[00:00:05] Speaker A: Hello everyone and welcome to another episode of Ahead of the Curve. Thank you for joining me today.
My name is John Pucciarelli. I'll be your moderator and host today for this podcast. With me again is co head of business development here at LSEG Post Trade Solutions, Stuart Smith. So good to see you again.
[00:00:26] Speaker B: You too.
[00:00:27] Speaker A: All right, we have some specific things to discuss today.
Really. It's around counterparty credit risk.
There have been two major papers that have come out recently around guidance around counterparty credit risk and the leverage in non bank financial intermediaries.
What I would like for us to do today is to talk about, you know, the FSB has come out with the, with the financial intermediary guidance and then we'll talk about something that I think we've talked about on previous podcasts around the counterparty credit risk from Basel, how they interact with each other and what are some of the common themes, what are some of the contradictions? And we can, we can talk about that a little bit more. But first, before we go into that, can you just for our listeners tell us what the FSB is and what do they do?
[00:01:17] Speaker B: Yeah, no, that's a, that's a great question because sometimes these acronyms just slip in and they don't always clear exactly what each body does.
[00:01:24] Speaker A: Yeah, I'm still trying to figure out more of them. There's other ones by the way, but go ahead.
[00:01:29] Speaker B: So the FSB was set up Post Financial Crisis 2009, along with a whole bunch of things that were done in that year.
Its role is to sit globally, sort of across all other regulators in a way, and to look for areas of financial instability, financial weakness areas that could cause major issues in the future, to identify those, propose solutions, whether that's regulatory, whether it's more guidance, whether it's whatever it needs to be, and then to try and coordinate the implementation of that.
So think of this as an incredibly high level body. This isn't someone who's going to write a regulation or derive a new capital standard for a bank, but this is someone that sits across a lot of those things and guides them to the answers that they, they get.
[00:02:15] Speaker A: Yeah, that's like the Basel Committee for, for non cleared margin. They had a, they had a, you know, they had the body that set the global standards and then everyone kind of implemented their own.
So similar to that.
[00:02:27] Speaker B: Yeah.
[00:02:29] Speaker A: So in terms of what they have come out, do you want to talk about the recommendations on the, the non buying financial intermediaries first or you want to talk about the Basel Paper first.
[00:02:43] Speaker B: Why don't we catch. We talked a little bit last time about what we did about the Basel side that's now been finalized.
[00:02:49] Speaker A: Yes.
[00:02:49] Speaker B: So the last time we spoke I think there was some still in draft, still taking feedback from banks. I think that feedback has happened. So we've seen quite a few minor changes in it, but no massive structural change in what's been recommended. Essentially they still remain concerned about the Archegos default, the other, some other similar events that caused massive losses and ultimately caused some banks to fail. And, and the, the feeling is, you know, this cannot happen. This is not what we're supposed to be. And therefore there has to be change. And I think that's, you know, really been, been set down. I think there has been change in that, in that piece. Some of it somewhat strengthened around disclosure. So that disclosure section, much larger now, more detailed around the fact what types of disclosures they expect in different circumstances.
But also some more leeway given to banks around appropriateness.
So when is it appropriate to ask for that and some more authority given to the banks to say when they need different things from different people. Yeah, so it's, it's, it's changed but still very much in the same direction that it was originally.
[00:03:54] Speaker A: So the Basel paper, just to get, just to go back a little bit. Yeah, the Basel papers was kind of laser focus on the Archegos default, right?
[00:04:03] Speaker B: I think. Yeah, it has to be for the most part.
[00:04:05] Speaker A: Right. I mean I think that was, that was a response to, to that, that event and they laid out, you know, things like we spoke about specific Runway risk, general Runway risk, so on and so forth.
And yet you said that recently they came out with kind of the follow up to that paper and that not much, as you just said, not much has changed.
Has anything changed?
I think I heard that maybe the specific wrong way risk piece might be either not in or maybe it's changed.
[00:04:38] Speaker B: I think changed. So I think there was some press pieces recently about the fact that it's no longer explicitly in the pfe, the potential future exposure section, but it's still very much there generically as a concept that banks need to capture. I think this is a reflection that banks should have quite a bit of freedom about how they choose to capture that quantity rather than being forced down a specific calculation approach which I don't think the banks ever like when they're being dictated to too much about explicitly how they have to capture a risk.
They know they need to capture it. I think this paper does a good job of Reinforcing that, reminding everybody this is very much something you need to do, but gives them that little bit of freedom about how it is they go about collecting that data and trying to, trying to measure that effect.
[00:05:20] Speaker A: And there's still. The feedback was still from at least what I have read. And I'm not putting the larger banks on the spot here. It's just information that's out there in public that a lot of those disclosures, especially when we talk about specific wrong way risk, are still generally difficult to do.
That was some of the feedback that I've read. I continue to read that. I don't know that that sentiment has changed much at all.
[00:05:47] Speaker B: No, I think that was some of the really big pushback is, well, this all sounds great, but I just don't have anywhere near enough information to be able to do that. And that actually quite nicely leads us onto the other paper, the challenge for the Basel Committee.
It's the committee that deals with banks.
So they write regulations for banks and they write rules for banks that they have to follow.
They don't govern anybody else, they don't govern hedge funds, they don't govern insurance firms or any other financial institutions.
[00:06:16] Speaker A: Now this is when we're talking about NBFIs here.
[00:06:19] Speaker B: So then you move into this world of NBFIs which are, you know, yeah.
[00:06:23] Speaker A: I shouldn't, I don't want to conflate hedge funds and NBFIs. We're talking about all different parts of the financial world that trade the same type of instruments. And there has been a focus on NBFIs because it's kind of out of the scope of the existing regs and there needs to be of a focus on it from a, you know, liquidity, you know, in times of, I guess in times of liquidity stress, there could be a move towards NBFIs. So therefore there needs to be a little bit more scrutiny and focus on them in terms of, I think, yeah, you know, resiliency and monitoring and things like that. Right.
[00:07:00] Speaker B: I mean, if you look at the major NBFIs, if you turn the clock back 30, 40 years, you know, you wouldn't be talking about major financial players who were NBFIs, you would be talking about banks.
Now, some of the MBFIs are some of the largest financial institutions in the world. And equally important to financial stability, as many of the banks are, as well as the fact that a small hedge fund can have a highly, highly leveraged impact on the financial community as a whole, which is what we saw with Archegos. That ability to create Generate leverage, probably as great as it's ever been. And that can do some spectacular.
Have some spectacular effects in the economy. The challenge is that it's not consistent across the globe, who regulates those, how they're regulated, what the rules are. And there is no equivalent Basel committee, really, for NBFIs. Hence the FSB feels the need to say something, something about, okay, come on, guys, we need to get our house together a little bit in terms of how we look at these people and how we ask them to report data, what kind of standards we ask them to comply to for the sake of financial stability.
[00:08:14] Speaker A: That sounds like. And I know you know this term. And we. You and I have spoken about this before on this podcast, even probably two years ago. But, you know, like you said, NBFIS go back for a very long time.
It's just now where they're bigger and they're more systemic in finance that it needs. There seems to be a need for more scrutiny. Oversight regulations. Is this FSB report is a report or recommendation? And do you remember when it came out?
[00:08:49] Speaker B: It came out mid December.
[00:08:50] Speaker A: Mid December.
[00:08:50] Speaker B: Okay, so they did a report a while ago identifying the problem.
[00:08:54] Speaker A: Yeah.
[00:08:54] Speaker B: So they identified this, I think everyone could identify as a problem when Archaeos.
[00:08:58] Speaker A: Happened just to stop you there. And I hate putting you on the spot, but Archegos was always dubbed a quote unquote, family office.
[00:09:05] Speaker B: Yeah.
[00:09:05] Speaker A: Right.
But the FSB would probably categorize them as an nbfi.
[00:09:11] Speaker B: NBFI is such a general term.
[00:09:12] Speaker A: It's a general term.
[00:09:13] Speaker B: Anyone who's.
[00:09:14] Speaker A: There's no official.
[00:09:15] Speaker B: Anyone who's not a bank and is somehow financial can come under the scope of nbfi. So it's almost anybody.
[00:09:21] Speaker A: Yeah. So according, I guess, in their view, Archegos kind of fits definitely into this category. Okay. Just want to make that clear for anyone listening. And. And I guess you could do. You could probably do a Google search for the. This FSB paper. Yeah.
What. What's the. Do you remember the exact title of it for.
[00:09:40] Speaker B: For folks so Leverage in Non Bank Financial Intermediation.
[00:09:45] Speaker A: Okay. Yeah, got it.
[00:09:47] Speaker B: And you know, this is their first stab at a set of recommendations for global regulators on how they should change their standards to better regulate this area of the market. And I think if you ask a lot of banks about Archegos, they'll tell you, look, the problem wasn't on the bank side. The problem was a hedge fund behaving, you know, in a very difficult to manage manner. And therefore you should go regulate those guys because they're the guys that caused the problem.
But the problem is that's not an easy thing to do. So this is probably the first step in saying, okay, how are we going to get a handle on regulating some of these firms, bringing a little bit more order to that without taking away their ability to trade and their ability to help the financial economy in the way that they do?
[00:10:30] Speaker A: I want to always be careful with kind of.
And look, I know this is our podcast and it's just the two of us talking about, but at the same time, if people listen, I don't. I don't necessarily want to convey that when you call something an NBFI that it's a negative thing. It's just a way to categorize a certain entity that's not a regulated, you know, swap dealer or bank or broker dealer or any of those things. This is kind of like they probably should come up with a better name, I would think. But we'll see.
I think this is probably the beginnings. This guideline in this paper is probably the beginnings of something that we'll probably see more of, perhaps.
[00:11:14] Speaker B: So it's interesting. I think it could go both ways.
[00:11:17] Speaker A: Because then there's going to be some kind of a rollout and we could talk about some of the challenges there, too.
[00:11:21] Speaker B: Yeah. So I think it could go in the direction that you say, yeah, we need a more global ability to manage these firms and therefore a definition of who they are, who's in scope, and then people who have the ability to oversee them and regulate them. Of course, some of those national bodies do exist, but they could be more joined up. Or alternatively, the alternative says, well, actually, this is still a bank problem. It's still mainly banks going bust that we're worried about, because that's what has an impact on people on the street. No one's particularly worried Okos went bust. That's a risk of being a hedge fund that you go bust. The nice thing is you go bust without bringing down the world economy at the same time.
So potentially, you can just change the way in which you regulate banks and therefore get banks to further regulate the buy side for you by applying different standards to them. So I think both are still open based on the paper, and I think this is part of the need for a consultation to have those conversations, understand a bit more about how people want to approach this. I think what's clear from the fact both papers have come out within six to nine months of each other, the global regulatory community feels a need to act and does not happy with the status quo and is definitely going to move forward with measures that are going to impact the way in which those firms trade together.
[00:12:37] Speaker A: What are some of those things?
If you could just highlight some of the improvements that they're really focusing in on.
Is it disclosure? Is it risk monitoring? Is it some of those things?
[00:12:50] Speaker B: So I think on the FSB side, you could say that an awful lot of it is around disclosure.
[00:12:54] Speaker A: Yeah.
[00:12:55] Speaker B: And how can additional disclosures help firms both from a public sense, have a public sense of. Okay, these are the important entities. Global regulators know where to focus their attention. Who's the most active firms? Where do they need to go check first?
[00:13:09] Speaker A: Okay.
[00:13:09] Speaker B: And then private disclosures bilaterally to help people educate the relationship that they have and therefore how much risk they're willing to take on that bilateral relationship.
Now the challenge is, you know, we're talking about firms which are typically very small family offices, can be a handful of people. You know, hedge funds nowadays can be incredibly lightweight. Thanks to some of the great technology that enables them to run and fund administrators to do a lot of the back end for them. They can be very lightweight. Organizations often don't have the capability of putting together those kind of disclosures, regularly sending them out, sending them in high quality in an automated standardized way.
[00:13:50] Speaker A: Data intensive exercise.
[00:13:52] Speaker B: Yeah. For thousands of small firms, I think there was that great start. There's more hedge fund managers in the world now than there are Burger King managers.
[00:13:59] Speaker A: Interesting. Yeah, never heard that one before.
[00:14:02] Speaker B: And you know, that's a massive amount of new disclosures you're asking that group of people today.
[00:14:06] Speaker A: It's interesting.
You know, we have trade reporting, trade repositories.
Do we have like, is there any idea of a repository for this type of data to be collected or has that been contemplated as far as, you know, I haven't heard of anything. I'm just wondering if you can.
[00:14:23] Speaker B: I think we're a long way ahead of that. And the banks I think pushing, saying, well, we did this, we gave you the trade repository data, it's all there, you can use it better. And I think is to showed it could be used better.
[00:14:35] Speaker A: Yeah.
[00:14:35] Speaker B: I think you can't underestimate the challenge though of using a data source that huge to try and understand what's going in the financial markets. Yes, a lot of the information is there, but it's. That's quite a task to understand what's in there.
[00:14:48] Speaker A: Yeah. So that kind of gets to.
I would assume that's going to be one of many challenges for rolling these kind of ideas. These initial Kind of ideas out for identification and disclosures for NBFIs.
Is it just data or is it, is it identification? The challenge is also probably coming up with, you know, who's going what. Regulators across the globe are going to be tasked with this type of, you know, sector of finance. I guess that's probably one of the first things because if you go down.
[00:15:25] Speaker B: The bank route and we go down through Basel and ask the banks to do this, to be the policeman for us, it's from a regulatory point of view. It's well, well trodden path. We know how to do that. If we go down the path of saying no, we need some rules against these firms themselves and we need someone to oversee.
Really is a patchwork of people across the globe that, you know, that's the FSB's job in many ways is to pull those guys together and provide them a framework to work together. But it's a much bigger task to ask those people to work together to do that. Also, you know, hedge funds, very easy to set up a hedge fund in different parts of the world.
[00:16:00] Speaker A: Oh yeah.
[00:16:00] Speaker B: And therefore the number of people that you have to work with is much, much bigger.
So it is a challenge if they go down that route. But if you feel you truly need regulation of that sector, you kind of have to go down that route.
[00:16:12] Speaker A: Yeah. Be interesting to see.
So typically when proposals come out, there's some type of comment period. I don't know that this type of paper is the.
[00:16:22] Speaker B: That yeah.
[00:16:23] Speaker A: Paper or is there, is there a. Is there a comment period?
[00:16:26] Speaker B: That comment period running for the next couple of months.
[00:16:28] Speaker A: Couple months.
[00:16:29] Speaker B: So relatively short. And we attended the first is to call and someone made that comment that we need to, we need to move fast on this.
[00:16:36] Speaker A: Wow. Yeah. Two months is.
[00:16:38] Speaker B: Is a. Yeah.
[00:16:39] Speaker A: Is a short period of time for, for something this large.
Are we looking at responses from. I mean, is to has always been great at this and you know, know, kind of being the voice of, you know, mostly the, mostly the dealer community. But they have plenty of buy side members.
It would be good to see what the buy side have to say. I'm sure they'll, you know, I'm sure they'll be willing to do some level of disclosure or you know, participate in this if it's in everyone's best interest. But I guess, you know, we'll see. We'll see how it goes. Well, listen, I always say the same thing. There's always more to come. This is the reason why we talk about these things because they're interesting they're going to affect our business in direct, indirect ways. So again, this is one of probably many things that we're keeping our tabs on from a industry regulatory perspective and how it affects the world of business development. So maybe we'll come back, we'll come back in a couple of months and see how those comments came out. Well, thank you for joining me today and thank you for this topic.
Like I said, we'll, we'll keep our eyes peeled on it and we'll talk about it again, I'm sure.
[00:17:52] Speaker B: Thank you very much.
[00:17:53] Speaker A: Thank you. Thank you for joining today's episode of Ahead of the Curve. I hope you enjoyed it. I know I did.
You can watch and listen to this podcast on Spotify, YouTube or any of your other favorite streaming services
[email protected]. thank you so much for joining us today and we'll see you again soon. Thank you.
