Bank regulation: Regulators seek data on systemic risk

By:
Sid Verma
Published on:

Standardization urgently needed, say analysts; banks now ‘more resilient to stress’.

The astonishing plunge in global stock markets in August failed to ignite fears over the health of balance sheets of international banks.

But markets should not be complacent. Systemic risk remains a big unknown. Regulators, therefore, need to redouble efforts to standardize and aggregate data on trades to map out financial interconnectedness, say analysts.

SNL Financial, for example, is concerned about the quality of systemic-risk data, citing questionable efforts made by the US Treasury’s Office of Financial Research (OFR). Four years after risk scores were introduced into the US marketplace, it finds the OFR relies on out-dated and inconsistent data. Morgan Stanley, for example, recently revised its figure for intra-financial system assets, such as derivatives, without shedding light on the methodology in its internal models.

Gerard Hartsink-160x186
  In several jurisdictions,
the derivatives regulators have decided to include the LEI in the reporting requirements

Gerard Hartsink,
GLEIF

Analysts at SNL note, citing Morgan Stanley: "When a bank’s derivative exposure shrinks by $314 billion – roughly half the size of Lehman when it filed bankruptcy – it raises questions about the company’s ability to model accurately in real-time. 

"When that change does not come until 16 months after the initial filing, it raises questions about the Fed’s vigilance. And when the government’s office established to track systemic risk uses incorrect, outdated data, it raises questions about the entire theory of macroprudential supervision."

In this regard, the Commodity Futures Trading Commission’s presumptive move to postpone rules to clamp down on banks’ efforts to book swaps overseas – to obtain capital relief – is a regressive step.

Global regulators have been grappling with data gaps since 2009, with an emphasis on cross-border exposures. Risk maps that highlight connections between collateral, funding, assets and product exposures are another diagnostic tool regulators could use to stress test financial systems. 

In June, researchers at the Bank of England called for greater firm-level exposure data to map contagion prospects in order to assess risks within sectors and interconnections between firms.

The main theme from banking conferences these days, therefore, is the onerous demands from regulators to provide workable data sets. There is a debate over whether this data should be at the aggregated level or whether banks should list all trades.

Many bankers say the latter is unfeasible.

Stefan Loesch, an independent derivatives analyst, formerly with JPMorgan, however, disagrees: "I think concerns about collecting the data are overblown. If Google and Facebook can essentially keep the majority of the social interactions of a significant portion of the global population then I do not see why it should be a technical issue to keep track of any financial transaction ever entered into by any legal entity anywhere in the world. It is of course not entirely trivial to create a data structure that is universal enough, but this is an issue that can be overcome."

Citing uniform resource identifiers, such as web addresses, and Companies House in the UK, which lists legally-incorporated entities, Loesch says the establishment of a financial registrar to detail the ownership of risk flows between financial companies should be technically feasible.

He adds: "On the other hand, any aggregate reporting structure is likely to become obsolete very quickly, and miss important segments, either from the start, or after a certain time." After all, institutions could game the system or distort reporting by, for example, tallying up notional positions of highly-leveraged derivative positions, he says.

Measures put in place mean banks should be more resilient to stress in the financial markets now than they used to be
Michael Rockinger, CRML

This is where the Global Legal Entity Identifier Foundation (GLEIF) comes in. Established by the Financial Stability Board (FSB) in June 2014, the organization is helping to standardize data-aggregation both within, and between, institutions across jurisdictions, through issuing freely-accessible global unique alpha-numeric codes to local operating units. 

Once parties to financial transactions are uniquely identified, regulators can then standardize data that identify the assets traded. This would help the bid to map systemic exposures in granular firm- and product-specific detail, and, by easing the identification process for counterparties to a trade, boost banks’ Know Your Customer efforts.

Gerard Hartsink, GLEIF board chairman, adds: "In several jurisdictions, the derivatives regulators have decided to include the LEI in the reporting requirements. Also securities regulators are considering whether to do so in the near future. Market participants are reviewing the option to include the LEI in their securities processing to manage better their counterparty risk in the end-to-end value chain." He adds there will be a "substantial" upgrade of its services before year-end.

But bankers say the post-crisis improvement in sector-wide capital ratios, liquidity, funding profiles and business models has curbed systemic risk, reducing the need to provide granular trading data.

One index at least paints a positive picture on the state of banking-sector fragilities and interconnectedness in Europe. A systemic risk index (Srisk) from the Centre for Risk Management (CRML) at HEC Lausanne, University of Lausanne, gauges size, leverage and vulnerability to equity market shocks, and stress tests banks in the event of a 40% semi-annualized fall in global bourses.