OCC: We must continue to improve risk management in the markets
09 November 2018 Chicago
Image: Shutterstock
鈥淭o continue improving risk management in the markets, [the industry] must support a principled approach to reducing regulatory arbitrage on an international level鈥�, according to John Fennell, OCC鈥檚 executive vice president and chief risk officer.
In a recent blog, Fennell said this principled approach should involve 鈥渆valuating the consistency with which international regulations have been adopted at a national level鈥�.
Fennell further indicated: 鈥淲e should work with regulators on the importance of aligning central bank access for Systemically Important Financial Market Utilities (SIFMUs) in the US with that of their European counterparts.鈥�
He said these principles should be carried out to avoid another market crash, such as the Financial Crash of 2008, as he questioned: 鈥淎re we more prepared to withstand the next crisis when it happens?鈥�
Fennell added: 鈥淎s the foundation for secure markets, we at OCC always have to consider extreme events. At least some degree of liquidity risk will be with us for as long as there are financial markets. That's why OCC is always striving to improve our resiliency and be prepared for the what-if events鈥攏o matter how unlikely they may seem.鈥�
To further reduce regulatory arbitrage, Fennell added: 鈥淲e should identify opportunities to align policy with risk reduction at a systemic level and promote incentives to support commercial or utility-based alternatives to enhance all SIFMUs' access to high-quality liquidity alternatives.鈥�
Fennell said that the OCC鈥檚 Financial Safeguards Framework 鈥渂uilds on the previous enhancements to our financial resources and resiliency as a SIFMU鈥�.
鈥淚ndeed, over the last several years, we have significantly expanded and diversified our access to liquidity.鈥�
Since before the 2008 Financial Crisis, Fennell said the emphasis of risk management leaned more toward credit risk鈥攚ith liquidity being a secondary concern.
However, during the crisis, it became clear liquidity risk was an accelerant toward the ultimate default of a market participant.
Fennell said the most obvious risk event is the failure of a counterparty, but the varying ways in which defaults could occur does present challenges.
鈥淒efaults can happen within a single legal entity, across related entities or even simultaneously with multiple counterparties. However, it cannot be assumed that more defaults are necessarily worse, as these scenarios can have both positive and negative impacts on the counterparty's liquidity risk profile, so all combinations and correlations must be considered.鈥�
He added: 鈥淔or instance, failures can occur with clearing firms or with a bank where liquidity resources are in custody, preventing access to them.鈥�
Fennell reiterated that a SIFMU like OCC is critical to the 鈥渃ontinuous functioning of our financial markets. It needs to be not only solvent from a credit perspective, but it also must have sufficient liquid resources to satisfy the funding commitments of its clearing firms鈥�.
In a recent blog, Fennell said this principled approach should involve 鈥渆valuating the consistency with which international regulations have been adopted at a national level鈥�.
Fennell further indicated: 鈥淲e should work with regulators on the importance of aligning central bank access for Systemically Important Financial Market Utilities (SIFMUs) in the US with that of their European counterparts.鈥�
He said these principles should be carried out to avoid another market crash, such as the Financial Crash of 2008, as he questioned: 鈥淎re we more prepared to withstand the next crisis when it happens?鈥�
Fennell added: 鈥淎s the foundation for secure markets, we at OCC always have to consider extreme events. At least some degree of liquidity risk will be with us for as long as there are financial markets. That's why OCC is always striving to improve our resiliency and be prepared for the what-if events鈥攏o matter how unlikely they may seem.鈥�
To further reduce regulatory arbitrage, Fennell added: 鈥淲e should identify opportunities to align policy with risk reduction at a systemic level and promote incentives to support commercial or utility-based alternatives to enhance all SIFMUs' access to high-quality liquidity alternatives.鈥�
Fennell said that the OCC鈥檚 Financial Safeguards Framework 鈥渂uilds on the previous enhancements to our financial resources and resiliency as a SIFMU鈥�.
鈥淚ndeed, over the last several years, we have significantly expanded and diversified our access to liquidity.鈥�
Since before the 2008 Financial Crisis, Fennell said the emphasis of risk management leaned more toward credit risk鈥攚ith liquidity being a secondary concern.
However, during the crisis, it became clear liquidity risk was an accelerant toward the ultimate default of a market participant.
Fennell said the most obvious risk event is the failure of a counterparty, but the varying ways in which defaults could occur does present challenges.
鈥淒efaults can happen within a single legal entity, across related entities or even simultaneously with multiple counterparties. However, it cannot be assumed that more defaults are necessarily worse, as these scenarios can have both positive and negative impacts on the counterparty's liquidity risk profile, so all combinations and correlations must be considered.鈥�
He added: 鈥淔or instance, failures can occur with clearing firms or with a bank where liquidity resources are in custody, preventing access to them.鈥�
Fennell reiterated that a SIFMU like OCC is critical to the 鈥渃ontinuous functioning of our financial markets. It needs to be not only solvent from a credit perspective, but it also must have sufficient liquid resources to satisfy the funding commitments of its clearing firms鈥�.
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