The article argues that Basel III, Dodd-Frank and market pressures are forcing banks to bolster their tier 1 and loss-absorbing capital levels on their balance sheets, a process that is under way but far from complete. There are few palatable options on the capital-raising menu.

In the article Ross Pepperell, risk consultant, argues “Now looks a good time to try to raise capital; markets and sentiment are buoyant. It may prove a good idea to act now to avoid any potential crowding out next year when more European stress tests are carried out prior to the ECB taking control over supervision,” especially for the mid-size and smaller banks, which face the greatest problems making the necessary adjustments in the given time.

The full article can be found here
http://www.euromoney.com/Article/3207945/Banks-ponder-regulatory-capital-conundrum.html?copyrightInfo=true

At the conference, Nick Bullman highlighted the importance of behavioural finance in helping to identify the likelihood of Black Swan events. Nick pinpointed the main characteristics of these events, and described the concept of risk clusters as a result of the work by CheckRisk and the Universities of Bath & Bristol, a concept which VaR does not capture.

Narrowing down the likelihood of the next Black Swan

Nick Bullman…”not yet at the end of 2008 risk cluster

Human beings can recognize and remember about 7,500 humanfaces–anamazing feat. But the pattern of recognition does not seem to translate to the notion of risk. Our recognition systems become incredibly unreliable.

Nick Bullman, founder and chair of the specialist investment risk research and consulting firm CheckRisk, told the conference that various behavioral factors affect the way we think about the past and, therefore, the future, such as over-confidence and extrapolation of recent conditions, or ‘recency bias’.

‘Black Swan’ events are impossible to predict by their nature, but, Bullman said, we can narrow down the points in time when they are more likely to occur – just not when they will occur.

The main characteristics of a Black Swan event are:

- A rare event that is extremely hard to predict beyond the realm of normal       expectationsinhistory,science,finance and technology
- Very small probabilities of occurrence means traditional models are inadequate
- Psychological biases make us blind to uncertainty and unaware of risk
- Perception of risk and actual
risk are usually different – Black
Swan Events have a disproportionate impact Cygnets (young swans) are what we usually have to deal with.

Work by CheckRisk and the University of Bath, with which it is linked, and University of Bristol has shown that risk can develop in clusters, wheretherearemultipleeventswithin a group of risks, such as with the occasional behavior of equities. The

clusters can infect other clusters by spreading around the system. They can also‘bridge’orjumpacrossthesystem to other clusters. This can occur when there are universal correlations of volatility and may mean rapid spread across the system.

Alarmingly, Bullman said that we haven’t arrived, yet, at the end of the 2008 risk cluster because Quantitative Easing i(QE) s being extended – “So, we should be extending risk budgets”.

Japan presented a high risk in the event of its recent stimulus package failing to lift inflation. This will be very serious for financial markets, Bullman said.

CheckRisk analysis since 2011 has consistently thrown up Asia as the best risk-adjusted region in the world, especially China. Counter-intuitively, the Japanese QE has also lifted that country’s risk-adjusted outlook.

“But you shouldn’t generalize across theregion,”Bullmansaid,“becausesome markets are quite pricey.”

Article extracted from the Special Conference Edition of Investment Operations & Custody Conference – World’s Best Practice

Regulation is not helping. “Solvency II will increase pressure to reduce funding risk in our view at the wrong time,” says Ross Pepperell, risk consultant at CheckRisk, a provider of risk consulting services. “It will increase pressure on employers’ contributions and mandate greater exposure to bonds to de-risk portfolios at a time when the risk within that asset class has increased significantly.”

Pepperell adds: “With inflation likely to persist over the medium term, and debt write-offs a possibility, pensions might consider increasing allocations to inflation-protected assets such as equities, property, infrastructure and resources.

“An investor is being forced to ask the question of how much interest rate risk they are willing to bear by holding a bond, versus whether they will take the risk on the capital of equities. On a 10-year view, you are being paid to take the risk of the equity versus the bond. This is the point of quantitative easing, to force risk-taking by penalizing the price of cash.”

To read full article at Euromoney click here

Pepperell says: “A certain amount of flexibility is needed, as opposed to dogmatism. However, long term, it is critical that the structural reforms take place and are not watered down by persistent lobbying, resulting in regulatory capture.”

Click here to read full article

In this video, Nick discusses the themes: “Are you being paid in upside potential to justify the risk you are taking?” & the 5 pillars of risk and their catalysts in depth:

• US Fiscal Cliff, Debt Ceiling, and Fiscal Drag
• European Sovereign Debt Crisis
• Middle East Tension & Oil
• Global Economic Slowdown
• Contagion Risk

(Please note this video is not compatible with iPads)