SA lenders are well prepared for stricter global regulations
By Humphrey Borkum, Chairman of JSE Limited
The bull market mind set which stumbled in the financial crisis of 2008 has led to the start of what I would call the decade of risk management and regulation. The pendulum has also swung on the risk versus return conundrum. In the present volatile markets I believe that risk is a more important driver than return in most trading transactions.
The demise of Lehman Bros, Bear Sterns and AIG started the swing with various regulatory investigations being set up particularly in the United States. Concerns raised included:
- The lack of transparency;
- Fragmented, uneven risk management;
- Inadequate risk governance, management practices and infrastructure; and
- The insufficient use of collateral and vulnerable market infrastructure.
Politicians, financial regulators, bankers and various anti-Wall Street movements all knew that something had to be done.
Probably the first co-ordinated global regulatory response was the November 2008 G-20 meeting in Washington. It gave finance ministers a reform mandate aimed at: ‘Strengthening the resilience and transparency of credit derivatives markets and reducing their systemic risks and improving the infrastructure of the over-the-counter markets’. These measures were endorsed at the September 2009 G-20 meeting in Pittsburg USA. As a member of the G-20 South Africa was obliged to implement these reforms where necessary.
The G-20 reforms were a catalyst for co-ordinated global regulatory responses, the most important of which being Basel lll.
The Basel Accords are a series of recommendations on banking laws and regulations issued by the Basel Committee of Banking Supervision under the auspices of the Bank of International Settlements (BIS). Basel l was first enacted in the 1980’s and Basel ll was revised last year to what is loosely dubbed Basel ll and a half and it expires at the end of this year.
The US opted not to implement Basel ll and the financial crisis erupted when US banks started making risky investments in the sub-prime mortgage market. High risk assets were moved to unregulated parts of the bank’s holding companies. Also, risks were transferred directly to investors by securitisation – the process of taking a non-liquid asset or group of assets and transforming them into a security that could be traded on open markets.
Now in response to a dynamically changing market profile Basel lll will descend on the world banking system from January 2013. This aims to:
- Improve the banking sector’s capital adequacy and to absorb shocks arising from financial and economic stress, whatever the source.
- Improve risk management and governance
- Strengthen banks’ transparency and disclosures
My overall assessment is many banks will fundamentally re-think their business model , evaluate their portfolios and move out of complex or less liquid instruments. Aside from the much publicised liquid asset requirements banks will need to hold prohibitive amounts of capital for proprietary trades and for over-the-counter trades (OTC) or off-market trades that are not cleared through an exchange.
Already in SA a number of banks have closed their proprietary trading desks and others considering their options. It is likely that banks will start clearing OTC instruments through exchange clearing houses. There is also a possibility that banks will charge more for loans to businesses as they strive to meet the new capital and liquidity requirements. More resources will need to be devoted to risk management.
Although Basel lll in effect triples the size of capital banks need to hold against losses, our South Africa banks are well capitalised and have a credible history of risk management. However banks in some developing countries will be hit by the part of Basel lll known as ‘liquidity coverage ratio’ that requires banks to hold assets that are easy to sell in the event of a market crisis.
At the JSE we are responsible for risk managing and guaranteeing the settlement of a central order book of cash equity transactions at an average of R13 billion per day at present or R3,3 trillion in the 249 trading days of 2011.
We are now subject to new and more demanding international standards for payment, clearing and settlement systems that have also been issued by two committees of the Bank for International Settlements. These 24 new standards or principles ensure that the essential infrastructure supporting global financial markets is even more robust and thus even better placed to withstand financial shocks than at present. They apply to all important payment systems, central security depositories, securities settlements systems, central counter parties and trade depositories. The JSE aims to comply with these principles by the end of 2012.
Everywhere one looks at present there seems to be new initiatives, structures or reports to mitigate against risk . Many businessmen might believe that the pendulum has swung too far towards regulation. However they must realise that it was reckless, naked capitalism that bought the world to the edge of a depression in 2008. Only a couple of months ago a rogue trader evaded the sophisticated risk management systems at JP Morgan and it also appears that Barclays have been manipulating interbank lending rates in the UK. Moreover we’re still on the edge of the abyss due to poor regulation for many years of the banks and economies of a number of countries of Southern Europe.
Here we must pause to reflect on our country’s blessings. Our financial system is sophisticated and the World Economic Forum has rated South Africa as number one in the regulation of capital markets for the past two years.
Despite our problems politically and economically we are comparatively well off when measured against numerous European countries. Our country is not bankrupt nor is there any prospect of it going bankrupt. Friends of mine who have visited Europe recently came back to South Africa with horror stories of what the recession has done to places that were previously tourist meccas.
On another positive note South Africa’s inclusion in Citi Group’s World Government Bond Index from October is a vote of confidence in our financial markets in which the JSE plays an integral part. Citi Group announced that South Africa had satisfied its three requirements of size, credit and lack of barriers to entry.
We are the first African and only the fourth emerging market along with Mexico, Malaysia and Poland to qualify. Our bond market offers an established yield curve and some traders regard it as a relatively safe haven bearing in mind the Eurozone’s debt crisis. This inflow of money could lower South Africa’s cost of borrowing and possibly even strengthen the rand.
From January to mid-June this year foreign purchases into our bond market are up 45% at R44,3 billion compared with last year’s R30,5 billion. The overall volume for the same period stands at R11,1 trillion this year compared with R9,6 trillion in 2011.