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A QUESTION OF CONVERGENCE

Posted: 22 February 2010 | FX-MM | No comments yet

Aiming for a “single version of the truth”

Drew Hillier talks to Selwyn Blair-Ford, Senior Domain Expert for FRSGlobal – London.

By inclination, Selwyn Blair-Ford is a problem solver. Having joined FRSGlobal in September 2006, Selwyn was integral to the UK FRSGlobal team that successfully analysed and designed the UK IRR reporting solution, which provided Basel II reporting for UK firms. His deep understanding of financial regulatory systems, rules and calculation methodologies has been honed over twenty years of first-hand banking and financial business processes, working in many of the world’s most noteworthy financial institutions. This, ultimately, has ensured FRSGlobal both maintains and builds upon the integrity of its solutions – from how they are configured and how they integrate, right through to the implementation process and beyond.

Aiming for a "single version of the truth"Drew Hillier talks to Selwyn Blair-Ford, Senior Domain Expert for FRSGlobal - London.By inclination, Selwyn Blair-Ford is a problem solver. Having joined FRSGlobal in September 2006, Selwyn was integral to the UK FRSGlobal team that successfully analysed and designed the UK IRR reporting solution, which provided Basel II reporting for UK firms. His deep understanding of financial regulatory systems, rules and calculation methodologies has been honed over twenty years of first-hand banking and financial business processes, working in many of the world's most noteworthy financial institutions. This, ultimately, has ensured FRSGlobal both maintains and builds upon the integrity of its solutions - from how they are configured and how they integrate, right through to the implementation process and beyond.

Aiming for a “single version of the truth”

Drew Hillier talks to Selwyn Blair-Ford, Senior Domain Expert for FRSGlobal – London.

By inclination, Selwyn Blair-Ford is a problem solver. Having joined FRSGlobal in September 2006, Selwyn was integral to the UK FRSGlobal team that successfully analysed and designed the UK IRR reporting solution, which provided Basel II reporting for UK firms. His deep understanding of financial regulatory systems, rules and calculation methodologies has been honed over twenty years of first-hand banking and financial business processes, working in many of the world’s most noteworthy financial institutions. This, ultimately, has ensured FRSGlobal both maintains and builds upon the integrity of its solutions – from how they are configured and how they integrate, right through to the implementation process and beyond.

The message imparted by Selwyn on the future of regulatory and risk reporting is clear. “As a result of the recent financial turmoil we will certainly see financial institutions under increasing scrutiny with increased reporting, capital and liquidity requirements. In such an environment, adherence to best practice in terms of reporting, business oversight and controls will become increasingly important. Indeed, the very rules by which the banking industry operates are likely to change, making the ability to analyse and report effectively and appropriately a key survival skill.

As Selwyn states: “Firms will also have to cope with increased levels of coherent firm-wide disclosure. Being able to report from a plethora of disparate sources of data for the whole firm is no longer an option. One should note that the creation of a single verified source is not just a technical problem; it is a business problem, since the information needs to be properly understood and usable for such a source to be meaningful.”

Starting with a timely, yet perhaps impossible question to answer succinctly, I nevertheless asked Selwyn to remind us of the major global regulatory changes we’re witnessing of late.

“It’s huge. We’ve got increases in capital; new approaches on securitisation; increases over regulation on the credit companies. We’ve also got liquidity changes, including liquidity buffer changes, and we’ve got new ratio regimes. There is also the idea of living wills and the ‘too large to fail’ issue that threatens to bring about drastic changes. Furthermore, as everybody’s been made very aware, remuneration is a thorny topic which has also come to a regulatory head, so it’s pretty hard to actually summarise them. Last year – or certainly the year before that – had you asked me this same question, it would be quite a comfortable task to give you a straightforward answer!”

With regard to how this landscape has changed dramatically post banking crisis – and indeed, how they continue to change – would it be a fair comment to suppose all this is overdue? I mean, have these issues been lurking with a degree of inevitability about them?

“I think when it comes to the argument to which you allude, Drew, people can get very comfortable with saying things post-event. It’s very easy now to look back and say “it’s obvious this was required” or “that was required”. Nonetheless, with regard to liquidity, I would agree it’s been the case for some time that it hadn’t been addressed as effectively as needed. Certainly it was something outstanding at the end of the Basel II process which needed to be dealt with. When it comes to the history of capital, it appears that we’ve taken a rather arbitrary Cooke ratio of eight percent and generally stuck to it. As such, when this ratio was set, there wasn’t a study to ascertain if indeed this was the right level; instead, people just accepted the situation and we simply rolled on. But it is easy to say the level of capital wasn’t right with the benefit of hindsight.

“Nevertheless, is it reasonable to ask if these were overdue? Whatever the answer to that, and I’m sure we’ll touch on it later, nobody imagined the actual impact of not acting would be anything like it has been, otherwise we would naturally have done something earlier. One needs to remember that the crisis happened during a time where the consensus believed that the risks being taken were appropriate. Now, in the aftermath, we’re moving on to see what measures we can put in place to make things safer; we know now that actually the bar was set too low.”

So you would agree that the banking crisis could be characterised in terms of it being an exercise in stress-testing for the entire system?

“Exactly right. And, in fact Drew, what it proved was what the system thought was a stress, turned out not to be severe enough. We had a liquidity crisis that went on for the best part of a year; I think some may argue even longer.”

There probably isn’t a set start-time per se, rather a consequence of evolution.

“Yes, so we had a liquidity crisis that lasted months and months where previously nobody would have thought of a stress scenario with a crisis longer than a month or two; we had institutions failing which no-one thought would fail; we had credit ratings that everybody assumed to be reasonable and solid which turned out to be not worth the paper they were written on. So under these circumstances we’d gone through an environment where people really had to contemplate what was not contemplatable before the crisis.”

Well, data by its very nature is based largely on historical precedence, and there wasn’t any historical precedence to this degree. It goes back to what you were saying about how we could have known.

“In some ways, actually, that statement illustrates how we’ve moved on. The crisis has shown how historical precedence can be a poor template, not least because history doesn’t repeat itself, it’s just that the incidents of tomorrow have similarities with incidents of the past, and that’s not the same as being repeated. We have to actually imagine new things and imagine stresses and new ways realities can unfold. Even if this is done diligently, what’s actually guaranteed is that any model or scenario contemplated will differ from the actual realities. The real work is determining at what point scenario and reality diverge and deciding if the scenarios used are right enough? If the answer to the last question is yes we will have a means of keeping ourselves relatively safe.”

Why is that? Is it because human beings are fallible and make decisions, rational or otherwise, based on an infinite variety of considerations that resist being pin-pointed simply in terms of what can be fed into a computer as data?

“I think that’s quite an interesting question: “why is it that our models and our predictions are always wrong?” And they are, I think, because ultimately there’s nobody with a complete enough view of everything to be able to run an accurate prediction. Even if you did have, random events occur which you could not collect any data about today to predict that it’s going to happen tomorrow. We’re dealing with the real world. Maybe it’s not reasonable, possible, desirable or in fact needed, to actually have a perfect model. But what we always settled for is a model that keeps us out of trouble. Over time, existing models do fail us so we have to be continually raising standards.”

So, what does ‘good data’ look like?

“What does good data look like? Perhaps a better question is what does good process look like? It is in the nature of data gathering that you go along and ask a question and you then have to collect the data and run your calculations and models, you get an answer. Then you question that answer and the result of that questioning is that you then have to go back and collect more data, so you’re always trying to gather more and better data. The point where it stops is when people become “satisfied” with the answers they’re getting. Satisfaction doesn’t last long.”

So, putting theory into effect, if you could briefly explain the new style regulation, including the more risk-based information, so as to see the future gap rather than the past value?

“I think we first need to go back, briefly, and look at the way regulations have come about. Basically, we simply had the balance sheet variety along with a few others where firms explained what they’re doing and a regulator came round for a chat with the CEO and put a rubber stamp on the reports. Financial crises and the resulting policy changes moved regulation on to consider an ever increasing variety of risks and statistical factors. Regulators have included banking book risk, market risk, credit risk, operational risk liquidity risk and various others in their analysis and reporting. But since the latest crisis we’ve had a change, not only are regulators looking to view risks, but they’re now looking to model those risks in a different way. Previously good regulation was firmly based on historical precedent; you would look at your experience in a firm; you would then generate a regulatory capital number, which is really a crude risk model. More and more, the nature of financial innovation results in risks being moved about in innovative ways. So now, regulators, firms and others moving to a combined model, a model that will allow firms to report the regulatory information but also stress and scenario model the entire business.

I think the ideal now, is, whereas firms previously would have said “what happens if certain curves move by this many basis points and defaults increase by that level?”, we’ve now moved to a world where we’re saying “OK, a disaster occurs in one of our major financial centres, what’s the impact? Where do the metrics go? How does our operational risk look? How does our liquidity risk look? etc. The important thing for firms is that they ought to be able to have a single scenario and see how it impacts all the relevant risk from a firm-wide perspective; that is you’re really looking at an overall view, not a segmented view. ”

And this is where FRSGlobal’s approach comes into it.

“Yes, our approach is to have a ‘single version of the truth’, from which firms can do all their stress testing, external regulatory and internal management reporting. In other words, there’ll be one single source which can be drilled down in to, is internally consistent, but well enough defined to meet the needs of capital risk, liquidity risk, credit risk and others. One should keep in mind that there are strict legal definitions of what should be reported to regulators and our model is able to meet these differing standards in over 40 jurisdictions. Of course our solution allows firms to treat the instrument in a wide variety of ways, but still maintain the ability to compare and contrast different outcomes. The advantage of which is to be much more responsive; providing a true overall view of an entire business, which I truly believe is highly valuable. And once the data has been collated in to a single system, why wouldn’t firms use it to create other reports for internal management and governing bodies for example? Basel II, Pillar 2 requires reg data be ‘fully reconcilable’ to data used by management to make decisions with – there’s no better way of ensuring it’s reconcilable as it being from the same source to start with.”

Moving on a bit, Selwyn, can you contrast for us the similarities and differences between regional regulatory landscapes; clearly there are variations, but FRSGlobal nonetheless has an overarching approach?

“From our point of view, as a global risk and regulatory firm, we have to track regulatory changes and structures across the entire world, which means we are constantly in touch with the regulatory scene both globally and at a local level. The introduction of the Basel accords, the globalisation of finance and financial products mean that the similarities are increasing. However every country has differing legal, cultural and business practices. There are also very different economic and political environments which results in a variety of regulatory reporting and risk analysis requirements.

“Looking at how the financial crisis evolved – the issue of how the regulators were organised in each country has not really appeared to be the key determinate of whether any given country has had a good or bad time of it. Instead, it seems to be more a case of the policy measures that have been in place.”

You could cite the Canadian model, for example?

“Canada, certainly, has not experienced a financial crisis as severe as many other countries. When it comes to securitisation of on/off-balance sheet products, the Canadians had an absolute capital-to-asset ratio, which really limits the size to which their banks can grow in a way that banks in the US and UK, as well as some throughout Europe, were not restricted. In Spain, for instance – even though there has been some suffering as a result of a well-documented mortgage crisis there – their banks have done quite well, relatively, because of their requirement for a counter-cyclical buffer, which, technically speaking, I believe shouldn’t have been in place.”

I guess you’re referring here to Basel II, which says you’re not supposed to recognise potential losses – rather, only the ones that can actually be identified.

“That’s correct. Nonetheless, the Spanish regulators in their wisdom decided to implement counter-cyclical buffering anyway, which, as it transpires, has served them very well. And so we find it’s the policy measures put in place by different countries that have actually resulted in how each one has suffered more or less in the financial crisis.”

Which might suggest, going forward, any form of one size fits all-ism – whilst of course there needs to be a unified approach – nevertheless has to be capable of being nuanced?

“Well, what we see is a lot of agreement for increased convergence in regulatory approaches. Hence the new raft of policy directives which are pushing towards that. Personally, however, from an industry perspective, I would say we’re quite concerned. It’s all very well if all these proposals are implemented in the correct manner, then hopefully we’ll end up with a system close enough to the one we want in order to mitigate risk. But considering the difference between the financial sector business and the policy makers there is the possibility of generating more problems. On the one hand we have traders and bankers used to operating in minutes, hours, weeks or perhaps months. Then on the other hand we have policy makers used to taking years to formulate policy. So, many of the banks – who, understandably, are lobbying to ensure that restrictions do not become too tight – will have reached the situation where they are saying things aren’t really going to change and if they do they are so far off as not to matter. The real concern, therefore, must be that once the financial crisis disappears from the front pages, the political will for a coherent set of regulatory changes will be lost. We see different jurisdictions are implementing slightly different parts of the evolving policy framework at different paces, so at the point where political will evaporates – or is diverted to other issues – we could end up with an equally, or an even more disjointed regulatory system or one where the efforts to make the system safer simply fall apart. One needs to be ever vigilant and ensure that the political elite maintain the will to properly see this project through, on a coordinated basis.”

Not an easy task.

“Far from easy; we seem hard-pressed enough as it is to agree about things in Europe, let alone the United States, Canada, China, Singapore, Dubai and elsewhere! But we are seeing the risk element move into the regulatory issues and the move to forward looking reporting which could avoid systemic risk.”

So, plenty of opportunities and a good deal of work for FRSGlobal!

“Yes – our solution is unique in that it combines risk and regulation on a unified platform, which means that it will cope very well. We are closely monitoring developments and we are clear how we would implement all the policy suggestions on the table at the moment in our system when they become a reality.”

From the UK perspective, and the demands being placed on firms with regard to transparency, reporting and perhaps the whole compliance mine-field, if you like, is the FSA slightly overreacting, not least bearing in mind they haven’t really set out any guidelines yet?

“I don’t think the FSA or other regulators are overreacting. The industry and the public have to understand there’s a balance between the amount of constrictions put on the financial sector and the amount of benefits you can get. Clearly, what the regulators are doing is redressing that balance, so by putting more restrictions and making banking less profitable, both for individuals and at a corporate level, you’re trying to have a strong banking sector with benefits to society. This does mean that you won’t be able to get loans so quickly and easily as before, but the likelihood of paying back for the financial crisis will also reduce. So it’s really a question of at what point that balance is; I think perhaps in some ways policy makers haven’t been absolutely clear, or maybe they haven’t even had an agreement on where they see that balance to be. It might be “yesterday wasn’t too bad but we just need to tweak it a little bit” to “actually, we need to make sure this doesn’t happen again so lock everything down”. There’s a real economic and personal cost to restricting banking, which isn’t very easily annunciated or explained, yet nonetheless can do an awful lot of damage if you were to restrict bankers in the way they were twenty or thirty years ago.”

In which case, with so much uncertainty more than ever stalking the scene, just how does a financial institution future-proof, as it were, against the shifting regulatory sands of compliance and reporting changes?

“Firstly, I’d say that universal systems and controls – those which look at the entire company from top to bottom – are absolutely key. I must reiterate the importance of how a single view of your business is crucial. This has been promised in a number of ways over many past decades: technologically speaking, people have pointed to everything from single data warehouses to ALM systems to enterprise risk systems. But in reality, they don’t actually deliver. Part of the reason behind this, I’m sure, is – simply because the people pushing these solutions are very much technologically-based – the integration of data into a single view uses technology as a tool, whereas, in fact, the problems and issues are entirely business-based. For example, only a business person can tell you how notional as measured by credit department, and notional as measured by treasury, and notional as measured by financial control, are the same or how and why they differ and the actual way in which one approaches the consolidated data model has to be very much from the business point of view. The issue here being that there is often not nearly enough business expertise actually applied to this issue, within even the largest banks, in order to properly complete the exercise. By way of an illustration, just consider the virtually countless millions of hours spent on enterprise-wide and global asset management systems that, ultimately, failed when the financial crisis struck. This is a very important area which firms need to tackle, and FRSGlobal has a solution that allows them to do just this.”

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FRSGlobal is the system of choice for more than 1500 financial organisations worldwide – including 41 of the top 50 banking institutions. Subscribers benefit from its unique FRSGlobal Regulatory Update Service Guarantee “to keep the regulatory reports in the (40+) countries we support up-to-date”. This service is enabled by the team of experts from the global FRSGlobal Centre of Risk & Regulatory Excellence (CoR²E) who maintain regular contact with global and local regulators.

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