C&B Notes

Whom Do You Trust?

Large financial companies, especially ones that carry large notional amounts of derivatives, continue to struggle to report timely and accurate information about their exposures to counterparties.  This gap implies that these firms don’t truly understand their counterparty risk, meaning regulators and investors have even less of a chance.  Investors should be aware that such assets may only be “good until reached for,” as Charlie Munger likes to say.

“Our observations in this report indicate that firms’ progress toward consistent, timely and accurate reporting of top counterparty exposures fails to meet supervisory expectations as well as industry self-identified best practices,” Sarah Dahlgren, who chairs the group and also heads the Federal Reserve’s Financial Institution Supervision Group, wrote in a letter to the Financial Stability Board.  The FSB is an international board that monitors the global financial system…  The area of greatest concern remains firms’ inability to consistently produce high-quality data on a regular basis, according to the report.  Incomplete data and timely reporting on counterparty risk during the early stages of the financial crisis hampered banks’ abilities to allay risk.  Many of the same firms that struggled to provide daily data in 2008 through 2011 also had problems meeting those weekly requirements from 2011 onward, based on the report.

“If firms cannot produce accurate data during relatively benign times, they would be unlikely to do so during periods of market stress, when exposures could be volatile and resources are operating under high-pressure conditions,” according to the report.