Post-crisis financial reforms have improved the stability of the global over-the-counter derivative market, but more needs to be done, according to the Bank of England.
The minutes of its financial policy committee meetings of Nov. 22 and Nov. 27 also show the bank's concerns about "stretched" U.K. property valuations, and that the BoE warned courts about a possible flood of applications from insurers to mitigate Brexit fallout.
OTC derivatives, stress tests
The BoE said a move toward greater central clearing has helped to reduce counterparty credit risk in the OTC derivatives market. The percentage of outstanding single-currency OTC interest rate derivatives cleared centrally has increased to at least 62% as of June-end, from 24% at the end of 2008.
However, it noted that, on a global scale, the rate of collateralization of OTC derivatives has increased, and the amount of margin held against OTC derivatives at the end of 2014 was more than $1 trillion greater than the level at the end of 2006, according to industry estimates.
It believes the transparency of the market must be improved. Many national authorities cannot access global-level data about derivatives markets, limiting visibility, the minutes noted.
The FPC met Nov. 22 to agree its view on the outlook for financial stability and again Nov. 27 to confirm its response to the annual cyclical scenario stress tests. The stress tests showed that, for the first time since 2014, no bank needed to raise additional capital in order to withstand two severe crisis scenarios which included a disorderly Brexit and stagflation.
'Stretched' property valuations, insurer concerns
The BoE also warned in the minutes that some asset valuations in the U.K. were looking "stretched," particularly in commercial property. Current prices in certain segments of the market are "at the top end of valuation levels" with commercial property in the West End of London "well above the range of sustainable valuation levels."
But it also said demand for U.K. assets remained "stable" and that flows of investment from abroad into the U.K. were less vulnerable to reversal than they had been in the run-up to the last financial crisis, when the bulk of money had gone into short-term bank liabilities.
The minutes noted that, while domestic credit conditions "did not point to elevated risk," consumer credit continued to grow quickly, increasing by 9.9% in the year to the end of September.
"This could create risks to financial stability by increasing the losses lenders incurred during an economic shock," the minutes said.
The BoE also revealed that it had warned the high court to warn of a potential influx of applications from insurers looking to resolve issues related to Britain's exit from the EU. Amid concerns about cross-border contracts, firms were planning to secure new authorizations that could rely on a lengthy court procedure.
It had discussed options with the Treasury and regulators, but decided to defer publication of the details so as not to encourage policyholders to take "costly and potentially unnecessary" actions to safeguard the future continuity of their contracts.
The central bank also mentioned in its minutes that it had considered raising the countercyclical buffer even higher than the 1% it announced Nov. 28, but decided not to because the likelihood of a combination of a severe global recession plus a disorderly Brexit was remote.
The bank agreed to raise the buffer from 0.5% to 1% as of Nov. 28.
