Perspective on Risk - January 19, 2025
Liquidity Management; Bank Reg Blog on SVB; Reflecting on Levine Reflecting on Private Banking; Leverage at Non-Bank Financial Institutions; More
Liquidity Management
Here I will discuss four important papers put out recently by the regulatory collaboratives. These four documents were published in late 2024/early 2025 as part of a coordinated policy response following the 2022 BCBS-CPMI-IOSCO review of margining practices. They address different aspects of the same underlying issues around margin practices that emerged during recent stress events (March 2020 COVID-19 shock, 2022 commodities market stress, etc.)
FSB Guidance on Liquidity Preparedness for Margin and Collateral Calls
In December, the Financial Stability Board issued Liquidity Preparedness for Margin and Collateral Calls
The FSB report is focused on non-bank market participants (insurance companies, pension funds, hedge funds, family offices, etc.) themselves, not their service providers. The report essentially expects non-banks to take responsibility for their own liquidity risk management rather than relying solely on their service providers to manage these risks for them.
The FSB’s recommendations here are high-level and principles-based. They don’t replace existing national rules, but are instead designed to promote more consistent practices across different types of market participants. The recommendations contain the usual stuff: risk management and governance, liquidity stress testing and scenario design, and collateral management practices.
This is the regulators at their best, surveying practices across all of the major firms, distilling the results into clear guidance, and issuing as transparently as possible.
Joint Guidance on Margining
Three global standard setting bodies, the Basel Committee, IOSCO and the BIS Committee on Payments and Market Infrastructures have jointly published Global standard-setting bodies publish three final reports on margin in centrally and non-centrally cleared markets (BIS).
This is important stuff.
The work is published in three parts:
Analyzing the documents, the most important changes appear to fall into three key categories:
Improving Responsiveness of Initial Margin Models,
Enhanced Transparency of Exposures,
Governance Around Model Overrides.
One can analyze these recommendations through an Information Theory lens. Thinking this way, the guidance seeks reduce information asymmetries, improving the signal-to-noise ratio, enhancing system observability, reducing information time delays, and strengthening feedback loops.
This document provides the most comprehensive background on the underlying issues that prompted this work. Specifically, it includes detailed background on recent market events that highlighted the need for reforms, context on margining practices generally, and and the process leading to these reports.
Of the three, this is the “policy” document. It provides 10 detailed policy proposals aimed at improving transparency and responsiveness of initial margin practices, and addresses how central counterparties (CCPs) should handle margin calculations, disclosures, and governance.
These proposals generally build on principles from the PFMI and CCP Resilience Guidance but provide significantly more detailed and prescriptive requirements in many areas. Some of the proposals around Clearing Members (CM) are entirely new.
Margin simulation tools should be made available by CCPs to all clearing members and where feasible their clients, including prospective CMs and clients.
Margin simulation tools should include minimum functionality for: a) Calculation of margin requirements for CCP stress test scenarios b) Incorporation of main add-on charges systematically required across CMs
CCPs should make margin model information available to CMs and where feasible their clients to enable understanding of material aspects
CCPs should publicly disclose and describe APC tools and model components affecting responsiveness
Public quantitative disclosure standards should include additional breakdowns of margin-related data
CCPs should compute and disclose standardized measures of margin responsiveness
CCPs should define an internal analytical and governance framework for assessing responsiveness
Where CCPs use discretion to override model margin requirements, they should: a) Have clear governance procedures b) Publicly disclose relevant information c) Communicate to authorities the aggregate size/duration of overrides d) Share reasons with affected CMs
CMs should provide transparency to clients regarding margin calculations
CMs should disclose relevant information to CCPs and authorities about exposures and liquidity needs
Streamlining variation margin in centrally cleared markets – examples of effective practices
This document focuses on variation margin practices in centrally cleared markets. It provides eight (8) examples of effective practices for CCPs and clearing members and is based heavily on survey responses from market participants. It is quite operational in nature, dealing with practical implementation aspects.
This document focuses specifically on variation margin processes in non-centrally cleared markets; it deals primarily with bilateral trading relationships rather than centrally cleared trades. It provides eight (8) recommendations split between streamlining variation margin processes and increasing initial margin responsiveness.
The language here is notably more “principals-based” than the subsequent the language around centrally-cleared margining.
Takeaway
I would expect that these are the new standards that firms will be expected to achieve. The smart thing to do would be to benchmark your firm against the appropriate set of recommendations and develop plans to come up to current standards before the supervisors come in the door (again).
Bank Reg Blog on SVB
The Bank Reg Blog has been all over the FDIC’s lawsuit against former officers of SVB, both on its substack and twitter. I recommend reading the below post.
FDIC Lays Out a Case Against Former SVB Officers and Directors
When SVB failed, its holding company, SVB Financial Group (SVBFG), sought to withdraw its deposits in the bank subsidiary. SBVF has sued the FDIC seeking its deposits. The FDIC will countersue the officers and directors of SVB. Bank Reg Blog summarizes the issue thusly:
Briefly and to oversimplify, SVBFG’s primary arguments contend that the systemic risk exception invoked in March 2023 was meant to, and was consistently described by the FDIC as, protecting all deposits held by all depositors of SVB. As a result, SVBFG reasons that it, like any other SVB depositor, should get full access to its deposits.
The above substack post goes through in some detail the FDIC’s allegations that the management of SVB mismanaged the HTM portfolio, exceeded its own internal risk limits and, when in breach, rather than change the portfolio they changed their deposit assumptions to lower the reported risk (cute), and inappropriately removed hedges. Most of this I think you already know, but the post does a nice job of telling the story.
What interested me more was information about dividends from the bank subsidiary to the parent holding company. Bank Reg Blog writes:
In 2020 SVB stopped paying a dividend to its parent company SVBFG. The FDIC alleges that as late as of March 2022 the plan was for SVB to SVBFG dividends to “remain suspended through FY2023.” But after the termination of the hedges discussed above resulted in additional income to SVB, SVB’s officers and directors began to consider resuming the SVB to SVBFG dividend. The FDIC alleges that the motivation for doing so was to “increase SVBFG’s liquidity and meet its cash-flow needs” while also helping to address the “particular concern” of “[p]ropping up SVBFG’s share price.”
The FDIC contends that by taking these factors into account and ultimately approving a $294 million dividend, SVBFG’s and SVB’s officers and directors “disregard[ed] SVB’s own needs for capital, liquidity, and adequate cash flow.”
This highlights an interesting tension. Holding companies typically rely on dividends from their subsidiaries to pay interest on parent company debt, fund dividends, stock repurchases, dividends, and to pay executive officer compensation. This is what management means by “increase SVBFG’s liquidity and meet its cash-flow needs.”
Regulators have the ability to prevent the upstreaming of dividends from a banking subsidiary to a parent, and it is a power that was used occasionally when I was at the Fed, and which has gotten more prominence recently. In general, a supervisors first priority is to “protect the bank” but when a bank is in difficulties arguments are made to allow certain payments in order to prevent an event of default at the parent (which typically would then lead to a run).
I don’t remember any reporting on regulators putting dividend restrictions in place prior to SVB’s failure. This would be consistent with a story that the regulators were slow to identify the issues the bank faced.
Reflecting on Levine Reflecting on Private Banking
Private Credit Wants to Be the Bank (Levine on Bloomberg)
The evolution of private banking is an evolution of “who is the customer” and “who owns the customer.” The customers are both the borrowers and the lenders.
In the corporate space, breaking apart bank intermediation means that insurers and pension funds provide more of the lending because of their advantage with long-term liabilities. The borrowers are probably more agnostic between bank and private credit deal teams.
In retail, the banks “own” the majority of the retail customers.
If you were building a financial system from scratch, and you had to decide “where should the money for 30-year mortgages come from,” and your choices were “people’s checking accounts” or “people’s retirement funds,” isn’t the retirement fund the obvious answer?
But the relationship should be unbundled from asset ownership
… if banks are no longer the best source of funds for loans — if “the fundamental model of a bank is changing from lending to earn a return to lending to make fees” — then the natural evolution is for the banks, which have the customer relationships and the loan officers, to make the loans, and for private credit funds to give them the money for those loans.
Banks currently have the infrastructure to obtain and service the customer
… since banks have historically been the big source of loans, they have a lot of the tools needed to make loans. They have branches and loan officers and customer relationships
But that is perhaps a temporary state of affairs on the road to narrow banking. If banks are not where the money is, why should they make the loans? If banks don’t hold the credit risk, why should they make the credit decisions? Banks have branches, yes, but who goes to a bank branch to borrow money? You go to an app.
But that may be changing.
Leverage At Non-Bank Financial Institutions
I’ve written in the past about how the evolution of the financial system with “private credit” increasingly holding the riskier tranches of the debt stack is perhaps a stabilizing trend. What many market watchers worry about is the build-up of leverage outside the eyes of policymakers, a valid concern. The policymakers (through the FSB in this case) have taken notice and have now put out a proposal for consultation:
Leverage in Non-Bank Financial Intermediation: Consultation report (FSB)
This consultation report sets out the Financial Stability Board's (FSB) analysis and proposed policy recommendations to address financial stability risks arising from leverage in non-bank financial intermediation (NBFI). Building on the findings of the 2023 FSB report on The Financial Stability Implications of Leverage in Non-Bank Financial Intermediation (NBFI leverage report), the proposed policy recommendations aim to enhance the ability of authorities and market participants to monitor vulnerabilities from NBFI leverage, contain NBFI leverage where it may create risks to financial stability, and mitigate the impact of these risks.
At first read, the proposal appears quite thoughtful. They seek both entity and activity-based information, a balance of public and confidential disclosures. The devil will be in the details, and this is by far only the first step in the process. Still, if this potentially affects you consider commenting.
More Stuff
The PRA announces a delay to the implementation of Basel 3.1 (BoE)
I love how direct they are.
The Prudential Regulation Authority (PRA) … has decided to delay the implementation of Basel 3.1 in the UK by one year until 1 January 2027. This allows more time for greater clarity to emerge about plans for its implementation in the United States.
BIS CPMI takes further steps to promote ISO 20022 harmonisation for enhanced cross-border payments (BIS)
Of Last Resort: Evaluating the Treasury-Equity Model of Federal Reserve Emergency Lending (Steve Kelly)
Very interesting paper for those of us involved in the development of bailout programs, and the first to my knowledge that challenges effectively whether the way of the past should be the blueprint for the future.
During the Global Financial Crisis, a model evolved whereby the Fed would lend in a senior position with a loss absorbing layer provided by Treasury above them, and the institutions taking the first-loss position. Steve argues that this structure is no longer required as the original legal risk to the Fed that justified Treasury involvement has already been addressed by Dodd-Frank Act (2010).
He further argues that instead of expanding lending capacity, Treasury’s involvement constrains the Fed’s ability to lend aggressively, making programs less effective in stabilizing financial markets. He also argues that Treasuries involvement leads to stricter lending criteria (due to political concerns) and bureaucratic delays.
Ratings Agencies: The Forgotten Constituency of Financial Crisis Interventions (Yale)
I’m going to quibble with Steve Kelly on this paper. He makes the important point that regulatory interventions need to consider how market participants will view the action (with the rating agencies often the proxy for the market opinion).
However he writes:
… all too often, … policy responses fail to initially consider the ratings agency reaction function, which can cause deleterious instability or uncertainty—and often force crisis-fighters back to the drawing board to respond anew.
“All-to-often” gives him a lot of wiggle room. I can say that at least at the NY Fed we were acutely aware of the role played by the rating agencies in both crisis’s and day-to-day risk management. He uses the following Millstein quote to argue it was insufficiently appreciated:
What all the people who were harping about what we were doing at the time missed is the centrality of the rating agencies as a constraint on how bailouts were structured, because a financial institution cannot operate without at least an investment-grade rating.
I read the same quote to say that is precisely what we were all focused on.