Douady New Financial Regulation New Projects Technology Ok

8/10/2019 Douady New Financial Regulation New Projects Technology Ok

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New FinancialRegulations,

New Projects inFinancial Technology

Complex Systems Design & ManagementRaphael DouadyCNRS, Univ. Paris 1, C.E.S.Riskdata


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AGENDA

Financial Regulations since 2008 Crisis Buy side: Basel III, DFA, EMIR Sell side: Solvency II, UCITS, DFA Purposes and Benefits Flaws and Dangers

Opportunities for Financial Technology Asset Pricing, Credit Value Adjustment, Internal Rating Risk Reporting, Capital Adequacy Margining, Collateral Management Data Quality, Processing, Big Data Order Management, High Speed, Algorithmic Trading

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BASEL CAPITAL ADEQUACY RULE

Source: Moodys Analytics

Basel I (1988, enforced 1992) Cooke Ratio

Basel II (2004, enforced 2008) 3 pillars (capital, governance,

discipline) Cooke ratio + VaR + Operational

risk

Basel III ( expd 2013, TBE 2018) Risk-Weighted Capital (Tier1, 2, 3)

vs. Risk-Weighted Assets

Stressed VaR = VaR + StressTests

Liquidity Buffer Credit Counterparty Risk (CCR) Credit Value Adjustment (CVA)

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Aim of Basel III Face Black Swans

Stressed VaR

Avoid ContagionCredit Counterparty RiskLiquidity Buffer

Align Capital with Expected losses

Risk Weighted AssetsCVA

BASEL CAPITAL ADEQUACY RULE

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Solvency II (EU, Insurance) Funding Ratio Methodology Long - term Risk (1 year)

Dodd-Franck Act (USA, applies to all financial institutions) Transparency, Exposures, Risks

Liquidation procedure, Forensics Supervision Reform

EMIR (USA, market standardization) Central Clearing of Derivatives (incl. CDS)

UCITS IV (EU norm for fund marketing) Fund Regulation and Disclosure Liquidity Choice of

Transparency Expert VaR Computation

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OTHER REGULATIONS

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MARKET DISCIPLINE

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PROCYCLICALITY A flaw of VaR-based Capital Adequacy

Market falls Volatility surges VaR increasesMassive sales to meet CA Market falls

A flaw of Marked-to-MarketDistrust Demand vanishes Price falls Distrust

Tragedy of the Commons in the Risk VaR + M2M produce an embedded instability

J.C. Trichet (Paris, 1994) Beware of herd behavior with VaR

DANGERS OF REGULATION

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PROCYCLICALITY IN BASEL III Stressed VaR

Stress Tests not procyclical, but SVaR = VaR +STests

Higher capital requirement More pressure

Overreaction to Market drops If simply added to VaR, stress tests increase procyclicality

CCR + CVA Same logic as VaR with each Counterparty

CTP Credit CVA CTP out of business Default Even worse with CTP credit hedging with CDS

CTP Credit Buy CDS CDS CVA


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What are you looking for?

Did you loseyour key there?

No, on theother side, but

hereI have light!

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REMEDY TO PROCYCLICALITY VaR = Market Scenario x Sensitivity When markets fall:

Scenario Sensitivity Sale Regulator computes Scenarios

Must anticipate crises Provides means to deflate a bubble before it bursts, by

preemptively widening scenarios Institutions compute Sensitivities

Must account for complex instruments and

nonlinearities Back-test possible to check sensitivity computation

Regulator must ask for Risk Transparency, notOperations Transparency


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11/1811Source: Accenture Basel III and Its Consequences


ADVERSE SELECTION

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ADVERSE SELECTION

Risk-weighted Assets + Quantitative EasingCapital arbitrage Lend to AA/AAA rather than High Yield

Capital is absorbed by less profitable business Growth More QE More money to AAA Leverage of AAA Systemic crisis

RWA rule imposes the ratio between creditspreads of investment grade and high yield bonds Biased markets Instability: capital flies away precisely when needed!


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REMEDY TO ADVERSE SELECTION

Weights in RWA apply only beyond a threshold Base Cooke Ratio = 8% Lend 12.5 x Capital

Below 6 x Capital Unweighted Assets Beyond 6 x Capital Weights apply

Impose Leverage limit Avoid procyclical definition of Capital

RWC amplify procyclicality Adapt weights to economic conditions in order to

maintain financing of the growth tank


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Global Financial Risk IT Spending

Total Bank IT Spending: CAGR 4.3%

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Source: Celent

Total Risk IT Spending: CAGR 25% Majority is due to Basel III and DFA

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Challenges due to New Regulations

Big data, scalability Regulations require (and computing power allows)

massive data processing: deal data + market data +other info

Systems must be scalable to handle more and moredata

Flexibility Regulation uncertainty imply that big systems be

flexible and immediately responsive to changes,without costly adaptation

Separation of common data and proprietary data

Speed Algorithmic trading (directional, market making,

speculative) represents today the vast majority (75%)of trades High frequency trading (HFT) imply low-latency

systems: order management (OMS), margining, etc.

Security, Reliability Cloud data and computing, IT evolution raise security

challenges

Operational Risk and Disaster Recovery Plans (DRP)

Innovations

Mass statistics Data Mining Databases Data quality

Cloud Architecture

Fast algorithms FPGA

Encryption Hardware protection Data centers

CHALLENGES IN FIN TECH

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Investors DrivenInnovation Real-time Risk Analysis

Complex Instruments Pricing

and Risks Liquidity Management

Portfolio Management andOptimization

Hedge Optimization

Long-term Risk Analysis Economic Scenarios Crisis Anticipation

Order execution Algorithmic trading

Sell-side DrivenInnovation Regulatory Capital Monitoring

Value-at-Risk

Credit Counterparty Risk Credit Value Adjustment

(CVA)

Collateral Management Margining

Pre-trade and Post-tradeManagement

What - if Analyses Risk Limit Control


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Customer Driven Innovation Real Time Access Personal Information Market Information + News Advanced Market Data

Risk + other Statistics Possibility to Act in Real Time

Trading Operations (transfers, etc.)

Security and Reliability Internet transactions, Credit cards Fraud detection

Suppliers Comparison

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The economy needs it Recognized French expertise

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Douady New Financial Regulation New Projects Technology Ok

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