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It’s an issue the Basel Committee on Banking Supervision attempted to address in a recent consultation on counterparty risk management, which we responded to last month. There’s a lot in the consultation that aligns with industry best practices, but it’s important that the measures are implemented with flexibility and in proportion to the risks posed.
The Basel guidelines are part of a broader effort by regulators to plug perceived vulnerabilities posed by non-bank financial intermediation. In the case of Archegos, the firm had taken exposures to certain stocks through total return swaps with multiple dealers, building a large, concentrated exposure. It subsequently defaulted on margin calls, causing dealers to terminate the positions and sell the underlying stocks they held as hedges, which led to more than $10 billion in losses for counterparty banks.
The proposals – published as more flexible supervisory guidelines rather than hard-and-fast prudential rules – are intended to incorporate market developments in counterparty risk management in recent years, focusing on due diligence and monitoring, credit risk mitigation, exposure measurement and management. While drafted with Archegos-type situations in mind, these guidelines apply to all counterparties, so it’s important they are implemented in a way that reflects the business type and risk profile of each counterparty.
For example, a potential stumbling block is the recommended data banks are expected to get their hands on. As part of their ongoing credit assessment, banks will need to obtain a variety of information from their counterparties, ranging from changes in the direction of their trading activities and performance to alterations in risk management procedures and changes in key personnel. Given the proprietary nature of that data, this will be practically difficult, if not impossible – not least, because of legal or regulatory constraints on counterparties providing it.
Our response to the Basel Committee, which we submitted with the Institute of International Finance (IIF) on August 28, calls for greater recognition of the limitations banks may face in sourcing some of this information. We also think more work is needed to understand the constraints on counterparties in disclosing data to banks and to assess the huge volume of relevant data that is already available. For example, the European Securities and Markets Authority published a report showing that regulatory reporting data it receives under the European Market Infrastructure Regulation gave warning signals that Archegos had increased its exposure to certain stocks two months before its collapse – something we also pointed out in a whitepaper last year....
more at ISDA