The Unfinished Business Of Regulating Clearinghouses

Financial derivatives have been widely blamed for causing the 2008 financial crisis. These complex instruments created a deep and opaque web of bilateral links between major financial institutions that contributed to the transmission of systemic risk throughout financial markets. In order to stabilize the derivatives markets, legislators included radical provisions in the Dodd-Frank Wall Street Reform Act of 2010. As a result, traders are now required to process derivatives through clearinghouses: specialized risk managers that act as middlemen between buyers and sellers and guarantee each party’s performance. Policymakers believed that clearinghouses would provide much-needed stability in derivatives markets by acting as designated systemic risk managers. However, this Article argues that the effect of clearinghouses on systemic risk is less clear-cut than scholars and policymakers have generally believed. While clearinghouses have removed much of the financial risk from markets, they have simultaneously concentrated it within their own walls. Yet, these walls stand on fragile foundations: the economic and governance incentives of clearinghouses and their stakeholders are misaligned, which could undermine their systemic resilience. This Article contends that the current regulatory framework has critical, overlooked flaws that exacerbate clearinghouses’ moral hazard while creating new, risky, too-big-to-fail institutions. It urges policymakers to intervene: in order to rectify this situation, financial regulators must do more to ensure that clearinghouses are bastions of financial stability and not systemic risk amplifiers. The implementation of a multi-stakeholder board and the creation of hybrid financial instruments to complement the capital structure of clearinghouses are the first steps toward enhancing the accountability and systemic resilience of these critical market infrastructures

Financial cycles, credit networks and macroeconomic fluctuations: multi-scale stochastic models and wavelet analysis

This project focuses on the macroeconomics of financial cycles. Usually defined in terms of self-reinforcing interactions between perceptions of value and risk, attitudes towards risk and financing constraints, which translate into booms followed by bust, the recent empirical literature has recurred to two approaches \u2013 turning point analysis and frequency-based filters - applied to measures of credit and asset prices to pose a number of stylized facts. First, financial cycles tend to display a greater amplitude and a lower frequency in comparison to business cycles, with peaks associated with systemic crises. Second, financial cycles depend on policy regimes and on the pace of financial innovations, leading to a wide cross-country heterogeneity and a time-varying degree of global synchronization. The latter point is clearly related to the structural transformations occurred in financial systems over the last three decades, like the cumulative integration of traditional banking with capital market developments and the increasing degree of interconnections among financial institutions. However, to date very little is known about determinants and mechanisms behind financial cycles, and on how they interact with business cycles and medium-to-long-run macroeconomic performance. In this project we plan to research along three dimensions: i) measurement issues, in order to provide a comprehensive assessment of the evolution of co-movements between financial and real variables across a sample of financial developed countries, both over time and at different frequencies; ii) theoretical issues, aimed at exploring under what circumstances the network of interconnections among financial intermediaries and between intermediaries and non-financial borrowers might evolve cyclically, contributing this way to regulate the incentives agents have in taking risks, and to set the importance of credit and financial frictions in accounting for time-varying misallocations of resources; iii) policy issues, given the role assigned by international supervisory bodies to a proper characterization and knowledge of the financial cycle as a prerequisite for the macro-prudential regulation of banks, and the scope of monetary policy in promoting financial stability in addition to the typical mandate of price stability. Our task requires the employment of a new approach to macroeconomic analysis, diverse analytical tools and one unifying economic principle. As regards the latter, our focal point is the notion of risk externalities, across financial institutions and between the financial sector and the real economy. The set of tools we plan to employ spans from wavelets methods to multi-scale models in continuous time, and from strategic network formation to agent-based computational techniques. All these tools are instrumental in building and estimating macroeconomic models characterized by interrelated markets operating at different time scales

New financial order : recommendations by the Issing Committee ; preparing G-20 – London, April 2, 2009

Content A. EXECUTIVE SUMMARY, INCLUDING MAJOR RECOMMENDATIONS B. COMPLETE REPORT 1. INTRODUCTION 2. RISK MAP 2.1 Why a Risk Map is needed, and for what purpose 2.1.1 Creating a unified data base 2.1.2 Assessing systemic risk 2.1.3 Allowing for coordinated policy action 2.2 Recommendations 3. GLOBAL REGISTER FOR LOANS (CREDIT REGISTER) AND BONDS (SECURITIES REGISTER) 3.1 Objectives of a credit register 3.2 Credit registers in Europe (and beyond) 3.3 Suggestions for a supra-national Credit Register 3.4 Integrating a supra-national Securities Register 3.5 Recommendations 4. HEDGE FUNDS: REGULATION AND SUPERVISION 4.1 What are hedge funds (activities, location, size, regulation)? 4.2 What are the risks posed by hedge funds (systematic risks, interaction with prime brokers)? 4.3 Routes to better regulation (direct, indirect) 4.4 Recommendations 5. RATING AGENCIES: REGULATION AND SUPERVISION 5.1 The role of ratings in bond and structured finance markets, past and present 5.2 Elements of rating integrity (independence, compensation and incentives, transparency) 5.3 Recommendations (registration, transparency, annual report on rating performance) 6. PROCYCLICALITY: PROBLEMS AND POTENTIAL SOLUTIONS 6.1 What is meant by “procyclicality” and why is it a problem? 6.2 The roots of procyclicality and the lessons it suggests for policymakers 6.2.1 Underpinnings of the phenomenon 6.2.2 Lessons to be learned 6.3 Characteristics of a macrofinancial stability framework 6.4 Recommendations 7. THE ROLE OF INTERNATIONAL INSTITUTIONS AND FORA, IN PARTICULAR THE IMF, BIS AND FSF 7.1 Legitimacy 7.2 Re-focusing the work 7.3 Recommendation

The lender of last resort in the european single financial market

The paper examines challenges in effectively implementing the lender-of-last-resort function in the EU single financial market. Briefly highlighted are features of the EU financial landscape that could increase EU systemic financial risk. Briefly described are the complexities of the EU’s financial-stability architecture for preventing and resolving financial problems, including lender-of-last-resort operations. The paper examines how the lender-of-last-resort function might materialize during a systemic financial disturbance affecting more than one EU Member State. The paper identifies challenges and possible ways of enhancing the effectiveness of the existing architecture

Regulating Systemic Risk: Towards an Analytical Framework

The global financial crisis demonstrated the inability and unwillingness of financial market participants to safeguard the stability of the financial system. It also highlighted the enormous direct and indirect costs of addressing systemic crises after they have occurred, as opposed to attempting to prevent them from arising. Governments and international organizations are responding with measures intended to make the financial system more resilient to economic shocks, many of which will be implemented by regulatory bodies over time. These measures suffer, however, from the lack of a theoretical account of how systemic risk propagates within the financial system and why regulatory intervention is needed to disrupt it. In this Article, we address this deficiency by examining how systemic risk is transmitted. We then proceed to explain why, in the absence of regulation, market participants cannot be relied upon to disrupt or otherwise limit the transmission of systemic risk. Finally, we advance an analytical framework to inform systemic risk regulation

News : 1/11 / Center for Financial Studies

Research and Policy 3 ; CFS Publications 3 ; CFS Financial Center Index 10 ; Events 12 ; CFS Visitors Program 12 ; CFS Colloquium 13 ; CFS Lectures 14 ; The Deutsche Bank Prize in Financial Economics 22 ; The ECB and Its Watchers 25 ; News from CFS 2

Leverhulme Lecture: The Global Financial Crisis and Systemic Risk

Lecture given November 9, 2010, is the first of three delivered by Prof. Schwarcz as Leverhulme Visiting Professor of Law, Oxford University. Prof. Schwarz examines the causes of the global financial crisis, showing it was triggered by market failures, not by financial institution failures, and arguing that any regulatory framework for managing systemic risk must address markets as well as institutions. The lecture also analyzes how regulation should be designed under that broader framework to mitigate systemic risk and its consequences. Finally, the lecture examines the potential systemic effects of sovereign debt crises, demonstrating how regulation can mitigate those effects

Extending the Scope of Prudential Supervision: Regulatory Developments during and beyond the “Effective” Periods of the Post BCCI and the Capital Requirements Directives.

The main argument of this paper is, namely, the need for greater emphasis on disclosure requirements and measures – particularly within the securities markets. This argument is justified on the basis of lessons which have been drawn from the recent Financial Crises, one of which is the inability of bank capital requirements on their own to address funding and liquidity problems. The engagement of market participants in the corporate reporting process, a process which would consequently enhance market discipline, constitutes a fundamental means whereby greater measures aimed at facilitating prudential supervision could be extended to the securities markets. Auditors, in playing a vital role in financial reporting, as tools of corporate governance, contribute to the disclosure process and towards engaging market participants in the process. This paper will however consider other means whereby transparency and disclosure of financial information within the securities markets could be enhanced, and also the need to accord greater priority to prudential supervision within the securities markets. Furthermore, the paper draws attention to the need to focus on Pillar 3 of Basel II, namely, market discipline. It illustrates how through Pillar 3, market participants like credit agencies can determine the levels of capital retained by banks – hence their potential to rectify or exacerbate pro cyclical effects resulting from Pillars 1 and 2. The challenges encountered by Pillars 1 and 2 in addressing credit risk is reflected by problems identified with pro cyclicality, which are attributed to banks’ extremely sensitive internal credit risk models, and the level of capital buffers which should be retained under Pillar Two. Such issues justify the need to give greater prominence to Pillar 3. As a result of the influence and potential of market participants in determining capital levels, such market participants are able to assist regulators in managing more effectively, the impact of systemic risks which occur when lending criteria is tightened owing to Basel II's procyclical effects. Regulators are able to respond and to manage with greater efficiency, systemic risks to the financial system during periods when firms which are highly leveraged become reluctant to lend. This being particularly the case when such firms decide to cut back on lending activities, and the decisions of such firms cannot be justified in situations where such firms’ credit risk models are extremely sensitive – hence the level of capital being retained is actually much higher than minimum regulatory Basel capital requirements. In elaborating on Basel II's pro cyclical effects, the gaps which exist with internal credit risk model measurements will be considered. Gaps which exist with Basel II's risk measurements, along with the increased prominence and importance of liquidity risks - as revealed by the recent financial crisis, and proposals which have been put forward to mitigate Basel II's procyclical effects will also be addressed