06 July 2010

Black Swan: Consumer Financial Protection Bureau...

The Consumer Financial Protection Bureau has been born out of the 2,300 pages of the final US Federal Financial regulation of 2010. The tone on what and how the CFPB operates is spelled out in the legislation and Operational Risk Managers are actively scouring the fine print to determine the compliance and legal ramifications. Yet the new Director's leadership may spell out the impact more than any of the new rules. The WSJ enlightens us:

The legislation says the bureau's purpose is to "regulate the offering and provision of consumer financial products or services." Details are left largely up to the new director, who would serve a five-year term. The law creates offices for research, tracking consumer complaints, consumer financial literacy and fair lending, among others.

Among the director's first tasks will be refining the agency's mission. Critics and supporters, though agreeing on the importance of the new agency, differ on what will constitute success.

Institutions will be adjusting their behavior to the new rules and it will be adjusting to how it continues to do proprietary trading. It's hedge fund ownership is now limited to 3% and the "Volcker Rule" is the same percentage for trading Tier 1 capital. The entire financial services industry is essentially gearing up for more of the same with minor adjustments on how it implements it's various risk management strategies. So what has changed and what will change?

Large banks and their supply chains will be looking for new ways to leverage their ability to improve margins. And when you look for ways to improve margins, you raise rates add more fees and incrementally gain a tremendous avenue for increased cash flows. Enterprise Risk Management will try to find a way to hedge against the "Black Swan" event from ever happening again. Even today, the business is still in the dark on the mathematical equations that caused the last implosion of world markets and the unraveling of the financial trust that is the foundation for the system to operate with efficiency and market speed.

Going forward the risk management professionals will be dissecting the final law to determine how it will impact their business, institution or agency for the next few years. As business owners and corporate institutions begin to see what direction the new Consumer Financial Protection Bureau (CFPB) chief will be taking, they will be devoting resources and budgets to adjust to these market changes.

And while all of this is evolving in the open and transparent world of finance you can bet that the next "Black Swan" event is on the horizon. As "Operational Risk Managers" who witness the speed and the complexity everyday in the trading pits, software development units and on the white boards of countless conference rooms will tell you; the next one is out there:

"A Black Swan is a highly improbable event with three principal characteristics: It is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was." Nassim Nicholas Taleb, from his book The Black Swan - The Impact of the Highly Improbable

Sens. Chris Dodd (D., Conn.) and Blanche Lincoln (D., Ark.) are trying to calm the fury among bankers and business groups over a last-minute change to the financial overhaul bill that critics now say could upend the way companies hedge against risk.

In the early hours of Friday June 25, Democrats altered a key provision to the derivatives section of the financial overhaul bill. It has a completely different meaning depending on who you ask. Some believe the language would require all people engaging in derivatives contracts to post “margin,” or more costs to engage in a deal. Others believe it would apply only to big banks and major derivatives dealers. The difference could swing billions of dollars one direction or another.

The confusion stems from a part of the section, tucked into the 2,300-page financial overhaul bill, that says margin requirements “shall” be set against “all” uncleared swaps. Some companies believe they should be exempted because they aren’t risky derivatives speculators, and fear it will drive up their costs. Several companies and business groups have said the language is such a glaring mistake that it could undermine the entire derivatives market, particularly for companies using these products simply to hedge risk.

But the language is in sections of the bill setting rules for “swap dealers,” which are essentially banks or large derivatives traders regulators plan to place tougher restrictions on. Depending on how it is interpreted, the language could apply only to those “swap dealers.”

Regardless, the confusion has led to an uproar…

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