Risk committees, basis risk and Emir

Bank risk committees: desperately seeking risk managers

Most boards still lack career risk specialists despite tighter governance requirements

Libor transition raises basis risk fear

Shift to secured benchmark could cause dislocation between bank funding and lending rates

Banks fear loss of Emir intragroup exemptions

Firms would have to clear or margin transactions with affiliates in non-equivalent jurisdictions

COMMENTARY: Calm seas?

Ten years after the immense operational risk losses of the 2008 crisis, op risk capital levels may have peaked for US banks. The drop-off isn’t related to the anniversary directly, as the 2008 losses will stay in the capital calculation indefinitely under the Advanced Measurement Approach, but the subsequent decade of relatively low losses has effectively diluted them under the loss distribution approach used by AMA banks to calculate op risk capital.

As an interesting aside, the cliff-edge would have been a good deal more abrupt under AMA’s planned replacement, the Standardised Measurement Approach, which dictates a strict 10-year lookback window for loss data. But the SMA isn’t due to come into effect until 2022, by which time the 2008 crisis will presumably have been diluted still further (assuming there has not been another financial crisis by then).

Another legacy of the financial crisis is proving similarly nebulous. In the wake of the collapse of Lehman Brothers, the SEC started to look hard at the composition of boards of directors, and attention soon focused on risk committees, which were often found to be extremely short on relevant experience. JP Morgan’s three-person risk committee consisted of the president of the American Museum of Natural History, the chief executive of aerospace manufacturer Honeywell, and James Crown, president of investment manager Henry Crown & Company. Crown was the only one with any banking experience, having spent 1980 to 1985 at Salomon.

Given that kind of oversight, risk experts weren’t exactly surprised when the bank lost $2 billion in what its chief executive called a “Risk 101 mistake”. But many other banks didn’t do much better, a Risk survey found in 2012. This week, Risk published the results of a follow-up survey, and the improvements have been modest. There has been an increase in the number of board members with financial industry experience: JP Morgan’s committee now looks a little more serious, with two new members having Berkshire Hathaway and GE Capital on their CVs, while the new chair is a former deputy head of risk management. But there are still some unusual appointments taking place – retired generals and vodka distillers among them.

There are still very few board members with experience as senior risk managers. Risk’s survey found only four former chief risk officers – no change since 2012. The rest of the board may have improved their risk knowledge over the past six years, but have they done enough? Ten years ago, risk committees – and boards of directors more widely – had an excellent record, until the financial crisis put their shortcomings on display in the most unforgiving way. Another crisis will happen; risk committees need to be in better shape when it comes.

STAT OF THE WEEK

European Union insurers have piled into infrastructure corporate bonds. About €91 billion ($106 billion), or 53%, of total infrastructure exposures were held in the form of “qualifying infrastructure corporate investments” – bonds issued by corporates engaged in infrastructure project financing – at the end of 2017. This is an increase from the 38% reported at the end of the first quarter of 2017. Over the same period, infrastructure exposures through government bonds almost halved, from 22% to 13%

QUOTE OF THE WEEK

“Eiopa will not care so much, but the EBA will care much more. It will be difficult [for them and Esma] to come to a consensus” – A head of legal at a European bank on European supervisory authorities extending intragroup margin exemptions for operations based in third countries not deemed equivalent with EU legislation.