WASHINGTON Federal Reserve Board Gov. Daniel Tarullo on Friday floated three ways policymakers could strengthen a set of proposed market-wide reforms for securities financing transactions.
Global regulators, under the auspices of the Financial Stability Board, have spent the past two years reviewing proposals to create a system for haircuts and margin requirements for securities financing transactions a topic Tarullo has repeatedly discussed.
Broadly, the suggested global framework would establish a system of numerical floors for haircuts that would force any firm that is looking to borrow against a security to post a minimum amount of excess margin that could vary depending on the asset class.
But Tarullo, who oversees bank supervision at the Fed, suggested the August proposal by the FSB was a "first step" in crafting such a framework but posed "significant limitations."
He said the proposal would only apply to SFTs regulated by entities providing financing to unregulated entities and would not cover SFTs between a regulated lender and regulated borrower or between an unregulated lender and an unregulated borrower. It also would only apply to lending against collateral other than sovereign obligations. Additionally, the numerical floors of the haircuts are calibrated at low levels.
In past speeches, Tarullo has outlined a number of policy options that regulators could pursue to curb such risks tied to SFTs, including a regulatory charge or increasing low charges under the current regulatory standards of SFTs matched books.
But Tarullo said additional measures being pursued by the FSB to incorporate regulatory reforms that can be applied on a market-wide basis to focus on specific kinds of transactions not just the type of firm engaging in those activities should be tougher.
"Such an approach would at least partially offset the incentives that will otherwise exist to move more securities financing activity completely into the shadows," said Tarullo, speaking at a conference by the Americans for Financial Reform and the Economic Policy Institute.
In his remarks, he offered three measures policymakers could pursue to help improve the calibration of the floors.
That included basing it on the floors of current repo market haircuts to help prevent a "return to less prudent practices" before the financial crisis, he said.
A second approach would be to establish a set of haircuts for long-term periods that would include periods of stress.
"While minimum haircut levels should not be set as high as the haircuts lenders demanded at the debts of the crisis, setting numerical floors in proportion to those levels might be reasonable," said Tarullo.
Lastly, policymakers could set levels that would be consistent with the amount of capital a bank would have to hold against a security if it was held in inventory.
"Such an approach could be viewed as an indirect way of extending bank capital requirements to the shadow banking system, and would reduce the current bank regulatory incentive to lend against a security rather than hold it directly," said Tarullo.