International Association of Risk and Compliance ...€¦ · International Association of Risk and Compliance Professionals (IARCP) ... International Association of Risk and ... 18th

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_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)

www.risk-compliance-association.com

International Association of Risk and Compliance Professionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com

Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the

week's agenda, and what is next

Dear Member,

The Basel Committee is really superb in enlarging its geographical outreach and enhancing its position as a global standard setter. In the opening speech by Mr. Stefan Ingves, Chairman of the Basel Committee on Banking Supervision (at the 18th International Conference of Banking Supervisors, Tianjin, China), we learn:

“China joined the Basel Committee in March 2009 - in the midst of what turned out to be a prolonged, far-reaching and complex financial crisis. Since then, the CBRC and the People's Bank of China have become active members of the Basel Committee and have made valuable contributions during an extremely busy and critical period. When I think about what the Committee has achieved since the financial crisis, I don't think it would have been possible without the support of the Chinese authorities and the other members that joined the Committee in 2009.” Honestly, I needed coffee at this point. Irish coffee I mean. Mr. Stefan Ingves continued: “I am pleased to announce that representatives from Chile, Malaysia and the United Arab Emirates have

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http://www.risk-compliance-association.com/Distance_Learning_and_Certification.htm

http://www.risk-compliance-association.com/CISRCP_Distance_Learning_and_Certification.htm


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been invited to join the Basel Committee and attended their first meeting earlier this week.” But it becomes more interesting: “At its meeting this week, the Committee agreed final modifications to the net stable funding ratio (NSFR), which will be published in the coming weeks. What? The paper!!! Where is the paper? “The NSFR complements the liquidity coverage ratio (LCR) and ensures that a bank maintains a stable funding profile in relation to the composition of its assets and off-balance sheet activities. After many decades of trying, we now have a global liquidity standard.” Wait! You have it. We have nothing yet! We learned some bad news too (good news for regulatory arbitrage experts). “Our assessments thus far have found significant variation in banks' risk-weighted assets that are not explained by underlying differences in the riskiness of banks' portfolios. Excessive variation in risk-weighted assets undermines confidence in the risk-based capital framework as a measure of bank safety. The Committee is well aware of these concerns, and we are taking steps to reduce the variation arising from differences in how banks measure risk. At the same time, we know that variation in risk-weighted assets can arise from differences in the rules and implementation standards set by national regulators, and so we are also focusing on these areas. The steps the Committee has taken, and plans to take, to address excessive variation in risk-weighted assets include:





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- the introduction of capital floors and benchmarks, and greater restrictions on the scope of banks' internal risk estimates. In this regard, there is recognition that not all risk parameters are suitable for modelling; - providing clarity on aspects of the Basel framework that are ambiguous, and reducing areas for national discretion; - strengthening the disclosure requirements relating to risk-weighted assets by amending Pillar 3 of the Basel framework; and -ensuring consistent implementation of Committee standards and monitoring outcomes of risk-weighted asset variability.” Oh, we will have a difficult winter…

Read more at Number 2 below.

Welcome to the Top 10 list. Best Regards,

George Lekatis President of the IARCP General Manager, Compliance LLC 1200 G Street NW Suite 800, Washington DC 20005, USA Tel: (202) 449-9750 Email: [email protected] Web: www.risk-compliance-association.com HQ: 1220 N. Market Street Suite 804, Wilmington DE 19801, USA Tel: (302) 342-8828





mailto:[email protected]


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Final rule - Regulatory Capital Rules: Regulatory Capital, Revisions to the Supplementary Leverage Ratio Office of the Comptroller of the Currency, Treasury; the Board of Governors of the Federal Reserve System; and the Federal Deposit Insurance Corporation.

Opening speech Opening speech by Mr Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of Sveriges Riksbank, at the 18th International Conference of Banking Supervisors, Tianjin, China

“Hosting a conference such as this, with more than 100 supervisory authorities from around the world, is a significant undertaking. On behalf of everyone here today, I express our deepest appreciation for all the hard work that has gone into organising the ICBS in Tianjin, and congratulate you on doing such an outstanding job.”

Are we there yet? The United States and Canada after the global financial crisis Remarks by Mr Timothy Lane, Deputy Governor of the Bank of Canada, at Carleton University, Ottawa, Ontario





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EIOPA Multi-Annual Work Programme 2015 - 2017 EIOPA’s Multi-Annual Work Programme 2015-2017 is the outcome of the Authority’s annual planning round.

Statistics on payment, clearing and settlement systems in the CPMI countries Interesting tables

Key Questions for Monetary Policy Dennis Lockhart President and Chief Executive Officer Federal Reserve Bank of Atlanta





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PCAOB Issues Staff Audit Practice Alert on the Auditor’s Consideration of a Company’s Ability to Continue as a Going Concern Following recent changes to U.S. GAAP This alert is being issued in light of recent changes to U.S. generally accepted accounting principles, or U.S. GAAP, about disclosure of uncertainties about a company's ability to continue as a going concern

Hearing at the Economic and Monetary Affairs (ECON) Committee of the European Parliament Gabriel Bernardino Chairman of EIOPA

Putting the right ideas into practice

Speech given by Mark Carney, Governor of the Bank of England at the Institute and Faculty of Actuaries General Insurance Conference, Wales “It is an honour to be invited to address you today. Insurance is at the core of the new Bank of England. As regulator, we are tasked with ensuring the safety and soundness of the UK’s insurance companies and the protection of their policyholders.





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To discharge these responsibilities, we draw on the entire resources of the Bank. Fully one third of our regulatory staff – over 200 supervisors and 50 actuaries – are engaged in supervising insurance companies.”

Community banks in the United States

Introductory remarks by Mr Jerome H Powell, Member of the Board of Governors of the Federal Reserve System, at the Community Banking Research and Policy Conference, co-sponsored by the Federal Reserve System and Conference of State Bank Supervisors, St. Louis, Missouri “As all of you surely know, community banks play a vital role in America's financial system, providing essential services to households, small businesses, and small farms in communities throughout the country.”





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Final rule - Regulatory Capital Rules: Regulatory Capital, Revisions to the Supplementary Leverage Ratio Office of the Comptroller of the Currency, Treasury; the Board of Governors of the Federal Reserve System; and the Federal Deposit Insurance Corporation.

Summary In May 2014, the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation (FDIC) (collectively, the agencies) issued a notice of proposed rulemaking (NPR or proposed rule) to revise the definition of the denominator of the supplementary leverage ratio (total leverage exposure) that the agencies adopted in July 2013 as part of comprehensive revisions to the agencies’ regulatory capital rules (2013 revised capital rule). The agencies are adopting the proposed rule as final (final rule) with certain revisions and clarifications based on comments received on the proposed rule. The final rule revises total leverage exposure as defined in the 2013 revised capital rule to include the effective notional principal amount of credit derivatives and other similar instruments through which a banking organization provides credit protection (sold credit protection); modifies the calculation of total leverage exposure for derivative and repo-style transactions; and revises the credit conversion factors applied to certain off-balance sheet exposures. The final rule also changes the frequency with which certain components of the supplementary leverage ratio are calculated and establishes the public disclosure requirements of certain items associated with the supplementary leverage ratio.





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The final rule applies to all banks, savings associations, bank holding companies, and savings and loan holding companies (banking organizations) that are subject to the agencies’ advanced approaches risk- based capital rules, as defined in the 2013 revised capital rule (advanced approaches banking organizations), including advanced approaches banking organizations that are subject to the enhanced supplementary leverage ratio standards that the agencies finalized in May 2014 (eSLR standards). Consistent with the 2013 revised capital rule, advanced approaches banking organizations will be required to disclose their supplementary leverage ratios beginning January 1, 2015, and will be required to comply with a minimum supplementary leverage ratio capital requirement of 3 percent and, as applicable, the eSLR standards beginning January 1, 2018. DATES: The final rule is effective January 1, 2015.

SUPPLEMENTARY INFORMATION: I. Background The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation (FDIC) (collectively, the agencies) adopted the supplementary leverage ratio in July 2013 as part of comprehensive revisions to the agencies’ regulatory capital rule (2013 revised capital rule). Under the 2013 revised capital rule, a minimum supplementary leverage ratio requirement of 3 percent applies to all banking organizations that are subject to the agencies’ advanced approaches risk- based capital rule (advanced approaches banking organizations). The supplementary leverage ratio in the 2013 revised capital rule is generally consistent with the international leverage ratio introduced by the Basel Committee on Banking Supervision (BCBS) in 2010 (Basel III leverage ratio).





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Under the enhanced supplementary leverage ratio standards (eSLR standards) finalized by the agencies in May 2014, U.S. top-tier bank holding companies (BHCs) with more than $700 billion in consolidated total assets or more than $10 trillion in assets under custody must maintain a leverage buffer greater than 2 percentage points above the minimum supplementary leverage ratio requirement of 3 percent, for a total of more than 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments. Insured depository institution (IDI) subsidiaries of such BHCs must maintain at least a 6 percent supplementary leverage ratio to be considered ‘‘well-capitalized’’ under the agencies’ prompt corrective action framework. On May 1, 2014, the agencies published in the Federal Register, for public comment, a notice of proposed rulemaking (NPR or proposed rule) to revise the definition of the denominator of the supplementary leverage ratio (total leverage exposure). The proposed rule would have revised the supplementary leverage ratio, consistent with the January 2014 BCBS revisions to the Basel III leverage ratio (BCBS 2014 revisions), to incorporate in total leverage exposure the effective notional principal amount of credit derivatives or similar instruments through which a banking organization provides credit protection (sold credit protection), modify the measure of exposure for derivative and repo-style transactions, and revise the credit conversion factors (CCFs) for certain off-balance sheet exposures. It would have required total leverage exposure to be calculated as the mean of total leverage exposure, calculated daily, and would have required public disclosure of certain items associated with the supplementary leverage ratio. In general, the proposed changes were designed to strengthen the supplementary leverage ratio by more appropriately capturing the exposure of a banking organization’s on- and off- balance sheet items.





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As discussed further below, the agencies are adopting the proposed rule as final (final rule) with certain revisions and clarifications based on comments received on the proposed rule. In addition, the agencies are revising the calculation of total leverage exposure to provide that the on-balance sheet portion of total leverage exposure will be calculated as the average of each day of the reporting quarter, but the off- balance sheet portion of total leverage exposure will be calculated as the average of the three month-end amounts of the most recent three months. Consistent with the 2013 revised capital rule, advanced approaches banking organizations will be required to disclose their supplementary leverage ratios beginning January 1, 2015, and will be required to comply with the minimum supplementary leverage ratio capital requirement and, as applicable, the eSLR standards, beginning January 1, 2018.

II. Summary of Comments on the NPR and Description of the Final Rule The agencies sought comment on all aspects of the NPR and received 14 public comments from banking organizations, trade associations representing the banking or financial services industry, an options and futures exchange, a supervisory authority, a public interest advocacy group, three private individuals, and other interested parties. In general, comments from financial services firms, banking organizations, banking trade associations and other industry groups were supportive of the proposed rule because it would enhance international consistency, but were critical of certain aspects of the NPR. Comments from an organization representing smaller banking organizations, a group of state bank supervisors, a public interest advocacy group, and two individuals were more generally supportive of the NPR, but they also expressed certain concerns. One individual commenter strongly opposed the proposed rule.





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A detailed discussion of the proposed rule, commenters’ concerns, and the agencies’ responses to those concerns are provided in the remainder of this preamble.

A. Calibration of the Supplementary Leverage Ratio and the eSLR Standards As noted above in Part I, a U.S. top- tier BHC with more than $700 billion in consolidated total assets or more than $10 trillion in assets under custody must maintain a leverage buffer greater than 2 percentage points above the minimum supplementary leverage ratio requirement of 3 percent, for a total of more than 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments. IDI subsidiaries of such BHCs must maintain at least a 6 percent supplementary leverage ratio to be considered ‘‘well capitalized’’ under the agencies’ prompt corrective action framework. The NPR did not propose changes to the minimum supplementary leverage ratio or eSLR standards, but did propose changes to the denominator of the supplementary leverage ratio, which could require banking organizations subject to the supplementary leverage ratio standards (including the eSLR standards) to hold higher amounts of tier 1 capital to meet the standards. The agencies asked in the proposal whether the proposed changes to the definition of total leverage exposure warranted any changes to the calibration of the minimum ratios, or the well-capitalized or buffer levels of the supplementary leverage ratio. Some commenters encouraged the agencies to reconsider the eSLR standards in general, raising issues similar to the comments that the agencies received on the proposal to implement the eSLR standards. For example, commenters expressed the view that the eSLR standards were not consistent with the BCBS’s leverage ratio framework and could therefore result in competitive disparities across jurisdictions.





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One commenter expressed disappointment with the decision to bifurcate the eSLR standards for BHCs and IDIs. A number of commenters expressed concern that the NPR, in combination with the eSLR standards, could cause the supplementary leverage ratio to become the binding regulatory capital constraint, rather than a backstop to the risk-based capital measure. These commenters concluded that a consequence of a binding supplementary leverage ratio could be that banking organizations may divest lower risk assets and assume more risk, to the detriment of financial stability. The agencies considered these comments in connection with adopting the eSLR standards, and the agencies’ views on those comments are set forth in the preamble to the final rule implementing the eSLR standards. As noted in that preamble, and discussed further below, the agencies believe that the maintenance of a complementary relationship between the leverage and risk-based capital ratios is important to ensure that each type of capital requirement continues to serve as an appropriate counterbalance to offset potential weaknesses of the other. The 2013 revised capital rule implemented the capital conservation buffer framework (which is only applicable to risk-based capital ratios) and increased risk-based capital requirements more than it increased leverage requirements, reducing the ability of the leverage requirements to act as an effective complement to the risk-based requirements, as they had historically. As a result, the degree to which banking organizations could potentially benefit from active management of risk- weighted assets before they breach the leverage requirements may be greater. To account for the increases in stringency in the risk-based capital framework, the agencies calibrated the eSLR standards so that they remain in an effective complementary relationship with the risk-based capital requirements.





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The proposed revisions to total leverage exposure were designed to more appropriately capture the exposure of a banking organization’s on- and off-balance sheet exposures, which furthers this complementarity. In adopting the eSLR standards and developing the proposed rule, the agencies considered the combined impact of the eSLR standards and the proposed changes to total leverage exposure. The agencies noted that, quantitatively, compared to the 2013 revised capital rule, the most important changes in total leverage exposure in the proposed rule are: (i) The proposed use of standardized CCFs for certain off- balance sheet activities, which should lead to a reduction in total leverage exposure, and (ii) the proposed treatment of sold credit derivatives, which should lead to an increase in total leverage exposure. However, the actual total leverage exposure under the proposed rule would be especially sensitive to the volume of sold credit derivative activities and would be dependent on whether those activities are hedged in a manner recognized under the proposed rule. As discussed in the proposed rule, supervisory estimates suggested that the proposed changes to the definition of total leverage exposure would result in an approximately 8.5 percent aggregate increase in total leverage exposure across the BHCs subject to the eSLR standards, relative to the definition of total leverage exposure in the 2013 revised capital rule. Based on current estimates, total leverage exposure across the eight BHCs subject to the eSLR standards would increase by an average of 2.6 percent under the proposed rule as compared to the definition of total leverage exposure under the 2013 revised capital rule. In both analyses, on an individual firm basis, for some BHCs subject to the eSLR standards, total leverage exposure increased, while for others it decreased, relative to the definition of total leverage exposure in the 2013 revised capital rule.





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The decline from an 8.5 percent to a 2.6 percent aggregate increase reflects a lower estimate of the impact of including the notional amount of credit derivatives, resulting from trade compression and possibly more offsetting of credit derivatives in response to the proposed rule. Using data as of the second quarter of 2014, the agencies estimate that BHCs subject to the eSLR standards will need to raise, in the aggregate, approximately $14.5 billion of tier 1 capital to exceed a 5 percent supplementary leverage ratio under the definition of total leverage exposure in the final rule, over and above the amount BHCs subject to the eSLR standards would have needed to raise under the definition of total leverage exposure in the 2013 revised capital rule. This is less than the incremental effect estimated in the proposed rule of $46 billion, based on data as of the fourth quarter of 2013. The change is the result of capital raising by BHCs subject to the eSLR standards, who increased their tier 1 capital by 9.3 percent, in combination with a 2.9 percent increase in total leverage exposure, between the fourth quarter of 2013 and the second quarter of 2014. Based on these considerations, the agencies believe that the revisions to the definition of total leverage exposure should not affect the calibration of the 5 and 6 percent supplementary leverage ratio thresholds under the eSLR standards.

B. Total Leverage Exposure Definition The proposed rule would have adjusted the measure of total leverage exposure to more appropriately capture the exposure of a banking organization’s on- and off-balance sheet items. For example, the proposed rule would have included in total leverage exposure the effective notional principal amount of credit derivatives and other similar instruments through which a banking organization provides credit protection (sold credit protection), which has the effect of increasing total leverage exposure associated with these credit derivatives, and would have introduced graduated CCFs for off-balance





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sheet exposures, which would have reduced total leverage exposure with respect to these items. The proposed rule also would have modified the total leverage exposure calculation for derivative contracts and repo-style transactions in a manner that is intended to ensure that the supplementary leverage ratio appropriately reflects the economic exposure of these activities.

1. Exclusion of Certain On-balance Sheet Assets Many commenters expressed the view that the definition of total leverage exposure should exclude certain categories of assets. Specifically, commenters encouraged the agencies to exclude from total leverage exposure highly liquid assets, such as cash, claims on central banks, and sovereign securities, particularly U.S. Treasuries. Some commenters expressed concern that including highly liquid and low- risk assets in total leverage exposure could have negative consequences, including the creation of disincentives for banking organizations to engage in prudent risk management practices. According to commenters, total leverage exposure as proposed could incentivize banking organizations to abandon lower-margin business lines in favor of higher-risk, higher-return activities, in order to increase return on equity. Some commenters also expressed the view that the inclusion of the full value of highly liquid and low-risk assets in total leverage exposure would conflict with the agencies’ proposed liquidity coverage ratio (LCR) rulemaking, which requires holdings of high-quality liquid assets (HQLA). These commenters maintained that the proposed changes to the supplementary leverage ratio would increase capital requirements for banking organizations that have been increasing their inventories of HQLA in an effort to comply with the LCR requirements because the proposed supplementary leverage ratio would effectively penalize HQLA with higher capital charges per unit of risk.





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Certain commenters also expressed the view that the inclusion of low-risk assets in the definition of total leverage exposure penalizes core aspects of the custody bank business model, including the intermediation of high-volume, low- risk, low-return financial activities and broad reliance on essentially riskless assets, notably central bank deposits. Specifically, these commenters recommended that the final rule exclude deposits with central banks (including Federal Reserve Banks) from total leverage exposure in order to accommodate increases in banking organizations’ assets, both temporary and sustained, that occur as a result of macroeconomic factors and monetary policy decisions, particularly during periods of financial market stress. Additionally, these commenters recommended that the agencies adjust total leverage exposure for central bank deposits associated with excess amounts of operationally-linked client deposit balances. Under this approach, a banking organization would be permitted to deduct its excess operational deposits placed with a central bank from its measure of total leverage exposure, subject to a standardized supervisory factor and excluding any balances resulting from reserve or other similar requirements. Several commenters noted that custody banks, which can experience volatility in deposits tied to day-to-day activities, could potentially take actions, such as limiting payment, clearing, and settlement activities, or placing unilateral restrictions on deposit inflows, if the definition of total leverage exposure is unchanged from the proposed rule. Some commenters also noted that the daily averaging provision in the NPR, which would have required that banking organizations calculate quarter-end total leverage exposure based on the daily average of exposure amounts throughout the quarter, would not significantly address these concerns. Alternatively, some commenters suggested that the agencies discount or cap the amount of such assets included in total leverage exposure.





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In particular, they suggested that the agencies could set certain threshold levels for particular low-risk assets relative to total assets where any holdings of such low-risk assets beyond this threshold would be excluded from total leverage exposure. In addition, some commenters recommended that the agencies preserve flexibility during periods of financial market stress, particularly to address a large, temporary increase in a banking organization’s cash account that could lead to a sharp decrease in the banking organization’s supplementary leverage ratio. The agencies addressed similar comments in the final rule implementing the eSLR standards. In general, the supplementary leverage ratio is designed to require a banking organization to hold a minimum amount of capital against total assets and off- balance sheet exposures, regardless of the riskiness of the individual assets. Excluding central bank deposits would not be consistent with this principle. In response to commenters’ concern that total leverage exposure as proposed could incentivize banking organizations to hold higher-risk, higher-return assets, the agencies maintain that the complementary relationship between the leverage and risk-based capital ratios is designed to mitigate any regulatory capital incentives for banking organizations to inappropriately increase their risk profile in response to a strict supplementary leverage ratio. If the supplementary leverage ratio were to become the binding regulatory capital ratio for a particular banking organization, and that banking organization were to acquire more higher-risk assets, risk-weighted assets should increase until the risk-based capital framework becomes binding. Conversely, if a binding risk-based capital ratio induces an institution to expand portfolios whose risk is insufficiently addressed by the risk- based





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capital framework, its total leverage exposure would increase until the supplementary leverage ratio would become binding. Regardless of which framework is binding, banking organizations could potentially increase their holdings of assets whose risks are not adequately addressed by the binding framework. In this regard, the agencies note the importance of the complementary nature of the two frameworks in counterbalancing such incentives. Moreover, the agencies observe that banking organizations choose their asset mix based on a variety of factors, including yields available relative to the overall cost of funds, the need to preserve financial flexibility and liquidity, revenue generation and the maintenance of market share and business relationships, and the likelihood that principal will be repaid, in addition to regulatory capital considerations. In response to commenters’ concern that the inclusion of the full value of highly liquid and low-risk assets in total leverage exposure would conflict with the agencies’ proposed LCR rulemaking, the agencies believe that while the supplementary leverage ratio requires capital to be held against the HQLA required by the LCR, there are actions a banking organization could take to address an LCR HQLA shortfall, such as reducing short-term funding sources or off-balance sheet requirements, that would not necessarily increase a firm’s capital requirement under the supplementary leverage ratio. The agencies believe that, in many ways, the LCR and the supplementary leverage ratio are complementary. In isolation, the supplementary leverage ratio may encourage firms to take greater liquidity risk by purchasing less liquid assets that have a greater yield. In contrast, the LCR, in isolation, may allow the firm to rely on substantial short-term funding as long as the firm also holds HQLA.





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The two measures together provide assurance that firms that rely substantially on short-term funding hold appropriate capital and liquid assets. The agencies understand the commenters’ observation that the custody banks, which act as intermediaries in high-volume, low-risk, low-return financial activities, may experience increases in assets that occur as a result of macroeconomic factors and monetary policy decisions, particularly during periods of financial market stress. The agencies also recognize that certain monetary policy actions, such as quantitative easing, create additional reserve balances that banking organizations must add to their balance sheets, thereby impacting firms’ leverage ratios. Because the supplementary leverage ratio is insensitive to risk, it is possible that banking organizations’ costs of holding low-risk, low-return assets—such as reserve balances—could increase if such ratio were to become the binding regulatory capital constraint. However, as mentioned above, the agencies observe that banking organizations consider many factors beyond regulatory capital requirements, such as yields available relative to the overall cost of funds, the need to preserve financial flexibility and liquidity, revenue generation and the maintenance of market share and business relationships, and the likelihood that principal will be repaid, when choosing an appropriate asset mix. With regard to the commenters’ request to exclude certain low-risk assets, such as cash, central bank deposits, or sovereign securities from total leverage exposure, the agencies believe that excluding broad categories of assets from the denominator of the supplementary leverage ratio is generally inconsistent with the goal of limiting leverage without differentiating across asset types. Such exclusions could, for example, allow a banking organization to take on additional debt without increasing its supplementary leverage ratio requirements (if the proceeds from such debt are invested in certain types of assets).





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The agencies therefore believe that all of a banking organization’s assets, including those that are viewed as low-risk assets, should be reflected in the supplementary leverage ratio. This makes the supplementary leverage ratio more difficult to arbitrage and results in a simpler calculation. Furthermore, the agencies do not believe that there is sufficient justification to treat certain low-risk assets, such as central bank deposits, differently in the denominator of the supplementary leverage ratio than other low-risk assets, such as cash or U.S. Treasuries. In addition, retaining the treatment as proposed better aligns the supplementary leverage ratio with the Basel III leverage ratio, which promotes international consistency in the calculation of total leverage exposure. Accordingly, the agencies have decided to not exempt or limit any categories of balance sheet assets from the denominator of the supplementary leverage ratio in the final rule. Thus, all categories of assets, including cash, U.S. Treasuries, and deposits at the Federal Reserve, are included in the denominator of the supplementary leverage ratio. The agencies note that, under the 2013 revised capital rule, the agencies reserved the authority to consider whether average total consolidated assets or total leverage exposure for a banking organization’s supplementary leverage ratio is appropriate given the banking organization’s exposures or its circumstances, and the agencies may require adjustments to those amounts. The final rule clarifies that this authority would be applicable by replacing the term ‘‘leverage ratio exposure amount’’ with the defined term ‘‘total leverage exposure.’’





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2. Cash Variation Margin Associated With Derivative Transactions The proposed rule would have revised the circumstances under which a banking organization could offset cash collateral received from a counterparty against any positive mark-to-fair value of a derivative contract for purposes of measuring total leverage exposure. Under the 2013 revised capital rule, total leverage exposure includes a banking organization’s on-balance sheet assets, including the carrying value, if any, of derivative contracts on the banking organization’s balance sheet. For the purpose of determining the carrying value of derivative contracts, U.S. generally accepted accounting principles (GAAP) provide a banking organization the option to reduce any positive mark-to-fair value of a derivative contract by the amount of any cash collateral received from the counterparty, provided the relevant GAAP criteria for offsetting are met (the GAAP offset option). Similarly, under the GAAP offset option, a banking organization has the option to offset the negative mark-to-fair value of a derivative contract with a counterparty by the amount of any cash collateral posted to the counterparty. Under the 2013 revised capital rule, regardless of whether a banking organization uses the GAAP offset option to calculate the on-balance sheet amount of derivative contracts, a banking organization must include any on-balance sheet assets arising from the receipt of cash collateral from the counterparty in its total leverage exposure. Under the proposed rule, if a banking organization applies the GAAP offset option to determine the carrying value of its derivative contracts, the banking organization would be required to reverse the effect of the GAAP offset option for purposes of determining total leverage exposure, unless the cash collateral recognized to reduce the mark-to-fair value is cash variation margin that satisfies all of the following conditions:





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(1) For derivative contracts that are not cleared through a qualifying central counterparty (QCCP), the cash collateral received by the recipient counterparty is not segregated; (2) Variation margin is calculated and transferred on a daily basis based on the mark-to-fair value of the derivative contract; (3) The variation margin transferred under the derivative contract or the governing rules for a cleared transaction is the full amount that is necessary to fully extinguish the current credit exposure amount to the counterparty of the derivative contract, subject to the threshold and minimum transfer amounts applicable to the counterparty under the terms of the derivative contract or the governing rules for a cleared transaction; (4) The variation margin is in the form of cash in the same currency as the currency of settlement set forth in the derivative contract, provided that, for purposes of this paragraph, currency of settlement means any currency for settlement specified in the qualifying master netting agreement, the credit support annex to the qualifying master netting agreement, or in the governing rules for a cleared transaction; and (5) The derivative contract and the variation margin are governed by a qualifying master netting agreement between the legal entities that are the counterparties to the derivative contract or by the governing rules for a cleared transaction. The qualifying master netting agreement or the governing rules for a cleared transaction must explicitly stipulate that the counterparties agree tosettle any payment obligations on a net basis, taking into account any variation margin received or provided under the contract if a credit event involving either counterparty occurs. With respect to the potential reduction of gross fair value amounts for cash variation margin, one commenter expressed the view that the calculation of total leverage exposure should follow the treatment of cash collateral under IFRS rather than GAAP.





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The agencies believe that the netting criteria specified in the proposal, which were developed without regard to whether a banking organization applies GAAP or IFRS, produce an appropriate measure of a banking organization’s exposure to derivative transactions. With respect to the first proposed criterion, commenters expressed concern that a banking organization that posts cash variation margin to a counterparty that is not a QCCP may not know whether that counterparty has segregated the cash variation margin that it has received. These commenters recommended that the agencies clarify in the final rule that a banking organization posting cash variation margin may presume that a counterparty has not segregated the cash variation margin received unless required to do so pursuant to applicable legal requirements or under contractual terms. In the final rule, the agencies are clarifying that unless segregation is required by law, regulation, or any agreement with the counterparty, a banking organization that posts cash variation margin to a counterparty may assume that its counterparty has not segregated the cash variation margin it has received for purposes of meeting this criterion. The agencies also note that ‘‘not segregated’’ in this context means that the cash variation margin received is commingled with the banking organization’s other funds. In other words, the counterparty that receives the cash variation margin should have no unique restrictions on its ability to use the cash received (e.g., the banking organization may use the cash variation margin received similar to other cash held by the banking organization). With respect to the second criterion, the agencies received a question about the calculation and transfer of cash variation margin on a daily basis. The commenter asked whether the second criterion would be met for certain categories of derivative transactions, such as exchange-traded options and energy derivatives, where variation margin may not be exchanged daily, but is exchanged on a regular basis.





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In addition, buyers of exchange-traded options do not receive variation margin from the options CCP, who holds the margin collected from option sellers during the course of the contract. For purposes of meeting the second criterion, derivative positions must be valued daily and cash variation margin must be transferred daily to the counterparty or to the counterparty’s account when the threshold and daily minimum transfer amounts are satisfied according to the terms of the derivative contract. With respect to the third proposed criterion, commenters expressed the view that there may be occasional short- term differences between the amount of the variation margin provided and the mark-to-fair value of derivative contracts. For example, it is common practice for a morning margin call to be based on the mark-to-fair value of a derivative contract based on the previous end-of-business day’s valuation. The commenters recommended that the agencies permit such small, temporary differences between the amount of variation margin provided and the current mark-to-fair value, so long as it is clear that the contract governing such transactions requires variation margin for the full amount of the current credit exposure. The agencies agree with the commenters that such temporary differences should not invalidate recognition of the variation margin already received, and as such, a morning margin call based on the mark from the end of the previous day should be considered to satisfy this criterion. Therefore, the agencies are clarifying that cash variation margin exchanged on the morning of the subsequent trading day would meet the third criterion for cash variation margin. As noted in the preamble to the proposed rule, the regular and timely exchange of cash variation margin helps to protect both counterparties from the effects of a counterparty default.





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The proposed conditions under which cash collateral may be used to offset the amount of a derivative contract were developed to ensure that such cash collateral is, in substance, a form of pre- settlement payment on a derivative contract. This approach is consistent with the design of the supplementary leverage ratio, which generally does not permit banking organizations to use collateral to reduce exposures for purposes of calculating total leverage exposure. The proposed conditions also ensure that the counterparties calculate their exposures arising from derivative contracts on a daily basis and transfer the net amounts owed, as appropriate, in a timely manner. Therefore, with the clarifications noted above, the agencies are finalizing the criteria as proposed for permitting the use of cash variation margin to offset the mark-to-fair value of derivative contracts.

3. Credit Derivatives Under the 2013 revised capital rule, a banking organization would include in total leverage exposure the potential future exposure (PFE) associated with a credit derivative using the current exposure methodology (CEM) as specified in section 34 of the 2013 revised capital rule. The proposed rule would have required a banking organization to include in total leverage exposure the effective notional principal amount (that is, the apparent or stated notional principal amount multiplied by any multiplier in the derivative contract) of sold credit protection, but would have permitted the banking organization to reduce the effective notional principal amount of sold credit protection with credit protection purchased under certain conditions. Specifically, a banking organization would be permitted to reduce the effective notional principal amount of sold credit protection on a single exposure by the effective notional principal amount of a credit derivative or similar instrument through which the banking organization has purchased credit protection (purchased credit protection), provided that the purchased credit protection has a remaining maturity that is equal to





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or greater than the remaining maturity of the sold credit protection, and that the reference exposure of the purchased credit protection refers to the same legal entity and ranks pari passu with, or is junior to, the reference exposure of the sold credit protection. In addition, the NPR would have permitted a banking organization to reduce the effective notional principal amount of sold credit protection that references a single reference exposure using purchased credit protection that references multiple exposures if the purchased credit protection is economically equivalent to buying credit protection separately on each of the individual reference exposures of the sold credit protection. For example, this would be the case if a banking organization were to purchase credit protection on an entire securitization structure or on an entire index that includes the reference exposure of the sold credit protection. However, if a banking organization purchases credit protection that references multiple exposures, but the purchased credit protection is not economically equivalent to buying credit protection separately on each of the individual reference exposures (for example, through an nth-to-default credit derivative or a tranche of a securitization), the proposed rule would not have allowed the banking organization to reduce the effective notional principal amount of the sold credit protection that references a single exposure. Under the NPR, to reduce the effective notional principal amount of sold credit protection that references multiple exposures, such as an index (e.g., the CDX) or a tranche of an index or securitization, the reference exposures of the purchased credit protection would need to refer to the same legal entities and rank pari passu with the reference exposures of the sold credit protection. The purchased credit protection also would need to have a remaining maturity that is equal to or greater than the remaining maturity of the sold credit protection.





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In addition, the level of seniority of the purchased credit protection would need to rank pari passu with the level of seniority of the sold credit protection. Therefore, offsetting would be recognized only when all of the reference exposures and the level of subordination of protection sold and protection purchased are identical. For example, a banking organization may reduce the effective notional principal amount of the sold credit protection on an index, or a tranche of an index, with purchased credit protection on such index, or a tranche of equal seniority of such index, respectively. In general, commenters expressed the view that the criteria in the proposed rule under which a banking organization could reduce the effective notional principal amount of sold credit protection with purchased credit protection were too narrow and would result in an overstatement of the actual economic exposure in some cases. For example, commenters recommended that purchased credit protection that has a residual tenor which is sufficiently long-term be considered eligible to reduce the effective notional amount of sold credit protection if all of the other criteria are met. These commenters expressed the view that such an approach would be appropriate because it would generally disqualify short-term purchased credit protection from reducing the effective notional amount of sold credit protection. In addition, these commenters recommended that purchased credit protection on a junior tranche of a securitization be allowed to offset protection sold on a senior tranche of the same securitization. One comment letter recommended a more restrictive approach, suggesting that offsetting sold credit protection against purchased credit protection should only be allowed if the protection seller has a very high credit rating and is not affiliated with the reference entity.





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The agencies believe that the criteria in the proposed rule strike a balance between recognizing the amount of sold credit protection and ensuring that the offsetting purchased credit protection appropriately matches the risks of the underlying reference exposure of the sold credit protection. Further, the proposed criteria for offsetting sold credit protection are generally consistent with the way banking organizations seek to limit their exposure to the underlying reference exposures of sold credit protection by purchasing credit protection on the same or similar exposures of the same or longer maturity. The proposed criteria result in a significant reduction of the effective notional amount of sold credit protection, while capturing the effective notional amount of sold credit protection that a banking organization has not fully hedged. The proposed criteria are also consistent with the Basel III leverage ratio standards. With regard to commenters’ suggestions of additional adjustments and modifications to these criteria, changing the proposed criteria for offsetting sold credit protection would complicate the calculation of total leverage exposure and the impact of any such modifications would likely be immaterial. With regard to the comment that the criteria for reducing the effective notional amount of sold credit protection should be stricter, the agencies believe that restricting the criteria further would unduly penalize banking organizations that have significantly reduced their exposure to the underlying reference exposures by purchasing credit protection. Therefore, the final rule does not modify the proposed criteria to reduce the effective notional amount of sold credit protection. Commenters also recommended allowing any purchased credit protection which covers the entirety of the subset of exposures covered by the sold credit protection to reduce the effective notional amount of sold credit protection.





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Specifically, commenters sought clarity regarding a situation in which a banking organization has purchased and sold credit protection on overlapping portions of the same reference index or securitization, but where the purchased credit protection does not cover the entirety of the portion of the index or securitization on which the banking organization has sold credit protection. The agencies note that the final rule does permit a banking organization that has purchased and sold credit protection on overlapping portions of the same reference index, but where the purchased credit protection does not cover the entirety of the portion of the index or securitization on which the banking organization has sold credit protection, to offset the sold credit protection by the overlapping portion of purchased credit protection. For example, if a banking organization has sold credit protection on the 3–7 percent tranche(s) of an index and purchased credit protection on the 5–10 percent tranche(s) of the same index, the banking organization may offset the 5–7 percent portion of the sold credit protection, assuming all of the other relevant criteria are met. In such situations, offsetting may be recognized because, in accordance with the final rule, all of the reference exposures and the level of subordination of sold credit protection and purchased credit protection are identical for the overlapping portion of purchased and sold credit protection. Commenters recommended that the agencies clarify that clearing member banking organizations are not required to include the effective notional amount of sold credit protection cleared on behalf of a client though a CCP, and that such a derivative transaction, or other similar instrument, related to the sold credit protection should instead be included in total leverage exposure of the clearing member banking organization in the same manner as other cleared derivatives. The agencies are clarifying that the effective notional principal amounts of sold credit protection that are cleared for clearing member clients through CCPs are not included in a clearing member banking organization’s total leverage exposure.





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In addition, the clearing member banking organization would include such a derivative transaction, or other similar instrument, related to the sold credit protection in its total leverage exposure in the same manner as other cleared derivative transactions (that is, if the clearing member banking organization guarantees the performance of a clearing member client with respect to a cleared transaction, the clearing member banking organization would treat the exposure to the clearing member client as a derivative contract). In addition, under the proposed rule, for sold credit protection, a banking organization would have accounted for the notional amount of sold credit protection in total leverage exposure through the effective notional principal amount, as well as through CEM (that is, the current credit exposure and the PFE), as described above. In the proposed rule, a banking organization would have been permitted to adjust the PFE for sold credit protection to avoid double-counting the notional amounts of these exposures. For example, if the sold credit protection was governed by a qualifying master netting agreement, a banking organization would have been permitted to adjust the PFE for sold credit protection covered by the qualifying master netting agreement. However, a banking organization would have been allowed to adjust only the amount Agross of the PFE calculation for sold credit derivatives and would not have been allowed to adjust the net-to- gross ratio (NGR) of the PFE calculation. Finally, a banking organization that elected to adjust the PFE for sold credit derivatives would have been required to do so consistently over time. The agencies did not receive any comments on the PFE adjustment, and are therefore finalizing this aspect of the rule substantively as proposed.

4. Repo-Style Transactions





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Under the 2013 revised capital rule, total leverage exposure includes the on- balance sheet carrying value of repo- style transactions, but not the related off-balance sheet exposure for such transactions. The proposed rule set forth a revised treatment of repo-style transactions, including the conditions under which a banking organization would be permitted to measure the exposure of repo-style transactions using the carrying value for the transactions (using the GAAP offset for repo-style transactions, as described below), rather than the gross value of all receivables due from a counterparty. The proposed rule also specified the treatment for a security-for-security repo-style transaction, a repurchase or reverse repurchase transaction, or a securities borrowing or lending transaction that is treated as a sale for accounting purposes, and the counterparty credit risk component of repo-style transactions. The proposed rule also clarified the calculation of total leverage exposure for repo-style transactions where a banking organization acts as an agent.

a. Criteria for Recognizing the GAAP Offset for Repo-style Transactions For purposes of determining the on- balance sheet carrying value of a repo- style transaction, GAAP permits a banking organization to offset the gross values of receivables due from a counterparty under reverse repurchase agreements by the amount of the payments due to the same counterparty (that is, amounts recognized as payables to the same counterparty under repurchase agreements), provided the relevant accounting criteria are met (GAAP offset for repo-style transactions). The proposed rule specified the criteria for when a banking organization would have been required to reverse the GAAP offset for repo-style transactions for the purpose of calculating total leverage exposure. If a banking organization entered into repurchase and reverse repurchase transactions with the same counterparty and applied the GAAP offset for repo- style transactions, but the transactions did not meet the criteria described below, the banking organization would have been required to





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replace the net on-balance sheet assets of the reverse repurchase transactions determined according to GAAP, if any, with the gross value of receivables for those reverse repurchase transactions. Those criteria are: (1) The offsetting transactions have the same explicit final settlement date under their governing agreements; (2) The banking organization’s right to offset the amount owed to the counterparty with the amount owed by the counterparty is legally enforceable in the normal course of business and in the event of receivership, insolvency, liquidation, or similar proceeding; and (3) Under the governing agreements, the counterparties intend to settle net, settle simultaneously, or settle according to a process that is the functional equivalent of net settlement. That is, the cash flows of the transactions are equivalent, in effect, to a single net amount on the settlement date. To achieve this result, both transactions must be settled through the same settlement system and the settlement arrangements must be supported by cash or intraday credit facilities intended to ensure that settlement of both transactions will occur by the end of the business day, and the settlement of the underlying securities does not interfere with the net cash settlement. With respect to the first proposed criterion, commenters expressed the view that the agencies clarify or revise the final rule to provide that undated repo-style transactions (sometimes referred to as ‘‘open’’ transactions), which can be unwound unconditionally at any time by either counterparty, may be treated as having an effective one-day maturity. Because the proposed rule referred to ‘‘explicit’’ settlement dates, it would not have permitted receivables or payables from ‘‘open’’ transactions to be offset against payables or receivables from overnight transactions (or against other ‘‘open’’ transactions).





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The criterion limiting offsetting to those repo-style transactions that have the ‘‘same explicit final settlement date’’ is consistent both with current accounting standards and with the BCBS 2014 revisions to the Basel III leverage ratio. This criterion helps to ensure that the counterparties agree in advance what the settlement date for a repo-style transaction would be, and thus helps a banking organization manage its counterparty exposure, including the net amount owed. To promote consistency in the treatment of repo-style transactions, and to ensure banking organizations do not understate their actual exposure to repo-style transactions for the purpose of calculating total leverage exposure, the agencies continue to believe that explicit identical settlement dates established at the origination of repo- style transactions should be a criterion for offsetting repo-style transactions in the final rule. Therefore, the agencies are finalizing this aspect of the rule as proposed. With respect to the third criterion, commenters recommended deleting the proposed requirement that ‘‘settlement of the underlying securities does not interfere with the net cash settlement.’’ The commenters expressed the view that the purpose of this requirement is unclear. In the final rule the agencies are clarifying that this criterion requires that the settlement of the underlying securities be subject to a settlement mechanism that results in the functional equivalence of net settlement. In other words, the cash flows of the transactions must be equivalent, in effect, to a single net amount on the settlement date. To achieve such equivalence, all transactions must be settled through the same settlement system, and any settlement system used to settle the transactions must not require all securities to have successfully settled before settling any net cash obligations.





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The settlement system’s procedures must provide that the failure of any single securities transaction in the settlement system should only delay the matching cash leg (payment) or create an obligation to the settlement system, supported by an associated credit facility. The requirement that settlement of the underlying securities does not interfere with the net cash settlement is not intended to exclude any settlement mechanism, such as a delivery-versus- payment or other mechanism, if it meets these functional requirements. If a settlement system’s procedures allow for all of the above, then the third criterion would be met. If the failure of the securities leg of a transaction in such a system persists at the end of the settlement period, however, then this transaction and its matching cash leg must be split out from the netting set and treated gross for the purposes of total leverage exposure. In the proposal, the agencies requested comment on the operational implications of the proposed netting criteria for repo-style transactions compared to GAAP, and the magnitude of the change in total leverage exposure for these transactions compared to GAAP. The agencies also asked about the potential costs of developing the necessary systems to offset amounts recognized as receivables due from a counterparty under reverse repurchase agreements. The agencies did not receive responses to these questions. One comment letter stated that if any additional costs exist, those would not be a valid reason for not requiring the netting criteria as a pre-requisite for the preferential capital treatment for netting.

b. Treatment of Security-for-Security Repo-style Transactions The proposed rule specified how a banking organization would have treated security-for-security repo-style transactions for purposes of calculating total leverage exposure.





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Under GAAP, in a security-for-security repo-style transaction, the receiver of a security lent (a securities borrower) does not include the security borrowed on its balance sheet provided that the lender has not defaulted under the terms of the transaction. A security that a securities borrower transferred to the lender (a securities lender) as collateral would remain on the securities borrower’s balance sheet. Consistent with GAAP, under the proposed rule, a securities borrower would have included a security that is transferred to a securities lender in its total leverage exposure, but the NPR would not have required the securities borrower to adjust its total leverage exposure related to such a transaction, unless and until the security borrower sold the security or the securities lender defaulted. The agencies did not receive any comments on the proposed treatment from the securities borrower’s perspective. Therefore, the agencies are adopting the treatment in a security- for - security repo- style transaction for the securities borrower as proposed. Under GAAP, from a securities lender’s perspective, a security received as collateral from a securities borrower is included on the security lender’s balance sheet as an asset. In addition, a securities lender also must continue to include the security that it lent on its balance sheet if the transaction is treated as a secured borrowing. Under the proposal, in a security-for-security repo-style transaction, a securities lender would have been allowed to exclude the security received as collateral from total leverage exposure, unless and until the securities lender sells or re-hypothecates the security. If the securities lender sold or re- hypothecated the security, the securities lender would have been required to include the amount of cash received or, in the case of re-hypothecation, the value of the security pledged as collateral in its total leverage exposure.





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Commenters expressed concern that the proposed treatment of security-for security transactions would not achieve consistency across differing accounting frameworks in periods subsequent to a sale or re-hypothecation by a securities lender, and recommended revising the proposed rule to permit banking organizations acting as securities lenders to reduce total leverage exposure by the value of the securities received in a security-for-security repo- style transaction, regardless of whether such banking organization sold or re- hypothecated the securities received. The agencies have decided not to change the proposal in response to these comments. The proposed approach, which is consistent with international standards, was designed to ensure that a securities lender would not have included both a security lent and a security received in its total leverage exposure, unless the securities lender sold or re-hypothecated the security received. In addition, the agencies believe the proposed treatment appropriately captures the exposure associated with a security that has been re-hypothecated because a banking organization is obligated to return or repurchase the security at a later date. Further, the agencies note that pursuant to the BCBS 2014 revisions, total leverage exposure would include amounts associated with the sale or re- hypothecation of collateral by a securities lender, thereby eliminating the effect of any differences in accounting frameworks. The agencies are therefore finalizing this aspect of the rule as proposed.

c. Repurchase and Securities Lending Transactions That Qualify for Sales Treatment Under U.S. GAAP The proposed rule specified the treatment for a repurchase or reverse repurchase transaction or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP (repurchase or securities lending transaction that qualifies for sales treatment under U.S. GAAP).





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The proposed rule would have required a banking organization to add the value of securities sold under such a repurchase or securities lending transaction that qualifies for sales treatment under U.S. GAAP to total leverage exposure for as long as the transaction is outstanding. The agencies did not receive any comments on this particular aspect of the proposed rule and are finalizing this aspect of the rule as proposed. The agencies are providing clarification of the treatment of a forward agreement associated with a repurchase or securities lending transaction that qualifies for sales treatment under U.S. GAAP. If a repurchase or securities lending transaction qualifies for sales treatment under U.S. GAAP, a banking organization would generally record an associated forward purchase agreement or forward sale agreement, which may be treated as a derivative exposure under GAAP. The replacement cost and PFE associated with this derivative exposure, in combination with the value of the security sold may overstate the actual exposure in total leverage exposure of such a repurchase or securities lending transaction that qualifies for sales treatment under U.S. GAAP. Therefore, the PFE related to a forward agreement associated with a repurchase or securities lending transaction that qualifies for sales treatment under U.S. GAAP may be excluded from total leverage exposure. Moreover, a forward agreement associated with a repurchase or securities lending transaction that qualifies for sales treatment under U.S. GAAP should not be included in total leverage exposure as an off-balance sheet exposure subject to a CCF.

d. Counterparty Credit Risk Measure The proposed rule also included a counterparty credit risk measure in total leverage exposure to capture a banking organization’s exposure to its counterparty in repo-style transactions.





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To determine the counterparty exposure for a repo-style transaction, including a transaction in which a banking organization acts as an agent for a customer and indemnifies the customer against loss, the banking organization would subtract the fair value of the instruments, gold, and cash received from a counterparty from the fair value of any instruments, gold, and cash lent to the counterparty. For repo-style transactions that are not subject to a qualifying master netting agreement or that are not cleared, the counterparty exposure measure would be calculated on a transaction-by-transaction basis. However, if a qualifying master netting agreement were in place, or the transactions were cleared, the banking organization would be able to net the total fair value of instruments, gold, and cash lent to a counterparty against the total fair value of instruments, gold, and cash received from the same counterparty across all those transactions. The agencies did not receive any comments on this part of the proposed rule and are adopting it as proposed. The proposed rule provided that where a banking organization acts as an agent for a repo-style transaction and provides a guarantee (indemnity) to a customer with regard to the performance of the customer’s counterparty that is greater than the difference between the fair value of the security or cash lent and the fair value of the security or cash borrowed, the banking organization would have been required to include the amount of the guarantee that is greater than this difference in its total leverage exposure. The agencies did not receive any comments on this part of the proposed rule and are adopting it as proposed.

e. Repo-style Transactions Cleared Through CCPs One commenter asked the agencies to clarify the proposed rule with regard to repo-style transactions cleared through CCPs, when a banking organization acting as an agent offers indemnifications to the client.





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According to the commenter, a banking organization that clears repo-style transactions through a CCP is generally required to post cash collateral to the CCP. The commenter stated that this would likely result in a larger counterparty exposure amount added to total leverage exposure than a similar repo-style transaction executed as a bilateral trade, and would discourage the clearing of repo-style transactions. However, the commenter did not provide any specific proposals to address the disincentives created by the clearing process, and acknowledged that most repo-style transactions are not currently cleared. The agencies acknowledge that the mechanics of the clearing process currently operate in a manner that results in a larger counterparty exposure than a similar transaction that is not cleared. The treatment is consistent with the approach for repo-style transactions, and the agencies do not believe that there is sufficient justification to provide a different treatment for repo-style transactions cleared through CCPs for purposes of calculating total leverage exposure. Therefore, the agencies are not making any revisions in the final rule to address the clearing of repo-style transactions and are finalizing this aspect of the rule as proposed.

5. Off-Balance Sheet Exposures Under the 2013 revised capital rule, banking organizations must apply a 100 percent CCF to all off-balance sheet items to calculate total leverage exposure, except for unconditionally cancellable commitments, which are subject to a 10 percent CCF. The NPR would have retained the 10 percent CCF for unconditionally cancellable commitments, but would have replaced the uniform 100 percent CCF for other off-balance sheet items with the CCFs applicable under the standardized approach for risk-weighted assets in section 33 of the 2013 revised capital rule.





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Commenters generally supported the adoption of the standardized approach CCFs. However, some commenters expressed concern over the scope of exposures that are treated as off-balance sheet and, therefore, subject to CCFs. Some commenters also requested that the agencies revise the CCFs applicable to certain trade finance exposures to effectively decrease the amount of such exposures included in total leverage exposure, specifically to make the treatment of these exposures consistent with the European Union’s treatment under the CRD–IV Directive. Commenters also recommended that the agencies clarify the treatment of certain exposures for purposes of inclusion in total leverage exposure. For example, commenters suggested that the CCF treatment could result in an overstatement of off-balance sheet exposures, specifically with respect to forward-starting reverse repos and securities borrowing transactions that have been entered into at an agreed rate but have not yet been settled. Commenters expressed the view that forward-starting reverse repos should be treated as derivative exposures rather than being assigned a CCF, and that the repo-style transaction counterparty credit risk measure should apply only where a qualifying master netting agreement is in place. Commenters further suggested treating deliverable bond futures and OTC equity forward purchases as derivative exposures rather than off-balance sheet exposures subject to CCFs, because they are trading positions. These commenters opined that total leverage exposure should exclude ‘‘forward forward deposits’’ that represent the renewal of an existing deposit on its maturity, because including these would double count them.





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Alternatively, commenters requested that the agencies clarify that ‘‘forward asset purchases,’’ which receive a 100 percent CCF, do not include deliverable bond futures or forward-starting repo transactions. Under the proposal, off-balance sheet exposures were included in total leverage exposure in a manner consistent with the standardized approach risk-based capital rules. The treatment of specific instruments depended on the characteristics of those instruments. For example, an exposure that receives a conversion factor under section 33 of the 2013 revised capital rule would receive the same conversion factor for purposes of calculating total leverage exposure, subject to the minimum 10 percent conversion factor applied to unconditionally cancellable commitments. Regarding the comment to revise the CCFs applicable to certain trade finance exposures, the agencies have decided not to modify the applicable CCFs for the purposes of calculating total leverage exposure. The proposed approach incorporates off-balance sheet exposures in total leverage exposure in a straightforward manner consistent with existing regulatory approaches and that already have proven effective. Thus, the agencies believe that the standardized CCFs, which also are consistent with international standards, are appropriate for measuring total leverage exposure for off-balance sheet exposures. Accordingly, the agencies have decided to adopt this aspect of the final rule as proposed.

6. Central Clearing of Derivative Transactions The 2013 revised capital rule provides that a banking organization must include in total leverage exposure the PFE for each derivative contract (or each single-product netting set of such transactions) to which the banking organization is a counterparty calculated in accordance with section 34 of the 2013 revised capital rule, but without regard to any





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collateral used to reduce risk-based capital requirements pursuant to section 34(b) of the 2013 revised capital rule. Although cleared transactions are generally addressed in section 35 of the 2013 revised capital rule, section 35 refers to section 34 for the purpose of determining the PFE of cleared derivative transactions. Thus, for the purpose of measuring total leverage exposure, the PFE for each derivative transaction to which a banking organization is a counterparty, including cleared derivative transactions, should be determined pursuant to section 34. The proposed rule would have revised the description of total leverage exposure to make this point more clear. When a clearing member banking organization does not guarantee the performance of the CCP, the clearing member banking organization has no payment obligation to the clearing member client in the event of a CCP default. In these circumstances, requiring the clearing member banking organization to include an exposure to the CCP in its total leverage exposure would generally result in an overstatement of total leverage exposure. Therefore, under the proposed rule, and consistent with the Basel III leverage ratio, a clearing member banking organization would not have been required to include in its total leverage exposure an exposure to the CCP for client-cleared transactions if the clearing member banking organization does not guarantee the performance of the CCP to the clearing member client. However, if a clearing member banking organization does guarantee the performance of the CCP to the clearing member client, then the proposed rule would have required a clearing member banking organization to include an exposure to the CCP for the client- cleared transactions in its total leverage exposure.





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One commenter requested that the agencies clarify in the final rule the treatment of a cleared derivative transaction where the clearing member and the clearing member client are affiliates. Without clarification, the commenter expressed concern that such a situation could result in a double counting of the transaction in the consolidated banking organization’s total leverage exposure. The agencies are clarifying in the final rule that a banking organization may exclude from its total leverage exposure the clearing member’s exposure to its clearing member client for a derivative transaction if the clearing member client and the clearing member are affiliates and consolidated on the banking organization’s balance sheet. Commenters also recommended excluding from a clearing member banking organization’s total leverage exposure cash provided by a clearing member client as initial margin and held in a segregated account. The commenters stated that a clearing member banking organization may reflect on its balance sheet both the initial margin passed on to the CCP as well as additional cash initial margin (excess initial margin) requested by the clearing member banking organization but not passed on to the CCP. Commenters further stated that under the customer asset protection rules issued by the CFTC, the clearing member banking organization may not use any segregated cash posted by a clearing member client to support the clearing member banking organization’s own operations. In effect, commenters asserted that such segregated cash constitutes an asset of the clearing member client. Commenters also argued that the proposed LCR rules recognize that such segregated cash cannot be treated as an asset available to meet a clearing member banking organization’s liquidity needs, even though cash is typically an optimal asset for providing liquidity.





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As a general matter the agencies do not believe it is appropriate to exclude segregated or otherwise restricted assets from a banking organization’s total leverage exposure and are finalizing this aspect of the rule as proposed.

C. Daily Averaging The 2013 revised capital rule defines the supplementary leverage ratio as the mean of the ratio of tier 1 capital to total leverage exposure calculated as of the last day of each month in the reporting quarter. Under the proposed rule, the numerator of the supplementary leverage ratio, tier 1 capital, would have been calculated as of the last day of each reporting quarter, while total leverage exposure, the denominator of the supplementary leverage ratio, would have been calculated as the mean of total leverage exposure calculated daily. After calculating quarter-end tier 1 capital, banking organizations would have subtracted from the measure of total leverage exposure the applicable deductions from the quarter-end tier 1 capital for purposes of calculating the quarter-end supplementary leverage ratio. In the NPR, the agencies asked specific questions about the operational burden of the proposed use of average of daily calculations and the burden associated with several alternatives, such as only requiring daily averaging for on-balance sheet assets. Commenters expressed the view that that the application of daily averaging to off- balance sheet exposures would introduce significant practical complexities with no offsetting compliance benefit. Several commenters supported an alternative approach in which a banking organization would calculate its total leverage exposure for a quarterly reporting period based on the daily average of on-balance sheet assets and the quarter-end balance or an average of month-end off-balance sheet exposures.





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Commenters expressed the view that such an alternative approach strikes an appropriate balance between the accuracy of reported minimum ratios and operational complexity. Commenters maintained that off-balance sheet exposure volatility is far less significant than on-balance sheet exposure volatility. In addition, commenters expressed the view that the industry has no operational processes that would permit the daily calculation of certain components of off-balance sheet exposures and that significant systems changes would be required to calculate off-balance sheet exposures on a daily basis. Commenters also recommended that if the final rule were to require the daily averaging of off- balance sheet exposures, this requirement should be implemented on a phased-in basis to allow more time for banking organizations to comply with the requirement. While calculating total leverage exposure as the mean of total leverage exposure for each day of the reporting quarter provides the more accurate depiction of total leverage exposure, the agencies recognize the operational burden associated with such calculation for off-balance sheet exposures. For this reason, the agencies are modifying the calculation of total leverage exposure so that total leverage exposure is calculated as the mean of the on-balance sheet assets calculated as of each day of the reporting quarter, plus the mean of the off-balance sheet exposures calculated as of the last day of each of the most recent three months, minus the applicable deductions under the 2013 revised capital rules. In addition, the agencies have removed the proposed reference to the calculation of tier 1 capital as of the end of the quarter to avoid the implication that the supplementary leverage ratio is calculated only at the end of the quarter. For purposes of public disclosures and reporting the supplementary leverage ratio on the applicable regulatory reports, a banking organization would calculate the off- balance exposure component of





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total leverage exposure as the mean of its off- balance sheet exposures as of the last day of each month in the applicable reporting quarter. For example, when a banking organization prepares a regulatory report for the quarter ending December 31, it would calculate the mean of its off-balance sheet exposures as of October 31, November 30, and December 31. The agencies will continue to monitor this issue and may revisit it at a future date if it is determined that monthly calculation of off-balance sheet exposure raises supervisory concerns. In addition, the agencies are evaluating the calculation methodology for the leverage ratio applicable to all banking organizations and may seek comment on a proposal applicable to advanced approaches banking organizations to align the methodology for calculating on-balance sheet assets for purposes of that leverage ratio and the supplementary leverage ratio in the future.

D. Supervisory Flexibility Some commenters recommended that the agencies preserve supervisory flexibility during periods of financial market stress, particularly to address a large, temporary increase in a banking organizations’ cash that could lead to a sharp decrease in the banking organization’s supplementary leverage ratio. Commenters suggested that the agencies emphasize that falling below the minimum supplementary leverage ratio would not necessarily result in supervisory action, but, at a minimum, would result in heightened supervisory monitoring. Commenters expressed the view that the agencies should adopt a formal process to address compliance with the supplementary leverage ratio minimums on a case-by-case basis during periods of financial stress. As previously noted, under the 2013 revised capital rule, the agencies reserved the authority to consider whether the average total consolidated assets or total leverage exposure for a banking organization’s





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supplementary leverage ratio is appropriate given the banking organization’s exposures or circumstances, and the agencies may require adjustments to such exposures. The final rule clarifies that this authority applies to the supplementary leverage ratio calculation by replacing the term ‘‘leverage exposure amount’’ with the defined term ‘‘total leverage exposure.’’

E. Replacement of the Current Exposure Method (CEM) The NPR proposed to use the current exposure method (CEM) to measure the total leverage exposure associated with derivative contracts. However, some commenters recommended that the agencies consider the replacement of the CEM with the standardized approach for measuring counterparty credit risk exposures (SA–CCR), recently agreed to by the BCBS though not yet incorporated into its leverage ratio framework. The commenters requested that the agencies address, in the preamble to the final rule, their intention to consider the replacement of the CEM with the SA–CCR, consistent with any final agreement of the BCBS with regard to the SA–CCR and the Basel III leverage ratio, which is currently under consideration. In general, the commenters supported adoption of SA–CCR. The agencies are participating in the BCBS’s development of the international leverage ratio standards, and will consider the extent to which any changes should be made to the calculation of total leverage exposure for derivative contracts in the United States once the BCBS has reached an agreement on whether and how to incorporate the SA–CCR into its leverage ratio.

III. Disclosures The agencies have long supported meaningful public disclosure by banking organizations of their regulatory capital with the goals of





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disclosing information in a comparable and consistent manner, and improving market discipline. Consistent with the BCBS 2014 revisions, the agencies are applying additional disclosure requirements related to the calculation of the supplementary leverage ratio to top-tier advanced approaches banking organizations. The agencies believe that the additional disclosures will enhance the transparency and promote consistency among the disclosures related to the supplementary leverage ratio for all internationally active banking organizations. Specifically, under the final rule, banking organizations will complete two parts of a supplementary leverage ratio disclosure table. Part 1 is designed to summarize the differences between the total consolidated accounting assets reported on a banking organization’s published financial statements and regulatory reports and the calculation of total leverage exposure. Part 2 is designed to collect information on the components of total leverage exposure in more detail, similar to the version of FFIEC 101, Schedule A. The agencies plan to reconsider the regulatory reporting requirements related to the supplementary leverage ratio on FFIEC 101, Schedule A, in the future, to reflect these disclosures and the revisions to the calculation of total leverage exposure.





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Consistent with the BCBS 2014 revisions, if a banking organization has material differences between its total consolidated assets as reported in published financial statements and regulatory reports and its reported on- balance sheet assets for purposes of calculating the supplementary leverage ratio, the banking organization must disclose and explain the source of the material differences. In addition, if a banking organization’s supplementary leverage ratio changes significantly from one reporting period to another, the banking organization must explain the key drivers of the material changes. Banking organizations must disclose this information quarterly, using the template set forth in Table 13, and make the disclosures publicly available.





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In the NPR, the agencies proposed to apply additional disclosure requirements for the calculation of the supplementary leverage ratio to top-tier advanced approaches banking organizations. One comment letter recommended that the final rule clarify that Part 1, line 2 of the disclosure table include associated entities reflected on a banking organization’s balance sheet on the basis of proportionate consolidation. The commenter noted that it sent the same suggestion to the BCBS to revise the Basel III leverage ratio disclosure requirements. The agencies proposed disclosure requirements for purposes of reporting of the supplementary leverage ratio consistent with the disclosure requirements in the Basel III leverage ratio. The agencies decided not to revise the disclosure table in response to this comment because proportionate consolidation generally does not apply to the U.S. banking organizations subject to the supplementary leverage ratio. If the BCBS reconsiders the Basel III leverage ratio disclosure requirements in light of this comment, then the agencies will consider a revision of the disclosure requirements in the U.S. Another comment letter stated that the required disclosures do not appear to provide a meaningful breakout of off- balance sheet exposures beyond derivative and repo-style transactions. The comment letter recommended that the agencies consider a more detailed breakout of off-balance sheet exposures for Part 2, lines 17 and 18. The agencies believe that the table is sufficiently granular, particularly when viewed in combination with the other regulatory disclosure requirements, including the Call Report and FR Y–9C. Therefore, under the final rule, the agencies are not making any changes to the required disclosures.





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Opening speech Opening speech by Mr Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of Sveriges Riksbank, at the 18th International Conference of Banking Supervisors, Tianjin, China

Introduction Good morning and welcome to the 18th International Conference of Banking Supervisors (ICBS). I'd like to thank our hosts, the China Banking Regulatory Commission (CBRC), and in particular Chairman Shang and his staff for hosting this year's ICBS. Hosting a conference such as this, with more than 100 supervisory authorities from around the world, is a significant undertaking. On behalf of everyone here today, I express our deepest appreciation for all the hard work that has gone into organising the ICBS in Tianjin, and congratulate you on doing such an outstanding job. China joined the Basel Committee in March 2009 - in the midst of what turned out to be a prolonged, far-reaching and complex financial crisis. Since then, the CBRC and the People's Bank of China have become active members of the Basel Committee and have made valuable contributions during an extremely busy and critical period. When I think about what the Committee has achieved since the financial crisis, I don't think it would have been possible without the support of the Chinese authorities and the other members that joined the Committee in 2009.





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The new members have brought an important new dimension to the Committee table - drawing, of course, on their own experience and perspective as emerging economies. If the Basel Committee is to achieve its core mission of strengthening regulatory standards and supervisory practices around the globe, then we must make sure that our reach is broad and our work is carried out in an inclusive manner. In this regard, I am pleased to announce that representatives from Chile, Malaysia and the United Arab Emirates have been invited to join the Basel Committee and attended their first meeting earlier this week. This is one of many steps that the Committee has taken in recent years to enlarge its geographical outreach and enhance its position as a global standard setter. The Basel Committee was founded almost 40 years ago to foster cooperation and coordination between central banks and, in doing so, to strengthen the regulation and supervision of international banks. The principles of cooperation and information-sharing remain as strong and important today as they did when the Committee was founded. No matter what the regulatory framework or how consistent the implementation - there is no escaping the need for cross-border coordination and cooperation. Indeed, it is a fundamental element of effective international banking supervision. The Committee's response to the crisis is a successful illustration of this. While many of us were managing national responses to the crisis, the Committee came together to develop and implement a revised international regulatory and supervisory framework. This framework - Basel III - strengthens prudential and supervisory safeguards and, more importantly, helps underpin the economic recovery.





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The Basel III package of reforms remains the centrepiece of the G20's regulatory response to the crisis. This is a reflection of the cooperative and collegiate spirit of the international supervisory community. The Committee is now close to finalising the Basel III package of reforms. At its meeting this week, the Committee agreed final modifications to the net stable funding ratio (NSFR), which will be published in the coming weeks. The NSFR complements the liquidity coverage ratio (LCR) and ensures that a bank maintains a stable funding profile in relation to the composition of its assets and off-balance sheet activities. After many decades of trying, we now have a global liquidity standard. It is now more than seven years since the start of the financial crisis. The biennial ICBS provides an opportunity for us, as an international community, to reflect on the effectiveness of the international standards, to discuss emerging issues, and to explore the challenges ahead. This ICBS focuses on both the post-Basel III reform agenda and the role of the financial system in promoting economic growth. However, finalising the Basel III framework does not mean that our policy work is done. We need to look closely at the regulatory framework, remind ourselves of the reasons why we put these measures in place, and ask whether they are delivering the right outcomes.

The reliability and comparability of risk-based capital ratios And that leads me to one of the important post-Basel III reform issues: the reliability and comparability of risk-based capital ratios.





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Consistency in the implementation of risk-based capital standards is a vital element in strengthening public confidence in regulatory capital ratios and promoting an international level playing field. The Committee is therefore assessing bank capital ratios with a view to ensuring that they appropriately reflect the risks that banks face. Our assessments thus far have found significant variation in banks' risk-weighted assets that are not explained by underlying differences in the riskiness of banks' portfolios. Excessive variation in risk-weighted assets undermines confidence in the risk-based capital framework as a measure of bank safety. The Committee is well aware of these concerns, and we are taking steps to reduce the variation arising from differences in how banks measure risk. At the same time, we know that variation in risk-weighted assets can arise from differences in the rules and implementation standards set by national regulators, and so we are also focusing on these areas.. The steps the Committee has taken, and plans to take, to address excessive variation in risk-weighted assets include: - the introduction of capital floors and benchmarks, and greater restrictions on the scope of banks' internal risk estimates. In this regard, there is recognition that not all risk parameters are suitable for modelling; - providing clarity on aspects of the Basel framework that are ambiguous, and reducing areas for national discretion; - strengthening the disclosure requirements relating to risk-weighted assets by amending Pillar 3 of the Basel framework; and -ensuring consistent implementation of Committee standards and monitoring outcomes of risk-weighted asset variability.





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Rather than go into the details of these measures, which I have spoken about previously, let me instead use this opportunity to talk more generally about the outcomes we are trying to achieve. We sometimes have a tendency to get bogged down in the policy details, and it is easy to lose sight of the overall objective. At the end of the day, the outcomes we are aiming for are: - a regulatory framework that promotes effective supervision; - consistent global implementation; - effective bank risk measurement and management; and, ultimately, - a strong, stable and efficient banking system. Too often, we have not given enough attention to whether the regulatory standards can be implemented consistently, or whether the standards serve to promote, or if they might potentially hinder, the task of day-to-day supervision. Improving the measurement and management of risk is, of course, a primary objective of bank managers and supervisors, and it is a critical factor for financial system stability. The Basel Committee spends a lot of time trying to ensure that banks' capital and liquidity buffers are strong enough to keep the system safe and sound. But a buffer can only be as reliable as the underlying risk measurement and management. No matter what we do as regulators and supervisors, it is ultimately bank managers that determine whether a bank will be successful. It is important to recognise the primacy of bank management - that is a fact that should also bear on the design of the regulatory and supervisory framework itself.





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With this in mind, how should the regulatory framework be designed in order to promote the outcomes we want to achieve? This brings me back to the issue of variability in risk-weighted assets. So, what should be done about it? Just as the unwarranted variation in risk-weighted assets arises due to a variety of factors, there are a multitude of measures that the Committee is considering to address the issue. But at the heart of the issue is a debate about the basic design of the regulatory framework itself. On one side of the debate is the view that the current regulatory framework, with its reliance on internal models, should be highly risk-sensitive and therefore most likely to promote better risk measurement and management in the longer term. The underlying principle is that improvements in risk management are best achieved by promoting regulatory approaches that are aligned with internal bank risk management practices. However, those who support this view still recognise that changes need to be made. There need to be more restrictions on modelling assumptions and techniques, and an acceptance that not all risks can be modelled. Moreover, safeguards can be put in place, such as capital floors and the leverage ratio, to serve as a backstop to the risk-based regime. In summary, one side of the debate believes that the outcomes we want to achieve are best promoted by maintaining internal risk models, though in in a more limited way with floors and other safeguards. On the other side of the debate, there is evidence that in some cases internal models have been used to minimise risk-weighted assets - and,





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therefore, regulatory capital - rather than to promote improvements in risk measurement and management. Those who hold this view argue that the complexity and opacity of internal modelling approaches have hindered rather than helped supervision. Moreover, they assert that the outcomes we want to achieve (including better risk management) can be promoted by significantly simplifying the regulatory framework. It is important to note that, even under this approach, there is a role in the regulatory framework for the internal models of large internationally active banks. For example, such banks could still be required to meet rigorous risk measurement and management standards but, instead of rewarding them with a lower capital requirement, a higher capital requirement would apply where banks fail to meet supervisory expectations for risk measurement and management. I have laid out two quite different views of how the regulatory framework should be designed to best achieve our desired outcomes. The one dangles a carrot to induce better risk measurement and management at banks and relies on internal models to determine regulatory capital requirements. The other relies on supervisory-determined models for setting minimum capital requirements, but threatens a stick to penalise those banks that do not meet required risk management standards. The questions I have posed, but which I do not intend to answer are: - which regulatory framework is most likely to promote effective supervision, consistent implementation and effective risk measurement and management? and





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- which approach is likely to find the right balance between simplicity, comparability and risk sensitivity? The simpler we make the framework, the less risk-sensitive it becomes. Conversely, the more risk-sensitive the framework is, the more complex implementation and supervision become. There are no easy answers, but the need to balance these items is becoming ingrained in the mindset of those responsible for policy development and implementation. The Committee is undertaking a long-term strategic review of the capital framework to determine whether there are areas where we could reduce the level of complexity or where comparability could be improved to better meet the Committee's objectives. We are also looking at whether the use of banks' own risk models to calculate regulatory capital is helping or hindering the Committee's pursuit of those goals.

Concluding remarks To conclude, I would like to come back to my starting point - that is, the importance of communication and cooperation amongst supervisors. The foundations of global banking are much stronger when we share information and act together in implementing sound prudential standards. Cooperation and coordination enhance trust between authorities and improve our effectiveness. Yet, as with any relationship, trust can take a long time to develop, but can be destroyed quickly. The ICBS offers us all an opportunity to further build that trust.





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For any financial system to function well, its players need to have confidence in each other - banks, regulatory authorities and market participants alike. Market participants need to be able to compare reported regulatory ratios, and comparability needs to be supported by consistent implementation and a comprehensive disclosure framework. And there needs to be confidence that the rules work: that riskier banks hold more capital and that the rules are consistently applied. At the same time, we must continue to monitor implementation of the Basel reforms. The Basel Committee has already started to assess the consistency of domestic implementation of Basel III capital requirements and will soon be broadening its review to include the LCR, systemically important bank frameworks and the leverage ratio. Consistent implementation will help improve comparability, and reassure market participants that they can accurately assess bank risk. As our work is ongoing, it would be wholly misleading to say that we are done. A supervisor's job is never done. We believe that we are on the right path to a more resilient financial system but we must remain vigilant in the face of changing banking activities and markets, and we must also learn the lessons from implementation. The Committee is exercising this vigilance through its impact monitoring, by assessing the consistency of implementation, by refining selected elements of the framework, and also by thinking more broadly about the regulatory framework while staying alert to new threats to financial stability.





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I hope that the discussions today and tomorrow are productive ones and that you find them valuable in steering your own work. I also look forward to hearing your views on the issues on the Committee's agenda and wish you an enjoyable and rewarding two days in Tianjin.





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Are we there yet? The United States and Canada after the global financial crisis Remarks by Mr Timothy Lane, Deputy Governor of the Bank of Canada, at Carleton University, Ottawa, Ontario

Introduction It is a pleasure to be here at Carleton University. It has been a long time since I was a student here, but I still get caught up in the back-to- school feeling of September. It’s a time of fresh starts and renewed energy. Today I would like to talk about the economies of the United States and Canada and how our economic ties are evolving as the recovery from the financial crisis of 2008–09 continues. I will discuss the impact on Canada of the Federal Reserve’s unconventional monetary policies, and how Canada will be affected as these policies are gradually brought back to normal. While there are risks associated with this process, the Bank of Canada sees it as a positive sign that the U.S. economy is experiencing its own fresh start and gaining renewed energy.

Ties that bind ... sort of Let me start with the ties between the United States and Canada. We are more than neighbours; perhaps we are more like fourth-year roommates. Economically, we need each other and have strong links. Over the years, we’ve been through good times and bad.





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We live comfortably together, provided that we respect each other’s space. On the whole, having our fortunes linked with those of the United States works in Canada’s favour. Our businesses can take advantage of the opportunities of a much larger market. That means more jobs in Canada. But, over the past several years, we have also been reminded that these strong ties expose us to adverse forces in times of stress. The old cliché is that “when the U.S. sneezes, Canada catches a cold.” There is an element of truth to that adage, but it only goes so far. Our economies do not move perfectly in sync, partly because they are structurally different: most obviously, ours is much more reliant on natural resources. And despite the strong influence of the United States, as economic policy-makers in Canada, we have plenty of scope to follow a different path. To explore these ties – particularly as they relate to my own field, monetary policy – let’s take a closer look at the financial crisis of 2008–09, the subsequent worldwide recession and the bumpy recovery. First, I’ll talk briefly about how Canada’s experience through that period has been similar to, yet different from, that of the United States. Then I’ll elaborate on where we are now, the challenges facing policy-makers in the United States, and what they mean for Canada.

Tales of a global recession





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The financial crisis, which started with an overheated and precariously financed U.S. housing market, did not just affect Canada – it triggered a worldwide recession. In 2008, the dramatic failure of Lehman Brothers was effective, if nothing else, in concentrating minds: the world looked into the abyss and took notice. In a historic display of consensus, the G-7 agreed to take whatever steps were required to stem the crisis. They lowered policy interest rates sharply (Chart 1) and in a coordinated manner; they flooded the financial system with liquidity to quell the panic; and they stood behind systemically important financial institutions.

These aggressive and coordinated policy actions prevented a financial and economic collapse that could have rivalled the Great Depression.





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Nonetheless, they did not prevent a severe and protracted global recession, which led to a period of weak and uneven global growth that continues to the present day. Through the crisis and beyond, the Federal Reserve acted aggressively and unconventionally – first to stem the crisis and, later on, to support the recovery. Like other central banks, the Fed began by boldly lowering its standard monetary policy instrument, the federal funds rate, as low as it could go. With policy interest rates at their lower bound, the Federal Reserve also went to unusual lengths in providing forward guidance – communicating how long those rates would be likely to stay at their current level and, more recently, the factors that they would take into account in deciding when to start raising them. The Fed also innovated by introducing large-scale asset purchases (LSAPs), best known as quantitative easing, or QE.





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QE provides an injection of liquidity into a stalled economy through the central bank’s purchases of financial assets such as government bonds and mortgage-backed securities. These operations have had pervasive effects on financial markets – not only in the United States but globally. They work through a variety of channels, including by pushing down long-term interest rates and the external value of the U.S. dollar and pushing up the prices of risky financial assets such as equities (Chart 2).

As a related effect, these operations by the Federal Reserve – together with the unconventional policies of central banks of other major economies – have pushed the volatility of financial assets down to near historically low levels (Chart 3). The resulting exceptionally buoyant financial conditions suggest that risk and vulnerability have increased in the financial system. But, during this period, returning the United States to sustained economic growth has been of paramount importance.

While there was some concern that QE could have resulted in runaway inflation, that hasn’t happened.





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In fact, the U.S. economy remained weak and inflation mainly below the Federal Reserve’s target. That’s because QE was being carried out in the context of the widespread private sector deleveraging after the financial crisis; and, despite the unprecedented scale of the operations, it was still not enough to break the economy out of its post-crisis funk.

Canada: innocent bystander? Here in Canada, we didn’t have a homegrown financial crash. While the Bank of Canada acted promptly and aggressively to provide liquidity to keep financial markets functioning, no banks had to be rescued and house prices didn’t plunge. This is not to say we were lily pure. In fact, in 2007, a specialized Canadian market collapsed – the market for non-bank- sponsored asset-backed commercial paper (ABCP). It was only through timely and forceful action by the public and private sectors that this situation was resolved without generating wider fallout. Nevertheless, the recession in Canada was painful. This was mainly because our exports collapsed. It’s not just that about three-quarters of our exports go to the United States, but also that they are linked to sectors of the U.S. economy, such as housing and business investment, that fared particularly badly in the recession. To get us through this period of very weak exports, we also relied on stimulative monetary policy. Like the United States and other advanced economies, we lowered rates to their “effective lower bound” – in our case, 1/4 per cent.





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Unlike the United States, we did not need QE, although we did provide forward guidance for our policy rate, itself a form of unconventional monetary policy, for the year following April 2009. Our financial system was more robust, so easy monetary policy was transmitted into expanding credit for Canadian households and companies. In contrast with the United States, we had a buoyant, albeit uneven, housing market through the recession and beyond. Another important factor is that natural resource prices remained at elevated levels, so our resource industries recovered quickly. These prices were supported by the strong growth in China and other emerging-market economies, which slowed down with the global recession but quickly picked up again. The resource economy powered ahead, boosting disposable incomes, employment, engineering investment and government revenues. Canada bounced back quickly. By late 2010, we had passed the pre-crisis peak in GDP and employment – we were out of the recovery and into the expansion. At the Bank of Canada, we saw a need to get interest rates off the floor and raised them in a series of steps to 1 per cent. But then we were in for a round of disappointments and challenges of our own. As Canada’s recovery unfolded, our economy became increasingly unbalanced. Our non-energy exports, after picking up quickly, stalled well below their pre-recession level (Chart 4).





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Economic growth became increasingly reliant on building more and more homes, mortgaged at rock- bottom interest rates and driving up the indebtedness of Canadians to unprecedented levels (Chart 5). That source of growth was increasingly tapped out.





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And it built up vulnerabilities in our financial system, which could spell trouble down the road. Another disappointment was that, last year, even as the U.S. economy began to strengthen, Canadian non-energy exports did not pick up as expected. Why not? This is a puzzle we are much closer to understanding – but our understanding is still imperfect. I won’t dwell on this topic, as my colleagues have already said a lot about our weak export sector. Suffice to say that weak exports have meant that Canada has had to rely on exceptional monetary policy stimulus for even longer than we expected. Our policy interest rate has stayed at 1 per cent since 2010.

What effects did the Federal Reserve’s unconventional monetary policies have on Canada during this period? Our analysis indicates that, for Canada, their net effect has been positive. The Fed’s policies have pushed down our market interest rates and, by promoting U.S. growth, have added to the demand for our exports. On the downside, these policies may have been one of the factors putting upward pressure on the Canadian dollar. But, on balance, the effects have been positive for Canada.

Morning in America? So where are we now, in this long process of getting back to sustained economic growth? The U.S. economy is in expansion, with the private sector taking the lead.





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The headwinds that came from deleveraging – consumers whittling away at heavy debt loads – are abating and the net worth of those consumers has improved markedly (Chart 6). And the process of fiscal consolidation – bringing the federal budget deficit down to a more sustainable level – is largely complete (Chart 7).





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But growth has remained fairly modest. It’s not quite clear why. Perhaps uncertainty about demand is still holding back business decisions and investment. Given the rocky road of the last few years, this is to be expected. While U.S. housing markets are reviving, they are following an uneven and uncertain path, and there is a lot of room for improvement. Home construction is well below its pre-recession level, and the excess housing stock has largely been depleted (Chart 8).

Likewise, there is room for improvement in labour markets, which are a long way from normal. On average, about 200,000 net new jobs were created each month during the past three years. Unemployment, which spiked during the recession, has fallen by about 4 percentage points since its peak.

How does Canada compare?





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Since Canada experienced a shorter recession, our labour market conditions did not deteriorate as much, and were also faster to recover. For instance, by January 2011, Canada had recovered the number of jobs it lost during the recession – whereas the United States only reached that point in May of this year (Chart 9).

But since 2011, Canada has been creating new jobs at a much slower pace than has the United States. Similarly, our unemployment rate did not rise as much during the recession, but has been coming down more slowly – and, if measured in the same way, is now at about the same level as it is in the United States. In both countries, the unemployment rate does not fully capture the labour market slack. In both the United States and Canada, there are still elevated levels of long-term unemployment and involuntary part-time employment, while wage gains continue to be moderate relative to historical norms (Chart 10).





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And here, as in the United States, young people are having a hard time finding jobs, and many have dropped out of the workforce.





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Our comprehensive measure of labour market slack has shown less slack than in the United States, but the gap has been narrowing (Chart 11).

In all, while the U.S. economy is improving, there have been bumps in the road, and there will be more as the expansion continues.

What is the Fed doing? It is in this context that the Federal Reserve has been winding down its QE purchases and has signalled its plan to return gradually to a more normal monetary policy stance, starting sometime next year. The precise timing and pace of that exit will depend on how the economy is performing. Like most decisions, this involves a balancing of risks. Tightening monetary policy too early could plunge the economy back into recession. Moving too late could let inflation take off and require more tightening to get it back under control. It could also result in bigger financial imbalances which, later on, if they unwind, could throw inflation into another downdraft. A formal difference between the Federal Reserve and the Bank of Canada is the Fed’s “dual mandate” to promote the goals of maximum employment and stable prices. This is in contrast to the Bank of Canada’s monetary policy framework: a target of 2 per cent inflation. But this contrast between our inflation target and the Fed’s dual mandate is not as sharp as it seems. When inflation expectations are well anchored, bringing inflation sustainably to the target depends mainly on bringing the economy to its potential – in other words, closing the output gap.





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In assessing the output gap, conditions in the labour market are one of the main things we look at. Last week, the Fed reconfirmed that it will likely end its QE program at its next meeting in October. This means that the Fed no longer expects to be purchasing additional financial assets under that program, which it has been gradually tapering since last January. The next challenge for the Fed is how to unwind the various other elements of unconventional monetary policy stimulus, which include ultra-low interest rates, a large volume of excess reserves in the financial system and a large Federal Reserve balance sheet (Chart 12). The composition of that balance sheet (e.g., government bonds of different maturities, mortgage-backed securities) may also matter. When is it time to start to reverse these policies? What are the right pace and sequence for each element?





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A key step in normalizing policy will be to start increasing the target for the federal funds rate, which is currently still in a range of 0 to 1/4 per cent. This can be accomplished, in part, by gradually raising the interest rate the Fed pays on excess reserves. The Fed will also remove excess reserves from the financial system, in order to control short- term interest rates. They have introduced and test-driven an overnight reverse repo facility that they will use for that purpose. Restoring the Federal Reserve’s balance sheet to its normal size is a process that is likely to be accomplished over a longer period. It is important to note, however, that the size of its balance sheet will not hinder the Fed’s ability to control the policy rate and liquidity in the economy. The framework they have outlined will limit the risk that large excess reserves could lead to excessive loan creation and a sharp increase in inflation. Does this sound complicated? Yes – because it is complicated. But we have full confidence in our colleagues at the Federal Reserve to manage this process well. How will the renormalization of monetary policy play out in the financial system – both in the United States and globally? Asset prices, risk spreads and volatility are at levels that reflect the abundant liquidity provided through unconventional monetary policies in the United States and some other countries, together with expectations that interest rates will be kept at very low levels for a long time. While the Federal Reserve will seek to guide the renormalization process so that markets readjust smoothly as monetary policy is brought back to





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normal, there is an important risk that there will be some bumps along the way.

What will the exit mean for Canada? On the whole, the Federal Reserve’s planned exit from unconventional monetary policies is part of a good news story for Canada. It is a sign that a sustained U.S. expansion is well under way. A more sustained U.S. expansion – a stronger housing market and robust business investment – should help our non-energy exports, which remain below their pre- recession level. As the U.S. economy regains vigour, it should also contribute to improved business and consumer confidence in Canada. However, from a policy-maker’s perspective, the renormalization of U.S. monetary policy will act to tighten Canadian monetary and financial conditions. The same analysis indicating that QE had stimulative effects on Canada should also work in reverse: unwinding unconventional policies will tend to push up market interest rates in Canada and dampen the U.S. expansion. This effect would only be partly offset by the downward pressure the exit would put on the value of the Canadian dollar. In the event that the Fed’s renormalization does not play out smoothly in financial markets, the impact on Canada could be significant. So how will all of this influence what the Bank of Canada would do? You can probably already anticipate my answer: “It depends.” The Bank of Canada’s goal is to achieve our 2 per cent target for inflation in a sustainable way, which requires that our economy run close to its full potential.





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We will need to assess the various countervailing effects in the context of Canadian economic and financial conditions more generally. Like the Fed, we will balance the risks of acting too soon and stifling burgeoning economic growth against the risks of acting too late and letting inflation overshoot and fuelling imbalances in our housing markets. But that balance of risks is likely to be different here than in the United States. Thus, while monetary policy in the United States has an important impact in Canada, I want to stress that Canadian monetary policy is independent and can diverge from the Fed’s policies. In fact, our policy rate is already higher than the Fed’s as a result of the moves we made four years ago in response to the improving economic conditions at that time. Looking forward, as always, our rate decisions will depend on the state of the Canadian economy. Preserving the value of money by keeping inflation low, stable and predictable is our mandate.

Are we there yet? Let me conclude. The financial crisis of 2008–09 reminded us how tightly linked the U.S. and Canadian economies are – for better or for worse. And the economic recovery has shown us that healing after a financial crisis is slow and often painful. The steps taken by the U.S. Federal Reserve, the central bank closest to the epicentre of the crisis, prevented the crisis and subsequent recession from being much worse. And they continue to support the U.S. and global economies through that long healing process.





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The Fed’s unconventional monetary policies affected Canada through various channels, notably by pushing down market interest rates worldwide. By the same token, as Fed policy returns to normal – which is likely to be a different state than before the crisis – that will tighten financial conditions in Canada. But this will be happening against the backdrop of stronger economic growth. It’s another step away from the dark days of the Great Recession and an affirmation that the hard work of economic reconstruction over the last six years is taking hold.





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EIOPA Multi-Annual Work Programme 2015 - 2017

1. Introduction EIOPA was set up in the year 2011, within the frame of the European System of Financial Supervision (ESFS), as a European Supervisory Authority with the aim of strengthening European supervisory arrangements with a view to better protect policyholders, pension scheme members and beneficiaries and to rebuilt trust in the financial system. EIOPA’s Multi-Annual Work Programme 2015-2017 is the outcome of the Authority’s annual planning round. This represents a series of exercises designed to establish where the focus of the Authority’s work lies, and where it should allocate its resources, both human and financial, allowing for appropriate prioritisation of tasks, and ongoing monitoring of progress towards the Authority’s strategic ambitions. It provides transparency and accountability to EIOPA’s main stakeholders and serves internally as a management toolkit, linking the specific annual and multi-annual products and services of the Authority to its overall strategic goals: 1. to ensure transparency, simplicity, accessibility and fairness across the internal market for consumers; 2. to lead the development of sound and prudent regulations supporting the EU internal market; 3. to improve the quality, efficiency and consistency of the supervision of EU insurers and occupational pensions;





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4. to identify, assess, mitigate and manage risks and threats to the financial stability of the insurance and occupational pensions sectors; and 5. EIOPA to act as a modern, competent and professional organisation, with effective governance arrangements, efficient processes and a positive reputation. The MAWP 2015 – 2017 sets the high level objectives and the main areas of work that will be delivered to achieve them. For each the ultimate desired outcome or ‘operational objective’, is described. This provides clarity on the purpose and value of EIOPA’s work, and enables prioritisation of the many competing demands for EIOPA’s limited resources. The following sections of the Multi-Annual Work Programme have been broken down by strategic goal and provide an overview of EIOPA’s main areas of work under each. To provide additional information there are three Annexes: • Annex I - providing greater detail on EIOPA’s work across the three years of the Multi-Annual Work Programme; • Annex II - describing the specific products and services that will be delivered in 2015; and • Annex III – the Key Performance Indicators (KPI), which will be used to judge EIOPA’s progress in achieving its strategic ambitions.

2. Strategic Goals 1. To ensure transparency, simplicity, accessibility and fairness across the internal market for consumers EIOPA has a clear and important mandate to tackle threats to consumer protection arising in the insurance and occupational pension markets.





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Within this goal, EIOPA’s strategic objectives are to: • develop a framework assisting consumers of insurance and occupational pensions’ products to make informed choices based on their rights and obligations as consumers; • develop a framework for proper selling practises for direct sellers and intermediaries ensuring that advice to consumers is based on what best suits their needs and profiles; • provide a framework for better governance, suitability and accessibility of insurance and (occupational) pensions products for consumers; • promote effective redress mechanisms at national levels, including as a basis consumers’ complaints and claims; and • promote the establishment of consistent insurance guarantee schemes across the Union as a last resort for consumer protection (in case insurers and other financial institutions have insufficient assets to meet their obligations or are insolvent). The ability of consumers1 to make informed choices is a decisive factor in ensuring they are able to find the best product to meet their demands and needs. Awareness of their rights will also give them confidence to hold providers to their obligations. Core to EIOPA’s framework for informed choice will therefore be the provision of sufficient and appropriate information, where a better, more consumer-friendly approach is needed. It is not only important that service/product providers disclose adequate information, consumers also need to be in a position to understand the information provided. In the consumer literacy domain, EIOPA will support coordination of Member State initiatives to address financial illiteracy amongst





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consumers by providing NCAs and consumers with an overview of activities across the member states. Through ongoing monitoring and analysis of trends in consumer behaviour and financial innovation, EIOPA will also seek to proactively identify potential threats of consumer detriment. In response to an identified threat, EIOPA will assess possible measures to be taken in response, and, where appropriate, issue warnings. Where any serious consumer detriment is identified in relation to packaged retail and insurance-based investment products (PRIIPs), EIOPA will in the future also be able to ban or restrict any such financial activity. Improper selling practices are one example of a potential consumer protection threat, and as such, is an area of focus for EIOPA. In terms of legislation and regulation, EIOPA will support a level playing field across the internal market in the domain of consumer protection via a number of key regulatory areas of work e.g. the amendment of Insurance Mediation Directive (IMD) and recast Insurance Mediation Directive (“IMD2”). EIOPA will also undertake work to ensure improved the governance, suitability and accessibility of insurance and occupational pension products. The framework developed by EIOPA in this domain will be closely related to Solvency II for the insurance market and Institutions for Occupational Retirement Provision (IORP) II for the occupational pensions market. It will include legal instruments designed to discourage the selling of products and services that may result in consumer detriment. EIOPA’s Advice to the Commission on consumer protection elements of personal pensions will also address identified issues in product governance, suitability and accessibility.





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Furthermore, EIOPA will pursue cross-sectoral and regulatory convergence in terms of governance, suitability and accessibility under the remit of the Joint Committee. This is crucial given the extent to which consumer detriment issues can be cross-sectoral in nature. EIOPA’s work to ensure improved consumer choice, selling practices and the products themselves will be supplemented by continued effort in the field of effective redress mechanisms, with a focus on good practice guidance on topics such as complaints- handling in the pensions area. EIOPA also stands ready to provide further technical input on Insurance Guarantee Schemes (IGS) on request by the European Commission. 2. To lead the development of sound and prudent regulation supporting the EU internal market A sound and prudent regulatory framework is key to improving the functioning of the internal market by removing scope for regulatory arbitrage and safeguarding effective consumer protection. The high quality common standards and practices developed by EIOPA within this framework contribute to a common supervisory culture and to a single rulebook in the field of insurance and pensions. Within this goal, EIOPA’s strategic objectives are to: • develop high quality and timely regulatory instruments, remove scope for regulatory arbitrage and safeguard effective consumer protection; • ensure rigorous assessment of advice, standards, guidelines and opinions via impact assessment, peer review, public consultation and other tools; • ensure in revision and continuous improvement of the regulatory instruments; and





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• foster a continuous dialogue with key stakeholders, both within the EU and internationally, in favour of sound and prudent regulation supporting the EU internal market. Developing high quality and timely regulatory instruments supporting application of Solvency II (scheduled for 1 January 2016) will continue to be a major focus for EIOPA. The Authority’s support to Solvency II will not end in 2016, but instead develop with the balance of activities shifting from the development of regulatory policy to implementation and review of that policy. The regulations under Solvency II comprise 25 empowerments for implementing technical standards. EIOPA will finalise the last 12 implementing technical and deliver the final 7 of 30 guidelines necessary for ‘day 1’ of Solvency II’s implementation. Further guidelines required to engender EU wide consistency in the approach of supervisors to insurance undertakings, but not necessary from day 1, will be developed after its application. EIOPA will be the source of consistent information required by undertakings to calculate their liabilities, including the relevant risk free rate term structure needed to calculate the best estimate, the application of the so-called equity dampener, and of the volatility adjustment. To ensure EIOPA is in a position to fulfil this important responsibility, during 2015 the Authority will design, test and implement processes supporting the various calculations. In 2016 and 17, this information will then be made available consistent with the requirements as described under Solvency II. EIOPA will also design the process by which it will review and gather data for the later review of the calibration of capital charges.





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EIOPA will report annually, as required by the Omnibus II directive, on the long term guarantee measures under that directive. EIOPA will also review the experience of the preparatory guidelines in order to make recommendations in respect of future guidelines. EIOPA’s regulatory work in the field of pensions will contribute to the development of an adequate, safe and sustainable pensions system. A cornerstone of this system is that the promises made by providers are promises that are kept and this is rooted in the availability of sufficient financial resources. Regulatory regimes collectively need to face the “economic reality test” of a transparent and realistic assessment of the financial position of pension funds. This can only be achieved via the objective valuation of assets and liabilities on a market-consistent basis. EIOPA will continue to provide advice on solvency topics for occupational pensions and supporting a risk-based regulatory regime providing Institutions for Occupational Retirement Provision (IORPs) with the right incentives for managing risks. EIOPA regulations will also help enhance the internal market by facilitating cross-border provision of occupational pensions, and ensure high standards of governance and disclosure for all members and beneficiaries. Activities on occupational pensions will be focused on the Institutions for Occupational Retirement Provision (IORP) II directive. The development of sound and prudent regulations requires an understanding of the size and nature of the insurance and occupational pensions sectors. EIOPA will therefore continue to update its register of EU pension arrangements, its register of IORPs and its database on EU (re)insurance undertakings.





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This data will provide the basis for better regulations which reflect the characteristics of European insurers and occupational pensions and allow for a proportionate approach to requirements setting. EIOPA is committed to ensuring that prior to finalisation, all the instruments (technical standard, guideline, opinion) it produces are subject to a rigorous assessment of the costs and benefits to different parties. EIOPA instruments will also continue to benefit from valuable input from Stakeholder Groups for insurance (IRSG) and occupational pensions (OPSG). These Groups represent those principally affected and participation includes consumer and employees’ interests, independent academics, as well as representatives of the providers and users of insurance and occupational pensions. EIOPA will also monitor the European and international accounting environment to ensure its instruments reflect the developments and requirements impacting on all EU undertakings. EIOPA regulatory work benefits from its outward facing and proactive engagement with its members and key international organisations. Active engagement with bodies such as the International Association of Insurance Supervisors (IAIS) provides EIOPA with the opportunity to shape international standards and to learn from good practice in other parts of the world. EIOPA will contribute to any proposal for a basic capital requirement and will continue to play a leading role in the European view on the development of international capital standards for insurance groups, including their field testing. Particular focus will be put on the higher loss absorbency requirements for Globally Systemic Insurers (g-SIIs).





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EIOPA will also participate in the debate on international accounting matters to ensure cross-sectoral consistency. EIOPA remains ready to provide equivalence assessments for third countries as requested by group supervisors, provide further equivalence assessments as requested by the European Commission (EC), and as required update previous assessments. Finally, EIOPA will continue its programme of regulatory dialogues with key regional bodies and countries. 3. To improve the quality, efficiency and consistency of the supervision of EU insurers and occupational pensions. EIOPA is mandated to support NCAs with a focus on enhancing the quality and consistency of national supervision, strengthening oversight of cross-border groups and helping national supervisors to deliver effective supervision. Day-to-day supervision is within the mandate, authority and responsibility of each individual NCA. By maintaining an independent position as it offers assistance and advice, EIOPA can support a fair and balanced supervisory system that is of benefit to all parties involved. Within this goal, EIOPA’s strategic objectives are to: • achieve a convergent approach to supervision across the EU in order to bring a level playing field, and remove scope for supervisory arbitrage and provide harmonised consumer protection; • ensure a consistent implementation of European regulatory and supervisory frameworks; • increase the quality of supervision in the EU, including contributing to an appropriate supervision of undertakings within the EU and to enhance consumer protection; and





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• Increase the overall efficiency of the supervisory system by promoting effective exchange of information and developing high quality supervisory tools. Convergence can be characterised as setting the sights on a spot on the horizon and all parties starting to move towards that point, whilst accepting that the singular point might never be reached. Convergence is the process (accelerated by EIOPA’s insightful, relevant and challenging feedback) of NCA’s moving closer towards a European approach to supervision/ supervisory outcomes that are consistent across countries, of high quality and efficient. The introduction of Solvency II offers both risk and opportunity. The years 2015-17 will be times of change within Members, as they implement the requirements of the new regulation. This brings the risk of inconsistent implementation, but in this time of fluidity EIOPA has an opportunity to influence how the new regulation is implemented and show the Authority’s value in achieving greater harmonisation and coherent application of rules for financial institutions by supporting and providing feedback to Members. As a result, EIOPA’s primary focus will be the implementation of Solvency II. EIOPA has already produced a number of tools to promote convergence e.g. Colleges Action Plan and good practices on Internal Models. A number of workstreams will be undertaken in support of these objectives. The Supervisory Handbook will be a cornerstone of this effort and will address areas, such as risk management, in which supervisory convergence will contribute to a level playing field with benefits for the functioning of the internal market. “Consistent” is not taken to mean “identical”.





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EIOPA recognises that different NSAs are starting the journey from very different places and that national specificities will continue into the long term. Colleges of Supervisors have a crucial role in the supervision of the largest and often most complex (cross-border) groups. EIOPA’s Colleges Team will continue to lead the promotion of consistency in the functioning of colleges. Consistency should apply between similar risks and units within one group, between similar risks and firms within one country (same NCA) as well as between similar risks and firms across EU countries (multiple NCAs). The team provides oversight on the functioning of colleges, along with tailored expert advice and the unique opportunity to compare practices. EIOPA also maintains up-to-date information on groups, and college members and participants, which it summarises and makes available to the public. EIOPA will increase its participation in joint on-site examinations, where the Authority can support the process and provide feedback on approaches and methods. The application of Internal Models will be an area of focus in 2015 and 2016, and the capability EIOPA is developing in this field will provide valuable support. EIOPA’s Centre for Expertise in Internal Models will also contribute to the enhancement of convergence and consistency through the development of new tools and practices. This key role for EIOPA in this field has been called for by industry and supervisors alike. Aspects of quality include:





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• prioritisation by an NCA (focusing on the important risks and firms); • people (having skilled and trained staff); • processes and decision taking; • independence (from influence by firms, industry or conflicting objectives set by government); and • taking into account the local conditions (not a one-size-fits-all approach). EIOPA’s Oversight Team will maintain regular bilateral contacts with NCAs in order to monitor their preparation for and ultimate implementation of Solvency II. This will provide the opportunity to better understand national variations in supervisory and regulatory frameworks, and provide feedback to each NCA in order to enhance convergence. This feedback will include identified good practices based on the reviewing, monitoring and reporting of supervisory programmes, practices and results. In addition to supporting convergence of supervisory practices this work will support development of the capability of national competent authorities to achieve high-quality supervisory outcomes. Many of the tools to promote convergence will also improve efficiency by providing solutions that NCAs will not need to develop themselves. Efficiency should be seen from the system perspective, not having 28 solutions to the same problem, but best practices, common templates and common tools developed by EIOPA. New regulations and initiatives offer an opportunity to take the initiative and improve consistency and efficiency in NCAs.





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In addition to EIOPA’s formal role in mediation, there is likely to be an equally demanding informal role, this includes the Question and Answers process as well as sharing practical solutions and examples of cooperation that will identify options for convergence based on practical experience of what works and what adds the greatest value. The Peer Review Process is another approach for developing consistency. Driven by Members and supported by EIOPA, EIOPA’s Members will continue to conduct peer reviews, each will focus on a specific topic and identify the outcomes achieved, identify best practices and make concrete recommendations for improving. EIOPA also seeks to positively influence the supervisory culture through sectoral and cross-sectoral training and events. By its nature, driving cultural change is a long-term goal as it impacts on deep rooted attitudes, beliefs and values. State-of-the-art methodology, and modern tools such as webinars and web conferences will be employed to increase outreach in the supervisory community. For each year’s training programme, EIOPA engages extensively with its stakeholders and the other ESAs to ensure its training and events programmes are of value and interest. EIOPA will consistently increase a number of events per year, with a shift in focus from policy to implementation, which will include technical training seminars and public events. 4. To identify, assess, mitigate and manage risks and threats to the financial stability of the insurance and occupational pensions sectors. In order to safeguard financial stability it is necessary to identify, at an early stage, trends, potential risks and vulnerabilities stemming from the micro-prudential level, across borders and across sectors. The Authority monitors and assesses such developments in the area of insurance and occupational pensions.





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Within this goal, EIOPA’s strategic objectives are to: • collect relevant, comprehensive, high-quality information to support the identification, mitigation and management of risks; • regularly assess the available information to identify risks and threats in order to develop mitigation and management proposals; • develop and Implement proposals to mitigate and manage risks and threats to financial stability; and • ensure continuous development and improvement of the tools and techniques used to identify, mitigate and manage risks and threats. The overarching theme for the financial stability area for the years 2015-2017 is to further build its capacity for collection of high quality information. As in the Oversight area, considerable focus will be on Solvency II, as the preparatory phase will introduce the first regular quantities reporting by NCAs of supervisory reports of individual firms to EIOPA. Having the detailed overview will equip EIOPA with the capacity to identify potential risks and vulnerabilities on a European level. The capacity to collect, store and process the quantitative reports and to provide feedback and reports to the NCAs will be the focus for 2015. In the years after, as Solvency II is implemented, the process of information collection and feedback will be further fine-tuned, with short processing times and improved overall quality at a European level. Also more granular and higher quality information will become available in the area of occupational pensions and consumer protection. The foreseen introduction of a global legal entity identifier (LEI) will improve the quality, reliability and comparability of data.





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EIOPA encourages the use of LEIs by the national competent authorities when fulfilling their reporting obligations to EIOPA which will enhance supervisory convergence. The evaluation and report on the pensions stress test, to be conducted in 2015, will provide further insights how the Authority can improve its identification of trends, potential risks and vulnerabilities. Early awareness and identification is the basic requirement to effectively address any risk or threat to financial stability arising from the insurance and pensions market. EIOPA will continue to implement and operate its regular risk assessment activity in conjuncture with the consideration of actions in terms of facilitation, coordination or other actions in response to a threat. Regular monitoring and analysis will take the form of the core EIOPA risk products of: quarterly risk dashboards, the publication of biannual Financial Risk reports and ad hoc risk surveys. This process should put EIOPA and its Members in a better position to identify, assess and respond to risks and threats. Having identified risks and threats and whether trigger events have occurred requiring action by EIOPA, the Authority must then develop proposals for a policy response. In addition to facilitating/coordinating action by National Competent Authorities, EIOPA will stand ready to use its powers under its Regulation in terms the publication of Opinions and Recommendations. EIOPA will also carry out a regular, formal assessment of whether the conditions exist to formally trigger action by the Authority to facilitate or coordinate a supervisory response by National Competent Authorities. As supervisory data available to EIOPA develops, this will allow EIOPA to develop more sophisticated analytical tools and to bring the quality and intensity of its analysis to a new level.





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This will be reflected in a continuous evolution of EIOPA’s techniques and methods for identifying, assessing and responding to risks to financial stability based on Solvency II consistent information. The core themes that EIOPA will pursue will cover the development of early warning indicators, metrics to measure vulnerability to key risks, metrics to measure financial stress in the insurance and pensions sectors overall, desktop models to allow simulation exercises, thematic studies on issues such as interconnectedness, systemic significance of the insurance and pensions sectors; and the development recovery and resolution policy. In order to disseminate this work and to promote debate, EIOPA plans to publish details of such new developments in the form of technical articles in the regular Financial Stability Report or as standalone papers. Stress tests are a core instrument to assess the resilience of financial institutions to adverse market developments. In addition to following up on any recommendations from the 2014 Stress Test in the insurance field, EIOPA will explore the development of new stress test techniques on the basis of lessons learned in 2014, with particular development expected in terms of validation standards, tools to allow top-down tests to be done to challenge the bottom-up exercises, as well the use of reverse stress tests. EIOPA will also continue its close cooperation with the ESRB in relation to stress scenario development. A pensions stress test will be run in 2015 for the first time, while a further insurance stress test is planned for 2016. 5. EIOPA to act as a modern, competent and professional organisation, with effective governance arrangements, efficient processes and a positive reputation EIOPA aims to ensure a high, effective and consistent level of regulation and supervision for the EU market for insurance and pensions.





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To fulfil its role in achieving this, EIOPA’s core business must be supported with appropriate and effective management and administrative functions. Furthermore, in order for a supervisory authority to be effective, moral authority and a strong reputation are key. This can only be achieved when the internal governance of the organisation is strong, its resources skilled and capable and its day-to-day management efficient. In order to achieve this goal, EIOPA’s strategic objectives are to: • ensure effective governance, internal control and accountability processes; • provide consistently efficient and high quality support services both internally and to stakeholders; • build a strong internal culture and positive reputation; and • build high quality data governance mechanisms servicing all data management needs. EIOPA will continue to implement efficiency measures wherever possible, ensuring value for money across its functions and effective governance whereby staff and stakeholders are not burdened with overly extensive administrative processes. By 2015, the maturity of the Authority’s governance, internal control and accountability processes will be well developed. Compliant and effective business, proactive finance, procurement and HR planning along with adherence to EU legislation across EIOPA’s operations will be strengthened as a result. However, maintaining a focus on continual improvement, EIOPA will continue to review and refine key processes and procedures in this area.





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All these developments and refinements are also used by EIOPA to identify areas where effective use of resources can be optimised and opportunities, in particular in terms of cost cutting, found. Effective cooperation and synergies with the European Institutions, Bodies and Agencies as well as with the German Authorities will lead to further efficiency gains. Where possible special attention will be given to sustainable and environmentally friendly solutions. Further improvements to the functioning of the organisation will be triggered by the finalisation of policy development for Solvency II. Considerable EIOPA resource has been invested in this task and its finalisation will allow for a more balanced approach, with greater focus on implementation. EIOPA’s role and work require highly skilled and engaged staff. Effort will continue to be invested in recruiting the right people and building a strong internal culture, so that when they arrive, they integrate well, feel a part of the corporate culture, strive for quality in their work, continuously develop and represent the Authority positively when engaging with its stakeholders. Internal and external communication also serves the aforementioned purpose, allowing the Authority to make its Members, the market and the general public aware of its good work, facilitating interaction and ensuring a culture of full transparency. This is not only self-promotion, but also a key element to realising the benefits of EIOPA’s products and services. EIOPA will continue the development of high quality data governance mechanisms servicing all data management needs, with a priority to secure exchange of information and information collected under the Solvency II framework.





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A secure, stable and well performing IT environment is a prerequisite for any modern organisation and EIOPA will undertake both development and maintenance work to ensure this is the case for its staff and stakeholders. EIOPA will also continue its work building a sophisticated technical infrastructure and data management environment to allow secure collection and processing of supervisory information. Core elements of this process include the creation of a secure data repository, the specification of a detailed data taxonomy and the implementation of detailed data management standards, rules and processes.

3. Joint Committee Close coordination through the Joint Committee to ensure cross-sectoral consistency in the activities of the ESAs As an integral part of the ESFS, EIOPA takes a proactive role in the cross-sectoral work undertaken under the aegis of the Joint Committee, thereby contributing to common positions and convergence, where appropriate, avoiding potential overlaps with sectoral work, in particular with a view on regulation and supervision, and, most important, enhancing a level playing field within the financial sector. The core areas of focus are: • financial conglomerates; • accounting and auditing; • risk and vulnerabilities for financial stability; • consumer protection together with anti-money laundering measures; • information exchange with the European Systemic Risk Board (ESRB); and





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• development of the relationship between the ESRB and the ESAs - providing advice on the EU framework applicable to financial entities, consumer protection and to contributing to the cross-sectoral identification of risks and vulnerabilities in the financial system. The work of the Joint Committee is detailed in its own work program, adopted by the Board of Supervisors of the three ESAs after a proposal of the Joint Committee itself. EIOPA will continuously take a proactive approach to the JC related activities and their enhanced importance in view of the ESFS review, contributing to the smooth delivery of the Joint Committee work programme. In 2016, EIOPA will again chair the Joint Committee.

Annex I: EIOPA Products and Services Overview 2015-2017





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Statistics on payment, clearing and settlement systems in the CPMI countries Interesting tables

Note It is important that the country tables are read in conjunction with the corresponding statistical methodology. Where the data provided are an exception to the methodology, this is indicated by in the table concerned. A second statistical methodology explains which data have been taken from the country tables for the comparative tables.





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To read more: http://www.bis.org/cpmi/publ/d120.pdf





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Key Questions for Monetary Policy Dennis Lockhart President and Chief Executive Officer Federal Reserve Bank of Atlanta

Key points - Atlanta Fed President and CEO Dennis Lockhart, in a September 25 speech before the Mississippi Council on Economic Education, shares his views on monetary policy over the medium term. - Lockhart's medium-term economic outlook calls for continued moderate growth around 3 percent annually accompanied by a substantial closing of the employment and inflation gaps. He notes that the economy's performance in coming quarters will dictate the decision to raise interest rates. He expects conditions for policy liftoff to ripen by mid-2015 or later. - Lockhart believes the United States will approach conditions consistent with full employment by late 2016 or early 2017. He believes the gap between headline employment and broader measures, such as the number of people working part-time for economic reasons, suggests there is more work to do before we can be satisfied with employment conditions. - Lockhart describes two inflation worries: persistent undershooting of the FOMC's 2 percent inflation goal and an overshoot of the goal that gets out of hand. Of those, a persistent undershoot is a bigger concern, in his view. - Lockhart also addresses concerns that the extended period of low rates might be feeding the risk of financial instability.





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He is comfortable that being patient regarding liftoff will not trigger a systemic financial event. - Lockhart is also carefully monitoring geopolitical risks. He says that financial markets seem to reflect a view that the U.S. real economy enjoys some insulation from severe spillover risk.

The speech Thank you for honoring me with the invitation to be your keynote speaker today. As you may know, the Federal Reserve Bank of Atlanta shares your goal to increase economic and financial literacy among our citizens. In fact, our New Orleans Branch staff has worked closely with the Mississippi Council on Economic Education for the past decade. Together, they produce "Focus on the Economy," an annual conference that attracts teachers from throughout Mississippi for sessions about the Fed, the economy, personal finance, and related topics. I am pleased to continue that tradition of partnership here this afternoon. Today I want to share my views on current and prospective monetary policy with a medium-term horizon. I'll start by describing the context in which the most recent decisions on monetary policy were made. I will round out my remarks with commentary on five front-and-center questions. They are questions my colleagues and I are having to engage as we shape monetary policy and public expectations.





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I must emphasize that the views you'll hear are my personal views. I am not speaking for the Federal Reserve or the Federal Open Market Committee (the FOMC). There is a healthy spread of opinion on the FOMC. I can assure you I have colleagues in the Federal Reserve System who will not entirely agree with my views. Before laying out the five questions, let me provide some background.

FOMC decisions change little Last week, I participated in a two-day meeting of the FOMC. The Committee's decisions involved very little change. The policy interest rate—the target range for the federal funds rate—was kept at zero to 25 basis points. This decision continues the policy of keeping the bellwether Fed policy rate effectively as low as it can go. The policy of a rock-bottom policy rate has been in effect since the fourth quarter of 2008. The statement that followed the meeting was updated in small ways from the July statement but conveyed little change in the outlook for the economy and the outlook for policy. Importantly, there was no substantive change in our forward guidance about how long the policy rate will be held at an effective rate of zero. The Committee reiterated the view that "liftoff" (the timing of the first move to raise rates) will likely occur a "considerable time" after the end of asset purchases (or QE, short for "quantitative easing") in October. The end of QE next month is now virtually certain. The statement also repeated the expectation of the Committee that once liftoff occurs, rates will rise at a gradual pace.





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I supported the Committee's decision to stay the course in both substance and language. For my part, I continue to expect conditions for liftoff to ripen by the middle of 2015 or a bit later. There are two more FOMC meetings this year and eight next year. As each meeting approaches, speculation will intensify that the Committee will signal in some way when the tightening cycle will begin. The timing isn't foreordained. The performance of the economy in the coming quarters should and will dictate the timing of liftoff. This conditionality has been expressed by stressing that the decision will be data-dependent. The phrase "data-dependent" is a kind of shorthand, as I see it. It's shorthand for a process of assessing, based on the best and most recent evidence we have, whether the economy is on the track we assume it's on. The data should tell us whether the outlook has worsened materially and give some hint as to whether downside risks around the outlook have intensified. Let me lay out in broad strokes my sense of the outlook. I expect GDP (gross domestic product) to grow at an average annual rate of 3 percent this quarter and next and through next year. Inflation, by most measures, is running below the FOMC's longer-run target of 2 percent. I expect inflation to firm up gradually as the economy continues on a 3 percent growth track.





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And I expect unemployment and underemployment to continue to decline at a steady pace. I think the country will approach a condition near full employment by late 2016 or early 2017. I'll ask you to keep this forecast in mind as I walk you through five questions confronting policymakers.

Question 1: Is the 3 percent growth story holding up? Yes, it appears so. The first half of the year 2014 had some wild swings from contraction in the first quarter to growth over 4 percent in the second. The second quarter had nonrecurring elements of a rebound from the drop-off in the first quarter. At this date, we have only tracking estimates for the third quarter. Tracking estimates gauge apparent growth in real time and make adjustments with each incoming piece of data. Most tracking estimates for the third quarter—including our own at the Atlanta Fed—gauge growth this quarter at around 3 percent. The recent run of data has been encouraging in many respects. Manufacturing data have shown improvement. The services sector has also seen improving activity. Consumer and business confidence indicators are rising. However, consumer activity per se has been growing only at a tepid pace, especially if you exclude auto sales. To be confident in an outlook of 3 percent or greater growth, we need to see consistency in consumer spending.





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The housing sector also raises some concern, and the recent appreciation of the dollar may dampen export activity in coming months. In some respects, I view GDP growth as a means to an end. A chief end is full employment. The question is whether the pace of growth is enough to sustain progress in reducing underutilization of labor resources in the economy. Will we get enough growth to continue to shrink labor market slack? That sets up the second question.

Question 2: How much labor market slack remains? Federal Reserve policy makers face the question of how much labor market slack remains. In its post-meeting communication last week, the Committee repeated the claim that significant underutilization of labor resources persists. I agree with this view. As you no doubt have heard or read, the recent national monthly payroll jobs report for August was disappointing relative to the average rate of jobs growth for the prior seven months. At the same time, the official unemployment rate—which stands at 6.1 percent—has been stuck around that level for a few months. I wouldn't read too much into short-term movements in the data. I think steady progress is still the right characterization of employment markets. No one measure of employment conditions tells the full story, in my view. I pay attention to a wide variety of indicators.





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In computing the unemployment rate, for example, if you worked an hour for pay in the last month, you're employed. A broader measure treats some part-time workers—namely those working part-time involuntarily—as not fully employed. The same broader measure includes the so-called marginally attached in the workforce and in the ranks of unemployed. Marginally attached workers are available for work but, for whatever reasons, have not looked for work in the last month. It's worrisome that the proportion of prime-working age men has grown among the marginally attached. The current level of headline unemployment is still some distance from my notion of full employment. And the gap between headline unemployment and broader measures suggests there is more work to do before we should be satisfied with employment conditions in the country.

Question 3: What is the risk of inflation? One way to assess the extent of labor slack is by observing wage pressures. Wage growth for the most part has been quite slow. We are not yet seeing much indication of broad-based wage or compensation pressure. Rising wages can be viewed as a link between employment conditions and broad price pressures, or inflation. Inflation is always a central banker's concern. I frequently hear a question about what inflation risk might be associated with keeping interest rates so low for longer.





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That's question three. As I said earlier, inflation is running below the 2 percent target the FOMC established in January of 2012. Inflation ran considerably below target for most of 2013 and early in this year. We saw some encouraging firming of prices in the spring, but recently measures of inflation have backed up a little. Separating short-term and transient effects from the underlying trend is always challenging. In its fundamentals, inflation is reflecting what are still, in my view, lukewarm demand conditions. I expect the inflation rate to rise only gradually to a sustainable 2 percent. There are two legitimate inflation worries. One is persistent undershooting, with all this would imply for the strength of economic activity. The other is an overshoot that gets out of hand. At this juncture, I'm more concerned about a persistent undershoot. I am relatively sanguine about the risk of a strong and undesired upside surge in inflation. Inflation expectations, which are very influential in shaping real outcomes, continue to be firmly anchored. Also, in talking to business contacts, I hear almost no claims of pricing power.

Question 4: What about financial stability?





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Another important question about the risk associated with keeping rates so low for longer is this: What risk of financial system instability might the Fed be feeding? Are we inviting another financial crisis? It's clear that U.S. equity market indexes are hitting historic highs. It's clear that buoyant bond markets are pricing in some continuation of ultra-low interest rate policy. And it's clear that investors have been searching for yield for quite some time. As a policymaker, I have to think about two scenarios. The first is that bond markets are somehow surprised in the coming months and that the transition to a period of tightening is disruptively and destructively volatile. Last year's so-called "taper tantrum" in the bond markets is something to avoid. The second scenario would resemble the recent financial crisis, not perhaps in its particulars, but in the sense that it was a systemic event. To my mind, the key filter in assessing risk levels in this regard is the word "systemic." I am comfortable that being patient regarding liftoff until the middle of next year or perhaps a little later will not bring on a systemic financial event. I take comfort in the much-strengthened defenses of the banking system, financial institutions in general, and financial regulators. I take comfort in the enhanced capital levels of the most systemically important institutions.





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I think defenses are dramatically improved, and the resilience of the financial system is measurably stronger than in 2007.

Question 5: What about geopolitical risks? My fifth and final question relates to the global context. With developments in the Middle East, tensions between the West and Russia over Ukraine, quite soft economic conditions in Europe, and challenges associated with a transitioning economy in China, it's fair to ask: how does a policymaker factor geopolitical risks into policy thinking? All these developments and others are monitored carefully, I can assure you. All these sources of potential geopolitical or global economic risk have been in our consciousness for a while. In my assessment, this concern is appropriately about an escalation of trouble that comes on suddenly and with great force. Such a shock could spill over through financial or commodity markets to the broad economy. It would be foolish to dismiss this risk entirely, but our financial markets seem to reflect a view that the U.S. real economy enjoys some insulation from severe spillover risk. I think that's a realistic assessment.

Conclusion I'll close with this thought: there are always risks around a projection of any path forward. There is always considerable uncertainty. Given what I see today, I'm pretty confident in a medium-term outlook of continued moderate growth around 3 percent per annum accompanied by a substantial closing of the employment and inflation gaps.





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In general, I'm more confident today than a year ago. I see the balance of risk around this outlook as reasonably balanced. No one has a perfect crystal ball, but I am rather confident that we'll get to economic conditions between mid- and late next year that would justify initiating a period of normalization of the interest rate environment.





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PCAOB Issues Staff Audit Practice Alert on the Auditor’s Consideration of a Company’s Ability to Continue as a Going Concern

Following recent changes to U.S. GAAP Washington, DC The Public Company Accounting Oversight Board issued a Staff Audit Practice Alert to remind auditors to continue to follow existing PCAOB standards when considering a company's ability to continue as a going concern. This alert is being issued in light of recent changes to U.S. generally accepted accounting principles, or U.S. GAAP, about disclosure of uncertainties about a company's ability to continue as a going concern. "An auditor's responsibility to evaluate a company's ability to continue as a going concern is an important part of the audit. With the recent changes to U.S. GAAP, the staff is issuing this alert to make clear that current auditing standards remain in effect," said PCAOB Chief Auditor and Director of Professional Standards Martin F. Baumann. The alert says that auditors should look to the applicable financial reporting framework—whether U.S. GAAP or International Financial Reporting Standards—to assess management's going concern evaluation and the related financial statement disclosures. The alert also makes clear that auditors should continue to look to the existing requirements of AU sec. 341 when evaluating whether the auditor's report requires an explanatory paragraph disclosing the auditor's substantial doubt about a company's ability to continue as a going concern.





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It also notes that the auditor's evaluation is qualitative based on the relevant events and conditions and other considerations set forth in AU sec. 341. A determination that no disclosure is required under U.S. GAAP or IFRS, as applicable, is not conclusive as to whether an explanatory paragraph is required under AU sec. 341. Auditors should make a separate evaluation of the need for disclosure in the auditor's report in accordance with the requirements of AU sec. 341. The PCAOB's standard-setting agenda includes a project to consider potential revisions to the going concern standard, AU sec. 341.





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Hearing at the Economic and Monetary Affairs (ECON) Committee of the European Parliament Gabriel Bernardino Chairman of EIOPA

Honourable Chair, Honourable members of the Committee on Economic and Monetary Affairs, As this is my first hearing since the European Parliament’s elections 2014, I would like to start by congratulating you for your election and you, Mr Chairman, on your appointment as Chair of the Committee on Economic and Monetary Affairs. I am happy to be back in front of the ECON Committee for our regular exchange of views. This is a key part of our accountability towards the European Parliament and transparency towards the European Citizens that elected you: to report on how we are delivering on the tasks and responsibilities assigned to us. Furthermore, to be able to discuss with you the challenges that we are facing today as well as those ahead of us. In the past 12-month period, EIOPA has achieved important milestones in all the areas foreseen by our mandate. Consumer protection continues to be one of EIOPA’s priorities, on the one hand by contributing to ensure that undertakings are soundly managed and have a robust solvency position and on the other hand by making sure that consumers receive the information they need, are treated fairly and get value and service for money.





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Our agenda in this area is focused on driving a paradigm shift in the direction of transparency towards consumers and on reinforcing fairness in selling practices. EIOPA undertook several initiatives aimed at product governance, product suitability, appropriate selling practices and better information for consumers. Reducing the challenge for consumers to understand complex products, EIOPA is leading cross- sectorial work to develop a Key Information Document for packaged retail and insurance-based investment products (“PRIIPs”). In order to enhance consumer protection EIOPA has identified potential conflicts of interest in insurance direct and intermediated sales, examined measures for addressing them, and assessed the impact for different stakeholders. Following our Guidelines on complaints-handling by insurance undertakings, many insurers updated their complaint management systems, which will ultimately help consumers to receive better services and solve problems, should they occur, in a quicker and a more efficient way. At the end of last year we published similar guidelines that were applicable to insurance intermediaries. Furthermore, EIOPA continued to work on the creation of the necessary basic conditions to identify consumer protection issues as they arise. In this context we developed an enhanced methodology for collecting, analysing and reporting on consumer trends and we started to explore the use of social media monitoring tools for our consumer trends analysis. We also created a Consumer Lounge on EIOPA’s website, which provides useful information about different products. On the regulatory side we have been heavily engaged in the development of the EU single rulebook for insurance, Solvency II.





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To ensure a consistent and convergent path towards the implementation of the Solvency II regime, avoiding market fragmentation, we issued Guidelines for the preparation of Solvency II. These Guidelines allow supervisors and companies alike to set up structures and get familiar with the new requirements. The Guidelines have been implemented by National Competent Authorities (NCAs) from 1 January 2014 and have been key in our common aim towards consistency. Following the political agreement on Omnibus II, EIOPA has been developing more than 20 Implementing Technical Standards and over 30 Guidelines that will contribute to the convergent application of Solvency II. Furthermore, we advised the European Commission on the Solvency II delegated acts, namely on the calibration for certain Long-Term Investments, proposing an innovative segmentation of securitizations according to their different risk profile. At the same time, EIOPA has started to put a stronger emphasis on the consistent implementation of the regulatory framework, by focusing more attention on supervisory practices. In this context we have been using a number of tools: participation in the colleges of supervisors, conducting peer reviews, and issuing opinions addressed to NCAs. Through our action plan for colleges we focused on reaching a shared view between supervisors on the assessment of the risk exposure of groups and solo entities. We finalised 2 peer reviews and launched 3 new ones that contribute to the development of convergent supervisory standards. As part of its supervisory mandate, EIOPA has participated together with the national supervisors in joint on-site inspections.





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EIOPA’s work on supervisory convergence is also underway through the development of a Supervisory Handbook that incorporates good supervisory practices. EIOPA’s Centre of Expertise on Internal Models has been heavily engaged in the development of good practices and sound indicators to support a consistent analysis and validation in this critical area of Solvency II implementation. EIOPA’s newly created Supervisory Oversight Team started to engage with NCAs to better understand their supervisory and regulatory framework and provide feedback to enhance convergence. As part of this process EIOPA, in close cooperation with the European Commission and the local supervisory authority, is going to oversee the balance sheet review of the Romanian insurance sector. The global dimension of insurance and the interconnectedness of markets call for delivery of robust international standards and increased cooperation between supervisors on a global basis. EIOPA continued to provide technical advice regarding 3rd countries supervisory regimes, in the context of the Solvency II equivalence decisions. Furthermore, we successfully coordinated the positions of EU insurance supervisors in the context of the development of a Basic Capital Requirement by the International Association of Insurance Supervisors (IAIS). Our work on pension issues recognizes that both occupational and personal pensions can play an important role for retirement savings in a more integrated Europe. The development of a truly internal market for pensions can increase member protection, transparency and be the catalyst for better outcomes for citizens, through economies of scale, and for the EU economy, through more stable long-term funding.





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In this context EIOPA provided extensive advice on the review of the Directive on Institutions for Occupational Retirement Provision (IORPII), strengthening the current Directive in removing barriers to cross border business, a prerequisite for a real Single Market; enhancing governance, defining necessary instruments and powers for supervisors, and improving disclosure arrangements through a pensions benefit statement. EIOPA’s work on a common European measurement of the solvency position of pension funds shows that pension funds have vulnerabilities in different areas, and that such vulnerabilities can and should be addressed. This has reinforced the need to continue working towards a risk based European regulatory regime that reflects economic reality and better protects members and beneficiaries. Simultaneously, upon the request of the EU Commission, EIOPA started to examine the potential development of a European internal market for personal pensions. Preventive supervision is based on anticipating risks and ensuring action is taken in advance to mitigate or eliminate them. EIOPA continually monitors and assesses risks and vulnerabilities to the stability of the insurance and occupational pensions sectors, and broader financial stability with a view to facilitate or coordinate supervisory action. EIOPA’s Financial Stability Report provides comprehensive economic analysis of risks and vulnerabilities and its Risk Dashboard monitors a common set of qualitative and quantitative indicators to identify and measure systemic risks. Stress tests are a tool for both undertakings and supervisors, providing a formal assessment of the resilience of financial institutions to adverse market developments using a consistent methodology. This year we launched an EU-wide stress test for insurance undertakings based on the upcoming Solvency II regime and testing a range of credible adverse market scenarios, developed in conjunction with the ESRB,





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complemented by a set of independent insurance-specific shocks covering mortality, longevity, insufficient reserves and catastrophe shocks. An additional stress test module addressed the impact of a low yield environment, as this has been identified as a key risk for insurers. The results will be published in November. Furthermore, this year we started to prepare the stress test for the occupational pension funds, which we will launch in 2015.

Challenges ahead Let me now turn to the challenges that we will face in the years to come. Going forward I believe that we need to focus ourselves on delivering smart regulation: • Regulation that delivers what is expected; • Regulation that is proportionate by reflecting the evidence of what works and what does not; • Regulation that is driven from the consumer perspective; • Regulation that looks forward, trying to anticipate problems, rather than to address only the problems of the past; • Regulation that is reviewed and revised if needed, that is checked against reality of implementation. At EIOPA our aim is to contribute to smart regulation. We will do this by continuing to engage with all stakeholders in a transparent and constructive dialogue. In the last three years EIOPA has been instrumental in the finalization of Solvency II, delivering a sound and robust risk-based regime for the insurance sector in the EU.





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We are now approaching a point in time where the priority is naturally shifting to the implementation of this regime across all the EU Member States. The development of a single rule book of harmonised regulation is a huge step forward for the single market, but let’s be honest: good regulation is just a first step. The real challenge will be to ensure that Solvency II is implemented in a consistent way throughout the EU. This requires effective and convergent supervision in all Member States in order to prevent regulatory arbitrage and guarantee a level playing field in the internal market. Bearing in mind the aforementioned, EIOPA will put a strong emphasis on the promotion of supervisory convergence by upgrading the quality and consistency of national supervision and strengthening oversight of cross-border groups. Strong and credible supervision is needed across the EU. Pre-emptive supervision and timely enforcement contribute to healthy market competition and are critical to avoid consumer detriment. In order to ensure that EIOPA will be capable to deliver on these objectives we need some enhancements to our Founding Regulation: • Strengthen our operational independence and in particular to find a stable solution for the financing of EIOPA; • Task EIOPA with a centralised oversight role in the field of internal models; and • Enhance our capacity to provide independent and challenging feedback on supervisory practices to the NCA’s.





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Furthermore, considering the developments of the banking union, EIOPA should be tasked with a coordinating role on insurance matters towards the Single Supervisory Mechanism. This would ensure a more coordinated approach to the supervision of financial conglomerates. Finally, as part of a step-by-step approach, consideration should be given to assign to EIOPA an enhanced supervisory role for the largest important cross-border insurance groups. I welcome the reports on the review of the European System of Financial Supervision produced by the European Parliament and the European Commission and I am happy to see that some of the aforementioned proposals are already included. I am looking forward to work with the EU political institutions to find the appropriate improvements in our Regulation that will allow us to reinforce our contribution to financial stability and consumer protection for the benefit of EU citizens and the EU economy. I am now looking forward to answering your questions.





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Putting the right ideas into practice Speech given by Mark Carney, Governor of the Bank of England at the Institute and Faculty of Actuaries General Insurance Conference, Wales

Introduction It is an honour to be invited to address you today. Insurance is at the core of the new Bank of England. As regulator, we are tasked with ensuring the safety and soundness of the UK’s insurance companies and the protection of their policyholders. To discharge these responsibilities, we draw on the entire resources of the Bank. Fully one third of our regulatory staff – over 200 supervisors and 50 actuaries – are engaged in supervising insurance companies. But that is just the start. Our supervisors are supported by hundreds of credit risk analysts, scores of monetary policy experts and macro-financial analysts. As a central bank with responsibilities for both monetary and financial stability, we have a view of both the asset and liability sides of your balance sheets. And as a highly active participant in global financial reform, we influence the measures that are reshaping the global system. In all of our actions, we recognise the importance of insurance to the economy.





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The UK insurance industry makes a major, direct contribution: £25bn to annual GDP and 300,000 high-paying jobs including many of the 14,000 members of the Institute & Faculty of Actuaries. It is a major exporter with about 30% of premiums earned overseas. And the Lloyd’s market underlines London’s status as a world centre for insurance excellence and innovation. But the economic contribution of insurance goes much deeper. By spreading and managing risks, it increases the resilience of corporations, investors and financial institutions. It makes entrepreneurship and trade more viable. And it safeguards companies and individuals from perils they could not otherwise shoulder. From a financial system perspective, insurance companies play a vital role in the efficient allocation of capital. By matching long-term savings and investment, it finances the infrastructure essential to build our economy. The long-term perspective of insurance companies diversifies the financial system and reinforces its resilience. The contribution of the UK insurance industry can’t be taken for granted – especially in a macro-financial environment that challenges traditional business models.

Challenges from the macro-financial environment Of course, relative to the recent past, the economic outlook is much improved. The UK has experienced the strongest growth in the G7 over the past year.





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Job creation has been the quickest on record. Inflation has fallen below target having been above for most of the past five years. With many of the conditions for the economy to normalise now met, the point at which interest rates also begin to normalise is getting closer. In recent months the judgement about precisely when to raise Bank Rate has become more balanced. While there is always uncertainty about the future, you can expect interest rates to begin to increase. We have no pre-set course, however; the timing will depend on the data. Moreover, the precise timing of the first rate rise is less important than our expectation that, when rates do begin to rise, those increases are likely to be gradual and limited. Why does the Bank expect this to be the case? In part, because the headwinds facing the economy are likely to take some time to die down. Demand in our major export markets remains muted. Public balance sheet repair is ongoing. And a highly indebted private sector is likely to be particularly sensitive to changes in interest rates. Over the medium term, several dynamics are likely to keep rates lower than in the past. UK rates could be restrained by continued imbalances between global saving and investment, together with potentially lower rates of global productivity growth. Central banks can also be expected to accommodate with lower risk-free rates the higher spreads that are likely to result from new regulatory requirements.





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All of these factors likely mean that, even when spare capacity is used up, Bank Rate will need to be materially lower than in the past in order to keep the economy operating at its potential and inflation at its target. The Bank is well aware that a prolonged period of historically low interest rates could encourage other risks to develop. In the UK, the biggest risks are associated with the housing market, which is why last spring the Bank took graduated and proportionate actions. We are also alert to the possibility that financial markets may be mispricing risk. As the FSB concluded last week, “there are increased signs of complacency in financial markets, in part reflecting search for yield amidst exceptionally accommodative monetary policies. Volatility has become compressed and asset valuations stretched across a growing number of markets, increasing the risk of a sharp reversal.” In such circumstances, insurers’ proven ability to look through such short term volatility is invaluable. Nevertheless, an abrupt correction in term and risk premia could have a sharp impact on the valuation of securities that are marked to market and reduce the effectiveness and availability of proximate hedging strategies. More fundamentally, by squeezing margins, persistently low interest rates challenge business models. Insurers feel this pressure on both sides of the balance sheet: through muted investment returns; and as long-term obligations to policyholders – most common for life firms but increasingly relevant to general insurers that have Periodic Payment Orders on their books - become more expensive in today’s terms.





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An understandable response would be to move towards less traditional types of investments – such as infrastructure; into new or more complex types of business – like telematics pricing; or into new geographies like emerging markets. All these strategies bring new risks that must be well understood and prudently managed Low rates are encouraging inflows of external capital into sectors like reinsurance. In effect, a “soft cycle” in financial markets is reinforcing a “soft cycle” in insurance – a particularly problematic combination. More capital boosts market capacity, but can also test underwriting discipline.

Putting the right ideas to work As supervisor, the Bank of England is monitoring closely how these new risks are being managed and how your business models are evolving. At the same time we’ll be implementing reforms. Reforms to promote a more resilient insurance sector without standing in the way of an effective insurance sector, and without imposing unnecessary impediments on your ability to evolve your business models in response to the challenges I described. To borrow the theme of this conference we will be ‘putting the right ideas to work’. Today I want to highlight three of them:

‐ Tailored, consistent and robust capital standards;

‐ Holding the right people to account; and

‐ Global standards for globally systemic insurers.

With those right ideas, we are promoting a resilient, innovative insurance industry that supports the real economy.





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Right idea 1: tailored, consistent and robust capital standards The first right idea is to implement tailored and consistent capital standards to ensure the safety and soundness of insurers. Resilience against unexpected losses requires risk-based capital standards and robust valuation practices. The UK’s Individual Capital Adequacy Standards deliver this and were one reason why the UK’s insurance sector weathered the crisis so well. The Bank of England wants the principles behind ICAS to be applied as widely as possible; to establish as level a playing field as possible. That is why we support Solvency II. It embeds across Europe the core principles necessary for sound regulation, namely:

‐ appropriate market-based valuation methodologies;

‐ a comprehensive measure of risk and solvency covering all group

activities; and

‐ capital resources of an appropriate quality to absorb loss.

Solvency II is the biggest change to insurance regulation in a generation, and it will be live in just over a year. While our shared history with ICAS means the UK insurance industry is relatively well placed, we must not underestimate the scale of the challenge. Even the standard formula, which nine out of ten UK insurers will use to determine their solvency requirements, is significantly more advanced than the Solvency I approach it replaces. Although more demanding, we have worked to ensure the standard formula does not impede your provision of long-term finance to the real economy.





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Steps have been taken to make Solvency II more accommodative of securitisation. And in parallel, the Bank of England has been working with the European Central Bank to remove other impediments to the revitalisation of securitisation markets, including pushing for revisions to regulatory requirements for banks and for the development of simple, transparent and consistent products. Where the standard formula is not a good fit for a firm’s risk profile, firms will be asked to consider developing a partial internal model; making an application for an undertaking-specific parameter; or adjusting their underlying business model. Many of you in this room are acutely aware of the demands of the Solvency II model approval process. This rigour has a purpose. The dangers of using poorly designed models were made all too clear in the banking sector. So the Bank won’t hesitate to withhold approval of inadequate or opaque models. Models must be based on appropriate data and account for all quantifiable risks. Boards have the responsibility to ensure models remain appropriate and to show they are used in practice. Of course, risk-based capital standards are about more than models. Models can never be relied upon in all circumstances or in isolation, nor can they be substitutes for sound judgment. Solvency II recognises this in its three-pillar approach – supplementing a modernisation of the quantitative regime with new supervisory review, governance, risk management and transparency requirements.





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These requirements, under pillars 2 and 3, build a coherent framework for the future. Tools like scenario testing and the Own Risk Solvency Assessment are therefore fundamentally important. By thinking about the risks that could harm future solvency – and the possible responses to a stress – ORSAs promote the protection of safety and soundness of insurance firms, while providing insights into overall financial stability.

Right idea 2: a regime that holds the right people to account The step-change in regulatory standards under Solvency II has several implications for the industry. Risk professionals like yourselves have a central role to play in building models; in using expert judgment to marry quantitative and qualitative assessments of risk; and in making technical subject matter accessible to Boards. Your work will be vital to making these new standards a reality and thereby to establishing a stronger, more consistent standard of resilience across the EU. But amidst our work to embed new regulatory standards, it must not be forgotten that the responsibility for running insurers rests with their Boards and senior managers. This leads to the second right idea we are putting into practice: the people running insurance companies should be more clearly held accountable for their actions. It is now clear that in some parts of the financial sector, the link between seniority and accountability had become blurred or even severed. The Parliamentary Commission on Banking Standards recognised this when they recommended a new regime for the senior-most managers in banks, ensuring their accountability.





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The principles underlying that regime are more widely relevant. Those individuals that run financial institutions should act with integrity, honesty and skill regardless of whether they work for global investment banks, regional building societies or in the general insurance sector. Solvency II recognises this imperative. It requires both firms and regulators to monitor the fitness and propriety of staff with key responsibilities in the insurance sector As a consequence, the Bank of England is now working with other regulators to develop a regime for the key people in your industry. That doesn’t mean we are about to extend the banking regime indiscriminately. For one thing, unlike in banking, there will be no statutory provision for applying a “reverse burden of proof” in the insurance sector. In developing a regime tailored to insurance we will also have to consider the particular skills and roles that matter. This includes the central role of actuaries, which is one of the important functions specifically recognised by Solvency II. In 18th century London, the title ‘actuary’ was often interchangeable with that of Chief Executive. It’s your role in backing entrepreneurship with science; in ensuring premiums, reserves and capital are prudent; and in scanning the horizon for new risks and opportunities, that means we are minded to include both life and general insurance actuaries within the scope of our updated fit and proper regime for individuals in insurance. By including your profession in the new regime, we recognise the importance of your skills, the range of your contributions, and your personal propriety.





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Later this year we will consult on a regime that includes the most senior actuaries – alongside CEOs, Chairmen and Chief Financial and Risk Officers – in our senior managers regime, making them directly accountable for how a firm is run, for their decisions, and for their actions. These senior persons will be expected to prove their fitness to regulators before they take up a role, and the onus will be on them to ensure risks are understood, measured and properly considered.

Right idea 3: global standards for globally systemic insurers While much progress has been made on the home front, the focus of the global reform agenda since the crisis has been on putting a third idea into practice: common global standards for systemically important insurers. The goal of this work is to increase systemic resilience; preventing spillovers from the failure of an insurer to the wider financial sector and the real economy. Policymakers agree that traditional insurance activities need not of themselves be a source of systemic risk. Indeed, recent events demonstrated three reasons why insurers are better able to withstand crises than other financial institutions. First, the underwriting cycle is generally not correlated with the business cycle; Second, the inherent resilience of business models that take a long-term view, and Third, an insurer’s production cycle is inverted as they collect premiums today with a view to paying claims tomorrow. This model reduces liquidity risks and immunises insurers against risks of a run. Insolvency takes time to manifest, and wind-down when it happens has historically been more orderly.





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Given all that, you might ask: why the concern about systemic risk in insurance? The answer is simple: The financial crisis laid bare that the actions of some individual insurers – like AIG – can have broad spillovers; that some insurance markets – like the monolines – are systemic, and that the insurance sector plays a systemic role in diversifying the financial sector thereby reinforcing its resilience. AIG was the extreme case of a systemic insurer. That sorry experience highlights the need to understand all the activities in which insurers are engaged, including on occasion substantial business beyond the boundaries of traditional insurance. Regulators have grouped those activities as ‘non-traditional’ and ‘non-insurance’ – including business involving extensive use of market instruments, like derivatives, and instruments that engage in substantial maturity transformation. Where this type of business is carried out in scale or across borders, risks to the system can be substantial. The crisis also showed how particular insurance markets can affect systemic stability. The Monolines demonstrated how sub-sectors that are excessively concentrated or undercapitalised can amplify shocks. The failure of multiple insurance companies in response to economic stress can disrupt the provision of critical economic functions. It can also suddenly transfer risks to other parts of the financial system that may be ill-equipped to manage them; or shift assets around in a way that can amplify and spread distress. As I said previously, the insurance sector is systemic in a positive way. Insurance companies have different risk bearing capacities than many other financial institutions.





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They play a stabilising role by deploying funds over a longer time horizons, in a manner less vulnerable to sudden outflows. The resilience of large insurers is therefore important to safeguard that positive contribution to the global economy. The starting point for the application of global standards has been the identification of systemically-important insurers. More than four-fifths of that assessment rests on the extent of non-traditional non-insurance activities in a firm’s business model and on its interconnectedness to the wider financial system. Nine firms have been designated. It is vital that these systemic insurers, like systemic banks or financial market infrastructure, can be resolved in the event of failure without the need for taxpayer support and without disruption of the wider financial system. That’s why the development of resolution plans is a top priority. Nonetheless, given the externalities from the failure of a systemic insurer, it is of course preferable that their probability of failure is lower. That’s why systemic insurers will be subject to higher global standards. The Higher Loss Absorbency requirements, being developed now by the IAIS, will ensure that all of the activities of a systemic insurance group – but especially non-traditional, non-insurance activities – are backed with an appropriate minimum level of capital resources. Given the patchwork of capital standards across major jurisdictions, the first step towards applying these heightened resilience requirements is the development of the Basic Capital Requirement – an internationally comparable capital measure that will act as the baseline for additional resilience.





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Last week in Cairns, the FSB approved the final BCR proposal which will be presented to G20 Leaders at the Brisbane summit in November. It is simple and factor-based, contains a common valuation approach, and captures all activities of insurance groups. This is an important milestone – one that takes us further towards embedding the right idea of increased resilience for those few insurers that have the capacity to impact the global financial system. I look forward to your continued support as the IAIS builds on this progress to put into practice the overall package of requirements for systemic insurers by 2019. And we will need your support as we further develop, over time, an International Capital Standard to apply to all internationally active insurance groups. Our aim is nothing less than a standard which embodies the principles which underpin ICAS and Solvency II.

Conclusion The ideas I’ve described today are vital to preserving the positive role of insurance in the financial system and the real economy. These ideas – tailored capital standards that promote a level playing field; a framework to hold the right people to account; and global standards for globally systemic insurers – are needed now in practice. The Bank knows that as our reforms are implemented and as your business models evolve we need a regulatory approach that is regularly reviewed, adjusted if necessary; and that takes account of evolving financial conditions, product innovation and changing markets. Robust interaction with the industry is essential to ensuring the right ideas can be put into action now, and for the future.





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The Institute & Faculty of Actuaries has been at the heart of the insurance industry for over 150 years, and the changes to regulation, the industry and the world around us mean your contribution is more essential than ever. Having the right people putting the right ideas to work has never been more important.





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Community banks in the United States Introductory remarks by Mr Jerome H Powell, Member of the Board of Governors of the Federal Reserve System, at the Community Banking Research and Policy Conference, co-sponsored by the Federal Reserve System and Conference of State Bank Supervisors, St. Louis, Missouri It is a pleasure for me to join Jim Bullard and John Ryan in welcoming all of you to the second annual Community Banking Research and Policy Conference, co-sponsored by the Federal Reserve System and Conference of State Bank Supervisors. I had the privilege of addressing the inaugural community banking conference held here last year, and as chairman of the Federal Reserve Board's Subcommittee on Smaller Regional and Community Banking, I am delighted to return to this venue to participate in this year's event. As all of you surely know, community banks play a vital role in America's financial system, providing essential services to households, small businesses, and small farms in communities throughout the country. Community banks differ from their larger cousins, not just in size, but in the fundamental focus of their business. Community bankers' primary objective is to serve the members of their local communities, who are not only their customers but also their neighbors and friends. They have strong links to the people and businesses that reside in their communities, as well as direct knowledge of local economic conditions. These close ties give community bankers a clear advantage in understanding local needs and tailoring their products and services to meet those needs.





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I will confess that I have never worked at a community bank; however, I have been a community bank customer, and in that role I have had personal experience interacting with bankers whose mission is to provide high quality of service to every customer who walks in the door. Despite the advantages that I just mentioned, life is not always easy for community bankers. The number of community banks in the United States has declined sharply over the past three decades, due to a combination of failures and acquisitions. And many remaining community banks have struggled to survive, especially during the last five or six years. Although improving overall economic conditions have begun to provide some relief to these struggling banks, they continue to face significant challenges. The burden of regulatory compliance can be particularly daunting for small banks. And competition, from large banks and credit unions as well as other nonbank financial service providers, is always a concern. My colleagues on the Federal Reserve Board and I are committed to making sure that we understand the challenges faced by community banks. One way that we further our understanding is by talking to the bankers themselves. The entire Board of Governors meets twice a year with the Community Depository Institutions Advisory Council, which includes representatives of community banks, thrifts, and credit unions in each of the 12 Federal Reserve Districts. Individual governors also take advantage of opportunities to meet with community bankers from time to time.





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During last year's conference I met with a group of St. Louis area community bankers to hear what was on their minds. I will conduct a nationwide webinar with community bankers next month. In fact, I speak regularly to a number of bank executives, including those who run smaller institutions. I find these types of conversations - with people who live and work in the world outside the Capital Beltway and far from Wall Street - to be particularly enlightening. And, of course, this conference, which was conceived as the result of a successful collaboration between the Federal Reserve System and the Conference of State Bank Supervisors, provides an annual opportunity for community bankers, bank regulators, and academic researchers to come together to share ideas and insights surrounding the issues that matter most to community bankers. This year's program includes presentations by the authors of a number of excellent academic research papers, the unveiling of the results of a new survey of community banks conducted on behalf of the conference organizers, reactions by community bankers to the research and survey findings, and several compelling speeches. The primary focus of today's agenda is research. The response to the conference's call for papers was quite impressive, and the conference research committee faced the challenging task of selecting the most relevant, interesting, and high-quality papers to be included in the program. The authors of these papers include academics and policymakers, with backgrounds in law, economics, and finance. The topics covered clearly demonstrate a desire, on the part of the researchers, to promote a deeper understanding of what makes





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community banks tick and of how a wide range of government policies affects the activities, profitability, and viability of community banks. The first session considers factors underlying community bank formation, behavior, and performance. The first paper looks at characteristics of newly chartered banks - where they form, and how they fare over time. The second paper also focuses on newly chartered banks, considering possible explanations for the near absence of new bank charters over the past few years. Those of us at the Fed pay a great deal of attention to this type of bank formation, because it is the primary source of new competition in the markets in which community banks compete. The third paper in this session looks at how rivalry among banks affects their decisions to adopt new technology, and the fourth seeks to explain the persistence of low net-interest income among community banks in recent years. The second session addresses the effects, both intended and unintended, of specific government policies on community bank behavior. One paper looks at how the 2006 commercial real estate guidance for banks affected loan growth. Another paper examines the effect of the creation of the Small Business Lending Fund on community bank lending to small businesses. The third paper in this session focuses on what happens when banks perceive that examiners have given them inappropriately negative evaluations. The underlying theme of the third research session is how broad government policies affect community bank profitability and viability.





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The first paper provides an overview of the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act on community banks. The second paper considers whether a provision of the JOBS Act that modified the threshold for Exchange Act reporting for unlisted banks and bank holding companies helped or hurt small banks. The third paper contrasts the thousands of small community banks operating in the United States with the handful of very large financial institutions and proposes a new approach to regulation that recognizes the very different business models of these two types of institutions. The fourth and final paper takes a high-level look at the effects of regulatory policy on the structure of the U.S. banking system and the viability of community banks. On day two of the conference, you will learn about the results of a recently conducted survey that was completed by more than 1,000 community bankers from across the country, as well as the feedback obtained from more than 1,300 bankers participating in town hall meetings hosted by state bank commissioners in 30 states. The presentation of these findings will be followed by a panel discussion by a select group of community banking experts. I hope I have succeeded in whetting your appetite for the sessions that lie ahead, and I encourage you to make the most of this unique opportunity to interact with bankers, regulators, and researchers who share a common interest in the future of community banking.





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