Systemic risk a top priority, says DTCC
The securities industry is beginning to “think more deeply” about the systemic risk associated with interconnectedness, said Michael Bodson, chief executive of the Depository Trust and Clearing Corporation (DTCC).
The post-trade market infrastructure for the global financial services industry, has released a white paper, Understanding Interconnectednes Risks, that explores the role of interconnectedness in the transmission of risk and offering practical guidelines for risk management professionals. Interconnectedness, or the relationship among economic agents that are created through financial transactions and supporting arrangements, is a key dimension of systemic risk and has become a critical topic for market participants and regulators following the 2008 financial crisis.
“This is a very complex issue,” said Bodson. “If you try to take an all-encompassing view of the many different types of risk, it will be overwhelming.”
The first step to take, he said, was to plot out with whom an institution is connected, the exposure and how risk can be mitigated. A pragmatic approach is needed to what essentially is “inventory”, said Bodson. Some risks an institution can deal with directly, such as by tracking, monitoring and diversifying; but others are inherent and an institution can only understand the risk and be aware of it.
Most research completed to date, said the report, has found that financial networks tend to be robust yet fragile, absorbing shocks up to a certain tipping point and spreading risk beyond this critical threshold.
Regulators have made progress in addressing interconnectedness risks and have adopted an approach that primarily focuses on increasing the resilience of the most interconnected – and most systemically important – financial institutions. Market participants must also assess and respond to this risk. The white paper recommends that market participants take actions, including making a comprehensive inventory of external entities on which they rely and then prioritising and identifying how the failure of an external entity would affect their business in its entirety.
Among the paper’s other key findings:
- While the importance of network structures in propagating financial shocks is generally recognised, it remains unclear under which circumstances interconnectedness promotes or impairs financial stability;
- Identifying and assessing interconnectedness risks promotes a broader and deeper understanding of the threats to an organisation; and
- In line with this comprehensive and inclusive approach, DTCC is working closely with market participants on several initiatives that are designed to mitigate industry-wide interconnectedness risks and proactively address related policy directives.
Andrew Gray, group chief risk officer at DTCC, said: “We believe that incorporating an interconnectedness lens into risk management activities can meaningfully contribute to enhancing