Letter to banks’ chief risk officers
The Bank of England has written to Chief Risk Officers (CROs) of banks operating in the UK following the Prudential Regulation Authority’s review of fixed income financing businesses.
The key points of the letter are highlighted below.
- Counterparty risk management: Firms need to improve their counterparty risk management processes, including their credit due diligence, client disclosure standards, and counterparty risk management controls. This applies to all client types in all secured financing and other relevant trading businesses, not just hedge fund clients in equity financing.
- Margining: Firms need to ensure that their margining platforms are sufficiently robust and scalable to cope with extended periods of heightened market volatility. This is important because large gross exposures to counterparties can lead to material counterparty credit risks from mark-to-market fluctuations in collateral valuations during periods of market stress.
- Liquidity risk: Firms need to focus more on the liquidity risks associated with their matched book repo businesses. This includes conducting appropriate liquidity risk analysis, particularly where internal treasury functions’ liquidity pools access third-party sources of secured financing collateral in multiple currencies, indirectly through their matched books.
In addition to the above, the letter makes a number of other observations, including the following:
- Firms should ensure that their operational processes are sufficiently robust and scalable to cope with extended periods of heightened market volatility. This includes being able to handle large volumes of margin calls and securities transfers.
- Firms should be aware of the maturity mismatches of assets and liabilities within their large, matched books. Liquidity risks would arise if firms were unable to monetise multi-currency secured financing collateral pools in stressed market conditions.
- Firms should consider the impact of their matched book repo businesses on their overall risk profile. This includes the impact on their capital requirements and their ability to withstand periods of market stress.
The PRA expects firms to remediate these shortcomings and to benchmark their own risk management frameworks against the observations and expectations set out in the letter. Firms should also share their analysis and any remediation plans with their supervision team by 8th December 2023.
Basel committee report on banking turmoil
The Basel Committee on Banking Supervision has published a new report on the banking turmoil witnessed earlier this year. This report provides an assessment of the causes of the banking turmoil, the regulatory and supervisory responses, and the initial lessons learnt. The report highlights a number of “fault-lines” withing banking risk management practice including the following.
- Basic risk management flaws in traditional banking, including interest rate, liquidity, and concentration risks.
- Lack of understanding regarding the interconnectedness and compounding nature of various risks.
- Unsustainable business models driven by short-term profits and growth, often at the expense of risk management.
- Weak risk culture and ineffective senior management and board oversight.
- Inadequate response to supervisory feedback and recommendations.
It also reports on the importance of strong and effective supervision including the following.
- Supervisors should proactively identify and swiftly enforce actions to address bank weaknesses.
- Ensure supervisory teams possess sufficient high-quality resources.
- Continuously monitor external and structural changes in the banking system and adjust supervisory methods accordingly, especially for rapidly growing or innovating banks.
- Sustain efficient cross-border supervisory cooperation across a broad network.
The report also covers a number lessons learnt from the turmoil.
- The importance of full and consistent application of Basel standards.
- Ensuring robust global standards for internationally active banks, considering market volatility and funding vulnerabilities.
- Maintaining a balanced approach between Pillar 1 regulation and Pillar 2 supervision, with both as essential components.
- Acknowledging that non-internationally active banks can still pose cross-border financial stability risks.
- Implementing proportionate regulatory frameworks aligned with the Basel Core Principles, tailored to a bank’s risk profile and systemic importance.
The report notes two follow up initiatives as follows:
- prioritising work to strengthen supervisory effectiveness and identify issues that could merit additional guidance; and
- pursuing additional follow-up analytical work to assess whether specific features of the Basel Framework performed as intended during the turmoil, such as liquidity risk and interest rate risk in the banking book, and assessing the need to explore policy options over the medium-term.
ESMA publishes second consultation on crypto market rules
The European Securities and Markets Authority (ESMA) has published the second of three consultations on developing regulatory technical standards (RTS) and implementing technical standards (ITS) to facilitate the Markets in Cryptoassets regulation (MiCA).
This second consultation package covers six draft RTS and two draft ITS on:
- the content, methodologies and presentation of sustainability indicators and adverse impacts on climate;
- continuity and regularity in the performance of CASP services;
- offering pre- and posttrade data to the public;
- content and format of order book records and record keeping by CASPs;
- machine readability of white papers and the register of white papers; and
- the technical means for appropriate public disclosure of inside information.
The deadline for comments on the consultation closes on 14th December 2023.
A selected summary of key developments for regulated financial institutions
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