The International Organisation of Securities Commissions, the umbrella group of global securities regulators, is planning further work to address issues raised by the ongoing credit market disruption.
At its annual conference in Paris, it published the final report of its technical committees Task Force on the Subprime Crisis, which focuses on the failings in the market for structured finance products, and includes recommendations for improving the functioning of these markets in three areas: issuer transparency and investor due diligence; risk management by firms and prudential supervision; and, valuation and accounting issues. These areas will be addressed in the future work of various standing committees that fall under the IOSCO technical committee.
The task force found that many institutional investors and investment banking firms had inadequate risk models and internal controls in place to understand the risks they were assuming when buying structured finance products, that they relied heavily (or even exclusively) on external credit ratings for their risk analysis, and that they had inadequate balance sheet liquidity even when adequately capitalised.
Therefore, its committees will be addressing these issues, specifically: studying the internal control systems of financial firms and asset managers and developing principles to address any concerns; surveying its members experience on liquidity risk management and liquidity standards; the technical committee will ask originators and sponsors of securitisation programs to develop best practices for due diligence and risk management; and, another committee will consider whether additional guidance and disclosure relating to off-balance sheet entities would be valuable in meeting the needs of investors.
The task force also concluded that the recent market turmoil had less impact on publicly traded structured finance products in some markets, and that secondary trading of structured finance products is generally opaque.
As a result, one of its committees will consider the viability of a secondary market reporting system for different types of structured finance products. Another committee will review the extent to which investment managers that offer collective investments (such as mutual funds) to retail investors have invested in structured products, the type of due diligence they conduct when making these investments, and the degree to which these investment managers have been affected by the current market turmoil.
Additionally, they will study the structures of, and disclosure practices for, private placements of asset-backed securities to determine how they compare with publicly traded ABS; review the degree to which existing issuer disclosure standards and principles are applicable to publicly traded ABS, and will develop them if they are not relevant.
Finally, the task force noted that concerns have been raised regarding the role fair value accounting principles played in providing investors and regulators with adequate information about the strength of financial firms facing illiquid market conditions and that some financial firms appear to have inadequate human and technological resources to model their financial positions using fair value accounting principles under illiquid market conditions.
So, IOSCO committees will consider whether additional guidance and disclosure related to measurement at fair value would be valuable for investors; and, whether registered intermediaries and investment advisers use practitioners who are skilled enough to model fair valuation adequately in illiquid market conditions.
This report makes clear that, while financial innovation is to be encouraged and plays an important role in the allocation of capital and risk, new financial products need to be accompanied by a thorough analysis of the risks as well as benefits they may bring. This report also highlights the need for all market participants, institutional investors and financial regulators to focus on adequate risk assessment and risk management,” says Christopher Cox, chairman, U.S. Securities and Exchange Commission, and co-chair of the IOSCO task force.
Recent events have shown how closely linked the worlds capital markets are and how great is the need for increased co-operation between regulators in developing and implementing international principles of regulation. The future work that we have committed ourselves to will help enhance that already deep cooperation, adds Cox.