Congress Recap

Greg Hands, Shadow Treasury Minister and a former banker, told the GARP conference in his Wednesday morning keynote that he had been surprised at how little parliament knew about banking. He left banking in 1997 and at the time risk management was in its infancy. He admitted to having written some models but suspected they were pretty basic compared to what is used now.

“Models can measure risk, but not uncertainty,” he said.

Hands warmed the hearts of risk managers by suggesting that the industry needs to compress the pay differences between risk managers and those who work on the trading floor.

He also offered a warning about efforts to regulate derivatives, which he said are usually a good thing. “They can’t be dis-invented. The most important thing to remember in new regulations is that derivatives arose to avoid regulation. We need to avoid regulations that will drive innovation into further, murkier waters.” The growth in credit derivatives was fueled partly by a desire to avoid certain securities rules.

“No one wants to deliver physical oil, and derivatives can help mortgage lenders arrange fixed and adjustable mortgages.” The problems arose when those markets made themselves deliberately obscure.
 
But he thought the new FSA Chairman Lord Turner was correct in his recent report to conclude that a lot of financial innovations have little social value but were designed for speculators. Derivatives require a powerful supervisor and the FSA failed by providing a level of oversight that was too much simple box ticking.

In addition to calling for banks to keep an eye on government cash flows, he said the industry needed to develop a great sense of social and corporate responsibility.

“Banks should start behaving a little more like medical profession. They should not just be loyal to the firm but to the overall sector and see a wider responsibility beyond compensation and bonus. The industry also needs tighter supervision with more a powerful and capable regulator. We have to create a system where risk management also has a reporting line into banks at a very high level -- to the board or nonexecutive directors. Probably reporting to non-execs would be the right thing, but then you would need non-execs who are capable of understanding risk issues.”

That would probably not be through a set of tests, added Hands, who recalled the U.S. Series 7 exam as a ridiculous multiple choice exercise.

“We need to foster a system where non-execs at a bank understand the risk they are taking on and the products.”

England needs to get the City back to a state of profitability. He favors independence for the Bank of England but would prefer a more flexible view of inflation that includes property prices.

“We want to be a growth based economy, and in times of growth we need to make sure the government isn’t running a deficit as it was during the first seven years of this decade.”

When banks fail, it is the national governments that have to step in. The role of the national regulator will continue, because every taxpayer will want to know the government has been looking at banks. Problems will arise with the European Union if a bank in a country like Greece gets into trouble.

“Should a British taxpayer fund the bailout of a Greek bank through the EU? The EU doesn’t have the funds to do that.” The industry needs a global regulator to avoid regulatory arbitrage, he added.

“We would like to get these banks back into the private sector as soon as reasonably possible, but doesn’t have to be in the current configuration. It could be different and more manageable size units. I think there is a strong argument that banking became much too consolidated with too many institutions that were too big to fail and too
big to bail.”

REGULATION AND MARKET RESPONSE

David Murano, director of market and ALM risk management at La Caixa, drew on his experience working at DTCC to say that regulators were too beholden and deferential to banks because they feared the firms would move. In early 2000 it was an open secret that thousands of OTC derivative deals were piling up in unsettled and unmatched transactions, but it took the regulators years to do anything about it.

The regulators could have required a 100 percent haircut on anything that wasn’t settled through a clearing house.

“But they were too deferential and too reliant on efficient market theories, that the market would work things out, that somehow shareholders had a special knowledge and could differentiate between good and bad risk managers, while even within a bank that was a struggle.”

The Federal Reserve representative at the conference seemed disconcerted to hear that compiling data was a big challenge, added Murano.

“But it wasn’t a surprise to anyone who has worked in a financial institution.”

For stress tests to be useful, regulators need to impose models and assumptions such as interest rate changes and insist the banks apply those against their positions. The banks could also use their own assumptions, but they should be defined and reported in addition to the assumptions and models from the regulators.

Tomas Hazelton, director of risk management, Europe, for AllianceBernstein, said firms whose results from proprietary models were vastly different from the results using the regulator’s models would have to explain the gap.

Regulators are not being allowed to do what risk managers should do – develop a holistic view of risk, he added, saying Basel II is too flexible and too open to gaming.

“Basel II was a distraction from good risk management. It was largely focused on operational risk with the assumption we were okay on market and credit risk. Every firm has limited resources; regulators have limited resources. For the last couple of years the whole focus was on operational risk and we missed what was happening to this other stuff that blew up.”

John Wertheim, head of operation risk for Europe at Citi, said Basel II was a big improvement over Basel I.  But, he added, there were a lot of failures, including regulators. The industry needs effective regulation, not a rules based approach. “You need to get the balance right.”
                                                                                                                                                                                                        

Robert Parker, Vice Chairman, Credit Suisse
Asset Management

Riccardo Rebonato, Head, Group Market Risk,
Royal Bank of Scotland

Jim O'Neill,  Chief Economist, Goldman Sachs 

Moderator: Andrew Lakin, QRM
Panellists:
     •   Brandon Davies, Non-Executive Director, Gatehouse Bank 
     •   Andrea Cremonino, Head of Risk Integration, UniCredit Group
     •   Aaron Sanders, Head of Market and Liquidity Analysis, QRM

Moderator: Brandon Davies, Non-Executive Director, Gatehouse Bank
Panellists:
     •   Patrick Armstrong, Managing Director and Co-Head of Investment Risk
         Management, State Street Global Advisors
     •   Martin Dooney, Chairman, Mercier Equity
     •   Roger Cole, Director of Banking Supervision & Regulation, Board of Governors of the
         Federal Reserve System