November Global Regulatory Brief: Risk, capital and financial stability | Insights

FCA Chief sets out private markets strategy

The UK Financial Conduct Authority’s Chief Executive Nikhil Rathi gave a speech setting out further detail with regard to the UK’s policy approach to private markets.

For context: While the FCA’s public markets reforms are well developed, Rathi began by underlining the opportunities on offer for the UK investment management sector associated with private markets. He gave the following metrics:

• Estimates of global private capital assets under management (AUM) as high as $14trn plus – triple a decade ago;
• Private assets outperforming public by 2.5 times in Europe; and
• Over half of European private markets AUM sit in the UK. 

Main takeaways: Rathi focused on a number of themes in his speech, including:

• More data to combat risk: Rathi called for transparency – particularly on data – to build a system-wide picture of risks, and to be clear about who owns them. Liquidity risk is a chief concern, and retail investors must understand investments cannot be redeemed on demand. The arrival of long-term asset funds (LTAFs) into UK retail markets is intended to help develop risk mindsets.
• Product innovation: Rathi noted how private market active ETFs are gaining momentum in the UK, with data infrastructure, such as indexation, also developing. The FCA will consult soon on a new disclosure regime for consumer composite investments – including investment trusts – which will reform cost disclosure. Ministers may decide to introduce more flexibility here.
• Tokenisation: The FCA is collaborating with other regulators on how tokenisation can democratise private assets while lowering operational costs and enhancing liquidity.
• Data collections: The FCA will review data collections next year as part of its work on the Alternative Investment Fund Managers Regulation (AIFMD) to provide greater transparency and standardisation on basic metrics such as private market AUM. Rathi referenced the SEC’s Form PF reporting for private fund advisers.
• Investment in capacity and skills: Firms need to invest in capacity and skills to understand private companies in greater depth, and to illustrate this Rathi used an example of a life sciences investor who used to monitor 50 private and 500 public companies, but this has now become 1000 private and 500 public companies.

RBA publishes research on Australian private credit market

The Reserve Bank of Australia published new research on the Australian private credit market, which it estimates to be around A$40 billion outstanding.

In more detail: Data collected by the Australian Prudential Regulation Authority (APRA) from registered financial corporations and London Stock Exchange Group (LSEG) on lending to Australian businesses facilitated by asset management firms indicates that the Australian private credit sector has grown strongly over recent years, though it accounts for a small share of total business debt.

• RBA’s estimate of A$40 billion captures lending to Australian businesses facilitated by asset management firms from investor money pooled into managed funds.
• It also includes direct lending from superannuation funds as part of a syndicated loan.
• The estimate does not capture non-syndicated direct lending by superannuation funds.

High growth: While the Australian private credit market is small relative to other lending to businesses (c.2.5% of total business debt) it is growing rapidly and private credit grew faster than business debt over the past few years.

• Growth has slowed in 2024 but is still around 2% higher than the growth of business debt.
• Domestic private credit funds account for around 70% of private credit outstanding and have contributed the most to growth in lending.

Australian market structure: Australian superannuation funds primarily invest in private credit via funds, though they also lend directly.

• The most common private credit investment vehicle outside Australia is a closed-end fund, with a limited life cycle that prevents redemptions during its life span.
• Notably, in Australia, open-ended funds are more common.

Key risks: The RBA identifies a number of risks to financial stability from private credit markets, including

• Leverage – Although private credit funds’ leverage appears low compared with other lenders, end borrowers tend to be more highly leveraged than those in public markets, increasing the risks to financial stability
• Liquidity – In the event of a large economic shock, intermediaries may request large amounts of capital from existing investors’ committed but uninvested capital via capital calls. There is a significant and growing amount of committed but uninvested capital, suggesting potentially large cash flow pressures if capital calls were widespread and synchronised. In such an event, end investors – such as pension funds or insurance companies – may struggle to meet the required payments and may therefore need to quickly sell other assets, potentially causing tension in financial markets.
• Interconnectedness – Banks are among the primary providers of leverage to private credit funds, and in the US, invest in private credit via collateralised loan obligations and are reportedly selling complex debt instruments to private fund managers in synthetic risk transfers. There are strong links between private credit and private equity markets.
• Transparency – While private credit funds must generally adhere to accepted accounting principles, these principles do not mandate specific techniques for asset valuation. Stale valuations may pose a risk to financial stability whereby a macroeconomic shock leads to a broad reassessment of asset valuations across the sector

Australian regulatory response: With private credit lacking the oversight of banks and the disclosure requirements of leveraged loans, the Australian regulators are taking a more proactive regulatory approach.

• The Australian Securities and Investments Commission (ASIC) is examining the growth of private markets as part of its drive for consistency and transparency across markets and products and is working to identify conduct issues and consider the implications for the integrity and efficiency of markets.
• APRA is heightening supervision of superannuation funds’ investments in unlisted assets and stress-testing potential sources of contagion.
• The Australian Treasury is also reviewing the regulatory framework for managed investment schemes, which are one form that private credit funds can take, with an aim to reduce risk to investors.

OSC consult on improving retail investor access to illiquid investments

The Ontario Securities Commission (OSC) published a consultation paper aimed at improving retail investor access to illiquid investments through a framework proposal for a long-term asset investment fund product structure.

In summary: The consultation proposes the creation of a new investment fund category, the Ontario Long-Term Asset Fund (OLTF), which would allow retail investors to gain exposure to assets they may not traditionally have exposure to. 

• These assets include venture capital, private debt and equity, and infrastructure and natural resource projects. 
• OLTFs could offer opportunities for more retail investors to participate in capital-intensive projects and diversify their portfolio. 
• While there are existing investment vehicles that would allow access to these assets many are privately funded and unavailable to retail investors.

In more detail: Long-term assets are illiquid assets that cannot be quickly disposed of, may be difficult to value, and generally have longer investment time horizons than other assets. 

• An investment fund would provide retail investors with an investment vehicle whose regulatory framework is more specifically tailored to their needs.
• The proposed new framework would allow retail investors to gain exposure to these long-term assets through the professional management of a registered investment fund manager and registered portfolio manager. 
• Distribution through a prospectus-qualified investment fund product would mean that suitability, “know-your-client” (KYC) and “know-your-product” (KYP) requirements would generally apply. 
• The consultation also seeks feedback on investor access to OLTFs through order-execution-only, or “DIY” dealers.

Looking ahead: The feedback received will guide the next phase of the proposal, which is anticipated to be the publication for comment of proposed rule amendments and policy changes.

• The deadline for responses is February 7, 2025.

Bank Negara Malaysia published final policy on liquidity risk management

Bank Negara Malaysia (BNM) published a new policy document which set out the requirements and guidance on the management of liquidity risk for financial institutions.

Background: The updated policy was developed based on the Principles for Sound Liquidity Risk Management and Supervision by the Basel Committee for Banking Supervision (BCBS) and the Guiding Principles on Liquidity Risk Management for Institutions Offering Islamic Financial Services by the Islamic Financial Services Board. 

• The requirements and guidance set out in the policy document also complement the Liquidity Coverage Ratio and Net Stable Funding Ratio policy documents which set out minimum regulatory liquidity requirements. 
• The guidelines are applicable to all licensed banks in Malaysia.

Key highlights: The policy requirements detail around the following principles:

• Board and senior management to exercise effective oversight of the financial institution’s liquidity risk
• To have sound process for identification, measurement, monitoring and control of liquidity risk
• To actively manage its intraday liquidity risk
• To actively monitor and control liquidity risk across entities within the group and business lines
• To establish a sound funding strategy
• To incorporate liquidity costs, benefits and risks in the internal pricing, performance measurement and new product approval process for all business activities
• To conduct liquidity stress testing on a regular basis
• To maintain a cushion of unencumbered, liquid assets
• To actively manage collateral positions, differentiating between encumbered and unencumbered assets
• To have a formal contingency funding plan
• To publicly disclose high-quality liquidity-related information on a regular and timely basis

JFSA publishes work program for next business year

The Japanese Financial Services Authority (JFSA) published its work plan for July 2024-June 2025.

Key priorities: The FSA highlighted three key focus areas for the year ahead –

• Sustainable economic growth: The FSA will work to enhance the functioning of the entire investment chain and respond to changes brought about by climate change and digital technology
• Stability and reliability of the financial system: Through robust inspection and supervision, the FSA will ensure soundness of financial institutions and promote the provision of high quality financial services
• Enhance the FSA’s administrative capacity: The FSA will continuously enhance data utilization, strengthen international and domestic policy communications, and build up skills and capacity of internal staff

Asset management in focus: The FSA will ensure the full implementation of the “Policy Plan for Promoting Japan as a Leading Asset Management Centre”, first published in December 2023. 

• The regulator will do so through promoting appropriate use of tax exemption for retail investors, advance corporate governance reforms, enhance reliability of capital markets, and enhance financial and economic education, among other initiatives. 
• With regard to ensuring stability and resilience of the financial system, the FSA will review financial institutions’ initiatives to manage climate-related financial risks, monitor the governance, internal audit and risk management systems, and hold dialogues with financial institutions to ensure the sustainability of their business models. 
• As for enhancing the FSA’s administrative capacity, the regulator will strengthen policy communication both domestically and internationally, and create a flexible and efficient work environment to enhance productivity.

PRA issues near-final policy statement on Basel 3.1 implementation

The UK Prudential Regulation Authority (PRA) has issued its second near-final policy statement and rules covering the Basel 3.1 implementation for credit risk, the output floor, reporting and disclosure requirements. 

Background: This policy statement is the second of two near-final policy statements related to Basel 3.1 The first policy statement came on 12 December 2023 – the Implementation of the Basel 3.1 standards near-final part 1 – which outlined the PRA’s rules regarding market risk, credit valuation adjustment (CVA) and counterparty credit risk, and operational risk. 

Key details: This second near-final policy statement includes a number of key changes to the original proposals that were previously consulted on, such as: 

• Amendments to the treatment of SME lending to reduce the operational burden for firms and lower capital requirements;
• Changes to treatment of infrastructure lending to lower capital requirements;
• Lower, more risk-sensitive conversion factors (CFs) for off-balance sheet items;
• Lower, more risk-sensitive and operationally simpler approach to the valuation of residential real estate under the credit risk Standardised Approach (SA); 
• An approach to calculating the output floor which enhances consistent between SA approaches and the output floor.

Important timing: The PRA has decided to delay implementation for the Basel 3.1 standards by a further 6 months to January 2026, with a 4-year transitional period ending on 31 December 2029.

Vice Chair Barr announces “broad and material changes” to Basel III Capital Plan, G-SIB Surcharge

Federal Reserve Board Vice Chair for Supervision Michael Barr announced in a speech a slew of “broad and material changes” to the Basel III endgame and G-SIB surcharge proposals (including a complete re-proposal) that he intends to recommend to the Board. 

In more detail: The changes in the endgame re-proposal will cover all major areas of the rule such as credit risk, operational risk, and market risk. 

• In general, Barr suggested that the intended revisions would result in a 9% increase (a cut of nearly 50% from originally proposed) of capital to the aggregate common equity tier 1 capital requirements for the G-SIBs. 
• Banks with between $100 and $250 billion in assets would see a less than 1% increase (down from nearly 6%). 
• Any changes must also be approved by the FDIC and OCC. Recent reporting indicates that there is bipartisan pushback on the proposed changes that Barr laid out. It is unclear when regulators intend to release a revised proposal for public comment.

EBA report on the eligibility and use of credit insurance

The European Banking Authority (EBA) published a report on the eligibility and use of credit insurance in response to the European Commission’ request under the Capital Requirements Regulation (CRR3). The EBA calls for an alignment of EU rules with the present Basel framework.

Important context: The report revisits the prudential banking framework on credit risk mitigation in relation to the changes affecting credit insurance that were introduced in the final Basel III framework. 

• These changes were introduced to take account of the level-playing field considerations compared to other products with similar features, or players subject to the same modelling restrictions as credit insurers.

Dual recourse: The report notes that credit insurance brings dual recourse to institutions in the event of the default of the obligor, as the bank has recourse to the credit insurer on top of the obligor, while this feature is not recognised in the Basel framework.

• Dual recourse is however a feature shared by any form of unfunded credit protection (UFCP), such as guarantees. 
• Hence, the report finds that credit insurance is not put at disadvantage compared to any form of UFCP.

Report conclusions: The report concludes that there is insufficient evidence to justify a deviation for credit insurers from the international Basel agreements.

SEC adopts new requirements for covered clearing agencies

The U.S. Securities and Exchange Commission (“SEC”) adopted rule amendments and a new rule seeking to improve the resilience, recovery, and wind-down planning of covered clearing agencies (“CCAs”). 

In more detail: The amendments are designed to strengthen the existing CCA rules with a view to monitoring intraday exposures and specifying the particular circumstances for collection of margin intraday, and ensuring that CCAs have effective tools for margin modeling even when inputs to the margin system become unreliable or unavailable. Specifically, the amendments require CCAs to, among other things:

• establish new policies and procedures regarding the collection of intraday margin to include a new requirement to monitor intraday exposures on an ongoing basis;
• make intraday margin calls “as frequently as circumstances warrant”;
• document when it determines not to make an intraday margin call pursuant to its written policies and procedures; and
• establish procedures to address circumstances in which substantive inputs to its risk-based margin system are not readily available or reliable.

Finally, the new rule will require covered clearing agencies’ recovery and wind-down plans to account for nine specific elements. These elements include describing the clearinghouse’s core services, as well as identifying critical personnel and service providers needed to support them.

Looking ahead: The CCAs will have 150 days after publication in the Federal Register to file any required proposed rule changes with the Commission. Any such proposed rule changes must be effective 390 days after publication in the Federal Register.