At the G20 Summit in Cannes in early November, a raft of critical papers from the Financial Stability Board (FSB) were endorsed, setting out not only the policy for addressing the “too-big-to-fail” issues posed by Systemically Important Financial Institutions (SIFIs), but also naming the first 29 groups of Global SIFIs (“G-SIFIs“). In this article, Rosali Pretorius and Emma Radmore of SNR Denton look at the G20 conclusions and the current thinking of the UK and US authorities.
The Cannes Summit and the FSB Recommendations
The FSB package of policy measures will include:
- An international standard to be a point of reference for national resolution regimes: setting out responsibilities, instruments and powers that all national resolution regimes should have;
- Requirements for resolvability assessments, recovery and resolution plans (RRPs) and cross-border cooperation agreements specific to individual G-SIFIs: this should prepare home and host authorities better for dealing with crises and cooperating during them;
- Requirements that all global systemically important banks (G-SIBs) hold loss-absorption capacity above Basel III standards: this will rise from 1 to 2.5% risk-weighted assets; and
- More intensive and effective supervision.
FSB intends to use the Basel Committee on Banking Supervision (Basel) methodology to review and update a list of G-SIFIs each November. FSB and Basel will work to extend the framework to all SIFIs, and the International Association of Insurance Supervisors should complete its methodology for identifying globally systemic insurers by the June 2012 G20 Summit. The 29 groups named now must meet the requirements on resolution by the end of 2012. Banks that are identified as G-SIFIs in 2014 will have to meet the new loss absorbency requirements and supervisory expectations by 2016. FSB also intends to put in place a peer assessment programme to ensure proper implementation. The initial list of G-SIFIs includes entities headquartered in several jurisdictions, including the US, UK, rest of Europe and Asia Pacific.
Before FSB finalised its plans, however, the UK and the US had already both moved quickly to require recovery and resolution plans to resolve UK SIFIs and US SIFIs. In the UK and in the US, these plans are often referred to as “Living Wills”. This article looks at the UK proposals, distinguishing key differences between the planned UK and US regimes.
Living Wills in the UK
The Banking Act 2009 created a Special Resolution Regime (“SRR”) giving the Financial Services Authority (the “FSA”), the Bank of England and the UK Treasury various tools for resolving failed deposit-taking financial institutions. However, the UK authorities require detailed knowledge and understanding of a financial institution’s business to exercise the SRR tools and enable the orderly resolution of a failed financial institution without relying on taxpayer support. In February 2011, a special administration regime was introduced for investment firms. This was initiated for the first time when MF Global UK entered the process. Using powers under the Financial Services Act 2010, FSA published proposals for certain financial services firms to prepare and maintain RRPs and, in addition, for firms holding client money and assets to develop client asset resolution plans (“CASS RP”) to promote swift return of clients’ money and custody assets (“CMA”) should they fail. Some firms will have to prepare RRPs and CASS RRPs; smaller firms with CMA only CASS RRPs.
In the US, the Dodd Frank Act created the framework for Resolution Plans for SIFIs, and this is bolstered by rules of the Federal Deposit Insurance Corporation.
Who is covered?
The RRP requirements will apply to:
- All FSA-authorised banks and building societies regardless of size, including UK incorporated subsidiaries of overseas banks.
- Significant investment firms authorised by FSA, specifically full scope BIPRU 730k investment firms (firms with authority to deal on own account) with assets exceeding £15 billion.
The CASS RP requirement will apply to all firms subject to the FSA’s client asset custody rules and investment business client money rules. So some banks and significant investment firms may not need to also prepare a CASS RP. The FSA is not calling for RRPs from UK branches of overseas entities, partly because the SRR tools are unavailable to resolve branches of overseas banks.
In contrast, under the US plans, US SIFIs subject to resolution planning requirements will include:
- US bank holding companies with at least USD50 billion in consolidated assets;
- US branches and agencies of international banks, where the consolidated worldwide assets of the international bank is at least USD50 billion; and
- Any nonbank financial company designated as a SIFI by the FSOC
- US insured depository institutions with at least US$50 billion in assets must also file Living Wills
What should the RRP include?
The purpose of a Recovery Plan is to enable firms to plan how they would try to recover from severely adverse conditions that could cause their failure. Firms are responsible for preparing their Recovery Plans which are subject to FSA review and require updating yearly. A key aspect is deciding when the firm will carry out its Recovery Plan. Firms will be required to develop their own unambiguous triggers.
The purpose of Resolution Planning is to provide a strategy to resolve a failed firm or group in a manner that minimises the impact on financial stability without needing to resort to taxpayer support. The UK authorities are responsible for preparing a Resolution Plan, which must allow decisions and actions to be taken and performed in a short space of time (for example, over a ‘resolution weekend’). However, firms must provide a Resolution Pack to FSA, which is regularly updated to reflect any material developments in a firm’s business. The Resolution Pack must include:
- Details of significant entities in the group and the key structural and operational issues relevant to separating significant legal entities.
- Critical Function Contingency Analysis (“CFCA”) covering separation and / or ‘controlled wind-down’ for each critical role of the firm.
- Plans to overcome any barriers to resolution which the UK authorities consider unacceptable.
CASS Resolution Pack
This aims to reduce the wider economic cost of an in-scope firm failure. It ensures that information and records that would help an insolvency practitioner or resolution authority return client money and custody assets to clients more quickly, will be accessible to the insolvency practitioner or resolution authority after the firm’s failure.
While the content of US Living Wills is to be very detailed, they are resolution plans, and do not also include recovery plans.
Where next for the RRP?
The consultation period has just closed. FSA will publish final rules in the first quarter of 2012. Certain rules will come into effect during the first quarter of 2012, but FSA will also provide transitional rules so firms will have until June 2012 to prepare their first RRPs. Large banks, though, have taken part in FSA’s pilot exercise already. FSA should take account of the developments at the Cannes Summit when finalising its rules, but as with other reforms agreed at G20 level, the UK and US are pressing ahead of the game.
Rosali Pretorius is a Partner and Emma Radmore is a Senior Associate at SNR Denton UK LLP
© 2011 SNR Denton. SNR Denton is the collective trade name for an international legal practice. SNR Denton UK LLP is a limited liability partnership registered in England and Wales under no. OC322045. Regulated by the Solicitors Regulation Authority. A list of its members is open for inspection at its registered office: One Fleet Place, London EC4M 7WS.
Any reference to a “partner” means a partner, member, consultant or employee with equivalent standing and qualifications in one of SNR Denton’s affiliates. This publication is not designed to provide legal or other advice and you should not take, or refrain from taking, action based on its content. Attorney Advertising. Please see snrdenton.com for Legal Notices. Rosali Pretorius (Partner) and Emma Radmore (Senior Associate and Professional Support Lawyer) are members of SNR Denton’s London Financial Markets and Regulation practice. Contact them on +44 (0)20 7246 7000 ([email protected] or [email protected]).
Bond scares linger, investors look to Powell
By Tom Arnold and Hideyuki Sano
LONDON (Reuters) – Worries about lofty U.S. bond yields hit global shares on Thursday as investors waited to see if Federal Reserve Chair Jerome Powell would address concerns about a rapid rise in long-term borrowing costs.
The spectre of higher U.S. bond yields also undermined low-yielding, safe-haven assets, such as the yen, the Swiss franc and gold.
Benchmark 10-year U.S. Treasuries slipped to 1.453%. They earlier touched their highest levels since a one-year high of 1.614% set last week on bets on a strong economic recovery aided by government stimulus and progress in vaccination programmes.
“Equities and yields continue to both drive and thwart one another,” said James Athey, investment director at Aberdeen Standard Investments.
“Fed speech continues to express very little concern and certainly is not suggestive of any imminent action to curb the rise in yields. The Powell speech today is hotly anticipated, but I fear more out of hope than rational expectation.”
The Euro STOXX 600 was down 0.5% and London’s FTSE 0.6% lower.
The MSCI world equity index, which tracks shares in 49 countries, lost 0.5%, its third day running of losses.
The MSCI’s ex-Japan Asian-Pacific shares lost 1.8%, while Japan’s Nikkei fell 2.1% to its lowest since Feb. 5.
E-mini S&P futures slipped 0.2%. Futures for the Nasdaq, the leader of the post-pandemic rally, fell 0.1%, earlier hitting a two-month low.
Tech shares are vulnerable because their lofty valuation has been supported by expectations of a prolonged period of low interest rates.
But the market is focused on Powell, who is due to speak at a Wall Street Journal conference at 12:05 p.m. EST (1705 GMT), in what will be his last outing before the Fed’s policy-making committee convenes March 16-17.
Many Fed officials have downplayed the rise in Treasury yields in recent days, although Fed Governor Lael Brainard on Tuesday acknowledged that concerns over the possibility a rapid rise in yields could dampen economic activity.
In addition, anxiety is building over a pending regulatory change in a rule called the supplementary leverage ratio, or SLR, which could make it more costly for banks to hold bonds.
“The market is likely to be unstable until this regulation issue will be sorted out,” said Masahiko Loo, portfolio manager at AllianceBernstein. “There aren’t people who want to catch a falling knife when market volatility is so high.”
The market will also have to grapple with a huge increase in debt sales after rounds of stimulus to deal with a recession triggered by the pandemic.
The issue is not limited to the United States, with the 10-year UK Gilts yield on Wednesday touching 0.796%, near last week’s 11-month high of 0.836%, after the government unveiled much higher borrowing.
On Thursday, Germany’s 10-year yield was down 2 basis points to -0.31% after rising 5 basis points on Wednesday, still moving in tandem with U.S. Treasuries.
Currency investors continued to snap up dollars as they bet on the U.S. economy outperforming its peers in the developed world in coming months. [FRX/] The dollar rose to a roughly seven-month high of 107.33 yen.
“U.S. dollar/yen has been on a one-way trajectory since the start of 2021,” said Joseph Capurso, head of international economics at the Commonwealth Bank of Australia. “The brightening outlook for the world economy is a positive for both U.S. dollar/yen and Australian dollar/yen.”
Other safe-haven currencies were weakened, with the Swiss franc dropping to a five-month low against the dollar and a 20-month trough versus the euro.
Other major currencies were little changed, with the euro flat at $1.2054.
Gold fell to a near nine-month low of $1,702.8 per ounce on Wednesday and last stood at $1,714.
Investor focus on a U.S. economic rebound was unshaken by data released overnight that showed the U.S. labour market struggling in February, when private payrolls rose less than expected.
Oil prices rose for a second straight session on Thursday, as the possibility that OPEC+ producers might decide against increasing output at a key meeting later in the day underpinned a drop in U.S. fuel inventories. [O/R]
U.S. crude rose 0.6% to $61.65 per barrel. Brent crude futures added 0.7% to $64.54 a barrel,
(Additional reporting by Koh Gui Qing in New York; editing by Sam Holmes, Richard Pullin, Simon Cameron-Moore, Larry King)
Analysis: Global bond rout puts BOJ’s yield curve control in spotlight
By Leika Kihara
TOKYO (Reuters) – The Bank of Japan’s success in controlling the shape of the bond market’s yield curve could tempt other central banks to consider deploying similar tactics as they grapple with a rise in borrowing costs that could cripple their economies.
The Japanese central bank has kept bond yields largely pinned inside a narrow range around 0%, since it adopted its yield curve control (YCC) policy in 2016.
The merits of the policy are clear. By shifting to targeting yields, the BOJ could buy fewer bonds than under its massive bond-buying programme many analysts saw as unsustainable.
With a pledge to cap the 10-year Japanese government bond (JGB) yield at zero, the BOJ has kept rises in the benchmark yield at just 17 basis points this year, even as the U.S. Treasury yield spiked 70 points.
“YCC is working quite well. It relieved the BOJ from the burden of having to buy bonds at a set pace,” said former BOJ executive Shigenori Shiratsuka, currently professor at Keio University.
“Major central banks will probably follow in the footsteps of the BOJ,” as keeping rates low would be crucial in helping governments manage the huge cost of combating COVID-19, he said.
Indeed, some central banks are warming to YCC as they hunt for ways to reflate growth with dwindling policy ammunition.
Australia’s central bank adopted YCC in 2020 and defended its three-year yield target with huge bond buying.
The European Central Bank does not conduct explicit YCC but is tying its stimulus more heavily to the yield curve.
ECB board member Fabio Panetta said on Tuesday the recent steepening in the yield curve was “unwelcome and must be resisted,” pointing to the merits of a “firm commitment to steering the euro area yield curve.”
“This has to be as far as any ECB official ever went in terms of YCC commitment,” Pictet Wealth Management strategist Frederik Ducrozet said of Panetta’s comments.
NOT FOR EVERYONE
Japan’s nearly five years of experience with YCC has exposed some of its flaws. The BOJ has said it will look into making its tools more “sustainable and effective”, including by addressing the demerits, when it carries out a policy review this month.
Indeed, YCC could be difficult to maintain and may not suit everyone. The Fed has stopped short of introducing a yield cap, despite studying it for years.
BOJ policymakers concede YCC worked in Japan because of the central bank’s huge presence in the bond market and a dearth of expectations that inflation would pick up.
On the rare occasion the 10-year yield deviated from its target, the BOJ stepped up purchases such as through a “special” operation where it offered to buy unlimited amounts at a set price.
This could be a costly operation in a vastly diverse $18 trillion U.S. Treasury market, where controlling yields could be far more challenging than in the $9 trillion JGB market.
“I won’t rule out the chance of the Fed adopting a two-year yield cap, if interest rates continue to rise and destabilise the stock market,” said former BOJ official Nobuyasu Atago, who is now chief economist at Japan’s Ichiyoshi Securities. “But there’s a lot of uncertainty on whether it will work.”
For now, major central banks see no problem with higher inflation. Fed policymakers consider the recent jump in yields as an “appropriate” reaction to hopes for higher growth.
Even if the rise were to be considered too much, the Fed has an interim step short of YCC, such as buying longer-dated bonds.
Being too successful with YCC comes at a cost. Market liquidity dried up as Japan’s 10-year yield mostly hugged a 20-basis-point band around the 0% target since YCC was rolled out.
(Click here for an interactive graphic of Japan’s JGB yields since early 2016: https://tmsnrt.rs/2May3Ye https://tmsnrt.rs/2May3Ye)
The BOJ will thus discuss ways to allow 10-year yields to deviate more from its target at the March review, sources have told Reuters.
Allowing yields to rise more would help make YCC more sustainable, as vaccine rollouts could drive up economic growth, inflation and long-term rates in the coming months, analysts say.
But if the BOJ allows rates to fluctuate more widely, it risks undermining the credibility of YCC.
“If the BOJ is being forced to allow yields to move at a wider range around its target, it shows that markets are deciding the shape of the yield curve and that there are limits to the BOJ’s ability to control it,” said former BOJ deputy governor Hirohide Yamaguchi.
“It’s hard to control long-term interest rates within a tight range for a long period of time.”
(Additional reporting by Balazs Koranyi in Frankfurt and Howard Schneider in Washington; Editing by Jacqueline Wong)
Wall Street slides on tech sell-off, other world stocks flat
By Suzanne Barlyn
NEW YORK (Reuters) – Wall Street fell on Wednesday as investors sold off technology stocks, while shares from Asia to Europe were flat, while the dollar rose even as U.S. jobs data disappointed investors and virtual currency bitcoin jumped.
The pan-European STOXX 600 index rose 0.05% and MSCI’s gauge of stocks across the globe shed 0.68%.
“We’re seeing a lot of what we’ve seen over the past week or so, that is markets being stymied to some extent by rising interest rates,” said Randy Frederick, vice president of trading and derivatives for Charles Schwab in Austin, Texas.
The Dow Jones Industrial Average fell 119.98 points, or 0.38%, to 31,271.54, the S&P 500 lost 50.51 points, or 1.31%, to 3,819.78 and the Nasdaq Composite dropped 361.04 points, or 2.7%, to 12,997.75.
Equities retreated as benchmark U.S. Treasury yields moved higher after declining for three straight days.
High-flying technology shares sold off as investors pivoted to sectors more likely to benefit as the economy recovers due to fiscal stimulus and vaccinations.
Emerging market stocks rose 1.30%. MSCI’s broadest index of Asia-Pacific shares outside Japan closed 1.42% higher, while Japan’s Nikkei rose 0.51%.
The U.S. economy’s modest recovery continued over the first weeks of this year, with businesses optimistic and housing demand “robust,” with slow improvement in the job market, the Federal Reserve reported.
Other data showed U.S. services industry activity unexpectedly slowed in February due to winter storms, while private payrolls increased less than expected as manufacturing and construction jobs declined.
Investors were growing optimistic that U.S. stimulus will soon energize the global economy. The U.S. Senate was set to open debate on President Joe Biden’s $1.9 trillion coronavirus relief package, with Democrats eager to pass it soon.
UK Finance minister Rishi Sunak delivered what he hopes will be a last big spending splurge to get Britain’s economy through the COVID-19 crisis, and announced a corporate tax hike starting in 2023 to bolster public finances.
Longer-term U.S. Treasury yields rose as investors looked toward comments from Federal Reserve Chair Jerome Powell on Thursday for signs the central bank was set to acknowledge the risk of a rapid rise in rates.
The benchmark 10-year note was poised to snap a three-day streak of declines following a jump to a one-year high of 1.614 percent last week, with many Fed officials having downplayed the rise in recent days.
Benchmark 10-year notes last fell 15/32 in price to yield 1.467%, from 1.415% late on Wednesday.
Euro zone government bond yields rose again on doubts about whether the bloc’s central bank will step in to curb the recent sharp increase, while data reflected optimism about economic recovery.
Although yields have dipped from their highs, pressure remains, with Germany’s 10-year Bund yield, the benchmark for the region, rising 5 basis points to -0.29%. It remained far below its Feb. 26 spike of -0.203%.
The dollar gained as investors priced for strong U.S. growth relative to other regions, while the safe-haven Japanese yen continued to weaken to a seven-month low.
The dollar index rose 0.157%, with the euro down 0.21% to $1.2064.
Bitcoin hit $52,652, the highest in a week. It was last up 4.1% at $50,533.
Spot gold dropped 1.3% to $1,715.40 an ounce. U.S. gold futures fell 0.85% to $1,715.30 an ounce.
Oil prices rose, boosted by expectations that OPEC+ producers might decide against increasing output.
U.S. crude recently rose 2.44% to $61.21 per barrel and Brent was at $64.04, up 2.14% on the day.
(Reporting by Suzanne Barlyn; Editing by David Gregorio)
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