National Bank of Belgium publishes first comprehensive analysis on the use of derivatives by Belgian financial institutions
Brussels 7 May 2018 – The National Bank of Belgium (NBB) has undertaken a comprehensive analysis of the use of derivatives by Belgian financial institutions. In its report, which was drafted at the request of the Minister of Finance, the NBB reviews the changes in the regulatory framework, analyses the trends in derivatives activities and highlights some policy concerns.
Derivatives are widely used financial contracts whose payment flows and valuations are determined as a function of some underlying asset or variable; e.g. a commodity, an equity index, interest rates, etc. Derivatives activities within financial institutions and the risks associated with them are often complex and involve many dimensions. In 2009, in response to the important role that derivatives had played in the financial crisis, the G20 leaders announced their intention to fundamentally reform the regulatory framework for derivatives markets.
The NBB report on derivatives has been drafted at the request of the Minister of Finance, Johan Van Overtveldt, following the recommendation by the High-Level Expert Group on the future of the Belgian financial sector, that the NBB conduct an analysis of derivative products in the Belgian financial system and the associated potential systemic risks. This is the first time such a study has been undertaken. The NBB report first reviews the key post-crisis changes relating to derivatives in the regulatory frameworks for banks and insurance firms, then analyses trends in Belgian banks’ and insurance firms’ derivatives activities and highlights some potential policy concerns. The report can be read here:
https://www.nbb.be/doc/ts/publications/other/20180507_report_derivatives....
Concerns and policy issues
One concern highlighted in the report relates to the post-crisis regulatory requirement of central clearing for standardised derivatives, which was one of the goals of the G20 reforms. While this requirement contributes to an important reduction in risk between individual institutions, one of its outcomes has been to make central counterparties (CCPs) systemically important financial institutions. This development has given rise to new potential systemic risks that need to be adequately monitored.
Along these lines, after completion of the NBB report, the results of the second EU-wide stress test of CCPs conducted by the European Securities and Markets Authority were published in February 2018. Although the results of this stress-test exercise suggest that the system of EU CCPs is currently resilient to defaults of multiple clearing members and to extreme market shocks, it is nevertheless necessary to remain vigilant, given the increasing role that CCPs play in the EU financial system.
Another policy issue highlighted by the NBB’s analysis is that financial institutions’ senior management may not always have a full understanding of the uses of derivatives within their institution or of the importance of new risks created by these transactions. An appropriate governance framework must be in place to allow senior management to fully understand the origin of derivatives exposures and to assess the risks associated with derivatives
With respect to the regulatory side, data quality issues hinder the ability of authorities to fully analyse and assess the risks associated with derivatives. There is considerable scope for international cooperation by authorities in building the necessary IT platforms and sharing data and expertise, in order to achieve the advances in knowledge of interconnectedness and systemic risk that were intended by the derivatives reporting requirements incorporated in European regulation.
The Minister of Finance, Johan Van Overtveldt, has commented on the report: “This is the first comprehensive assessment of the issues and potential risks related to derivatives in the Belgian financial sector. It is important that national and international stakeholders continue the efforts to deepen our understanding of the issues.”
Jan Smets, Governor of the Belgian National Bank states: “The NBB will continue its efforts at national and international levels to monitor the potential risks associated with derivatives and to address the concerns highlighted in the report.”