The Trends and Risks in Bond Market Liquidity Q&A panel featured (from left to right): Robert Akeson, Daewoo Securities (America), Peter Curley, Promontory Financial Group and Michael Leibrock, DTCC.
Executives from The Depository Trust & Clearing Corporation (DTCC) joined more than 60 risk and operations professionals, representing approximately 30 DTCC clients, to discuss key issues related to developing and emerging systemic risks during the DTCC Systemic Risk Event, on the morning of August 12 in Jersey City, NJ.
Discussions focused on:
- Catastrophic failures - why they happen and how to prevent them
- Trends and risks in market liquidity
- Importance of cyber security in safeguarding financial services institutions
The event is a component of DTCC’s ongoing engagement with clients to increase industry awareness of systemic risk issues and share insights on new tools and resources to help reduce systemic risk.
“Risk mitigation is at the heart of everything we do at DTCC. It’s in our DNA,” said Michael Bodson, DTCC President and CEO, who attended the event. “These meetings reinforce our commitment to collaborate with industry partners to foster discussion and advance strategies on risk mitigation.”
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Chris Clearfield, Principal at System Logic, a boutique research and consulting firm that helps clients understand and manage the risks that arise from complexity, led a presentation titled “Why Catastrophe is Everywhere (and What You Can Do About It).”
During his presentation, Clearfield walked through the complexity of risks that are present within organizations and the role complexity plays in contributing to catastrophic risk - supplemented with examples from the financial services industry as well as a wide range of other industries. Clearfield highlighted that some of the most common recommendations to resolve a problem (i.e., more controls, more technology) are not always the answer and often times can compound a problem across increasingly complex systems and organizations.
As an example, adding a patch or fix to a legacy technology system could change the system architecture and restrict some of the technical functionality. Rather, Clearfield focused on the importance of changing organizational behavior to cultivate an environment that promotes collaboration and challenges decisions. This requires breaking down silos and hierarchies that exist within organizations to increase the diversification of opinions and perspectives.
Clearfield also provided practical techniques that can be utilized within organizations to start to change organizational behavior. The first involved having a dedicated skeptic to challenge significant decisions. The second involved conducting a pre-mortem ahead of a significant business decision or initiative, as opposed to a post-mortem after the fact. Often times after failed decisions, it emerges that there were pockets of doubt and skepticism on the direction within organizations. By conducting a pre-mortem and visualizing why the decision would be unsuccessful, individuals have the opportunity to plan accordingly.
The session How to Mitigate Cyber Risk in Financial Services featured (from left to right): Tim McKnight, GE, Justine Bone, Medsec, Royal Hansen, American Express, Phil Venables, Goldman Sachs and Stephen Scharf, DTCC (moderator).
Trends and Risks in Bond Market Liquidity
While concerns around market liquidity are intensely debated, the views on this subject differ wildly. Much of the discussion focuses on the impact of regulations and other structural changes that affect liquidity. Michael Leibrock, DTCC Chief Systemic Risk Officer, discussed and debated these issues with Robert Akeson, Chief Operating Officer, Daewoo Securities (America) and Peter Curley, Managing Director, Promontory Financial Group.
Leibrock noted perspectives vary across regulatory agencies, asset managers, broker-dealers, etc., both in terms of overall market liquidity as well as liquidity challenges within specific asset classes. He explained that metrics to monitor and assess liquidity can also present a mixed message. “Some of the traditional measures of fixed income liquidity are showing relative stability, but an enhanced, more-intensive analysis of these metrics may point to declining liquidity,” he said.
The panelists discussed the impact that regulations (Basel III, Dodd Frank, Fundamental Review of Trading Book “FRTB”, etc.) are having on activities and functions associated with liquidity (all asset classes), within banks or across the financial services industry as a whole. The panel noted that regulatory compliance costs have increased due to the requirements associated with Anti-Money Laundering (AML), Know Your Customer (KYC), Office of Foreign Assets Control (OFAC) among others.
New regulatory requirements are causing banks to have much less flexibility than they did prior to the financial crisis, and it’s questionable if this sector will have the capacity to provide the volume of liquidity that will likely be needed during a future market crisis.
Structural Changes Impact Liquidity
Following the financial crisis, a number of formal and informal structural changes have developed across financial markets. Market participants and regulators have differing opinions over which, if any, of these structural changes are most responsible for impacting liquidity, or whether today’s markets are simply re-pricing risk to reflect the “new normal.”
As a component of the Market Liquidity Panel, the panel identified a number of structural changes it has seen emerge across markets, which are impacting liquidity including, among others, post-financial crisis regulations, an increase of electronic trading frequency and a contraction of the repo market. The panel closed this session talking about opportunities for collaboration across the financial services industry and what initiatives and solutions could be undertaken by the collective industry to promote and enhance market liquidity.
How to Mitigate Cyber Risk in the Financial Services Sector
In the day’s final session, Stephen Scharf, DTCC Chief Security Officer, led a panel of leading industry practitioners in a discussion on financial market infrastructures’ strategies to thwart cyber attacks. The panelists discussed best practices and lessons learned across central counterparty clearing houses and financial services firms, and the importance of detective and preventative controls as part of a sound cyber defense strategy.
Joining Scharf on the panel were Royal Hansen, Senior Vice President, American Express, Phil Venables, Chief Information Risk Officer, Goldman Sachs, Tim McKnight – Chief Information Security Officer, GE and Justine Bone, CEO of Medsec.
The panelists agreed that cyber risk is no longer an isolated risk, which has lead to increased collaboration among banks to share cyber threat information. For example, banks are setting up a Financial Services Analysis Center, which will be used by approximately 7,000 banks. Large broker dealers are also establishing a collaborative monitoring system to help prevent and detect threats.
“The threat has evolved as well,” Scharf said. “Attacks are coming in multiple forms and it is no longer a matter of ring-fencing your systems to protect from the outside. Now you have to consider and address threats from all angles, which require increased understanding and attention to internal activities.”
The panel discussed the evolution of the role of the Chief Security Officer (CSO) within organizations. Traditionally, the core competencies for this role were focused around strong technical background. Now, CSO positions require more business perspective and strong communications skills for management of internal and external stakeholders.
The rising interest in cyber insurance products was an important topic of discussion. Panelists agreed cyber insurance is a tool that has a place within the risk management framework. However, the group agreed that the reputational damage that a firm would suffer as the result of a cyber attack would outweigh any financial money that was recouped from insurance.
A Look Ahead
DTCC has a number of risk-focused initiatives on its agenda for the remainder of 2016, including:
- The DTCC Systemic Risk Barometer - Q3 2016
- The Barometer is a semi-annual pulse check that monitors emerging trends on risks that may impact the safety and resiliency of the global financial system.
- DTCC Client Risk Forum - November 15
- The event will feature three panels/sessions with updates on DTCC risk management initiatives, various DTCC business initiatives and geopolitical risk.
- DTCC Systemic Risk Roundtable – Q4
- The Systemic Risk Roundtable offers a forum to informally exchange ideas among risk management professionals from DTCC’s members.