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What drove most directly the absolute
and relative dimensions of loss were the strategic decisions that
some firms made to retain large exposures in super-senior
tranches of CDOs that far exceeded the firms’ appreciation of
the risks inherent in such instruments. Firms did not recognize
the possibility that losses on the underlying MBS could reach
levels that could impair the value of even the super-senior
tranches of collateralized debt obligations of asset-backed
securities (ABS CDOs).

II. SUMMARY OF KEY OBSERVATIONS
AND CONCLUSIONS
The market distress that began in the second half of 2007
occurred after an extended period of ample financial market
liquidity and generally low credit spreads. The banking
organizations and securities firms in our sample entered the
turmoil in relatively sound financial condition and generally
with capital well above regulatory requirements. However, as
a result of these events, many firms absorbed significant losses,
and the prolonged disruption in market liquidity stressed most
firms’ liquidity and capital.
The widespread retraction of interest among investors in
purchasing various kinds of assets caused many major financial
services firms to experience substantial write-downs and
unexpected losses in their portfolios; some firms have
subsequently had to raise new capital. Financial businesses
such as those involved in the syndication to external investors
of leveraged loans to corporate borrowers faced dwindling
demand for their products and consequently losses as positions
had to be marked down.
But the primary source of losses came from concentrated
exposures that some major financial services organizations had
to U.S. subprime mortgage-related credit, particularly in
businesses involved in the warehousing, structuring, and
trading of CDOs backed by such credits. Several firms found
that their aggregate exposure to this risk was larger than they
initially recognized. What drove most directly the absolute
and relative dimensions of loss were the strategic decisions that
some firms made to retain large exposures in super-senior
tranches of CDOs that far exceeded the firms’ appreciation of
the risks inherent in such instruments. Firms did not recognize
the possibility that losses on the underlying MBS could reach
levels that could impair the value of even the super-senior
tranches of collateralized debt obligations of asset-backed
securities (ABS CDOs).
Many firms were more vulnerable to a prolonged
disruption in market liquidity than they expected. Firms were
surprised by the nature and length of the market disruption
and were forced to fund exposures that they had not
anticipated in their contingency funding plans. This included
retaining exposures in warehouse portfolios for significantly
longer periods of time than expected when firms realized they
were unable to find buyers for securities such as residential
mortgage-backed securities (RMBS), ABS CDOs, and highyield
bond exposures. Firms likewise found that they could
neither syndicate to external investors their leveraged loan
commitments to corporate borrowers nor cancel their
commitments to fund those loans despite material and adverse
changes in the availability of funding from other investors in
the market. Moreover, some firms were required to fund
contractual commitments backstopping a range of offbalance-
sheet financing vehicles that they had not anticipated
they would have to fund themselves, such as ABCP conduits.
In other cases, firms under no contractual obligations still
provided voluntary support to these and other off-balancesheet
financing vehicles, including structured investment
vehicles (SIVs), because of concerns about the potential
damage to their reputations and to their future ability to sell
investments in such vehicles if they failed to provide support
during the period of market distress.
Nevertheless, during the turmoil, all firms were able to
obtain adequate liquidity to fund their operations and, in
certain cases, to bring additional assets onto their balance
sheets that they had not planned to fund. However, all firms
faced higher funding costs and, in most cases, did not have as
much contingent funding liquidity as they would have liked.
While firms were neither universally effective nor
ineffective across all relevant dimensions, our supervisory
group identified actions and decisions that have tended to
differentiate firms’ performance during the period of market
turbulence through year-end 2007. Some firms recognized the
emerging additional risks and took deliberate actions to limit
or mitigate them. Others recognized the additional risks but
accepted them. Still other firms did not fully recognize the
risks in time to mitigate them adequately. Many of our
observations on risk management practices relate to the
decisions that firms made to take, manage, measure, aggregate,
and hedge (or not hedge) such exposures. In particular, we
found important differences in firms’ approaches to four
firm-wide risk management practices and to three specific
business lines.
http://www.newyorkfed.org/newsevents/news/banking/2008/ssg_risk_mgt_doc_final.pdf

Firms that avoided such problems demonstrated a comprehensive approach to viewing firm-wide exposures and risk, sharing quantitative and qualitative information more effectively across the firm and engaging in more effective dialogue across the management team. Senior managers in such firms also exercised critical judgment and discipline in how they valued its holdings of complex or potentially illiquid securities both before and after the onset of the market turmoil. They had more adaptive (rather than static) risk measurement processes and systems that could rapidly alter underlying assumptions to reflect current circumstances;
management also relied on a wide range of risk measures to gather more information and different perspectives on the same risk exposures and employed more effective stress testing with more use of scenario analysis.
In addition, management of better performing firms typically enforced more active controls over the consolidated organization’s balance sheet, liquidity, and capital, often aligning treasury functions more closely with risk management processes, incorporating information from all businesses into global liquidity planning, including actual and contingent liquidity risk.
Using the observations of the report to set expectations, primary supervisors are critically evaluating the efforts of the individual firms they supervise to address weaknesses in risk management practices that emerged during the period of market turmoil. Each supervisor is ensuring that its firms are making appropriate changes in risk management practices, including addressing deficiencies in senior management oversight, in the use of risk measurement techniques, in stress testing, and in contingency funding planning.
Finally, our observations help to define an agenda for strengthening supervisory oversight of relevant areas. In particular, we have identified the following areas relevant to this agenda.
First, we will use the results of our review to support the efforts of the Basel Committee on Banking Supervision to strengthen the efficacy and robustness of the Basel II capital framework by:
• reviewing the framework to enhance the incentives for firms to develop more forward-looking approaches to risk measures (beyond capital measures) that fully incorporate expert judgment on exposures, limits, reserves, and capital; and
• ensuring that the framework sets sufficiently high standards for what constitutes risk transfer, increases capital charges for certain securitized assets and asset-backed commercial paper liquidity facilities, and provides sufficient scope for addressing implicit support and reputational risks.
Second, our observations support the need to strengthen the management of liquidity risk, and we will continue to work directly through the appropriate international forums
(for example, the Basel Committee, International Organization of Securities Commissions, and the Joint Forum) on both planned and ongoing work in this regard.
Third, based on our shared observations from this review, individual national supervisors will review and strengthen, as appropriate, existing guidance on risk management practices, valuation practices, and the controls over both.
Fourth and finally, we will support efforts in the appropriate forums to address issues that may benefit from discussion among market participants, supervisors, and other key players (such as accountants). One such issue relates to the quality and timeliness of public disclosures made by financial services firms and the question whether improving disclosure practices
would reduce uncertainty about the scale of potential losses associated with problematic exposures. Another may be to discuss the appropriate accounting and disclosure treatments of exposures to off-balance-sheet vehicles. A third may be to consider the challenges in managing incentive problems created by compensation practices.

FRANCE
Banking Commission
Didier Elbaum
Alain Laurin
Guy Levy-Rueff
Frederick Visnovsky
GERMANY
Federal Financial
Supervisory Authority
Sabine Lautenschläger-Peiter
Peter Lutz
SWITZERLAND
Federal Banking Commission
Tim Frech
Roland Goetschmann
Thomas Hirschi
Daniel Sigrist
UNITED KINGDOM
Financial Services Authority
Stan Bereza
Nicholas Newland
Andrea Pack
UNITED STATES
Board of Governors of the
Federal Reserve System
Deborah P. Bailey
Roger T. Cole
Jon D. Greenlee
Steven M. Roberts
Federal Reserve Bank
of New York
Arthur G. Angulo
Brian L. Peters
William L. Rutledge
(Chairman)
Office of the Comptroller
of the Currency
Kathryn E. Dick
Douglas W. Roeder
Scott N. Waterhouse
Securities and Exchange
Commission
Matthew J. Eichner
Denise Landers
Michael A. Macchiaroli
Erik R. Sirri

Mr. Mario Draghi, Chairman
Financial Stability Forum
Bank for International Settlements
Centralbahnplatz 2
CH-4002 Basel
Switzerland
March 6, 2008

Specifically, supervisors focused on
practices related to the following:
• the role of senior management oversight in assessing
and responding to the changing risk landscape;
• the effectiveness of market and credit risk management
practices in understanding and managing the risks in
retained or traded exposures as well as in counterparty
exposures, in valuing complex and increasingly illiquid
products, and in limiting or hedging exposures to credit
and market risk, and
• the effectiveness of each firm’s liquidity risk
management practices in assessing its vulnerability to
that risk in a stressed environment and taking
appropriate action.

from:

http://www.fsforum.org/

Senior Supervisors Group’s Report on Observations on Risk Management Practices during the Recent Market Turbulence

http://www.fsforum.org/links/index.htm

Links to FSF members and other institutions

Australia
Reserve Bank of Australia
www.rba.gov.au
Australian Securities and Investments Commission
www.asic.gov.au
Australian Prudential Regulation Authority
www.apra.gov.au
The Treasury
www.treasury.gov.au
Canada
Bank of Canada
www.bank-banque-canada.ca
Canada Deposit Insurance Corporation
www.cdic.ca
Ontario Securities Commission
www.osc.gov.on.ca
Office of the Superintendent of Financial Institutions
www.osfi-bsif.gc.ca
Department of Finance
www.fin.gc.ca
France
Banque de France
www.banque-france.fr
Autorité des Marchés Financiers
www.amf-france.org
Ministère de l’Economie
www.minefi.gouv.fr
Germany
Deutsche Bundesbank
www.bundesbank.de
Bundesanstalt für Finanzdienstleistungsaufsicht
www.bafin.de
Bundesministerium der Finanzen
www.bundesfinanzministerium.de
Hong Kong SAR
Hong Kong Monetary Authority
www.hkma.gov.hk
Office of the Commissioner of Insurance
www.info.gov.hk/oci
Securities & Futures Commission
www.hksfc.org.hk
The Treasury
www.info.gov.hk/tsy
Italy
Banca d’Italia
www.bancaditalia.it
Istituto per la Vigilanze sulle Assicurazioni Private e di Interesse Collettivo (ISVAP)
www.isvap.it
Commissione Nazionale per le Società e la Borsa
www.consob.it
Ministero dell’Economia e delle Finanze
www.tesoro.it
Japan
Bank of Japan
www.boj.or.jp
Financial Services Agency
www.fsa.go.jp
Ministry of Finance
www.mof.go.jp
The Netherlands
De Nederlandsche Bank
www.dnb.nl
Autoriteit Financiële Markten
www.afm.nl
Ministerie van Financiën
www.minfin.nl
Singapore
Monetary Authority of Singapore
www.mas.gov.sg
Ministry of Finance
www.mof.gov.sg
Switzerland
Swiss National Bank
www.snb.ch
United Kingdom
Bank of England
www.bankofengland.co.uk
Financial Services Authority
www.fsa.gov.uk
HM Treasury
www.hm-treasury.gov.uk
United States of America
Federal Deposit Insurance Corporation (FDIC)
www.fdic.gov
Office of the Comptroller of the Currency (OCC)
www.occ.treas.gov
Board of Governors of the Federal Reserve System
www.federalreserve.gov
Federal Reserve Bank of New York
www.newyorkfed.org/
U.S. Commodity Futures Trading Commission
www.cftc.gov
National Association of Insurance Commissioners (NAIC)
www.naic.org
U.S. Securities & Exchange Commission (SEC)
www.sec.gov
U.S. Department of Treasury
www.treasury.gov
International Organisations
Bank for International Settlements (BIS)
www.bis.org
European Central Bank (ECB)
www.ecb.int
International Monetary Fund (IMF)
www.imf.org
Organisation for Economic Coordination and Development (OECD)
www.oecd.org
The World Bank
www.worldbank.org
International standard-setting bodies and other groupings
Basel Committee on Banking Supervision (BCBS)
www.bis.org/bcbs/index.htm
Committee on the Global Financial System (CGFS)
www.bis.org/cgfs/index.htm
Committee on Payment and Settlement Systems (CPSS)
www.bis.org./cpss/index.htm
International Association of Insurance Supervisors (IAIS)
www.iaisweb.org
International Accounting Standards Board (IASB)
www.iasb.org
International Organization of Securities Commissions (IOSCO)
www.iosco.org
International Association of Deposit Insurers
www.iadi.org

***

Many firms were more vulnerable to a prolonged
disruption in market liquidity than they expected. Firms were
surprised by the nature and length of the market disruption
and were forced to fund exposures that they had not
anticipated in their contingency funding plans.

***

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