RD News 18Jan12

• Andrew Sheng: The natural evolution of markets
• There were two major reasons for the large profits in finance.
• The first is that the physical cost of creation of a financial derivative is almost zero, as it is an abstract product of its creator’s imagination. For many, the reason to buy a derivative is to hedge and reduce risk. If a buyer believes that the hedge is useful, which it can be under specific circumstances then he or she will be willing to pay a premium for that hedge.
• A second reason is leverage. The greater the leverage, the larger the profits are for both lender and borrower. But there is a catch – it adds systemic risk to the entire market and can be fatal to the over-leveraged borrower.
• The Holy Grail of financial theory and practice in the world’s advanced economies is to identify at what level of complexity financial markets exceed the limits of social stability.

• CPSS: OTC derivatives data reporting and aggregation requirements - final report
• Trade repositories, by collecting data centrally, would provide authorities and the public with better and more timely information on OTC derivatives. This would make markets more transparent, help to prevent market abuse, and promote financial stability.
• Questions remain regarding how best to address current data gaps and define authorities' access to TRs.
• The FSB will establish an ad hoc group of experts to further consider means of filling current data gaps, while the CPSS and IOSCO will establish a joint group to examine authorities' access to TRs.

• Elizabeth Duke (Fed Board): Opportunities to reduce regulatory burden and improve credit availability
• Vital to have regular feedback from bankers and consumers of banking services to understand the impact of regulation - both its effectiveness in achieving intended results and in limiting any unintended consequences.   

• K C Chakrabarty (Dep Gov Reserve Bank of India): Crisis preparedness in interconnected markets – prevention is better than cure
• Focussing on only one part of the financial system can obscure vulnerabilities that may prove very important from the perspective of systemic stability.
• A highly interconnected world tends to increase both the probability and the impact of crisis.
• The potential for systemic risks increase, for example, due to potential build-up of leverage and liquidity mismatches at the same time or due to exposures to common networks of intermediaries.
• This leaves the financial system vulnerable to adverse changes in the macrofinancial environment, on the one hand, while, on the other, pervasive interconnections can result in a rapid transmission of adverse shocks across the global financial system at an amplified speed.
• The system dynamics of a set of networked markets and institutions can, thus, play a critical role in the amplification as well as the propagation mechanisms of shocks.

• Adam Posen (BoE): What the return of 19th century economics means for 21st century geopolitics
• As US hegemony, that is relative economic dominance, recedes into multipolarity, the international economic system will have less strict rule enforcement and be subject to greater economic volatility.
• The erosion of (intellectual and other) property right enforcement will have significant effects on the global division of labour, which will reinforce this multipolarity and income convergence.
• International diversification of investment will increase, and so will the gross flows of capital, with capital accounts in the major emerging markets moving more towards balance if not deficit.

• Court of BoE: Response to Treasury Committee on accountability of BoE
• Propose establishment of an Oversight Committee, with direct access to the policymaking processes and papers in the Bank, and formed of non-executive directors.
• Role of this Oversight Committee should be to assess whether the processes employed in making financial stability policy decisions have considered a full range of options and have taken reasonable account of the relevant information, analysis (including of the lessons from the past), differing views amongst policymakers, and challenges from outside the Bank.
• Future Governors of the Bank should be appointed for a single eight-year term.

• BIS (Claudio Borio): Stress-testing macro stress testing: does it live up to expectations
• Given current technology, macro stress tests are ill-suited as early warning devices, ie as tools for identifying vulnerabilities during seemingly tranquil times and for triggering remedial action.
• As long as properly designed, stress tests can be quite effective as crisis management and resolution tools.
• Generating more realistic non-linearities and feedback effects is a priority.
• Sceptical of attempts that see the secret of success in modelling network effects or the iterative bottom-up aggregation of individual responses.