During the past few years, structured finance products have become very popular
in the western world and growth will be global soon. Whilst Basel II attempts to
better, regulate global financial markets, the challenge posed by complex product
structures in the structured finance world is huge.
This paper attempts to capture the viewpoint of market participants on the impact
of Basel II on the Structured Credit Products Market. It is based on interview
centred research conducted in 2004 at the Cass Business School City University
London by the author and Mr. Kapil Chadda and is a forward looking, market
orientated study. It does not explain in detail the treatment of structured finance
products under Basel II nor explore the different product structures available in
the structured finance market.
One may wonder if it would be premature at this point of time to discuss a topic
related to Basel II and structured finance in Sri Lanka as the domestic structured
finance market is still in its infancy and Basel II has only caught the attention of
the local banking community during the past two years or so.
The objective of the article is to focus on the current thinking of selected financial
professionals, mainly based in London, on Basel II and its impact on the structured
finance market. Such investigation will benefit the local banking community in
two ways.
1. Firstly it gives a fair view of the concerns and thoughts of 23 financial
professionals from London , New York and Paris who directly deal with
structured finance and Basel II on a day to day basis.
2. Secondly it will draw attention to issues of implementation, opportunities,
and drawbacks of Basel II in the structured finance world.
For the purposes of this study, Structured Credit Products (“SCP”) broadly cover
Asset Backed Securities (ABS), Mortgaged Backed Securities (MBS), Collaterised
Debt Obligations (CDO), and Credit Default Swaps (CDS).
The aim is to give the reader an insight into how the dynamics of this market may
be impacted by the new regulatory capital framework and how Issuers, Investors,
Regulators and Ratings Agencies will adapt to the way business is done under
the new guidelines. Recognising that some uncertainty remains over the decisions
and implementation processes that Basel II will to require. This execise is a forwardlooking
project on the anticipated changes.
The 23 participants who were interviewed, represented the following cross section
of the financial industry:-
1. Buyers of Structured Credit Products (Investors)–
Asset Managers, Insurance Companies, Pension Funds, Hedge Funds
(6 participants)
2. Sellers of Structured Credit Products (Issuers)–
Banks and Securities Houses (8 participants)
3. Regulators (2 participants)
4. Credit Ratings Agencies (3 participants)
5. Advisors/ Consultants to the above parties (4 participants)
The market participants interviewed, represented senior levels of their
organisations and for the purpose of this paper, all references to names of
institutions and individuals have been omitted to maintain confidentiality.
The key areas researched were,
1. Will Basel II achieve its objectives?
2. How will Basel II impact the SCP market
3. The role of Regulators and Rating Agencies in making Basel II work for the
Structured Credit Market.
The main finding of the study was that whilst Regulatory Capital is an important
factor in determining the rationale for conducting this business, it is not the only
one; and in fact is not believed to be the most important one. Most market
participants will not change their business strategies fundamentally, though
smaller players will have to make considerable investments in systems in order to
keep up with the larger players and enjoy advantageous regulatory capital relief
for their business.
Whilst Regulatory Capital Arbitrage opportunities may be reduced, other
motivations for the growth of this business remain strong and the expected future
growth will continue undiminished. What will be evident is that the nature of
structures will change and the allocation of capital will become more risk sensitive
and efficient as financial institutions become Basel II compliant. Financial
institutions that anticipate the changes will emerge winners.
Efficient capital management is a foundation for maximization of Shareholder
Value for Financial Institutions. The key objective of capital regulation is to ensure
that Financial Institutions have a sufficient equity buffer to absorb unexpected
credit events and other risks to ensure that unnecessary systemic risk is not created
in the financial markets.
The more advanced calculations of the new Basel accord will allow greater
emphasis on the risk sensitivity of products based on the internal ratings systems
of banks, external ratings or the ‘Statutory Formula’ in the case of Securitization
exposures. This approach compared to the Standardised Approach allows for
less stringent capital requirement standards, disclosure requirements, and market
discipline, under the three pillars of the new proposals.
With the publication of the accord recently, the main focus of banks is currently
on implementation and IT installation through 2005-06. Banks will be running
Basel I and Basel II rules in parallel through 2007 and Basel II will come into
formal effect by the end of that year for most significant players in the market
(with US banks having an extra year).
Regulatory capital has been accepted as a useful tool to reduce systemic risk and
manage the financial industry effectively. First Basel I and thereafter the proposed
Basel II framework were two giant steps in establishing a global framework in
setting regulatory capital standards. A common issue that is of interest to
academics and practitioners, is how Regulatory Capital is treated when trying to
optimize Economic Capital. In the majority of cases in Europe there is an excess
of Regulatory capital and therefore regulatory capital is looked upon as a
minimum requirement, which most firms more than adequately meet, and
therefore the focus is largely on the optimisation of Economic capital.
Basel Accord has influenced the change that has taken place in the financial
industry over the past decade and expectations are that Basel II will have a more
pronounced impact. As financial markets have become increasingly efficient,
spreads have narrowed and financial institutions are becoming extremely effective
in managing their capital resources. On the other hand, markets have become
complex in response to demanding client requirements and regulators have been
challenged to ensure that the systems are in place to prevent complex financial
instruments creating undue systemic risk.
One of the significant developments that changed the landscape of the financial
industry during the past decade was the development of the structured finance
market. This market has grown rapidly during the past 10 years and it is
anticipated that it will grow at an even faster rate during the next 5 years. Products
such as ABS, MBS, CDO and synthetic securitization products have become
important tools in the financial industry and this has led to the development of a
sophisticated credit derivatives market.
The growth of the SCP market is by now well documented. Its usefulness, growth
and prevalence in today’s market are no longer an issue of debate. As the market
continues its growth, there is now a greater focus on the secondary market trading
in the products, rather than the origination and structuring of products to
restructure balance sheets on a “cash” basis.
As risk becomes a better understood commodity and better managed by banks,
there will be a significant shift to a portfolio management approach from a pure
credit management approach of balance sheet assets. In addition, most risk is
now marked to market, which is also encouraging the need to originate and
distribute assets rather than hold them to ensure an optimised portfolio.
Credit risk constitutes a significant portion of the risk in a bank portfolio of assets.
This can be packaged into Cash or Synthetic securitization or an “Insurance”
product (such as CDS, CDO’s, CLN’s etc) to off lay the risk into the market. The
implication of this is that the risk is therefore reduced and so is the need for
Regulatory Capital. The release of this need to hold regulatory capital is a big
motivator for the expansion of this market apart from the prime reasons such as
reduction/redistribution of credit risk concentration, insurance from the event of
default and freeing up the balance sheet to be able to undertake further risk and
develop new business.
The Basel Committee has published its final proposals and now financial
institutions are required to put in place the required systems and procedures. The
Basel Committee has been careful to assign a critical role for the national
supervisors in the implementation of the proposals. Whilst this would encourage
countries to implement the most appropriate models, it also opens doors for
differences in treatment of financial products in different markets resulting in
regulatory arbitrage opportunities.
For each area that was investigated, a series of questions (listed under each topic)
was posed. Presented below are the key findings from the interviews, in summary
bullet form. This will allow the reader an insight to a range of comments the
questions elicited and this is followed by brief comments on significant issues that
concern the various participants. The interviewers’ comments are made in italics.
i) Does Basel II meet the expectations of the market?
ii) Should Regulatory Arbitrage elimination be a goal of BASEL II?
iii) How will BASEL II affect the Capital Structure of Banks?
These questions were posed to the participants to assess their views if the accord
met their expectations and what its potential impact will be on the banking
industry. The interviewers believe that the success of Basel II will greatly depend
on confidence of the market participants in the broader objectives of Basel II.
Broad agreement that the accord as published is a step in the right direction
with its greater focus on Risk management, with particular focus on the
management of correlation risk. Better than what is in place currently.
Some issues that remain with regards to implementation, are:
- Operational Risk – not clear as to what the calculations will be
- Granularity needs clarification (6 assets making a granular pool,
currently proposed is not sensible)
- Trading Book Capital Measurement – needs to be defined
- Clarity on transfer of credit risk
Recognition of “double default” effects
- Definition of eligible capital (reduce Tier 1 capital requirement relative
to the total capital requirement)
Geographically Europe will be putting in place a regulatory framework under
the EU directive that will be a stricter interpretation of Basel II whilst the US
will enforce it to its largest 10-20 banks. Asia and other markets are far behind
in that some have opted out (China) whilst others are either undecided or
are far behind.
Business decisions will not be made solely on the basis of regulatory capital
charges as it may be capital intensive and yet profitable. It is a consideration
but not a key driver.
Arbitrage will remain and possibly grow between the regulated parts of the
Financial industry (Banks, Securities Houses) and the unregulated parts of
the industry (Insurance companies and Hedge Funds) which was a consensus
reached by most Issuers and Investors that were interviewed.
Overall capital held in the industry is not going to increase or decrease
significantly. It will however, be more aligned with risk.
The process of implementation and enforcement will evolve to eliminate
loopholes that may exist. Different speeds and forces of implementation by
National Regulators, will lead to a non-homogeneous regulatory environment
across the globe.
There is however a question of whether the cost of implementation of Basel
II will provide an adequate benefit for the smaller financial institutions, given
the investment needed to update risk and operational management systems
The main issue regarding effective implementation is change management
with regard to culture and decision making throughout the organisation
(especially senior management).
i) How does Basel II affect you? Will it limit/increase your interest in SCP?
ii) Should Pillar II / Pillar III be more important as a standard than P I for SCP products?
In order to assess the impact of Basel II on the SCP markets (which was the core
of this project) the participants, were asked, if they thought that there would be
any significant change to the markets as a result of Basel II.
The overall impact of Basel II on the SCP market is considered to be “neutral”
– Regulatory Capital is only one amongst many factors that motivate
participants to be in this business whilst market sentiment will remain a key driver. Regulatory Capital is by far not the most important driver in either Securitisation or Credit Derivatives.
There will be fewer arbitrage opportunities as there will be uniformity in the application of regulations; but there will be opportunities to securitize bad credits
The recognition of credit protection should spur the derivatives market.
The type of investors involved will change from regulated investors (banks)
to a greater interest to those that are non-regulated (and don’t suffer from the same capital charges).
There is currently a trend to provide a hedge against impact from Basel II, by
inserting options within the structures that allow participants to mitigate
their positions from an adverse interpretation Basel II when it comes into
effect. An example of such a structure could be a synthetic CDO with an
embedded “regulatory call option” that would allow the transaction to be called in case of a significant change in the regulatory capital requirement for the structure.
There will be differentiation in pricing for two similar ratings in different asset classes reflecting more closely the underlying risk (e.g. sub-prime loans vs. mortgages).
Those banks on the standardised approach may be penalised both from a
risk rating point of view and also from a cost of funds point of view for not
applying the IRB approach (especially if their competitors are adopting the
IRB approach). This may even lead to M&A opportunities between the IRB and standardised banks.
Pillar II and III will be complimentary to Pillar I but will have little value on a stand alone basis. Pillar I will lay the foundation for risk measurement and reporting.
Pillar III, over time, will increase in importance as there is a greater drive in
the market towards transparency from a compliance, corporate governance
and financial disclosure point of view. This may be tempered by banks not
wanting to disclose too much to allow their competitors insight into their
methods.
i) What are the top 3 motivators to do SCP business?
ii) Has the Market “matured”?
iii) Costs versus benefits: Can income and costs of structuring/ issuing be quantified accurately? What is the business case
The objective was to see if the changes in Basel II would impact the growth of the SCP markets given one of their key drivers having been regulatory arbitrage.
Motivation to be in this business was determined by
- Yield enhancement and cheaper cost of funding remain key drivers
- How bankers are rewarded for doing this business
- Ability to develop flexible structures geared to investor demands
- Negative correlation and diversification to other assets in the portfolio are key drivers for Investors
- None of the respondents said that regulatory capital was today THE KEY motivator to do this business.
Recognition of double default probability would increase the use of credit wraps on SCP structures and therefore reduce the regulatory capital required and promote further growth of the market
Innovation to move products from banking book to the trading book is the key focus for the market and CDO2 and CDS2 are becoming increasingly popular to allow financial engineering of assets.
Regulatory capital for retaining senior tranches of CDO’s will be reduced
under Basel II and will be an incentive to hold on to these, whilst focusing more on sale of the mezzanine levels which attract very unfavourable treatment under the new rules.
There was a common consensus that the SCP markets have now reached a
level of maturity, as evidenced by:
- Smaller spreads – gone from 50bps to 5 bps –
- Documentation being standardised – and tested by recent default events, like Marconi, WorldCom and Enron
- The time to market has shrunk from 2 months to 20 minutes for single
name CDS’s over the last 10 years.
- Migration from banking to trading book of the instruments
- Plain Vanilla SCP could move to becoming an exchange traded product
- Indices are traded as much as US$ 1bn trade in a day
However, maturity may still not be at its peak due to:
- Lack of liquidity in certain Credit Derivative instruments, such as CDS’s where the top 10 names still constitute 50% of the market (with GM, Ford and Daimler-Chrysler constituting a disproportionate majority).
- Highly structured solutions are still required, which will continue to spur innovation (maturity would reduce innovation)
- Number of names in CDS market grown from 125 to 600 in the last year
- but that is still far short of the total market of corporate credit that is traded in the bond market .
With introduction of more sophisticated systems being introduced for risk
management, institutions will have better ways of calculating the true cost
of dealing in SCP and therefore will be able to arrive at a more realistic cost/
benefit analysis of their business.
A general feature of this market does seem to be that income was measured far
more accurately than costs and in many cases the analysis of costs was mainly
focused on headcount. There seemed to be little appreciation of the “hidden cots”
of being in a business (such as capital usage, technology etc) as it was considered
a function for back office/accounts departments to figure out.
iv) Do buyers and sellers understand the risk - Can / Do they measure risk properly?
v) Do Credit Derivatives pose a systemic risk to the financial system?
vi) Have the developments in the Securitisation market led to a more efficient
functioning of the financial system or are the innovations motivated by
reasons other than risk management – if so what are they?
Given that one of the key objectives of both Securitisation and Credit Derivatives was to better manage risk, interviewers wanted to establish whether participants
were cognisant of the risk measurement and management perspective.
Today sophisticated portfolio management systems that allocate capital
efficiently and allow for internal transfer pricing of risk are becoming popular
and help the relationship managers to better focus on profitable client
relationships.
Buyers don’t always understand the risk as there is still an overdependence
on ratings and reliance on sellers whilst the larger more sophisticated players
better understand risk.
There could be a tendency for the front office to take on risk that they may
not understand well, as their motivations could be different from the control
departments
With the envisaged growth in the cross industry (eg. Insurance Industry)
trades, there is a greater need for non-banking financial institutions to better
understand the risks associated with the products that they deal in, as it
would lead to a healthier financial environment .
Very few sellers have the ability to measure the risk on a continuous fair
value basis and very few buyers take in to account the correlation risk (second
order risks) of the products they buy.
Basel II has drawn focus on risk modelling and past data has become very
important, which is welcomed by the industry. However, lack of default
history, prevents any great depth in the analytics that can be generated by
ratings agencies or banks.
When continuously repackaging risk, the cash can leak out leaving the final
holder of the risk with an inadequate asset base to absorb the risk.
Depending on the participant, the time horizon for the risk assessment is
very different: A mono-line insurer will look at a structured deal from cradle
to grave whilst a Hedge fund will look at the same deal for a matter of months.
Documentation has a great impact on the ultimate risk of these products.
i) What role should national supervisors play in the future?
ii) Do they have the resources to deal with BASEL II/SCP market developments, given the rate of growth and volume/complexity of regulation?
iii) How do regulators view the provisions of Basle II, in helping them to better supervise bank risk and regulatory capital?
iv) Should Insurance companies (Investors) be subject to regulatory capital
management
Regulators around the world have been entrusted with a challenging and critical
role in implementing Basel II. The success and final shape of the Accord will
depend on how well the regulators rise to the challenge. It’s equally important
for the different market participants to have confidence that their national regulators are capable to fine tune the implementation so that wider interests of the industry are met.
Many participants considered the Financial Services Authority (FSA) as the leading light globally in the application of Basel II for structured credit products.
There is confusion within the market place in terms of the role and involvement of regulators between their Regulatory position and their supervisory role.
Emerging market regulators (China, India) are thought to be well behind
the curve and have not yet even got to the basic standards of Basel I (B4) with great reluctance to contemplate the implications of Basel II. (It is believed that this position has changed during the past year.)
There was a common perception that Insurance companies should be better regulated with a greater focus on putting aside regulatory capital. Regulators should not get involved in the micro-management of banks.
Regulators need to help educate the market in terms of how to get to the IRB standards.
There was a common perception that Insurance companies should be better
regulated with a greater focus on putting aside regulatory capital. Regulators
should not get involved in the micro-management of banks.
There was doubt expressed on the resources available to the regulators
specially to deal with complex financial instruments.
i) Will the role of rating agencies change with Basel II ?
ii) Should they be regulated? (considering greater dependence on ratings)
The objective was to establish the view of the market as to the future relevance of
ratings agencies and if given their prominence in the SCP markets, they should
be better regulated in terms of their output.
Rating Agencies are confident that they are well prepared for the
implementation of Basle II.
There was a unanimous view that regulating the ratings agencies is not a
viable solution, especially if the independent opinions of the agencies would
be affected.
Most participants agreed that the role of rating agencies was going to continue
to be important and critical for the effective implementation of Basel II.
As internal ratings systems will not have enough data to determine their
own historical track record, there will be continued reliance on external
ratings. However one of the rating agencies interviewed felt that they too
would face similar constraints.
There was also the feeling that instead of external regulation, self-regulation
was more appropriate. As rating agencies are significantly exposed to
reputation risk, reputation risk would be a key driver for rating agencies to
implement systems for self-regulation. It was felt that more competition in
the industry would be healthy and lead to greater concern for reputation
risk.
The pro-cyclicality of ratings remains an issue that is unresolved in the new
framework of Basel II.
Investors still rely on ratings even though they do their own analysis; the
restricted numbers of rating agencies means there is probably a greater reliance
than there should be.
There could be a conflict of interest developing, as agencies did both the
ratings and credit advisory and modelling business. However, a rating agency
explained that the Chinese walls that existed between these two activities
were of an adequate standard.
The agencies need to prove their worth through the analytics that they apply
and that can be tested in a downturn.
Based on the analysis arising from the interviews, research done on the Internet
and review of publications, some of the key issues that were of consequence to
the participants appeared to be as follows:
The major issues that Banks are dealing with regard to the preparation for Basel
II, is the implementation of new risk management and measurement systems as
most of them have made the strategic decision of selecting either the IRB or
Standardised approach. Another concern is the training of staff and re-evaluation
of strategy on origination, distribution, portfolio management and whether they
wish to focus on the cash or the synthetic markets. Banks may face change
management issues. The top 5 to10 players in Europe and the US appear to be
ahead of the pack currently but with the investment in infrastructure and resources
being put in place this gap will be narrowed.
There may be a change in the business mix that issuers undertake as residential
mortgages, credit cards, retail assets and high-grade corporate bonds become
more attractive. Conversely, deals in low grade assets such as high yield corporate
bonds, commercial mortgages, project finance, sub-sovereign & emerging countries
will attract high levels of regulatory capital and the focus will shift to cost of
funding and risk transfer rather than regulatory capital arbitrage. The impact of revised accounting standards, Sarbanes-Oxley and Basel II may however influence
the business in multiple ways and will make the future incentive of these
transactions difficult to predict.
From an investors’ point of view the impact on the treatment of these instruments
for issuers will create interest for investors to take a more active role in the market.
Investors that are not regulated by the Basel II guidelines, will not require to put
aside regulatory capital and therefore may have different motivations influencing
the demand of such products. The potential arbitrage opportunities amongst banks
on the standardised approach (SA) as opposed to those amongst banks on the
Internal Ratings Based Approach (IRB) will create a two class system.
Other factors affecting the growth in the Credit Derivatives market such as
transparency, standardisation of documentation and liquidity will also be major
influences on the level of interest, investors show in the market.
Securitisation exposures rated BBB and below will be sold outside the Basel II
sphere to either insurance companies, hedge funds or specialised private equity
funds or even to Basel I banks / Basel II banks on the simplified standardised
approach, where there will be more attractive treatment of the tranche. Hedge
funds that are already doing a lot of CDO2 and CDS2 business will focus on
setting up CDO’s of BBB tranches .
Rating agencies’ role will gain prominence in the future whilst the onus will be
on them to be self-regulated and to provide an independent and timely analysis
for investors. They will have to nevertheless comply with ECAI (External Credit
Assessment Institution) requirements.
Whilst the dependence on ratings will increase, especially from those that rely on
the Standardised Approach, those that rely on the IRB approach will use ratings
under the supervisory formula more as a reference tool rather than a benchmark.
Similarly, investors that are sophisticated will also only use them as a reference
tool; however, financial institutions that have a binary view of the risk profile of
a client will depend on ratings as guide.
There is a general desire from the market to see more competition and to ensure
the Chinese walls between rating agencies’ advisory business and the credit risk
management/measurement systems business are not conflicting.
Securitisation deals will be encouraged to have a public rating, as without this,
they will be disadvantaged and may suffer from a pricing and marketability
penalty. Whereas seeking a public rating for an unrated (risky) corporate appears
to have even less incentive than today, based on how they will be treated by
banks from a regulatory capital perspective.
Regulators have a challenging task ahead of them with regard to interpretation
and implementation of Basel II while ensuring that the gaps between the global
regulators environment are minimised. In most less developed financial markets
the regulator also has a critical role as a catalyst. The effective use and active
participation of Global forums for the co-ordination of their activities is very
important going forward.
Most regulators are challenged by the quality, quantity and reward structure for
their personnel and therefore their biggest challenge remains their ability to
implement these new rules effectively and trying to keep up with the innovation
in this market segment in a timely manner. Regulation of the structured finance
market will be a major strain on the resources available to the regulators.
The distinction between regulating and supervision will be an important split in
the role of a regulator and there is currently a wide divergence between the
countries with advanced financial markets and the less developed countries, in
terms of where the emphasis should be for regulators, going forward.
Regulators are burdened with the volume of work and the level of detail that has
to be dealt with and specifically at the evolutionary nature of their work. The
dialogue between industry and regulators has to move from a consultative process
to one where the less well equipped market participants receive guidance from
the regulators as to how to implement their reporting and management systems.
There is broad agreement that Basel II will lead to a more risk sensitive capital
provision and also encourage improvement in the risk management techniques
applied by banks. However, while regulators are trying to eliminate arbitrage
opportunities, banks are hard at work looking for future arbitrage opportunities
within the new framework. Though regulatory capital is taken in to consideration
in decision making, it is not the driving force. Economic capital is of more
significance and market participants believe that eventually regulatory capital
will converge with economic capital measurements.
Most market participants disagreed on the argument that ‘usage of credit
derivatives and securitisation will lead banks to creating higher levels of risk as
they hardly retain any risk’, pointing out the importance of reputation and long
term objectives of the market players. There was consensus that the focus on
operational risk in Basel II was positive, even though operational risk measurement
was impaired by weak models and lack of understanding of the nature of risk.
The new regulatory framework will have an impact on the securitization and
credit derivatives markets in areas such as counterparty concentration and ratings
as well as the types of assets being securitised. It is not expected to affect the
overall growth rate of the market which will be driven by other market dynamics.
The market has already begun to factor some of the expected implications of
Basel II in to structured finance products by way of regulatory call up options
and pricing decisions. Whilst Pillar I will remain the building block of the new
regulatory framework, market participants strongly believe that Pillar II and Pillar
III would become more important in the future.
The majority of the interviewees were of the view that there was growth potential
for highly structured products and there was a tendency for the basic products
in the market to move towards a more standardised format. Developments in
documentation, indices and a sharp drop in spreads and time taken to complete
a transaction were all cited as signs of maturity in the market whilst lack of liquidity
and counter-parties was considered as one of the main concerns.
It was believed that though most of the large and sophisticated players in the
market were well positioned to understand and measure the risks in the industry,
many players did not have the required systems nor were fully aware of the risks.
They were also highly dependent on recommendations made by the rating agencies
and pitch documents prepared by the sellers. This points towards the significance
of more accountability, transparency and better business practices in the industry.
Banks that remain on the standardised approaches will pay a penalty for not
having sophisticated risk management systems and this penalty will result in a
cost of funding disadvantage. As these banks look at efficient capital usage, they
will need to raise additional capital and may use structured products to both
raise funding and restructure their capital base. This remains a key opportunity
for those banks on the IRB approach and could lead to regulatory arbitrage
opportunities between the IRB approach based banks and the banks that follow
the Standardised Approach. “Regulatory Swaps” similar to total return swaps
could be a new product to surface in the market.
The market in SCP products will gain a further impetus from those sections of
the financial services industry that are not regulated by regulatory capital rules.
These non regulated financial institutions (such as Hedge Funds, Insurance
companies, private equity funds) will have greater interest in these products and
banks that are both on Basel II and especially on the IRB approach will find them
to be appealing counter-parties.
Part of the success of Basel II will depend on the crucial role that the regulators
have been called upon to play and there is a clear distinction between the
regulators who are better prepared than the others and most market participants
expressed their confidence in the UK and US regulators to be ahead of the league.
Regulators are aware of their changing role and are trying to find the right balance
between being a regulator (setting and enforcing rules for all institutions) and a
supervisor (involved in detailed review of individual institutions).
Rating agencies would have increased responsibility in providing an important
component (ratings) that Basel II framework requires and were believed to be
generally geared to meet the challenge. Regulation of rating agencies was not
considered to be the way forward and any regulatory action that would undermine
the independence of the rating agencies was believed to negatively impact the
industry.
Undoubtedly Basel II would change the length, breath & colour of the structured
finance market and has opened the doors for financial institutions to identify
new opportunities. Proactive financial institutions that identify the opportunities
will emerge as winners in the new landscape.
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