Systemic risk watch



Synthetic ETFs

Last year, Bank of England analysts wrote:
Synthetic ETFs exhibit more of the characteristics that might contribute to the build-up of systemic risk. They are more complex than physical ETFs, although the degree of complexity remains far below that of some structured credit products developed in the run-up to the crisis. The derivative transactions between ETFs and affiliated banks (or those that the bank itself might undertake to gain exposure to the index) result in the build-up of counterparty credit exposures between market participants. And synthetic structures might pose funding liquidity risk to banks acting as swap counterparties if there is a sudden withdrawal of investors from the ETF market.
There’s an extremely good discussion of the risks of synthetic ETFs in this paper by the Bank for International Settlements. But the short version is that all of the risks get bigger when you see a large pronounced move to withdraw funds at once


Insurance-linked securities provided by G-Siis


Regulators are targeting insurers’ use of variable annuities and insurance-linked securities in their fight against global systemic risk. But insurers say these products are fundamental to the way the insurance industry works. Louie Woodall reports

The pressure is now on to reach an accord. By the end of the second quarter, the FSB will have published its first list of designated G-Siis (global systemically important insurers), and the IAIS should have finalised its policy proposals for the heightened regulation of these higher risk groups. But time is running out for the major insurance groups in the regulators’ spotlight, such as MetLife, Allianz, Axa and Prudential Financial, to make their case.

In practical terms, G-Siis will need to ring-fence their NTNIA and place them in separate entities to eliminate the threat of these risky activities inflicting losses on the insurer’s core balance sheet. They may also find themselves subject to an additional, higher loss-absorbency capital charge.

The fundamental purpose of identifying such activities and loading additional regulatory requirements onto the insurers that engage in them is to avoid a repeat of the shock collapse of AIG in 2008, and discourage firms from dabbling in the dark art of shadow banking. 


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