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The report proposes Principles of Conduct together with Best Practice Recommendations on issues such as risk management, compensation policies, valuation of assets, liquidity management, underwriting and the rating of structured products as well as boosting transparency and disclosure.
“This report is not intended to be an exercise in self-regulation”, Mr. Ackermann said announcing the report in
“We are establishing a global financial Market Monitoring Group (MMG) for the better and earlier detection of new, emerging vulnerabilities in the markets and the financial system”, he added.
Summary of recommendations:
Risk management: Firms should develop a robust risk culture that is embedded in the way they operate, covering all areas and activities. This should result in risk management being a priority for the whole institution. Firms should take a comprehensive approach to risk, integrating strands such as credit, market, operational, liquidity and reputational risk.
Compensation policies: Compensation incentives should be based on performance, and aligned with shareholder interests and long-term, firm-wide profitability.
Liquidity risk, conduit and securitisation issues: The recommendations on liquidity risk from the IIF’s Principles of Liquidity Risk Management (2007) have been validated by recent experience, and firms should ensure their appropriate implementation as updated in the IIF’s Final Report:
• Recent events show the importance of effective internal liquidity-transfer pricing, by which firms can create incentives for business lines to act in full cognisance of the liquidity risks their businesses incur.
• Firms need to emphasise stress testing to enhance liquidity risk management under changing market conditions.
• Firms that rely on market funding should evaluate asset liquidity and potential reputation risks under stressed market conditions.
• Good liquidity risk management requires the inclusion of formal contingent obligations to off-balance vehicles, and a clear appraisal of the potential impact of supporting such vehicles.
Valuation issues: Fair value accounting is an essential element of global capital markets, fostering transparency, discipline and accountability. The Final Report recommends that there should be a high level dialogue on the application of fair value accounting in illiquid or difficult market conditions.
Credit underwriting, ratings and investor due diligence in securitisation markets: Firms involved at all stages of the originate-to-distribute process should conduct adequate due diligence and apply appropriate lending standards (including internal credit approval) regardless of whether assets are to be held on the books or distributed.
Transparency and disclosure issues: At structured product level, prospectuses should have a summary of key characteristics, and a list of critical risk factors. Global harmonisation of market definitions and structures would greatly assist the future development of the structured product market. At financial institution level, firms should ensure that their disclosures provide a sufficient overview of their current risk profiles and risk management processes, including their securitisation activities.