Here at the Center for Financial Professionals, we often interview senior financial professionals to give our readers some valuable insight and knowledge on trending subject matters. We recently have spoken with Mark Penney, Head of Capital Management Global Markets at HSBC who will be presenting at our upcoming inititative Capital Management Forum 2016.
Mark, can you tell the Center for Financial Professionals’ readers a little bit about yourself and your professional experience?
I have been working in the city since 1987 for UK headquartered firms, starting as a Gilts analyst, moving through quant roles, treasury management and analysis, corporate advisory, equity proprietary trading, equity product development and structuring, management in the balance sheet and liquidity team, and capital management for markets.
It’s a bit of a list and has spanned quite a few key crises, recently these included being at the epicentre of management of liquidity in the liquidity crisis and moving to capital management in time for the capital crisis.
I have become interested more recently in the sustainability of businesses and business models and the stability effects of new regulation, but it is part of my day job to try to see if we can help policy makers achieve their objectives while getting the balances right.
At the Capital Management Forum you will be discussing the effects of the Fundamental Review of the Trading book requirements in practice. Without giving too much away, could you explain what key implications businesses need to be aware of?
At the time of writing we are poised to receive the final standard from the Basel Committee on Banking Supervision for part
i) of the FRTB, with part
ii) on CVA risk being expected a little after the date of our conference.
Apart from earlier drafts, discussions with the policy makers, and initial quantitative impact studies, the industry has little to go on as to the precise calibration and therefore effects.
It seems that the sensitivity based approach, which is likely to have to be disclosed, could in general be a few times the size of the internal model approaches, so it is pretty uneconomic to have a trading book and not have models.
Unfortunately, getting models and having them be applied is not a flick of a switch; operationally and computationally there is likely to be an enormous barrier to entry.
Even if you can make the nuts and bolts work, the back testing requirements are more prone than current methods to failure and therefore to the forced the use of the unmodelled approach for a desk for at least a year at a time. This in turn means the loss of certainty on pricing: if you can’t be sure a product will be modelled during its whole life, and if the cost could quadruple, the potential cost range to you is very wide.
What are some of the pricing considerations that should be looked at when reviewing the trading book?
To some extent the pricing considerations spring straight out of the structural design of FRTB which reduces price certainty. However, combined with the different levels of capital requirements imposed on different banks, for example the GSIB buffers, but also pillar 2 requirements, even if the assessment of RWA were the same between houses (which is extremely unlikely by design), the perceived expense of that RWA could be more than 25% different.
It is reasonable to expect that the prices for particular risk will not be homogeneous, and that the prices for products will not be the same from different banks, because the products themselves are effectively not the same even if their legal terms and form is identical.
There is a significant possibility of backwardations being created by the regulation (where one parties bid is excess of another’s offer). In a market where the products are actually the same product, this arbitrage would normally be expected to be exploited and disappear, but the policy has capacity to create structural arbitrage where each participant books a positive return. Policy makers have to work closely with those responsible for stability to remove these kind of anomalies.
How do you see the role of the Capital Management and Risk Professional changing over the next 6-12 months?
There are so many changes which interact.
The role will become far more project coordination to ensure that the sharp end of the business can actually be managed economically, but also to ensure that the interaction of measures is sufficiently understood and if possible optimised.
The role of the risk professional is likely to shift as well into a more complex function whereby risks are recognised as non-orthogonal and so the interaction of risks needs to be better understood.
We know you have great knowledge on the capital management spectrum as a whole. What are your thoughts on a potential transition from CRD IV to CRD V and what would this mean for banks?
I am not quite sure what CRD V really includes, but the moving parts from structural reform and the final steps on prudential regulation, perhaps including floors, recalibrations and hard wiring of presently observation-only metrics will be key.
It is very unlikely that the transition phases will be anomaly free, and my advice to banks would be to watch market effects with great care, because the response time to anomalies and interpretation shifts in regulation and different timeframes for transition are likely to create material ebbs and flows which may catch out the unwary.
