New SIFMA Analysis: The Fed & CCAR 2020 — Stay the Course for the Sake of Economic Recovery

Key Points

  • There is no evidence that the COVID-19 experience requires revisions to the CCAR 2020 GMS factor shocks. In fact, in most asset classes, the GMS factor shocks are multiples of the COVID-19 one-day and 10-day most adverse experience. Many asset classes are near or within reach of early March levels.
  • Layering on an extreme tail scenario for capital market products on top of the already conservative 2020 CCAR framework will result in an unjustified increase in the SCB. An unnecessary higher SCB will negatively impact the capacity of banks to support economic recovery including providing credit and liquidity to households and businesses, contributing to orderly markets, and intermediating the capital markets.
  • The CCAR approach essentially double taxes capital markets participants and capital market products. It estimates post stress capital under the severely adverse scenario (the nine-quarter path) reflecting two loss estimation paths: the Global Market Shock and Large Counterparty Default instantaneous losses and the trading losses based on the macroeconomic scenario.
CCAR requires Capital Market Participants to generate losses from the application of the GMS and the LCD and from the application of the macroeconomic scenario to the trading book under the severely adverse scenario to estimate losses.
As depicted in the chart, the 2020 GMS factor shock required firms to assume a one-day decline of -26% in the S&P 500. The 2020 shock was approximately 30% more harsh than the 2019 GMS shock and was only approximately 13% less punitive than the most severe shocks applied in four of the seven years. To put the 2020 GMS factor shock for S&P 500 in a historical context, it is approximately 27% higher than any one-day decline in the S&P 500, ever.
The graph above depicts the series of GMS factor shocks applied to two-year and 10-year treasury exposures over the past seven years. The factor shocks for these asset classes vary significantly year-over-year in terms of direction (spread widening/spread tightening) and severity. Clearly, the 2014 and 2018 GMS factor shocks standout as dramatic shifts year-on-year. The 2020 GMS factor shocks for U.S. Treasury Rates are more severe than 2019 and are more significant for the two- year bond than the 10-year bond. Accordingly, the 2020 US Treasury rate shocks for the two-year and the 10-year are more punitive by 83% and 50%, respectively, than the previous year.
This chart illustrates how the Fed’s approach to sizing the spread shock has shifted over time. Overall, the GMS shocks applied to A and BBB rated exposures have declined somewhat since the initial years of the GMS (2013–2015). Conversely, the Fed has significantly amplified the shock to B rated exposures (over 60% between the 2013 GMS and the 2020 GMS for B rated exposures) from the initial years of the GMS.
The 2020 Corporate Credit factor shocks for BBB and B rated exposures were unchanged from 2019, whereas the factor shock for A rated exposure declined approximately 18% from the prior year. In terms of comparison to the most adverse one-day historical experience, the 2020 factor shock for A rated exposures is almost five times the historical most adverse one-day movement in A rated credit spread. The 2020 GMS factor shock for BBB rated credit spreads is more than five times greater than the historical most adverse one-day movement in BBB rated spreads. Finally, the 2020 GMS factor shock for B rated credit spreads is approximately four times greater than the historical most adverse one-day movement. In fact, for B rated spreads not only has there never been a one-day adverse movement as large as the 2020 GMS factor shock, it is more severe than a six-month series of historical one-day most adverse price moves.
The GMS factor shocks for spot EUR/USD and GBP/USD positions for the past seven CCARs are illustrated in the chart to the left. Both the EUR/USD and the GBP/USD spot factor shocks were substantially less severe in 2020 than in the previous year, however, in 2019, the EUR/USD GMS rate shock was the most severe since the inception of CCAR. The 2019 GBP/USD factor shock was severe however but not nearly as harsh as the 2016 factor shock. The 2020 factor shock for spot EUR/USD represents about 80% of the historical one-day most adverse performance; whereas the 2020 factor shock for spot GBP/USD represents about 41% of the historical one-day most adverse performance.
  • Ali Mostafa
  • Bradley Harper


The sections below highlight the findings and recommendations that were noted in our 2019 Study of the GMS and LCD

Section 1: Global Market Shock

Key Findings Recommendations· The severity of any single GMS factor shock is an extreme, low-probability event when compared to historical observations and empirical estimations.· Recommendation 1: GMS factor shocks should be tailored to reflect the liquidity and price stability characteristics of particular asset classes.· The correlation assumptions underlying the GMS factor shocks are not empirically or historically supported, and do not meet the FRB’s “severe but plausible” standard.· Recommendation 2: Correlation assumptions need to be rationalized and validated based on empirical analysis and historical observation in order to meet the “severe but plausible” standard.· The extent of volatility in prior GMS shocks — in terms of severity and direction — conflicts with the FRB’s embedded assumption of near-perfect correlation and hinders capital planning.· Recommendation 3: Year-over-year changes in stress testing should explore salient emerging risks and avoid unexpected, extreme or random swings do not facilitate capital risk identification and management.· GMS assumptions regarding the duration of market dislocation for certain asset classes are not supported by empirical analysis or historical observation, conflict with other U.S. and Basel Committee on Banking Supervision (BCBS) standards (e.g., the LCR and the Fundamental Review of the Trading Book) and do not pass a “severe but plausible” test.· Recommendation 4: Replace the blunt three- to six-month GMS with a framework that accounts for the liquidity and price stability of assets. Assets with high price stability and liquidity should be calibrated towards historical observation, at a maximum of 30 days or fewer.

Section 2: Large Counterparty Default (LCD)

Key Findings Recommendations· The use of GMS shocks to estimate LCD losses leads to an overstatement of risk, particularly for the most liquid and easiest-to-hedge exposures.

Section 3: CCAR Framework and Approach

Key Findings Recommendations· The FRB does not provide disclosure regarding how the GMS shocks are sized, including how calibration and correlation are considered, other than they are based on a “principle of conservatism” and a “severe but plausible” standard.

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