Sail with the regulatory wind at your back

As an institutional trader and executive, I learned an important lesson midway through my career: sail with the regulatory wind at your back. Changes in regulation have a way of working themselves into market behavior for very long periods of time. The shift in market action is at first very slow and hardly noticeable. Over time, it feeds on itself as others mimic the behavior of regulated institutions communicated to them via price action. 

There are some major regulatory changes ahead. When larger institutions are involved, they never are implemented overnight. Banks and other FIs get a running start quarters in advance. 

One of the most important shifts in 2016 is in the central bank-mandated requirements for calculating aggregate risk. Regulatory capital, i.e., the capital regulators require institutions to hold in order to operate legally in the marketplace, will over time be calculated using Expected Shortfall rather than VaR itself. Expected Shortfall is the amount that a portfolio is expected to lose if there is a catastrophic tail event. This accords with the intuition of many investors and risk managers. While the specifics are too technical for this forum, we can note that it forces attention on behavior of security markets under cataclysmic circumstances. 

It is worth learning more about the shifts in institutional portfolio management. While they may not impact trading action at the margin, they are quite influential in longer term. Investors in bank stocks might pay particular attention.