Thursday, December 3, 2009

Procedural Remedies from existing infrastructures


Author: David Schwartz J.D. CPA David Schwartz J.D. CPA

IOSCO members wish to collect data and create risk profiles of hedge fund managers, in order to help assess systemic risk and "inform the relevant legislative debates."

"Systemic risk has to be identified and guarded against," agrees the Bundesbank, by finding "adequate measures for indicating economic stress." Preferably, these metrics would rely upon dynamic financial market data, not static balance sheet statistics, although reliance on market data will create new challenges for file maintenance and model development by central bankers

The BIS has identified two dimensions of systemic risk to be monitored: the "common exposures and inter-linkages" in the cross-sectional dimension, and the procyclical risk factors that result from the "progressive buildup of financial fragility" in the time dimension. However, the BIS believes that "it is not entirely clear how central banks need to be equipped" to manage "the flow of information in systemic risk regulation." However, "Financial supervisors can also benefit from the information collected by central banks in the context of their liquidity operations."

The ECB has no illusions about the difficulty of the monitoring challenge: "The analysis for systemic risk surveillance and assessment is indeed very demanding." The ECB's need to analyze the "implications of interlinked pages in complex systems" and the risk transmission mechanisms in the market will be particularly difficult, yet it will also be quite necessary in order to develop a set of early warning metrics which rely on "a comprehensive set of macro-financial variables and forward-looking indicators." Says the ECB, "This task will require a detailed understanding of the channels through which emerging risks are transmitted." A supplemental benefit of the new systemic and macro-financial metrics will be "further enhancement of financial institutions' internal models, including stress testing [and] will lead to more accurate indicators of aggregate average, correlation and concentration of exposures to specific asset classes and of a firm's interconnectedness." Through frequent contact with market participants, the ECB expects to be able to identify and calibrate systemic risk trends "such as growing financial imbalances, convergence of business models, similarities in investment strategies and innovations in financial instruments -- to name just a few."

The U.S. Securities and Exchange Commission is moving forward with a leveraged supervisory framework, by empowering the chief compliance officers (CCO's) within investment companies and asset managers. "We have been seeking ways to leverage third parties to assist us in our core mission of protecting investors," said the SEC. In a sweeping expansion of the authority of CCO's, the SEC has sent that "you need to know [your firms] clients and its investment strategies. You need to know your firms business partners, including custodians administrators and prime brokers as well as how they are selected. Ask yourself whether you know who your firm trades with and what your counterparty risk is. And give careful thought to how the money moves at your firm, including potential conflicts of interest and the effect of compensation on decision-making. And, finally, are you regularly reviewing communications involving police officers to ensure everyone is following the rules?"

The urgency with which regulators view their work has been characterized very effectively by the ECB: "we have to succeed." The nearly 500 million EU citizens have been asked to pay a heavy price in this Crisis, says the ECB, and "they would not forgive us if we had to do so a second time."

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