April 10, 2012
RISKJOURNAL - Spring 2012
Welcome to the Spring April 2012 issue of PRMIA DC's newsletter.
(Click here to view our Spring April 2012 issue)
Topics covered include:
• Yet Another Sovereign Debt Crisis
• Foundations of Sand
• Global Identification Standards for Counterparties and Other Financial Market Participants
• Derivative Accounting: Tools & Techniques for Testing Hedge Effectiveness
• Bet the House: Why the FHA is Going (for) Broke
• RiskRegulations - Recent Proposed & Finalized Rules
• Highlights of Upcoming RiskEvents
Yet Another Sovereign Debt Crisis
In the foibles and adventures of lending and borrowing, at least one constant law holds: loans that cannot be repaid will not be repaid, whether they are to governments or to anybody else. History shows us that sovereign governments often default on their loans, particularly in times of war or economic upheaval. Europe finds itself in this situation now and would do well to examine past sovereign debt crises — particularly, the European sovereign debt crisis of the 1920s — for lessons.
Foundations of Sand
Despite the remarkable advances made over the past 25 years, David Rowe argues that the industry’s existing risk models are not fit for purpose when it comes to stress testing and analysis of tail risk and that the time is ripe for a paradigm shift in the ways financial risk management models are developed, tested and interpreted.
Global Identification Standards for Counterparties and Other Financial Market Participants
Financial markets, financial products and financial networks are complex, ubiquitous and highly interconnected and there are currently no global standards for identifying market participants. As a result, there is a lack of data transparency in the financial market making it almost impossible to track counterparty risks at the micro and systemic levels. Financial agencies and sovereign regulators have consequently started soliciting studies and whitepapers on legal entity identifiers in order to better understand the interconnectedness of financial institutions and to develop solutions to monitor systemic risks.
This paper explores how existing technologies that have been successfully implemented in other industries such as the retail industry can be harnessed to develop a global identification standard because a global identification system is the pillar of future risk management and global financial risk monitoring.
Derivative Accounting: Tools & Techniques for Testing Hedge Effectiveness
A company can record its derivatives transactions either by using hedge accounting or speculative accounting. Some companies choose speculative accounting over hedge accounting because of its flexibility and less onerous requirements. However, hedge accounting is the preferred choice when a company is concerned about the volatility that the use of derivative instruments may introduce into its earnings. Because of the comparative advantage of using hedge accounting to manage earnings volatility over the flexibility of using speculative accounting to record derivative transactions however, the process of recording and reporting derivative transactions under hedge accounting is not a walk in the park. Companies that choose to use hedge accounting to record their transactions are subjected to stringent accounting and documentation requirements. This include a requirement to test the prospective and retrospective effectiveness of the hedging arrangements at every reporting period.
This paper thus seeks to shed some light on the tools and techniques available for testing hedge effectiveness under the relevant accounting standards.
Bet the House: Why the FHA is Going (for) Broke
No serious observer of the Federal Housing Administration (FHA) believes its financial future is bright. But few recognize just how troubled this government agency really is. That is because it uses lax accounting standards that obscure real and present danger to its own bottom line and the American taxpayer. In fact, when measured against the accounting system used by private mortgage insurers, the FHA is deeply insolvent, with a capital shortfall of tens of billions of dollars. If it were a private firm, state regulators would immediately shut it down.
Even using its own rosy numbers puts the FHA’s leverage at 840 to 1, a far more scandalous ratio than even Fannie Mae and Freddie Mac. As shown by Fannie and Freddie as recently as 2008 and the slow-motion collapse of the savings and loans (S&Ls) in the 1980s, if government-backed entities are allowed to continue operating when they are insolvent, their losses will only compound.
Indeed, the FHA has almost tripled its insurance in force in only three years, in part to cover its losses. And Congress made matters worse last fall when it raised the FHA’s conforming loan limit to $729,750. That pleased the powerful National Association of Realtors, but it simply poured fuel on the fire. Before the agency’s losses skyrocket, triggering a massive taxpayer bailout that deepens our nation’s debt, Congress should reverse that mistake and enact reforms to pull the FHA back from the brink.
RiskRegulations - Recent Proposed & Finalized Rules
To help us stay abreast of developments in the regulatory front, we highlight some recent proposed and finalized rules in our RiskRegulations column. These recent proposed and finalized rules are extracts from the websites of relevant regulatory agencies and we created hyperlinks in the magazine to the resources to help you access the regulations.
Highlights of Upcoming RiskEvents
For your risk education, we have highlighted upcoming risk management related events in our RiskEvents column. Please save the date and register for the events via our PRMIA Global website. In certain instances, discounts are available to PRMIA sustaining members. The highlights contain clickable links to direct you to the registration page.
Posted by neil222966 at April 10, 2012 07:18 PM