11 June 2009

FSA Sato – outlines changes in financial regulation

The Commissioner highlighted six key concepts that indicate the likely changes in financial regulation. However, he warned that regulators must avoid impeding the vigour of financial business and innovations in financial markets by excessive regulation.

Takafumi Sato, Commissioner of the Japanese Financial Services Agency (FSA) outlined the broad directions of likely changes in financial regulation following the ongoing global market turmoil.

 

Sato highlighted six key concepts that indicate the broad directions of likely changes in financial regulation:

Ø       Enhancing risk management at financial firms: Risk management at financial firms needs to be upgraded and given higher priority in their organisations, Sato said, criticizing that the internal presence of risk management sections at financial firms was low. Furthermore, even the new Basel II framework did not pay sufficient attention to the complexities of risks regarding structured finance.

Ø       Misaligned incentives in business models: The lack of transparency and conflicts of interest in the “originate-to -distribute” business model led to moral hazard in the securitisation market. Compensation practices at financial firms were giving excessive incentives that favoured maximisation of short-term profitability. Reviews of incentive structures have been proposed in addition to new regulation on CRAs. More risk-adjusted compensation schemes have been advised.

Ø       Enhancing integrity and transparency: Recommended measures include improving the transparency of securitised products, strengthened disclosure by financial institutions, enhanced quality of accounting standards, regulatory framework for credit rating agencies, and more rigorous due diligence.

Ø       Broadening the regulatory scope with a view to systemic risk: G20 leaders declared that the scope of regulation and supervision would be broadened to cover all systemically important institutions, products, and markets. The measures will include strengthening regulation on hedge funds and OTC derivatives, and discussions are underway at both national and international levels.

Ø       Strengthening international co-operation among regulators: Regulators have established supervisory colleges for each of the global financial firms. At the Financial Stability Forum (FSF) that has now been re-established as the Financial Stability Board (FSB), the regulators have also agreed to the fundamental principles for cross-border co-operation on crisis management.

Ø       Macro-prudential perspectives for supervision: Traditional micro-prudential supervision focusing on the soundness of individual financial firms will not be sufficient. In addition, the macro-economic impact of the financial system or financial regulation should also be analysed. Addressing procyclicality of the capital adequacy requirements can be seen as one of these macro-prudential approaches in this broader sense.

 

The Commissioner, however, warned that regulators must avoid impeding the vigour of financial business and innovations in financial markets by excessive regulation. They need to implement both short-term crisis management measures and medium-term regulatory reforms in a balanced manner, he said.

 

Pointing out the consequences for the financial services industry, Sato sees the following business implication for the business future:

• significant reduction of leverage in the financial system.
• more emphasis placed on risk management which may result in increased internal management costs.
• business models will be based more on risk-adjusted profitability and may include modifications of the compensation schemes.
• possible more standardisation of financial products. A shift of transactions out of OTC to exchanges could be another related development.

 

Full speech

 

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