1. The Basle Committee on Banking Supervision ¹ and the Technical Committee of the International Organization of Securities Commissions ² (IOSCO) have been working to enhance the prudential supervision of the derivatives operations of banks and securities firms. For example, in July 1994 the Basle Committee and IOSCO jointly released documents providing guidance on the sound risk management of derivatives activities ³. Since 1995, the two Committees have published yearly surveys of disclosures about the trading and derivatives activities ⁴ presented in the annual reports of global banks and securities firms. This effort is designed to encourage greater transparency in this important area.

2. The Basle Committee and IOSCO share a common interest in the effective supervision of the trading and derivatives activities of banks and securities firms and in adequate public disclosure of these activities. Their common concern prompted the Basle Committee and IOSCO to design and distribute the initial version of the information framework elaborated in this paper to supervisors of banks and securities firms in 1995. This framework describes information which the two Committees believe should be available within regulated firms and material affiliates active in the derivatives markets and that should be accessible to supervisors to assess the risks of derivatives and their impact on institutions' financial condition, capital adequacy and performance.

3. Moreover, this revision enhances the framework to incorporate information on financial innovations, such as credit derivatives ⁵, and enhanced information about the market risk of trading and derivatives activities.

4. Broadly defined, a derivative instrument is a financial contract whose value depends on the values of one or more underlying assets or indexes. While derivatives generally involve risks to which banks and securities firms have long been exposed, the rapid growth and complexity of these activities pose new challenges for firms and their supervisors. These challenges, together with the continuing growth of trading and derivatives activities, underscore the importance of ensuring that firms maintain and supervisors have access to meaningful, timely information concerning financial institutions' trading and derivatives activities.

5. The overall supervisory information framework advanced in this paper consists of two main components: 1) a catalogue discussing data that the Committees have identified as important for an evaluation of derivatives risks and that supervisors may choose from as they expand their reporting systems and 2) a common minimum framework of data elements (a subset of the catalogue) to which relevant supervisory authorities should have access. The catalogue component of the framework, discussed in section II, identifies the major types of risks arising from derivatives activities and the information needed to evaluate those risks. The areas identified as being of particular interest to supervisors are credit risk, market risk, liquidity risk and earnings.

6. This catalogue of data elements is intended to facilitate the development among supervisors of consistent conceptual methods for assessing the risk exposures related to derivatives. The catalogue is also intended to serve as a basis for discussion between firms and their supervisors about the type of information which the firm should be aiming to maintain as part of its overall risk management control mechanism. While the catalogue has been developed for both banks and securities firms, some of the items of the catalogue may be more relevant for banking supervisors than for securities firm supervisors and vice versa.

7. The common minimum framework, which is discussed in section III, represents a baseline of information that supervisors can use in assessing the impact of derivatives on an institution's overall risk profile. The minimum framework focuses to varying degrees on information relating to overall derivatives activity and to credit risk, market risk and liquidity risk. Individual supervisors can then supplement this information with other data elements drawn from the catalogue.

8. The minimum framework is also intended to provide a basis for coordinating supervisory reporting with other data collection initiatives on derivatives. In general, less information is available to supervisors on OTC derivatives than on exchange-traded derivatives, where statistics are available on the volume and value of transactions and on open interest. In the case of OTC derivatives, in most jurisdictions bank and securities supervisors do not collect information which gives an overall profile of activity in such products. At the time that the supervisory information framework was first published in 1995, such information was not available on a global basis.

9. Aggregated statistics on derivatives markets can be of significant value to supervisors. The growing use of OTC derivatives in conjunction with exchange-traded instruments reflects the financial market interrelationships between organised exchange markets, OTC derivatives activities and related underlying cash markets. This interrelationship between the markets underscores the need for supervisors to have access to timely and accurate information on OTC risk exposures of major market participants as well as the overall activity in the OTC markets.

10. In this context, a minimum level of harmonisation across G-10 countries of supervisory information about derivatives has served as an important input to the initiative of the Euro-currency Standing Committee of G-10 central banks to collect globally on a regular basis aggregate statistics on OTC and exchange-traded derivatives markets, both for macroeconomic and for macroprudential purposes. Under the Euro-currency Standing Committee initiative, data on the OTC and exchange-traded derivatives activities of larger banks and securities firms, and other major derivatives dealers will be collected and aggregated. Coordination between supervisors and central banks on the data to be evaluated helps to reduce duplication of efforts and thus limits the reporting burden for the banking and securities industry ⁶.

11. For the purpose of this overall information framework, the mechanism for supervisory data analysis is not specified, allowing for flexibility in the collection and the assessment of information. Specifically, information may be obtained and assessed through various channels such as on-site examinations, discussions with institutions, special surveys or standard reports routinely submitted to supervisors and audited financial statements and other reports submitted by external auditors. The appropriate method for gathering information depends upon the nature of the data, the institutions under review and the relevant supervisory authority. Certain information may be appropriate for all institutions whereas other types of data may be meaningful only for larger dealers.

(b) Basic principles

12. In developing an overall supervisory information framework for banks' and securities firms' derivatives activities, the two Committees have been guided by a number of basic principles. In particular, the data should be comprehensive. It should cover all types of derivative instruments and their major related risks and facilitate the supervisor's analysis of how derivatives contribute to an institution's overall business and risk profile. The two Committees recognise that derivatives activities constitute only a part of the overall activities of banks and securities firms. Consequently, derivatives should not be evaluated in isolation from the overall risks of an institution. This implies, for example, that for purposes of assessing an institution's market risk and earnings profile, a portfolio approach incorporating related cash and derivatives positions - and, thereby, also the impact of hedging and other risk management transactions - is required for meaningful interpretation. Moreover, quantitative information on derivatives activities needs to be seen in the context of qualitative information on an institution's overall risk profile and its ability to manage this risk.

13. Comprehensive evaluation of the risks of derivatives generally implies the aggregation, consolidation and assessment of information across a number of activities and legal entities. Where institutions undertake business activities which fall under the jurisdiction of different supervisors, or where certain affiliates are not supervised, supervisors should discuss with regulated firms how best to assess information that provides a comprehensive, timely picture of the risks associated with their overall derivatives and related activities. Bank supervisors should attempt to obtain information about these activities on a consolidated basis, while recognising the legal distinctions among subsidiaries.

14. Data on trading and derivatives activities should be assessed with sufficient frequency and timeliness to give a meaningful picture of an institution's risk profile. Derivatives activities may change dramatically due to changes in the types of derivatives products involved and whether institutions are end-users of such products to manage their risks or are acting as dealers. Changes in derivatives products and the role of an institution as an end-user or dealer can affect the impact of derivatives on an institution's risk profile and profitability. Therefore, it is important for supervisors to be aware of new derivative instruments in a timely manner (particularly about higher risk and more complex instruments), how they are being used by institutions and how institutions' risk management systems are being enhanced to address these new developments. Moreover, it is important for supervisors to be aware in a timely manner of significant increases in the derivatives exposures of banks and securities firms.

15. The two Committees are aware of the potential costs associated with requests by supervisors for additional information on institutions' derivatives activities and recognise that additional information requirements should only arise where there is a clear supervisory need. To limit the regulatory burden, supervisors are encouraged to draw on information that banks and securities firms generate for internal purposes, where appropriate, for assessing the impact of derivatives activities on financial condition and performance. Moreover, there should be as much consistency as is possible between information obtained for reporting purposes and data that institutions must already compile to comply with other supervisory requirements. The overall information framework should be sufficiently flexible to permit the incorporation of new market innovations without requiring frequent updating of the framework itself. The two Committees recognise that different institutional, accounting and public policy approaches to supervision require that each supervisory authority has flexibility to implement the common minimum framework in a manner best suited to its regulatory environment. Each supervisor would apply the common minimum framework to internationally active institutions with significant derivatives operations, with flexibility also to extend the framework to other institutions with significant involvement in derivatives or material exposure to market risks.

16. The common minimum information framework has been constructed with the aim of achieving the assessment of understandable and meaningful information about the trading and derivatives activities of banks and securities firms that could facilitate comparisons across institutions and, where possible, across countries. In this regard, it is intended that the overall information framework contributes to simplifying the regulatory reporting environment for banks and securities firms operating internationally. To the extent that the information is used for aggregation purposes, the Committees recognise the importance of ensuring that the process of aggregation not prejudice the confidentiality of information obtained on individual institutions by their supervisory authorities.

Footnotes:

1. The Basle Committee on Banking Supervision is a committee of banking supervisory authorities which was established by the central bank Governors of the Group of Ten countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States. It usually meets at the Bank for International Settlements in Basle, where its permanent Secretariat is located.

2. The Technical Committee of IOSCO is a committee of supervisory authorities for securities firms in major industrialised countries. It consists of senior representatives of the securities regulators from Australia, France, Germany, Hong Kong, Italy, Japan, Malaysia, Mexico, the Netherlands, Ontario, Quebec, Spain, Sweden, Switzerland, the United Kingdom, and the United States.

3. Examples of derivative instruments include forward contracts and their variations, such as swaps, forward rate agreements and futures contracts, and option contracts and their variations, such as caps, floors and swaptions.

4. For purposes of this framework, "trading and derivatives activities" refer to (a) trading activities involving on-balance-sheet instruments and off-balance-sheet derivatives and (b) non-trading derivatives activities, such as the use of derivatives to hedge the interest rate risk of the banking book.

5. Credit derivatives are financial instruments used to assume or mitigate the credit risk of loans and other assets. They may take the form of on-balance-sheet instruments (e.g., credit-linked notes) or off-balance sheet instruments (e.g., credit default swaps or total-rate-of-return swaps). Banking organisations and securities firms may employ these instruments either as end-users, purchasing credit protection or acquiring credit exposure from third parties, or as dealers intermediating such activity. End-user institutions may use credit derivatives to reduce credit concentrations, improve portfolio diversification, or manage overall credit risk exposure. Although the market for these instruments is relatively small when compared with other derivatives activities, institutions are entering into credit derivative transactions with increasing frequency.

6. The G-10 central bank Governors in January 1997 approved, for implementation from June 1998, a proposal by the Euro-currency Standing Committee (ECSC) for the regular collection of statistics on derivatives markets through reporting by leading market participants. The reporting framework is based on a July 1996 ECSC report entitled "Proposals for improving Global Derivatives Statistics" and is closely linked to the joint Basle Committee/IOSCO supervisory information framework.