Efficient Risk Transfer Between Financial Institutions: Back to the - - PowerPoint PPT Presentation
Efficient Risk Transfer Between Financial Institutions: Back to the future? Moodys Analytics Tamar JOULIA-PARIS Practitioners Conference TJ Capital Chicago, October 2012 Senior Risk Advisor 1 Content Solvency 2 Basel 3 IFRS Economic
Tamar JOULIA-PARIS TJ Capital Senior Risk Advisor Moody’s Analytics Practitioners Conference Chicago, October 2012
1
Unintended consequences
Consumer confidence Investor confidence Economic downturn Deleveraging Risk Transfers Shadow Banks
1.
Understanding the regulatory context for Financial’s
Regulations for Banks & Insurers: similitudes, differences, impact
Next to regulatory reforms: Accounting reforms
2.
The need to revive a robust risk transfer market between Financial’s
Impact on Capital & Liquidity requirements
Impact on Risk Management
The case to facilitate lending risk transfers
3.
Current initiatives and case for enabling investment
ECB European DataWarehouse (ED)
Legal Entity Identifier (LEI)
Prime Collateral Securities (PCS)
Registry of credit risk transfers (Credit Utility)
4.
Conclusion
3
All Financials : Banks (B3), Insurers (S2), Fund managers, soon also shadow
banks
3 Pillars structure: Min Financial resources, governance, disclosure
Minimum Financial Resources : Capital for all Financials, plus Liquidity for banks
2 levels of Capital requirements:
Gone-Concern, for mandatory regulatory intervention (CET 1 for Banks, MCR for Insurers)
Going-Concern, for submission of a recovery plan (Total Capital for Banks, SCR for Insurers)
One year time horizon
2 capital formulae:
Standard formula and Stress Tests
Internal Models (if validated)
Etc But regulations are entity-based, and not functional (activity-based): What about regulatory arbitrage ?
4
More favorable Less favorable Tier 1 ratio
Low risk assets (mortgages, govt debt) Trading activities Financials, securitization, wrong-way risk High risk assets, re- securitization
Leverage ratio
High risk assets Central clearing
Low risk assets, undrawn commitments
LCR
(short term liquidity) Cash, central bank reserves, govt bonds Low risk corporate and covered bonds Unsecured bank bonds
NSFR
(long term funding) Term deposits>1yr Stable savings Wholesale savings Funding from Financials LT debt, high quality bonds Low LTV mortgages High LTV mortgages Liquidity facilities
Increased amount & cost of capital, combined with additional cost of liquid assets & long term funding, make some banking products more expensive or reduce banks ROE
5 “Both banks and financial regulation need to be simplified if another crisis is to be averted”, according to Andy Haldane, head of financial stability at the Bank of England (Telegraph, Aug 31, 2012)
2 levels of capital requirements: . MCR = Minimum Capital Requirement (85% 1 yr, 25-45% of SCR) . SCR = Solvency Capital requirement (99.5% 1yr)
A fair value principle-based approach, with recognition
A valuation of Assets different from accounting valuation
A distinction between hedgeable / non-hedgeable Liabilities : Technical Provisions =
the Best-Estimate, PV of the probability-weighted average future cash flows, plus
a Market Value Margin (MVM), calculated as the cost of providing funds equal to the SCR to support the run-off of the liabilities. unless they can be replicated using financial instruments with observable market values.
Capital requirements for Insurers will be more volatile
Both assets and liabilities should be valued at the level at which they could be transferred to a “knowledgeable willing party in an arm’s length transaction”.
6
Changing accounting regimes will impact differently banks and insurers:
IAS 39 migrating to IFRS 9 for Financial Products probably in 2015 : Accounting in fair value (via P/L) or amortized cost, no accounting in Available for Sale (Value change accounted via Capital) anymore,
IASB Exposure draft for accounting of Insurance Contracts : migration from book value to fair value
IASB Exposure Draft for accounting of impairments of assets at amortized cost (ex: Loans) : from Incurred to Expected Losses Insurers: Higher earnings volatility (thereby also of available capital), complexity due to differences in IFRS/ S2 valuations Banks: Lower earnings volatility, complexity due to differences in regulatory/accounting EL
7
8
On Banks:
deleveraging, affecting general economic recovery,
sheet intermediation (NSFR),
leverage & liquidity ratios across all business lines,
balance-sheet and capital efficiency
On Insurers:
purchasing shorter-term investment portfolios, more bonds & loans,
As with banking, this requires a new operating framework to improve balance-sheet
8
1.
Understanding the regulatory context for financial’s
Regulations for Banks & Insurers: similitudes, differences, impact
Next to regulatory reforms: Accounting reforms
2.
The need to revive a robust risk transfer market between Financial’s
Impact on Capital & Liquidity requirements
Impact on Risk Management
The case to facilitate lending risk transfers
3.
Current initiatives and case for enabling investment
ECB European DataWarehouse (ED)
Legal Entity Identifier (LEI)
Prime Collateral Securities (PCS)
Registry of credit risk transfers (Credit Utility)
4.
Conclusion
9
Capital requirements increase for all Financials, but
and insurers
will be impacted very differently,
minimum and eligible Capital for Banks
Active balance-sheet management will be critical, to comply with
regulations while adjusting business models and products for clients
Unintended capital arbitrage will be considered:
loans, credit protection, etc),
extending systemic risks across both the bank and insurance sectors
10
Short term liquidity requirements (LCR) is a concern for Banks, Regulators and Central Banks (ECB)
Increased demand for sovereign debt, but insufficient supply
Pressure to revisit LCR eligibility criteria (One single level of eligible assets, ABS/MBS if eligible as collateral for funding by the ECB, ..)
Long term liquidity / funding requirements is a concern for both Banks (NSFR) and Insurers (FV of liabilities in capital calculation)
Increased demand for sovereign debt by both Banks and Insurers
Increased issuance and demand for covered bonds vs unsecured debt : depositors will be less protected in case of bank’s default
Reduced incentive for long term assets (5-10 yrs for banks, > 20 yrs for Insurers)
11
Importance of Scenarios and Stress Tests
Plausible best/worst scenarios for business, finance and risk planning,
Stressed scenarios for capital, liquidity and appetite for risk management.
Importance of Risk Appetite :
Risk tolerance defined at the top, aligned with strategy and planning,
Cascaded down via Indicators connected to Capital, Liquidity, Earnings & Value,
Integrated contingency plans for capital, liquidity and recovery/resolution
Break-up of silo-based Risk Management at portfolio level
Competences are improving for Active Balance-Sheet Management…
The “new” risk paradigm : managing risk together with return on a pro-active basis, while improving risk coverage, earnings from portfolio assets, as well as capital and liquidity analytics…
12
On the Banking side:
Disintermediation and re-emergence of Shadow Banking:
Loan hedge funds, lending by corporates, corporate placements at ECB,…
Need to segregate desirable and non-desirable shadow banking, and to
avoid regulatory arbitrage (Functional Regulation)
On the Investment side:
Growing interest of LT investors for alternative investments less sensitive
than equities/bonds to inflation and sovereign risk, like ABS/MBS,
Necessity to introduce systemic risk fire breaks and pre-empt price
spirals from reduced transparency following multiple risk transfers and re- leveraging.
Facilitating simple credit risk transfers between banks and insurers could reduce systemic risk and support the real economy
13
Without credit risk transfers, lending slows as originators wait for their exposure to amortize …
Source: AFME – Issuance of securitization
14
« Ideal » deleveraged Banks 2012
A revitalised and more robust credit risk transfer market is needed to maintain “real economy” lending
Liquidity Buffer Short term Customer Deposits Real economy loans Invest- ments
(ABS, MMF, etc)
WS funding
(Interbank and repo’s)
Real economy loans Short term Customer Deposits
Standard and registered securitizations
Market Investments (MT-LT) Customer Deposits (Long Term savings) Real economy loans securities (MT-LT)
Banks 2008 Insurers Pension funds
15
1.
Understanding the regulatory context for Financial’s
Regulations for Banks & Insurers: similitudes, differences, impact
Next to regulatory reforms: Accounting reforms
2.
The need to revival a robust risk transfer market between Financial’s
Impact on Capital & Liquidity requirements
Impact on Risk Management
The case to facilitate lending risk transfers
3.
Current initiatives and case for enabling investment
ECB European DataWarehouse (ED)
Legal Entity Identifier (LEI)
Prime Collateral Securities (PCS)
Registry and mannping of risk transfers (Credit Utility)
4.
Conclusion
16
17
Cornerstones to restore confidence in loan securitizations:
Transparency on underlying loans: European DataWarehouse (ED)
(Q4 2012)
Initiated by the ECB, as a binding condition for eligibility in the Eurosystem collateral framework
Central European Repository and Data Handling infrastructure
Standard Templates with loan-by-loan information per asset class
Recognition of legal counterparts: Legal Entity Identifier (LEI)
(Q1 2013)
Initiated by the Financial Stability Board (FSB), for Systemic Risk Management
Creation and implementation of a Single, Universal and Standard Identifier
Applicable to any organization or firm involved in a financial transaction internationally.
17
18
Cornerstones to restore confidence in loan securitizations :
Transparency on legal structures : Prime Collateral Securities
(PCS) label
Initiated by the Industry (AFME) and aimed at investors
Provides a labelling of good quality and robust loan products per country
Requires simple & consistent structures, Rating threashold, Minimum documentation,
Sets minimum reporting standards for originators/loan servicing providers
Transparency on interconnections and capital support : Private
initiative by CreditUtility
Initiated by professionnals
Non-profit utility seeking to modify the risk transfer’s market infrastructure by mapping and monitoring market flows
Reduces interconnectedness (systemic risk)
Facilitates functional regulation and economic growth
18
Regulators may also use the CreditUtility as a channel for market signalling and support in times of stress. However, as a “public good”, this would only come about through a policy initiative
19
CreditUtility’s main contribution will be to increase transparency and market simplification
1.
Understanding the regulatory context for financial’s
A comprehensive macro and micro regulatory framework
B3 & S2 regulations : similitudes & differences
Next to regulatory reforms: Accounting reforms
2.
The need to revival a robust risk transfer market between financial’s
Impact on Capital & Liquidity requirements
Impact on Risk Management
The case to facilitate lending risk transfers
3.
Current initiatives and case for enabling investment
ECB European DataWarehouse (ED)
Prime Collateral Securities (PCS)
Legal Entity Identifier (LEI)
Registry of credit risk transfers (Credit Utility)
4.
Conclusion
20
21
interest rates are driving a restructuring of Financial’s balance-sheets
between regulated originators and long term investors
multiple regulatory approaches
structures, on interconnectedness and on supporting capital. Risk Transfer market liquidity, resilience and efficiency can improve if the market infrastructure is modified.
21