A report on global financial stability prepared by a group of market players in the private sector is a good risk management reference.
I wonder whether stakeholders in the financial system of Hong Kong are aware of a report published at the end of July this year entitled Toward Greater Financial Stability: A Private Sector Perspective. The Report is the product of intensive work by the Counterparty Risk Management Policy Group II – a group of private sector practitioners of leading Wall Street houses. For those who have not had a chance to read the Report, I recommend that they do so, and soon. It is located conveniently on www.crmpolicygroup.org. It is quite a long report, but worth spending time on. I specifically recommend that the senior management of financial institutions focus at least on Section I, which is a short introduction, and Section II, which gives an executive summary and recommendations. They can then, if they do not have more time for it, assign the rest as homework for those responsible for risk management in their organisations, with a requirement that they make an assessment of how the risk management systems of their organisations compare with the 47 recommendations and guiding principles in the Report.
I also had the privilege recently of listening to a presentation of the Report by the Chairman of the Group. Noting that systemic financial shocks can be very damaging to both the financial system and the real economy, he pointed out, quite rightly, that it is in everybody's interest to prevent their occurrence as far as possible and, if they do occur, to contain and limit their damage. Although we are talking about infrequent events, the extensive damage they cause justifies more attention by all concerned, not just policy makers and regulators, but also, and crucially, by financial intermediaries. To guard against and reduce the probability of systemic financial shocks, there is a need for more attention to risk management and monitoring and increased transparency. Some may take the view that there is a cost for devoting ever-increasing attention to these issues, in terms of, for example, the efficiency and effectiveness of the financial system or the freedom and profitability of financial intermediaries. A balance obviously has to be struck, but I find the fact that a group from the private sector put forward the Report very encouraging, as is, in particular, what the Chairman of the Group calls "the statesmanship they displayed in their willingness to put aside narrow interests in order to produce a Report that unquestionably serves the public interest".
The Report identifies three categories of recommendations and guiding principles. Category I are actions that individual institutions can and should take on their own initiative. Category II are actions which can be taken only by institutions collectively in collaboration with industry trade groups. Category III are actions which require complementary and/or co-operative actions by the official sector. We at the HKMA will be examining the recommendations and guiding principles in the Report in detail and, to the extent that they are relevant to our areas of responsibility and circumstances, will consider how they should be taken forward involving the industry associations as necessary.
As an illustration of its rigour and quality, the Report repeatedly emphasises the importance of financial infrastructure and operational integrity, especially in times of stress, arguing that these factors are crucial mitigants of systemic risk in their own right. In this area, the Report points out the backlog of unsigned confirmations in some segments of the over-the-counter market and proposes monitoring it. It also recommends speeding up the development of straight-through processing of over-the-counter transactions and a ban on assignment of trades without the consent of all parties to the trade. I am sure those in the financial industry know about these practices. They are precisely the kind of practices that increase market volatility in the event of a market adjustment and may even raise questions about the creditworthiness of counterparties, causing market participants to try to mitigate risk, for example by liquidating positions. This puts further pressure on asset prices, which in turn triggers an evaporation of market liquidity and so on until, before we know it, we have a systemic financial shock on our hands.
There is a saying that if shocks were anticipated they would not occur. So let us try to anticipate them and enjoy their absence. Reading the Report, taking action on the relevant recommendations, and observing the relevant guiding principles will help us do this better.
Joseph Yam
13 October 2005
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