Judging by the number of references that have been made to living wills legislation during reference data related events and conferences recently, the market is already well aware of the data challenge awaiting it. However, for those that may have been asleep for the last few months, Thomas Huertas, director of the banking sector for the UK Financial Services Authority (FSA) and vice chairman of the Committee of European Banking Supervisors (CEBS), has been doing his level best to raise awareness of these challenges and how the industry can tackle them.
Last month, for example, Huertas gave a speech about how the concept can be implemented to the Wharton School of Management in Philadelphia. The perceived benefits and challenges of living wills has also been highlighted by other members regulatory community frequently over the last six months, see Fed board governor Daniel Tarullo’s speeches on the subject, for just one example. Huertas, for his part, has displayed ample consideration of the data management challenge that will stem from mandatory “recovery and resolution plans”, but feels they are important in order for the assessment of the “social risk posed by the failure of a large, systemically important bank” on society as a whole.
While recovery plans will have a dramatic impact on capital planning and liquidity, both recovery and resolution planning will likely require significant investment in data architecture. The capital and liquidity planning required for mandatory resolution plans will entail firms keeping a tight rein on where its liquidity is located and therefore the organisation of counterparty and instrument data will become paramount in a business sense. Unlike boom times, financial institutions now cannot afford to throw away opportunities due to bad data and may be severely penalised for such failures, but recovery plans take this one stage further: failure of the firm itself may be a result.
At last resort, banks will need to know to which counterparties they can turn in order to raise capital or liquidity in a crisis and this necessarily involves having a complete picture of exposures to those entities. This data will need to be readily at hand in order to take action swiftly and effectively, hence an investment in a data infrastructure to store this vital information is needed to replace the heavily siloed infrastructures that are currently endemic across the industry.
Resolution plans, on the other hand, are for regulators to implement but require banks to establish sufficiently detailed wills for the purposes of winding down. The regulators will be checking therefore that banks could in fact generate the details of such information, including granular detail such as counterparty exposures on a position level, on short notice. Really short notice: “The longest period of time that the authorities are likely to have to make a decision is the roughly 36 to 48 hours between the close of business on a Friday in Europe and North America and the opening of markets in Asia when it is still Sunday evening in North America.”
Huertas elaborated on the type of information required for resolution: “This includes the legal vehicle structure of the banking group, a mapping of its principal businesses against that legal vehicle structure and identification of financial and operational dependencies among various elements of the group. It also includes information concerning the bank’s membership in payments, clearing and settlement infrastructures, information concerning the segregation of client assets and the procedures by which such segregated client assets could be transferred to third parties. Finally, the authorities will need information concerning the bank’s deposit base: what is insured and what is not, as well as what is the maturity structure, terms and conditions of the deposits.”
The regulatory community has warned that it will run ‘fire drills’ to check that firms are able to produce this data in a timely fashion, which given the current state of most data architectures in these large firms, wouldn’t be a pretty process if they tried it any time soon.
For those of you still in the dark about the basics, Huertas elaborated on what a recovery plan actually is: “Under a recovery plan the bank is forced to think through in advance what it would do if the bank were to fall under extreme stress, much the way the bank is forced to think through what it would do to assure business continuity in the event of an extreme disruption to its physical infrastructure, such as might result from fire, flooding, earthquake, pandemic or terrorist attack.”
He also elaborated on the details of a resolution plan: “Under a resolution plan, the bank is asked to plan for how it would provide to the authorities in a timely manner the information the authorities would require in order to make a choice among the resolution methods available to resolve the bank, should resolution be required. To some extent this planning would enable the authorities in advance to focus their contingency planning on methods that are likely to be feasible, as well as to identify obstacles to resolution that might potentially be removed in advance, either by the firm itself or by the authorities.”
Huertas’ full speech is available to download on the FSA website here.