Just wanted to start this post with a quick best wishes to all affected by Hurricane Sandy in the New York area. Nature is a awesomely powerful thing and amply demonstrated it is always to be respected as a "risk".
Good event on regulatory progress organised by PRMIA and hosted by Credit Suisse last night. Dan Rodriguez introduced the speakers and Michael Gibson of the Fed began with his assessment of what he thinks regulators have learned from the crisis. Mike said that regulators had not paid enough attention to the following factors:
- Resolvability (managing the failure of a financial institution without triggering systemic risk)
Capital - Mike said that regulators had addressed the quality and quantity of capital head by banks. With respect to Basel III, Mike said that the Fed had received around 2,500 comments that they were currently reviewing. In relation to supervision, he suggested that stress testing by the banks, the requirement for capital planning from banks and the independent stress tests undertaken by the regulators had turned the capital process into much more of a forward-looking exercise than it had been pre-crisis. The ability of regulators to limit dividend payments and request capital changes had added some "teeth" to this forward looking approach. Mike said that the regulators are getting more information which is allowing them to look more horizontally across different financial institutions to compare and contrast business practices, risks and capital adequacy. He thought that disclosure to the public of stress testing results and other findings was also a healthy thing for the industry, prompting wider debate and discussion.
Liquidity - Mike said that liquidity stress testing was an improvement over what had gone before (which was not much). He added that the Basel Committee was working on a quantitative liquidity ratio and that in general regulators were receiving and understanding much more data from the banks around liquidity.
Resolvability - Mike said in addition to resolution plans (aka "living wills") being required by Dodd-Frank in the US, the Fed was working with other regulators internationally on resolvability.
There then followed a Q&A session involving the panelists and the audience:
Basel III Implementation Timeline - Dan asked Mike about the 2,500 comments the Fed had received on Basel III and when the Fed would have dealt with these comments, particularly in the context of where compliance with Basel III for US Banks had been delayed beyond Jan 1 2013. Dan additionally asked whether Mike that implementing Basel III now was a competitive advantage or disadvantage for a bank?
Mike responded that the Fed had extended its review period from 90 days to 135 days which was an unusual occurence. He said that as yet the Fed had no new target data for implementation.
Brian of AIG on Basel III and Regulation - Dan asked Brian Peters of AIG what his thoughts were on Basel III. Brian was an entertaining speaker and responded firstly that AIG was not a bank, it was an insurer and that regulators need to recognise this. He said regulators need to think of the whole financial markets and how they want them to look in the future. Put another way, he implied that looking at capital, liquidity and resolvability in isolation was fine at one level, but these things had much wider implications and without taking that view then there would be problems.
Brian said he thinks of Basel III as a hammer, and that when people use a hammer everything starts to look like a "nail". He said that insurers write 50 year-long liabilities, and as a result he needs long term investments to cover these obligations. He added that the liquidity profile of insurers was different to banks, with life policies having exposures to interest rates more like bank deposits. He said that AIG was mostly dealing with publicly traded securities (I guess now AIG FP is no longer dominant?). Resolvability was a different process for insurers, with regulators forcing troubled insurers to limit dividends and build up cash reserves.
Brian's big concern for the regulators was that in his view they need to look at the whole financial system and what future they want for it, rather than dealing with one set of players and regulations in isolation. Seems Brian shares some similar concerns to Pierre Guilleman on apply banking regulation to the insurance industry, combined with the unintended consequencies of current regulation on the future of the whole of financial markets (maybe the talk on diversity of approach is a good to read on this, or maybe more recently "Regulation Increases Risk" for a more quantitative approach).
Steve of Credit Suisse on Basel III - Dan asked Steven Haratunian whether implementing Basel III was a competitive advantage or disadvantage for Credit Suisse. Steve said that regardless of competitive advantage, as a Swiss bank Credit Suisse had no choice in complying with Basel III by Jan 1 2013, that Credit Suisse had started its preparations since 2011 and had been Basel 2.5 compliant since Jan 1 2012. He said that Basel III compliance had effectively doubled their capital requirements, and had prompted a strategic review of all business activities within the investment banking arm.
This review had caused a reassessment of the company's involvement in areas such as fixed income and risk weighted assets had been reduced by over $100Billion. Steven explained how they had looked at each business activity and assessed whether they could achieve a 15% return on equity over a business cycle, plus be able to withstand CCAR stress testing during this time. He said that Credit Suisse had felt lonely in the US markets in that they were many occaisions where deals were lost due directly to consideration of Basel III capital requirements. Credit Suisse felt less lonely now given how regulation is affecting other banks, and that for certain markets (notably mortgages and credit) the effects of Basel III were very harsh.
Volcker Rule and Dodd-Frank - Dan asked Mike where did the Volcker Rule fit within Dodd-Frank, and does it make us safer? Mike didn't have a great deal to say on this, other than he thought it was all part and parcel of Congress's attempts to make the financial markets safer, that its implementation was being managed/discussed across an inter-agency group including the Fed, SEC and CFTC. Brian said that Dodd-Frank did not have a great deal of impact for insurers, the only real effects being some on swap providers to insurers.
Steve said that many of the many aspects or "spirit" of Volcker and Dodd-Frank had been internalised by the banks and were progressing despite Dodd-Frank not being finalised. He said that in particular the lack of certainty around extraterritoriality and margining in derivatives was not helpful. Mike added that in terms of progressing through Dodd-Frank, his estimated was that the Fed had one third of it finished, one third of the rules proposed, and one third not started or in very early stages. So still some work to be done.
Living Wills - Brian at this point referred to a recent speech by William C. Dudley of the Fed with title "Solving the Too Big to Fail Problem" (haven't looked at this yet, but will). Mike said that the Fed was stilling learning in relation to "Living Wills" and eventually it will get down to a level of being very company specific. Brian asked whether this meant that "Living Wills" would be very specific to each company and not a general rule to be applied to all. Mike said it was too early to tell.
Extraterritoriality - On extraterritoriality Steve said that Credit Suisse having to look at its subsidiaries globally more as standalone companies when dealing with regulators and capital requirements, which will great increase capital requires if the portfolio effect of being a global company is not considered by regulators. Dan mentioned a forthcoming speechto be made by Dan Tarullo of the Fed, and mentioned how the Fed was looking at treating foreign subsidiaries operating in the US as bank holding companies not global subsidiaries, hence again causing problems by ignoring portfolio effect. Mike said that the regulators were working on this issue, and that unsurprisingly he couldn't comment on the speech Dan Tarullo had yet to make.
The Future Shape of the Markets - Brian brought up an interesting question for Mike in asking how the regulators wanted to see financial markets develop and operate in the future? Brian thought that current regulation was being implemented as almost the "last war" against financial markets without a forward looking view. He said that historically he could see Basel 1 being prompted by addressing some of the issues caused by Japanese banks, he saw Basel II addressing credit risk but what will the effects of Basel III ultimately be?
This prompted an interesting response from Mike, in that he said that the Fed is not shaping markets and is dealing only with current rules and risks. He added that private enterprise would shape future markets. (difficult to see how that argument stacks up, regulation implemented now is surely not independent of private sector reaction/exploitation of it) Steve added that Basel III had already had effects, with Credit Suisse already reducing its activity in mortgage and fixed income markets. Steve said that non-banking organisations were now involved in these markets and that regulators have to be aware of these changes or face further problems.
Did Regulators Fail to Enforce Existing US Regulation - one audience participant was strongly of the opinion that Basel III is not needed, that there was enough regulation in place to limit the crisis and that the main failing of the regultors was that they did not implement what was already there to be used. Mike said he thought that the regulators did have lessons to learn and that some of the regulation then in place needed reviewing.
Keep it Simple - another audience member asked about the benefits of simple regulation of simpler markets and mentioned an article by Andrew Haldane of the Bank of England on "The Dog and the Frisbee". Mike didn't have much to add on this other than saying it was a work in progress.
Brian thought that the central failure behind the crisis was the mis-rating of credit instruments, with AAA products attracting a 4bp capital charge instead of a more realistic 3%.
Regulations Effects on Market Pricing - Steve was the first to respond on this, pointing to areas such as cmbs and credit markets as being best performing areas that also have the lower capital risk weights. Dan said he felt that equity markets had not fully adjusted yet, and ironically that financial equities had the highest risk weights. Combined with anticipated rises in tax, high risk weightings were taking capital out of the risk bearing/wealth generating parts of the economy and into low weighted instruments like US treasuries. Dan wondered whether regulation was one of the key dampening factors behind why the current record stimulus was not accelerating the economy in the US more quickly.
Derivatives Clearer and Clearing - this audience question was asking how the regulators were dealing with the desire to encourage clearing of derivative trades whilst at the same time not incentivising the banks to set themselves up as clearers. Mike said that there was an international effort to look at this.
What Happens When the Stimulus Goes - an audience member asked what the panel thought would happen once the stimulus was removed from the markets. The panelists thought this was more an economics questions. However Dan said that the regulators were more sensitive to the markets and market participants when considering new stimulus measures, and cited problems in the fall of 2011 caused by Fed actions in the market crushing mortgage spreads. Brian said insurers need yield so the stimulus was obviously having an impact. Dan mentioned that given the low risk weighting of US Treasuries then everyone was holding them and so the impact of a jump in rates would hurt many if done without preparation.
Wine Shortage and Summary - Just had to mention that there was no wine made available at the networking session afterwards. A sign of austere times or simply that it was too early in the week? Anyway it was a great discussion and raised some good points. In summary, all I hear still supports the premise that the "Law of Unintended Consequences" is ever-present, ever-powerful and looming over the next few years. Hearing regulators say that they are dealing with current risks only and are not shaping the future of financial markets smacks of either delusion or obfuscation to me.