Keep up to date with the latest international, European and UK regulatory developments and pertinent regulatory activity affecting the financial services industry through Risk and Regulation Monthly. The latest edition is below.
|Risk and Regulation Monthly - August 2014
Highlights included the ECB’s manual on its Comprehensive Assessment, the PRA’s third consultation on Solvency II transposition, and the FCA’s statement that 2.5 million PPI claims needed to be reassessed.
Expand each theme below for an overview of the major regulatory developments affecting the European financial services industry.
Capital continues to make the headlines, and 2013 has been another busy year on this front. The final Capital Requirements Directive IV and Capital Requirements Regulation (CRD IV/CRR) were published in the Official Journal of the European Union at the end of June, allowing implementation to begin from January 2014. However, there is significant further technical work to be done, particularly for the European Banking Authority (EBA) which must write technical standards, and for national authorities to transpose elements of Directive and take positions where national discretion is permitted.
The proposals are far reaching, covering everything from minimum capital levels and countercyclical buffers, through to governance requirements and remuneration rules. Internationally, the Basel Committee on Banking Supervision has moved on from writing the Basel III rules to their implementation, with a focus on international consistency. However, that is not to say that the standard setting process is complete. Indeed, the Committee published revisions to the Liquidity Coverage Ratio in January 2013, and an ongoing reassessment of the risk-weighted assets regime could well lead to further amendments to the capital framework, particularly relating to risk-modelling and disclosure. A second consultation on the Fundamental Review of the Trading Book is expected in autumn 2013, at which point the Basel Committee is likely to issue draft rules. The Basel Committee has also set out its proposals on the leverage ratio.
Beyond Basel III, the Banking Reform Bill was introduced to the UK Parliament in February 2013, with proposals to “electrify” the ring-fence proposals of the Independent Commission on Banking. Work on the secondary legislation continues, with HM Treasury having recently consulted on a range of documents, including rules to implement higher loss absorbency requirements for large UK banks.
Away from banking, Solvency II continues to meet delays, with no fixed deadline for implementation in sight, and a European previously scheduled for October 2013 now without a fixed date. With the original implementation deadline having now been missed, interim measures are being coordinated by the European Insurance and Occupational Pensions Authority (EIOPA) while uncertainty over the final regime persists.
Conduct of business continues to be at the forefront of the regulatory reform agenda. On the supervisory side, conduct regulation will become increasingly intrusive and judgement-based, both at the UK level, as the new Financial Conduct Authority (FCA) establishes itself, and at the EU level, as the European Supervisory Authorities (ESAs) continue to develop their supervisory style more clearly. In response to mis-selling of payment protection insurance (PPI) and interest-rate hedging products, and in line with their new approach, supervisors are likely to demonstrate their readiness to intervene at all stages of the product lifecycle. This trend will affect a growing number of retail business lines, with implications for profitability. Wholesale conduct is also set to become an increasing area of focus for the new FCA. In response to the LIBOR scandal, certain banks have received record fines, and regulatory action in this area looks set to continue.
On the regulatory side, there is increasing focus on transparency and investor protection. In the UK, the Retail Distribution Review came into force at the start of 2013, introducing sweeping changes to how investment advisers are remunerated, how they describe their services, and professionalism. At the EU level, the proposed revisions to the Markets in Financial Instruments Directive and Regulation (MIFID II / MIFIR) and the Insurance Mediation Directive (IMD II) and the proposed Regulation on Key Information Documents for Investment Products (the ‘PRIPs’ initiative) seek to harmonise and increase investor protection and transparency across sectors.
In the aftermath of the financial crisis, the issue of firms perceived as too big, complex and interconnected to fail was placed at the top of the regulatory agenda. Policy measures to address the risks posed by systemically important financial institutions (SIFIs) are advancing. At the international level a methodology for identifying global systemically important banks (G-SIBs) and a set of principles to guide national regulators in identifying domestic systemically important banks (D-SIBs) have been finalised. Banks designated as SIBs will be subject to more intensive supervision and additional equity capital buffers in comparison to non-systemic firms, with the aim of strengthening their defences. Internationally, 28 identified G-SIBs are required to have recovery and resolution plans (RRPs) in place. Currently, the focus is on improving international cooperation and coordination, ensuring that a G-SIB’s home and host supervisors are effectively coordinating through firm-specific crisis management groups. The Financial Stability Board is currently developing an international approach to assessing resolvability and is expected to begin peer assessment of firms’ resolvability in H2 2013.
Two distinct resolution strategies have emerged, single point of entry (SPE) and multiple points of entry (SPE): the former requires the application of resolution powers (including bail-in) at the parent company level; the latter involves the application of resolution powers by two or more authorities to multiple parts of the group. The FSB recently published finalised guidance on the preconditions for these stylised resolution strategies.
In the UK RRP requirements have been extended to all credit institutions and large investment firms. Similarly, the EU Recovery and Resolution Directive extends the scope of international recovery and resolution frameworks and tools, and will introduce measures for cooperation and coordination across Europe. In addition 39 cross border European banks have been given an end-2013 deadline for completing group recovery plans.
Regulatory developments for non-bank SIFIs are less advanced than for banks; nevertheless significant progress is expected in 2013. A finalised methodology for identifying global systemically important insureres (G-SIIs) and an initial list of G-SIIs has been released by the FSB, in addition to a set of policy measures; a consultation on a methodology for identifying other non-bank SIFIs is anticipated; and finalised guidance on recovery and resolution for central counterparties is planned.
There is also on-going work on structural reform of the banking sector; several countries have introduced or are considering introducing legislation to restructure the banking sector, with the aim of either reducing risk or supporting the swift and effective resolution of banks in distress. There are two main approaches to restructuring the banking sector: ‘ring-fencing’; and full structural separation of certain banking activities. In the EU, a proposal for legislation to ring-fence “risky trading activities” from the insured deposit and retail payment services arm of a banking group (based on the High Level Expert Group’s recommendations) is not expected before the end of Q3 2013.
There are a number of continuing and emerging concerns relating to disclosure which may lead to policy action. The International Accounting Standards Board (IASB) has turned its attention to what it has termed “disclosure overload”, with a view to addressing the subject in its Conceptual Framework, used to develop International Financial Reporting Standards (IFRS). The complexity of disclosure, as well as a lack of comparability between institutions, continues to be a concern both for regulators and financial market participants.
Elsewhere, the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) have repeatedly singled out the complexity of disclosure as an issue. In October 2012 the FSB-appointed private sector Enhanced Disclosure Task Force (EDTF) issued seven principles for enhancing risk disclosure for banks, which are to be taken in consideration by the BCBS, which is due to produce further guidance on Pillar 3 disclosure. The subject is also likely to be addressed as part of the BCBS’ Fundamental Review of the Trading Book, on which a second consultation is expected in autumn 2013. At the EU level, Pillar 3 disclosures were looked at by the European Systemic Risk Board, which is considering the option of creating a centralised EU Pillar 3 depository to facilitate comparability.
IASB’s work on IFRS is on-going, with a number of Standards applicable from the beginning of 2013, while IFRS 9 has been delayed to 2015. It remains unclear whether the IASB and the US Financial Accounting Standards Board (FASB) are set to converge, and if so at what speed and on what terms.
New EU requirements
EU firms have been given more clarity on upcoming capital and capital disclosure requirements with the fourth Capital Requirements Directive (CRD IV) and Capital Requirements Regulation (CRR) now finalised. In particular, banks will have to disclose information on profit, taxes, staff and subsidies on a country-by-country basis. CRR is also introducing Prudent Valuation requirements to all EU member states.
The UK Financial Conduct Authority (FCA), which came into existence on 1 April 2013, took over the FSA’s financial crime responsibilities, with a mandate to safeguard the integrity of UK financial markets. The Prudential Regulatory Authority (PRA) also has oversight of financial crime, to the extent that it can be a source of operational and reputational risk. While enforcement has always been a key supervisory responsibility, the twin-peaks authorities have committed to a more forward-looking and proactive approach and firms can expect the authorities to intervene earlier and more readily. A relatively new feature of anti-money laundering (AML) supervision will be systematic, recurrent, and in-depth reviews of the biggest banks’ AML and sanctions breaches defences. This work is part of the ‘Systemic Anti-Money Laundering Programme’ which the FSA piloted in 2011. Asset managers are increasingly coming into focus, with the outcome of a thematic review on risk of bribery and corruption, sanctions and money laundering in the sector expected in Q3 2013. The FCA will also keep a close eye on identifying and reporting suspicious transactions with the aim of tackling market manipulation. These new supervisory commitments suggest that there will be no slowdown in terms of firms seeing enforcement action. At the same time, firms remain exposed to high risks of enforcement action from foreign authorities, as the tendency towards the extraterritorial application of domestic rules continues. At the European level, in February 2013 the Commission adopted two proposals to reinforce the EU’s existing rules on anti-money laundering and fund transfers, in order to align the EU with changes in international standards, which will have to be adopted by the European Parliament and the Council of Ministers. Additionally, the EU has been stepping up its work in the area of intellectual property rights and cybercrime, with a new European Cybercrime Centre launched at the beginning of 2013, and a decision to set up an expert group on enforcing intellectual property rights pending.
The financial crisis revealed apparent weaknesses in firms’ governance, risk management and risk culture. In response to this, there has been increasing regulatory expectations on the responsibilities of the Board, senior management and the CRO in relation to risk. Risk appetite is viewed as essential in providing the link between a firm’s strategy and its risk management framework and there will be increased focus on firms establishing, embedding and maintaining the ‘right’ culture. Remuneration has also received increasing attention. In addition to the bonus cap recently agreed as part of the revision to the Capital Requirements Directive (CRD4), the Alternative Investment Fund Managers Directive (AIFMD) and proposed revision to the UCITS Directive (UCITS V) seek to set rules on remuneration in a way which is said to support sound risk management practices.
June 2013 saw the publication of the final report of the UK’s Parliamentary Commission on Banking Standards (PCBS), which proposed sweeping changes to the governance arrangements of UK banks in order to “reinforce individual responsibility.” The UK Government quickly accepted many (but not all) of the Commission’s recommendations, which included an overhaul of the Approved Persons Regime, the creation of a criminal offence for “reckless” management of a bank, and further deferral of variable remuneration. The PCBS set out a mixture of short-term and long-term proposals, the development of which will be watched keenly over the rest of 2013 and into the years ahead.
The rising reputational, regulatory and operational impact of security and privacy breaches is becoming a boardroom level concern. Organisations are required to interpret and comply with complex and diverse international regulations on how they handle personal data, how it is controlled and how it is protected. With the EU Commission announcing its plans to reform European data protection regulation, the rules seem set to move once again. A pro-active approach to security and privacy is now seen as a competitive advantage and can minimize the likelihood of a security breach, support trusted customer relationships and help organisations prepare for regulatory change.
At the front of regulators’ minds is liquidity, or the lack of it. The current challenge is focussed on balancing the need for banks to have suitably liquid assets to withstand a period of stress, without unnecessarily curtailing banks’ capacity to lend to the real economy.
Basel III has introduced a new liquidity framework for the banking industry. The Liquidity Coverage Ratio (LCR) will support banks’ resilience to a short-term period of severe liquidity stress. Firms will be required to hold an adequate level of unencumbered high quality liquid assets (HQLA) to cover net cash outflows during a 30-day period. Conversely the proposed Net Stable Funding Ratio (NSFR) aims to improve banks’ resilience to medium-term stresses and reduce funding mismatches by ensuring that longer term assets are funded with a minimum amount of stable liabilities. Detailed requirements for the NSFR are yet to be finalised, whilst LCR requirements have recently been relaxed, introducing for example staggered implementation of the buffer; a new category of HQLA including equities; and reduced outflow rates for certain types of wholesale funding and retail deposits. At present it is unclear how far or how soon recent developments within Basel III will be reflected in the EU regulatory framework, although the EU will review certain specific elements of the framework in the coming years to assess the case for their inclusion. In the UK changes to the enhanced liquidity regime (launched in 2009) were made recently, in order to bring them more into line with the agreed international timetable.
The ‘shadow banking’ regulatory agenda continues to progress steadily at the international and national levels. The Financial Stability Board is leading international efforts, while a variety of regional and domestic institutions grapple with how best to monitor and regulate the non-bank financial sector. While regulation is being formulated in some areas, it is clear that regulators are still struggling to disentangle the complex web of financial relationships which constitute shadow banking. Data continues to be a challenge, with the European Central Bank noting in February 2013 that “existing statistical data […] provide only a limited picture.” The Financial Stability Board’s annual “macro-mapping” of shadow banking, in conjunction with other ongoing data initiatives, will be refined and expanded.
While data and monitoring are improved, however, regulatory policy continues to be formulated. The Financial Stability Board has indicated five specific areas in which it believes policy action is needed in response to systemic risks posed by shadow banking, with workstreams covering: spillovers between banks and shadow banks; money market funds; non-MMF shadow banking entities; securitisation; and securities lending and repo transactions. These workstreams, in place since 2011, have since developed more specific recommendations, some of which have been developed in conjunction with IOSCO. Following further consultation, final recommendations for each workstream will be published in September 2013, after which attention will turn to implementation. Meanwhile in the EU, initiatives include the Alternative Investment Fund Managers Directive (transposed in July 2013); the European Market Infrastructure Regulation (being implemented from March 2013); and the regulation of Money Market Funds, on which proposals are expected in autumn 2013. In short, the expansion of the regulatory perimeter beyond banks shows no signs of slowing, with regulatory consequences for a vast array of firms across many industry sectors.
2013 sees a raft of changes in regulatory architecture. Top of the EU agenda is making progress on the Single Supervisory Mechanism (SSM) for euro area countries, as well as EU Member States choosing to ‘opt-in’ to the regime. SSM, which constitutes one of the pillars of the proposed euro area Banking Union, will look to transfer prudential supervision of major banks in participating countries to the European Central Bank (ECB). After finalisation of the relevant regulations in 2013, there is expected to be significantly more detail on the implementation of the SSM before it takes over its responsibilities, likely to occur in the second half of 2014. Establishing a common ‘supervisory language’, and meeting resourcing challenges, will be just two of the issues the ECB will have to address right away. Alongside SSM, the European Commission is reviewing the structure and performance of the European System of Financial Supervision (made up of the European Supervisory Authorities (ESAs) and the European Systemic Risk Board (ESRB), as well as national competent authorities), which has now been in operation for two years. In the meantime, resourcing may be an issue in the EU, with the ESAs having set out ambitious work programmes for 2013. The European Commission’s work to create a Single Resolution Mechanism for the Banking Union is also in its early stages, with a legislative proposal having been published in July.
In the UK, the new twin-peaks supervisory regime came into existence on 1 April 2013. Both the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA) have set out their approach to supervision and firms are already seeing the new approach applied in practice. One of the final pieces of the puzzle, the transfer of consumer credit regulation to the FCA, is also now under way, with a number of consultations launched in Q1 2013, and a transfer date of April 2014.
Basel Committee on Banking Supervision (BCBS)
Financial Stability Board (FSB)
International Association of Insurance Supervisors (IAIS)
International Organisation of Securities Commissions (IOSCO)
European Commission (DG MARKT)
European Banking Authority (EBA)
European Insurance and Occupational Pensions Authority (EIOPA)
European Securities and Markets Authority (ESMA)
European Systemic Risk Board (ESRB)
Financial Services Authority (FSA)
HM Treasury (HMT)
Independent Commission on Banking (ICB)
Bank of England