The Financial Stability Board (FSB) has recently indicated that its shadow banking taskforce is working on some recommendations for strengthening the oversight of the non-bank systemically important sector, which will necessarily require these firms to provide detailed legal entity structural and hierarchical data to the regulatory community. But how will the community tackle the oversight challenge for this sector when globally adopted data standards for reporting purposes are still lacking and the sector is much more challenging to oversee than the banking sector?
Granted, the FSB, the Office of Financial Research (OFR) and numerous other regulators are working on the introduction of a new legal entity identification (LEI) standard, but the shadow banking sector could prove somewhat problematic due to its lack of a designated regulator and the nature of the institutions involved. How far down the hierarchical data rabbit hole will the regulatory community be able to go to track systemic risk without hitting potential data privacy issues and data standards related blockages? To what level will LEIs be assigned and how will the regulators treat individuals in this regard?
At the moment, the FSB is working from what it describes as “high level principles for the relevant authorities and a stylised monitoring process,” which entails the monitoring of market trends using information sources such as flow of funds and sector balance sheet data. But it seems the regulatory community is keen to drill down into much more detail to examine items such as credit risk transfer and leverage, both of which entail the perusal of counterparty and structural data. Ditto with regards to determining the interconnectedness between the shadow banking system and the regular banking system
The FSB notes: “Monitoring should be sufficiently flexible, forward looking, regular, and adaptable to capture innovations and mutations in the system that could lead to growing systemic risks as well as to arbitrage that undermines the effectiveness of financial regulation.” Quite a task, given what the regulatory community has to work with at the outset.
In order to kick things off, the taskforce has conducted a data and information sharing exercise during the summer as a step toward evaluating and adjusting the proposed framework. The FSB therefore reckons this could lay the basis for the data collection and assessment of global trends and risks in shadow banking from 2012 onwards. It is rather sketchy on the details of this at the moment, but suggests that the quality of these assessments should improve over time as more data become available through initiatives by FSB member authorities. It will be a process of trial and error, in other words.
With regard to the initial recommendations for strengthening regulation of the shadow banking system, the taskforce has developed general principles for designing and implementing regulatory measures. It has also conducted a regulatory mapping exercise to take stock of existing national and international initiatives, as well as identifying five areas where more detailed work is warranted to help gauge the case for further regulatory action.
The five areas are:
- The regulation of banks’ interactions with shadow banking entities (indirect regulation), in particular, examining: consolidation rules for prudential purposes; limits on the size and nature of a bank’s exposures to shadow banking entities; risk-based capital requirements for banks’ exposures to shadow banking entities; and treatment of implicit support.
- The regulatory reform of money market funds.
- The regulation of other shadow banking entities;
- The regulation of securitisation, in particular with regard to retention requirements and transparency.
- The regulation of activities related to securities lending/repos, including possible measures on margins and haircuts.
In order to make progress, the FSB has decided to set up dedicated work streams to focus on each area. In some cases the work streams will be undertaken by the relevant international standard setting bodies, while in others work will be carried forward under the guidance of the FSB Task Force. The regulatory body indicates that the work streams will develop preliminary work plans “shortly”, and report their progress as well as the proposed policy recommendations to the FSB by July 2012. The FSB will then elaborate on the recommendations for strengthening the oversight and regulation of shadow banking in a report for the G20 in October.
One can expect data standards discussions to form the basis of some of this work over the next 10 months and this, in turn, could feed into some of the developments regarding a global reference data utility.