Implementing Regulatory Reforms to Effectively Manage Risks relating to Financial Innovation, Emerging Products and Trends Jennifer Elliott Monetary and Capital Markets Department International Monetary Fund April 2015

Lessons from the GFC CreditMarket contagionInterconnectedness

Lessons for Reform Institutions were not sufficiently resilient ▫Capital ▫Liquidity ▫Funding profiles The full picture of the financial system was missing

Lessons for Reform Effect of a nonbank failure on a common asset market ▫ Bear Stearns, Lehman Brother: impact on repo, commercial paper markets

Lessons for Reform Credit asset markets had a broad impact Banks exposed to mispriced asset market ▫CDS market: mispriced because AIG finance arm was not regulated and was mispricing its risk. ▫AIG had to be saved to preserve this market, otherwise bank balance sheets would have collapsed ▫Monolines and credit guarantees

Lessons for Reform ▫Nonbank role in Funding markets :  US Money Market Funds: key investors in commercial paper, asset backed commercial paper and repos; vulnerable to abrupt withdrawal  Luxembourg money market funds: major source of short term funding for European banks; vulnerable to withdrawals/German bank guarantees

What about innovation? Securitization CDS Whole sale funding Mortgages

G20 Reform agenda Bank centered ▫Market and trading risk ▫Loss absorption and resilience to liquidity events ▫Too Big To Fail

Nonbank sector Still work in progress ▫OTC: trade reporting, CCPs ▫MMMFs: IOSCO standards ▫Shadowbanking:  Data gaps  Monitoring framework  Securities lending

Doing it differently: lessons for evolving markets Protect the core Better supervision (intrusiveness) Identify data needs (much is missing in nonbanks) Identify issues for perimeter of regulation Understand the channels of contagion or the risk picture Resolution and crisis management tools

Asset management, an example Systemically important non banks? Changes in profile? Search for yield? Recommendations ▫Data and analysis ▫More attention to liquidity profile  Supervision ▫Macroprudential outlook

Why do we emphasize supervision? Global Financial Crisis exposed supervisory failures FSAPs consistently show regulatory frameworks stronger than supervisory practices

What is good supervision? Ability to Act ▫Legal Authority ▫Human and technological capacity ▫Clear supervisory strategy ▫Robust internal organization ▫Coordination/cooperation with other agencies Will to Act ▫Independence ▫Accountability ▫Skilled staff ▫Healthy relationship with industry ▫Partnership with governing boards of banks and other institutions

What does good supervision look like? Intrusive Proaction Adaptive Comprehensive Conclusive

FSAP Findings BCP, ICP and IOSCO ratings on principles related to independence and resources and legal authority are consistently weaker points Increased focus on these elements in post crisis FSAPs Not just a problem for emerging and developing markets, although clear correlation to income and some regional differences

Global Implementation 17 Independence

Supervision Is supervision intrusive enough? Is the right mix of off- site and on-site work being used? 18

Independence Is there a capacity to act? Is there a will to act? 19

Identification of risks Do regulators have all the data that they need? Do regulators have the expertise to understand it? 20

Conclusions Innovation carries potential risks Supervision needs to play its role ▫Understanding risks ▫Understanding the big picture ▫Challenging the market ▫Policing the perimeter ▫Strong internal culture of supervion=agility in the face of change Life as a regulator will never be dull