Evolving Banking Regulation Nov 2010

8/8/2019 Evolving Banking Regulation Nov 2010

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FINANCIAL SERVICES

EvolvingBanking

RegulationA marathon or a sprint?

November 2010

kpmg.com


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Editorial team

Giles Williams

Partner

Financial Services

Risk and Regulatory

Center o Excellence

EMA region

KPMG in the UK

Jim Low

Partner

Financial Services

Risk and Regulatory

Center o Excellence

Americas region

KPMG in the US

Simon Topping

Partner

Financial Services

Risk and Regulatory

Center o Excellence

ASPAC region

KPMG in China

About this report

This report was developed by KPMGs

network o regulatory experts. The

insights are based on discussions with

our frms clients, our proessionals

assessment o key regulatory

developments and through our links

with policy bodies.

Special thanks

We would like to thank members o the

editorial and project teams who have

helped us develop this report:

Kara Cauter, KPMG in the UK

Clive Briault, KPMG in the UK

Alexandra Dean, KPMG in the UK

Amber Stewart, KPMG in the UK

Meghan Meehan, KPMG in the US

Karen Staines, KPMG in the US

2010 KPMG International. KPMG International is a Swiss cooperative. Member fr ms o the KPMG network o indep endent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor do es KPMG International have any such authority to obligate or bind any member frm. All rights reserved.


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Contents

Foreword 2Executive Summary 4

1. Capital

Perspectives: ASPAC 8

2. Liquidity

Perspectives: Europe 12

3. Systemic risk 16

4. SupervisionPerspectives: US 20

5. Governance and remuneration 26

6. Customer treatment 30

7. Traded markets 34

8. Accounting and disclosure 40

Acknowledgements 44

2010 KPMG International. KPMG International is a Swiss cooperative. Member frms o the KPMG network o independ ent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor does KPMG International have any such authority to obligate or bind any member frm. A ll rights reserved.


4/48 2010 KPMG International. KPMG International is a Swiss cooperative. Member fr ms o the KPMG network o indep endent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor do es KPMG International have any such authority to obligate or bind any member frm. All rights reserved.

Foreword

When we released our frst Evolving Banking Regulation report in

November 2009, there was still signifcant uncertainty around the

eventual shape o banking regulation. What a dierence a year makes.

Policy makers in every region have sprinted ahead with new rules or

banks. The Basel Committee has fnalized new principles or capital

and liquidity. The United States has passed the Dodd-Frank Act,

which touches on virtually every aspect o its fnancial sector.

Proposals have been put orward by global, regional and national

policy setting bodies which will change the structure, supervision and

governance o fnancial services. But we are nowhere near the fnish

line regulatory change remains on the G20 agenda and will continue

so or years to come, as we enter the much longer marathon towards

implementation and transormation o the industry.

Working through the enormous volume

o policies and proposals which have

been issued this year, I am struck by

how much uncertainty remains. High

level proposals are still subject to

detailed rulemaking and implementation

guidelines and I have no doubt the

devil will be in the detail. All stakeholders

agree on the need or a sae, eective

inancial sector. But how we strike thebalance between sae and eective

or there will be trade os remains

a contentious issue, as evidenced in

some o the announcements in the

lead up to the G20 summit in Seoul in

November. Tensions and competing

priorities between nations will, in the

end, inluence the tone and detail o

how changes are inally implemented

on a local level. Outcomes look

increasingly likely to dier by region,

and indeed by country, but by how much?


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Evolving Banking Regulation | November 2010 | 3

Despite commitment to a level playing

ield rom the G20, the IMF, the FSB

and other major players, the reality is

very dierent. Major jurisdictions are

taking dierent paths over issues

including systemically importantinancial institutions, governance,

remuneration and supervision. This is

partly driven by very dierent starting

points countries that emerged

relatively unscathed rom the inancial

crisis are reluctant to implement costly

measures to improve saety and

resilience. Timelines or implementation

will also diverge both by geography,

and within that by institution as larger

cross-border banks race ahead to

demonstrate their stability and position

themselves or opportunities.

Saety and soundness dominate

the policy agenda in Europe. We are

seeing the end o light touch

supervision in avor o a multi layered

intensive supervision with potential

knock on consequences or Europes

competitiveness in the global inancial

markets. In the US, compliance with

Dodd-Frank will require liaison with

new and reconigured regulatory

entities, operational redesign, and

vigilant attention to one o the largestrule-making exercises in the history o

the country. But the accelerated time

line to inalize rules increases the risk o

unintended consequences which will

have an eect on all markets globally.

Asia Paciic is not a homogenous

region, there is signiicant variation in

the approach to inancial services

regulation; however overall the Asia

Paciic banks were relatively unscathed

by the crisis. Nevertheless, there is

signiicant work to be done to developthe inrastructure, governance and

risk management required to manage

businesses which will become more

complex and global in outlook.

Given these developments, I believe

our themes are likely to have the

greatest impact on the inal shape o

the new rules as we move into the core

implementation phase:

Stakeholder expectations must be re-adjusted to relect capital and liquidity

constraints banking will be a more

costly business both or institutions

and or their customers. How these

changes play out between nations

is likely to vary, in some cases

signiicantly, which will increasingly

make some markets more attractive

to do business in.

Systemic risk will be a key ocus,

but sharp national dierences on

insolvency law and economic

imperatives will continue to complicate

a cross-border approach to supervision,

crisis management and resolution,

as central bankers try to balance the

need or market saety with political

pressure to create a ramework or

economic growth.

Demonstrable change in how banks

govern their businesses with much

greater weight given to risk-adjusted

returns, and a signiicant increase in

the accountabilities o management,

the Board, and on supervisors toassess the eectiveness o these

changes. There are signiicant

consequences or attracting and

retaining sta, and developing markets.

Increased ocus on the customer and

core banking services added capital,

liquidity and operational costs will

make trading business less attractive

and lead to reduced capital allocation

to these businesses. Banks will

reocus on retail and commercial

banking, and core services such aspayment and custody. But this area

too has challenges increasing

regulatory ocus on consumer

protection means banks must

simpliy oerings and increase

transparency, which risks stiling

innovation and choice at a time when

state pensions and investment and

savings returns, are diminishing.

Development o the regulatory

paradigm is clearly having a signiicant

impact on the industry, and around the

world. Regulators are under pressure

to get the mix right between a sae

and eective inancial system by

establishing a new ramework o rules

or local supervisors to implement, but

the success will only be evident some

way down the track. Leading global

inancial institutions are acing the

challenge to implement critical changes

in capital and liquidity well ahead o

stated timetables, in order to meet or

exceed market expectations. But many

national inancial institutions are not yet

in a position to respond to the ull

implications o these changes and the

journey to ull compliance will be long

and intensive.

So is it a sprint, or a marathon?

I believe it will be both and it is the

inancial institutions that plan and

prepare early, embedding the new

requirements in how they govern anddirect the business, who will be best

positioned or success.


Jeremy Anderson

Global Chairman

KPMGs Financial Services practice


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Executive Summary


The journey towards a re-shaped fnancial sector is now well under

way. Policy bodies are moving towards the fnal stages o rule making

around the core objectives o the agenda or regulatory change set

out by the G20. Signifcant changes are inevitable or every acet

o the banking industry and indeed the wider fnancial services

industry. But how this change will play out or dierent business

models and in dierent jurisdictions looks set to be very dierent.


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Capital and liquidity have been a primary

ocus o the inancial press since the

crisis. The new bank capital and liquidity

requirements agreed by the Basel

Committee on Banking Supervision

(BCBS), and supported by G20governments, will strengthen the

resilience o inancial irms. We argue in

our chapters on Capital and Liquidity

that these changes will cause a systemic

reduction in banking proits, resulting in

a undamental re-shaping o the sector.

Changes may make banking saer

but could also limit the diversity and

innovation which has underpinned

economic expansion.

The G20 summit in Seoul supported

an emerging ocus on inancial

institutions deemed globally systemic

(G-SIFIs). As we discuss in our chapter

on Systemic Risk these institutions

are likely to be subject to additional

layers o regulatory and supervisory

scrutiny. While the G20 has approved a

ramework or a consistent international

approach to G-SIFIs, it leaves scope or

additional national supervisory add-ons

or G-SIFIs and application o dierent

rules or local SIFIs. This could result

in a very unlevel playing ield or large

cross-border institutions.Imposing new regulations will require

a signiicant step up in supervisory

authority and scrutiny, which has been

in evidence or some time in major

markets. Our chapter on Supervision

sets out the signiicant structural changes

to the supervisory ramework in Europe

and the US, which will add urther

complexity. As we argue in our chapter

on Governance and Remuneration,

supervisors are also using expanded Board

and senior management accountabilities

to shine the light on governance and

remuneration. Changes in these areas

are proving extremely challenging or

banks in all regions, and may prove moreso in Europe where new rules rather

than principles are under discussion.

Customer treatment receives a

renewed ocus by policy bodies. The

G20 in Seoul re-emphasized the need or

customer protection, and as we observe

in our chapter on Customer Treatment

we expect a move towards simpliied

retail oerings which may enhance

transparency but could limit choice.

Traded markets is an area which has

received relatively little mainstream

press. Yet changes in the capital

requirements and market structure

around securities and in particular

derivatives trading will drive a major shit

in the sector. As we argue in our chapter

on Traded Markets, many product

oerings will no longer be economically

viable. These changes may weed out

some o the purely speculative trading

o the past, but could limit useul inancial

market innovation.

The level o new capital requirements

will be inextricably linked to theaccounting bases associated with

inancial assets and liabilities, an area

subject to signiicant revision in the

coming years. The eort continues,

at the G20s urging, to create an

internationally harmonized set o

accounting standards but dierences

add urther uncertainty and complexity

to banks eorts to plan or the new

regulatory ramework.

The new bank capital and liquidity

requirements agreed by the

Basel Committee on Banking

Supervision (BCBS), and

supported by G20 governments,

will strengthen the resilience

of nancial rms. We argue

in our chapters on Capitaland

Liquiditythat these changes

will cause a systemic reduction

in banking prots, resulting in

a fundamental re-shaping of

the sector.



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6 | Evolving Banking Regulation | November 2010

Table 1: Regulatory Pressure Index

Regulatory reform Europe North

America*

Asia

Pacific

Regulatory drivers

Capital 4 4 2 All banks will eel the impact o higher charges, regulators in the US andparticularly in key European markets are already indicating they may levy higher

charges than global minimums. Global SIFIs will ace the highest charges,

but mid tier banks ace particular challenges to meet new requirements at

a cost consistent with adequate returns.

Liquidity 5 4 4 Liquidity requirements will bite hard across the industry, but particularly indeveloped markets where the added cost o unding will reduce margins and

curtail more complex (and higher return) product lines, while at the same

responding to supervisory expectations, particularly in Europe, o local liquiditysel suiciency. In Asia Paciic banks will have to make major changes to how

they look at liquidity, and in some markets there may be issues with the quantity

o high quality liquid assets available.

Systemic Risk 5 5 1 Large cross border banks, based predominantly in Europe and the US, willsuer the brunt o eventual proposals or systemic institutions, with European

markets subject to multiple layers o macro-prudential supervision which could

add urther to their compliance burden.

Supervision 4 5 2 Supervisory intensity is already increasing substantially in the US and Europe,and this will add signiicantly to the compliance burden o irms in these regions,

whereas the shit in ASPAC is less marked given more conservative approaches

already in place in many markets.

Governance 4 4 4 New guidance on governance, and enhanced supervisory scrutiny, will drive asigniicant step up or inancial institutions in every region, and equipping boards,

management and sta to ulil their obligations is a signiicant challenge. In Asia

it is recognized that improving corporate governance is an important issue, likely

to be given additional impetus by recent events.

Remuneration 4 3 1 Remuneration is relatively lower proile in Asia Paciic, and not a ocus.Despite public outcry in the US, regulators are taking a measured but

pragmatic approach. The EU is considering the introduction o additional

regulation which could set the most restrictive pay criteria with knock on

eects or its attractiveness to high quality sta.

Customer

Treatment

3 4 1 Now prominent on the regulatory agenda, customer treatment will be a

particular step change in the US with the introduction o a dedicated agencyto write and police consumer issues, but igures only marginally in Asia Paciic

where Australia has traditionally set a strong standard or consumer protection

and other markets are still ocussed on a basic suite o retail products.

Traded Markets 4 4 1 The US and Europe will be most aected by capital charges given the sizeo trading activity, but the US has proposed additional restrictions which could

drive a proportionately bigger reduction there.

Accounting

and Disclosure

3 3 3 Uncertainty over the inal outcome o new rules and the scale o convergencebetween IASB and FASB will complicate planning or banks, but the general

thrust o change in key areas like valuation, recognition and impairment is

expected to increase the base or calculation o regulatory capital requirements

even urther.


* The US is currently subject to its rule making phase: approximately 240 rules by 14 ederal agencies needs to be created over

the next 12 months in order to implement Dodd-Frank.

Key: 5 = signiicant pressure 3 = moderate pressure 1= low pressure


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Table 1: Regulatory Pressure Index

sets out our assessment o the scale o

the challenge posed by key areas o

inancial sector reorm or three major

regions the United States, Europe and

the Asia Paciic region (ASPAC). This isbased on discussions with our irms

clients in each o these regions, as well

as on our proessionals assessment o

key regulations and discussion papers.

The accumulation o additional costs

driving out o regulatory change will drive

a systemic reduction in returns or all

banks. Changes to capital and liquidity

are a major actor, but so too are the

costs associated with expanded

compliance requirements around

reporting, monitoring, documenting, data

capture and modelling. The challenge

around retaining talent could lead to less

innovation, with uncertain impacts or

national economies and their objectives to

increase private savings and investment

and underpin economic growth.

However, taking account o the

practicalities o addressing the issues on

institutions, we expect Europe to eel the

most signiicant pressure overall, with

the US close behind. Both the EU and

the US are going through signiicant step

ups in supervisory intensity, and theconcentration o cross border systemically

important inancial institutions will pose

additional challenges or some o their

biggest banks. Large proprietary trading

books, which were a major driver o

proits or some banks in these regions

pre crisis, are already being wound down

in avour o a ocus on less capital hungry

banking services.

However, taking account of

the practicalities of addressing

the issues on institutions, we

expect Europe to feel the most

signicant pressure overall,

with the US close behind

Challenges in the ASPAC region

will differ by country, but overall

much of the transition to more

intensive and conservative

supervision was embedded after

the Asian crisis of the late 1990s.

Challenges in the ASPAC region will

dier by country, but overall much o

the transition to more intensive and

conservative supervision was embedded

ater the Asian crisis o the late 1990s.

The pressure is on and or manythe journey has already started. Eective

compliance, and more importantly,

successul positioning or growth in this

changing environment, requires careul

planning and a steady pace which can

adapt to new rules and approaches that

continue to emerge. Are you out o the

starting blocks yet?


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01

CapitalRaising the bar

Basel III undoubtedly sets a higher standard or banks to maintain

more robust cushions o capital against their risks. However its

impacts on the shape and diversity o the banking market are yet to

be properly explored. While the large cross-border banks will be hit

the hardest overall, they are also generally in a better position to adapt,

because o their size, diversity and access to investors and customers.

It may be the mid tier banks and investment houses that will fnd it

harder to implement the changes: the ormer fnding it difcult to raise

capital in a constrained market without government subsidy, and the

latter fghting to maintain returns in an environment where many

strategies are no longer viable. Impacts on the competitive landscape

will be o concern to those who see innovation and diversity as

important to a healthy system. All banks will ace higher costs

and signifcant changes to the processes which underpin the

management, measurement, monitoring and reporting o capital

the cost and complexity o which may drive urther all out among

more marginal players.


Since the previous Evolving Banking

Regulation publication last year, the

BCBS has announced and inalized its

ramework or strengthening capital

standards. Although some particularly

diicult issues are still subject to

consultation and inal calibration, the

revised capital requirements and the

transition path to them were agreed

by the G20 at its meeting in Seoul inNovember. Increased requirements

or trading book capital in particular

may drive signiicant re-shaping o many

businesses, as we discuss in chapter 7

(Traded Markets). The key requirements

rom the BCBS are summarized in Table

2: Capital Requirements. The emphasis

on common equity and retained earnings

to meet new minimum regulatory capital

requirements is a major shit or many

inancial institutions, particularly or

developed markets where there had


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been higher penetration o innovative

capital instruments to satisy

requirements. In addition, banks will

be subject to a minimum leverage ratio

o tier 1 capital o at least 3 percent

o (unweighted) total assets including

o-balance sheet items.

The European Commissions (EC)

process is running in parallel with the

BCBS roadmap. Changes to trading book

capital were passed through amendments

to the Capital Requirements Directive

(CRD), in September 2010, the so-calledCRD 3. In early 2010, the EC launched

an initial public consultation on urther

possible changes to the CRD or banks

and investment irms (CRD 4). These

proposed changes are closely aligned with

the Basel III requirements or capital and

liquidity. A urther consultation is expected

in Q1 2011 relecting a more inal version

o Basel III.

The Dodd-Frank Act in the US echoes

international regulatory pronouncements

on capital by calling or all inancial

institutions to hold more and better

quality capital, initially ocusing on larger

bank and non-bank inancial institutions.

The Federal Reserve (Fed) has been given

powers to set higher capital and liquidity

standards or large, interconnected bank

holding companies with total consolidated

assets o US$50billion or more, and or

non-bank inancial companies deemed

to be suiciently systemically signiicant

to warrant Fed supervision. Several

speciic provisions also aim to impose

higher capital on risky activities, to limitproprietary trading (the Volcker rule)

and to shit some swaps activity into

separately capitalized ailiates.

US regulators are expected to

incorporate certain eatures o Basel III

(conservation buer, countercyclical

buer, and liquidity coverage ratio)

in advance o the agreed-upon

implementation schedule. In the

meantime, the US is continuing to

implement Basel II or mandatory

and opt-in institutions.

Key Implications

Common equity requirements or

banks will jump rom a minimum o

2 percent to a minimum o 7 percent

under Basel III, including the capital

conservation buer. While many banks

already have common equity ratios

above 7 percent the proposals will be

more o a challenge than might irst

appear as current calculations are based

on Basel II deinitions. A tight deinition

o qualiying capital, higher deductions

rom capital, and increased capitalrequirements or the trading book will

make a 7 percent capital ratio much

more challenging. In addition some

national regulators may impose higher

requirements than these minimums,

either to all institutions or on a case-by-

case basis.

Europe

Although many cross-border UK banks

are well positioned to meet these higher

core tier 1 capital requirements, having

already started the process o bolstering

their capital base, government supported

banks and continental European banks

ace tougher challenges. Basel III is

stricter than Basel II in its treatment o

tax-deerred assets and mortgage-

servicing rights, which could reduce

capital ratios or some continental

European banks by up to one percentagepoint. German banks may be among

those hardest hit as capital components

such as silent participations and

subordinated loans, which were

commonly used or tax reasons in the

past, will need to be veriied on a case

by case basis to assess to what extent

Table 2: Capital Requirements

CoreTier 1

TotalTier 1

TotalCapital

Notes

Minimum

requirement

4.5% 6% 8% Core tier 1 represents the

highest orm o loss absorbing

capital (share capital and

retained earnings)

Capital Conservation

buffer

2.5% Must comprise common

equity, bringing total common

equity requirement to 7%

Countercyclicalcapital buffer

0 2.5% Current proposal:Added by national supervisors

depending on local

circumstance

Additional

Systemically

Important Financial

Institution (SIFI)

capital requirement

To be determined

by the BCBS

Still under consideration at a

global level. Expected to be set

in the region o an additional

minimum possibly 5% or

G-SIFIs and 23% or domestic

SIFIs, as a combination o

common equity and contingent

capital


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they can still be treated as capital under

the new regime. The leverage ratio will

also have signiicant implications or

some banks in the UK and Europe,

where these banks carry large amounts

o low risk-weighted and o-balance

sheet assets. The greater emphasis

likely to be placed by host country

supervisors on the adequacy o locally

held capital will also have an impact

on total capital requirements or

international banking groups.

ASPAC

In the ASPAC Perspective on page 11,

Simon Topping explains that Asian banks

generally remained well capitalized

throughout the crisis. Many commentators

have questioned the appropriateness o

the Basel III package or a region whose

business ocus is local and is conducted

largely by way o retail and small

business and commercial lending.

Additionally, an upcoming KPMG/Oracle

survey Evolving Regulatory Reforms:

Impact on Asia Pacific Financial

Institutions, highlights concerns over

the implications o Basel III or growth in

the region. The ocus o regulators and

banks in Asia is more likely to be on the

liquidity requirements orming part o

the Basel proposals, risk management

and governance, and the challenges o

bolstering the expertise and availability

o internal resources, data quality and

inormation technology capabilities.

North AmericaIn general, North American banks are

considered to be well capitalized to meet

the Basel III standards as many o these

banks have been accumulating capital

since the inancial crisis, and were

unwilling to release this capital during

the uncertainty o the legislative phase

o the Dodd-Frank Act. To the extent

that leading banks are in eect over-

capitalized, they may release unds

towards lending and acquisitions.

Further capital changes are expected.Systemically Important Financial

Institutions (SIFIs) will be subject to

urther capital requirements both under

eventual global standards, and in some

cases under super-equivalent national

standards, as discussed in chapter 3

(Systemic Risk).

Impact on core banking activities

Requiring banks to hold greater capital

buers to absorb potential losses could

lead to a urther tightening in the price

(interest margins and higher collateral

requirements) and availability o bank

lending. The relatively easier and cheaper

access o larger banks to capital and the

impact o regulatory costs more generally,may result in smaller banks being

acquired by larger banks or choosing to

leave the market. This will raise signiicant

issues about the impact o regulatory

reorm on competition in the banking

sector. For this reason, there are long

implementation periods being allowed,

to try to ensure that this potential

tightening o availability o credit does

not occur.

The stated implementation dates

o Basel III extend to 2018, but in the

regulatory race, supervisory pressure

ocusing on capital planning and stress

testing by banks and market discipline

are likely to push banks towards much

earlier implementation. Many banks

are thereore preparing or the new

capital regimes well in advance o theirproposed implementation dates, and

aiming or core tier 1 capital ratios

comortably above 7 percent, rather

than risk supervisory sanctions on

earnings distribution and remuneration

or market censure.

Issues to consider

Banks should begin by thinking

strategically about what impact the

new capital requirements will have

on the shape o their business:

Have you carried out appropriate

scenario planning and impact

assessments to ensure the

development o a successul

capital strategy?

Which businesses have the most

attractive undamentals which

businesses in your portolio should

you be considering exiting,

growing or divesting?

Is your organization geared up toeectively and consistently deliver

real time measurement,

management and reporting o your

capital position?

How will you address the pricing

implications arising rom changes

in the capital requirements or

certain products?

Can the same business models

continue under a dierent structure,

minimizing capital requirements?

(eg branch versus subsidiary)

Are you prepared to meet timescales

which eectively may be shorter

than the announced starting dates?

Have you considered the strategic

advantages/disadvantages o these

timescales?

Have your capital planning and

capital management processes

been reviewed in light o the new

requirements?

Will you set your capital targetwith reerence to the regulatory

requirements, or will you use other

means (economic capital, ICAAP)

to determine the appropriate level?

Have you considered the optimum

capital mix in this new environment,

including possibly replacing existing

capital with higher quality capital?


13/48 2010 KPMG International. KPMG International is a Swiss cooperative. Member frms o the KPMG network o independ ent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor does KPMG International have any such authority to obligate or bind any member frm. A ll rights reserved.

Perspectives:ASPACViews on Basel III

When you cut through all the complexity,

Basel III is really very simple its about

making banks more resilient to stress,

through stronger capital and liquidity

positions and enhanced risk management.

Basel II was a move in the rightdirection, in that it helped encourage

banks to make use o more sophisticated

risk management techniques, and made

capital requirements more risk-sensitive,

but one o the problems with Basel II was

that it wasnt suiciently comprehensive.

It was silent on key issues such as

liquidity, deinition o capital, and leverage.

Basel III redresses this. It also gives

increased emphasis to some important

areas such as stress-testing and capital

management, which were present, but

underplayed in Basel II.

Banks in Asia Paciic generally ared

much better during the inancial crisis

o the last ew years than those in the

US and Europe, and so a question some

are asking is whether Basel III is really

necessary or them. But it would be

very short-sighted to take such a view

its always important to learn rom others

experience. Certainly, there are some

key messages that all should take on

board, and three in particular:

First is the need to make the riskmanagement process more

sophisticated, more comprehensive

and better integrated; to consider all

types o risk, not just credit and market

risk, and how they are related and

interact. Second, to make greater use

o stress-testing o risk positions, o

capital, and o liquidity and to develop

well-articulated contingency plans or

responding to adverse scenarios, both

o an institution-speciic and a system-

wide nature. Third is the need to ensurethat the banks strategy, business

model and risk appetite are well thought

through, and that the capital planning/

management process is consistent

with this.

Maybe it will be a surprise to some that

I havent identiied the requirement or

a greater amount and higher quality o

capital as a key issue or banks in Asia

Paciic. Certainly there will be some or

which this will be an issue but, generally

speaking, banks in Asia Paciic already

operate at considerably higher ratios than

is the norm in the US and Europe, and a

high proportion o this is typically in the

orm o common equity, so it is generally

o high quality too. So you could say,

Basel III endorses what has been thenorm or many in Asia Paciic or some

time. Similarly, I dont see the new

leverage ratio as being a big issue or

most in Asia Paciic. Business models

here have generally not involved the

build-up o excessive leverage. Likewise,

the longer-term liquidity ratio, the net

stable unding ratio, shouldnt generally

be a problem, as regulators have tended

to discourage mismatching short-term

unding and long-term lending.

What could well prove the most

problematic area, however, is the shorter-

term 30 day liquidity coverage ratio.

This is basically a good idea that a bank

should hold enough liquidity to see it

through a stress period but the problem

is that 30 days is probably not the right

time horizon in many Asia Paciic

jurisdictions. Once a bank gets into

diiculty, things tend to happen rather

quickly, and so ive or seven days may be

more appropriate. Local regulators seem

likely thereore to stick with this much

shorter time horizon, possibly in additionto the 30 day ratio.

Another issue associated with the new

liquidity requirements is where all this

liquidity is going to come rom, as many

Asian jurisdictions simply do not issue

suiciently large enough amounts o

government debt to satisy the likely

demand. The BCBS acknowledged this

issue in its July 2010 press release

detailing broad agreement on the Basel

Committee capital and liquidity reorm

package, and some lexibility is likely.No doubt these details will be ironed

out over time. Hopeully the issue o

provisioning will also be made clearer.

Again, this is an area where many banks

in Asia Paciic are relatively well-prepared,

as regulators have in many cases required

banks to hold provisions in excess o

the amount suggested by the impaired

loss model, in eect pre-empting the

move to provisioning on an expected

cash low basis.

So, in many important ways, banks in

Asia Paciic are perhaps better-placed to

meet the new capital and liquidity numbers

under Basel III than many banks elsewhere.

For them, the challenge may be more on

the risk management side, and it is here

that, in my view, the emphasis needs tobe on systems and people resources

rather than inancial resources.

O course, Asia Paciic is a very

diverse region, with both advanced and

less advanced economies and inancial

systems. Some have very well developed

supervisory capabilities; others are urther

down the learning curve. Some have

implemented Basel requirements (such

as Basel II) on the same timetable as

other major jurisdictions, while others are

still in the process o doing so. But i there

is one thing that is a common actor in

most Asia Paciic jurisdictions, and which

perhaps dierentiates Asia Paciic rom

the US and Europe, it is that both bank

managements and regulators have

consistently tended to be relatively

conservative in relation to risk-taking,

innovation, and capital and liquidity

positions. This innate conservativeness

possibly a cultural eature, possibly a

response to having gone through the

Asian inancial crisis in the late 1990s

has served Asia Paciic institutions wellin the recent crisis.

Simon Topping

Head o Financial Risk Management,KPMG in China and Head o the Risk

and Regulatory Center o Excellence

or ASPAC region

Formerly Executive Director (Banking

Policy), Hong Kong Monetary Authority


14/48

02

LiquidityA steep incline

Although capital grabs the headlines, the new liquidity requirements

in Basel III will be at least as signifcant, i not more, or many banks

and their customers. Maintaining higher liquidity buers may depress

banks margins and ultimately reduce the range o products they

oer customers. Banks will have to make signifcant investments

to monitor and manage liquidity more eectively in an increasingly

constrained and heavily supervised landscape, and to respond to the

increasing demands o some host supervisors or branches to meet

local liquidity requirements.


One key contributor to the ailure or

near-ailure o many banks during the

crisis was a lack o liquidity and the

consequential impact o a loss o

depositor conidence. Given the nature

o the banking business model and

the key role banks play in maturity

transormation, a perceived liquidity

shortall can rapidly escalate into a

run with collateral damage acrossthe system. Since the crisis, regulators

have been ocusing much more attention

on ensuring and deending adequate

liquidity standards and reducing the

moral hazard generated by public

support or banks and their depositors.

The BCBS has proposed two new

minimum liquidity requirements,

designed to enhance both the ability

o banks to repay their liabilities as

they all due and the maturity matching

o banks balance sheets. There is aparticular emphasis on moving banks

away rom relying too heavily on short-

term wholesale unding:


15/48



Liquidity coverage banks must hold

suicient high quality liquid assets

(cash, government bonds, covered

bonds and highly rated corporate

bonds) to enable them to withstand

or 30 days the loss o a proportiono their retail deposits and an inability

to roll over any corporate and

wholesale deposits.

Net stable unding banks must hold

suicient stable sources o unding

to match their lending o over one

year maturity.

Both the BCBS and national regulators

have also emphasized the importance

o the boards o banks understanding

liquidity risk, taking a close interest in

setting a risk appetite, and satisying

themselves that these risks are properly

monitored and controlled; the need or

banks to run a range o stress tests,

covering both bank-speciic and market-

wide vulnerabilities; and or banks to

have adequate systems, data, reporting

and management inormation to enable

continuous management o liquidity.

These quantitative and qualitative

requirements are expected to be

implemented in the EU through the

CRD. In the US detailed liquidityrequirements will emerge rom the rule

making currently being undertaken by

various US ederal banking regulators.

As with capital, some national

regulators may set additional standards

to those in Basel III. The UK has already

implemented new liquidity arrangements

which are, in many respects, more

restrictive than those proposed by the

BCBS and are likely to remain so.

Key implicationsUnder the new liquidity regime proposed

by the BCBS, banks will be aced with

higher requirements or liquidity buers.

One key contributor to the failure

or near-failure of many banks

during the crisis was a lack of

iquidity and the consequential

mpact of a loss of depositor

condence Since the crisis,

regulators have been focusing

much more attention on ensuring

and defending adequate liquidity

standards and reducing the moral

hazard generated by public support

for banks and their depositors.

The costs o liquidity will increase

sharply, as a larger amount o liquid

assets will need to be held in low risk,

low return assets such as government

bonds, and as banks shit rom short-

term wholesale deposits to retail andlong-term wholesale deposits. In

combination, there will be a signiicant

drag on liquidity reducing proitability. As

Clive Briault discusses in the Europe

Perspective on page 15, this could be

urther reinorced while all banks seek

to increase their reliance on a limited

pool o retail and longer-term wholesale

deposits. It may be hard to re-price other

businesses to compensate, especially

at a time when aggressive moves to

migrate customers to alternative, more

proitable, products will be under greater

political and competition authorities

scrutiny. This is likely to drive a long-term

shit in balance sheet planning rom

an asset-based approach to a liability

management strategy, reducing the

probability o signiicant balance sheet

expansion.

Banks will also need to put in place

stronger systems and controls or

managing liquidity and liquidity risk.

Senior management has a clear

obligation to monitor perormance andto deliver signiicantly enhanced and

more requent reporting o liquidity

positions. In the UK, the Financial

Services Authority (FSA) is already

moving to make daily reporting part o

a regular regime. It also intends to drill

down more deeply into individual banks

positions; and at the same time quantiy

aggregate industry risk positions on a

regular basis. Meeting these requirements

will place enormous strains on banks

data and systems which may in manycases be inadequate to the task.

Major investment will be necessary.

In Germany, the latest consultation

l

i


16/48



papers are moving closer to the UK and

US requirements that banks run regular

stress tests and take proper account o

the results in assessing the adequacy

o their liquidity buers.

For international banks the deinitiono individual liquidity pools will become

a critical and contested area. This

relects both the demands o some host

national supervisors that the branches

o oreign banks should be sel-suicient

in terms o their local liquidity; and the

dominance o the legal entity driver in

the approach o some supervisors,

orcing legal entity simpliication and the

matching o liquidity pools with each

legal entity.

With the increasing requirements on

liquidity, it is clear that liquidity transer

pricing will be an issue or banks,

aecting their pricing and thereore

their business model. Many complex

structures will struggle to demonstrate

adequate return in this environment.

In October 2010 the Committee o

European Banking Supervisors (CEBS)

inalized its Guidelines on Liquidity Cost

Beneit Allocation. According to CEBS,

liquidity management has to include

adequate unds transer pricing policy

that considers all relevant liquiditycosts (direct and indirect), beneits and

risks. Implementation is expected by

mid-2011.

Issues to consider

Do you understand your current

liquidity position in suicient detail

and know where the stress pointsare e.g. how sticky are your retail

and wholesale deposits?

Have you considered the impact o

new liquidity rules on proitability

has liquidity risk/cost been

actored into key business

processes and priced internally?

Is liquidity planning, governance

and modeling in line with leading

industry practice?

Are systems, data and

management reporting adequate

to meet the new requirements?

How do you determine what an

appropriate series o stress tests

is and how these will change

over time?

Are you aware o the likely

implementation timetable or

dierent elements o the global

and national rameworks being

proposed?

Have you assessed your liquidity

strategy in light o the existing legal

and regulatory structure o yourorganization? Have you considered

the uture liquidity requirements

o overseas subsidiaries/branches

and how these might be met?

Have you reviewed your liquidity

contingency plan? Have you set

up Key Risk Indicators to give early

warning o impending liquidity

problems?

Are all areas o your business aware

o the implications o the new

requirements? What impact will

this have on your business model?

Have you considered the interaction

between the new liquidity and

leverage requirements?

Have you discussed with your

supervisor their plans/intentions

regarding providing liquidity to the

market/individual institutions,

including in times o stress?


17/48


18/48

03

Systemic riskPart of the bigger picture

The fnancial crisis continues to expose the political and economic

impacts o major disruption in fnancial services. Policy makers are

establishing new rameworks to deal with both systemic institutions

and systemic risks. Detailed proposals on additional capital

requirements and other add-ons or systemically important fnancial

institutions (SIFIs) are in progress, but a lack o clarity between global

and national SIFIs gives rise to the risk o an unlevel playing feld.

Large cross-border banks are likely to bear the brunt o the

additional regulatory burdens and changing prudential supervisory

relationships, and ace a period o considerable uncertainty. Many

argue that it is the approach to risk rather than the size o the

institution that should be the determining criteria or additional

systemic requirements and supervisory arrangements. In any case,

the monitoring o systemic risk does not guarantee the identifcation

and prevention o the next crisis. Some threats to fnancial stability

may not be identifed, while even identifed threats may not be

addressed in the context o other, political imperatives.


The inancial crisis highlighted two major

shortcomings in how the authorities

dealt with systemic risk. First, the threat

to the system arose in part rom the

collective actions o inancial institutions

(or example the combined rapid growth

o asset prices and collateralized credit,

a slackness in loan origination), and the

use o securitizations and credit

derivatives to spread risk. But supervisorshad ocused mainly on the risks acing

individual regulated irms, and not

enough on system-wide risks. Second,

many governments had to commit public

unds to support SIFIs, rather than risk

the inancial instability, loss o key

inancial unctions and damage to the

real economy that would have resulted

rom their ailure.


19/48



The policy response has been aimed at

achieving our core objectives:

Reduce the risk o ailure o SIFIs.

Increase the powers o the authorities

to resolve a ailing SIFI without

disruption to the inancial systemand without taxpayer support.

Instil greater market discipline through

a more credible threat o loss to

shareholders and creditors.

Intensiy the monitoring o systemic

risk, both across the system and

within individual institutions.

Global policy setting bodies have

proposed a series o measures in varying

stages o implementation to meet these

objectives, as outlined below.

More capital, and better quality capital

and higher liquidity

The risk o the ailure o a SIFI can be

reduced in part through the capital and

liquidity buers or all banks as set

out in Basel III, and in part through the

imposition o additional capital and

liquidity buers or SIFIs. Additional

capital buers could include both

contingent capital which would convert

to equity at an early stage when a SIFI

began to experience diiculties, andthus help the SIFI to continue as a going

concern and bail in capital which

would convert to equity just beore a

SIFI ailed, thereby spreading losses

to creditors and reducing the need or

public support.

The BCBS is developing its own

proposals to address systemic issues,

including higher capital and liquidity

requirements, additional loss absorbency

through contingent capital and enhanced

supervision, but details are not expecteduntil mid-2011.

In the US the Dodd-Frank Act requires

SIFIs to be subject to higher capital,

leverage and liquidity requirements,

and to meet enhanced requirements on

disclosures, rigorous risk management,

concentration o exposures, and

resolution plans. In Switzerland, the

Swiss National Bank has proposed a

total capital requirement o 19 percent

on its two largest banks, to be made upo core tier 1 capital o 10 percent and a

urther 9 percent o capital in the orm o

two dierent types o contingent capital.

Enhancement o resolution and

insolvency regimes

Clearly, SIFIs would be less o an issue

i eective resolution, in the event o

their ailure, were possible. However,

many question the likelihood o an

eective globalresolution and insolvency

regime being developed and agreed.

Requirements are already in place in

some jurisdictions or SIFIs to ormulate

recovery and resolution plans (sometimes

known as living wills or uneral plans),

which would assist the authorities in

resolving ailing SIFIs in an orderly

manner, thereby reducing the contagion

impact o any such ailure. Similarly,

some countries have implemented, or

are planning to implement, enhanced

powers or the authorities to intervene

to resolve a ailing SIFI by replacing the

management o the SIFI and transerringor selling parts o its business in order to

maintain core inancial services. The

US, UK and some other countries are

pushing hard or improving national

resolution regimes.

Under the Dodd-Frank Act, the FDIC

has extended powers to manage the

resolution o SIFIs. The International

Monetary Fund (IMF) is seeking progress

on a cross-border resolution regime.

The EU is also examining its approach

to resolution and crisis managementwith the intention o creating consistent

crisis management tools or inancial

services. This could include cross-border

cooperation, recovery and resolution

plans, resolution unds supported by

Clearly, SIFIs would be less of

an issue if effective resolution,

in the event of their failure,

were possible. However, many

question the likelihood of an

effective global resolution

and insolvency regime being

developed and agreed.


20/48


national bank levies and eventually

greater harmonization o legal resolution

rameworks across the EU. However,

some countries remain unconvinced

that these regimes will be capable o

resolving a ailing SIFI and so place moreemphasis on preventing ailure (and

ensuring that in the event o a ailure

the losses do not all on taxpayers) as

the best way orward.

Supervision

The Financial Stability Board (FSB) has

recently set out proposals or more

intensive supervision o SIFIs, an

approach already well under way in

major developed markets, to allow or

early identiication and prevention o

issues. More intensive and challenging

supervision, along with additional

disclosures on risk, are expected to be

the norm. Many countries, including

Australia and the US, have also taken

speciic steps to extend the remit

o supervisors to capture previously

under regulated entities such as

hedge unds and investment advisers,

discussed urther in chapter 4

(Supervision).

Structural change in the industryProposals in some jurisdictions would

limit the size o banks and the activities

they are allowed to undertake. In the

US, the Volcker rule limits proprietary

trading and investments in private pools

o capital. The UK has set up an

Independent Commission on Banking

which is exploring multiple options

intended to support a stable and

competitive banking sector, including

limits on activities and mandatory

disposals to reduce balance sheetsand risk. Proposals in both the EU and

the US to move the bulk o over the

counter (OTC) derivatives trading to

central counterparties are intended to

minimize market instability arising rom

counterparty ailure.

It remains to be seen whether policy

makers will ultimately determine that big

banks should be broken up. The

argument goes both ways. On the onehand, big banks pose a concentration (or

systemic) risk, on the other, big banks

have generally been regarded as

providing strength and stability to

inancial systems.

Taxation

Bank levies have been implemented

in some countries, notably the UK,

Germany, and France, and proposed

by others including the US and across

the EU. The orm and purpose o these

levies vary between jurisdictions

some are intended to cover the costs o

resolution, some to establish a und to

meet uture resolution costs, and others

to lessen government deicits. Opponents

o resolution unds argue that they would

reinorce moral hazard by creating the

expectation that the unds would be used

to support ailing banks in the uture.

Systemic overview

Various existing and newly created

national and international bodies havebeen tasked with macro-prudential

oversight, including the European

Systemic Risk Board (ESRB) in the EU,

the Financial Stability Oversight Council

(FSOC) in the US, and the Financial

Policy Committee (FPC) in the UK. Their

role is to identiy risks to inancial stability

including credit and asset price growth

and vulnerabilities in payment, clearing

and settlement systems and to take or

recommend actions to mitigate these

risks.

Key Implications

While the high level objectives around

the regulation o SIFIs are broadly

accepted, this masks some signiicant

ault lines over the detailed measures

being proposed. These ault lines

include the deinition o SIFIs, and the

eectiveness in practice o applying

resolution plans and contingent capital with many skeptics doubting that either

would avoid the need or government

support o a ailing SIFI.

Global versus Local SIFIs

Views dier on how dangerous SIFIs

are. The US, UK and Switzerland are

the most concerned, given the size and

concentration o their SIFIs relative to

their GDP. In contrast, many in ASPAC

and parts o Europe whose banks were

less entangled in the crisis, view the

size and business model o their largest

banks as a source o strength and

stability.

The most recent statements rom the

FSB and the G20, which distinguish

between global (G-SIFIs) and national

SIFIs, relect these diering levels o

concern, but risk creating an unlevel

playing ield on a number o ronts,.

Global minimum standards or additional

capital, liquidity and supervisory

requirements look increasingly likely to

be targeted at G-SIFIs. National SIFIs(i.e. those which are systemic only at a

national level) could then be set lower

additional requirements by their national

supervisors. Implementation may not

be consistent, with some jurisdictions

choosing to gold-plate the minimum

standards.

These developments will put pressure

on global banks to reconsider how they

operate and whether they can take a

group-wide approach to capital and

liquidity. Uneven implementation o SIFIstandards may cause some to consider

restructuring themselves and relocating

parts o their operations to take

advantage o less onerous regulation.



21/48



Resolution regimes

Contrasting views across countries on

the potential eectiveness o resolution

regimes, raise questions about the

proper balance between preventing

ailures o SIFIs through additional capitaland liquidity requirements and relying

on an orderly resolution regime to limit

the impact o a ailing SIFI. Again, this

could lead to an unlevel playing ield

or SIFIs subject to dierent national

regimes. The eectiveness o

supervisory colleges in resolving issues

with cross-border institutions has yet

to be tested and may ultimately be

constrained by national insolvency law.

Signiicant dierences in national

resolution powers and the speed o

contagion in the inancial sector may

undermine the eectiveness o

resolution powers or cross-border

institutions. Large cross-border

institutions have grown complex, and

in many cases unwieldy, business and

legal entity structures. Eective

resolution plans will require that these

are thoroughly reviewed and rationalized

as part o the process o writing recovery

and resolution plans (RRPs).

Practicality o contingent capitalIt is by no means certain that contingent

capital can be raised in the volume which

is implied in recent proposals. Nor is it

clear that contingent capital will meet its

objective. Depending on where trigger

levels are set, the act o the conversion

could add urther stress through a loss o

conidence in individual banks and in the

inancial system more generally.

Both contingent capital requirements

and government insistence that bail

outs will no longer be available, willsigniicantly increase unding costs

or large banks as investors seek

compensation or added risk. The risk

premium required may undermine the

viability o contingent capital as an option,

in which case these banks will need to

raise even more common equity.

Systemic overview

Although various new bodies are beingestablished, it remains to be seen how

eective they will be in identiying and

addressing risks to inancial stability.

In particular, little progress has been

made outside Asia in designing the

macro-prudential toolkit o measures

that could be taken and in determining

the conditions under which the

measures would be deployed. Financial

institutions thereore ace considerable

uncertainty over the national and

international measures that might be

taken, and in planning or the impact

o these measures on their businessstrategies and on the capital they

need to hold. There is also considerable

scope here or uneven choice and

use o measures across countries

and across dierent types o inancial

institution G-SIFIs, national SIFIs

and other banks.

Issues to consider

Does management understand

which aspects o the business

are systemically important?

Does your business and/or

management structure need to be

reorganized to acilitate resolution

planning?

How ar will unding proiles shit

given the push to ensure that

private creditors bear any losses?

Have you begun to understand

how to develop a resolution plan,

including multiple levels within

your organization? Can you collect

the inormation you need to satisy

multiple requests?

Being designated a SIFI may impose

greater costs (in terms o increased

capital etc) but it may also bring

beneits (e.g. in terms o lower

unding cost because o the

perception o having been identiied

as systemically important. Have

you considered how you might be

aected by this (whether or not

you are a SIFI)?

Have you considered the pros and

cons o being located in dierent

jurisdictions?


22/48

04

SupervisionApplying the rules of the game

Banking supervision is changing signifcantly. Reducing the likelihood

and severity o uture fnancial crises through stronger regulation

and supervision is an agreed priority or most governments and policy

makers. Stronger supervision will mean not only more intensive

reviews o activities diving deep into individual business areas, but

also more challenge o banks strategies and business models.

Larger cross-border frms will have to rely on eective cooperation

between colleges o supervisors to prevent duplicate and inconsistent

supervisory requirements.

The precise tone o supervision, and the balance between

supervisory discipline and market discipline remain to be determined.

This will depend as much on politics as on the organizational structure

o supervisory agencies, with both the supervisors o individual banks

and the macro-prudential supervisors o the overall fnancial system

acing a fne balancing act between eective supervision and

pressures to deliver a broader political and economic agenda.


The substance and execution o

banking supervision in key inancial

markets aces substantial changes

(in both structure and policy). There

are six broad themes:

Implementation o the tougher and

more extensive regulations being

introduced under the G20 regulatory

reorm agenda.

More intrusive, intensive andchallenging supervision.

Expansion o the scope o

supervision to capture additional

actors in the supervisory net.

Increased cooperation and

coordination among supervisors

to improve the scrutiny o cross-

border activities.

New and expanded supervisory

powers in relation to the capital

conservation buer and

countercyclical buer. New supervisory structures and

the allocation o responsibilities or

macro-prudential oversight.


23/48


The substance and execution

of banking supervision in

key nancial markets faces

substantial changes (in both

structure and policy).


The implementation o these changes

will depend in part on local political

and economic developments. The

common element will be more

intensive and challenging supervision,

within a more rigorous, risk-based andorward-looking approach. This change

is already being experienced by

regulated irms in areas such as the

eectiveness o corporate governance,

remuneration, the riskiness o

business models, stress testing,

enterprise-wide risk management,

systems and controls, liquidity, and

tighter ring-encing o the local branches

and subsidiaries o overseas irms.

Europe

The current Level 3 Committees

(CEIOPS, CEBS and CESR)1 will

become European Supervisory

Agencies (ESAs) rom 1 January 2011,

with greater regulatory and legal

powers. Initially the ESAs will be

relatively small and will require support

rom key national supervisors in

developing policy but their size

and inluence could be increased

signiicantly ater three years when

the success o the new structure is

set or review.The ESAs will be able to write

policy, with the aim o creating a

single European rulebook, subject to

adoption by the European Commission

(EC). In some evolving areas, ESAs

may gain a primary role. For example,

the European Securities and Markets

Authority (ESMA) is lined up to play a

key role in the registration and

supervision o credit rating agencies

and central counterparties though

with support rom national supervisorsplaying host to these bodies. They will

also have a mandate to ensure the

consistent application o Directives by

national supervisors. The ESAs will

have the power to mediate and

mandate actions where there are

disagreements or inconsistencies

between national supervisors in

how they apply these rules.

In practice, this system o peer

review should minimize (but noteliminate) the scope or national

variation, and highlight weaker

supervision practices. In both cases,

there could be signiicant impacts or

the local approach to supervision it

limits the scope or national supervisors

to take a more competitive approach

to political issues, as seen recently

with the remuneration debate urther

discussed in chapter 5 (Governance

and Remuneration) and the Alternative

Investment Fund Managers Directive

(AIFMD), even i it still leaves scope

or local regulators to apply super-

equivalent rules.

A European Systemic Risk Board

(ESRB) will look at emerging macro-

prudential risks. Its role will include

carrying out market-wide stress tests

to help determine the systems

sensitivity to shocks as discussed in

chapter 3 (Systemic Risk). Its main

interaction with irms will be in issuing

risk warnings (public and private) and in

recommending (but not mandating)mitigating action on such risk warnings.

UK

The UK arrangements are diverging

rom the wider European model. Unlike

the ESA structure, planned supervisory

changes will separate prudential rom

market and conduct o business

regulation and supervision, with

signiicant implications or UK regulated

irms in dealing with multiple supervisory

agencies. The Bank o England willdischarge its responsibilities or the

prudential regulation and supervision o

banks and insurance companies through

a subsidiary agency, the Prudential

Regulatory Authority (PRA). One major

1. CEIOPS: Committee o European Insurance and OccupationalPensions SupervisorsCEBS: Committee o European Banking SupervisorsCESR: Committee o European Securities


24/48


Managing multiple relationships

and the changing supervisory

spheres of inuence, may cause

some rms to consider changing

their structures and business

models to achieve the most

effective balance of supervisory

oversight.


driver or these changes is to ensure

the eective coordination o macro-

prudential oversight with the prudential

regulation and supervision o individual

irms. Thus the Bank o England will also

have a Financial Policy Committee (FPC)to assess threats to inancial stability,

including the growth o credit and o

asset prices.

Meanwhile, the Consumer Protection

and Markets Authority (CPMA) will ocus

on consumer and market protection and

act as a single conduct o business

regulator and supervisor or both retail

and wholesale irms. The implications o

this is outlined in chapter 6 (Customer

Treatment). This division o regulatory

responsibilities relects a historically

greater ocus on consumer protection in

the UK than in much o the rest o Europe.

However, ways o working and the

boundaries between micro and macro

issues, between prudential and conduct

o business issues, and between market

supervision and market stability issues,

remain to be determined. Teething

problems may cause diiculties or

supervised irms.

US

The Dodd-Frank Act eectively expandsthe ramework o inancial services

regulation to a variety o new irms,

products and regulators. The core

regulatory ramework or insured

depository institutions (banks and thrits)

is not substantially dierent, but there

are our key exceptions:

The creation o the Financial Stability

Oversight Council (FSOC).

The creation o the Consumer

Financial Protection Bureau (CFPB).

Increased powers or the Fed whereinstitutions (both inancial and non-

inancial) are deemed to be

systemically important.

The long anticipated elimination o the

Oice o Thrit Supervision (OTS),

with the reallocation o its powers

and duties to the other ederal bank

regulatory agencies (OCC, the Fed

and FDIC).

The FSOC will undertake macro-

prudential supervision within the US.

Working through the Fed, it has

signiicant powers to review and modiy

the strategy and activities o institutions

deemed to be systemically important.

The impact o more supervision on these

irms, their strategies and their business

models is likely to be substantial.

The consumer protection unctions

o the OTS, OCC, FDIC and the Fed

will be largely transerred to the CFPB on

or around July 2011. The CFPB will have

all consumer protection rule-making

authority in addition to supervisory

responsibility or insured depository

institutions with assets in excess o

US$10billion, as well as their ailiates

and service providers. The CFPB will

also have supervisory responsibility or

non-bank inancial companies that

provide consumer inancial services

and products. Smaller institutions stay

under the purview o their primaryederal regulator while also being subject

to the rule-making authority o the CFPB.

Finally, the OCC will now supervise

ederally-chartered thrits in addition

to national banks and has rule-making

responsibility or all thrits. The Fed has

authority over thrit holding companies.

Thrits are likely to ind themselves

subject to much more rigorous

supervisory standards under the OCC,

eliminating a regulatory arbitrage

opportunity to take advantage o themore lexible approach o the OTS.

Industrial banks, credit card banks

and trust banks are likely to be subject

to enhanced regulatory scrutiny in

areas such as governance and risk

management.

There are a number o other changes in

the authority o individual regulators: The FDIC gains authority to act as

receiver or certain systemically

important institutions that ail

(including bank holding companies

and non-bank inancial companies).

The Securities Exchange Commission

(SEC) and CFTC will share supervisory

responsibility or OTC derivatives,

subjecting this market or the irst

time to coordinated oversight o its

activities and risks.

Investment advisers to private pools

o capital (including private equity,

hedge unds and certain real estate

unds) are also pulled in to the

regulatory net by requiring registration

by July 2011 and will then be

regulated by the SEC.

As Hugh Kelly discusses in the US

Perspective on page 24, the scale o

supervisory change brings signiicant

risks o an outcome which is rushed and

uncoordinated.


25/48



ASPAC

As noted earlier in this report, regulators

in ASPAC have generally adopted quite

a conservative approach, relecting

the less developed nature o some

jurisdictions, plus the lessons learnedrom the Asian Financial Crisis.

Regulators in ASPAC never went in

or light touch or principles-based

regulation, and thereore have less back-

tracking to do. Generally they have been

more rules-based, more prescriptive, and

have required banks to hold conservative

buers and maintain conservative limits.

As a consequence, there may be a less

dramatic change in the style o regulation

and supervision in many ASPAC

jurisdictions compared with elsewhere.

Similarly, there is likely to be ar less

organizational change in the supervisory

set-up.

Key Implications

More supervision

Financial institutions are already acing

more intensive and intrusive supervision,

more coordinated supervision among

supervisory agencies and a widening

o the regulatory net. Larger and more

complex irms ace a balancing act to

manage relationships with multiplesupervisors who may ind themselves

pulled in dierent directions, not only

by regulatory initiatives but also broader

political and economic imperatives.

This will drive increased cost and

changes to compliance. Managing

multiple relationships and the changing

supervisory spheres o inluence, may

cause some irms to consider changing

their structures and business models to

achieve the most eective balance o

supervisory oversight.

Unknown quantities

The tone, style and demands o new

agencies have yet to be established.

Firms are gearing up or another wave

o rule making and supervisory scrutiny,

as new bodies come on line and lookto establish their authority. This will

have implications or data, systems and

reporting requirements, and provide

scope or disruption or irms as the lines

o demarcation between the new bodies

take shape. The rise o the ESA structure

in Europe is likely to mean less scope

or local variation in the implementation

o EU-wide requirements this may

even the race, but could reduce the

competitiveness o larger and more

international irms and markets.

The macro-prudential overlay

Financial institutions will be subject

to both micro and macro supervisory

action irm-wide level supervisory

requirements will be supplemented

with actions

Evolving Banking Regulation Nov 2010

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