brussels nov 09

Financial Future ForumFinancial Future Forum

Barbara C. MatthewsBarbara C. MatthewsBCM International Regulatory Analytics LLCBCM International Regulatory Analytics LLC

www.bcmstrategy.comwww.bcmstrategy.comNovember 2009November 2009

BCM International Regulatory Analytics LLC

ConclusionsConclusions

Merriam-Webster definition of arbitrageMerriam-Webster definition of arbitrage: : • Etymology: French, from Middle French, arbitration, from Old French, from Etymology: French, from Middle French, arbitration, from Old French, from

arbitrerarbitrer to render judgment, from Latin to render judgment, from Latin arbitrari,arbitrari, from from arbitr-, arbiterarbitr-, arbiter• Date: 1875Date: 1875• 11 :: the nearly simultaneous the nearly simultaneous purchasepurchase and sale of securities or foreign and sale of securities or foreign

exchange in different markets in order to profit from exchange in different markets in order to profit from priceprice discrepancies discrepancies22 :: the purchase of the stock of a takeover target especially with a view to the purchase of the stock of a takeover target especially with a view to selling it profitably to the raiderselling it profitably to the raider

Economist.com definition of regulatory arbitrageEconomist.com definition of regulatory arbitrage• Exploiting loopholes in Exploiting loopholes in REGULATIONREGULATION, and perhaps making the regulation , and perhaps making the regulation

useless in the process. This is often done by international investors that useless in the process. This is often done by international investors that use use DERIVATIVESDERIVATIVES to find ways around a country’s financial regulations. to find ways around a country’s financial regulations.

Regulatory Arbitrage: Definitions

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Dynamic Innovation & EvolutionDynamic Innovation & Evolution

Experimentation Market growth Customization

Regulatory Inquiry, cautious standards

1908 1929 1974 1987 1991 1997 2007-08

StandardizationLegislation

Regulation Mind the Gap

©BCM International Regulatory Analytics LLC all rights reservedwww.bcmstrategy.com



Even with directional normative consistency at the global level, Even with directional normative consistency at the global level, prospects for divergent outcomes remainprospects for divergent outcomes remain

National priorities to cover liabilities generates significant National priorities to cover liabilities generates significant centrifugal forces in both normative & enforcement areas.centrifugal forces in both normative & enforcement areas.

Arbitrage hits BOTH sides of the balance sheet and all sides of the Arbitrage hits BOTH sides of the balance sheet and all sides of the intermediation framework.intermediation framework.

Incentives to arbitrage differences in regulatory frameworks are Incentives to arbitrage differences in regulatory frameworks are not limited to specific asset classes or financial institutions and can not limited to specific asset classes or financial institutions and can apply to governments and corporations.apply to governments and corporations.

The classic debate: regulating products v. regulating actors (or The classic debate: regulating products v. regulating actors (or both)both)

Regulatory Arbitrage?




Regulatory Arbitrage?: The Intermediaries



Data, Data, Data…and sharingData, Data, Data…and sharing


DataProvider

8

DataProvider

7

DataProvider

6

DataProvider

5

Data Provider

4

DataProvider

3

Data Provider

2

Data Provider

1

DataProvider

9

Central data

Data Providers

•Financial firms

•Regulators

•Governments

•Individuals

•Exchanges

•Corporates?

Data Collectors

•Regulators

•CCPs

•Risk Managers

•IMF

•Exchanges

•Dark Pools

•Central banks


What happens when information flows from central points across borders?




•Initial Margin requirements/capital•Variation margin: marking to market credit exposures?!•Presumption of lower risk in CCP transactions: expressed how?•Changes in operational risk capital charges on banks for transactions within CCPs•Transaction data and other reporting requirements: substance & IT issues•Governance (restrictions on board memberships/ownership)•Operational reliability requirements•Contract continuity in the event of CCP default•Role of government fisc in the event of CCP default: domestic & cross-border•Which government entities have access to which data?•What information is available to non-government entities/the trading public?•Who approves contract issuance? Who sets position limits?•Asset segregation requirements•Who is authorized to be a transacting member of a CCP or exchange?•Cross-border information sharing by CCPs and/or regulators?•Geography of oversight authority, of course

The Pressure Points


1. Expectations Management: Will cross-border policy harmonization of OTC policy eliminate regulatory arbitrage, make the derivatives marketplace safer for “legitimate” hedging, generate financial system stability, and still provide corporate end-users with flexible financing options?



Two Questions

2. Link to the Real Economy: What incentives and impacts will increased regulation of the derivatives markets create for governments and corporate end-users?


Regulatory Arbitrage?: European Banks



““The US dollar shortage in global banking and the The US dollar shortage in global banking and the international policy responseinternational policy response,” ,”

BIS Working Paper no. 291 (Oct. 2009)BIS Working Paper no. 291 (Oct. 2009) Growth in European and Japanese banks’ USD assets produced Growth in European and Japanese banks’ USD assets produced structural structural

USD funding requirementsUSD funding requirements that could not be met when money, interbank that could not be met when money, interbank & swap markets shut down.& swap markets shut down.

Figure 5: “the major European banks’ US dollar funding gap had reached Figure 5: “the major European banks’ US dollar funding gap had reached $1.0-1.2 trillion by mid-2007. Until the onset of the crisis, European banks $1.0-1.2 trillion by mid-2007. Until the onset of the crisis, European banks had met this need by tapping the interbank market ($432 billion) and by had met this need by tapping the interbank market ($432 billion) and by borrowing from central banks ($386 billion) and used FX swaps ($315 borrowing from central banks ($386 billion) and used FX swaps ($315 billion) to convert (primarily) domestic currency funding into dollars.”billion) to convert (primarily) domestic currency funding into dollars.”

Currency & maturity mismatches “can be understood only by looking at Currency & maturity mismatches “can be understood only by looking at banks’ worldwide positions consolidated across all office locations.”banks’ worldwide positions consolidated across all office locations.”

Counterparty sector breakdown in BIS banking stats “can serve as a proxy Counterparty sector breakdown in BIS banking stats “can serve as a proxy for maturity transformation and, hence, funding risk, since the maturity of for maturity transformation and, hence, funding risk, since the maturity of positions is likely to vary systematically with the type of counterparty.”positions is likely to vary systematically with the type of counterparty.”

““Demand deposits held by households, for instance, are a stable source of Demand deposits held by households, for instance, are a stable source of funding with a long funding with a long effective effective maturity.” footnote 16maturity.” footnote 16




Regulatory Arbitrage?: Corporates



External Loans External Loans to non-banking sectorto non-banking sector

Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD)Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD)estimated exchange rate adjusted changesestimated exchange rate adjusted changes

-600,000

-400,000

-200,000

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

2007 3Q2008 1Q2009

All countries

Developed countries

Europe

External DepositsExternal Deposits non-banking sector non-banking sector

Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD)Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD)estimated exchange rate adjusted changesestimated exchange rate adjusted changes

-600,000

-400,000

-200,000

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

2007 3Q2008 1Q2009

All countries

Developed countries

Europe

AA asset-backedAA asset-backed

FRB Volume FRB Volume Statistics for Statistics for Commercial Paper Commercial Paper IssuanceIssuance (as of (as of October 21, 2009)October 21, 2009)

All values in USD All values in USD millionsmillions

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

1-4days

5-9days

10-20days

21-40days

41-80days

81+days

2007

2008

2009*


©BCM International Regulatory Analytics LLC all rights reservedwww.bcmstrategy.com

0

500

1000

1500

2000

2500

3000

3500

1-4 days 5-9 days 10-20 days 21-40 days 41-80 days 81+ days

2007

2008

2009*

AA nonfinancialAA nonfinancial

International Commercial Paper IssuesInternational Commercial Paper IssuesSource: BIS Quarterly Review, Sept. 09, Table 13ASource: BIS Quarterly Review, Sept. 09, Table 13A

NET values, in billions USDNET values, in billions USD

-40

-20

0

20

40

60

80

2007 2008 4Q 2008 1Q 2009 2Q 2009

Total Issues

US dollar

euro

Yen

Pound sterling



International Debt SecuritiesInternational Debt SecuritiesCorporate Issuers, NET values in billions of dollarsCorporate Issuers, NET values in billions of dollars

Data Source: BIS Quarterly Review Table 12C, Sept. 2009Data Source: BIS Quarterly Review Table 12C, Sept. 2009

-50

0

50

100

150

200

250

2007 2008 3Q2008

4Q2008

1Q2009 2Q2009

United States

France

Germany

UK

Brazil

India

China

Russia



ImplicationsImplications Shifting maturity transformation function = Shifting maturity transformation function =

f(survival, not necessarily arbitrage). Permanent?f(survival, not necessarily arbitrage). Permanent?

Targeted but volatile short-term use of financial Targeted but volatile short-term use of financial trading markets as alternative to credit markets. trading markets as alternative to credit markets.

Decreased funding flexibility for foreign Decreased funding flexibility for foreign expansion, trade, sourcing, and R&D. Will flow expansion, trade, sourcing, and R&D. Will flow through to jobs and economic growth.through to jobs and economic growth.




Regulatory Arbitrage?: Derivatives Markets



Amounts Outstanding: OTC derivativesAmounts Outstanding: OTC derivativesSource: BIS Quarterly Review, Table 13 (in billions USD, gross market value) Source: BIS Quarterly Review, Table 13 (in billions USD, gross market value)

0

5000

10000

15000

20000

25000

30000

35000

40000

Dec-0

4

Mar

-05

Jun-

05

Sep-0

5

Dec-0

5

Mar

-06

Jun-

06

Sep-0

6

Dec-0

6

Mar

-07

Jun-

07

Sep-0

7

Dec-0

7

Mar

-08

Jun-

08

Sep-0

8

Dec-0

8

Unallocated

CDS

Commodity

Equity

IR

FX



Derivative Financial Instruments Traded on Organized ExchangesDerivative Financial Instruments Traded on Organized ExchangesContracts Outstanding (all futures)Contracts Outstanding (all futures)

Source: BIS Quarterly Review, Sept. 2009, Table 23BSource: BIS Quarterly Review, Sept. 2009, Table 23B

0

50

100

150

Dec-0

7

Feb-0

8

Apr-08

Jun-0

8

Aug-08

Oct

-08

Dec-0

8

Feb-0

9

Apr-09

Jun-0

9Other Markets

Asia & Pacific

Europe

Noth America

Other Markets 11.6 11.8 12.5 14.2Asia & Pacific 7.8 5.9 5.9 6.5Europe 23.3 20.4 19.6 19.2Noth America 96.4 72.3 68.9 65.1

Dec-07 Dec-08 Mar-09 Jun-09



Consolidated foreign claims and other exposures of Consolidated foreign claims and other exposures of reporting banks: Ultimate risk basisreporting banks: Ultimate risk basis

Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD)Source: BIS, preliminary International Banking Statistics, second quarter 2009 (in millions USD)

0500,000

1,000,0001,500,0002,000,0002,500,0003,000,0003,500,0004,000,0004,500,0005,000,000

end-June 2009

All countries

Developed countries

Europe

United States


brussels nov 09

Documents

regulatory frameworks

international investors

international policy

ccps transaction data

arbitrage hits

financial institutions

ccp transactions

crossborder information