The regulatory years
22 August 2017
Were the 10 years that followed the financial crisis a decade of discontent and discomfort, or were the significant regulatory changes necessary? Jenna Lomax takes a look
Image: Shutterstock
The day that BNP Paribas closed three of its main hedge funds marked what was the very beginning of the financial crisis. On 9 August 2007, the 10th anniversary of which passed this month, the French bank was forced to acknowledge the sub-prime loan crisis.
It was the first bank to learn the instability of sub-prime mortgage markets, in that it had no way of valuing the assets within them, known as collateralised debt obligations. In the months that followed, a ripple effect would be felt around the world.??
The American housing market had lent too much money to people who essentially couldn’t afford to pay it back. High delinquency rates led to a slip in value of mortgage-backed securities, which included bundled loan portfolios, derivatives and credit default swaps. The main banks that were invested in these assets—BNP Paribas, Lehman Brothers and the Royal Bank of Scotland (RBS)—began to experience a liquidity crisis. Within a year, Lehman Brothers had filed for bankruptcy, the US government had bailed out Fannie Mae and Freddie Mac, and the investment bank, Bear Stearns, had been bought out by J.P. Morgan.?
In the UK, Northern Rock faced a liquidity crisis after borrowing too much money to fund mortgages for customers, which saw the first run on a British bank for 150 years.
Elsewhere, the government had just bailed out RBS for a reported £45 billion. A crisis on this scale had not been seen since the Great Depression of the 1930s.??
Although it is clear that securities lending was not a direct cause of the crash, the sector gained a degree of attention in the aftermath because of its loose association with shadow banking. The securities lending market was forever changed by the event because of the regulation that came as a result of it.? ??
Jeff Kidwell, director at Direct Repo, discusses where he was when the financial crisis struck: “I was working as the co-head of the global repo division at primary dealer Cantor Fitzgerald, managing a large repo matched book in New York City.”??
“At the time, everything escalated very quickly, from rumours about problems with settlements and margin calls, to multiple account portfolio liquidations and massive movement in securities prices,” Kidwell says. “We in the industry worked around the clock, frequently past midnight, even on weekends, meeting among our peers and regulators to determine what to do to reduce systemic risk, meeting internally to analyse prices and portfolios and manage various risks, including settlement, possible counterparty defaults, margin calls, and liquidity. The amount of turmoil and upheaval in the repo market (and in broader fixed income and equity markets) were unprecedented.”
More than 4,000 miles away in Vienna, Philippe Seyll, CEO of Clearstream, was attending the annual Sibos conference. Looking back, he says: “Most of us senior banking representatives had to leave the conference to go back to our head office to attend crisis meetings.”??
Andrew Dyson, CEO of ISLA, who was based in London at the time, remembers: “Upon seeing the first signs of the crisis, I was struck by how similar the circumstances were to the UK’s secondary banking crises of the mid-1970s when we saw a dramatic crash in British property prices that caused dozens of small (‘secondary’) lending banks to be threatened with bankruptcy. I thought what was happening all looked very familiar, but the scale of what was now before us was very different.”
In the years that followed, sweeping changes were made to how financial services are regulated, as entire economies were bailed out from the brink. In Greece, a furious austerity programme is still being implemented, drawing regular protests from a population that feels like it’s being punished for the mistakes of bankers.
Basel III, in particular, was created in response to the perceived lack of regulation prior to the financial crisis. It was introduced in 2010 but is so complicated that it will take until 2019 to implement the regulation in its entirety. Its intention was to strengthen capital and liquidity asset holdings, as well as leverage ratios, essentially to guarantee that financial institutions will have the capital they need should a crisis come calling again.
Seyll says of the sweeping regulatory changes of the last decade: “I believe that good cooperation between the banking sector and regulators is helping the financial market to be operated in a most harmonious manner. I am pleased that the market participants, jointly with the regulators, have undertaken a number of reforms to further strengthen the genes of the financial markets. In my opinion, the groundwork that financial markets are based on is now more solid and elaborate than it used to be.”
But there is a catch, particularly where businesses such as securities lending are concerned.?Seyll says: “I feel that in my role as co-CEO of a financial market operator, I am now spending even more time on those topics.”??
Andrew Dyson says of new regulations: “The flow of post-crisis regulation has created a more transparent market and specific regulations, such as the Securities Financing Transactions Regulation (SFTR), which will address legacy concerns around transparency.”??
“There is no doubt that with banks being better capitalised and adhering to more robust prudential regulation, they should be better positioned to withstand any future market traumas.”
“However and notwithstanding our support for better and more effective regulation, we do see risks primarily associated with the provision of market liquidity as potentially being magnified as a result of some of the current regulatory regimes.”
Kidwell adds: “Depending on which definition of shadow banking you are speaking about and which regulatory reforms combatted it, I’m not sure that all sectors of the market benefited from those rules. I believe that many may have suffered a significant loss of liquidity that has yet to return.”
The next decade
Skip ahead 10 years to 2017 and President Donald Trump is in the White House and de-regulation is top of the agenda. In his first six months as president, Trump signed 38 executive orders, with three eying up a lessening of the regulatory burden placed on banks since the financial crisis struck.
In particular, Trump ordered US agencies to conduct a review of post-financial crisis regulation, with a view to rolling back rules that have adversely affected profitability.
The Treasury has since reported that there is a range of changes that can be made, including substantially amending the controversial Volcker Rule, which restricts short-term proprietary trading using banks’ own funds, and is under threat of being scrapped altogether by the Financial CHOICE Act currently making its way through Congress.
These are just two regulatory overhauls being discussed and are far from the sum of what could be undone under a Trump administration, although, after everything they’ve been through, it would be wise to seek the opinion of financial institutions, from their securities lending desks to their CEOs, to find out what exactly it is they need from a de-regulation programme.
Kidwell says: “With over $30 billion spent by the financial industry so far on the new regulatory reforms and painstakingly managing their firms’ responses to them, I wonder how willing those firms will be to now scrap all of that work and expense to embrace repeal of portions or all of those reforms.”
A decade ago, they started their journey through one massive change. They might not be prepared to embark on another.
Financial crisis: How it happened
9 August 2007
BNP Paribas freeze three of its major hedge funds
14 September 2007
Northern Rock faces a liquidity crisis and needs a loan from the UK government after demand for securitised mortgages falls
24 January 2008
Analysts announce the largest single-year drop in US home sales for 25 years
17 February 2008
The UK nationalises Northern Rock after the bank borrows too much money to fund mortgages for customers
14 March 2008
Failing investment bank Bear Stearns is bought by J.P. Morgan
7 September 2008
The US government bails out Fannie Mae and Freddie Mac—two huge firms that had guaranteed thousands of sub-prime mortgages to customers in the US
15 September 2008
The US bank, Lehman Brothers, files for bankruptcy after the sub-prime mortgage market falls into disarray
13 October 2008
To avoid the demise of its banking sector, the UK government bails out several banks, including the Royal Bank of Scotland and Lloyds TSB
2 April 2009
The G20 agrees on a global stimulus package worth $5 trillion
2009 onwards
Basel III is introduced by the G-20’s Basel Committee on Banking Supervision, aiming to strengthen banks’ minimum capital ratios in an effort to prevent another financial crisis from occurring, while major markets around the world embark on the reform of their own financial services markets
10 October 2009
George Papandreou’s socialist government is elected in Greece, marking the start of a fierce austerity programme
2 May 2010
Greece is bailed out by the EU for the first time, with a loan of €110 billion
12 March 2012
The number of unemployed Europeans reaches its highest ever level. Spanish unemployment reaches a record level of 5.6 percent
It was the first bank to learn the instability of sub-prime mortgage markets, in that it had no way of valuing the assets within them, known as collateralised debt obligations. In the months that followed, a ripple effect would be felt around the world.??
The American housing market had lent too much money to people who essentially couldn’t afford to pay it back. High delinquency rates led to a slip in value of mortgage-backed securities, which included bundled loan portfolios, derivatives and credit default swaps. The main banks that were invested in these assets—BNP Paribas, Lehman Brothers and the Royal Bank of Scotland (RBS)—began to experience a liquidity crisis. Within a year, Lehman Brothers had filed for bankruptcy, the US government had bailed out Fannie Mae and Freddie Mac, and the investment bank, Bear Stearns, had been bought out by J.P. Morgan.?
In the UK, Northern Rock faced a liquidity crisis after borrowing too much money to fund mortgages for customers, which saw the first run on a British bank for 150 years.
Elsewhere, the government had just bailed out RBS for a reported £45 billion. A crisis on this scale had not been seen since the Great Depression of the 1930s.??
Although it is clear that securities lending was not a direct cause of the crash, the sector gained a degree of attention in the aftermath because of its loose association with shadow banking. The securities lending market was forever changed by the event because of the regulation that came as a result of it.? ??
Jeff Kidwell, director at Direct Repo, discusses where he was when the financial crisis struck: “I was working as the co-head of the global repo division at primary dealer Cantor Fitzgerald, managing a large repo matched book in New York City.”??
“At the time, everything escalated very quickly, from rumours about problems with settlements and margin calls, to multiple account portfolio liquidations and massive movement in securities prices,” Kidwell says. “We in the industry worked around the clock, frequently past midnight, even on weekends, meeting among our peers and regulators to determine what to do to reduce systemic risk, meeting internally to analyse prices and portfolios and manage various risks, including settlement, possible counterparty defaults, margin calls, and liquidity. The amount of turmoil and upheaval in the repo market (and in broader fixed income and equity markets) were unprecedented.”
More than 4,000 miles away in Vienna, Philippe Seyll, CEO of Clearstream, was attending the annual Sibos conference. Looking back, he says: “Most of us senior banking representatives had to leave the conference to go back to our head office to attend crisis meetings.”??
Andrew Dyson, CEO of ISLA, who was based in London at the time, remembers: “Upon seeing the first signs of the crisis, I was struck by how similar the circumstances were to the UK’s secondary banking crises of the mid-1970s when we saw a dramatic crash in British property prices that caused dozens of small (‘secondary’) lending banks to be threatened with bankruptcy. I thought what was happening all looked very familiar, but the scale of what was now before us was very different.”
In the years that followed, sweeping changes were made to how financial services are regulated, as entire economies were bailed out from the brink. In Greece, a furious austerity programme is still being implemented, drawing regular protests from a population that feels like it’s being punished for the mistakes of bankers.
Basel III, in particular, was created in response to the perceived lack of regulation prior to the financial crisis. It was introduced in 2010 but is so complicated that it will take until 2019 to implement the regulation in its entirety. Its intention was to strengthen capital and liquidity asset holdings, as well as leverage ratios, essentially to guarantee that financial institutions will have the capital they need should a crisis come calling again.
Seyll says of the sweeping regulatory changes of the last decade: “I believe that good cooperation between the banking sector and regulators is helping the financial market to be operated in a most harmonious manner. I am pleased that the market participants, jointly with the regulators, have undertaken a number of reforms to further strengthen the genes of the financial markets. In my opinion, the groundwork that financial markets are based on is now more solid and elaborate than it used to be.”
But there is a catch, particularly where businesses such as securities lending are concerned.?Seyll says: “I feel that in my role as co-CEO of a financial market operator, I am now spending even more time on those topics.”??
Andrew Dyson says of new regulations: “The flow of post-crisis regulation has created a more transparent market and specific regulations, such as the Securities Financing Transactions Regulation (SFTR), which will address legacy concerns around transparency.”??
“There is no doubt that with banks being better capitalised and adhering to more robust prudential regulation, they should be better positioned to withstand any future market traumas.”
“However and notwithstanding our support for better and more effective regulation, we do see risks primarily associated with the provision of market liquidity as potentially being magnified as a result of some of the current regulatory regimes.”
Kidwell adds: “Depending on which definition of shadow banking you are speaking about and which regulatory reforms combatted it, I’m not sure that all sectors of the market benefited from those rules. I believe that many may have suffered a significant loss of liquidity that has yet to return.”
The next decade
Skip ahead 10 years to 2017 and President Donald Trump is in the White House and de-regulation is top of the agenda. In his first six months as president, Trump signed 38 executive orders, with three eying up a lessening of the regulatory burden placed on banks since the financial crisis struck.
In particular, Trump ordered US agencies to conduct a review of post-financial crisis regulation, with a view to rolling back rules that have adversely affected profitability.
The Treasury has since reported that there is a range of changes that can be made, including substantially amending the controversial Volcker Rule, which restricts short-term proprietary trading using banks’ own funds, and is under threat of being scrapped altogether by the Financial CHOICE Act currently making its way through Congress.
These are just two regulatory overhauls being discussed and are far from the sum of what could be undone under a Trump administration, although, after everything they’ve been through, it would be wise to seek the opinion of financial institutions, from their securities lending desks to their CEOs, to find out what exactly it is they need from a de-regulation programme.
Kidwell says: “With over $30 billion spent by the financial industry so far on the new regulatory reforms and painstakingly managing their firms’ responses to them, I wonder how willing those firms will be to now scrap all of that work and expense to embrace repeal of portions or all of those reforms.”
A decade ago, they started their journey through one massive change. They might not be prepared to embark on another.
Financial crisis: How it happened
9 August 2007
BNP Paribas freeze three of its major hedge funds
14 September 2007
Northern Rock faces a liquidity crisis and needs a loan from the UK government after demand for securitised mortgages falls
24 January 2008
Analysts announce the largest single-year drop in US home sales for 25 years
17 February 2008
The UK nationalises Northern Rock after the bank borrows too much money to fund mortgages for customers
14 March 2008
Failing investment bank Bear Stearns is bought by J.P. Morgan
7 September 2008
The US government bails out Fannie Mae and Freddie Mac—two huge firms that had guaranteed thousands of sub-prime mortgages to customers in the US
15 September 2008
The US bank, Lehman Brothers, files for bankruptcy after the sub-prime mortgage market falls into disarray
13 October 2008
To avoid the demise of its banking sector, the UK government bails out several banks, including the Royal Bank of Scotland and Lloyds TSB
2 April 2009
The G20 agrees on a global stimulus package worth $5 trillion
2009 onwards
Basel III is introduced by the G-20’s Basel Committee on Banking Supervision, aiming to strengthen banks’ minimum capital ratios in an effort to prevent another financial crisis from occurring, while major markets around the world embark on the reform of their own financial services markets
10 October 2009
George Papandreou’s socialist government is elected in Greece, marking the start of a fierce austerity programme
2 May 2010
Greece is bailed out by the EU for the first time, with a loan of €110 billion
12 March 2012
The number of unemployed Europeans reaches its highest ever level. Spanish unemployment reaches a record level of 5.6 percent
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