Zoltan Pozsar’s recent paper on the macro view of Shadow Banking pointed out an important connection in financial markets – that the Bank of England is now the global backstop for liquidity in Eurodollar transactions. This is a massive change in the functioning and perception of offshore US dollar markets. Here are the details.
One of our favorite thinkers on Shadow Banking, Zoltan Pozsar, has released a new paper on the role of Shadow Banking in financial markets. His previous work focused on the microstructure and mapping of Shadow Banking – who does what and how they do it. This latest piece makes the case that Shadow Banking plays an important part in leveraged bond portfolios, which in turn could create new policy arguments for increasing market liquidity without increasing balance sheet utilization. We review his draft paper published on January 31, 2015.
We argue for better language to describe various functions in financial markets. There are banks and bank holding companies that offer a wide variety of credit intermediation and agency services. There are nonbanks including hedge funds and asset managers that provide liquidity and offer credit intermediation. Calling something Shadow Banking doesn’t work when we are talking about financial market activities since banks can perform supposedly Shadow Banking activities, and nonbanks like insurance companies and corporates issue funding obligations, like a bank, on a regular basis. The language doesn’t work. We propose here some straight-forward alternatives based on function, not form.
The Fed has published a staff report on the emergence of new banks that is sure to confound and distress some market participants. In the report, “Hybrid Intermediaries“, author Nicola Cetorelli argues that some of today’s nonbank intermediaries look very similar to earlier nonbank conglomerates that have become banks post-Lehman. BlackRock in securities lending is cited as an example. The subtext argument here is whether BlackRock and firms like it are SIFIs, should be forced to become bank holding companies, or receive some other form of bank-like regulation.
On October 30th the FSB released “Global Shadow Banking Monitoring Report 2014”, their annual examination of the world of shadow banking. Shadow banking is described as “non-bank credit intermediate with bank-like systemic risks…includ[ing] maturity transformation, liquidity transformation, imperfect risk transfer, and leverage…” We take a look at the report.
In October 2014, the International Monetary Fund (IMF) published its Global Financial Stability Report (“the Report”) entitled “Risk Taking, Liquidity, and Shadow Banking: Curbing Excess while Promoting Growth”. The report asserts that global economic recovery is dependent upon “accommodative” monetary policy in advanced economies by way of shadow banking. At the same time, the Report cautions that prolonged accommodation may also encourage excessive financial risk.
The October 2014 Global Financial Stability Report (GFSR) finds that six years after the start of the crisis, the global economic recovery continues to rely heavily on accommodative monetary policies in advanced economies. Monetary accommodation remains critical in supporting the economy by encouraging economic risk taking in the form of increased real spending by households and greater willingness to invest and hire by businesses. However, prolonged monetary ease may also encourage excessive financial risk taking.
Interesting news and articles from the last week that we haven’t gotten a chance to talk about elsewhere, including MiFID and liquidity, a suggestion that Moody’s has preferenced ratings of bonds held by its corporate owners, and securities lending CCPs. Read on.
Sheila Blair, former head of the FDIC and now head of the private, nonpartisan Systemic Risk Council wrote an article in the July 24th Wall Street Journal “The Federal Reserve’s Risky Reverse Repurchase Scheme”. She has joined a group of regulators and former regulators who have some hesitation about the Fed’s RRP program.
We’ve seen several recent news articles and commentary on Shadow Banking, from The Economist’s special report to news on China’s CITIC. Below are the most interesting articles we’ve seen lately.
An article published in December 2013 by the Centre for Economic Policy Research “The roots of shadow banking” by Enrico Perotti of the University of Amsterdam, ECB and CEPR grabbed our attention. The author blames repo for the bad lending in the mortgage markets during the financial crisis.
IMN held its 20th beneficial owners in securities lending last week in Austin, TX. Finadium chaired the conference and was represented in both individual talks and a panel. Here’s a synopsis of what we heard and what we said.
Reading the news this morning we were struck by how far Shadow Banking has spread into the popular financial lexicon. We point out five recent observations from the spot-on to the dubious.
Following the initial reactions of regulators to protect market stability and dial down risk, we are seeing several points suggesting that the tide is turning: maintaining market liquidity is being looked at more kindly than in the last few years. In particular, we note European suggestions that securitization is really alright and that even Shadow Banking might not be so bad after all.
The Federal Reserve’s Daniel Tarullo give a speech last Friday called “Shadow Banking and Risk Regulation,” in which he laid out a few new ideas for regulating securities finance transactions (SFTs) including repo and securities lending. Most of the speech was old news for those of us who follow shadow banking but some of the new ideas warrant closer investigation.
It’s not the big bang, but there are a number of important points in the new FSB publication, “Strengthening Oversight and Regulation of Shadow Banking: Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos,” that market practitioners should note.
We’ve collected some spot data on the size of the Shadow Banking market today, in light of regulators starting to ease up on regulations reducing credit and maturity transformation trades. Here’s what we’ve got:
After years of careful investigation into the dangers of shadow banking, some regulators appear to be concluding now that the benefits of liquidity provided by credit and maturity transformation may outweigh the inherent risks.
While we are new to China’s banking system and its policies, we do know a thing or two about Shadow Banking. That’s why recent articles tying China’s credit boom to Shadow Banking activities have us paying attention. Here’s what recent reports are saying about the matter.
We’ve been thinking lately about hedge fund dynamics, the “other side of the fence,” if you will. Finadium’s next two research reports are surveys of hedge funds on prime brokers, leverage, repo and prime custody, the first of which will be out next week. Today we read an interesting piece from Citi about where new hedge fund growth will come from.
A speech over the weekend by Federal Reserve Vice Chair Janet Yellen gave a concise status of the Fed’s thinking on shadow banking. We review the main elements and provide some supporting evidence for future regulatory actions.
An article in Bloomberg BusinessWeek, “EU Weighs Curbs on Banks’ Use of Client Assets as Collateral” by Jim Brunsden last week, discussed a move that could have some serious ramifications for repo.
The Wall Street Journal published an article on May 22nd, “The Fed Squeezes the Shadow-Banking System”, written by Andy Kessler. Much of it was about repo. While we appreciate the attempt to talk up repo by linking it to the real economy, we think some of the technical points were off in important ways. Here’s our commentary:
One theme of the Finadium conference this year was that securities finance is now meeting the world. This idea extends to how regulators view securities lending and repo. A regulatory understanding of these markets is critical not only for regulators to achieve their goals, but also to connect regulatory objectives with impacts for the real world. We think that the dangers of disconnect in some parts of the world is at a real high; the sooner that regulators understand the role that securities finance plays in financial markets and real economies, the better the results of their policy making for banks and real economies.
ESMA published last week their first Trends, Risk, Vulnerabilities report of the year. The report is worth reading for its data points and a view into the thinking of this important European regulator. We take a look at what ESMA had to say about Shadow Banking and collateral, particularly the prospects of upcoming collateral shortages.
In a speech today before the Committee on Banking, Housing, and Urban Affairs of the U.S. Senate, Federal Reserve Governor Daniel Tarullo will outline key priorities for the Federal Reserve in 2013 including work on Basel III, Dodd-Frank 165 and Shadow Banking. Excerpts from the speech are below.
Reading the public responses to the Financial Stability Board’s Shadow Banking consultation paper provides an important view into the thinking of major banks and international organizations on Shadow Banking. Below are a selection of quotes we found compelling.
William Dudley, the President of the New York Fed, just gave a speech at the New York Bankers Association 2013 Annual Meeting. His focus was on wholesale funding and these days, that means tri-party repo and money market funds. This post takes a look at what he had to say on tri-party repo. It was an important speech.
From Securities Lending Times:
In a December 4 2012 research report, the IMF discussed their views on how to best regulate shadow banking. The paper, “Shadow Banking: Economics and Policy,” has some interesting points that we discuss below. The paper was written by Stijn Claessens, Zoltan Pozsar, Lev Ratnovski, and Manmohan Singh; as far as we can see, Pozsar and Singh are the IMF’s leading thinkers on all things collateral, stability and shadow banking. On a related note, Finadium has the honor of speaking at two events in January 2013 featuring Manmohan Singh.
An interesting speech last week from Marisa Lago, Assistant Secretary for International Markets and Development at the US Treasury, offers the US view on Shadow Banking activity in China. It also highlighted areas where the US Treasury is concerned about China’s financial market evolution. Excerpts from the speech follow, along with our commentary.
The FSA consultative document “Strengthening Oversight and Regulation of Shadow Banking, A Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos” has a lot to chew on. This post will focus on the idea they floated on minimum repo haircuts.
The Financial Stability Board has released its next paper on possible steps for managing risk in the “Shadow Banking” world of securities lending and repo. Some of these recommendations are tame while others have very serious potential implications. We will be providing our analysis on several of these recommendations as the weeks go on. For today however, below are the recommendations themselves.
An article in Bloomberg on September 17, 2012 by Rebecca Christie and Jim Brunsden entitled “ECB to Set Up Repo Database as EU Moves to Rein in Shadow Banks “ is worth a quick read. We have some thoughts on the matter too.
From Bloomberg News:
A “Commentary” piece in the Telegraph by Lord Turner, Executive Chair of the FSA, was published on September 8, 2012. While a lot of it is hashing what we already know, there are some hints of how the British regulators will go after shadow banking and in particular securities financing.
On Monday, August 27th the FRBNY Liberty Street Economics blog posted a story entitled “Interest on Excess Reserves and Cash “Parked” at the Fed”. Written by Gaetano Antinolfi and Todd Keister, it basically says that lowering Interest on Excess Reserves (IOER), not unlike what the ECB did recently, won’t really make a difference. Well, in our humble opinion, yes and no.
The demise of US SEC Chairman Mary Schapiro’s plan to vote on additional money market reforms can be seen as a major loss for the SEC and a major win for money market fund operators. We hear that the lobbying going on in Washington was fast and furious. However, taking the SEC out of the game in the short term in no way ends the conversation about money market reform in the US. We see two factors keeping the ball rolling: Shadow Banking conversations and the loud and persistent commentary of the US Treasury and the Federal Reserve that change is required.
The US Treasury’s Office of Financial Research (OFR) recently published its first annual report, including an interesting section on data transparency in the repo markets. The OFR was created as part of Dodd-Frank to promote analytics and critical thinking on financial markets – basically it is a think tank within the US Treasury. Beyond the regular platitudes on data integrity, here are three highlights that we think professionals in securities finance should note.
A July 2, 2012 post by IMF Economist Manmohan Singh and consultant Peter Stella in the blog Vox revisits a familiar topic: the velocity of collateral. We’ve written about this before, often citing Singh’s work. We have some thoughts about the article to share.
We’ve found so much important in the world of securities finance that today’s article needed to summarize the latest news. Topics include progress on Basel III, the Fed on money markets, Asian banks and capital rules, and an important hire in collateral management.
An article in the June 1, 2012 Business Week by Jody Shenn and Lisa Abramowicz, “Cantor Plans to Enter Shrinking Shadow Banking”, took us by surprise. Cantor Fitzgerald is starting a repo conduit called Institutional Secured Funding. For those who aren’t familiar with repo conduits, they are classic shadow banking. Traditional repo conduits allow securities dealers to obtain financing for the weird, wonderful and illiquid by repo’ing in those assets and issuing asset-backed commercial paper (ABCP) to fund themselves. Ratings agencies rely on the credit worthiness of the repo bank to support the repo conduits’ rating and could pretty much care less about the collateral. So the paper that goes in can be stuff that otherwise might not be eligible in tri-party shells or for bi-lateral repo trades.
Banks everywhere are focusing on the Liquidity Coverage Ratio (LCR) provisions in Basel III. The provisions don’t kick in until 2015, but the observation period is in full swing and no one wants to tell their management that they missed the target. The epicenter of the ratio at many institutions is the repo business. They can best manage the measurement and control the flows. And, it wouldn’t be the finance sector if a number of tricks innovations hadn’t emerged to soften the blow.
A recent Federal Reserve report, An Analysis of OTC Interest Rate Derivatives Transactions: Implications for Public Reporting, has some lessons for the potential impact of trade reporting in securities lending. We think that global regulators, particularly those working on Shadow Banking issues, will soon make calls for these kinds of trade repositories. Market practitioners might want to get up to speed on what sorts of impacts they can expect.
On Monday we wrote about the speech given on April 27th by Paul Tucker “Shadow banking: thoughts for a possible policy agenda.” Mr. Tucker is Deputy Governor of the Bank of England with a remit for financial stability and this was an important speech. While there are many points and comments to make here, in this post we want to focus on just one sentence: “Financial firms and funds should not be able to lend against securities that they are not permitted or proficient enough to hold outright.” This sounds simple enough. How could financial firms take collateral – which they might have to own one day if their counterparty defaults – that they aren’t allowed to otherwise own outright? Um, wait a second.
The Financial Stability Board (FSB) Workstream on Securities Lending and Repos has released “Securities Lending and Repos: Market Overview and Financial Stability Issues” (April 27, 2012). We mentioned yesterday that it was more of an update than new information. Given all the “sturm und drang” we have been hearing from financial regulators who fold repo & securities lending into the shadow banking debate, the expectation was for the FSB report to be more critical, perhaps even foreshadow next steps. In fact, this report was remarkably tame but after a couple of reads, we have some details to report.
Speaking last Friday at a European Union conference on Shadow Banking, Bank of England Deputy Governor Paul Tucker began to put some flesh around the bare skeleton of what Shadow Banking regulation might look like. This is the first time that we have seen ideas move out of the “maybe, how about this one” and into the “we propose” phase of regulation. Mr. Tucker’s role in the global financial community has been previously noted in articles on this site, hence his comments should be considered carefully.