The Global Reform of Financial Regulation and Architecture: How to Balance Safety and Efficiency

Event

Summary
Date: 
September 17th 2013

Time: 9.00am - 5.30pm
Venue: London
Organisers: Ron Anderson, Malcolm Knight and Jean-Pierre Zigrand
Conference overview: Major policy initiatives are underway on both sides of the Atlantic to reshape the way financial institutions and markets are regulated and structured. This conference assembled thought leaders in the field to take stock of the status of these measures and to reflect on the complex dynamics of change in the financial sector.

Photographs from this event are available to view here.

Programme:

Keynote address: “Replumbing our banking system: uneven progress”
Speaker: Professor Darrell Duffie (Stanford University)
Chair: Christopher Polk (FMG, LSE)

Session 1: Regulatory reform and the efficiency of financial intermediation

Session 2: Institutional connectedness and the soundness of markets

Session 3: The competitive dynamics of financial intermediaries under the influence of new prudential regulation and structural reforms

Session 4: “Reform of financial regulation and financial structure: where do we stand?”
Panel: Darrell Duffie (Stanford University), Malcolm Knight (Deutsche Bank, Swiss Re and LSE), Gillian Tett (Financial Times), Paul Tucker (Bank of England)

This conference is generously supported by The Clearing House. The support of the Economic and Social Research Council (ESRC) is gratefully received [grant number ES/K002309/1].

Full Report

The Global Reform of Financial Regulation and Architecture Conference was organised by Ron Anderson (LSE), Malcolm Knight (Deutsche Bank, Swiss Re and LSE) and Jean-Pierre Zigrand (SRC) with support from The Clearing House and the Economic and Social Research Council. The conference comprised of four sessions:
1. Regulatory reform and the efficiency of financial intermediation
2 Institutional connectedness and the soundness of markets
3 The competitive dynamics of financial intermediaries under the Influence of new prudential regulation and structural reforms
4 Reform of financial regulation and financial structure: where do we stand?

Darrell Duffie (Stanford University) delivered the day’s keynote speech entitled “Replumbing our banking system: uneven progress”. He began by illustrating the positive and negative effects of the regulatory responses that were intended to redesign the banking system’s architecture after the financial crisis of 2007-09. In particular he discussed ring fencing in the US banking system and the effects of Section 23A on the ability of the Federal Reserve to provide indirect liquidity to affiliates of regulated banks. Subsequently, Darrell pointed out that the proliferation of Central Clearing Parties (CCPs) for OTC derivatives might give rise to an unnecessary increase in counterparty exposure. On the plus side, competition amongst CCPs could reduce requirements for collateral. Duffie continued by discussing the tri-party repo market and its fragility due to the heavy reliance of major dealers
on short-term financing. Thanks to the current design of money-market funds, large institutional investors are prone to run in face of losses, leading to a liquidity shortage in the financial system. Finally, he concluded by suggesting that tri-party repo clearing services probably should operate through a dedicated regulated utility given its systemic importance.

Session one began with a presentation by Rafael Repullo (CEMFI) who started by observing that Europe is going through a creditless recovery. Firms seem financially constrained and, although evidence in support of a supply (rather than demand) side generated credit freeze is still under discussion, Repullo suggested a common sense approach to the problem. As initially requested by the G20 group, credit should especially be made available to firms during recessions. The response of the Basel Committee, according to Repullo, has gone in the complete opposite direction; capital requirements have been made stricter which has exacerbated the credit crunch and lead to procyclicality. Repullo concluded his presentation with three simple policy recommendations: firstly the valuation of banks’ assets by central banks should be more rigorous; secondly capital requirements should be softer, in order to avoid excessive rigidity in the credit system; and finally policy uncertainty should be eliminated.

Paul Saltzman (The Clearing House) then continued proceedings by chairing a panel discussion on whether the response of non-bank institutions and markets support recovery. The panellists were: Wilson Ervin (Credit Suisse), Jack Mahler (OMERS Capital Markets) and Peter Praet (European Central Bank). Saltzman began by explaining that the panel discussion would be focused on the functions of banks (or shadow banks) such as credit creation, maturity transformation and liquidity provision. Praet contributed to the debate by presenting the aforementioned banking system functions from the perspective of the information provision role of the financial market. He believes that information creation and transmission is a particularly relevant issue for Continental Europe banks, especially those whose capital market is heavily dependent on banks that generate large amounts of private and opaque information. On the European Central Bank health check, Praet said “The asset quality review is aimed to reduce a little this gap of information that paralyses the market.” Jack Mahler highlighted how shadow banking can represent a response to the impossibility, induced by the economic crisis or by regulatory requirements, of providing some of the services that used to be at the core of banks’ business model.

Session two began with Hal Scott (Harvard University) who presented “Connectedness and contagion”. He first analysed the asset connectedness and liability connectedness witnessed during the past few years and then discussed in details the Basel response to contagion. He continued by providing empirical evidence related to liability connectedness on money market mutual funds and concluded with suggestions of how to deal with contagion. Among these suggestions, he emphasised the importance of a strong and clear lender of last resort. After a short discussion with
the audience, Ron Anderson (LSE) chaired a panel discussion on financial infrastructure and resilience of the financial system. The panellists
were: Diana Chan (EuroCCP), Charles-Albert Lehalle (Capital Fund Management) and Antoine Martin (Federal Reserve Bank of New York). Martin concentrated his presentation on US repo markets and pointed out two main infrastructure weaknesses: the unwinding process (that may induce huge exposures for the clearing banks and conflict of interests) and the fire sale risk. Although the industry has already pushed forward internal reforms to deal with the unwind issue, no progress was made on fire sales except for the continuing risk. Chan continued Martin’s presentation from the perspective of CCP and discussed the pros and cons of competition among CCPs. She agreed that the competition among CCPs would be dynamically efficient. Lehalle focussed his input to the session on features and failures of the market’s microstructure. Firstly, he showed several well-known microstructure related events (such as the Flash Crash in May 2010 or the Hash Crash in April 2013) and the recent changes in market design due to post-crisis regulatory reform. Then he raised three microstructure related issues: operational risk, misleading information and collective runaway, and concluded his speech by suggesting potential solutions. During the audience question time which followed, the focus was on competitions among CCPs and Chan gave a detailed explanation of CCP operations and provided participants with her view on the role of central
clearing in post-crisis financial markets.

Jan-Pieter Krahnen (House of Finance, University of Frankfurt and Member of the Liikanen Group) started session three with his presentation entitled “Interplay of business models and regulation in the financial industry: current challenges”. He employed two cases to illustrate the dialectics of regulatory intent and expected business response. He first discussed the separation of proprietary trading and market making from universal banking and then spoke about the mandatory bail-in debt issuance with holding ban. Following Krahnen’s presentation, David Webb (LSE) led the panel discussion on business models and the changing shape of the financial sector. The panellists were: James Chew (HSBC), Rob Henrikson (Swiss Re), Carsten Kengeter (LSE) and Ben Langworthy (Centrebridge Partners). During this session the speakers provided their insights on the prospective role of the banking sector in the global economy and discussed the impact of different regulatory frameworks on the diversification, segmentation or concentration of the financial industry. The practitioners’ approach to credit creation and risk management was presented both from the perspective of a leading retail bank and of a private equity investment entity, while Henrikson mainly discussed the issues related to the (re) insurance business, its connection with the banking sector and its regulatory framework.

Malcolm Knight (Deutsche Bank, Swiss Re and LSE) chaired the final session of the day on “Reform of financial regulation and financial structure: where do we stand?” The panellists were comprised of experts from academia, financial press and regulators: Darrell Duffie (Stanford University), Gillian Tett (Financial Times) and Paul Tucker (Bank of England). While acknowledging the improvements in terms of transparency and discipline in the financial sector, the panellists remarked that Europe still faces severe problems when it comes to handling a fresh bank failure. While the US in comparison has made a big step by giving lawmakers the necessary tools to handle the bank failure, which is yet to be implemented in EU. When pressed by an audience member, the importance of interaction among national regulatory bodies was highlighted by the panellists. Tucker stated that the Bank of England, which supervises banks in Britain, would be prepared to “step aside” and allow the United States to wind down a global bank that has operations in London.