Nov 302018

The latest Financial Stability Review  of the European Central Bank (ECB) says that the euro area financial stability environment has become more challenging since May. Among the major concerns, the following has been highlighted:

  • Possibility of broader stress in emerging markets, rising debt sustainability concerns and trade tensions pose challenges
  • Bank resilience improved, but structural vulnerabilities continue to restrain profitability
  • Liquidity concerns are growing amid increased risk-taking by investment funds

On the positive side, a growing economy and improved banking sector resilience have continued to support the financial stability environment in the euro area. Furthermore, a series of volatility events have not spread to the broader global financial system. At the same time, downside risks to the global growth outlook have become more pronounced since May relating to a resurgence in protectionism and stress in emerging markets. Vulnerabilities in financial markets continue to build up amid pockets of high valuations and compressed global risk premia. In the euro area, political and policy uncertainty, related to market concerns about public spending plans have increased over the review period. In addition, the possibility of a cliff-edge Brexit could pose a risk to financial stability.

With a maturing global business and financial cycle, a number of market indicators appear to signal downside risks to global asset prices. A snapback of term premia on global benchmark bonds, in particular, could materialise and possibly spill over to the euro area. Meanwhile, the prospect of renewed stress in emerging market economies tested the resilience of the global financial system. Over the summer months Argentina and Turkey witnessed significant increases in bond spreads, falling stock prices and large currency depreciations. Higher US interest rates or rising trade tensions could spark further stress in emerging market economies, the FSR warns.

Within the euro area, market concerns about budgetary plans in Italy have risen since May. Losses observed in Italian financial markets over the past six months have however not meaningfully spilled over to other euro area countries.

The profitability of euro area significant banks remained broadly stable in the first half of 2018. However, the average return on equity (at around 7%) still falls short of banks’ cost of capital. Structural vulnerabilities including overcapacity in certain domestic banking markets and high operating costs continue to dampen bank profitability. At the same time, reductions in non-performing loans (NPLs) continued apace. As a result, banks’ NPL ratios have nearly halved since 2014.

Banks’ solvency positions remain solid. The recent European Banking Authority (EBA) stress test confirmed that the capitalisation of euro area banks is sufficient to weather a severe adverse scenario. Additional sensitivity analyses to account for recent developments not specifically catered for in the test lead to an additional capital depletion of around 30 to 70 basis points on top of the overall Common Equity Tier 1 ratio depletion of 380 basis points in the adverse scenario of the EBA stress test.

The FSR also highlights risks building up outside the banking sector – notably in the investment fund sector. Over the past ten years the total assets of euro area investment funds have more than doubled to €13.8 trillion in June 2018, with the size of the non-bank financial sector approaching half that of the euro area banking sector. Growing exposures to illiquid and risky assets make the funds vulnerable to potential shocks in global financial markets.

The Review also contains three special features. The first special feature examines how banks can reach sustainable levels of profitability. The second examines the implications for financial stability of a resurgence of trade tariffs. The third discusses the rapid growth in exchange-traded funds and their potential for transmitting and amplifying risks within the financial system.

Nov 302018

The FSB today published its fourth annual report on the implementation and effects of the G20 financial regulatory reforms. Ten years after the crisis, the report highlights the progress made in the reform agenda as the FSB pivots towards implementation and rigorous evaluation. Looking ahead, the report highlights some challenges in promoting a financial system that supports the G20’s objective of strong, sustainable and balanced growth, while preserving open and integrated markets and adapting to rapid technological change.

The report documents the substantial progress that has been made in implementing key post-crisis financial reforms; discusses how the reforms have contributed to the core of the financial system becoming more resilient to economic and financial shocks; describes the FSB’s work to evaluate whether reforms are working as intended; lays out why preserving financial stability, and supporting sustainable growth, requires the continued monitoring of developments in the global financial system; and documents the benefits of cooperation between jurisdictions in the aftermath of the crisis.

The report, which will be delivered to the G20 Summit in Buenos Aires, calls for the support of G20 Leaders in implementing the agreed reforms, and reinforcing global regulatory cooperation.

  • Regulatory and supervisory bodies should lead by example in promoting the timely, full and consistent implementation of remaining reforms to Basel III, resolution regimes, OTC derivatives and non-bank financial intermediation. This will support a level playing field and avoid regulatory arbitrage.
  • Frameworks for cross-border cooperation between authorities should be enhanced in order to build trust, allow for the sharing of information, and to preserve an open and integrated global financial system.
  • Authorities should evaluate whether the reforms are achieving their intended outcomes, identify any material unintended consequences, and address these without compromising on the objectives of those reforms.
  • Financial stability authorities should continue to contribute to the FSB’s monitoring of emerging risks and stand ready to act if such risks materialise.

Implementation and Effects of the G20 Financial Regulatory Reforms: Fourth Annual Report (PDF)

Nov 302018

The European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA), together the European Supervisory Authorities (ESA), have today published a report with draft regulatory technical standards (RTS) proposing to amend the Commission Delegated Regulation on the risk mitigation techniques for OTC derivatives not cleared by a CCP (bilateral margin requirements) under the European Market Infrastructure Regulation (EMIR).

The draft RTS propose, in the context of the United Kingdom’s (UK) withdrawal from the European Union (EU), to introduce a limited exemption in order to facilitate the novation of certain OTC derivative contracts to EU counterparties during a specific time-window. The amendments would only apply if the UK leaves the EU without the conclusion of a withdrawal agreement – a no deal scenario. The draft RTS complement the similar proposal published by ESMA on 8 November with respect to the clearing obligation.

In the context of the on-going withdrawal negotiations between the EU and the UK, and to address the situation where a UK counterparty may no longer be able to provide certain services across the EU, counterparties in the EU may want to novate their OTC derivative contracts by replacing the UK counterparty with an EU counterparty. However, by doing this, they may trigger the clearing obligation or the bilateral margin requirements for these contracts, therefore facing costs that were not accounted for when the contract was originally entered into.

Limited exemption from the bilateral margin requirements to facilitate novations

The draft RTS allows UK counterparties to be replaced with EU ones without triggering the new procedures defined in the bilateral margin RTS. This limited exemption would ensure a level playing field between EU counterparties and the preservation of the regulatory and economic conditions under which the contracts where originally entered into. Its scope, time and intent are aligned with the draft RTS regarding the clearing obligation that ESMA published on 8 November.

The window for the novation of OTC derivative contracts which fall under the scope of this amending regulation and the one published by ESMA would be open for twelve months following the withdrawal of the UK from the EU. Counterparties can however start repapering their contracts ahead of the application date, making the novation conditional upon a no-deal Brexit, given the conditional application date of these two amending regulations.

Participants Brexit preperations

The ESAs and other EU authorities and institutions have been clear on the importance for market participants to be prepared for Brexit, including the possibility of a no-deal scenario. These draft RTS provide regulatory solutions to support counterparties’ Brexit preparations and to maintain a level playing field between EU counterparties, while addressing potential risks to orderly markets and financial stability.

As regards non-centrally cleared OTC derivative contracts, these two measures will be the only regulatory measures the ESAs intend to propose to help address the legal uncertainty raised by the withdrawal of the UK from the EU and to ensure a level-playing field between EU counterparties.

Counterparties should start negotiating as soon as possible the novations of their transactions which are in the scope of these amending regulations, given the twelve month timeframe to benefit from it.

Final Report EMIR RTS on the novation of bilateral contracts not subject to bilateral margins (PDF)

Nov 302018

Patrick Armstrong, Senior Expert of the European Market and Securities Authorities (ESMA), described the the latest feedbacks in the field of Regtech and Suptech at  Paris Dauphine University, Paris, 27 November,

A number of supply-based developments and demand-based needs are combining to potentially transform the way financial institutions comply with regulation and supervisory authorities oversee market participants.
The use of technology for compliance and supervisory monitoring predates the financial crisis of 2007. However, a new regulatory landscape in response to the crisis has been a catalyst for greater use of technology. The use of new technology in this context evolves on a continuous basis and may soon lead to radical changes in compliance and supervision work. Foremost among the technological drivers are the widespread use of cloud computing, the increased acceptance of Application Programming Interfaces (APIs) and advances in the fields of Artificial Intelligence and Machine Learning (AI/ML). Cloud computing allows for the use of an online network of hosting processors, increasing the scale and flexibility of computing capacity.

APIs comprise rules and an interface for communication and interaction between different software programmes. AI is the theory and development of computer systems able to perform tasks that traditionally require human intelligence. ML, a form of AI, is a method of designing a sequence of actions to solve a problem that optimise automatically through experience and with limited or no human intervention.


RegTech and SupTech are developing in response to various demand and supply drivers. Demand is linked to regulatory changes and the need of market participants and supervisors to process large amounts of data. Supply factors primarily focus on advances in technology.
The regulatory requirements placed on market participants have increased greatly over the past ten years. While many of these regulations came in response to the known market failures that led to and exacerbated the crisis, others reflect the increasingly complex nature of global financial services. Failure to comply with the regulations has significant consequences, which has in turn led to large spending increases on compliance and risk management programs by firms. Examples include increased reporting and compliance obligations implemented pursuant to the Dodd-Frank Act in the US and within the EU the Markets in Financial Instruments Directive (MiFID II).

Demand drivers

  • There is a continued push for efficiencies and cost savings, particularly for back-end and legacy systems as well as for labour-intensive processes.
  • As the financial services sector becomes increasingly digitalized and data-driven the advantages of technology-driven compliance monitoring compared to less automated alternatives have become more and more evident. The increased volume of information needed to monitor and evaluate regulatory compliance provides challenges for enterprise data governance, but also opportunities to use the information for better risk management. Examples include developments in stress testing and enhanced risk monitoring.
  • Government-driven mandates in some countries have led firms to implement technologies such as APIs and more effective authentication methods. An example is the Payment Services Directive 2 (‘PSD2’) in the EU.
  • ESMA believes the move towards a more data-driven and pro-active approach will enhance monitoring of the financial sector and help ensure better outcomes for market participants and consumers. As we move to this more intense data driven supervisory process, supervisors and regulators need to adapt. Failure to do so risks the undermining of the many years of work involved in implementing the regulation.

Supply drivers

  • Recent years have seen a sharp drop in the costs of computing power and storage. This enormous increase in capacity is acting as an important catalyst for AI/ML tools, which are extremely data-intensive. Many of these tools are at the heart of the RegTech/SupTech renaissance and could not be deployed in a non-digital infrastructure. For example, cloud computing provides remote access to servers on which large amounts of data can be stored.
  • Improved digitalised data architecture that minimizes interoperability, reduced redundancy and allows for improved communication among data centres.
  • Advances in AI and Big Data offer new capabilities. For example, pattern-recognition using machine learning algorithms has wide applications, including in monitoring markets for potential misconduct.


RegTech applications by market participants
Regulatory pressure and budget limitations are pushing the market towards an increased use of automated software to replace human decision-making activities. AI/ML tools are often used to implement such automation, with the calibration of the tools based on the recognition of patterns and relationships in large amounts of structured or unstructured data (Big Data). This section examines the most relevant RegTech technologies used in such contexts.

AI and machine learning
AI/ML techniques can be used to find patterns in large amounts of data from increasingly diverse and innovative sources. AI is a broad field, of which ML is considered a sub-category. Financial firms are exploiting such technologies in the following contexts: (1) customer-focused (or ‘front-office’) uses such as credit scoring, insurance, and client-facing chatbots; (2) operations-focused (or ‘back-office’) uses, including capital optimisation, model risk management and market impact analysis; (3) trading and portfolio management in financial markets.

Big Data

‘Big Data’ is used broadly to describe the storage and analysis of large and/or complicated data sets using a variety of data elaboration techniques. AI/ML tools are generally used in a Big Data environment, allowing the implementation of new data management platforms that can capture, store and analyse enormous volumes of structured and unstructured data. Financial firms can feed the new converged data platforms with a variety of data sources:

  • Internal sources: customer data are a primary form of proprietary internal data, along with data on all internal operations (assets, liquidity, loans, payments, etc.). Whether from internal or external sources, personal data are subject to strong privacy safeguards under EU legislation. Many datasets are unstructured, making them difficult to work with using traditional infrastructure.
  • External sources: a myriad of third-party specialized data providers offer data related to specific contexts, typically via open real-time software interfaces and with standardised query methods.

This large amount and variety of data can be exploited by financial firms with Big Data technologies to improve business, assure regulatory compliance and analyse trends. Some common RegTech applications by banks and financial services firms are:

  • Fraud detection: banks and financial firms use analytics to recognise fraudulent transactions.
  • Reporting: regulations require financial firms to report specific business data to authorities.
  • Risk management: regulatory schemes require firms to manage a variety of risks in a proper way (e.g.: liquidity risk, operational risk).

SupTech applications by regulators
Regulators are increasingly harnessing the benefits of technology. For example, compliance reporting has frequently not been efficient as desired. Financial institutions often need to submit information in response to ad hoc requests from regulators. The non-machine-readable data submitted by financial institutions makes the application of data analytics by regulators difficult and time consuming. In turn, some regulators have been investigating how FinTech can be used to make supervision more effective, improve surveillance and reduce the compliance requirements imposed on financial institutions.

Potential applications of AI/ML

An area of interest for regulators is the application of AI/ML. Authorities such as the ECB and the US Federal Reserves are using Natural Language Processing, a form of AI, to help them identify financial stability risks.
Another potential application of AI/ML is to detect trade syndicates in the securities market. Collusive behaviour and price manipulation can be especially hard to detect using traditional methods. Rule based systems, such as transaction monitoring systems, have very high false positive rates, bringing extra costly work to both exchanges and regulators.

Another challenge which AI/ML tools may help tackle is complicated network analysis, especially when the network is large and changes over time. Finally, a challenge for the application of AI/ML arises when a potential misconduct case is detected. At present, external human experts are required to verify that such cases warrant further investigation.

As experts are costly to employ and very limited in number, regulators would benefit from any potential extension of AI/ML technologies to this context. Recent attempts to use machine learning to detect potential cases of market abuse show some promise. Some regulators, such as the UK FCA, have been exploring how best to analyse large data sets to study suspicious trading behaviour. In this context, AI/ML tools may help identify cases of collusion to manipulate share prices or circular trading to create a false impression of market interest.1 Such tools can be tested with market data to generate better detection results from below three aspects:

  • Compared to the high false positive detection rate from traditional rule-based surveillance systems, machine learning based surveillance systems have, through mathematical optimisation techniques, been able to reduce false positive rates.
  • Some regulators are employing technological tools to reduce the need for humans to manually conduct complicated network analysis. This approach involves analysing years of raw order book data with modern network analysis techniques. The benefit of this system is not only in processing big volumes of data, but also in detecting complicated network relationships across long time periods and often involving substantial numbers of participants.
  • Machine learning approaches, especially semi-supervised machine learning algorithms, can handle certain cases for which human experts’ judgement has traditionally been required. In particular, NLP2 technology could be used to automatically analyse the historical case document and extract meaningful information on which machine learning algorithms can operate.

Preliminary work by authorities using Big Data processing systems has made clear that many years of transaction data and even order book data can be analysed. However, further improvement and refinement of these ML based systems is needed, due to the limited availability of training cases. Other challenges include how to make machine learning detect unknown misconduct and how to interpret the results from the machine learning algorithms.

Regulatory dialectic
To students of financial innovation, the emergence of RegTech seems a predictable response to the post-crisis regulatory agenda. It is a clear example of what the “regulatory dialectic” whereby regulatory action on the part of public authorities is met by a private sector response designed to ameliorate the impact of the regulation, off balance sheet financing such as such as SPVs and CDOs are such examples that contributed to the recent financial crisis. In some cases, this response may aim to side-step regulations, which may prompt the authorities to tighten the regime further. In other cases, market participants respond to manage their regulatory requirements more efficiently. RegTech fits in to the latter scenario, designed to help firms adapt to regulation in an effective, cost efficient manner.

Risks and challenges for regulators and market participants

Improving data collection and management
A critical step in transforming financial supervision is improving data collection. Currently, the prevalent approach to data collection by regulatory authorities is periodically collecting data in the shape of standard reporting templates. Much current focus is on creating reporting templates rather than the primary data constructing the desired reports. Regulatory reporting can be challenging for financial institutions and is often resource-intensive.
Increasingly regulatory authorities are exploring opportunities to automate the regulatory processes and create reporting utilities. These are centralised structures that act not only as a common database of reported granular data but also as a repository of the interpretation of reporting rules in a format that is readable by computers. RegTech is therefore offering an alternative and a move away from templates and manual procedures. In the move to a data driven supervisory or compliance process, cleanliness and accessibility of the underlying data is paramount. The use and accuracy of such tools as AI/ML relies upon the strength of the underlying data. This means that prior to the use of data, regulators and supervisors must have in place the appropriate procedures and systems to ensure that the data they receive is
of good quality. One possible solution to achieve this is to develop machine-readable regulations, in particular in the field of regulatory reporting. Indeed, the use of IT solutions can help regulators to standardise and codify the information they receive from market participants, making it easier to manage and use the data.

Digital transition
In the wake of the financial crisis, much of the global regulation implemented is highly dependent on technology. Failure on the part of market participants to adapt to the newer digitalized infrastructure presents business risk that may separate winners from losers in the coming years. As well, failure to adapt to a more automated regulatory compliance process may leave participants with platforms ill-suited for the current regulatory framework.
For their part, many in the regulatory community are moving increasingly to a data driven supervisory process. To process such data, regulators need to invest in the technological tools and human skills that will allow them to effectively analyse the results.3 In turn, regulators must migrate to a digital based supervisory process; only then can they cope with the volume of data they will soon receive.

Operational risks
As both regulators and market participants move to a digitalized architecture, risks related to cyber resiliency must become a core part of their supervisory and compliance strategies respectively. Indeed, as market participants and regulators become increasingly interconnected through regulatory reporting, security risks increase. In addition, reliance on APIs, cloud computing and other new technologies facilitating increased interconnectivity could potentially make the system more vulnerable to cyber-threats and expose large volumes of sensitive data to potential breaches. A related form of operational risk arising from a move to greater use of data and risk management tools via third-party providers is concentration risk. Regulators and market participants will therefore need to devise and implement appropriate strategies to manage these operational risks. To this end, it is important that market participants and regulators cooperate to promote effective management and control of cyberrisk and to enhance cyber-resilience.

Risks from strategic incentives
One risk which authorities should bear in mind when developing automated detection tools is the possibility that malicious agents may learn to frustrate the tools by adapting their behaviour.
For instance, market participants could in theory learn what types of behaviours that are likely to cause a flag in a SupTech monitoring system. Using such information, firms might be able to structure their regulatory returns in such a way as to remain undetected. Separately, as firms develop their expertise in RegTech, their systems may become able to identify potential regulatory loopholes.

Just as FinTech is introducing changes to the way in which market participants offer their services, so too RegTech and SupTech will alter the way in which financial institutions and regulators respectively comply with the rules and supervise markets. In so doing, these technologies have the potential to reshape the
relationship between regulators and market participants.

For example, technologies such as APIs are facilitating more efficient filing of regulatory data by market participants, while regulators are looking to develop AI/ML tools to enhance their market surveillance and to improve their capacity for fraud detection. Inevitably, new technological abilities bring with them new challenges and new sources of risk, notably including operational risk.

Nonetheless, provided they are implemented correctly and monitored effectively, RegTech tools have the
potential to improve a financial institution’s ability to meet regulatory demands in a cost-efficient manner.

Nov 242018

The Bank for International Settlement (BIS) published a snapshot of the outstanding OTC derivatives transactions statistics at the end of the first semester of this year. The main results are summarized as follows:

  • The notional value of outstanding OTC derivatives increased from $532 trillion at end-2017 to $595 trillion at end-June 2018. This increase in activity was driven largely by US dollar interest rate contracts, especially short-term contracts.
  • The gross market value of OTC derivatives continued to decline, nearing $10 trillion at end-June 2018 from $11 trillion at end-2017 – compared with the peak of $35 trillion observed in 2008. This decline reflected in part ongoing structural changes in OTC derivatives markets.
  • The proportion of outstanding OTC derivatives that dealers cleared through central counterparties (CCPs) held steady, at around 76% for interest rate derivatives and 54% for credit default swaps (CDS).

Gross market values declined despite an increase in notional amounts

Outstanding OTC derivatives, USD trillions

Graph 1: Outstanding OTC derivatives, USD trillions (interactive graph).
Source: BIS OTC derivatives statistics (Table D5.1).

Activity in OTC derivatives markets increased in the first half of 2018, driven mainly by short-term interest rate contracts. The notional amount of outstanding OTC derivatives contracts – which determines contractual payments – increased to $595 trillion at end-June 2018, its highest level since 2015 (Graph 1, red line). Nevertheless, the gross market value of outstanding derivatives contracts – which provides a more meaningful measure of amounts at risk – continued to decline, to $10 trillion, its lowest level since 2007 (blue line). Gross credit exposures, which adjust gross market values for legally enforceable bilateral netting agreements, remained stable at $2.6 trillion at end-June 2018 (yellow line).

US dollar contracts drove the increase in notionals

Outstanding notional amounts of OTC interest rate derivatives, USD trillions

Graph 2: Outstanding notional amounts of OTC interest rate derivatives, USD trillions (interactive graph).
Source: BIS OTC derivatives statistics (Table D7)

The increase in notional amounts outstanding was driven mainly by OTC interest rate derivatives, in particular for US dollar-denominated contracts, which rose from $157 trillion at end-2017 to $193 trillion at end-June 2018 (Graph 2, red line). An increase in US dollar activity was also seen in exchange-traded derivatives markets, where the average daily turnover of futures and options on dollar interest rates climbed to a record high of $9.6 trillion in the month of February. This increased activity may reflect changing expectations about the path of future US dollar interest rates during the period. The notional amounts outstanding of euro-denominated interest rate derivatives also went up over this period, but more modestly, from $122 trillion to $129 trillion (blue line).

The increase in OTC interest rate derivatives activity was concentrated in the short-term segment. The notional amount of outstanding contracts with a remaining maturity up to and including one year rose from $191 trillion to $231 trillion between end-2017 and end-June 2018. The increase for contracts with a remaining maturity between one and five years was less pronounced, from $140 trillion to $155 trillion, and longer-term contracts (with a remaining maturity over five years) held roughly constant, at around $94 trillion.

Turning to OTC foreign exchange (FX) derivatives markets, notional amounts rose to a record high of $96 trillion at end-June 2018, up from $87 trillion at end-December 2017. This was also driven by activity in short-term instruments. In contrast to other OTC derivatives, most FX derivatives require counterparties to repay the notional amount at maturity and thus can be viewed as a form of collateralised borrowing, with the associated foreign currency repayment and liquidity risks.

Market value of interest rate and credit derivatives declined further

Outstanding gross market values, trillions USD

Graph 3: Outstanding gross market values, trillions USD (interactive graph).
Source: BIS OTC derivatives statistics (Table D5.1).

Despite the increase in notional amounts in the first half of 2018, the gross market values of outstanding OTC derivatives continued to decline. Gross market values for all OTC derivatives stood at $10.3 trillion at end-June 2018, down from $11.0 trillion at end-2017 (Graph 3, red line). Over that same period, the gross market value of interest rate derivatives declined by $1 trillion, ending at $6.6 trillion (purple line). Other segments of OTC derivatives markets saw smaller movements, with FX derivatives increasing from $2.3 trillion to $2.6 trillion (yellow line) and credit derivatives decreasing from $0.3 trillion to $0.2 trillion (blue line).

The continuing decline in gross market values reflected in part ongoing structural changes in OTC derivatives markets. These changes include central clearing and greater possibilities for trade compression – that is, the elimination of economically redundant derivatives positions. In addition, in recent periods an increasing number of banks have been recording variation margin on cleared derivatives as settlement payments rather than as transfers of collateral. The practice of so-called settled-to-market (STM) allows counterparties to take ownership of the collateral that they receive. Consequently, daily payments of variation margin are recorded as settlements of the derivatives transactions rather than as transfers of collateral and the market value of the derivatives is reset daily to zero. STM, which is increasingly adopted for cleared swaps in particular, thus results in lower market values for a given derivative.

Clearing in credit default swap markets was steady at 54%

 Outstanding notional amounts of CDS, USD trillions

Graph 4: Outstanding notional amounts of CDS, USD trillions (interactive graph).
Source: BIS OTC derivatives statistics (Table D10.1).

Notional amounts of CDS continued to decline, owing to decreased activity between reporting dealers. From end-June 2016 to end-June 2018, total notional amounts dropped from $12 trillion to $8 trillion, amounts vis-à-vis reporting dealers declined from $5 trillion to $2 trillion, and amounts vis-à-vis CCPs remained steady around $4.5 trillion (Graph 4). In the first half of 2018, the share of notional amounts cleared with CCPs was stable at 54%, in contrast to the upward trend over the past few years.

In OTC interest rate derivatives markets, the proportion of contracts cleared was also steady in the first half of 2018, at around 76% overall. Across currencies, the proportion ranged from 73% for euro interest rate contracts to 77% for US dollar contracts and 89% for Canadian dollar contracts. In OTC FX derivatives markets, clearing accounted for only 3.0% of dealers’ outstanding contracts at end-June 2018. While low, this was up from 2.4% at end-December 2017.


Statistical release: OTC derivatives statistics at end-June 2018 (PDF)

Nov 242018

The European Banking Authority (EBA) published today its final draft Regulatory Technical Standards (RTS) specifying the nature, severity and duration of an economic downturn. These RTS complete the EBA’s regulatory review of the internal ratings-based (IRB) Approach, with the objective of restoring market participants’ trust in internal models by reducing the unjustified variability in resulting risk weighted exposure amounts. The EBA is currently finalising the related Guidelines on the estimation of loss given default (LGD) appropriate for conditions of an economic downturn.

The final draft RTS set out the notion of economic downturn to be taken into account when estimating the LGD and the conversion factors (CF). Given the specificities of the types of exposures covered by a rating system, the economic downturn should be identified separately for each rating system. However, as a rating system may cover exposures from different businesses, sectors and geographical areas, the notion of an economic downturn included in these RTS may comprise several disjunctive downturn periods (e.g. where a rating system covers two sectors which experienced downturn conditions in different periods of time).   

In addition, the final draft RTS specify the nature of an economic downturn via macroeconomic or credit-related factors (‘economic factors’) that are explanatory variables or indicators for the business cycle of the considered type of exposure. The severity of an economic downturn is specified by the set of the most severe observations on the economic factors constituting the nature of an economic downturn, based on historical values of these factors over the last 20 years. The duration of an economic downturn is determined by the duration of the identified downturn periods and is generally specified as the 12-month period where the most severe values are observed. However, some flexibility is embedded in the draft policy to ensure that the severity and duration are appropriately specified.  


Final draft RTS on the specification of the nature, severity and duration of an economic downturn (PDF)

Nov 242018

The Financial Stability Board (FSB) and the other standard-setting bodies (SSBs) (i.e. the Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures, the Financial Stability Board and the International Organization of Securities Commissions) reconvened the Derivatives Assessment Team (DAT) to “re-examine whether adequate incentives to clear centrally over-the-counter (OTC) derivatives are in place” as one of the first evaluations under the FSB framework for the post-implementation evaluation of the effects of the G20 financial regulatory reforms. The data collected and the analysis conducted by the DAT suggest the following findings:

  1. The changes observed in OTC derivatives markets are consistent with the G20 Leaders’ objective of promoting central clearing as part of mitigating systemic risk and making derivatives markets safer.

    Data from trade repositories and other regulatory reporting shows that central clearing has increased markedly for many types of derivatives, notably interest rate and credit derivatives. Increased clearing is found both for products subject to mandatory clearing and for some that are centrally cleared on a voluntary basis. For example, clearing levels (as measured by notional amounts outstanding) increased from 24% (in 2009) to 62% (in 2017) for interest rate derivatives. Increased clearing levels are found among the large dealing banks and, more recently, among clients.

  2. The relevant post-crisis reforms, in particular the capital, margin and clearing reforms, taken together, appear to create an overall incentive, at least for dealers and larger and more active clients, to centrally clear OTC derivatives.

    Mandatory clearing requirements have led to increased central clearing. The preferential capital treatment of centrally cleared derivatives is considered an important incentive for dealer banks. Analysis of quantitative survey results suggests that the incentive to centrally clear OTC derivatives is also strong where standards requiring the exchange of initial margin for uncleared derivatives trades are in effect. This finding generally holds across a range of product types in different asset classes, but it is not universal. It is supported by regulatory data showing a marked increase in clearing volumes for some non-mandated OTC derivatives around the implementation dates of the margin requirements for uncleared derivatives.

  3. Non-regulatory factors are also important and can interact with regulatory factors to affect incentives to centrally clear.

    Surveys and market outreach show that market participants, especially larger firms, consider that factors such as market liquidity, counterparty credit risk management and netting efficiencies are also important factors for incentives to centrally clear. Regulation can interact with such factors to affect incentives. For example, clearing mandates may shift liquidity into central clearing. Once liquidity is established, market participants may also wish to clear non-mandated products, perhaps to benefit from netting opportunities or a lower capital requirement. On the other hand, the relatively higher fixed costs of accessing central clearing can have a material impact on incentives too, especially for smaller, lower activity firms.3

  4. Some categories of clients have less strong incentives to use central clearing, and may have a lower degree of access to central clearing.

    Mandatory clearing requirements have contributed to an increase in the total number of clients clearing derivatives and increases in the notional cleared by clients overall. However, while there are challenges in identifying effects on small and less active clients in regulatory data, survey responses and information from market outreach suggest that the incentives for them are mixed. Some clients reported a preference not to centrally clear when not required to do so by a clearing mandate.

    There are several factors that may be contributing to this. The benefits of central clearing, such as netting opportunities and deeper liquidity pools, may be lower for smaller clients or for those with more directional positions. Survey responses state that providing connectivity to CCPs requires incurring high fixed costs, which are likely passed on to clients through minimum fees and other charges, increasing clients’ costs of central clearing. For smaller, lower activity clients in particular, this can raise their cost of cleared trades, and thus can have a material impact on their incentives to centrally clear.

    Some smaller clients and some of those with more directional portfolios report experiencing difficulties gaining and/or maintaining access to central clearing. These access issues in turn impact the incentives for these clients to centrally clear.

  1. The provision of client clearing services is concentrated in a relatively small number of bank-affiliated clearing firms.

    The majority of OTC derivatives market participants are not direct clearing members of CCPs, but rather access central clearing as clients through clearing service providers. Therefore, access to client clearing is a key structural feature of the post- reform derivatives markets.

    The provision of client clearing for OTC derivatives remains generally concentrated. For example, five firms, all bank-affiliated, account for over 80% of total client margin for cleared interest rate swaps in the United States, United Kingdom and Japan. Regulatory data illustrates that, although the overall amount of client margin posted at CCPs has increased substantially since the implementation of reforms, the number of clearing service providers has stayed broadly flat over the same period.

    Survey responses and market outreach are also consistent with a view that concentration in clearing service provision could amplify the consequences of the failure or withdrawal of a major provider. In particular, concerns have been expressed about the ability to port client positions and collateral in this situation. This could impact clients’ incentives to centrally clear.

  2. Some aspects of regulatory reform may not incentivise provision of client clearing services.

    Survey data, research and market outreach suggests that some regulations aimed at improving institutional resilience may in some circumstances be discouraging individual firms from providing client clearing services; see below for further discussion. This may in turn affect access challenges for clients and the concentration of client clearing service provision.

Incentives to centrally clear OTC derivatives: A post-implementation evaluation of the effects of the G20 financial regulatory reforms (PDF)

Nov 242018

The European Securities and Markets Authority (ESMA) is publishing this Public Statement to address the risks of a no-deal Brexit scenario in the area of central clearing. The ESMA Board of Supervisors supports the continued access to UK CCPs to limit the risk of disruption in central clearing and to avoid negatively impacting EU financial market stability.

ESMA therefore welcomes the communication Preparing for the withdrawal of the United Kingdom from the European Union on 30 March 2019: a Contingency Action Plan, published on 13 November 2018 where the EC stated that it will act, to the extent necessary, to address financial stability risks in the EU arising from the withdrawal of the UK without any agreement. In such a scenario the EC has stated that it will adopt a temporary and conditional equivalence decision in order to ensure that there will be no disruption to central clearing.

Therefore, ESMA is engaging with the EC to plan, as far as possible, the preparatory actions for the recognition process of UK CCPs, in case of a no-deal scenario. ESMA has already started engaging with UK CCPs to carry out preparatory work. The aim is to ensure continued access to UK CCPs for EU clearing members and trading venues as of 30 March 2019, should all the conditions in EMIR, including any conditions set out in the equivalence decision, be fulfilled.


Preparing for the withdrawal of the United Kingdom from the European Union on 30 March 2019: a Contingency Action Plan- 1 (PDF)

Preparing for the withdrawal of the United Kingdom from the European Union on 30 March 2019: a Contingency Action Plan – 2 (PDF)

Nov 242018

The Solvency II directive requires a review of the long-term (LTG) measures and the measures on equity risk until end of 2020.*

The LTG measures are:

  • the extrapolation of risk-free interest rates,
  • the matching adjustment (MA),
  • the volatility adjustment (VA),
  • the extension of the recovery period in case of non-compliance with the Solvency Capital Requirement,
  • the transitional measure on the risk-free interest rates (TRFR)
  • the transitional measure on technical provisions (TTP).

The equity risk measures are:

  • the application of a symmetric adjustment mechanism to the equity risk charge (SA),
  • the duration-based equity risk sub-module.

783 insurance companies on the European Economic Area uses at least one of these measures, 74% of technical provisions: 730 (66%) use VA, 163 (25%) use TTP, 38 (15%) use MA. 46% of all life insurance undertakings in Europe use VA.

There are eight countries that do use any measure (mostly small central east countries, including Poland).

Removing MA, VA, TRFR, TTP, technical provisions at the European level would go up by €215 bn, Own funds would reduce by €164 bn, the SCR would go up by €73 bn. The average impact in terms of SCR ratio for undertakings using at least one measure at European level would be -69%: Germany (-113%), UK (-108%), Denmark (-80%), Spain (-76%), Portugal (-66%). For Italy it would be almost insignificant: -9%. 11% of undertakings using these measures would be below the SCR and 5% below the MCR.

On average, undertakings that apply the measures MA, VA, TRFR or TTP hold bonds of lower credit quality (in particular Corporate bonds and Government bonds) than undertakings that do not apply any of these measures. Also the duration is longer (in UK is more than the double).

MA is only used in Spain and UK (53% of technical provisions), the average advantage in terms of bps in UK is 110 yielding an advantage of 89% on the SCR ratio. 42% of the companies (in Spain and UK) using the MA would be below 100% without it.

In ten countries (including UK but not Italy), the approval by the authority for the application of the VA is needed. In Italy 95% of technical reserves use the VA, only 35% in UK. The advantage in terms of SCR ratio for undertakings using the VA is mostly for Denmark (80%), Germany (53%), Netherlands (49%), quite limited in Italy and UK (9 and 6%, respectively). The average at the European level is 24%. 3% of undertakings (20) at European level using the VA would be below 100%.

The size of the VA as at end of 2016 for the Euro (it applies to all Euro-countries) is 13 bps (22 in 2015). In UK it was 30 bps. In four countries (Greece, Italy, Portugal, Spain) the country spread is higher than the double of the currency spread but below 100 and therefore it doesn’t provide a contribution (country-VA).

In UK, 54% of technical provisions adopt TTP (mostly Life) with a 47% improvement on the SCR ratio, the effect for all the companies at the European level adopting the TTP is 88% with a huge advantage for French undertakings (139%), Germany (233%), Belgium (135%) and Spain (107%). 26% of undertakings (43) at European level using TTP would be below 100% (13 in Germany and UK, 10 in Portugal).

The market share in technical provisions of undertakings using TRFR is negligible. The effect of equity risk measures is negligible.

169 undertakings adopted TTP or TRFR, of these 60 were required to provide a phase in plan: retention of profits or earnings (27), raising new capital (16), reduction of risk profile (20), change of product design (10), reduction on expenses (17).

It emerges that Italian undertakings do not take advantage in a significant way of Long Term Guarantees measures. Instead there are countries (Germany, UK, Demark, Spain, Portugal, Greece, Norway, The Netherlands) where these measures help significantly to cope with regulatory constraint.


*EIOPA (2017) Report on long-term guarantees measures and measures on equity risk.

Nov 242018

L’iniziativa di “Il termometro dei mercati finanziari” vuole presentare un indicatore settimanale sul grado di turbolenza/tensione dei mercati finanziari, con particolare attenzione all’Italia.

Significato degli indicatori

  • Rendimento borsa italiana: rendimento settimanale dell’indice della borsa italiana FTSEMIB;
  • Volatilità implicita borsa italiana: volatilità implicita calcolata considerando le opzioni at-the-money sul FTSEMIB a 3 mesi;
  • Future borsa italiana: valore del future sul FTSEMIB;
  • CDS principali banche 10Ysub: CDS medio delle obbligazioni subordinate a 10 anni delle principali banche italiane (Unicredit, Intesa San Paolo, MPS, Banco BPM);
  • Tasso di interesse ITA 2Y: tasso di interesse costruito sulla curva dei BTP con scadenza a due anni;
  • Spread ITA 10Y/2Y : differenza del tasso di interesse dei BTP a 10 anni e a 2 anni;
  • Rendimento borsa europea: rendimento settimanale dell’indice delle borse europee Eurostoxx;
  • Volatilità implicita borsa europea: volatilità implicita calcolata sulle opzioni at-the-money sull’indice Eurostoxx a scadenza 3 mesi;
  • Rendimento borsa ITA/Europa: differenza tra il rendimento settimanale della borsa italiana e quello delle borse europee, calcolato sugli indici FTSEMIB e Eurostoxx;
  • Spread ITA/GER: differenza tra i tassi di interesse italiani e tedeschi a 10 anni;
  • Spread EU/GER: differenza media tra i tassi di interesse dei principali paesi europei (Francia, Belgio, Spagna, Italia, Olanda) e quelli tedeschi a 10 anni;
  • Euro/dollaro: tasso di cambio euro/dollaro;
  • Spread US/GER 10Y: spread tra i tassi di interesse degli Stati Uniti e quelli tedeschi con scadenza 10 anni;
  • Prezzo Oro: quotazione dell’oro (in USD)
  • Spread 10Y/2Y Euro Swap Curve: differenza del tasso della curva EURO ZONE IRS 3M a 10Y e 2Y;
  • Euribor 6M: tasso euribor a 6 mesi.

I colori sono assegnati in un’ottica VaR: se il valore riportato è superiore (inferiore) al quantile al 15%, il colore utilizzato è l’arancione. Se il valore riportato è superiore (inferiore) al quantile al 5% il colore utilizzato è il rosso. La banda (verso l’alto o verso il basso) viene selezionata, a seconda dell’indicatore, nella direzione dell’instabilità del mercato. I quantili vengono ricostruiti prendendo la serie storica di un anno di osservazioni: ad esempio, un valore in una casella rossa significa che appartiene al 5% dei valori meno positivi riscontrati nell’ultimo anno. Per le prime tre voci della sezione “Politica Monetaria”, le bande per definire il colore sono simmetriche (valori in positivo e in negativo). I dati riportati provengono dal database Thomson Reuters. Infine, la tendenza mostra la dinamica in atto e viene rappresentata dalle frecce: ↑,↓, ↔  indicano rispettivamente miglioramento, peggioramento, stabilità.

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