurisdictions.
The specific legal and regulatory frameworks governing inter-affiliate
derivatives transactions depend largely on the specific features of the
applicable jurisdictions.
For example, some jurisdictions require inter-affiliate transactions to be
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subject to centralised risk management whereas others oblige affiliates to
enter into transactions on an arm’s length basis.
Such transactions may not necessarily be suited to harmonisation as
varying legal systems may be driven by the specifics of each jurisdiction and
its legal framework.
Key principle 6
Transactions between a firm and its affiliates should be subject to
appropriate regulation in a manner consistent with each jurisdiction’s legal
and regulatory framework.
Requirement 6
6.1 Local supervisors should review their own legal frameworks and market
conditions and put in place initial and variation margin requirements as
appropriate.
Element 7: Interaction of national regimes in cross-border
transactions
Background discussion
7(a) The existing structure of markets for non-centrally cleared derivatives
is global in scope.
Key derivatives market participants are often engaged in derivatives activity
through a variety of legal entities in different national jurisdictions and
frequently deal with counterparties on a cross-border basis.
Given the global nature of these markets, and as noted in the Executive
Summary, the effectiveness of margin requirements could be undermined if
the requirements were not consistent internationally.
7(b) Accordingly, the BCBS and IOSCO have considered, as part of the
framework for margin requirements, specific approaches to ensuring that
implementation of the margin requirements at a national jurisdiction-level
is appropriately interactive – that is, that each national jurisdiction’s rule is
territorially complementary such that
(i) regulatory arbitrage opportunities are limited,
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(ii) a level playing field is maintained,
(iii) there is no application of duplicative or conflicting margin
requirements to the same transaction or activity, and
(iv) there is substantial certainty as to which national jurisdiction’s rules
apply.
When a transaction is subject to two sets of rules (duplicative
requirements), the home and the host regulators should endeavour to
(1) harmonise the rules to the extent possible or
(2) apply only one set of rules, by recognising the equivalence and
comparability of their respective rules.
Key principle 7
Regulatory regimes should interact so as to result in sufficiently consistent
and non-duplicative regulatory margin requirements for non-centrally
cleared derivatives across jurisdictions.
Requirement 7
7.1 The margin requirements in a jurisdiction may be applied to legal
entities established in that local jurisdiction, which would include locally
established subsidiaries of foreign entities, in relation to the initial and
variation margins that they collect.
Home-country supervisors may permit a covered entity to comply with the
margin requirements of a host-country margin regime with respect to its
derivatives activities, provided that the home-country supervisor considers
the host-country margin regime to be consistent with the margin
requirements described in this framework.
A branch is part of the same legal entity as the headquarters; it may be
subject to either the margin requirements of the jurisdiction where the
headquarters is established or the requirements of the host country.
Commentary
7(i) It is recommended that home and host country supervisors closely
cooperate to identify conflicts and inconsistencies between regimes with
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respect to cross-border application of margin requirements.
It is further recommended that authorities coordinate their approaches via
multilateral or bilateral channels to reduce such issues, to the extent
possible.
7(ii) In addition to margin requirements, a number of other aspects of the
regulation of OTC derivatives have cross-border implications.
As approaches to these issues evolve, the BCBS and IOSCO may consider
modifications to the requirements set out above, with a view to ensuring
consistency in the treatment of cross-border transactions across all aspects
of OTC derivatives regulation.
Element 8: Phase-in of requirements
Background discussion
8(a) Margin requirements on non-centrally cleared derivatives will
represent a significant policy change for most market participants.
Initial margin requirements, in particular, are not currently applied to a
large number of transactions across many market participants.
Such requirements will require significant operational enhancements and
will also require significant amounts of collateral for which liquidity
planning will be required.
While the changes that will be required as a result of universal margin
requirements are important for limiting systemic risks, these changes must
be managed effectively so as to allow for an appropriate transition and not
create unduly large transition costs.
Moreover, the benefits gained by managing the transition to the new
requirements must be weighed against systemic risks that are left
unmitigated during any transition period.
8(b) In addition, the requirements could impose some unnecessary
operational costs on smaller entities that pose no significant systemic risk
to the system and would not be expected to be bound by the initial margin
requirements, in particular, in light of the provided threshold amount of
€50 million.
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8(c) Also, these requirements are new and interact with a large number of
existing regulatory initiatives that, over time, should be reviewed and
harmonised as appropriate.
Accordingly, it is important that the appropriateness, efficacy and
relationship of these requirements with other related requirements be
monitored and evaluated on an ongoing basis.
Key principle 8
The requirements described in this paper should be phased in so that the
systemic risk reductions and incentive benefits are appropriately balanced
against the liquidity, operational and transition costs associated with
implementing the requirements.
In addition, the requirements should be regularly reviewed to evaluate their
efficacy, soundness and relationship to other existing and related
regulatory initiatives, and to ensure harmonisation across jurisdictions.
Requirement 8
8.1 From 1 September 2016, any covered entity belonging to a group whose
aggregate month-end average notional amount of non-centrally clear
derivatives for March, April, and May of 2016 exceeds €3.0 trillion will be
required to exchange variation margin when transacting with another
covered entity (provided that it also meets that condition).
The requirements to exchange variation margin between these covered
entities only applies to new contracts entered into after 1 September 2016.
Exchange of variation margin on other contracts is subject to bilateral
agreement.
8.2 From 1 March 2017, all covered entities will be required to exchange
variation margin.
Subject to paragraph 8.1 above, the requirement to exchange variation
margin between covered entities only applies to new contracts entered into
after 1 March 2017.
Exchange of variation margin on other contracts is subject to bilateral
agreement.
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8.3 The requirement to exchange two-way initial margin with a threshold of
up to €50 million will be staged as follows.
8.4 From 1 September 2016 to 31 August 2017, any covered entity belonging
to a group whose aggregate month-end average notional amount of
non-centrally cleared derivatives for March, April, and May of 2016 exceeds
€3.0 trillion will be subject to the requirements when transacting with
another covered entity (provided that it also meets that condition).
8.5 From 1 September 2017 to 31 August 2018, any covered entity belonging
to a group whose aggregate month-end average notional amount of
non-centrally cleared derivatives for March, April, and May of 2017 exceeds
€2.25 trillion will be subject to the requirements when transacting with
another covered entity (provided that it also meets that condition).
8.6 From 1 September 2018 to 31 August 2019, any covered entity
belonging to a group whose aggregate month-end average notional amount
of non-centrally cleared derivatives for March, April, and May of 2018
exceeds €1.5 trillion will be subject to the requirements when transacting
with another covered entity (provided that it also meets that condition).
8.7 From 1 September 2019 to 31 August 2020, any covered entity
belonging to a group whose aggregate month-end average notional amount
of non-centrally cleared derivatives for March, April, and May of 2019
exceeds €0.75 trillion will be subject to the requirements when transacting
with another covered entity (provided that it also meets that condition).
8.8 On a permanent basis (ie from 1 September 2020), any covered entity
belonging to a group whose aggregate month-end average notional amount
of non-centrally cleared derivatives for March, April, and May of the year
exceeds €8 billion will be subject to the requirements described in this
paper during the one-year period from 1 September of that year to 31
August of the following year when transacting with another covered entity
(provided that it also meets that condition).
Any covered entity belonging to a group whose aggregate month-end
average notional amount of non-centrally cleared derivatives for March,
April, and May of the year is less than €8 billion will not be subject to the
initial margin requirements described in this paper.
8.9 For the purposes of calculating the group aggregate month-end average
notional amount for determining whether a covered entity will be subject to
the initial margin requirements described in this paper, all of the group’s
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non-centrally cleared derivatives, including physically settled FX forwards
and swaps, should be included.
8.10 Initial margin requirements will apply to all new contracts entered into
during the periods described above.
Applying the initial margin requirements to existing derivatives contracts is
not required.
8.11 Global regulators will work together to ensure that there is sufficient
transparency regarding which entities are and are not subject to the initial
margin requirements during the phase-in period.
Appendix A
Standardised initial margin schedule
Appendix B
Standardised haircut schedule
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is not necessarily comprehensive, complete, or up to date;
is sometimes linked to external sites over which the Association has no
control and for which the Association assumes no responsibility;
is not professional or legal advice (if you need specific advice, you should
always consult a suitably qualified professional);
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is in no way constitutive of an interpretative document;
does not prejudge the position that the relevant authorities might decide to
take on the same matters if developments, including Court rulings, were to lead it
to revise some of the views expressed here;
does not prejudge the interpretation that the Courts might place on the
matters at issue.
Please note that it cannot be guaranteed that these information and documents
exactly reproduce officially adopted texts.
It is our goal to minimize disruption caused by technical errors.
However some data or information may have been created or structured in files or
formats that are not error-free and we cannot guarantee that our service will not
be interrupted or otherwise affected by such problems.
The Association accepts no responsibility with regard to such problems incurred
as a result of using this site or any linked external sites.
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The International Association of Risk and Compliance
Professionals (IARCP)
You can explore what we offer to our members:
1. Membership – Become a standard, premium or lifetime member.
You may visit:
www.risk-compliance-association.com/How_to_become_member.htm
If you plan to continue to work as a risk and compliance management
expert, officer or director throughout the rest of your career, it makes
perfect sense to become a Life Member of the Association, and to continue
your journey without interruption and without renewal worries.
You will get a lifetime of benefits as well.
You can check the benefits at:
www.risk-compliance-association.com/Lifetime_Membership.htm
2. Weekly Updates - Subscribe to receive every Monday the Top 10 risk
and compliance management related news stories and world events that
(for better or for worse) shaped the week's agenda, and what is next:
http://forms.aweber.com/form/02/1254213302.htm
3. Training and Certification - Become
a Certified Risk and Compliance
Management Professional (CRCMP) or a
Certified Information Systems Risk and
Compliance Professional (CISRSP).
The Certified Risk and Compliance
Management Professional (CRCMP)
training and certification program has
become one of the most recognized
programs in risk management and compliance.
There are CRCMPs in 32 countries around the world.
Companies and organizations like IBM, Accenture, American Express,
USAA etc. consider the CRCMP a preferred certificate.
You can find more about the demand for CRCMPs at:
www.risk-compliance-association.com/CRCMP_Jobs_Careers.pdf
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International Association of Risk and Compliance Professionals (IARCP)
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You can find more information about the CRCMP program at:
www.risk-compliance-association.com/CRCMP_1.pdf
(It is better to save it and open it as an Adobe Acrobat document).
For the distance learning programs you may visit:
www.risk-compliance-association.com/Distance_Learning_and_Certificat
ion.htm
For instructor-led training, you may contact us. We can tailor all programs
to specific needs. We tailor presentations, awareness and training programs
for supervisors, boards of directors, service providers and consultants.
4. IARCP Authorized Certified Trainer
(IARCP-ACT) Program - Become a Certified Risk
and Compliance Management Professional Trainer
(CRCMPT) or Certified Information Systems Risk
and Compliance Professional Trainer (CISRCPT).
This is an additional advantage on your resume,
serving as a third-party endorsement to your knowledge and experience.
Certificates are important when being considered for a promotion or other
career opportunities. You give the necessary assurance that you have the
knowledge and skills to accept more responsibility.
To learn more you may visit:
www.risk-compliance-association.com/IARCP_ACT.html
5. Approved Training and Certification Centers
(IARCP-ATCCs) - In response to the increasing
demand for CRCMP training, the International
Association of Risk and Compliance Professionals is
developing a world-wide network of Approved Training
and Certification Centers (IARCP-ATCCs).
This will give the opportunity to risk and compliance managers, officers and
consultants to have access to instructor-led CRCMP and CISRCP training at
convenient locations that meet international standards.
ATCCs use IARCP approved course materials and have access to IARCP
Authorized Certified Trainers (IARCP-ACTs).
To learn more:
www.risk-compliance-association.com/Approved_Centers.html
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International Association of Risk and Compliance Professionals (IARCP)