Over the past few months, spreads for credit default swaps (CDS) have widened quite dramatically. This is true for European sovereign CDSs as well as financial institutions, including those for US banks. For example, in September, the five-year CDS spread for Bank of America widened to 228 basis points from 297, and Citigroup’s hit 221, up from 204. Goldman’s was 227, up from 206.
At the height of the financial crisis in September 2008, financial regulators in several EU Member States adopted emergency measures to restrict or ban short selling in some or all securities. These regulatory actions were prompted primarily by concerns that at a time of considerable financial instability, short selling can be highly disruptive and could aggravate the downward spiral in the prices of shares, notably in financial institutions, in a way which could ultimately threaten their viability and create systemic risks. These measures implemented by the EU member states were not coordinated as the EU does not yet have a common regulatory framework for dealing with short selling issues, resulting in divergent and fragmented sets of restrictions between the states.
In a dialog at the Managed Funds Association Outlook 2011 seminar held in October between SEC Chairman Mary Schapiro, former SEC Chairman Harvey Pitt, and Managed Fund Association head, Richard Baker, Chairman Schapiro commented on the international and domestic challenges regulators face in coordinating the regulation of derivatives.
Domestically, coordination between the SEC and CFTC in the area of derivatives is critical because the agencies have different approaches to regulation, statutory authority, and the OTC derivatives markets they are charged with overseeing are not exactly the same. In addition, while the CFTC and SEC may effectively demarcate the types of OTC derivatives the oversee, the firms using these derivatives are not similarly demarcated. Differences in regulation between the two agencies may cause these firms difficulties.
In a strongly worded letter to Federal Reserve Chair Ben Bernanke, Rep. Maurice Hinchey (D-NY), Rep. Peter Welch (D-VT), and 15 other House members urged the Fed and other federal regulators to reject the current draft of the Volcker Rule regulations and replace them with stronger language to prohibit commercial banks from engaging in investment activities. Citing the current version of the Volcker Rule as unnecessarily complex and filled with loopholes, the letter contends that the Fed’s current draft of the rules fails to protect bank deposits from risky trading activities and falls short of what the Dodd-Frank Act intends.
The Basel Committee on Banking Supervision has issued a Frequently Asked Questions document providing technical elaboration on its counterparty credit risk rules, published in June. This FAQ document questions and technical interpretations grouped according to the relevant paragraphs of the rules, in particular, default counterparty credit risk charge, and the credit valuation adjustment (CVA) capital charge, and asset value correlations:
On November 9, 2011, Senators Kay R. Hagan (D-NC) and Bob Corker (R-TN) introduced a bill that would provide a legislative framework for establishing a US covered bond market. The purpose behind creating a covered bond market in the US is to enhance liquidity and provide a new source of stable, long-term financing to financial institutions and others derived from private capital markets. According to Senator Hagan, this legislation would provide an important source of funding for the capital markets sorely missing in the United States.
Institutional Shareholder Services Inc. (ISS) has published the 2012 updates to its US and international corporate governance policies. These guidelines are applicable to shareholder meetings held on or after February 1, 2012. Given the attention regulators and legislators have taken in corporate governance issues as of late, the new ISS guidelines for US companies include changes in several important areas.
In a forthcoming article in the Vanderbilt Law Review, Robert P Bartlett III, Assistant Professor of Law at the University of California, Berkeley, proposes a disclosure regime designed to enhance accurate pricing of a bank’s exposure to credit risk while at the same time safeguarding the confidentiality of a bank’s proprietary investment strategies and customer information. The article, Making Banks Transparent, begins from the premise that bank disclosures are notoriously lacking in granular, position-level information concerning their credit investments. Consequently, in times of market stress, investors must speculate as to which and to what extent banks maybe exposed, causing disruptions in credit markets and amplifying systemic risk. Bartlett proposes a mandatory disclosure regime based on credit modeling employing the very analytical tools banks themselves have developed and use to understand their own credit exposures.
In his October 6, 2011 testimony before the before the US Congress’s Committee on Banking, Housing, and Urban Affairs, Treasury Secretary Timothy F. Geithner made it clear that shadow banking remains an an area of great concern on his regulatory agenda. Geithner testified that “shrinking the shadow banking system” is a major item in the Department of the Treasury’s recent regulatory successes. This testimony, coupled with his other recent statements makes it clear that that he hopes to see the shadow banking system further reduced.
For the most part, provisions of the Dodd–Frank Wall Street Reform and Consumer Protection Act (Pub. L. No. 111-203, H.R. 4173 (the Act) relating to derivatives are aimed at increasing transparency, altering clearing and exchange trading requirements, regulation of swap dealers and other swap market participants, restrictions on swaps trading by banks and associated increases in capital and margin requirements. The Act leaves many of the details of implementation to regulators. With over a year behind us, we can now reflect on what regulators have proposed, adopted, and left unfinished with regard to swaps.