Big banks return to risky trading

From GARP

“The exotic financial products that nearly crippled the economy in 2008 are roaring back at the nation's biggest banks, according to data released Friday that reform advocates worry come just as regulations to rein in risky trading are being weakened in Washington.

Demand for derivatives - contracts whose value is derived from stocks, bonds, loans and currencies - is growing as investors and corporations try to lock in low interest rates. But critics worry that there are too few rules to protect taxpayers from a market dominated by a handful of banks."

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'Too Big to Fail' a Myth? What a Relief

“What a relief it was to read that the "too big to fail" problem — in which the nation's largest financial institutions benefit from government support because of the risks they pose — does not exist!”

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Assessing the possible sources of systemic risk from hedge funds

The Financial Services Authority’s (FSA) has just published the results of its latest “Hedge Fund Survey” conducted in September 2010 and the “Hedge Fund as Counterparty Survey” conducted in October 2010.

These two surveys provide a basis to analyze the systemic risk posed by hedge funds and are conducted every six months as part of the FSA’s work in assessing risks to financial stability of the UK financial system from outside the boundary of prudential regulation.

The full report can be downloaded from the FSA website – CLICK HERE

Short Selling or Shorting – Is it really a conspiracy?

Bloomberg's Sara Eisen reports on a February 8, 2010 secret dinner of hedge fund managers, at which the investors discussed big bets against the euro.

CPSS-IOSCO Review of Standards for Payment, Clearing and Settlement Systems

The Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO) have launched a comprehensive review of their existing standards for financial market infrastructures such as payment systems, securities settlement systems and central counterparties.

There are currently three sets of standards involved, namely:
• the 2001 Core principles for systemically important payment systems
• the 2001/2 Recommendations for securities settlement systems
• the 2004 Recommendations for central counterparties.

Financial market infrastructures generally performed well during the recent financial crisis, and did much to help prevent the crisis becoming even more serious than it actually was. Nevertheless, the committees believe that there are lessons to be learned from the crisis and, indeed, from the experience of more normal operation in the years that have passed since the standards were originally issued. It thus seems timely to review the standards with a view to strengthening them where appropriate.

Robust financial market infrastructures make an essential contribution to financial stability by reducing what could otherwise be a major source of systemic risk. Moreover, insofar as they enable settlement to take place without significant counterparty risk, they also help markets to remain liquid even during times of financial stress.

The review will be led by representatives of the central banks that are members of the CPSS and those of the securities regulators that are members of the IOSCO Technical Committee. The International Monetary Fund and the World Bank are also participating in the review. The review is part of the Financial Stability Board's work to reduce the risks that arise from interconnectedness in the financial system.

The committees will coordinate with other relevant authorities and communicate with the industry, as appropriate, as the work progresses. They aim to issue a draft of all the revised standards for public consultation by early 2011.

Separately, as announced in the press release on 20 July 2009, the CPSS and the Technical Committee of IOSCO are already in the process of providing guidance on how the 2004 Recommendations for central counterparties should be applied to CCPs handling OTC derivatives. The guidance will also cover other relevant infrastructures handling OTC derivatives such as trade repositories. This aspect of the work has been put on a fast track because of the new CCPs for OTC derivatives and trade repositories that have recently started, or are about to start, operating.
A consultative document on the guidance will be issued within the next few months. This new guidance will not entail amendments to the existing recommendations for CCPsbut will of course be incorporated into the general review of the standards that has now begun.

The Committee on Payment and Settlement Systems (CPSS) serves as a forum for central banks to monitor and analyse developments in payment and settlement infrastructures and set standards for them. Its members are central banks from 24 countries and regions. The chairman of the CPSS is William C Dudley, President of the Federal Reserve Bank of New York. The CPSS secretariat is hosted by the BIS. More information about the CPSS, and all its publications, can be found on the BIS website at www.bis.org/cpss .

The International Organization of Securities Commissions (IOSCO) is a policy forum for securities regulators. The organisation’s membership regulates more than 95% of the world’s securities markets in over 100 jurisdictions. The Technical Committee is a specialised working group established by IOSCO’s Executive Committee and is made up of 18 agencies that regulate some of the world’s larger, more developed and internationalized markets. Its objective is to review major regulatory issues related to international securities and futures transactions and to coordinate practical responses to these issues. Kathleen Casey, a Commissioner of the US Securities and Exchange Commission, is the chair of the committee. More information about the Technical Committee can be found at www.iosco.org/ .

The review will be co-chaired by the chairs of the CPSS and the IOSCO Technical Committee, ie William C Dudley and Kathleen Casey.

Royal Bank of Scotland's cheque system falls because of EDS mainframe failure

The Royal Bank of Scotland's cheque clearing system fell over on the 15th December after a massive mainframe failure at HP Enterprise Services (formally EDS).

An IBM Z10 at HP Enterprise Services's site in Stockley Park, near London apparently failed because microcode fixes had not been applied. The vendor's disaster recovery plan saw processes switched to an IBM Z10 in Mitcheldean, Gloucestershire, but this machine also failed to work, according to a report in UK technical journal. “The Register”.

The problem affected several large customers, including RBS, which saw its cheque clearing system go down for at least 12 hours, causing a huge backlog, says the Register, citing "insiders".

EDS was acquired in a $13.9 billion deal last year by HP, which promptly revealed plans to axe over 24,000 jobs worldwide.

According to “The Register” the Stockley Park hardware team, who would have made the microcode fixes, have all been made redundant, with a similar problem facing the Mitcheldean site.

RTGS Payment System Glitch – Operational Risk Vulnerabilities in India

A snarl in the real-time gross settlement (RTGS) system this past Monday, saw a few banks face a near default-like situation. This has yet again raised questions on the value and the soundness of the infrastructure supporting the Indian financial system.

RTGS, for the uninitiated is an almost instantaneous funds-transfer and settlement system. In the Indian RTGS system, it’s possible to transfer money to another bank account within a maximum of two hours. RTGS is mainly used for high-value clearing.

When contacted, a Reserve Bank of India (RBI) spokesperson said, “There was a glitch (in the system) on Monday, after we upgraded the RTGS software over the weekend.” She clarified that RBI had rectified the problem on the same day.

Bankers familiar with the RTGS system said that while clustering of payments is an often-enough occurrence (four to five times a year) this is the first instance of such large-scale malfunction. One large state-owned bank, in particular, faced an acute payment crisis that forced it to request assistance from other banks, to meet its obligations. After a considerable delay, funds were arranged.

“Many of the counterparties did not receive payment till as late as 1.00 am the next morning. And by virtue of one critical fund or counterparty not paying up, it would have had a cascading effect on other banks,” said the head of treasury at one foreign bank.

Customer payments can be processed through the RTGS facility only up to 4.30 pm on weekdays while inter-bank transactions are possible up to 6.00 pm.

People familiar with the matter maintain that central bank officials and computer staff worked towards moving the entire RTGS load to the back-up site of the system vendor. It was only after this switch that RTGS operations could be brought back on an even keel.

While some say, the incident highlights the inadequacy of the RTGS infrastructure, others were too quick to commend RBI for the promptness with which it acted to restore order. “Any system is open to the occasional risk. However, there should always be a fallback arrangement to cater to such eventualities,” said an irate banker who had to soothe quite a number of ruffled clients.

However, a section of the industry terms it as just a blip on account of the fact that RTGS users have grown many-fold. “RBI and several banks are still in the process of enhancing their servers to cater to the excess load. This has occurred, because banks have crossed normal threshold limits, hence, the bunching up of payments. However, in such times, the National Electronic Fund Transfer (NEFT) system can provide an alternate. The only difference is that the window would be slightly larger than 4-6 hours,” said a senior staff member of a leading public sector bank.

Under NEFT, the transfer takes place either on the same day or on the next day, depending on the time of instructions given. Yet, senior private sector bankers disagree. “NEFT can’t be an alibi for RTGS. The bottom-line is that any robust infrastructure should have a fall back. If this had occurred during the month end, we would have had a virtual stampede,” a senior private sector banker said.

“Quants” say their bosses don't understand them

A staggering two thirds of quantitative analysts (Quants) think their supervisors do not understand the work they do, according to a survey from training firm “7city Learning”.
The poll of almost 400 active quants and risk professionals reveals a significant gap in understanding between them and their supervisors.

Quants and risk managers have been pointed to by many economists as one of the principle reasons the global financial crisis escalated so precipitously.

Yet 86% of quants feel their supervisors' level of understanding of the job of a quant is the same or worse than it was a year ago. In addition, 70% feel that the level of understanding of the role of quants within their institutions has decreased or has not changed at all from a year ago.

Paul Wilmott, director of 7city's Certificate in Quantitative Finance course, says: "These numbers are alarming. They indicate that even with the events of the past year, financial institutions are still not taking the importance of financial education seriously, especially as it pertains to improving relationships and understanding between quants and their managers."
A recent report by financial regulatory agencies called on financial services firms to make substantial and sustained investments in IT infrastructure if they are to overcome severe underlying weaknesses in their risk management capabilities.

The Senior Supervisors Group (SSG) that comprises watchdogs from seven countries (United States, Canada, France, Germany, Japan, Switzerland, United Kingdom) says that underlying weaknesses in governance, incentive structures, information technology infrastructure and internal controls require substantial work to address.

Systemic Risk

The financial crisis has taken us down paths we have never dreamed of. Much research and discussion is taking place (and will for years to come) on many aspects of what we have been experiencing over these past two years.

In a paper published in the September edition of the “International Journal of Central Banking” Piergiorgio Alessandria, Prasanna Gaib, Sujit Kapadiaa, Nada Moraa, and Claus Puhrc describe a prototype quantitative framework for gauging systemic risk which explicitly characterizes banks’ balance sheets and allows for macro credit risk, interest income risk, market risk, network interactions, and asset-side feedback effects. In presenting their results, the authors focus on projections for system wide banking assets in the United Kingdom, considering both unconditional distributions and stress scenarios. The paper “Towards a Framework for Quantifying Systemic Stability” is available at http://www.ijcb.org/journal/ijcb09q3a2.htm