Specialists in Change Management

A Response to the FSB paper

On November 18th the Financial Stability Board (FSB) published a series of papers proposing policies for shadow banking. One paper is specifically on securities lending, but some of the other papers may also have an impact on our industry.

The FSB are developing these policy recommendations following an agreement of the G20 to “strengthen oversight and regulation of shadow banking”. The policies will inform global regulation going forward and so are likely to have a profound effect on the market landscape in the future.

The paper on securities lending focuses on three specific aspects on the industry: transparency (to regulators, the market and investors), regulation, and structural aspects of the market – with thirteen recommendations.

The paper looks at the type of information that regulators may need to monitor the potential build-up of leverage and systemic risk and considers the different options of delivery including trade repositories

In terms of regulation the paper proposes that there should be regulation which provides for minimum haircuts, cash collateral re-investment, re-hypothecation and collateral valuation and management. Of these, imposing minimum haircuts is probably the most controversial.

The paper argues that imposing minimum haircuts may limit the build-up of excessive leverage and reduce procyclicality in the financial system via the financing of risky assets, in particular by entities not subject to prudential regulation. It proposes a risk based calculation for haircut levels which seems to be based on a classic VaR model using 95% confidence levels and using pricing data that covers at least one stress cycle. It also proposes imposing a numerical floor. However it does recognise that these should apply to financing trades only and not stock specific securities lending and also discusses whether these should be applied to all market participants or a sub set based around whether one or more of the counterparties is a regulated financial intermediary.

For structural aspects of the market, the paper considers the benefits of imposing a Central Counterparty but recognises that the pro’s and cons are balanced and so stops short of recommending and absolute requirement.

Over the last twelve months there seems to have been a deluge of papers discussing different aspects of our market. This consultation paper and the proposals within it is probably one of the most important. The influence that the FSB has and the global nature of their reach suggests that their final recommendations are likely to be far reaching and inform future global regulatory change. It is crucial that market participants are engaged in this process, consider the implications and practicalities of the proposals and respond to the consultation paper – the deadline is January 14th 2012.

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