Mark Carney of BoE Speaks on Addressing Systemic Risks for Non-Banks

By Regulatory News

June 06, 2019

Systemic Risk, Basel III, Stress Testing: UK, Stress Testing, Basel Liquidity Compliance

The BoE Governor Mark Carney spoke at the Institute of International Finance (IIF) Spring Membership Meeting in Tokyo. He highlighted that capital flow volatility is rising because of the fundamental asymmetry in the international monetary financial system and the rapid rise of market-based finance. The IIF, with its diverse and global membership, can make a major contribution in addressing these issues. He also outlined the ongoing regulatory work to address systemic risks for non-banks.

The information to be provided by a third party seeking authorization to assess the compliance of securitizations with the STS criteria provided for in Securitization Regulation should enable a competent authority to evaluate whether and, to what extent, the applicant meets the conditions of Article 28(1) of the Securitization Regulation. An authorized third party will be able to provide STS assessment services across EU. The application for authorization should, therefore, comprehensively identify that third party, any group to which this third party belongs, and the scope of its activities. With regard to the STS assessment services to be provided, the application should include the envisaged scope of the services to be provided as well as their geographical scope, particularly the following:

To facilitate effective use of the authorization resources of a competent authority, each application for authorization should include a table clearly identifying each submitted document and its relevance to the conditions that must be met for authorization.
To enable the competent authority to assess whether the fees charged by the third party are non-discriminatory and are sufficient and appropriate to cover the costs for the provision of the STS assessment services, as required by Article 28(1)(a) of Securitization Regulation, the third party should provide comprehensive information on pricing policies, pricing criteria, fee structures, and fee schedules.
To enable the competent authority to assess whether the third party is able to ensure the integrity and independence of the STS assessment process, that third party should provide information on the structure of those internal controls. Furthermore, the third party should provide comprehensive information on the composition of the management body and on the qualifications and repute of each of its members.
To enable the competent authority to assess whether the third party has sufficient operational safeguards and internal processes to assess STS compliance, the third party should provide information on its procedures relating to the required qualification of its staff. The third party should also demonstrate that its STS assessment methodology is sensitive to the type of securitization and that specifies separate procedures and safeguards for asset-backed commercial paper (ABCP) transactions/programs and non-ABCP securitizations.

The use of outsourcing arrangements and a reliance on the use of external experts can raise concerns about the robustness of operational safeguards and internal processes. The application should, therefore, contain specific information about the nature and scope of any such outsourcing arrangements or use of external experts as well as the third party's governance over those arrangements. Regulation (EU) 2019/885 is based on the draft regulatory technical standards submitted by ESMA to EC.

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Effective Date: June 18, 2019

Press Release

Proposed Rule 1

Proposed Rule 2

Proposed Rule 3

Presentation on Regulatory Framework (PDF)

Presentation on Resolution Plan Rules (PDF)

Mr. Carney noted that over half of investment funds have a structural mismatch between the frequency with which they offer redemptions and the time it would take them to liquidate their assets. Under stress they may need to fire-sell assets, magnifying market adjustments and triggering further redemptions. Two-third of investment funds with structural mismatches are domiciled in the U.S. and Europe; therefore, as is the case for banks, ensuring that leverage and liquidity risks are managed in funds investing abroad is both a national asset and a global public good. System-wide stress simulations are currently being developed, including at the BoE, to assess these risks. Authorities are beginning to consider macro-prudential policy tools to guard against the build-up of systemic risks in non-banks.

Furthermore, regulators have far less sight of risks within funds compared to the core banking system, particularly synthetic leverage arising from funds’ use of derivatives. The upcoming FSB-IOSCO evaluation of implementation and effectiveness of recommendations to address liquidity mismatch in funds will be crucial to improve the understanding of best practices, including the merits of adjustments to redemption periods to be more consistent with investments. Mr. Carney noted that better surveillance, a more resilient core of the financial system, and a macro-prudential approach to market-based finance will all help increase sustainable capital flows, but they will be most effective if they are underpinned by an adequate global financial safety net.

Pooling resources at the IMF is much more efficient than individual countries self-insuring against Capital Flows-at-Risk, distributing the costs across all 189-member countries. The design of the global financial safety net is also important. Positive steps have been taken in recent years by introducing precautionary liquidity facilities to allow countries to borrow to prevent crises and mitigate their impact. This should also reduce stigma of drawing on the facilities. However, so far, only a few countries have taken them up. The BoE Governor concluded that "we are all responsible for addressing the fault lines in the global financial system and its safety net." Doing so will reduce the volatility of capital flows, increase the sustainability of cross-border investment, and meet the great challenges of this age.

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Keywords: Europe, UK, Banking, Securities, Systemic Risk, Stress Testing, Capital Flow Volatility, Market Based Finance, Liquidity Risk, Macro-Prudential Approach, BoE

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