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Capital (including stress testing)

Changes in capital requirements continue to present a significant challenge across the financial services industry. From January 2013 banks and 2014 insurers will be required to meet increased capital requirements under their respective regulatory frameworks (namely Basel III and Solvency II). With respect to banks, the transition to full implementation will take a number of years.

International and European Union regulatory developments

The final Basel III requirements are now more or less complete although consultation continues on some aspects and banks are expected to comply in full by 2019. The Basel III requirements raise minimum capital levels, increase the ratio of equity to risk-weighted assets and tighten the definition of core tier one capital. In addition, a new countercyclical capital buffer and a leverage ratio requirement are due to be introduced following the initial supervisory monitoring periods. There is the possibility of further change resulting from the fundamental review of the trading book capital rules. Capitalisation of bank exposures to CCPs is an important part of Basel IIII, and the Basel Committee on Banking Supervision (BCBS) published a second consultation in this area in November 2011 – the final rules are expected in early 2012 for implementation by 2013. Another area that was put out for further consultation in December 2011 is the application of own credit risk adjustments to derivatives.

In Europe, the European Commission’s (EC) Capital Requirements Directive IV (CRD IV) proposal was published in July 2011 in the form of a Directive and a Regulation. Most notably, capital conservation and countercyclical buffer requirements are in the Directive, leaving national regulators with more discretion, and the proposal makes no reference to a 3% leverage ratio backstop, in contrast to Basel III. The latest Danish Presidency compromise text, published in January 2012, includes new provisions for systemically important banks (SIBs) including an additional systemic buffer of up to 2.5% of total risk exposure. Political agreement on the final scope and details of CRD IV is not expected until late 2012 The insurance industry also faces new EU-wide capital requirements and risk management standards through the Solvency II Directive. The Solvency II Directive deadline has been pushed back by a year, with 1 January 2014 the new deadline by which the requirements will be switched on for firms. 1 January 2013 remains the date at which the responsibilities of supervisors and EIOPA will be switched on. The European Insurance and Occupational Pensions Authority (EIOPA) is expected to launch a public consultation on draft technical standards and guidelines for Solvency II implementation in May 2012, with finalised proposal expected in September 2012.

With regards to stress-testing, the European Banking Authority (EBA) published in July the results of its bank stress test, which eight banks failed. Furthermore, in December 2011 the EBA published recommendations to strengthen banks’ capital positions, which include building up a temporary capital buffer against sovereign debt exposures such that the Core Tier 1 capital ratio reaches 9% by the end of June 2012. EIOPA also published the results of its stress testing exercise in July, which showed that overall European insurers remain robust, although 10% of the sample would fail Solvency II minimum capital requirements under the adverse stress.

UK regulatory developments

In October 2011, the Financial Services Authority (FSA) published a new webpage outlining the process and timelines for Basel III / CRD IV implementation in the UK. In November 2011 the FSA published a policy statement on Strengthening Capital Standards III - further consultation on CRD III, and published final rules and guidance on CRD III implementation. These came into force on 31 December 2011. The FSA has revised its planning assumptions for Solvency II to reflect the implementation date delay agreed at the EU level and is currently consulting on the transposition of Solvency II into UK law as well as proposed changes to FSA rules regarding linked long-term insurance business. The Independent Commission on Banking (ICB) published in September 2011 its Final Report with recommendations for the structure and regulation of the UK banking Industry. The UK Government published a White Paper setting out proposals for implementing the package of measures recommended by the ICB in July 2012. Those measures consist of i) ring-fencing banking services vital to the UK's economy; ii) increasing banks' loss absorbency; and iii) enhancing competition in the banking sector.  Following a 2-month consultation period the Government published high-level, draft primary legislation – Banking Reform Bill. All primary and secondary legislation is aimed to be completed by May 2015, with a view to banks having to comply with all measures by 2019.

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