Treasury Official Says Private Sector Will Play Large Role in Reforming Securitization

The reform of the securitization process will involve a public-private partnership in which the private sector will have a critical role to play, in the view of Assistant Treasury Secretary Anthony Ryan. As part of this process, the President’s Working Group on Financial Markets is engaged with several private sector committees that are developing best practices on disclosure, risk management, and ratings. The senior official's remarks were made at a London Euromoney Investors Forum.

Sound risk management is a key to reforming securitization, observed the official, since by better assessing risks financial institutions are better placed to manage capital, liquidity and leverage. Moreover, strong, well-capitalized financial institutions with robust risk management systems are better positioned to take advantage of new opportunities and secure the confidence of creditors, shareholders, investors and regulators.

Once identified and assessed, he continued, risks must be better managed. During the past year, many financial institutions, money managers, and investors simply failed to appreciate the magnitude and nature of risks on their books. This inability to aggregate risk and transparently address public concerns led to even further uncertainty, volatility, and dislocations. With this in mind, the senior official emphasized that risk management practices by investors and financial institutions must be improved.

Risk monitoring and management is not a function to be left solely to a back office or a set of quants, he said, rather it is the senior-most management's responsibility to be fully aware of the risk they are taking on daily basis. Firms that employed such practices fared better than others during the financial crisis, he pointed out.

In this spirit, a private-sector group is reassessing the implementation of the Counterparty Risk Management Policy Group II's principles and recommendations regarding risk management, risk monitoring, and transparency. They are modifying and developing new recommendations to incorporate lessons from the recent turmoil, including lessons learned regarding valuation practices. This group intends to issue a report in late July focusing on four areas of reform: financial institutions' risk management practices; structured financial products; off-balance sheet activities, including accounting policy and disclosure; and market infrastructure.

The Counterparty Risk Management Policy Group II, chaired by former NY Fed President Gerald Corrigan, published a far reaching report a few years ago. The report is a forward-looking, integrated framework of initiatives dealing with risk management, enhanced disclosure, transparency, and sound corporate governance.

Another private sector group is developing best practices regarding disclosure to investors in securitized credits, including asset-backed securities and collateralized debt obligations of asset backed securities. The American Securitization Forum and the Securities Industry and Financial Markets Association (SIFMA) are leading this group. They are covering transparency and disclosure practices, including standardized templates, price discovery and valuation tools, and credit rating practices. They expect to issue a report later this summer.

In addition to disclosure, another area in which market participants must become more aware is in the use of ratings. While there will be regulatory reform of credit rating agency practices, he noted, the users of their services must rely less on, and appreciate more, the limitations of rating products. To aid in accomplishing this goal, a second private-sector group is outlining further steps that issuers, underwriters, and credit rating agencies can take to ensure the integrity and transparency of ratings, and to foster the appropriate use of ratings in risk assessment. The Asset Managers' Group at SIFMA is leading this effort. They are exploring issues including: use and quality of ratings; business models; and credit rating agency independence. There work should be completed by the end of July.