7 days in 60 seconds – AMA, leverage and the year of XVA

The week on Risk.net, December 4–10, 2015

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AMA "almost impossible", Bafin head says

NEW LEVERAGE RULES coming, but they won't solve clearing problems

XVA has dominated academic discussion of risk this year


COMMENTARY: AMA leaves the stage

Germany's top supervisor this week appeared to be delivering a eulogy for the industry's flagship – but foundering – operational risk capital methodology, the advanced measurement approach (AMA).

"It was almost impossible to come up with a sufficiently robust and broadly supported approach at an AMA level to capture operational risk," said Felix Hufeld, president of the Federal Financial Supervisory Authority (Bafin), in an interview with Risk.net.

Risk.net broke the news in October that the AMA might be heading for the exit. The committee's formal proposals (drawn up at a meeting Hufeld was due to attend after the interview) are now said to have been delayed – sources who met with committee members in New York claim to have been told proposals will appear early next year, not this month. Regulators are said not to have changed their stance, however.

The AMA has been in trouble more or less from its inception. The Basel Committee's original vision was that banks would initially use the basic indicator approach (BIA) and standardised approach (TSA) to calculate operational risk capital, but the goal – certainly for the larger and more complex institutions – was that they should graduate to using their own internal models, approved for use by regulators under the AMA. This never really happened. The plan ran headfirst into the 2008 financial crisis, which made regulators understandably wary of allowing banks to use internal models without close supervision.

Post-crisis, too, academic research continued to unearth deep-seated flaws in many AMA models. Operational risk losses are dominated by a few large tail risk events, making modelling expected losses challenging, and meaning capital figures can be highly volatile in the face of a few major loss events. Worse, there was little consistency among banks in modelling terms. The multi-billion-dollar penalties imposed on many banks for wrongdoing during and after the crisis blew straight through many banks' operational risk capital reserves, undermining confidence in the models still further. The AMA parallel run for US banks lasted years longer than planned, as wary regulators debated introducing robust capital floors – giving greater peace of mind, but undermining the capital advantage originally planned as the reward for switching to the more flexible but organisationally costly AMA method. In the UK, the AMA fell victim to disinterest, and former regulators now acknowledge the process may also have been hindered by the difficulty they had in keeping up with developments in operational risk modelling techniques.

Earlier this year, economists at the US Fed were cutting themselves loose from AMA at the OpRisk North America conference in New York, and the revised standardised approach (RSA) was taking the stage as the likely successor. RSA might mean dramatically higher capital levels for AMA banks, and industry members have criticised its relative insensitivity to risk, but most acknowledge that it is, at least, a less bad solution than the ambitious but flawed method it now looks set to replace.

 

QUOTE OF THE WEEK

"I don't like the idea of pre-hedging; I think it creates conflicts, and puts us in a hard place to create boundaries. There is client information I don't want the trading businesses to know about, because it is not appropriate – positioning, or even views" – Head of rates at a large European bank

 

STAT OF THE WEEK

Investors withdrew $6.7 billion from US mutual funds investing in corporate bonds in the last week of September – the biggest weekly outflow since October 2008 and the second largest since records began in 1992.

 

ALSO THIS WEEK

EU regulators split over using initial margin to resolve CCPs
Rules on CCP resolution were due last month but are now slated for February

Carney: leverage ratio could limit clearing benefits
European officials should look at the impact of the leverage ratio on clearing, the Bank of England chief tells MEPs

Fundamentally fraught: the chaotic last weeks of the FRTB
Quick fixes should have no place in a sweeping three-year reform project

Overcrowding puts low volatility indexes under pressure
The increased popularity of low volatility indexes may be to blame for a rise in correlations that has affected performance, say traders

Asset managers urge SEC to adopt swing pricing
The SEC's swing pricing proposal could help mutual funds navigate illiquid markets, but implementing it could be easier said than done

Banks clamp down on pre-hedging over manipulation fears
Front-running concerns could leave market more exposed to liquidity risk

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