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By James Hamilton, J.D., LL.M., Senior Writer Analyst, CCH Federal Securities Law Reporter; Co-Author, CCH Federal Privacy Rules for Financial Institutions and Financial Services Modernization - Gramm-Leach-Bliley Act of 1999 - Law and Explanation; contributing author, CCH FOCUS. |
n the decade since the Basel Committee on Banking Supervision introduced its 1988 Capital Accord, the business of banking, risk management practices, supervisory approaches and financial markets each have undergone significant transformation. To address this change, the Committee released a proposal in June 1999 that would replace the 1988 Accord with a more risk-sensitive framework. The Committee in January 2001 presented a more concrete proposal, reflecting the comments and the results of ongoing dialogue with the industry and supervisors worldwide. The comment period for this proposed Accord closed May 31, 2001. Based on the comments received, the Committee has determined to modify the timetable for completion and implementation of the new Accord. The Committee will release a complete and fully specified proposal for an additional round of comment in early 2002 and will finalize the new Accord during 2002. Accordingly, the Basel Committee envisions an implementation date of 2005 for the new Accord.
Based on the more than 250 comments received on its January 2001 proposed Accord, Basel has made several decisions regarding the proposal:The SIA wants financial regulators to clarify that the capital rules under the current Accord’s market risk amendment apply to all products subject to mark-to-market (or fair value) accounting when the mark-to-market incorporates the pricing of the credit risk inherent in the position. It was noted that mark-to-market valuation of credit sensitive securities effectively integrates market and credit risk. In this way, all positions subject to mark-to-market accounting would have capital requirements calculated on a consistent basis.
Mark-to-market or fair value accounting records securities and financial instruments based on listed market prices or broker or dealer price quotations with unrealized gains and losses recognized in earnings. To the extent that prices are not readily available, fair value is based on either a firm’s internal valuation models or a firm’s estimate of amounts.
In the SIA’s view, mark-to-market accounting is a key tool that strengthens market discipline, supports appropriate capital allocation and facilitates the integration of market and credit risk. A timely and reliable system of disclosing mark-to-market financial data is an effective means of providing risk information to investors, lenders, regulators, commercial partners and other stakeholders.
The SIA also urged that the Accord’s recommended disclosure requirements apply only to the assets not included in its trading book, and that it require a firm adhering to mark-to-market accounting to make risk disclosures broadly in line with those outlined in the Multidisciplinary Working Group on Enhanced Disclosures report (the Fisher Report) and those in the Working Group on Public Disclosure (the Shipley Report).
Asset managers registered with the SEC as investment advisers are currently not subject to capital requirements in the United States. In addition, the ICI pointed out that, in 1999, Congress expressly rejected the imposition of capital requirements on bank holding companies based on the activities of their investment adviser affiliates. Thus, the ICI questioned whether the Basel Committee should require holding companies that have asset management subsidiaries to incur a capital charge for the asset management affiliates.
In addition, the ICI feels it is unwise to impose capital requirements without clearly identifying the specific operational risks of asset management. The Institute urges the Basel Committee to conduct a study of these risks before calibrating capital to the operational risks of asset management. Finally, Basel is encouraged to make use of consultation with the industry to mitigate operational risk.
He noted that Basel recently published the results of a two-year study on disclosure practices. The study revealed that, while the quality of disclosure has improved, disclosure practices have not kept up with changes in how financial institutions manage their businesses and in how they measure and mitigate their risks. Before the situation can improve, he emphasized, the notion of what is public versus what is proprietary information must change.
Transparency promotes confidence, he concluded, and, in light of the increasingly international nature of markets, oversight supervisors must ensure that disclosure in different countries is sufficient and broadly consistent to promote greater financial stability across markets. Achieving this goal will require additional harmonization of accounting standards so that supervisors, bankers and other market participants can better understand and act appropriately to manage their exposures to markets or institutions abroad.
The market discipline pillar of the Accord is supported by IOSCO, which notes that disclosure has an important role to play in allowing market participants to accurately assess risks and returns. Timely information about the nature and effectiveness of a firm’s own risk management processes is an important aspect of this principle.
The disclosure rules that emerge for banks will be of great importance for securities firms, noted IOSCO, since they will play a large role in establishing broader market standards for disclosure. Thus, IOSCO believes it is important that the catalogue of disclosure issues finally emerging from the Basel process be appropriate to a broad range of financial institutions.
Another pillar of the proposed Accord, capital requirements, includes the use of external credit assessments. The use of these assessments to distinguish among credit risks is set forth in the proposal. External credit assessments are used by the SEC where capital requirements for broker-dealers are dependent on the credit quality of the debt securities they hold, as measured by nationally recognized statistical ratings organizations. In designating a rating organization an NRSRO, the SEC takes into account many of the same criteria as those proposed in the Accord for the recognition of eligible external credit assessment institutions.
IOSCO agrees that safeguards in the form of a track record and other rigorous selection procedures are of paramount importance in ensuring the integrity of agencies’ ratings. In most countries, however, ratings agencies are less well established than in the U.S. and their coverage is very narrow. This means that neither an existing market franchise nor the discipline of an established marketplace may exist. In IOSCO’s view, this poses two risks. First, regulators may be placed in the undesirable position of having to vet ratings agencies; second, ratings agencies may be recognized even though their assessments are questionable.
The Accord proposes to treat claims on securities firms as claims on banks provided certain conditions are met. IOSCO pointed out that capital requirements for securities firms often differ markedly from those for banks. Thus, implementation of the proposal could create a number of practical difficulties and involve difficult judgments on the part of banking regulators.
The proposed Accord neither considers risk exposures to central counterparties, such as clearing houses for futures exchanges, nor addresses the credit risk of OTC clearing houses. IOSCO pointed out that both it and the Basel Committee have historically recognized that central counterparties can be a source of systemic risk and consequently need to have rigorous risk management procedures and an enforceable legal basis for netting. IOSCO urges the explicit recognition of the risks embodied in dealing with counterparties. In this regard, IOSCO said that regulated counterparties with sound risk management arrangements should attract favorable capital weightings.