A 15-Year Retrospective on the 2008-09 Credit Crisis: Regulatory Successes, Failures, and Prospects

Written by John Pucciarelli, Head of Industry and Mark Demo, Co-Head Business Development at Acadia

The credit crisis of 2008-09 marked a pivotal moment in global finance, revealing systemic vulnerabilities that demanded a comprehensive re-evaluation of regulatory oversight. A decade and a half later, the regulatory landscape has shifted dramatically. By having the ability to look back and reflect on specific facets of this evolution (the non-cleared margin rules), we can draw conclusions about what went right, what missed the mark, and crucially, where improvements can be made.

As regulators, financial institutions and industry groups found out, the processes surrounding rule making and developing appropriate regulations can often be messy. Post crisis, the G20 set the stage for regulatory reforms in Pittsburgh in 2009, leading to the proposal of rules by local prudential regulators, which the industry quickly deemed unworkable. However, influenced by industry concerns, the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) then established the BCBS-IOSCO framework and the WGMR (The Working Group for Margin Reform). Local prudential regulators then re-proposed rules that were largely consistent in nature and proved to be acceptable to the industry. The iterative process, while challenging, ultimately contributed to refining the rules, highlighting the difficulties of global coordination and the significance of comprehensive initial rule making.

When it Comes to Regulation, Less is More

US regulators took a decidedly measured approach post-crisis by mandating that only prudentially regulated firms were required to collect, post, and validate regulatory initial margin, contrasting sharply with the EU’s process whereby both buy-side and sell-side firms maintained a similar requirement. Prudentially regulated firms are required to maintain model validation teams while buy-side firms are generally not, making the UMR (Uncleared Margin Rules) model validation requirement overly burdensome on these smaller firms. European regulators and buy-side firms are still grappling with this challenge as evidenced with the recent Revised RTS on Model Validation, whereas the US has largely moved on. As of the date of this paper the RTS is still not final and the industry awaits their next move, which creates uncertainty in the market. While comprehensive regulation is essential, over-regulation can stifle competitiveness. Ultimately, a balance must be struck between robust oversight and market vitality. The US’s more limited approach, in retrospect, provided clarity and stability for market participants.

The Role of Trade Associations in Coordinating Industry Dialogue

Initial regulations post-crisis sometimes lacked feasibility, emphasizing the risks of rulemaking in isolation. Trade associations such as the International Swaps and Derivatives Association (ISDA), the Securities Industry Financial Markets Association (SIFMA), and the Managed Funds Association (MFA) played a pivotal role in bridging gaps between the regulator and the industry, fostering better communication and ultimately more practical regulations. It became rapidly clear that close collaboration between industry and regulators is essential for crafting regulations that are both effective and feasible in terms of wide implementation. Increased participation from industry groups allowed for the standardization of certain collateral management practices of the bi-lateral OTC derivatives business, which has allowed for enhanced risk management while preserving market diversity. This enabled the introduction of a risk-based model like ISDA SIMM™, which has transformed how the industry manages daily initial margin. To this day, we’ve seen that model be successful across market testing events such as COVID and the Ukraine war volatility, underscoring its efficacy. Models like ISDA SIMM™ exemplify how industry-wide initiatives can significantly reduce systemic risk and enhance market resilience.

Success in Standardization

Standardizing certain collateral management practices of the bi-lateral OTC derivatives business has allowed for enhanced risk management while preserving market diversity. However, over standardization can hinder competition. The drive towards standardization was largely successful, but care must be taken to ensure markets remain competitive and adaptive.

Unfinished Business - Proactive Versus Reactive Regulation

Regulators have amassed vast amounts of data since the events that took place in 2008. Just a couple of examples of the types of data now available to regulators since this time include information reported to the Trade Repositories and monthly collateral disputes between firms. Rather than crafting regulations purely in response to crises, regulators should utilize this data proactively to anticipate and mitigate emerging risks. While significant strides have been made, the regulatory approach can and should evolve beyond reactionary measures to incorporate more data driven analysis.

Newly Minted Regulators and the Integrity of Financial Markets

Regulatory bodies continually recognize their responsibility towards maintaining market integrity. However, the long-term success of global financial markets is closely tied to regulatory competence and diligence. There’s a growing need for the next generation of regulators to undergo continuing education which reinforces their role in ensuring robust and competitive financial markets while balancing market stability and integrity. Fifteen years after the credit crisis, the regulatory landscape has undeniably evolved, with many successes but some clear areas of improvement. Collaboration between industry and regulators, a move towards standardization, and innovations like ISDA SIMM stand out as significant achievements. However, challenges like the CFTC-SEC split, and the subsequent jurisdictional split, and the need for more proactive regulations underline the continuous evolution required in regulatory oversight. What is undeniable is that the lessons from 2008-09, and the subsequent regulatory responses, will shape financial markets for decades to come.