A strange irony is underway in the financial services industry. A recent client survey conducted by the DTCC finds that compliance with the regulatory onslaught is causing securities firms the greatest concern over systemic risk. A whopping 82% of clients say that meeting regulatory requirements strains their focus on day-to-day risk—effectively undoing the point of regulatory reform.
The massive scope of Dodd-Frank, CPSS IOSCO, Basel III and other regulations is cause firms to make a “tremendous commitment of time and resources” to establish compliance structures and is “keeping people up at night,” says Michael Leibrock, vice president, operational and systemic risk management for the DTCC, in a prepared statement. “The findings suggest that if execution of regulatory mandates is done poorly, that could actually create risks which supervisors are trying to avoid, including the potential failure of a firm as a worst-case scenario.”
The regulatory situation gets even murkier as firms construct their compliance infrastructures. A new article in The Nation by Gary Rivlin argues that over the past three years Wall Street’s lobbyists and regulatory lawyers have effectively delayed and defanged Dodd-Frank. If this is the case, then why have firms been scrambling, losing sleep and spending millions for mere cosmetic fixes?
But most firms have little time to ponder the big questions. They must concentrate on staying solvent and DTCC officials say that the 80 institutions that responded to the survey—most of whom are banks and broker/dealers—are ranking their top 10 systemic risk concerns as follows:
1.) The Impact of New Regulations: 82%
The clients report that the time and resources needed to conform to new regulations could result in companies “taking their eye off the ball” from managing day-to-day risk.
2.) The disruption or failure of a key market participant: 61%
DTCC clients think the too-big-to-fail issue is a top concern because “the interconnected nature of the financial system could cause a domino effect if one major player fails.” I should also point out that the flood of new laws and regulations has never attacked the issue directly.
3.) Cyber Security: 53%
The survey says that small firms with limited resources for IT departments or constant technology upgrades are “considered the weakest link in combating cyber threats.” Major firms have also been victim to cyber threats although they may have more resources to do a fast clean-up job after an attack.
4.) Significant Business Continuity Event: 45%
If meeting new regulatory requirements aren’t enough of a burden, clients cite unpredictable events such as natural disasters and terrorist acts and more predictable events such as extreme weather as considerable concerns.
5.) Sudden Dislocation in Stock or Bond Market: 37%
Concern over massive losses in the fixed income markets is high up on the list as yields on most bonds are at or near historical lows, according to the survey results. Clients fear that “even a modest increase in yields” could spur big losses.
6.) U.S. Recession: 37%
Not surprisingly, DTCC clients are justifiably troubled that the U.S. government’s inability to effectively address the deficit and “the cumulative effects of heavy regulations” could serve as catalysts for a return to recessionary conditions.
7.) Partial or Full Eurozone Breakup: 35%
Systemic risk caused by the over-leveraged nature of certain Eurozone countries and a “lack of fiscal/monetary integration across the region” that results in the voluntary or compulsory exit of one or more member nations would lots of systemic risk ramifications.
8.) Major Compliance or Governance Event: 35%
Survey respondents say that major global firms making huge blunders in compliance and causing a ripple effect across the industry is giving credence to the perception that the financial markets belong to the insiders. Of course, the lax compliance could be attributed to distractions caused by meeting new regulatory demands—but that might be a stretch.
9.) Interconnection Risks: 25%
The links among global financial firms provide many benefits across the industry. Yet this millisecond access can backfire when high-speed transactions create rollercoasters that result in massive losses in minutes.
10.) High-Frequency Trading: 18%
Controversial HFT firms are seen as causing “future anomalies in the securities markets,” according to the survey. Yet the systemic challenges that HFT firms pose will be ongoing because the industry and the regulators have not effectively dealt with this inevitable phenomenon.
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