U.S. financial firms aren’t the only ones who need to worry about how to shore up their data management skills to comply with potential legislation on monitoring their enterprisewide risk.
Last week, the Financial Services Authority in the United Kingdom sent a “Dear CEO” letter to 2,800 firms, giving them one month to confirm they can comply with the regulator’s new liquidity reporting regime.
On December 1, the FSA said that firms had forty days to implement new systems and controls and with the deadline now passed the FSA wants firms to declare whether they maintain strong policies on making sure they have enough cash on hand or enough assets that can be easily converted into cash. Planning to prove one’s liquidity, the measurement and governance of same and testing stresses against cash or cash-equivalent assets won’t be easy.
And will require a lot more data. Which might in turn not be easy to pull from existing internal applications or databases.
”The granularity of the information required, the type of information and the processes behind the daily management and monitoring of the information must be taken into consideration when preparing,” says Mario Onorato, senior director of balance sheet risk management solutions at Algorthmics, a global risk management software firm headquartered in Toronto.
The new requirements will mean more reporting for all firms, but especially investment firms who have not previously been required to do so.
In addition to information on liquid assets and cash flows, firms will need to provide additional data on areas such as types of funding sources and prices for the funding. Some of the new reports must be provided weekly and submitted on the Monday following the reporting week. In times of market turmoil, some reports may even be required daily, making the need for automation that much more important.
The new liquidity rules also require firms to perform extensive stress testing to identify sources of potential strain and ensure that risks can be tolerated. When performing these stress tests firms must consider the impact on wholesale and retail operations, intragroup liquidity risk, intraday liquidity risk, and off-balance sheet liquidity risk, says the FSA.
The regulator’s goal is to fix one of the most glaring shortcomings in global banking regulation to have been exposed by the financial crisis. Inadequate regulation of liquidity triggered the rapid collapse of Northern Rock, the mortgage lender, as well as the failure of Iceland’s banks, some of which had substantial operations in the U.K.
The FSA’s move puts the U.K. at the forefront of international efforts to prevent a repeat of recent bank collapses such as Lehman Brothers and Northern Rock. While the Group of 20 countries have pledged tighter liquidity rules and Australia recently put forward a first draft of its plans, the U.K. is the first to adopt formal requirements. And it could set a precedent for other markets.
But analysis conducted by the JWG-IT, a London-based consultancy specializing in regulatory compliance, last year showed that almost half of the London-based firms could fall short because there are no clearly defined benchmarks.
“Although the FSA has recognized that there are issues surrounding the data they have concentrated on the mechanics of the process rather than what the good data looks like. A more focused effort will be required to get in front of the data tsunami created by this regime,” says PJ DiGiammarino, chief executive of JWG-IT. “Data quality discussions are long overdue.Without banks and regulators agreeing on common methods of providing and receiving data the clarity sought by these regulatory efforts will not be achieved.”
So in the absence of some type of data rulebook what can firms do? Onorato recommends they evaluate the following – and quickly if they have not done so already.
- Management Oversight: Do we have an effective liquidity risk management framework which includes dissemination of risk-related information and management reporting?
- Technology: Do we have a strong technical framework to deliver the complex stress testing and simulations required and can information from all potential sources of an institution be incorporated?
- Functionality: Do our existing systems have the ability to analyze risk from multiple perspectives? To do this requires multiple risk analytics; flexibility of scenario testing; and an easy way to st up the new reports.
- Best practice: Can we future-proof our investment in compliance and be prepared for further regulatory developments.
U.K. financial firms shouldn’t be lulled into a false sense of security that they will be granted a waiver for good behavior. Neither should firms anywhere else. And there is no cheap way of understanding and measuring liquidity risk, but if you don’t do it you’ll have more than just the regulators on your back.
Creditors will also be knocking at your door and based on Lehman Brothers’ scenario, you don’t want that.
This article can also be found at SecuritiesIndustry.com.
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