The FSA is set to turn the regulatory spotlight on the valuation of traded positions and is calling for a specific assessment of valuation uncertainty.
In its discussion paper, published today, it outlines its plans for a fundamental review of trading activity regulation, one of the key recommendations of the Turner Review following huge trading losses during the recession.
The FSA says it wants to address areas of structural weakness that exacerbated the build up of risk before the financial crisis.
In addition to re-assessing valuations of trades, the paper recommends changing the capital framework of the UK financial system to reduce the opportunities for structural arbitrage, especially within the banking sector.
In capital structure arbitrage, investors exploit yield mismatches between two loans from the same reference entity.
The FSA also calls for specific measures aimed at improving firms' risk management and modelling standards, and ensuring these are aligned with regulatory objectives.
Paul Sharma, FSA director of prudential policy, says: "There are clear benefits of participants in traded financial markets taking risks to facilitate a more efficient allocation of resources across the economy - where these gains in efficiency are real and the risks posed are adequately captured or controlled we are not seeking to undermine these activities.
"However, the balance needs to be redressed to ensure that risks posed to the system as a whole are more adequately reflected in the structure of prudential regulation."
The closing date for responses to the discussion paper is 26 November 2010. The FSA will issue a feedback statement in the first half of 2011.
