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Basel Committee on Banking
Supervision, The Joint Forum
Review of the Differentiated
Nature and Scope of Financial Regulation
Key Issues and
Recommendations (January 2010)
V. Recommendations and options for effective and consistent
financial regulation across sectors
The Joint Forum provides 17
recommendations arranged in the same order as the five
key issues and gaps addressed in this Executive Summary.
The recommendations seek to enhance
the nature and expand the scope of financial regulation to
achieve particular goals.
Most of the
recommendations are broad in nature.
As a result, some follow-up work will be needed to further
elaborate upon the recommendations and to successfully and fully
implement them, taking into account ongoing work or intiatives
by the parent committees.
In cases where the Joint Forum
could not reach consensus on recommendations, policy options are
provided to give policymakers choices for strengthening
financial regulation or broadening its scope.
A. Reducing key regulatory differences across the banking,
securities, and insurance sectors
Financial supervision and regulation is sector-specific, as
evidenced by the independent development of core principles and
standards for the banking, securities, and insurance sectors.
Such principles do not specifically take into account
systemic risk or financial system stability in a consistent
manner.
In addition, differences exist with respect to
the relative importance attached to prudential or market conduct
regulation by supervisors across the three sectors.
Even
though the boundaries of activities among the three sectors have
become increasingly blurred over time, this sector-specific
approach comes at the risk of more differentiated financial
supervision among sectors.
The Joint Forum recommends a
more coordinated approach among the three sectors.
Recommendation n° 1:
The BCBS, IOSCO, and IAIS should review and revise their core
principles to ensure that the principles appropriately take into
account systemic risk and the overall stability of the financial
system.
Work should also be carried out to update and make more
consistent principles related to market conduct, consumer
protection, and prudential requirements.
In the
March 2009 report on Enhancing Sound
Regulation and Strengthening Transparency, the G-20 recommended
that, as a supplement to their core mandate, the mandates of all
international financial bodies and standard setters (the IASB,
BCBS, IOSCO, and IAIS) should take account of financial system
stability.
The Joint Forum agrees that maintaining
overall financial system stability and reducing systemic risk is
a cross-sectoral principle of financial supervision and
regulation that should be further developed in each sector’s
core principles.
The Joint Forum agrees with the G-20
recommendation and encourages BCBS, IOSCO, and IAIS to review
and revise, as necessary, their respective core principles to
take into account financial system stability.
The extent
to which concerns over systemic risk and financial stability
play a role in the development of supervisory policies and
approaches should be made clearer for each sector, possibly to
include an overarching principle addressing overall financial
system stability.
Generally, the Joint Forum believes
that increasing the consistency of the sectors’ core principles
will contribute to reducing regulatory gaps.
Work should
also be carried out to strengthen consistency in core principles
related to market conduct, consumer protection, and prudential
requirements. For example, ensuring that there are adequate
principles regarding market conduct and customer protection
would be for the benefit of customers and would enhance
confidence.
This assurance would also help reduce the
possibilities for regulatory arbitrage regarding product
manufacturing and distribution across sectors.
Recommendation n° 2:
International prudential frameworks for minimum capital adequacy
should be in place within each sector to reduce regulatory
arbitrage across countries and to facilitate the supervision of
cross-border groups.
A uniform
minimum global capital standard does not exist for the
securities and insurance sectors.
The BCBS’s core
principles alone incorporate the requirement for a uniform
risk-based capital standard to reduce competitive inequalities
across countries and to safeguard financial stability.
IOSCO and IAIS expect supervisors to promulgate capital
requirements, but they do not have a single global capital
standard for their respective sectors.
It is the Joint
Forum’s view that the lack of a uniform global standard for
capital adequacy within each sector can contribute to regulatory
arbitrage, competitive inequalities across jurisdictions, and,
in some cases, financial system instability.
Striving for
a single global standard, however, should not result in the
lessening of existing prudential standards.
Recommendation n° 3:
In addition to making core principles more consistent across
sectors, the BCBS, IOSCO, and IAIS should work together to
develop common crosssectoral standards where appropriate so that
similar rules and standards are applied to similar activities,
thereby reducing opportunities for regulatory arbitrage and
contributing to a more stable financial system.
The G-20 noted that, in order to avoid
regulatory arbitrage, there is a need for greater consistency in
the regulation of similar instruments and of institutions
performing similar activities, both within and across borders.
The Joint Forum agrees with this need for greater
consistency.
Comparable high-quality cross-sectoral
standards should be developed with the goal of reducing
opportunities for regulatory arbitrage by ensuring, to the
extent possible, that similar activities are subject to similar
rules and standards.
Recommendations for mortgage
origination and credit risk transfer products, as outlined in
Chapters 3 and 5 of this report, provide examples of possible
crosssectoral standards.
Further work is needed to
identify additional instances where similar standards should be
applied to similar activities, regardless of the sector in which
the activities are conducted.
B. Strengthening supervision and regulation of financial groups
The Joint Forum believes that all financial groups,
particularly those that are active across borders, should be
subject to supervision and regulation that captures the full
spectrum of their activities and risks.
A
variety of
regulatory frameworks and approaches have contributed to
financial groups being subject to supervision and regulation
that did not fully capture the significance or potential costs
of their risks.
Frameworks for supervision and regulation
of financial groups should be clear and applied consistently,
and should cover all financial activities and risks within
groups, irrespective of where they may arise or whether those
activities are conducted through regulated or unregulated
entities within each group.
These frameworks should
clearly set out the powers and responsibilities of supervisors
and supplement the supervision and regulation applicable to
individual regulated entities or activities within the group.
As noted in the previous section,
common cross-sectoral standards should be developed whenever
justified.
These standards would supplement the
recommendations that aim at strengthening supervision and
regulation of financial groups.
These standards should
also be applied with particular intensity
when a group or any single entity within a group is identified
as systemically important.
Any differences in the
supervision and regulation of financial groups should be
justified.
Identifying and addressing these
differences will improve the ability of supervisors to monitor
and, as appropriate, mitigate the potential risks and threats
financial groups can create.
Recommendation n° 4:
Policymakers should ensure that all financial groups
(particularly those providing cross-border services) are subject
to supervision and regulation that captures the full spectrum of
their activities and risks.
The cost of the failure or
near-failure of financial groups, together with lessons learned
from the financial crisis, has reaffirmed the importance of the
supervision and regulation of financial groups.
As the
financial crisis has shown, risks assumed by unregulated
companies within a group may significantly affect the whole
group, including in particular its regulated entities.
To be effective, the supervision of financial groups should seek
to ensure full capture and treatment of all risks and entities
of the groups.
This implies that financial groups should
be subject primarily to group-wide
supervision.
Given the diversity across sectors
for the supervisory and regulatory frameworks of financial
groups, group-wide supervision should be fully implemented and
practiced by each sector while also recognising the critical
importance of supervision and regulation of the individual
entities within the group.
The IAIS underscored the
importance of appropriate supervision of financial groups by
assigning a task force in 2009 to consider the merits of
designing a common framework for the supervision of insurance
groups.
In this context, substantial progress toward
strengthening the supervision and regulation of financial
groups, including unregulated risk, is expected to be achieved.
Recommendation n° 5:
The 1999 Joint Forum principles on the
Supervision of Financial Conglomerates should be reviewed and
updated.
The Joint Forum defines a financial
conglomerate as any group of companies under common control
whose exclusive or predominant activities consists of providing
significant services in at least two different financial sectors
(banking, securities, and insurance).
In 1999, the Joint
Forum issued a comprehensive set of principles covering capital
adequacy, sound and prudent management, supervisory information
sharing, intra-group transactions and exposures, and risk
concentration.
The recommended review
should focus on the
supervisory powers over unregulated parent holding companies,
the oversight and access to information of unregulated entities
within a group, the calculation of capital adequacy on a group
basis with regard to unregulated entities and activities (such
as special purpose entities), the oversight of intra-group
transactions and exposures involving regulated entities, the
coordination among supervisors of different sectors, and the
governance and risk management systems and practices of groups.
The principles should be updated to:
- ensure that the principles properly
address developments in sectoral frameworks (eg Basel II) and in
the markets since 1999;
- facilitate more effective
monitoring of activities and risks within a financial group,
particularly when these activities span borders and the
boundaries across the regulated and unregulated areas of the
financial system;
- provide a basis for increased
intensity of supervision and regulation of financial groups,
particularly when a group or any of its institutions are
identified as systemically important;
- improve
international collaboration, coordination, and cooperation among
supervisors across sectors;
- clarify the responsibility
and power of supervisors with respect to the risks in their
jurisdictions stemming from an entity being part of a financial
group;
- ensure that financial groups’ structures are
transparent, consistent with their business plans, and do not
hinder sound risk management; and
- provide, to the
extent possible, credible and effective options for action
during a crisis or to avoid a crisis.
Recommendation n° 6:
The BCBS, IOSCO, and IAIS should work together to enhance the
consistency of supervisory colleges
across sectors and ensure that cross-sectoral issues are
effectively reviewed within supervisory colleges, where needed
and not already in place.
Independent of the development
of common standards and principles across sectors, actions are
needed to improve coordination and cooperation with regard to
the supervision, and potential cross-border resolution, of
financial groups.
Actions are also needed for
accessing
and sharing information, notably for unregulated entities.
The FSB, BCBS, IOSCO, and IAIS have identified supervisory
colleges as a major tool to improve this supervisory
coordination and cooperation.
The Joint Forum recognises
that work is being done on a sectoral basis but believes that
there is merit in developing colleges of a cross-sectoral nature
or in making supervisory colleges consider effectively
cross-sectoral issues.
C. Promoting consistent and effective underwriting standards for
mortgage origination
Because each country’s mortgage industry is shaped by
distinct real estate markets, cultural influences, and
socioeconomic policies, it would be challenging to construct a
single regulatory approach to mortgage underwriting standards.
To help prevent recurrences of the market disruption and
financial instability recently experienced, however, supervisors
should address issues in their respective mortgage markets to
achieve more consistent and more effective regulation of
mortgage activities.
Sound underwriting standards are
integral to ensuring viable, robust mortgage markets at the
local and global levels and may improve financial stability
notably when mortgages are securitised.
Systemic risk will be reduced if mortgages are properly
underwritten, ensuring that borrowers have the capacity and
economic incentive to honour their commitments to retire the
debt in a reasonable period of time.
Indeed, by focusing
on prudent underwriting, supervisors can help institutions and
markets avoid the broad-based issues and disruptions experienced
in recent years and potentially help restore
securitisation/structured finance markets.
Therefore, the
Joint Forum recommends that supervisors take the following
actions:
Recommendation n° 7:
Supervisors should ensure that mortgage originators adopt
minimum underwriting standards that focus on an accurate
assessment of each borrower’s capacity to repay the obligation
in a reasonable period of time.
The minimum standards
adopted should be published and maintained in a manner
accessible to all interested parties.
Measuring a
borrower’s ability and willingness to repay:
Standards
should incorporate requirements consistent with the following
basic principles, with guidelines and limits adjusted to reflect
the idiosyncrasies of the supervisors’ respective markets and
regulatory framework.
Effective verification of income
and financial information.
Capacity measurements, such
as debt-to-income ratios, are only as good as the accuracy and
reasonableness of the inputs.
That is, the efficacy of
debt-to-income ratios and other capacity measures is dependent
on stringent guidelines for verifying a borrower’s income and
employment, debt, and other financial qualifications for
repaying a mortgage.
When lenders
allow borrowers to claim unsubstantiated financial information,
or do not require such information, they undermine underwriting
policies and introduce additional credit risk as well as expose
themselves to fraud.
Supervisors should therefore
generally require lenders to verify information submitted for
mortgage qualification.
There also should be penalties
for borrowers and other originators who misrepresent such
information.
Reasonable debt service coverage.
One of the most fundamental components of prudent underwriting
for any product that relies on income to service the debt is an
accurate assessment of the adequacy of a consumer’s income,
taking into account all debt commitments.
These
assessments and calculations should accurately capture all debt
payments, and any exclusions should be well controlled.
The assessment also should ensure sufficient discretionary
income to meet recurring obligations and living expenses.
Supervisors should adopt appropriate
standards to ensure reasonable debt-to-income coverage for
mortgages.
As a secondary capacity test,
supervisors should consider appropriate standards regarding
incometo- loan amount (eg loan amount should generally not
exceed a particular multiple of annual earnings).
Realistic qualifying mortgage payments.
At least in the
United States, there was a proliferation of mortgage products
with lower monthly payments for an initial period that were to
be offset by higher monthly payments later (eg “teaser rate”
mortgages, “2/28” adjustable rate mortgages, payment option
mortgages).
In some cases, the initial monthly payments
were much lower than the payments scheduled for later.
Many lenders determined whether a borrower
qualified for a mortgage by calculating the debt-to-income ratio
using only the reduced initial monthly payment, without taking
into account the increase in that payment that would occur
later.
When house prices stopped appreciating, and
then declined, borrowers could no longer refinance loans and
very often could not afford the mortgage payment once it reset
to a higher rate.
To address this problem,
underwriting standards should require that
the analysis of a borrower’s repayment capacity be based on a
mortgage payment amount sufficient to repay the debt by the
final maturity of the loan at the fully indexed rate, assuming a
fully amortising repayment schedule.
Any potential
for negative amortisation should be included in the total loan
amount used in the calculation.
Appropriate loan-to-value
ratios.
Supervisors should adopt appropriate standards
for loan-to-value (LTV) ratios. Equity requirements should
address loan underwriting in the form of both minimum down
payments16 and caps on subsequent equity extraction through
cash-out refinancing and other types of home equity borrowing.
Meaningful initial down-payment requirements help validate
borrower capacity as well as ensure necessary commitment to the
obligation. Equity extraction limitations contribute to housing
market stability, deter irresponsible financial behaviour that
puts homes at risk, and promote savings through equity build.
They effectively limit the fallout associated with
unfettered “monetization” of the equity gained during periods of
rapid home price appreciation, especially since that
appreciation may not prove sustainable. However, while LTV
limits help control the lender’s loss exposure upon default,
they should not be relied on exclusively because they are not a
substitute for ensuring the paying capacity of the borrower.
Effective appraisal management.
The LTV measure relies on sound real estate values.
If lenders assign unsubstantiated values to mortgage
collateral, the effectiveness of LTV thresholds or minimum down
payments is significantly diminished.
Therefore,
supervisors should ensure the adoption of and adherence to sound
appraisal/valuation management guidelines, including the
necessary level of independence.
No
reliance on house appreciation. Lenders should not consider
future house price appreciation as a factor in determining the
ability of a borrower to repay a mortgage.
Other
factors important to an effective underwriting program:
The following are not substitutes for sound underwriting
practices but should be taken into consideration when
determining the soundness of an underwriting program.
Mortgage insurance.
Mortgage insurance provides
additional financing flexibility for lenders and consumers, and
supervisors should consider how to use such coverage effectively
in conjunction with LTV requirements to meet housing goals and
needs in their respective markets.
Supervisors should
explore both public and private options (including
creditworthiness and reserve requirements), and should take
steps to require adequate mortgage insurance in instances of
high LTV lending (eg greater than 80 percent LTV).
Recourse. Individual financial responsibility is critical to
ensuring the smooth functioning of the mortgage market for all
participants. Consequently, mortgage loans should be backed by
full recourse to the borrower.
Recommendation n° 8:
Policymakers should ensure that different types of mortgage
providers, whether or not currently
regulated, are subject to consistent mortgage underwriting
standards, and consistent regulatory oversight and enforcement
to implement such standards.
The goal is to
ensure
that similar products and activities are subject to consistent
regulation, standards, and examination, regardless of where
conducted.
The role of mortgage participants should be
clear, and they should be subject to appropriate and consistent
levels of regulatory oversight and enforcement.
Any
framework should include provisions for ongoing and effective
communication among supervisors.
The lines of
supervision must be clearly drawn and effectively enforced for
all market participants.
The Joint Forum recognises that
this recommendation presents many challenges because it requires
changes to some countries’ legal and supervisory regimes.
Nevertheless, the importance of the goal of consistent
underwriting standards makes these changes worthwhile.
Recommendation n° 9:
National policymakers should establish appropriate
public disclosure of market-wide mortgage underwriting
practices.
In addition, the Financial Stability
Board should consider establishing a process to review sound
underwriting practices and the results should be disclosed.
While there are efforts under way in some parts of the world
to harmonise mortgage lending practices across borders, this is
a longer term challenge given the differences in mortgage
markets.
However, these individual markets can be evaluated to
determine the overall adequacy of underwriting practices and
mortgage market trends.
To address this recommendation
and to have an international effect, the
following should occur:
•
Countries should have adequate public disclosure that includes
dissemination of information concerning the health of their
mortgage market, including underwriting practices and market
trends, encompassing all mortgage market participants.
•
The Financial Stability Board should consider establishing a
process to periodically review countries against the sound
mortgage underwriting practices noted in recommendation 7, and
the results should be made publicly available.
The
goal is to evaluate the soundness of mortgage practices overall
rather than to evaluate individual components.
For
example, a country with high LTV limits may mitigate the risk
through more stringent debt-to-income or other capacity limits.
The review process would consider the level of risk
posed by the underwriting criteria as a whole rather than focus
solely on the high LTV limits.
The review may also
consider underwriting in light of macroeconomic conditions,
including evolution of housing prices, interest rate levels,
total mortgage debt to gross domestic product, and reliance on
various funding mechanisms.
• The Financial Stability
Board should consider monitoring the health of the mortgage
market (eg country volumes, funding needs, bond performance) to
highlight emerging trends and to consider recommending
adjustments or changes as warranted.
D. Broadening the scope of regulation to hedge fund activities
Hedge funds have been clearly identified as one of the most
significant group of institutions in the “shadow” banking
system, notably by the G-20.
Measures have already been taken or are under discussion to
supplement the traditional indirect approach to regulate hedge
funds (ie where supervisors regulate other entities’
interactions with hedge funds).
These measures would
increase direct regulation of hedge funds or their managers and
may help to mitigate their risks.
In June 2009, IOSCO
made a significant contribution at the international level
regarding regulation of hedge funds with the publication of its
report titled Hedge Fund Oversight: Final Report.
The
following Joint Forum recommendations and policy options fully
take into account IOSCO’s work to avoid duplication of efforts
and to leverage analysis already conducted.
The Joint
Forum fully supports the six high-level principles on the
regulation of hedge funds and/or hedge fund managers/advisers
(or hedge fund operators) as set forth by IOSCO.
Prime
brokers and banks that provide financing and other services to
hedge funds are subject to both conduct of business and
prudential regulations in all jurisdictions.
This
regulation includes standards on risk
management of counterparty risk exposures.
In
fact, as mentioned, the prevailing indirect approach to
addressing risks posed by hedge funds has, thus far, been
through regulation of relevant counterparties.
Therefore,
although counterparties and investors can be a transmission
mechanism for financial distress, the Joint Forum in this report
focuses on existing gaps in the direct prudential regulation of
hedge fund operators and relevant hedge funds.
Because
most of the concerns relating to hedge fund activities are
shared with other categories of market participants, such as
similar types of less-regulated investment vehicles and/or their
operators, the Joint Forum’s recommendations and policy options
have a functional tenor.
They apply
to all pools of capital and to managers/advisers who engage in
activities posing risks substantially similar to hedge funds,
regardless of how they are denominated or qualified
domestically.
This approach is aimed at
encompassing existing differences in the definition of hedge
funds at the national level, or even the lack of definition, and
at avoiding regulatory arbitrage.
Recommendation n° 10:
Supervisors should introduce and/or strengthen (in view of the
risk posed) appropriate and proportionate
minimum risk management regulatory standards for hedge fund
operators. If necessary, supervisors should be given the
authority to do so.
The minimum risk management
regulatory standards should be scaled to the size and complexity
of the funds ; in particular, supervisors should strongly
consider adopting the following standards:
Maintenance of
an appropriate risk management policy. Hedge fund operators
should be required to develop and maintain appropriate,
proportionate, and documented risk management policies to
identify, measure, monitor, and manage all risks stemming from
the activity of each managed hedge fund, consistent with its
intended risk profile.
Appropriate reporting lines
should be established to ensure frequent and timely reporting to
senior management about the actual level of risks.
Establishment of an effective risk
management function.
Risk
management policies and procedures should be implemented through
the establishment of an effective risk management function
within the hedge fund operator, appropriate to their respective
risk profile.
The risk management function should
be hierarchically and functionally independent from the hedge
fund management functions.
Where the establishment of a
separate risk management function would be disproportionate to
the nature, scale, or complexity of the hedge fund operator’s
activity, the hedge fund operator should establish appropriate
safeguards against conflicts of interest and be able to
demonstrate that the risk management process is consistently
effective.
Management of liquidity risk and
stress tests. The operator should
be required, for each hedge fund it manages, to employ
appropriate liquidity risk management systems.
This is
to ensure that the liquidity profile of the hedge fund’s
investments complies with its obligations and the redemption
policy that has been disclosed to its investors, including
possible gates and suspensions.
The hedge fund operator
should be required to conduct stress tests to assess and monitor
the liquidity risk (and possibly other risks) under normal and
exceptional circumstances for consistency with the funds’
liquidity profile.
Conditions for delegation of
activities relating to risk management.
When a hedge
fund operator delegates the performance of risk management to a
third party, the hedge fund operator should remain fully
responsible for the selection of the third party and for the
proper performance of the risk management activity.
The
delegation should not prevent effective supervision by the
relevant authorities of the adequacy of the risk management
process.
Need for adequate and effective risk measurement
methods and techniques.
Hedge fund
operators should be required to adopt adequate and effective
arrangements and techniques for risk measurement to ensure that,
for each hedge fund they manage, the risks of the positions and
their contribution to the overall risk profile are accurately
measured to ensure consistency with the fund’s risk profile.
These methods should include both quantitative measures and
qualitative techniques aimed at measuring the effects of market
risk, credit risk (including issuer risk and counterparty risk)
and liquidity risk.
Recommendation n° 11:
Supervisors should impose reporting
requirements on hedge fund operators to identify current or
potential sources of systemic risk and to enable cross-sectoral
monitoring of systemically important hedge funds.
If necessary, supervisors should be given the authority to
do so.
Meaningful information should be reported to
supervisors to enable them to monitor, evaluate, and exchange
information on systemic risks on a cross-sectoral basis.
To this end, the Joint Forum supports the IOSCO initiatives
to develop appropriate reporting requirements.
Recommendation n° 12:
In view of the operational risks
posed and in order to allow for orderly winding down of a fund
operator in the event of bankruptcy, supervisors should impose
minimum initial and ongoing capital requirements on operators of
systemically relevant hedge funds.
If necessary,
supervisors should be given the authority to do so.
There
should be initial and ongoing capital
requirements for relevant hedge fund operators as a condition
for registration and ongoing supervision.
Such
requirements could be designed to absorb losses arising from
operational failures and may allow for orderly winding down of a
fund operator in the event of bankruptcy.
The level of
minimum capital standards should be enough to allow an orderly
liquidation of or transfer of funds managed by a failing hedge
fund operator and take account of the obligations of the
operator.
Operators should be subject to timely regular
reporting to their supervisors in order to allow supervisors to
monitor on an on-going basis the capital adequacy.
Options to be considered for systemically
relevant pools of assets
In addition to the prior
recommendations, other options set forth below may help mitigate
any risks posed by hedge funds and comparable pools of assets.
The Joint Forum has not reached a consensus on the
following policy options but has nevertheless decided to include
them in the interest of providing policymakers with regulatory
actions that are supported by some but not all Joint Forum
members.
The following options are aimed at addressing
the macroprudential risks, particularly procyclicality and
leverage-related risks, posed by a pool of assets itself (as
opposed to its operator), where the size or other
characteristics of the pool are deemed to make it systemically
relevant.
The identification of the criteria to assess
the systemic importance of a pool of assets, such as a hedge
fund, should take into account the work done by the
International Monetary Fund, the Bank for International
Settlements, and the Financial Stability Board.
Haircuts and margin requirements:
To mitigate counterparty credit risk, supervisors could require
hedge funds to provide collateral in excess of the value of the
funds borrowed.
This option would limit leverage only if
generally imposed by all counterparties, since otherwise the
collateral for one counterparty could be financed by borrowing
from the other.
Imposing closed-end
form/redemption gates: To limit excessive funding
liquidity risks, supervisors could require hedge funds that
significantly invest in illiquid assets (eg more than a certain
percentage of their portfolio) be set up as closed-end funds or
to adopt adequate gating structures in order to address
liquidity mismatches.
Risk-independent leverage requirements: To avoid
excessive risk-taking, supervisors could impose direct and
simple caps on leverage, including from exposures arising from
derivatives and/or financing.
Risk-based capital or leverage requirements: Supervisors
could limit leverage, including from exposures arising from
derivatives and/or financing, specified as a function of risk
weighted assets, so that limits become more stringent when
assets are riskier.
Risk management procedures for the
timely delivery of financial instruments.
Short selling is a legitimate trading
technique.
But hedge fund operators that engage in
short selling should be required to ensure that each hedge fund
they manage, irrespective of the hedge fund’s domicile and legal
nature, is organised and operated to comply with applicable
regulatory requirements to avoid market disruption.
To promote this goal, hedge fund operators engaging in short
selling should be required to adopt procedures that ensure
timely delivery of the short sold financial instruments (eg by
adhering to a master agreement that governs borrowing/lending of
securities).
Potential advantages
of options: These options might be used as tools for
imposing limits to the level of leverage and preventing
excessive risk taking by hedge funds.
This approach
would promote a more level playing field between hedge funds and
other more traditional regulated market participants that pose
similar prudential risks, for example, operators of other types
of collective investment undertakings and bank trading desks.
Potential disadvantages of options:
Setting ex ante leverage or liquidity caps or leverage
requirements could be an extremely difficult and complex task,
considering the different strategies and activities of hedge
funds.
The risk is that setting arbitrary limits could
cause market distortion and would almost certainly be gamed.
Imposition of limits beyond those essential to mitigate
excessive systemic risk would unduly limit investor choice.
Outright regulation might also be expected to increase moral
hazard or shift the activity to any jurisdiction that imposes
less hedge fund regulation.
In this context,
international regulatory and supervisory convergence remains
critical.
Basel Committee on
Banking Supervision, The Joint Forum
Review of the Differentiated
Nature and Scope of Financial Regulation
Key Issues and
Recommendations (January 2010)
Conglomerates
- Part 1:
Introduction, Mandate, Focus and guiding principles of this study,
Key issues and gaps
Conglomerates - Part 2:
Supervision and regulation of financial groups. Mortgage
origination. Hedge funds
Conglomerates - Part 3:
Recommendations and options for effective and consistent
financial regulation across sectors. Reducing key regulatory
differences across the banking, securities, and insurance sectors.
Strengthening supervision and regulation of financial groups.
Promoting consistent and effective underwriting standards for
mortgage origination. Broadening the scope of regulation to hedge
fund activities
Conglomerates - Part 4:
Strengthening regulatory oversight of credit risk transfer
products. Key differences in regulation across the banking,
securities, and insurance sectors.
Background and approach adopted by the Joint Forum. Key issues
and gaps
Conglomerates - Part 5:
Recommendations to reduce key differences in regulation across
the banking, securities, and insurance sectors. Supervision and
Regulation of Financial Groups. SPEs. Key issues and gaps.
Recommendations to strengthen supervision and regulation of
financial groups
Conglomerates - Part 6:
Mortgage Origination. United Kingdom, United States, Spain,
Canada, Germany. Key issues and gaps. Recommendations to promote
consistent and effective underwriting standards for mortgage
origination
Conglomerates - Part 7:
Hedge Funds. Key issues and gaps
Conglomerates - Part 8:
Recommendations and policy options to broaden the scope
of regulation to hedge fund activities.
Credit Risk Transfer Products.
Key issues and gaps common to both CDS and FG insurance (CDS -
Credit default swaps, FG - Financial guarantee)
Conglomerates - Part 9:
Key issues and gaps specific either to CDS or FG insurance.
Recommendations and policy options to strengthen regulatory
oversight of credit risk transfer products
Conglomerates - Part 10:
Annex 1-9
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