* Impact of 'Stressed VaR' measure now being felt in markets
* European supervisor admits 'unintended consequences'
* Liquidity hit and trading costs rise as banks curtail
* Trading driven to unregulated entities like dark pools
* Assets that crashed in 2007/8 forever 'tainted' in new
By Laura Noonan
LONDON, Jan 16 Arcane measures designed to make
banks safer are pushing trading activity into areas where the
banking regulator's writ doesn't run, making conventional
markets more risky as volumes dwindle.
Regulators determined to avoid a repeat of the financial
crisis that floored investment banks in 2008 and beyond
introduced a rule at the beginning of last year that makes banks
hold enough capital to cover the worst 12 months in the history
of their trading portfolio, on top of a capital provision to
cover recent asset volatility.
This "Stressed Value at Risk" (VaR) rule and other measures
such as a risk charge that makes it harder for banks to hold
lower-rated credit assets have tripled the amount of capital
global banks have to hold against their trading books, according
to Jouni Aaltonen, director of prudential regulation at European
financial industry group AFME.
The knock-on effects are widespread and not always intended.
Bankers say the post-crisis regulation has forced them to
trade less, sucking liquidity out of the market and making
buying and selling assets more expensive for everyone, from
pension funds to corporates.
"The regulators, as well as the banks, don't necessarily
have a full grasp of the impact of these types of things yet,
and won't have for some time," said one senior executive at a
major investment bank, who said there had been "pretty big"
repercussions in some markets already.
Mark Denny, head of global markets dealing at Investec Asset
Management, said the fall in liquidity had increased the bid/ask
spreads for large fixed-income and index trades, making trading
"This has resulted, from our perspective, (in our) being
very cognisant of the increased trading costs within our
business and exploring liquidity pools across asset classes," he
Investors can seek out pools of liquidity on alternative
trading venues and platforms that buy or sell direct without the
help of a dealer. That effectively takes the business into the
shadow banking sector, over which banking regulators have no
One European supervisor, who asked not to be named, agreed
that the regulations had "unexpectedly compressed the liquidity
of important markets with the related consequences".
The Basel Committee of Banking Supervision, which is
responsible for drawing up these and other global banking rules,
did not respond to requests for comment.
A review into the rules is in its early stages, and new
measures won't come into place until 2015 at the earliest, and
probably later, so markets must live with Stressed VaR for now.
As well as the higher total capital levels demanded by
Stressed VaR, the rules also lead to biases against certain
assets, said David Soanes, head of financial institutions at
The European supervisor said once-troubled assets such as
the debt of U.S. financials, which plummeted after the 2008
collapse of the Lehman Brothers investment bank, were an example
of those that could effectively be "blacklisted".
"The extreme volatility experienced ... will forever affect
the risk content of debt issuances of the concerned firms,
irrespective of the fact that in the meantime they have
materially strengthened their balance sheets to the point that
in some cases they are actually different animals," he said.
That appears to be contributing to a fall in the size of
Data compiled by investment banking consultancy Tricumen
shows the Stressed VaR figures for European investment banks
fell sharply from year end 2011 to estimates for the end of
"The reduction is because smart banks have been looking to
trim their businesses (and hence trading books) to reduce the
impact of measures like stressed VaR," said Tricumen's Seb
Some think that's no bad thing.
"Inevitably it's going to have impact - it was intended to
have impact," said a senior banker at a second investment bank.
"The fact that dealers are holding less inventory is not only
predictable, it's desirable."
But as more banks curtail their activities, increasing
market volatility, that also raises the capital banks must set
aside for Management VaR, which is based on recent volatility
and is assessed on top of Stressed VaR. So as banks leave the
market, the costs go up for the remaining players.
"You can argue that collectively it's suicide, but
individually it makes sense," said UBS's Soanes. "These are
mechanical rules; there's nothing dealers can do except put more
capital into their business, but that's not what banks are
They are cutting back on business instead.
"The reality is the world is riskier," said Roger Lister,
chief credit officer at ratings agency DBRS. "Management is
giving them (traders) less room to hold inventory, and there's
less inventory around, so prices are more volatile, which means
that risk managers are more worried," he said.
"It's probably exaggerating to say that there is a death
spiral, but there is this recognition that volatility is going
to be greater and liquidity is going to reduce."