Wednesday, October 24, 2012

Stricter Capital Requirements Forcing as Many as 25% to Exit the Market

Increased capital requirements are squeezing as many as 25% of financial firms out of certain business lines, according to the fourth annual survey by the Professional Risk Managers’ Association (PRMIA), which was co-sponsored by SunGard. The survey finds, among other things, that the introduction of central clearing is expected to result in lower margins, increased collateral requirements, and generally increase the cost of doing business in OTC derivatives. Twenty-five percent of the respondents to the survey reported that they had withdrawn from capital-intensive businesses, while 58 percent admit that they are more selective when undertaking such business. Eighteen percent say they would pass on these extra capital costs to clients.

The other findings of the survey are quite telling as well:
  • Sixty-four percent of respondents feel that less than half of OTC contracts will be cleared via central counterparties (CCPs), suggesting that bilateral clearing will still have a significant role to play. Among sell-side respondents, who are more closely involved in the clearing process, only 43 percent agreed, whereas 84 percent of buy-side respondents hold this view.
  • Half of buy-side firms do not measure credit valuation adjustment (CVA). Only 24 percent of the sell side reports the same. While 26 percent of sell-side firms actively manage and hedge their CVA, no buy-side respondents do.
  • Nearly twice as many buy-side firms (45 percent) as sell-side firms (24 percent) do not run any reverse stress testing.
  • Wrong way risk continues to be ignored by roughly a third of institutions, although there is a slight increase from 34 percent to 36 percent since last year’s survey in the number of firms that have an automated system in place to detect wrong way risk.
  • There has been a marked reduction in the amount of proprietary trading following the Volcker Rule, with only 24 percent of firms saying they can carry on as before.
This joint SunGard and PRMIA survey is an excellent source of feedback into risk management practices of international institutions, particularly in light of the rapidly changing risk adjusted return dynamics that are shaping the strategic direction of the global banking system. The results are vital to institutions in assessing the quality of their own risk management practices in relation to central clearing and valuation adjustments, rules and regulations, and models and measurement.

Dan Travers, director of product management for SunGard’s Adaptiv business unit, said: “As banks begin to fully appreciate the impact of initiatives that were previously confined to silos in the risk management, front office or the exchange margining worlds, risk managers should have an increasingly direct impact on the bank and its business model. Buy-side firms are also starting to feel the pressure to implement risk management practices that were previously the domain of their sell-side counterparts.”