Dear,
The more the Systemic Crisis evolves, the more clear is that the new model of the Financial System will be based in the efficient Management of Capital.
Recently, the EU Regulatory body has announced that Central Counterparty Clearing Houses (CCPs) should be subject to Recovery and Resolution proposals.
http://www.bloomberg.com/news/articles/2016-10-05/eu-readies-plans-for-clearing-crisis-the-next-too-big-to-fail
More or less at the same time, the Bank of England has announced that Clearing Houses should be subject to Stress Testing and Capital Requirements Calculations, in order of keeping a Capital buffer to cover potential losses during the Financial Instruments settlement.
http://www.reuters.com/article/boe-derivatives-clearing-idUSL5N188411
Remember that as a consequence of the 2008 Financial Crisis, it was decided that Derivatives should be traded in centralized Clearing Houses. This decision was translated to the regulatory body by the Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US, and by the European Market Infrastructure Regulation in Europe. Similar regulations have been also implemented in other jurisdictions.
https://www.sec.gov/spotlight/dodd-frank/derivatives.shtml
http://ec.europa.eu/finance/financial-markets/derivatives/index_en.htm
Now, we’re entering in a new phase of the transformation, as the regulator forces the Clearing houses to give more transparency to their Risk Exposures and holding higher Capital levels, as a buffer for potential losses on the Derivatives trading.
As Capital requirements and costs increase for the Clearing Houses, they will have to pass this cost to its counter-parties (Financial Instruments traders), and they will have to pass the costs to their counter-parties, and so on. At the end of the chain, the Capital costs will be higher to all the market participants.
The more expensive Capital is, the more incentives the market participants will have to optimize Capital and reducing its associated cost.
In the case of the Clearing Houses, we can easily identify two opportunities for Capital Optimization.
1) Reducing the settlement time. New distributed Ledger Technologies like Blockchain represent a big improvement on this. Blockchain offers Near Real Time Settlement between counter-parties; with this technology the Clearing House can reduce the time that the House is the counter-party for the market participants, and consequently reducing the Risk Exposures and the Capital cost.
The Risk for the Clearing Houses is that, the more the settlement times are reduced, the more chances are that the counter-parties settle their trades directly, killing the Clearing House business model. Anyway, this is a different matter and we’ll talk about it in a future blog.
2) With detailed and preemptive analysis of the Risk Exposures, which facilitates the efficient measurement and request of Collaterals to the market participants, and supporting the implementation of pricing strategies, escalated according to the expected Capital costs.
For supporting the analysis of the Risk Exposures, reporting the Capital Requirements and Risk Weighted Assets calculations, and Stress Testing Requirements, Clearing Houses can use the Credit Risk Module of Bank Analyzer.
Recently I had an interesting conversation with a colleague, very experienced in Bank Analyzer implementations. He mentioned that, although he agrees that Bank Analyzer can be used in non-banking organizations, the common opinion is that Bank Analyzer target should be only Banks.
I disagree, Banking regulation requesting higher Capital levels and more transparency in the reporting of the Risk exposures is a driver, which increases the Capital costs in the whole Financial System.
The Capital costs are transferred from the Banks to the other market participants, and make them look at the capital consumed in their business processes, in order of optimizing their Capital consumption.
At the same time, the regulator increases the number of companies and market participants, which must improve their Risk exposures reporting and increase their Capital levels.
Consequently, focus in Capital consumption is spreading from the Too big to fail Banks, to smaller Banks, Insurance Companies, Clearing Houses, market agents exposed to derivatives, and more.
At the end, this is the logical conclusion of a Financial System which is moving from a model based in Volume to a model based in Efficient Management of Capital.
Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860
Let's connect on Twitter: @FerranFrancesGi
Looking forward to read your opinions.
Kind Regards,
Ferran.
The more the Systemic Crisis evolves, the more clear is that the new model of the Financial System will be based in the efficient Management of Capital.
Recently, the EU Regulatory body has announced that Central Counterparty Clearing Houses (CCPs) should be subject to Recovery and Resolution proposals.
http://www.bloomberg.com/news/articles/2016-10-05/eu-readies-plans-for-clearing-crisis-the-next-too-big-to-fail
More or less at the same time, the Bank of England has announced that Clearing Houses should be subject to Stress Testing and Capital Requirements Calculations, in order of keeping a Capital buffer to cover potential losses during the Financial Instruments settlement.
http://www.reuters.com/article/boe-derivatives-clearing-idUSL5N188411
Remember that as a consequence of the 2008 Financial Crisis, it was decided that Derivatives should be traded in centralized Clearing Houses. This decision was translated to the regulatory body by the Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US, and by the European Market Infrastructure Regulation in Europe. Similar regulations have been also implemented in other jurisdictions.
https://www.sec.gov/spotlight/dodd-frank/derivatives.shtml
http://ec.europa.eu/finance/financial-markets/derivatives/index_en.htm
Now, we’re entering in a new phase of the transformation, as the regulator forces the Clearing houses to give more transparency to their Risk Exposures and holding higher Capital levels, as a buffer for potential losses on the Derivatives trading.
As Capital requirements and costs increase for the Clearing Houses, they will have to pass this cost to its counter-parties (Financial Instruments traders), and they will have to pass the costs to their counter-parties, and so on. At the end of the chain, the Capital costs will be higher to all the market participants.
The more expensive Capital is, the more incentives the market participants will have to optimize Capital and reducing its associated cost.
In the case of the Clearing Houses, we can easily identify two opportunities for Capital Optimization.
1) Reducing the settlement time. New distributed Ledger Technologies like Blockchain represent a big improvement on this. Blockchain offers Near Real Time Settlement between counter-parties; with this technology the Clearing House can reduce the time that the House is the counter-party for the market participants, and consequently reducing the Risk Exposures and the Capital cost.
The Risk for the Clearing Houses is that, the more the settlement times are reduced, the more chances are that the counter-parties settle their trades directly, killing the Clearing House business model. Anyway, this is a different matter and we’ll talk about it in a future blog.
2) With detailed and preemptive analysis of the Risk Exposures, which facilitates the efficient measurement and request of Collaterals to the market participants, and supporting the implementation of pricing strategies, escalated according to the expected Capital costs.
For supporting the analysis of the Risk Exposures, reporting the Capital Requirements and Risk Weighted Assets calculations, and Stress Testing Requirements, Clearing Houses can use the Credit Risk Module of Bank Analyzer.
Recently I had an interesting conversation with a colleague, very experienced in Bank Analyzer implementations. He mentioned that, although he agrees that Bank Analyzer can be used in non-banking organizations, the common opinion is that Bank Analyzer target should be only Banks.
I disagree, Banking regulation requesting higher Capital levels and more transparency in the reporting of the Risk exposures is a driver, which increases the Capital costs in the whole Financial System.
The Capital costs are transferred from the Banks to the other market participants, and make them look at the capital consumed in their business processes, in order of optimizing their Capital consumption.
At the same time, the regulator increases the number of companies and market participants, which must improve their Risk exposures reporting and increase their Capital levels.
Consequently, focus in Capital consumption is spreading from the Too big to fail Banks, to smaller Banks, Insurance Companies, Clearing Houses, market agents exposed to derivatives, and more.
At the end, this is the logical conclusion of a Financial System which is moving from a model based in Volume to a model based in Efficient Management of Capital.
Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860
Let's connect on Twitter: @FerranFrancesGi
Looking forward to read your opinions.
Kind Regards,
Ferran.
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