Ahead of the curve podcast

Navigating Counterparty Credit Risk & NBFI Oversight

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In this insightful episode, John Pucciarelli and Stuart Smith dive into two pivotal regulatory developments shaping the financial landscape. They explore recent guidance from the Financial Stability Board (FSB) on leverage in non-bank financial intermediaries (NBFIs) and the finalised Basel Committee paper addressing counterparty credit risk, particularly in the wake of the Archegos collapse. The discussion highlights the evolving role of NBFIs, the challenges of global regulatory coordination, and the growing emphasis on disclosure, risk monitoring, and data transparency. A must-listen for professionals tracking regulatory trends and systemic risk in modern finance.

Hello everyone and welcome to another episode ofAhead 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 developmenthere at LSEG Post-Trade Solutions Stuart Smith.Stuart, good to see you again.You too.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 recentlyaround guidance around counterparty credit riskand the leverage in non-bank financial intermediaries.What I would like for us to do today, is to talk about- the FSB has come out with thefinancial intermediary guidanceand then we’ll talk about something that I think we’ve talked about on previouspodcasts around the counterparty credit risk from Basel.How they interact with each otherand what are some of the common themes, what are some of the contradictionsand we can talk about that a little bit morebut first, before we go into that,can you justfor our listeners tell us what the FSB is and what do they do?That's a great question because sometimes these acronymsjust slip in and they not always clear exactly what each body does.Yeah I'm still trying to figure outmore of them, there's other ones by the waybut go ahead.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'swhatever 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,you know, write a regulation or derive a new capital standard for a bank.This is someone that sits across a lot of those things and guides themto the answers that they get.Yeah, that's like The Basel Committee for non clear marginthey had the body that set the global standardsand then everyone kind of implemented their ownso similar to that.So in terms ofwhat they have come out, do you want to talk aboutthe recommendations onthe non-bank financial intermediaries first or do you want to talkabout the Basel paper first?We talked a little bit last time about what we did about the Basel side.That's now been finalised.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.Some other similar eventsthat caused massive losses and ultimately caused some banks to failand the feeling is this cannot happen.This is not what we’re supposed to be and therefore there has to be changeand I think that's really been being set down.I think there has been change in that piece.Some of it somewhat strengthened around disclosure.So that disclosure section, much larger now more detailed around the factwhat 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 authoritygiven to the banks to say when they need different things from different people.So it's changed but still very much in the samedirection that it was originally.So the Basel paperjust to go back a little bit, the Basel paper waskind of laser focus on the Archegos default, right?I think yeah.For the most part.I mean I think that was a response to that eventand they laid out things like, well, we spokeabout specific wrong way risk, general wrong way risk, so on and so forthand you said that recently they came out with kind of the followup to that paper and that not much, as you just said, not much has changed.Has anything changed?I think I heard that the maybe the specific wrong way riskpiece might be either not inor maybe it's changed.I think changed.So I think there was some press pieces recentlyabout the fact that it's no longer, I think explicitly in the PFEThe Potential Future Exposure sectionbut it's still very much there generically as a concept that banks need to capture.I think this is a reflection that banks should havequite a bit of freedom about how they choose to capture that quantityrather than being forced down a specific,calculation approach, which I don't think the banks everlike when they've been dictated totoo much about explicitly how they have to capture 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 dobut gives them that little bit of freedom about how it isthey go about collecting that data and trying to measure that effect.The feedback was still from at least what I have readand I'm not putting the larger banks on the spot hereit's just information that's out there in publicthat a lot of the disclosures, especiallywhen we talk about specific runaway 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.No, I think that was some of the really big push back is well, this all sounds great, butI just don't have anywhere near enough information to be able to do thatand that actually quite nicely leads us on to the other paper.The challenge for thethe Basel committee, it's the committee that deals with banks.So they write regulations for banks and they write rules for banksthat they have to follow.They don't govern anybody else.They don't govern hedge funds, they don't govern insurance firmsor any other financial institutions.Now, this is when we're talking about NBFIs here.So then you move into this world of NBFIs which are-I don't want to conflate hedge funds and NBFIswe're talking aboutall different parts of the financial world that trade the same type of instrumentsand there has been a focus on NBFIs because it'skind of out of the scope of the existing regsand there needs to be more of a focus on it fromyou know, liquidity, in times of I guessin times of liquidity stress, that could be a move towards NBFIs.So therefore there needs to be a little bit more scrutinyand focus on them in terms ofresiliency and monitoring and things like that.I mean, if you look at the major NBFIs, if you turn the clock back 30, 40 years,you wouldn't be talking about major financial players who were NBFIsyou would be talking about banks.Now, some of the NBFIs are some of the largest financial institutionsin the world and equally important to financial stability,as many of the banks are,as well as the fact that a smallhedge fund can have a highly, highly leveragedimpact on the financial community as a whole, which is what we saw with Archegos.That ability to generate leverage is probably as great as it's ever beenand 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 areand there is no equivalent Basel committee really for NBFIs.Hence the FSB feels the need to say something about okay,come on, guys, we need toget our house together a little bit in terms of how we look at these peopleand how we ask them to report data, what kind of standardswe ask them to comply to for the sake of financial stability.That sounds like and I know you know, this termand you and I have spoken about this before on this podcast,even probably two years agobut 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 systemicin finance that it needsthere seems to be a need for more scrutiny, oversight, regulations.Is this FSB report is it a report or recommendationand do you remember when it came out?It came out mid-DecemberMid-December ok.So they did a report a while ago identifying the problem.So they identified this.I think everyone could identify its problem when Archegos happened.Just to stop you there and I hate putting you on the spotbut Archegos was always dubbed a quote unquote family office.Yeah.But the FSB would probably categorise them as an NBFI.NBFI is such a general term.It's a general term.There's no official rule.Anyone who's not a bankand is somehow financial can come under the scope of NBFIsso it's almost anybody.So I guess in their viewArchegos kind of fits into this category.I just want to make that clear for anyone listening and I guess you couldprobably do a Google search for this FSB paper.Do you remember the exact title of it for folks,‘’Leverage in non-bank financial intermediation’.Ok.This is their first stabat a set of recommendations for global regulators on how they shouldchange their standards to better regulate this area of the marketand I think if you ask a lot of banks about Archegos,they'll tell you, look, the problem wasn't on the bank sidethe problem was a hedge fund behaving,you know, in a in a very difficult to manage mannerand therefore you should go regulate those guysbecause they're the guys that cause the problembut the problem is that's not an easy thing to do.So this is probably the first step in saying,how are we going to get a handle on regulating some of these firms,bringing a little bit moreorder to thatwithout taking away their ability to trade and their ability tohelp the economy in the way that they do.I want to always be careful with kind of,look, I know this is our podcast and it's just the two of us talking,but at the same time, people listen,I don't necessarily want to convey that when you call somethingan NBFI, that it's a negative thing.It's just a way to categorise a certain entitythat's not a regulated,you know, swap dealer or bank or a broker dealer or any of those things.This is kind of likethey probably should come up with a better name, I would thinkbut we'll see.I think this is probably like the beginningsthis guideline in this paper is probably the beginnings of somethingthat we'll probably see more of, perhaps.So it's interesting.I think it could go both ways. -Because then there's going to be alike some kind of a roll outand we could talk about some of the challenges there, too.So I think it could go in the direction that you sayyeah, we need a more global abilityto manage these firms and therefore definition of who they are.Who's in scopeand then the people who have the ability to oversee them or regulate themand of coursesome of those national bodies do exist, but they could be more joined upor alternatively the alternative saying iswell, actually this is still a bank problem.It's still mainly banks going bust that we're worried aboutbecause that's what has an impact on people on the street.No one's particularly worried Archegos went bust.That's a risk of being a hedge fund that you go bust.The nice thing is you go bustwithout bringing down the world economy at the same time.So potentially you can just change the way in which you regulate banksand therefore get banks to further regulate the by sidefor you by applying different standards to them.I think both are still open based on the paperand I think this is part of the need for consultation to havethose 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 within6 to 9 months of each other.The global regulatory community feels the need to act and is nothappy with the status quo and is definitely going to move forwardwith measures that are going toimpact the way in which those firms trade together.What are some of those things, if you can just highlightsome of the improvements that they're really focusing in on, is it disclosure?Is it risk monitoring?Is it you know, some of those things?So I think on the FSB side, you could say that an awful lot of itis around disclosureand how can additional disclosures help firms,both from a public sense, have a public sense of,ok, 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? And then private disclosures bilaterally to help people educate the relationshipthat they have and therefore how much risk they're willing to take on thatthat bilateral relationship.Now the challenges you know, we're talking about firmswhich are typically very small and the offices can be a handful of people.You know, hedge funds nowadays can be incredibly lightweightthanks to some of the great technology that enables them toto run and fund administrators to do a lot of the back end for them.They can be very lightweight organisations that often don't have the capabilityof putting together those kind of disclosuresregularly sending them out,sending them in high quality and then automated standardised way.Data intensive exercise.For thousands of small firms.I think there was that great stat.There's morehedge fund managers in the world now than there are Burger King managers.Interesting. I never heard that one before.And, you know, that's a massive amount of new disclosuresyou're asking that group of people to do.It's interesting, we have trade reporting,trade repositories.Is there any idea of a repositoryfor this type of data to be collected, or has that been contemplatedas far as you know?I haven’t heard of anythingI'm just wondering if you came across that.I think we're a long way ahead of thatand 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 betterand I think ISDA showed it could be used betterI think you can't underestimatethe challenge though of using a data source that huge.To try and understand what's going on the financial markets.Yes, a lot of the information's there, butthat's quite a task to understand what's in that.Yeah, so that kind of gets toI would assume that's going to be one of many challengesfor rolling these kind of ideas, these initial kind of ideas outfor identification and disclosures for MBFIs.Is it just data or is it is it identification?The challenge is also probably coming up withwhat regulators across the globe are going to be tasked withthis kind of sector of finance.I guess that's probably one of the first things.If you go down the bank route and we go down through Baseland that's the banks to be the policeman for usfrom a regulatory point of view it's well-trodden path.We know how to do that.If we go down the path of say no, we need some rules against these firms themselvesand we need someone to oversee it.It really is a patchwork of people across the globe that,that's the FSB’s job in many ways is to pullthose guys together and provide them a framework to work togetherbut it's a much bigger task to ask those people to work together, to do that.Also, you know, hedge funds. It’s very easy to set up a hedge fundin different parts of the worldand therefore the number of peoplethat you have to work with is much, much bigger.So it is a challenge if they go down that routebut if you feel you really truly need regulation of that sector,you kind of have to go down that route.Yeah, it’ll 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 that.Is there a comment period?Comment period running for the next couple of months,so relatively short and we attendedthe first ISDA call and someone made that comment thatwe need to move fast on this.Yeah. Two months is ashort period of time for something this large.Are we looking at responses from- I mean ISDAhas always been great at this andkind of being the voice of mostlythe 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 be willingto do some level of disclosure orparticipate in this, if it's in everyone's best interestbut, I guess 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'rekeeping our tabs on from an industry regulatoryperspective and how it affects the world of business development.So we'll come back in a couple monthsand see how those comments came out.Well, thank you for joining me todayand thank you for this this topic.Like I said, we'll keep our eyespeeled on it and we'll talk about it again, I'm sure.Thank you very much.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, YouTubeor any of your other favourite streaming services or at Acadia Inc.Thank you so much for joining us today and we'll see you again soon.Thank you.

Navigating Counterparty Credit Risk & NBFI Oversight

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