1. Don, AxiomSL is set to participate at the Risk Americas 2016 Convention later this year in May to deliver a presentation on LCR/2052a implementation. What key components do banks need to be aware of? Where will banks face the biggest implementation challenges?
LCR requirements will vary significantly by institution. A smaller bank with a very simple business model and simple data will often lack the requisite LCR subject matter expertise. This is a very different challenge than problems a larger institution will face with sprawling data sources, and therefore it’s not a one-size-fits-all approach.
Key components involve early self-assessment and assembling an optimal plan and governance process to tackle LCR. Once you figure out what you have and need, you assemble the team — some inside with others including consultants and technology providers — looking at those resources, plan around that team, and then design the governance process that will guide a firm through LCR milestones and benchmarks, unit testing, user acceptance testing and other aspects of the implementation process.
For larger banks in the United States, a fundamental part of this process is 2052a. Currently, there isn’t an LCR report requirement in the U.S. per se; rather there is this compliance requirement. The Federal Reserve has produced some element mapping that illustrates how 2052a is used in LCR, but there is no real template here yet, and currently 2052a is actually filed under a separate name, 5-g. Putting those two together is an important component: they’re closely interrelated, and firms currently implementing LCR and 2052a separately will risk significant disconnects.
Therefore, the greatest technology challenge treasury teams face is to source relevant granular information across the bank, as with 2052a compliance, so as to now proactively monitor the LCR in an effective and operationally coherent way.
How are banks meeting LCR/2052a requirements today, and how are these set to evolve and expand?
The largest systemically important banks (G-Sibs) began complying with LCR starting last year. They’re already doing this daily by calculating and submitting 5-g, but from an LCR standpoint, the actual ratio is still being phased in incrementally: rising to 1 next year after .9 this year and .8 last year.
In this sense, they’re already looking at the LCR calculation from a compliance-aggregation perspective, baking in rules-based logic to analyze these numbers in context, so that managers can see which parts of their business are consistently contributing to, or causing, any liquidity risk management compliance problems. Right now it’s still considered a compliance number with zero cost associated with it, and many firms — especially smaller banks without that internal subject matter expertise —will view it this way as they navigate mandated LCRs for the first time, though that is certain to change in coming years.
How can LCR/2052a be used beyond compliance and regulatory reporting?
Liquidity risk management and compliance is now a daily priority. Firms don’t want any mystery about their compliance status. Falling out of LCR compliance will incur a whole host of consequences once reported to regulators, and so these calculations need to be made accurately and reliably. But many banks only view this as a first step.
What the more advanced firms are doing next is constructing a liquidity risk management decomposition process: putting together the costs associated with LCR and identifying the drivers of those costs. These activities can typically include optimization of the low-yielding HQLAs (high-quality liquid asset) holdings required as part of the ratio’s numerator, and scrutinizing internal users whose outflows don’t sufficiently net with inflows (given that current reporting rules say only 75 percent of inflows can count towards an LCR, no matter where they come from).
Whereas the earlier part of the process is governance-centric, this is a step where more sophisticated technological wherewithal is required. Firms are looking to create a central hub — usually located within the treasury function — to run analytics around the costing of transfer pricing and forecasting, and many of the largest clients we speak with say they are still trying to solve for this particular piece of the puzzle. There is an especially strong need for technology partnership to achieve that level of dexterity and at AxiomSL, for example, the Liquidity Risk and Regulatory Reporting’ platform delivers the flexibility to comply with industry regulations and provides the scalability to meet multiple regulatory reporting requirements with greater speed and accuracy while ensuring full transparency and control. Further, firms can analyze and report required data, as well as model cash flows and implement a wide range of stress and scenario tests in a cost effective manner.
How can institutions develop liquidity risk management and reporting frameworks for the wider range of business and regulatory requirements?
This is where the discussion over LCR really gives way to the much broader topic of liquidity risk management. The Federal Reserve, OCC, and FDIC oversee Banks’ LCR and 2052-a requirements, but for many universal financial institutions operating different business arms, it’s only the tip of the iceberg.
To start with, FINRA has developed its own rules for broker dealers that are significantly more stringent than the LCR calculation. In particular, the FINRA formula doesn’t allow recognition of assets that can be quickly liquidated as contributing to outflows, and it makes no distinction between treatments of bank-owned and standalone dealers, either. For banks with a broker-dealer arm, we believe some convergence will be required to avoid looming compliance headaches.
Perhaps even trickier are the liquidity risk-related rules currently being developed by the US Securities and Exchange Commission (SEC) for fund managers — including hedge funds and exchange-traded funds (ETFs), as well as retail and institutional fund management arms. These aim to assess a fund’s ability to cope with redemptions and manage the cash flow requirements necessary to meet investment objectives. As first proposed last year, they were met by significant resistance by the industry, which proposed important questions be clarified like how to treat ETFs composed of highly-illiquid assets, or how to assess those that are redeemed traditionally (i.e. bought outright) versus liquidated in kind, where the underlying assets of the ETF are returned proportionally.
A final implementation deadline for fund management, and for that matter wealth management and asset liability management (ALM) businesses, is likely still years away; however these discussions, whether ongoing or on the horizon, prove just how hot the topic of liquidity risk management has become.
They also portend the increasing operational complexity required to solve for liquidity risk principles at diversified institutions, and the need for partners that can leverage both domain expertise and technology with precision.
What does a solution to the liquidity risk reporting challenge look like?
Banks will want to leverage their existing IT investment and supplement their incumbent infrastructure with the functionality it lacks, while creating the flexibility to meet not only the latest rules, but also those that will undoubtedly follow in time. The solution needs to be able to extract relevant information from systems and bring it together for analysis. It may have to generate missing information, such as the synthetic flows required by FR 2052a, and it needs to be able to perform the calculations necessary to create the numerators and denominators for the LCR and NSFR.
A critical characteristic of the solution will be the ability to respond quickly to the stream of demands emanating from the authorities. Rules are appearing with barely any breathing space between publication and implementation deadlines. Further, large multi-jurisdictional banks will face the additional challenge of having to meet individual local rules while also reporting at a global level. A single common platform can have a number of advantages. It can be more efficient and cost effective because it brings data and reporting services together in centralized facilities. Running common applications reduces operational complexity and makes it easier to train and transfer staff when necessary.
A global platform can function as a hub, with a central liquidity regulatory engine and common data source linked to local regulatory liquidity engines. These satellite engines will draw relevant data from the hub and supplement it with local information to calculate jurisdiction-specific liquidity ratios and generate disclosures. Such architecture allows for local ownership of the compliance function, while maximizing efficiencies through shared services and ensuring consistency of critical information.
AxiomSL’s platform for Liquidity Risk and Regulatory Reporting delivers the flexibility to comply quickly with industry regulations changes and provides the scalability to meet multiple regulatory reporting requirements with greater accuracy while ensuring full transparency. AxiomSL’s integrated platform gives institutions control of the entire liquidity risk management process, from data sourcing to reporting, including XBRL submission. As a result, the platform enables firms to measure their liquidity more accurately – by business line, client and transaction – and provide warnings and prompts as their liquidity position evolves in order to facilitate more efficient management of assets.
Knowing what level of liquidity is available and where it is located will enable banks to proactively manage their liquidity and maximize their potential by making better decisions and faster. As a result, banks can transform liquidity risk management from a cost center to a competitive edge.
