Stepping into the light
30 April 2013
Ambiguity and outstanding reservations of authority should prompt a call-to-action for market participants, says SunGard’s Daniel Parker
Image: Shutterstock
The overarching mandate of financial reform is to mitigate the potential risks that are associated with systemically important financial activities and institutions. Statutory authority has purposely reserved an abundance of discretionary authority for regulators to capture and reconfigure processes that have ‘an effect upon’ covered activities.
As a means of exercising this reservation of authority, rule-makers as well as regulatory-framework-setting bodies now seek to target shadow banking.
For instance, the Financial Stability Board (FSB), which itself does not have rule-making authority yet is considered a persuasive advisory body concerning international standards within the financial system, seeks to “mitigate the spill-over effect between the regular banking system and the shadow banking system”.
Additionally, the Financial Stability Oversight Council (FSOC), which has rule-making authority under Section 120 of the US Dodd-Frank Act, seeks to enhance and substantively modify the shadow banking space. The FSOC has concluded that the current state of shadow banking contributes to systemic risks. As a result, it now seeks to address the perceived bank-like activities that pose risks by subjecting shadow banking, and related activities such as money market mutual funds (MMFs), and securitisation activities to more onerous oversight.
Changes are coming to
shadow banking
Shadow banking, which arguably provides a valuable funding conduit that supports real economic activity, broadly covers credit intermediation, liquidity optimisation and maturity transformation involving entities and activities outside of the traditional banking system. Shadow banking may include securitisation activities such as origination, or alternatively, wholesale funding through MMFs.
For example, MMFs, which had approximately $3.1 trillion in assets under management as of 31 December 2012, according to the Investment Company Institute, provide a substantial portion of the short-term funding available in the capital markets and are an integral part of shadow banking.
The regulators purport that MMFs generally lack loss-absorption capacity and are susceptible to runs. The FSOC and the US Securities Exchange Commission (SEC) propose substantive rule changes that constitute the second regulatory enhancement since 2010. The present rule related to MMFs seeks to incorporate a variable value calculation that would replace the traditional fixed valuation.
Specifically, the proposed regulatory enhancements call for a mark-to-market variable NAV as opposed to the fixed NAV that is used currently. The migration toward a variable NAV, which values the asset(s) at the current available market price, calls for supporting automation that would allow investors to monitor and contemplate risk and valuation changes in the MMF’s assets through a data-driven dashboard.
Additionally, the credit risk retention rule under Section 941 of the Dodd-Frank Act, which supplants Section 15G to the Securities Exchange Act of 1934, requires securitisation sponsors to retain a portion of the credit risk and an economic interest in the assets that they securitise.
According to the rule, securitisation sponsors may retain credit risk in a number of ways. Since the manner and method in which risk retention is accomplished remains discretionary, based on certain limitations, firms are then faced with a technology challenge. That is, the flexibility of the rules in light of the heterogeneity of products and market participants provides a robust business case for automation. Accordingly, sponsors, or other market participants with independent technology processing capabilities, may achieve compliance with the risk retentions requirements in Section 941, or alternatively, may leverage the analytics in other ways.
Still, shadow banking will continue to evolve
Shadow banking takes a variety of forms, which are continuously evolving despite the regulatory scrutiny of these activities. From a regulatory monitoring perspective, authorities intend to cast a wide net, potentially subjecting all non-bank credit intermediation activities that might arise to new rules.
From a regulatory policy perspective, the proposed rules likely require enhanced automation processes for all covered shadow banking activities that involve credit intermediation, liquidity optimisation and maturity transformation. This is true because enhanced transparency almost always requires connectivity reconfiguration and quantitative capabilities.
It is important to note that the FSOC and FSB regulatory objectives are not merely minor revisions to existing regulatory structures, but substantial changes in the ways that shadow banking will be regulated globally.
The ambiguity of these directives and outstanding reservations of authority given to regulators should prompt a call-to-action for shadow banking participants—including buy-side beneficiaries—regarding necessary automation advancements to support these industry changes.
As a means of exercising this reservation of authority, rule-makers as well as regulatory-framework-setting bodies now seek to target shadow banking.
For instance, the Financial Stability Board (FSB), which itself does not have rule-making authority yet is considered a persuasive advisory body concerning international standards within the financial system, seeks to “mitigate the spill-over effect between the regular banking system and the shadow banking system”.
Additionally, the Financial Stability Oversight Council (FSOC), which has rule-making authority under Section 120 of the US Dodd-Frank Act, seeks to enhance and substantively modify the shadow banking space. The FSOC has concluded that the current state of shadow banking contributes to systemic risks. As a result, it now seeks to address the perceived bank-like activities that pose risks by subjecting shadow banking, and related activities such as money market mutual funds (MMFs), and securitisation activities to more onerous oversight.
Changes are coming to
shadow banking
Shadow banking, which arguably provides a valuable funding conduit that supports real economic activity, broadly covers credit intermediation, liquidity optimisation and maturity transformation involving entities and activities outside of the traditional banking system. Shadow banking may include securitisation activities such as origination, or alternatively, wholesale funding through MMFs.
For example, MMFs, which had approximately $3.1 trillion in assets under management as of 31 December 2012, according to the Investment Company Institute, provide a substantial portion of the short-term funding available in the capital markets and are an integral part of shadow banking.
The regulators purport that MMFs generally lack loss-absorption capacity and are susceptible to runs. The FSOC and the US Securities Exchange Commission (SEC) propose substantive rule changes that constitute the second regulatory enhancement since 2010. The present rule related to MMFs seeks to incorporate a variable value calculation that would replace the traditional fixed valuation.
Specifically, the proposed regulatory enhancements call for a mark-to-market variable NAV as opposed to the fixed NAV that is used currently. The migration toward a variable NAV, which values the asset(s) at the current available market price, calls for supporting automation that would allow investors to monitor and contemplate risk and valuation changes in the MMF’s assets through a data-driven dashboard.
Additionally, the credit risk retention rule under Section 941 of the Dodd-Frank Act, which supplants Section 15G to the Securities Exchange Act of 1934, requires securitisation sponsors to retain a portion of the credit risk and an economic interest in the assets that they securitise.
According to the rule, securitisation sponsors may retain credit risk in a number of ways. Since the manner and method in which risk retention is accomplished remains discretionary, based on certain limitations, firms are then faced with a technology challenge. That is, the flexibility of the rules in light of the heterogeneity of products and market participants provides a robust business case for automation. Accordingly, sponsors, or other market participants with independent technology processing capabilities, may achieve compliance with the risk retentions requirements in Section 941, or alternatively, may leverage the analytics in other ways.
Still, shadow banking will continue to evolve
Shadow banking takes a variety of forms, which are continuously evolving despite the regulatory scrutiny of these activities. From a regulatory monitoring perspective, authorities intend to cast a wide net, potentially subjecting all non-bank credit intermediation activities that might arise to new rules.
From a regulatory policy perspective, the proposed rules likely require enhanced automation processes for all covered shadow banking activities that involve credit intermediation, liquidity optimisation and maturity transformation. This is true because enhanced transparency almost always requires connectivity reconfiguration and quantitative capabilities.
It is important to note that the FSOC and FSB regulatory objectives are not merely minor revisions to existing regulatory structures, but substantial changes in the ways that shadow banking will be regulated globally.
The ambiguity of these directives and outstanding reservations of authority given to regulators should prompt a call-to-action for shadow banking participants—including buy-side beneficiaries—regarding necessary automation advancements to support these industry changes.
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