Douady New Financial Regulation New Projects Technology Ok
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Transcript of Douady New Financial Regulation New Projects Technology Ok
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New FinancialRegulations,
New Projects inFinancial Technology
Complex Systems Design & ManagementRaphael DouadyCNRS, Univ. Paris 1, C.E.S.Riskdata
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AGENDA
Financial Regulations since 2008 Crisis Buy side: Basel III, DFA, EMIR Sell side: Solvency II, UCITS, DFA Purposes and Benefits Flaws and Dangers
Opportunities for Financial Technology Asset Pricing, Credit Value Adjustment, Internal Rating Risk Reporting, Capital Adequacy Margining, Collateral Management Data Quality, Processing, Big Data Order Management, High Speed, Algorithmic Trading
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BASEL CAPITAL ADEQUACY RULE
Source: Moodys Analytics
Basel I (1988, enforced 1992) Cooke Ratio
Basel II (2004, enforced 2008) 3 pillars (capital, governance,
discipline) Cooke ratio + VaR + Operational
risk
Basel III ( expd 2013, TBE 2018) Risk-Weighted Capital (Tier1, 2, 3)
vs. Risk-Weighted Assets
Stressed VaR = VaR + StressTests
Liquidity Buffer Credit Counterparty Risk (CCR) Credit Value Adjustment (CVA)
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Aim of Basel III Face Black Swans
Stressed VaR
Avoid ContagionCredit Counterparty RiskLiquidity Buffer
Align Capital with Expected losses
Risk Weighted AssetsCVA
BASEL CAPITAL ADEQUACY RULE
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Solvency II (EU, Insurance) Funding Ratio Methodology Long - term Risk (1 year)
Dodd-Franck Act (USA, applies to all financial institutions) Transparency, Exposures, Risks
Liquidation procedure, Forensics Supervision Reform
EMIR (USA, market standardization) Central Clearing of Derivatives (incl. CDS)
UCITS IV (EU norm for fund marketing) Fund Regulation and Disclosure Liquidity Choice of
Transparency Expert VaR Computation
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OTHER REGULATIONS
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MARKET DISCIPLINE
Is more capital safer?12/12/2012
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PROCYCLICALITY A flaw of VaR-based Capital Adequacy
Market falls Volatility surges VaR increasesMassive sales to meet CA Market falls
A flaw of Marked-to-MarketDistrust Demand vanishes Price falls Distrust
Tragedy of the Commons in the Risk VaR + M2M produce an embedded instability
J.C. Trichet (Paris, 1994) Beware of herd behavior with VaR
DANGERS OF REGULATION
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PROCYCLICALITY IN BASEL III Stressed VaR
Stress Tests not procyclical, but SVaR = VaR +STests
Higher capital requirement More pressure
Overreaction to Market drops If simply added to VaR, stress tests increase procyclicality
CCR + CVA Same logic as VaR with each Counterparty
CTP Credit CVA CTP out of business Default Even worse with CTP credit hedging with CDS
CTP Credit Buy CDS CDS CVA
DANGERS OF REGULATION
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What are you looking for?
Did you loseyour key there?
No, on theother side, but
hereI have light!
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REMEDY TO PROCYCLICALITY VaR = Market Scenario x Sensitivity When markets fall:
Scenario Sensitivity Sale Regulator computes Scenarios
Must anticipate crises Provides means to deflate a bubble before it bursts, by
preemptively widening scenarios Institutions compute Sensitivities
Must account for complex instruments and
nonlinearities Back-test possible to check sensitivity computation
Regulator must ask for Risk Transparency, notOperations Transparency
DANGERS OF REGULATION
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11/1811Source: Accenture Basel III and Its Consequences
DANGERS OF REGULATION
ADVERSE SELECTION
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ADVERSE SELECTION
Risk-weighted Assets + Quantitative EasingCapital arbitrage Lend to AA/AAA rather than High Yield
Capital is absorbed by less profitable business Growth More QE More money to AAA Leverage of AAA Systemic crisis
RWA rule imposes the ratio between creditspreads of investment grade and high yield bonds Biased markets Instability: capital flies away precisely when needed!
DANGERS OF REGULATION
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REMEDY TO ADVERSE SELECTION
Weights in RWA apply only beyond a threshold Base Cooke Ratio = 8% Lend 12.5 x Capital
Below 6 x Capital Unweighted Assets Beyond 6 x Capital Weights apply
Impose Leverage limit Avoid procyclical definition of Capital
RWC amplify procyclicality Adapt weights to economic conditions in order to
maintain financing of the growth tank
DANGERS OF REGULATION
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Global Financial Risk IT Spending
Total Bank IT Spending: CAGR 4.3%
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Source: Celent
Total Risk IT Spending: CAGR 25% Majority is due to Basel III and DFA
Source: The 2010 SIFMA-IBM Technology Survey14
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Challenges due to New Regulations
Big data, scalability Regulations require (and computing power allows)
massive data processing: deal data + market data +other info
Systems must be scalable to handle more and moredata
Flexibility Regulation uncertainty imply that big systems be
flexible and immediately responsive to changes,without costly adaptation
Separation of common data and proprietary data
Speed Algorithmic trading (directional, market making,
speculative) represents today the vast majority (75%)of trades High frequency trading (HFT) imply low-latency
systems: order management (OMS), margining, etc.
Security, Reliability Cloud data and computing, IT evolution raise security
challenges
Operational Risk and Disaster Recovery Plans (DRP)
Innovations
Mass statistics Data Mining Databases Data quality
Cloud Architecture
Fast algorithms FPGA
Encryption Hardware protection Data centers
CHALLENGES IN FIN TECH
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Investors DrivenInnovation Real-time Risk Analysis
Complex Instruments Pricing
and Risks Liquidity Management
Portfolio Management andOptimization
Hedge Optimization
Long-term Risk Analysis Economic Scenarios Crisis Anticipation
Order execution Algorithmic trading
Sell-side DrivenInnovation Regulatory Capital Monitoring
Value-at-Risk
Credit Counterparty Risk Credit Value Adjustment
(CVA)
Collateral Management Margining
Pre-trade and Post-tradeManagement
What - if Analyses Risk Limit Control
CHALLENGES IN FIN TECH
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CHALLENGES IN FIN TECH
Customer Driven Innovation Real Time Access Personal Information Market Information + News Advanced Market Data
Risk + other Statistics Possibility to Act in Real Time
Trading Operations (transfers, etc.)
Security and Reliability Internet transactions, Credit cards Fraud detection
Suppliers Comparison
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The economy needs it Recognized French expertise
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