Michael Shashoua: The Smart Play on Stress Tests

The scope of the impact of new European regulations is expected, in all quarters, to be great. Last month in this space, I examined the potential for delaying the implementation of Mifid II and the reasons why that might allow the industry to become slack about improving its data management.

The point of this argument is further supported when one considers the strong prospect that the new regulations could effectively push European firms to discover more value in their data, as they figure out how to comply with the rules. In particular, putting together fragmented data stores and managing data across enterprises are worthwhile efforts, as S&P Capital IQ’s Cristiano Zazzara argued in Inside Reference Data’s December 2 webcast.

The key is seeing data for its value rather than its cost, as ING’s Stephane Malrait stated during the same event. “In other industries, the value of the company is driven based on the data they have,” he said. “They don’t see data as a cost; they see it as a revenue center. The financial industry is starting to slowly move toward that.”

As a result, asset management firms are looking to organize and draw upon data that can meet multiple compliance needs at once, such as Mifid II, Solvency II and Basel III. If they can do so with Solvency II, the EU directive on insurance firms’ capital adequacy reporting, they may be able to optimize and grow assets they find on their balance sheets, as Gareth Mee of Ernst & Young told us recently.

Put Aside Basel Uncertainty

The cost of making these changes is relatively small compared to the potential value.

Speaking of Basel III, there has been talk about a tougher, updated version of its risk modeling and capital assessment rules, which would be dubbed “Basel IV.” Yet, loose ends are still hanging off Basel III, partly due to recent changes and updates made by its architect, the Basel Committee on Banking Supervision (BCBS).

The changes being made to Basel III are “pretty radical,” according to Brad Hintz, a New York University professor who recently worked with Broadridge on a survey of the industry about operational challenges for the next five years. “European banks face some real issues with their risk weightings. If you adjust risk weightings, it’s going to change inventory positions and your ability to hold legacy positions and work them out over time,” he says. The result, according to Hintz, is that firms must offer a “smorgasbord of every product to everyone, all the time.”

BCBS 239, the stress-testing regimen carrying out Basel III’s principles, is about to see its first run in 2016. To know how to organize, process and report data to complete its tests and comply with Basel III depends on clarity about what the rules are and specificity about how they are being updated. In the present climate, it’s questionable whether that’s available.

US CCAR Challenges

While capital adequacy and stress-testing appear to be getting tougher in Europe, they may be getting easier in the US, if the US Federal Reserve removes, at the industry’s urging, its assumption in Comprehensive Capital Analysis and Review (CCAR) testing that firms would continue dividends and stock buybacks even in a severe economic downturn. “From the Fed’s perspective, it wants to use CCAR correctly, and that means they have to keep it opaque,” says Hintz. So, even with easing one aspect of CCAR, firms could still have difficulties completing its tests.

Whether in the US or Europe—and whether regulation deadlines hold or not—firms would be wise to ensure capital adequacy and collect and organize the data that proves their capital is adequate. The resulting benefit, as industry practitioners and observers know all too well, is that firms get more accurate and better organized data to support investment and trading decisions, which in turn leads to increased revenue. The cost of making these changes is relatively small compared to the potential value.