Friday, January 24, 2014

Report of SEC, Fed and other Senior Derivatives Regulators Reveals Deficiency in Financial Firms Measurements of Counterparty Risk

Five years after the financial crisis began a group of global derivatives regulators, including the SEC and the Fed, found that financial firms have made unsatisfactory progress on achieving timely and accurate measures of counterparty risk in derivatives transactions. In a report to the Financial Stability Board, the regulators said that the goal of consistent, timely, and accurate reporting of top counterparty exposures failed to meet both the expectations of regulators and industry best practices. Given the rising need for accurate and timely counterparty data in firms’ own and in regulatory stress-testing plans as well as in other areas of regulation, such as collateral management, the lack of firms’ progress is even more pronounced.

The Senior Supervisors Group includes senior supervisory authorities of major financial services firms in a number of countries, including, in addition to the SEC and the Fed in the U.S., the Prudential Regulation Authority in the U.K. BaFin Germany, the Financial Services Agency in Japan, and the Superintendent of Financial Institutions in Canada.

In a cover letter to FSB Chair Mark Carney, who is also Chair of the Bank of England, Sarah Dahlgren, N.Y. Fed Executive Vice President and Chair of the Senior Supervisors Group, said that the regulators of these financial firms must prioritize the effort within the scope of their own work and commit to impressing upon these firms the importance of being able to quickly and accurately aggregate top counterparty exposures. She added that the counterparty exposure data collection program of the group had two primary aims: 1) to inform regulators of the level of and changes in significant bilateral derivatives and other counterparty exposures; and 2) to enhance the ability of firms to produce accurate and timely counterparty information.

Counterparty reporting for management and supervisors should be the product of standardized, repeatable, and highly automated processes, advised the Group. While some firms have developed their information technology infrastructure to support improved counterparty reporting, noted the report, many still rely on time-consuming and error-prone manual processes. The report also observed that firms should be farther along in their capacity to accurately report risk exposure. While they have improved their data capture systems and can provide more complete and timely data, said the report, data accuracy is still noticeably deficient at many institutions. If firms cannot produce accurate data during relatively benign times, reasoned the Group, they would be unlikely to do so during periods of market stress when exposures could be volatile. Going forward, regulators will expect firms to continue to devote time and attention to the infrastructure necessary to aggregate and update derivatives counterparty exposures accurately and in a timely manner, including the ability to thoroughly review dat quality and trend analysis to identify data anomalies.

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