michael s barr : the importance of counterparty credit risk management speech by mr michael s barr, vice chair for supervision of the board of governors of the federal reserve system, at the basel committee on banking supervision - federal reserve counterparty credit risk conference, new york city, 27 february 2024. * * * thank you for the opportunity to be part of this important discussion on counterparty credit risk. 1 it's particularly appropriate for the federal reserve bank of new york to host these discussions. twenty - five years ago, new york fed officials convened the creditors of long - term capital management ( ltmc ) to facilitate the firm's stabilization. ltcm was a heavily leveraged hedge fund that had borrowed more than $ 125 billion from its counterparties and had derivatives estimated at over $ 1 trillion in notional value. stabilizing ltcm narrowly averted significant financial stress, an event i remember vividly from my vantage point as a treasury official at the time. that event prompted deep reflection on both the risks presented by nonbanks such as hedge funds and the state of counterparty credit risk management practices by banks that finance their activities. the more recent failure of archegos capital management resulted in over $ 10 billion of reported losses across several banks and revealed many of the same gaps in how banks manage their exposure to investment funds, which are far larger today than at the time of ltcm's collapse. managing these exposures has become more challenging as the financial system has become more complex, diverse, and interconnected. for example, the sudden rise in commodities prices in march 2022 rippled around the global financial system in part because of the sudden rise in margin requirements on commodities derivatives as the stress hit. further, an increasingly varied and evolving collection of nonbank clients, including pension funds and asset managers, is playing a significant role in the global economy and presenting new and unconsidered risks. for instance, losses in 2022 in the liability - driven investments of pension funds in the united kingdom demonstrated how even traditionally safe exposures, such as government bonds, when combined with excessive leverage, can threaten the stability of bank counterparties and the global financial system. these events highlight why counterparty credit risk is such an important risk discipline. banks have made important progress since the failure of archegos to improve counterparty credit risk management practices because of their own reflection on the lessons learned from archegos and in response to supervisory input. for instance, banks have improved information disclosure

those goals may change over time. and once the loan is made, lenders should do the hard work to continually obtain necessary and timely information about the borrower. this understanding is especially important when customers are counterparties in complex or dynamic trading activities. banks need reliable, comprehensive, granular, and frequent information about their counterparties to make prudent decisions. obtaining this information can be challenging because of client activity happening away from the bank. having only partial disclosure of the positions of a counterparty prevents banks from understanding the vulnerabilities in the counterparty's risk profile, such as excessive concentrations and leverage, that could lead to major losses. if a counterparty is unwilling to offer an appropriate level of disclosure, the bank should take this into account in whether to deal with the counterparty and the terms that it offers if it nonetheless chooses to lend or provide other services. in the case of both ltcm and archegos, the lack of appreciation for their overall size, leverage, and concentration was a significant factor in explaining the deficiencies in how banks risk - managed their exposures to those funds. this lack of transparency contributed to remarkable growth of the funds'positions and exacerbated the risk to counterparty banks from their collapse. measuring risk and the importance of margining 2 / 5 bis - central bankers'speeches next, i'll discuss the importance of identifying and measuring counterparty credit risks, as well as mitigating those risks through sound margining practices. sound counterparty risk measurement rests upon four important foundations. the first involves understanding a counterparty's risk profile through a range of risk measurement tools. in contrast to many traditional lending relationships, trading activities can be more complex and riskier, which demands more nuance and attention in risk measurement. second, banks should conduct risk aggregation within and across products, business lines, and clients. large trading clients may have varied exposures across different products, asset classes, and business lines at the bank. managing this effectively requires the bank to understand how these risks fit together and how they add up. third, banks should have capabilities for timely and accurate risk measurement given the dynamic and complex nature of trading activities. there should be appropriate understanding of the risk measurement tools used within the organization - including their strengths and limitations - to allow for appropriate use and action. fourth, based on their assessment of the risk, it is important that banks maintain appropriate levels of margin to insulate them from loss. risk - based