Buried within the latest European proposals on curbing risky trading by banks are two issues that may strike dread into the heart of every trading executive.
Waking up to the systemic market dangers inherent in the so-called “shadow banking” market, Brussels yesterday proposed tightening oversight of the repo and securities financing market.
Sometimes an understated part of the daily functioning of global capital markets, the shadow banking sector nevertheless provide huge amounts of credit and collateral to banks and other investors.
As the commission noted “in practice, shadow banking entities and activities raise funding with deposit-like characteristics, perform maturity or liquidity transformation, allow credit risk transfer or use direct or indirect leverage”.
At the end of 2012, global shadow banking assets accounted for €53tn, representing about half the size of the regulated banking system and mainly concentrated in Europe (about €23tn) and in the US (about €19.3tn).
Maintaining its passion for transparency, the commission is considering limiting the rehypothecation of assets, trying to keep a lid on using the same piece of collateral over and over again to gross up the level of activity in the shadow banking sector.
That may yet have a serious long term impact. A recent white paper by the Depository Trust and Clearing Corporation suggested that margin call activity for incoming over-the-counter derivatives trading may rise 500-1,000 per cent in coming years, which will drive demand for more collateral.
But the commission has decided to follow the lead in its flagship derivatives legislation, Emir, and plans to introduce trade repositories.
“The details shall be reported no later than the working day following the conclusion, modification or termination of the transaction,” the proposal says. Considering how much of the repo market is overnight or 48-hour transactions, that’s going to be an awful lot of data.
There’s also a boldness to the EC’s timing. Right now trade reporting is the top concern for every trading and derivatives executive in Europe and their worries have all been caused by what they describe as incoherent regulation and ill-thought out deadlines.
Unlike the US, Europe has mandated that both listed derivatives and OTC derivatives be reported, as well as both sides of the trade. Not only that but the obligation will apply to derivatives entered into on August 16 2012. Trades outstanding on that day, even if they have since been closed, are also captured.
To complicate matters further, investors will be allowed to report their side of the trade to their choice of repository. It will be entirely possible for two sides of the same trade to be reported to a different repository. At least there is a system of reconciliation in place.
In its haste to get it done, the commission overrode the concerns of Esma, the market regulator and insisted on a three-month timeframe for systems to be compliant. The hard February 12 deadline means Europe now faces the absurd and pointlessly risky situation of turning on a large IT project in midweek. As any competent IT manager knows, big technology switchovers are done at the weekend.
The good news for stressed out managers is that the next round of changes are likely to be a few years away. But let us hope the commission learns a few lessons next time round.