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The FSB Workstream on Securities Lending and Repos ("Workstream") under the FSB Shadow Banking Task Force has published an interim report on its findings and progress. The mission of the Workstream is to present, by the end of 2012, policy recommendations to strengthen regulation of securities lending and repos within the context of the shadow banking system.  In order to inform its decision on proposed policy recommendations, the Workstream has reviewed current market practices through discussions with market participants,  and existing regulatory frameworks through a survey of regulatory authorities.  This interim report identifies a number of issues that might pose risks to financial stability, and these financial stability issues will form the basis for the next stage of its work in developing appropriate policy measures to address risks where necessary.

In an April 13 address, Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, made clear that he sees the system of shadow banking as a key vulnerability that makes another catastrophic economic crisis nearly inevitable.  In Bernanke's view, the increased importance of the so-called shadow banking system is the primary reason for the severity and pervasiveness of the financial crisis, and the regulatory gaps in which shadow banking activities operate must be addressed by policy makers.

Following the financial crisis, regulators embarked on a two-step process of reforming the regulation of MMFs, despite an already comprehensive regulatory framework system of oversight. In 2010, the SEC approved new regulations intended to address credit quality, liquidity, maturity, and transparency concerns. Since that time, the SEC, legislators, the Fed, and market participants have vigorously debated further regulatory measures aimed at reducing the risk of a run on MMFs and providing a cushion against losses.  Are these further reforms necessary? Or have we done enough already?

The Bank for International Settlements has issued preliminary locational and consolidated banking statistics for the quarter ended September 30, 2011.  These statistics, though not final, show mixed but encouraging signs of rebound in banking activity.  

Responding to strident criticism of proposed regulations implementing the Volker Rule, former Fed Chair Paul Volker and the Senate authors of the Dodd-Frank Volker Rule provisions defended the rule as absolutely vital and urged the SEC and banking agencies to eliminate unjustified exclusions and exemptions, such as proposed hedging exemptions related to bank investments in private funds.

Dismissing calls to weaken or reconsider global financial reforms, Jaime Caruana, General Manager, Bank for International Settlements, argues that it is more important than ever to continue reforms and see through what has already begun.  Caruana lays out in a recent address before the 2012 ADB Financial Sector Forum four principles he feels should guide these ongoing reform efforts.

OTC derivatives legislation and clearing reforms understandably have European and US market participants scratching their heads about what this "sea of change" has in store for them and the future of OTC markets.   David Felsenthal, a partner at Clifford Chance LLP, has given the matter some serious thought, and provides some guidance in his January 14, 2012 post at Harvard Law School's Forum on Corporate Governance and Financial Regulation.

K&L Gates' 2012 Annual Outlook provides a valuable collection of articles that address important industry and regulatory trends and their correlation with government and political developments. This edition highlights regulatory issues in areas such as: systemic financial risk regulation, anti-corruption and white-collar enforcement initiatives, tax policies, competition and antitrust law matters, intellectual property and international trade developments. Of particular interest in this year's report is the section on financial services. In this chapter, K&L Gates covers, among other things, updates on regulatory efforts and emerging developments that K&L Gates has identified as areas global financial professionals should keep on their radar screens

On December 20, 2011, the Federal Reserve Board of Directors published its long awaited proposal on enhanced prudential standards and early remediation requirements.  This proposal, required by the Dodd-Frank Act, would impose greater levels of regulation and supervision on certain US bank holding companies and systematically important non-bank financial companies.  

Over the past few months, spreads for credit default swaps (CDS) have widened quite dramatically. These widening CDS spreads are a clear sign of stress on banks, and that the cost of protecting financial
institution and government debt against default is steadily rising, causing worry across the global financial markets.

In a dialog at the Managed Funds Association Outlook 2011 seminar held in October, SEC Chairman Mary Schapiro commented on the international and domestic challenges regulators face in coordinating the regulation of derivatives. From this dialog we can take away some nuggets of assurance that the process of regulating OTC derivatives is being thoughtfully considered, efforts are being made to coordinate both domestically and internationally, and that the implementation process will contain few surprises. 

In a strongly worded letter to Federal Reserve Chair Ben Bernanke, Rep. Maurice Hinchey (D-NY), Rep. Peter Welch (D-VT), and 15 other House members urged the Fed and other federal regulators to reject the current draft of the Volcker Rule regulations and replace them with stronger language to prohibit commercial banks from engaging in investment activities.  

The UK's Chancellor of the Exchequer has proposed a radical reformulation of financial services regulation, ending the shared oversight of the Treasury, Financial Services Authority, and the Bank of England.  The proposed new structure would unify regulation and supervision under new structures housed in the Bank of England.  This move to centralize oversight could give EU oversight entities, the European Systemic Risk Council and the European System of Financial Supervisors, greater influence in UK financial oversight.  
  

A Financial Stability Board task force has published recommendations to strengthen the oversight and regulation of the shadow banking system. These eagerly awaited recommendations provide much needed guidance to regulatory authorities on monitoring and designing regulation of shadow banking activities and entities.

FSB data published in its October 27, 2011 report, Shadow Banking: Strengthening Oversight and Regulation, reveals that among the eleven largest economies with significant shadow banking, the shadow banking sector has surpassed the levels prior to the financial crisis.

On October 18, the Basel Committee issued a report documenting Basel Committee members' progress in adopting Basel II, Basel 2.5 and Basel III as of September 2011.  The report provides a high level summary of the the status of domestic legislative and rule-making intended to incorporate the Committee's capital standards into national law or regulation according to the internationally agreed time frames.

In his October 6, 2011 testimony before the before the US Congress’s Committee on Banking, Housing, and Urban Affairs, Treasury Secretary Timothy F. Geithner made it clear that shadow banking remains an an area of great concern on his regulatory agenda.  Geithner...

In a forthcoming article, Robert P Bartlett III, Assistant Professor of Law at the University of California, Berkeley, proposes an intriguing model-sensitive disclosure regime he hopes will enhance accurate pricing of a bank's exposure to credit risk while at the same time safeguarding the confidentiality of a bank’s proprietary investment strategies and customer information.  

For the most part, provisions of the Dodd–Frank Wall Street Reform and Consumer Protection relating to derivatives are aimed at increasing transparency, altering clearing and exchange trading requirements, regulation of swap dealers and other swap market participants, restrictions on swaps trading by banks and associated increases in capital and margin requirements. The Act leaves many of the details of implementation to regulators. With over a year behind us, we can now reflect on what regulators have proposed, adopted, and left unfinished with regard to swaps.

At its September 28, 2011 meeting, the Basel Committee (the “Committee) approved a range of measures aimed at finalizing the Committee’s July 2011 consultative document, “Global systemically important banks: Assessment methodology and the additional loss absorbency requirement.” The document sets out the Committee’s proposal on the assessment methodology for (1) determining global systemic importance, (2) determining the magnitude of additional loss absorbency that global systemically important banks should have, and (3) proposes the arrangements by which the methodologies will be phased in. 

In their Quarterly Bulletin (Q3 2011), the Bank of England (BOE) updates us on the latest market-driven and regulatory developments in securities lending, and lays out the lessons learned from the financial crisis about the risk of contagion arising from the interconnectedness between participants created by securities lending transactions, and the dangerous opacity of risks incurred across all participants.

The UK Independent Commission on Banking's much anticipated report examining options for the reform of the country’s banking industry was released on September 12.  The report proposes several changes to the structure of the UK banking system that potentially may simplify identification and remediation of failing financial institutions and reduce the probability and effect of bank failures, including the novel idea of "ring-fencing" of retail and wholesale/investment banking activities within universal banks to insulate UK retail banking services from investment banking risk. 


 

The Financial Stability Board announced on September 1 the formation of dedicated work streams to help gauge the case for further regulatory action in five areas associated with shadow banking, notably including securities lending and repos. 

In a September 1, 2011 speech at Clare College in Cambridge, Paul Fisher, Executive Director for Markets of the Bank of England, outlined his thoughts on ways risk taking is executed and how contracts between parties assuming these risks can have profound effects on systematic stability beyond the normal consideration of formal regulations.  In balancing public policy objectives of appropriate investor protection and systemic stability, it is important that that regulators and market participants critically evaluate their exposures, and take into account stress correlations with an eye on capturing tail events properly.

Paul Tucker, Deputy Governor for Financial Stability at the Bank of England, explained his thoughts on redrawing the social contract between banking and society in light of the contract’s failure leading up to and during the financial crisis. According to Mr. Tucker, the traditional framework of the social contract was ill prepared to handle the realities of shadow banking and financial innovation, and hasty reregulation without first reexamining the social contract would be foolish.

At the request of the G20, on April 12, 2011 a Financial Stability Board task force on shadow banking issued its initial report, “Shadow Banking: Scoping the Issues,” laying out the current thinking of the task force on the definition of "shadow banking," "potential approaches to monitoring it, and possible regulatory measures to address systemic risk and regulatory arbitrage concerns posed by the shadow banking system.  Though preliminary in nature, this “background note” may provide some valuable clues about the nature, scope, and extent of upcoming proposals to regulate shadow banking.

Regulators have reported the conclusions of study groups looking into the causes of, and remedies for the Credit Crisis. A consensus of opinion exists as to causes, with a growing emphasis among larger central banks on the failings of liquidity risk management. All regulators believe new forms of infrastructure will be needed to prevent a recurrence...

Regulators during the crisis were most concerned about the nearly unmanageable spike in systemic risk which, according to the IMF, FSB and BIS, is defined as "a risk of disruption to financial services that is caused by an impairment of all or parts of the financial system and has the potential to have serious negative consequences for the real economy."

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From July 2007 to March 2009, share prices for global banks fell by 75%. That erased US$5 trillion in shareholder equity. Considering all markets, McKinsey has estimated that the fall in global wealth was US$25 trillion. To put that in context, the lost wealth was nearly 45% of global GDP, or a half year’s wages for the entire working world. On that...

Prior to the Crisis, it was thought that diversification of counterparty networks would work to reduce systemic risk in the financial system.

European Central Bank: The element that had been more unexpected in the current crisis is the rigour with which systemic risk has been triggered by the collective behaviour of financial institutions and...

The Bank of England has called the Credit Crisis an "extraordinary period" which will have "deep and long-lasting consequences" for the global capital markets. The United States Federal Reserve has said the "the sources of the crisis were extraordinarily complex and numerous," but at the root was the Fed’s belief that banks' "risk management systems...