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CommentP&M Notebook

P&M Notebook: Once more with feeling

Just when it seemed like the round of investment bank restructuring was quieting down, and moving from splashy announcement to dogged execution, along comes Credit Suisse, again.

The bank ducked out of a presentation at Morgan Stanley’s European Financials Conference in London on March 15, announcing it was going to update the market separately, and oh boy did it deliver an update.

Lots of the press coverage, including in GlobalCapital has rightly seized on what appears to be a giant control failure. Traders in illiquid and distressed products kept running up positions that they were supposed to be winding down.

The size of the positions seems to have been a surprise to senior management Tidjane Thiam, the chief executive, certainly seemed surprised, but even vaguely defined internal people who ought to have known were also surprised. It does not, however, seem to have been a case of the rogue traders; there were no secret accounts, no hidden losses, and it doesn’t look like there’ll be jail time or public penitence, though it seems unlikely that the individuals involved will have a high-flying career with CS.

You have to admire the honesty, at least, in bringing this into the open. It’s difficult to see what the plus points are for Credit Suisse, but it seems like the right thing to do.

Plenty of banks would have slipped this sort of thing out with a mutter about adverse trading conditions in certain illiquid inventory positions or some such gibberish. But then, Credit Suisse under Thiam has been a paragon of disclosure and detail.

Perhaps this sort of transparency hurts in the short term, when a flurry of negative headlines might spank the stock, but longer term it can only build trust. Investment banks are trading on low multiples partly because investors have no idea what’s inside them; good disclosure might change that. GlobalCapital’s glass is half full.

It’s also interesting, and curious, because Credit Suisse is in the market with a 'cat bond' designed pretty much exactly to hedge its 'rogue trader' risk and let it claim some relief on operational risk weighted assets. The deal was set to close in March, but was pushed back as the bank decided to add its extra strategy update. For investors in the deal the control failure doesn’t look good. But in a world of endless new metrics for assessing risk, maybe you want to invest in a firm with a bitemark-shyness ratio of 1:2 when it comes to compliance.

New model

It was a big week for regulation, as well, with the Basel Committee racing to put out one of its biggest changes to bank regulation: new rules for banks using internal models in credit risk.

This means, inevitably, far less modelling. Banks won’t be able to use internal models to assess the credit risk of other financial institutions, or large corporates (meaning larger than €50bn).

That’s good news for the capital markets, since it ought to push more corporate funding into bonds and commercial paper, but it’s another blow for banks, that, despite regulatory assurances, almost certainly need to raise more capital to meet the next round of Basel regulations, supposed to be finalised by the end of the year.

The paper also limits flexibility on derivatives, with restrictions on using internal models for CVA capital (the amount that counterparty credit risk changes). Even where models are still allowed, there are new limits — banks cannot assume probability of default below 5bp, they have a limit of the loss-given-default tailored by asset class, and there will be another limit on model outputs.

The output limit is the really serious part — it will take the form of a “floor”, restricts how much capital banks can save by using internal models. So they will only be able to reduce capital to between 60%-90% of the capital required under standard risk weights.

Where the figure falls is crucial. 60% will be manageable; 90% will be crippling.

Liquidity: solved!

While Basel is keeping things complicated for bank capital, trading businesses have to shoot at the moving target of MiFID.

It’s an ugly, unloved regulation, created by the previous European Commission, rushed through by the previous European Parliament, and still staggering through the European legislative process like some bewildered elderly relative in need of a caring home but who has instead become the subject of family arguments.

The Parliament seems to be threatening a veto if ESMA doesn’t tweak details; the Commission is making subtly different threats, while ESMA is throwing hissy fits about legislative process.

German statesman Otto von Bismarck said: “to retain respect for sausages and laws, one must not watch them in the making.”

If you have a stronger stomach than him, then GlobalCapital’s MiFID pieces this week have full coverage.

At least that pesky liquidity problem has been solved though! The FCA paper on how liquidity wasn’t as bad as everyone was saying, published the week before, continues to attract ridicule, including from GlobalCapital.

One can only hope the regulator’s market observers take up the offer from TwentyFour Asset Management soon, and spend a day with the team trading credit.

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