Global Financial Reform:

Transcription

1 Global Financial Reform: Rules, Impacts, and Backlash Presented by Larry Tabb (Founder & CEO) June 2013

2 Agenda Why regulate? What are legislators doing / done? Crisis fallout G-20, Basle III, Dodd-Frank, EMIR General principals for financial markets Transparency, central clearing, Market Structure Why the pushback? What is the impact? 2

3 Mortgage debt (prices) soared and then crashed 3

4 Easy credit inflated values. When balloon popped, credit stopped 4

5 Many financial institutions didn t make it Forced Sale Nationalized Bankruptcy Acquisition Bailout Commercial Bank Collapse 5 Acquisition?

6 Top investment banks took it on the chin and at the market bottom lost $734b in market cap BoA/Merrill Market Cap from 12/31/07 to 3/17/2009 $40 $265 Change in Market Cap Citi $14 $ JP Morgan Chase $95 $ UBS $29 $ Goldman $46 $ Deutsche Bank $20 $ Credit Suisse $33 $ Morgan Stanely $26 $ Lehman $0 $ Bear Stearns $13 $ /7/ /31/2007 6

7 To stem the red ink, we bailed out many of the banks. Then banks took bonuses & public rebelled 7

8 Legislative / regulatory reaction was/is significant US Led Dodd Frank Swaps Clearing SEF Rules Volcker Rule LEI / UPI Implementation SEC Market Structure Review Large Trader Market Access HFT Reviews FACTA EU/UK Led Solvency II EMIR MAD AIFM MiFIR Financial Transaction Tax Banker Bonus Rules 8 Global Basel III

9 Capital buffers most impactful regulatory initiative. Basle III is global standard but other countries have own ideas Basle III Ensure banks have larger capital cushion Move bank capital from 2% Tier I capital to 6% Tier I capital of risk-weighted assets With a 2.5% surcharge for larger organizations Also with a 2.5% pro-cyclical surcharge or relief Also new liquidity coverage ratios Requires banks to hold high-quality liquid assets to cover its total net cash outflows over 30 days Other Initiatives Brown / Vitter This is a real challenge Most investment banks are financed overnight Proposal to set a floor on bank capital at 15% Switzerland Surcharge of up to 2.5% 9

10 Dodd Frank Wall Street Reform and Consumer Protection Act, will be very impactful Capital Markets Impact Systematic Risk Regulation Office of Financial Reporting (OFR) Orderly Liquidation of Too Big to fail Volcker Rule on Proprietary Trading Swaps Carve Out of Banks Bank Capital Derivatives Regulation Advisor Regulation (Hedge Funds, Private Equity & Others) Investor Protection Elimination of Office of Thrift Supervision Deposit Insurance Amendments to Bank & Thrift Holding Co Depository Institutions Payment, Clearing and Settlement Consumer Financial Protection Emergency Stabilization & Fed Governance Pay It Back Act Insurance International Sovereign Assistance 10

11 EMIR (European Market Infrastructure Regulation) is similar to swaps rules written into Dodd-Frank Reporting for OTC derivatives Clearing for eligible OTC derivatives Counterparty credit risk and operational risk rules for bilaterally cleared OTC derivatives Confirmations, compression and recon, Mark-to-market, collateral exchange, and capital requirements Central counterparty (CCPs) rules Trade repository requirements Data to be made available to public and regulators Interoperability between CCPs 11

12 Post flash crash, SEC's looking at market structure but efforts inconsistent Post flash crash regulation Circuit Breakers / Limit up/down 2. Ban stub quotes 3. Better clarity around Clearly Erroneous 4. Short sale restrictions (only in turbulent times) 5. Direct access rules 6. Large Trader ID 7. New Market Data tools New technical team 8. Consolidated Audit Trail 9. Mandatory IT Testing Reg SCI (Systems, Compliance and Integrity)

13 MiFIR will have significant impact to HFT firms which will crimp their flow. More flow to exchanges, more trading of index products Across Asset Class Not only equities but fixed income as well Trading Development of Organized Trading Facilities (not for equities) Mandated trading of standardized derivatives on organized trading platforms OTFs vs. SIs Transparency Pre & post- trade transparency Data Reporting Services APAs (approved publication arrangements) are part of the fix for OTC data quality CTPs are to provide the Consolidated Tape (consolidated tape provider) Data standardization and costs HFT and algorithmic trading Algorithmic trading requirements HFT and algorithmic trading: systems and controls Enabling Competition 13 Opening up indices to allow trading on all platforms Vertical silos and open access

14 Overall what are legislators / regulators trying to accomplish? Global initiatives US 14 Reduce risk Reduce leverage in the banking system Reduce reliance on overnight funding Reduce the interconnectedness Increase transparency (pre, trade, and post trade) Promote competition by reducing reliance on banks as intermediaries Limit risk-taking incentives Reduce proprietary trading Europe Transaction taxes Clampdown on HFT Extend OTC push toward exchange trading to debt markets Asia Very fragmented depends upon geo

15 Impact 15

16 Basle III is about leverage. Reduce leverage, reduce risk, but reduce profitability Return on Capital / Leverage on Various 5 Year Spreads (X-leverage Calculated Using 100m & 2% Haircut) 140% 40x Leverage Return on Capital / Leverage on long-term spreads (X-leverage Calculated Using 100m & 2% Haircut) 140% 40x Leverage 120% 12x Leverage 120% 12x Leverage 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% % Current 5year spread 5 Year Jan 04 5 Year Jan '95 Current 30 year spread 20 Year Jan Year Jan '95

17 Besides leverage, funding is the critical issue Investor buys stock Capital Used to Buy Bonds Capital Flows to Bank Bonds Repo-ed to Institutional Investors / Corps Cash for Bonds flow Back To Banks 17 Bonds Repo-ed to Institutional Investors / Corps Cash Used to Buy Bonds Cash for Bonds flow Back To Banks

18 Goal of G20 is to change derivatives market. The existing market is bilateral with dealers in the middle Corporation (end user) Existing Market Structure Futures Exchange Hard Inventory Corporate End User Minerals Accept Dealer 1 Inventory Bid Hedge Fund Asset Valuation/ Agriculture Balance Sheet Risk Energy Treasurer Bid Bid Dealer 2 Dealer 3 Asset Manager Inter-dealer broker Currency Corporate End User Asset Manager Corporate end users accumulate risk through their day to day business. This could be inventory, commodities, currencies, credit or interest rate risk. They work with dealers to model the risk and solicit bids from one to multiple dealers to hedge that risk. The corporate treasurer picks a dealer who wins the deal. The dealer typically will try to find and end user or a financial institution that wants the opposite risk and will try to sell it to another counterparty. Sometimes the dealer with use and Interdealer broker to lay off the risk with another dealer Source: 18 TABB Group 18

19 Reducing interconnectedness reduces contagion End Users Trades & Margin Futures Exchange OTF/SEF Members OTF/SEF Members Corporate End User Fixed/FR Debt Service Bid Bid Large Dealer 1 Large Dealer 2 Dealer 1 Clearing Firm 1 Small Dealer 1 Hedge Fund Asset/Liability Alignment Treasurer Bid Large Dealer 3 OTF/SEF Trade Info & Market Data Clearing Fund Margin Prime Broker 1 Hedge Fund Asset Manager Inter-Dealer Broker Currency Exposure Prop Shop Regulator Trade Repository Clearing House Pricing Trade Info Valuation 19 Source: TABB Group Risk Mgt

20 Greater transparency allows for greater Insight on pricing Resolution Ability to value positions in case of resolution Risk Management Valuation Margin Competition Open market for wider access 20

21 Downside of transparency Who provides capital? As transparency increases competition which reduces spreads Dealers reduce capital commitment Become agency players vs. principal Relying on market to provide liquidity Buy-side not in the business of taking capital risk Providing liquidity migrates to Hedge funds Which rely on banks for leverage (which rely on repo financing) Frequently take same side Overall not large enough to support risk Prop shops don t take long-term risk 21

22 Too much transparency Makes it harder to trade As banks back away, risk is pushed to other players (hedge funds, prop shops or to other investors) Trade size declines Timeliness speeds up Trading must automate Harder to get trades executed Banks may not fail directly but their clients may Pushes risk outside of regulators purview The not on my watch syndrome Well the banks (who I am responsible for) didn t blow up Weren t you supposed to be watching over them? 22

23 While equities market is price sensitive swaps market is about size Swaps market is more about size and specific characteristics than price When firms are hedging large exposures they need specific hedges While they could do most of their hedges with futures 23 It becomes a problem Very complex Hard to manage Easier to talk to bank and get exact swap By creating too much transparency dealers won t take exposure Smaller dealers, hedge funds and prop shops can t

24 This is why dealers (and large investors) are not happy with SEF rules "SIFMA strongly disagrees with CFTC s final SEF rules, will negatively impact investors and hinder the ability of American businesses to manage risk Restricting an institution s ability to manage risk will discourage responsible capital management, limit job creation and dampen economic growth The decision to impose a minimum bid requirement for certain swap transactions will impair market liquidity at the expense of all market participants, ultimately harming the everyday investors that the rule aims to protect," We are equally troubled by the CFTC s rule for determining block sizes. SIFMA believes that the CFTC s methodology in determining block sizes is flawed and results in arbitrary outcomes that are not based on observable market data. Although an improvement, we believe that it is too restrictive and not adequately justified. Additionally, we strongly support the amendments that would have injected credibility and objectivity to the process. We urge the CFTC to reconsider the methodology for determining block trades after the initial phase-in period. 24

25 Issues in corporate bonds. Market worried about how market functions when rates rise & investors sell? Who will buy? And how? Which reform effort will have a bigger impact on your business? $250 Primary Corporate Bond Inventory 17 October, 2007 $235.3bn Basel III 60% $200 DFA 28% $150 EMIR 24% $100 March 27, 2002 $46.3bn January 4, 2012 $46.2bn MiFID II 24% Based on conversations with 24 dealers in October 2011 $50 The Cheap Credit Bubble? The Real Market? $0 Source: TABB Group 25 Source: TABB Group, Federal Reserve Bank of NY

26 On the equities side, HFT and Dark Pools, and capital formation are front and center. Dark liquidity has become issue du jour Has dark volume impacted price discovery with un-displayed liquidity levels consistently at 35-37% Does this mask anything important? How does the shift of prints away from the primary market quality? Trade-At Proposal Implement in Canada and Australia How will these markets turnout? Is HFT a threat? How do you define How do you measure? If you stop HFT will markets function? What has happened to capital formation? Number of public companies has declined over 44% since From 8,920 to under 4,900 But is it market structure or Sarbanes Low interest rates Reg FD Private Equity? All of the above 26

27 Bottom line Legislation & regulation has industry tied in knots Additional cost structures (Basle III) has banks worried Which has larger clients worried Many banks focused on cost not innovation Significant concerns about market efficiency How will firms manage risk? (Will they manage risk?) How much more cost will be incurred? Will capital flee to lesser regulated geos? While banks are fighting and lobbying It isn t all for show and about profit There are real market, fairness, and global economic issues involved Banks are just intermediaries Cost will eventually be shifted back on investors, corporates, and marketplace 27