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ISDA PRESS REPORT - MAY 11, 2001
* UK Building Societies To Use Derivatives For Credit Risk - Dow Jones * Currency swap agreements strengthen Asian co-operation - Financial Times * Greenspan Backs Risk-Based Pricing Of Deposit Insurance Provided by FDIC - BNA * SEC, CFTC Propose Joint Rules For Trading of New 'Security Futures' - BNA * New Rules to Improve Competitiveness Of European Markets, Commissioner Says - BNA * Top securities lawyer set to head SEC - Financial Times * Bush Intends to Nominate Roseboro for Treasury Job - Wall Street Journal * Darwinism With Chinese Characteristics - The Asian Wall Street Journal UK Building Societies To Use Derivatives For Credit Risk Dow Jones International News - May 11, 2001 LONDON -(Dow Jones)- The U.K. Treasury said Thursday that it is proposing legislation to allow building societies to use derivatives to protect themselves against credit risk. Building societies are already allowed to use certain types of derivatives to protect themselves against interest rate risk, currency risk and house price fluctuations. But the treasury proposal - agreed by the Building Societies Commission - will allow the building societies to use derivatives to protect themselves against credit risks, a treasury spokesman said. Unlike banks which are allowed to use derivatives to protect themselves against credit risk, building societies haven't been allowed to do so so far because of a clause in the 1986 Building Societies Act. The proposal will be put to parliament and is likely to be approved unless a member of parliament opposes it, the spokesman said. The BSC considers the credit derivatives market to be sufficiently developed to offer building societies broad and flexible protection. Credit derivatives will initially be used only by societies which already have a sophisticated treasury management capability, the treasury said. Currency swap agreements strengthen Asian co-operation Financial Times - May 11, 2001 By Edward Luce Japan yesterday announced that it had concluded bilateral swap agreements with Thailand, South Korea and Malaysia as part of the region's continued progress towards strengthened monetary co-operation. The agreements, which were reached on the first day of the annual conference of the Asian Development Bank in Honolulu, come a year after the 10 Asian member countries plus China, Japan and South Korea pledged mutual central bank support at a meeting in Chiang Mai. The swap arrangements were designed to provide the former victims of the 1997 Asian financial crisis with firepower to fight off any speculative attacks on their currencies. Japan said it was also negotiating central bank swap agreements with the Philippines and China. But Seichiro Murakami, Japan's deputy finance minister, would not disclose the nature or the terms of the swaps agreements except to say they were not based on the defense of any pre-agreed exchange rate levels. Most of the region's economies have adopted free floating or managed float currencies after speculative attacks obliterated their exchange rate pegs with the US dollar in 1997. The bilateral deals provide Korea with Dollars 2bn (Pounds 1.3bn) in possible currency support, Dollars 1bn for Malaysia and Dollars 3bn for Thailand. Tun Daim Zainuddin, Malaysia's finance minister, said the agreement, which comes in addition to the Dollars 1bn pledged in mutual swap support by Asian countries last November, would help prepare the region for "any eventualities". "We will not be caught by surprise this time," said Mr. Daim. "Our currencies are not at risk now. In fact, in most of the Asian countries, our reserves have increased." Mr. Daim also pointed out that the Dollars 1bn in potential support for Malaysia came in addition to a further Dollars 2.5bn in currency support that had been pledged by Japan under the "Miyazawa plan", named after Japan's former finance minister. Unlike the Miyazawa pledge, which comes free of broader conditions, only 10 per cent of the bilateral swap agreement can be drawn before triggering control by the International Monetary Fund. Wednesday's announcements mark a weakening of Japan's drive towards the creation of an Asian Monetary Fund, vetoed by the US in the late 1990s. In contrast to Tokyo's original goal of devolving more decisions to Asia, Japan described the bilateral swap agreements as "complementary" to the broader financial framework supervised by the International Monetary Fund in Washington. The Honolulu agreements, which will be reviewed in three years, form part of a broader drive by Asian countries to strengthen regional co-operation following the 1997 crisis. Such efforts, which span deeper trade liberalisation within Asian and greater political dialogue between Asian and its east Asian neighbours, have been given further impetus by the damping effects of the US economic slowdown on the region's high-tech export sector. Paul O'Neill, US Treasury secretary, told delegates at the opening ceremony of the ADB annual conference, that, in spite of the region's impressive recovery since 1997, Asian countries had to accelerate and deepen efforts to restructure their financial and corporate sectors. Mr. O'Neill, whose remarks were clearly directed at South Korea, Thailand and Indonesia, which are still struggling to resolve the overhang of bad debts from the 1997 crisis, also urged Japan to take steps to boost aggregate global demand by confronting obstacles to the revival of domestic demand Greenspan Backs Risk-Based Pricing Of Deposit Insurance Provided by FDIC BNA - May 11, 2001 CHICAGO--Federal Reserve Board Chairman Alan Greenspan May 10 called for more risk-sensitive pricing of deposit insurance provided to banks by the Federal Deposit Insurance Corporation, saying recent FDIC proposals to move toward risk-based pricing are "useful." Greenspan spoke at during the Federal Reserve Bank of Chicago's 37th Annual Conference on Bank Structure and Competition. Federal Reserve Board Governor Laurence H. Meyer, who spoke at the conference the same day, said the system must be adapted to manage the challenges posed by new technologies, new financial strategies and the globalization of the financial services industry. Though Greenspan said federal regulation of the financial services industry has provided an admirable degree of stability to banks and investors, he said these benefits come at a significant cost and reform is needed. He called for financial industry supervisory policies that promote the type of market discipline that existed prior to the erection of current safety net structures, which evolved in the wake of the Great Depression. In addition, he reminded large institutions engaged in risky practices and their investors that the safety net cannot and will not insulate them from every type of financial crisis. Market-based reforms would better protect investors, reduce costs to the economy, and allocate risk more equitably, the Fed chairman said. "While valuing the benefits of stability that the safety net confers, we nonetheless need to recognize that the benefits are not without costs," Greenspan said "In this context," Greenspan added, "reform of the safety net must remain on the agenda. I believe this means being very cautious about purposefully or inadvertently extending the scope and reach of the safety net. It also means supervisory reform to create, as best we can, inducements to bank behavior similar to those that would exist with no safety net. And, it means, I think, that there be a presumption that uninsured claimants are at risk." It appears "politically infeasible" to eliminate government subsidies of deposit insurance altogether, but "more risk-sensitive pricing is nonetheless helpful, and prudential regulation has already begun to move in the right direction to reduce the safety net subsidy," Greenspan said. The so-called financial safety net, as currently configured, is comprised of banking regulation, deposit insurance, the Fed's discount window, and access to Fedwire and daylight overdrafts, he said. He said these structures provide depository institutions and market players with a degree of safety, liquidity and solvency never before seen in economic history. At the same time, this structure comes at a cost to the economy. Among other things, Greenspan pointed to distortions in the price signals used to allocate resources, inducements for institutions to take excessive risks and relatively high degrees of government supervision as a strategy for limiting moral hazard. FDIC Proposal 'Useful.' To avoid these distortions, Greenspan suggested reforms aimed at pricing and managing the safety net in a manner aimed at simulating what the markets alone might do. Toward this end, he called for fairer pricing mechanisms with respect to FDIC insurance premiums. Greenspan did not discuss specific components of the recently released FDIC reform proposal, but he described it as "useful" and commented that the plan moves the agency toward better pricing to safety net access. On April 5, the FDIC proposed a system under which all institutions would pay risk-based premiums based on indexed coverage levels and a merger of the bank and savings association insurance funds (67 DER A-40, 4/6/01). The House Financial Services Committee will broach the controversial subject of how best to reform the deposit insurance system in a hearing scheduled for May 16. Greenspan also called for regulatory structures aimed at making capital requirements sensitive to each bank's particular risk profile and exposure. He said supervision and examination policies are moving in this direction and are evident in the new Basel Capital Accord. Finally, Greenspan called for greater market discipline--a factor that preserved the banking system prior to the development of the safety net. "The real pre-safety-net discipline was from the market and we need to adopt policies that promote private counterparty supervision as the first line of defense for a safe and sound banking system," he said. Disclosure Key, Greenspan Says To promote this concept, Greenspan called for wider disclosure by financial institutions so counterparties can better evaluate risk. While banks are already subjected to significant degrees of disclosure, Greenspan said the quantity and quality of the data is often uneven. He suggested that, "all entities could, should, and may soon be required to disclose more and better data." But Greenspan stressed that market discipline will never be achieved unless uninsured private counterparties understand that they will not be protected by the safety net. He suggested too many players live under the false assumption that they will always be made whole under a, "de facto too-big-to-fail policy." "Let me remind you that the ten largest U.S. banking organizations fund only about one-fourth of their worldwide banking assets with insured deposits," Greenspan said. "Let me also remind you that the least-cost resolution exception [contained in the Federal Deposit Insurance Corporation Improvement Act] does not require that all uninsured creditors be made whole, but rather only that they be made no worse off than they would have been if the bank were liquidated. The potential for greater market discipline at large institutions is substantial." Greenspan said he could conceive of "rare situations" when the FDIC or other governmental resources would temporarily be used to sustain failing institutions pending managed liquidation, but that "indefinitely propping up insolvent intermediaries is the road to stagnation and substantial resource misallocation, as recent history attests." Meyer Seconds Reform Call Meyer, in his speech, also argued for a more risk-based regulatory structure. Meyer acknowledged the FDIC's April 5 proposal for reform but would not comment on it. Meyer complimented the agency on its diligence, but said the board would withhold judgment on the plan until it has had a chance to fully review it. "There seems to be a widespread feeling, which I share, that additional, or at least improved, efforts toward limiting moral hazard, enhancing market discipline and lowering taxpayer liabilities should and can be made," Meyer said. "Our world is a rapidly changing place with technological change, financial engineering, globalization and deregulation combining to alter the realities we all face. As a result, all of us must be willing to adapt old policies and adopt new one if the circumstances require." Meyer noted that, unfortunately, existing risk-based capital standards are becoming divorced from the realities of modern risk management for a growing number of financial institutions. As such, he said the 1998 Basel Accord's capital ratios have become a less reliable tool for determining the capital strength of a particular firm. Meyer said the new Basel Capital Accord creates standards that will reflect the true risks being taken by the most financially sophisticated and complex banks. He called on bankers to provide public comments on the proposal to the Basel Committee on Banking Supervision by the end of May. "[I]t is of the highest priority that, for the most financially sophisticated and complex banks, we make the capital standards more reflective of the risks that they are, in fact, taking," Meyer said. FDIC's Murton Speaks Arthur J. Murton, director of the FDIC's division of insurance, also spoke at the conference. He said that in developing the reform plan, the FDIC hoped to make significant improvements in the safety net while acknowledging political realities. "We hoped it would represent an intersection of sound economic and financial principles on the one hand and political realities on the other," Murton said during the same panel discussion with Meyer. "Our goal was to offer a framework that, with further discussion and modification, could generate a consensus around these issues and could make its way through the legislative process. We might have come up with a different approach if we had started from scratch. Instead, we recognized that passing banking legislation without a banking crisis requires consensus." Murton said the plan calls for a merger of the Bank Insurance Fund and the Savings Association Insurance Fund and the elimination of current restrictions on charging risk-based premiums. In addition, the plan calls for indexation of insurance coverage levels to reflect inflationary changes and a shift from the current 1.25 percent Designated Reserve Ratio to a target level between certain ranges. The plan also suggests the development, for the first time, of a rebate system when certain triggers are achieved. SEC, CFTC Propose Joint Rules For Trading of New 'Security Futures' BNA - May 11, 2001 The Commodity Futures Trading Commission and the Securities and Exchange Commission announced May 10 that they have proposed joint rules to implement new statutory provisions relating to security futures products. "Security futures" are single stock futures and futures on narrow-based stock indices--given new life by last year's sweeping Commodity Exchange Act reform legislation after a nearly 20-year ban. In related matters, the SEC May 8 proposed rules and a new registration form for designated contract markets and derivative transaction execution facilities to use to register as national securities exchanges to trade the new instruments (Release No. 34-44279, 5/8/01). Joint Regulation Under the law, security futures are "securities" under the federal securities laws, but may be traded on either futures or securities exchanges. The CFMA also established a framework for the joint regulation of security futures products by the CFTC and SEC, the agencies noted. However, they added, futures contracts on broad-based indexes remain under the exclusive jurisdiction of the CFTC. Accordingly, the SEC and CFTC related, they proposed joint rules regarding the distinction between broad-based and narrow-based security indexes. According to the regulators, the CFMA defines the criteria for an index to be considered "narrow-based," including, among other factors, the market capitalization of each security in the index and the dollar value of that security's average daily trading volume. The statute also requires the two agencies jointly to specify the methods that must be used to determine these values. In their release, the SEC and CFTC said the proposed rules "are designed to fulfill that statutory mandate, as well as to address other issues that arise in the application of the definition of narrow-based security index." They noted that trading in security futures products may begin Aug. 21, provided certain regulatory requirements are met. After considering any comments, the agencies said, they expect to adopt final rules prior to Aug. 21. New Rules to Improve Competitiveness Of European Markets, Commissioner Says BNA - May 11, 2001 Key legislation needed to make European financial markets more competitive with U.S. markets is expected to be introduced by early 2002, Frits Bolkestein, a Dutch member of the 20-person European Commission, said May 10. In a speech at the American Enterprise Institute, Bolkestein reaffirmed the European Union's commitment to requiring all E.U.-based companies to use the International Accounting Standards (IAS) practices in their record keeping in order to enhance transparency and provide higher quality financial information to investors across the world. "The use of one global accounting language will greatly benefit European companies. It will help them compete on equal terms for global capital," Bolkestein said. He added that the legislation would require companies to begin preparing their consolidated accounts using IAS by 2005. Bolkestein also said he is hopeful that the U.S. Securities and Exchange Commission will begin to accept financial statements prepared by firms in the European Union without requiring them to be reconciled with the generally accepted accounting principles (GAAP) standard used in the United States. A major reason that changes are needed in the European Union's financial regulations is because of the "unprecedented volume of mergers and acquisitions" between American and European firms. Another reason is that the European Union has established a goal of becoming "the most competitive and dynamic knowledge-based economy in the world, capable of sustainable growth with more and better jobs, and greater social cohesion," Bolkestein said. Since 1990, Bolkestein said the European community has added 900,000 jobs and has seen improved competition and productivity add 1.5 percent to gross domestic product growth because of measures taken to create a single market for financial services. If the European Union is successful at restructuring its financial system by 2005, Bolkestein said he sees other benefits to include a lower cost of capital for all companies, a deeper and more vibrant venture capital market, lower costs of purchasing financial products, and higher returns on pensions and investment funds. To realize those benefits, Bolkestein said the European Commission would like to see an integrated securities market in place by 2003, replacing the individual domestic securities markets of the European Union's 15 member states. "Mergers and alliances between existing exchanges are already breaking down barriers, pooling liquidity, reducing clearing costs, decreasing volatility, and increasing transparency," Bolkestein said. He added that Europe is also seeing "a marked increase in the number of on-line brokerage accounts, which further contributes to efficiency and transparency," but also creates a greater need for changes in the way the European Union regulates its financial sector. Top securities lawyer set to head SEC Financial Times - May 11, 2001 By John Labate President George W. Bush yesterday named securities lawyer Harvey L. Pitt to head the US Securities and Exchange Commission after one of the administration's longest searches yet to fill a key post. If approved by the Senate, Mr. Pitt would replace Arthur Levitt, who stepped down as chairman in February after more than eight years. Mr. Bush is expected to send a formal nomination to the senate soon but no date for a confirmation hearing has been set. Mr. Pitt, a partner at New York-based law firm Fried, Frank, Harris, Shriver & Jacobson, is widely regarded as one of the country's leading experts on securities law and one of its toughest litigators. His long list of clients has included Ivan Boesky, for whom in 1986 he negotiated a $100m settlement with SEC officials on insider trading charges. Other clients include LLoyd's of London, the New York Stock Exchange, and all "big five" accounting firms. The move would return Mr. Pitt, 56, to the SEC, where he worked for a decade after law school and where, at age 30, he served as its youngest ever, general counsel. He has remained at Fried, Frank, Harris since leaving the SEC in 1978. The planned nomination comes as the SEC faces a number of difficult issues, including decisions on the structure of securities trading as more markets, inside and outside the US, seek to become publicly traded companies. "We're heading into a period of globalisation that will call for change," said Richard Phillips, former SEC assistant general counsel and partner at the law firm Kirkpatrick & Lockhart. "It won't be for congress to take the lead but a chairman with vision, and Harvey could be that kind of chairman." The decision to nominate Mr. Pitt was welcomed by Senator Phil Gramm, the Republican Chairman of the Senate banking committee, which oversees the SEC. "I look forward to working with him and anticipate prompt consideration of his nomination by the banking committee," he said. Mr. Pitt is known as a tireless worker, who employs three secretaries to work round the clock for him. "Some people are going to have to run quicker and run longer to keep up with him, but the vast majority of people here are delighted with the choice," said one SEC staff member. Mr. Pitt will be closely watched in the coming months for his views on several controversial rules passed in the final year of Mr. Levitt's term. Among them are those on overseeing consulting services by accounting firms and a new disclosure rule, Regulation Fair Disclosure, fiercely opposed by securities firms. The administration encountered unexpected difficulty in filling the top SEC job. Several leading candidates withdrew from the process or turned down offers. Mr. Bush still has to fill forthcoming vacancies among the SEC's commissioners. He named Laura Unger, a corn- -missioner, as acting SEC chairman soon after Arthur Levitt stepped down. Bush Intends to Nominate Roseboro for Treasury Job The Wall Street Journal - May 10, 2001 WASHINGTON -- President Bush announced his intent to nominate Brian C. Roseboro, of New York financial-services giant American International Group Inc., to be assistant Treasury secretary for financial markets. The job involves making and implementing policy on capital markets and federal-debt management. Mr. Roseboro is deputy director of market-risk management for AIG. Mr. Roseboro earlier worked at financial-services firm SBC Warburg Dillon Reed, from 1993 to 1996, and at First National Bank of Chicago, from 1990 to 1993, the White House said. From 1983 to 1986, he held several positions at the Federal Reserve Bank of New York, including chief dealer for foreign-exchange trading. Election records show Mr. Roseboro didn't contribute to Mr. Bush's presidential campaign, although AIG's political action committee contributed $5,000 to it, and also gave $5,000 to his GOP rival, Arizona Sen. John McCain. AIG Chairman Maurice "Hank" Greenberg raised at least $100,000 for Mr. Bush in the insurance and financial-services industries. Darwinism With Chinese Characteristics The Asian Wall Street Journal - May 11, 2001 By Pu Yonghao The expansion of China's capital markets is central to the government's plan to finance long-term economic growth. While observers have focused primarily on efforts to reform and broaden the equity markets, two other developments are important to meet the objective: a mature debt market and a wider variety of derivative products. About 1,100 companies are listed on China's domestic stock exchanges in Shanghai and Shenzhen. About 90% are state-owned enterprises and some 62% of the total issued shares are state held. The two bourses combined had a market capitalization of $580 billion at end of 2000, though some two-thirds, about $360 billion, of A shares (which can be purchased only by Chinese investors) are in state hands. Chinese companies generally turn to banks for funding. By the end of 2000, bank lending was $1,200 billion, equivalent to 112% of China's gross domestic product. In the wake of the 1997 Asian financial crisis, the government realized that a dependence on bank lending leaves both the corporate and banking sectors vulnerable to crises. That is why it has decided to expand the capital markets to finance long-term growth. If all goes well, the market cap of the two boards together is likely to double to $1.2 trillion by 2005 and play a leading role in the country's evolution into a market economy. The reasons for this kind of growth are numerous. First, China's economy should grow at an annual average rate of 7.5% between 2001-05, bringing total GDP to about $1.6 trillion (based on an inflation of 2%). The country's high savings rate of 40% (currently $809 billion) should provide ample capital to facilitate the expansion. Second, the government is pushing forward with the reform of SOEs. Privatization, the reduction state holdings and expansion of the private sector will increase the market-capitalization-to-GDP ratio. Listing SOEs will deepen the restructuring program and usher in good corporate governance. Moreover, the government's fiscal resources are limited. Revenues comprise only 14% of GDP and social-welfare costs are rising. The growth of the stock markets is likely to help expand China's private sector and bolster employment at a time when many SOEs are downsizing their labor forces. The stock markets will also become an important vehicle for channeling long-term investment, and thus help increase the efficient allocation of capital and improve returns on infrastructure projects. And finally, foreign investors and investment banks are expected to play an active role in the domestic markets after China's accession to the World Trade Organization. But this picture of thriving capital markets will be incomplete without the speedy evolution of debt trading and derivative instruments. The development of a debt market is important because bank savings remain China's primary investment vehicle, despite a 20% tax on deposit interest income and historically low interest rates. Bonds generally offer relatively high returns with low risk and fill the gap between high-return, high-risk equities and low-return yet safe bank deposits. Moreover, social security funds need to hold bonds to balance their portfolios. A mature debt market diversifies the financing channels of enterprises, enabling them to gain capital leverage. Debt pricing is more sensitive to interest rates, spurring more efficient capital pricing and thus allocation. A mature debt market can also help finance the state's budget deficit and provide capital for long-term construction projects. Government bonds enable effective monetary policy through open-market operations. The use of bonds to control the base money supply reduces the reliance on a credit plan for implementing macro-economic objectives. The government's ability to conduct open-market operations can help it control the impact of external capital inflows. The Chinese government appears to be drafting debt-market regulations that will allow the listing of more corporate bonds, firms to use the proceeds as they see fit and new debt products. But many other issues need to be addressed before the debt market can take off. First, an environment of commercial trust and a system for contract enforcement and liquidation must be established. Second, a comprehensive and reliable credit-rating system is needed. Some mainland Chinese rating agencies are pressured to make positive evaluations. When rating agencies are reliable, investors can better gauge whether a company will repay. Third, a benchmark rate and yield curve must be established. Currently, the benchmark coupon-rate on debt is a one-year deposit rate of 2.25%, but this is not entirely appropriate. The coupon rate is 3.07%, for example, on a five-year treasury bond, 2.87% for a three-year treasury bond, and capped on the former at 4%. This provides little scope for corporates to price new issues attractively. The average yield of listed-corporate debts is already 4.5%, or 5.1% for maturity of more than five years. Moreover, debt markets need to merge. At present, trading occurs at exchanges or between banks. Since trading volume is small and liquidity low, prices face distortion. The trading volume of enterprise bonds, for example, is just 1% of treasury bonds. Finally, there is need for a wider range of debt products (for example, floating-rate bonds as opposed to simply fixed-rate debt instruments). As it stands now, there only about 10 types of corporate debts. Most are zero-coupon bonds, one is floating. The development of derivative products would provide another important impetus to growth of the capital markets. Mainlanders have few financial products to choose from -- just 1,100-plus listed stocks and a handful of corporate bonds and closed-end funds. China does have some futures exchanges, but trading is limited to a few commodities like soybeans, wheat and copper. The trading of derivatives would enhance economic efficiency. First, they enable investors and underwriters to hedge their positions and "lock in" profits. Second, derivatives temper stock-price volatility by reducing the concentration of money in one market. Once an index derivative market is established, variance between two markets can prompt arbitrage opportunities. Derivatives also enable better risk management, attracting more capital to the stock markets, especially risk-sensitive pension, insurance and offshore funds. However, the value of mature capital markets goes beyond capitalization. Full fledged, they can force enterprises to compete for funds, weeding out the weak from the strong. Last month, the China Securities Regulatory Commission delisted washing-machine maker Narcissus from the Shanghai Stock Exchange after the company racked up four consecutive years of losses. The rules for stripping companies of their listing had been murky, but the CSRC assertively clarified them in February, saying firms posting three or more years of losses would be given just six months to make a profit or face delisting. Narcissus soon came back with a turnaround plan, but the Shanghai exchange rejected it, claiming the proposal was unworkable. That's just one example of an array of reforms regulators are pressing ahead with to bring China's capital markets in line with the survival-of-the-fittest ethos that characterizes their more mature counterparts elsewhere. Mr. Pu is senior economist at Nomura International in Hong Kong. Scott Marra Administrator for Policy & Media Relations ISDA 600 Fifth Avenue Rockefeller Center - 27th floor New York, NY 10020 Phone: (212) 332-2578 Fax: (212) 332-1212 Email: smarra@isda.org
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