Monday October 15, 2012 - Top 10 Risk Compliance News Events

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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 National Institute of Standards and Technology (NIST) announced the winner of its five-year competition to select a new cryptographic hash algorithm, one of the fundamental tools of modern information security.

The winning algorithm, Keccak (pronounced “catch-ack”), was created by Guido Bertoni, Joan Daemen and Gilles Van Assche of STMicroelectronics and Michaël Peeters of NXP Semiconductors.

Keccak will now become NIST’s SHA-3 hash algorithm.

Hash algorithms are used widely for cryptographic applications that ensure the authenticity of digital documents, such as digital signatures and message authentication codes.

These algorithms take an electronic file and generate a short "digest," a sort of digital fingerprint of the content.

Read more at Number 3 below.

Welcome to the Top 10 list.

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

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New Bank Liquidity Rules: Dangers Ahead

A Position Paper by EBA’s Banking Stakeholder Group

The EBA’s Banking Stakeholder Group is composed of 30 members appointed to represent in balanced proportions credit and investment institutions operating in the Union, their employees’ representatives as well as consumers, users of financial services and representatives of SMEs.

Governor Elizabeth A. Duke, at the Federal Reserve Bank of New York, New York, New York

Addressing Long-Term Vacant Properties to Support Neighborhood Stabilization

NIST Selects Winner of Secure Hash Algorithm (SHA-3) Competition


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UK FSA

Financial Crime newsletter

Issue 16 of the Financial Crime newsletter. So far, 2012 has been particularly busy.

EBA Work Programme 2013 The annual work programme describes and summarises the main objectives and deliverables of the EBA in the forthcoming year derived from the tasks specified in the Regulation and from the relevant EU banking sector legislation.

Introductory Remarks at SEC’s Market Technology Roundtable

By Chairman Mary L. Schapiro, U.S. Securities and Exchange Commission, Washington, D.C.

“Thanks to technology, our securities markets are more efficient and accessible than ever before.

But we also know that technology has pitfalls. And when it doesn’t work quite right, the consequences can be severe”.

Why we should be interested in the history of currencies

Address by Ernst Baltensperger Presentation of “Der Schweizer Franken – eine Erfolgsgeschichte”

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High-level Expert group on reforming the structure of the EU banking sector presents its report The Commission has received the report prepared by the High-level Expert Group on reforming the structure of the EU banking sector (MEMO/12/129). The Group chaired by Erkki Liikanen presented the main findings to Michel Barnier, Commissioner for internal market and services.

A Statement by His Excellency the Governor of Saudi Arabian Monetary Agency, Dr. Fahad bin Abdullah Almubarak

On the occasion of the National Day of the Kingdom of Saudi Arabia

German banks successfully complete EU-wide recapitalisation exercise

After deduction of the "sovereign capital buffer", all 12 German institutions in the sample achieved the minimum core tier 1 capital ratio of 9% as at 30 June 2012. The average ratio is 10.7%, which means all institutions taken together exceed the EBA minimum capital requirement by €15.5 billion. The five banks which were found to need an additional €12.9 billion as at 30 September 2011 have covered this requirement.

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NUMBER 1

New Bank Liquidity Rules: Dangers Ahead

A Position Paper by EBA’s Banking Stakeholder Group

Note: The EBA’s Banking Stakeholder Group is composed of 30 members appointed to represent in balanced proportions credit and investment institutions operating in the Union, their employees’ representatives as well as consumers, users of financial services and representatives of SMEs. The Group’s role is to help facilitate consultation with stakeholders in areas relevant to the tasks of the EBA. In particular, the Group shall be consulted on actions concerning regulatory technical standards and implementing technical standards and, guidelines and recommendations, to the extent that these do not concern individual financial institutions. The Group may also submit opinions and advice to the Authority on any issue related to the tasks of the Authority, with particular focus on common supervisory culture, peer reviews of competent authorities and assessment of market developments. The Group may also submit a request to the Authority, as appropriate, to investigate the alleged breach or non-application of Union law.

1 Overview and Key Issues 1.1 Liquidity rules and the role of EBA Credit institutions across Europe face an unprecedented amount of regulatory reforms, originating from the 2009 De-Larosière Report and the third release of the Basel Accord (“Basel 3”) in 2010.

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The new Capital Requirements Directive (CRD4) and Regulation (CRR), that the European Union is currently debating, will create a common sine qua non for institutions throughout the European Union. The CRR will establish a consistent and integrated regulatory framework for many aspects of bank management – including liquidity – providing a homogeneous standard under a unified set of prudential rules. In relation to liquidity, two new requirements have been proposed by Basel 3 to ensure that financial institutions are more stable and will require them to hold more liquid assets and issue more long-term debt. The Liquidity Coverage Ratio (LCR) is aimed at ensuring short-term resilience of financial institutions. They will be required to hold at all times liquid assets, the total value of which equals, or is greater than, the net liquidity outflows which might be experienced under stressed conditions over a short period of time (30 days). Net cash outflows are to be computed on the basis of a number of assumptions concerning run-off and draw-down rates. The LCR will be monitored in the EU after January 2013 and the European Banking Authority (EBA) will test various eligibility criteria for liquid assets. Calibration will also be undertaken regarding net cash outflows. This fine-tuning will provide input for the level-two regulations to be introduced by the European Commission before January 2015, when the LCR will become binding for all credit institutions in the EU. The Net Stable Funding Requirement (NSFR) requires that available stable funding (equity and liability financing expected to remain stable over a one-year time horizon) at least equals the matching assets, i.e. illiquid assets which cannot be easily turned into cash over the following 12 months.

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In the European Union the components of the NSFR will be monitored from 2013 with a view to introducing a binding requirement in 2018. The CRR – while setting a clear and comprehensive framework for the measurement and control of bank liquidity – leaves many details open for calibration, impact assessment and review. As mentioned above, the EBA has been assigned a key role in the implementation of the new regulatory framework; it is required to provide supervisors and European institutions with criteria, standards and technical advice on a wide-ranging set of issues.

1.2 The LCR: expected impact and scope for calibration As it will be phased in first, the case for calibration and careful implementation of the LCR is stronger. Similar attention will be required for the NSFR once a full consensus on the its structure has been achieved. Accordingly, although this report covers all liquidity rules introduced by the CRR, the LCR has been the main the focus of the contributions. Based on the latest impact studies, the LCR shortfall of EU banks (that is, the absolute amount of extra liquid assets needed for all banks to comply with the ratio) currently exceeds 1 trillion euros. Between 2009 and 2011, this shortfall has not improved. Actually, it has deteriorated from €1tn to €1.15tn, with a 15% increase in the (almost overwhelming) amount that EU banks would need to invest in liquid assets in order to be compliant. This clear risk or threat is that European banks may channel new funding towards LCReligible assets rather than to loans and other “illiquid” assets. E.g., European banks could increase their liquidity buffer through additional deposits with central banks (which play no role in financing

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the real economy and which, in 2011, already amounted to about €850 million for large EU banks). Essentially the LCR would have the effect of crowding out productive investments and sterilize €1 trillion of liquidity out of the real European economy. In other words, unless the funding base available to European banks can quickly be increased (which appears quite unlikely in the current macroeconomic scenario), the LCR might lead to €1trillion loan deleveraging process by December 2014. Such a risk would become especially acute if a narrow definition of LCR-eligible assets were enacted, which would deny adequate recognition to some financial instruments supporting the financing of companies and individuals, like corporate bonds, covered bonds or asset backed securities. While, in principle, capital markets may provide a substitute for reduced bank funding, this looks improbable given the limited development of corporate debt markets in many European countries and the high degree of risk aversion currently shown by investors. All the above provides a strong incentive for a rigorous calibration of the LCR. There are indeed, a number of steps in the computation of the ratio which could be reconsidered, in order to make it closer to market practices and to reduce the foreseeable burden for banks and the European economy. Any ratio is made up of two components. One can look at the LCR numerator, and consider ways to enhance the set of assets eligible as liquidity buffer. By allowing banks to use, for example corporate bonds and asset-backed securities as liquid assets, regulators would greatly support the development of those asset classes throughout Europe, and thus help the

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European capital market absorb the loans that banks will no longer be able to provide. Alternatively (or, rather, jointly) one can look at the denominator and carefully revise the assumptions on runoff/drawdown/rollover factors underlying the computation of the net cash flows. The definition of liquid assets in the LCR will affect the behaviour of market participants, hence the liquidity of different asset classes. Banks will prioritise “liquid assets” as defined in LCR and “down-prioritise” other assets, which will alter the demand for different securities. Additionally, during a crisis banks while trying to comply with the LCR will generate liquidity in the first place by selling assets which are not eligible for the ratio. The definition of liquid assets in the CRR will not just depend on the current market conditions, but rather will drive behaviours affecting the future liquidity of different security types. If such definitions were to prove inadequate, unintended consequences could build up through a snowball effect. Assumptions on cash flows (including run-off, draw-down and roll-over factors) will also have a dramatic impact on the underlying bank products, and may shift funds across business lines and different categories of bank stakeholders. E.g., limited recognition for the benefits of self-liquidating facilities (including trade finance) may increase their cost and ultimately undermine the economic viability of some lending activities. Credit provided to SMEs might become unduly expensive.

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Interbank lines of credit – a key tool to improve bank resilience to liquidity shocks – may prove less and less attractive due to over-conservative rules.

1.3 This report This position paper was produced by the Banking Stakeholder Group to provide the EBA and European policy makers with a technical discussion of several areas where the new rules risk to have unintended effects unless properly calibrated and carefully implemented. Its structure is the following. Part 1 provides a general framework to introduce the calibrations in liquid assets and net cash flows that will be discussed in the following sections. We highlight the main implications of the new liquidity ratios for banks and for the European real economy; we then go back to the rationale of the liquidity requirements and discuss whether their anticipated costs are consistent with expected benefits. The next contribution surveys national regulations on liquidity – prior to and after the 2008-2009 financial crisis – and finds that the provisions in the CRR appear comparatively stricter than most pre-existing requirements. Finally, we discuss how the new liquidity-related ratios could modify the accounting choices of banks. Part 2 focuses on caveats and possible adjustments concerning the numerator of the LCR, that is, liquid assets that banks are allowed to use to meet their liquidity buffer. We review the eligibility criteria set out by the CRR for high quality liquid assets, highlighting why they may prove inadequate in capturing systematic liquidity risk.

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We then discuss the appropriateness of such criteria for Europe, to find that, unless appropriately calibrated, they may prove a major source of disadvantage compared to the US. Subsequently, we address the link between liquidity ratios and possible changes in credit risk weights for government debt, to conclude that a more risk-sensitive approach to sovereign risk weights could introduce a pronounced “cliff edge” effect into the LCR and reduce the demand by banks for government debt. Finally, we look at a specific asset class, notably covered bonds, whose full eligibility as a liquid asset may help incentivise portfolio diversification and keep credit flowing to European consumers. Part 3 discusses a number of potential calibrations which may be introduced in the computation of the LCR’s denominator, i.e., the net cash outflows experienced by a bank under a 30-day distressed scenario. This includes customer deposits (where the new liquidity rules may unduly penalise retail and commercial banks), credit and liquidity facilities (where banks would be discouraged from holding liquidity lines with other institutions, a key tool that can be used to ease liquidity pressures) and trade finance (where the parameters of the LCR could prove detrimental for a low-risk industry that underpins global economic growth).

1.4 Time to sound the alarm As the CRR, and therefore the liquidity rules, are about to enter implementation stage, a number of hot spots must be clearly identified to stimulate further debate and highlight the risk of unintended consequences. The first issue is the definition of liquid assets in the LCR and whether this risks being too prescriptive and rigid.

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The Eurozone sovereign crisis has shown that liquid assets can become illiquid quickly, so flexibility is needed to accommodate different market conditions and the changing economic environment. The changing risk profile of government bonds has shown how important it is to create incentives for portfolio diversification. Another area for further consideration is the link between LCR-eligibility and central bank eligibility. The CRR requires that liquid assets be central-bank eligible, but states that not all central bank collateral will be acceptable for the LCR. During a crisis, central bank eligibility is crucial in facilitating the provision of liquidity to cash-strapped institutions and markets. The definition of liquid assets and the rules on central bank collateral need to be looked at the same time – they cannot be regarded as two separate issues. Furthermore, liquidity is an elusive concept, which fluctuates over time and cannot be predicted in infinitum. Hence, supervisors should resist the temptation to draw up lists and to create parameters that will stay unchanged over time. Any “black and white” approach to liquid assets’ definition will prove increasingly unhelpful. Developing criteria that are granular enough to accommodate many different scenarios would be better to provide for a smooth transition of asset classes between different liquidity grades. Conversely, a liquidity scale which has only one or two levels is most likely to prompt cliff effects when changes occur in the perceived characteristics of specific eligible assets.

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Overlooking the different degrees of liquidity provided by a wide range of investable assets, could result in regulators setting the threshold too high and consequently focusing on many fewer asset classes. The wish to “err on the safe side” would ultimately lead to investment concentration and higher risk. As concerns cash flows, no set of rules, no matter how conservative, will ever isolate a bank from systemic risk. E.g., assuming that all liquidity and credit lines that an institution has secured on the wholesale market will suddenly become unavailable in a crisis could give a false sense of security, while increasing banks’ costs and creating wrong incentives. The potential for dirigisme in the new rules should not be underestimated, as minor changes in the factors imposed to banks (including drawdown, rollover and runoff coefficients) may cause huge shifts of funds across business lines in a way which interferes with the free interplay of demand and supply. It is important to remember that the aim of the LCR is not to enable banks to withstand liquidity pressures on their own and to survive through stressed scenarios without supervisory support. Rather, it is to buy time and make sure that supervisors can rescue ailing institutions – and possibly wind them down – without the impending threat of a disordered meltdown and its potentially unmanageable systemic costs. There is a fundamental difference between liquidity as a micro and macro phenomenon. Many assets might well be liquid if one single bank needs to sell them, but can quickly become illiquid if all banks want to get cash out of them. The quest for assets which stay liquid “at all times” might prove frustrating, since under severe systemic scenarios liquidity can only be

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ensured by monetary authorities. Accordingly, prudential rules should not be carried too far, as providing banks with a bulletproof jacket in times of distress may, in fact, lead to imposing a straightjacket on the everyday business of financial institutions and their customers. Increasing compliance costs may not only make credit more expensive and undermine growth; it may also move intermediation towards shadow banking, channelling money through weakly-regulated schemes which rely significantly on wholesale funding and may prove strongly pro-cyclical. The calibrations mentioned above should be carried out by the regulators and policy makers with representatives of the financial industry, users of financial services and banking scholars. The availability of reliable data sources is a major bottleneck for any effort to investigate funding and market liquidity risk; databases should be shared loyally and transparently. Any rule developed without a thorough involvement of banks and other stakeholders is bound to prove both short-lived and short-sighted.

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NUMBER 2

Governor Elizabeth A. Duke, at the Federal Reserve Bank of New York, New York, New York

Addressing Long-Term Vacant Properties to Support Neighborhood Stabilization

Good afternoon. I want to thank the Federal Reserve Bank of New York and the Rockefeller Institute for inviting me to participate in this important discussion of distressed residential real estate.

The boom and bust in housing that is a hallmark of the recent economic cycle has resulted in an unprecedented volume of foreclosures that has, in turn, left us with an extraordinary level of vacant and distressed properties.

Even after the official end of the recession, home sales and house prices continued to decline for several years, and residential investment languished.

All of this has resulted in a slow recovery in housing, which is one of the primary reasons why our overall economic recovery has been so sluggish.

In order to see the robust economic recovery we all want, we need to deal effectively with the large volume of vacant and distressed properties throughout the country.

Our housing crisis has many dimensions and will require a full spectrum of policy actions to restore health to the housing market, our economy,

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and most importantly, to neighborhoods and communities across the country.

The Federal Reserve System has been active in studying various aspects of the crisis, bringing together community leaders and market participants to share experiences in forums such as this, and using data to identify areas of particular need.

I have spoken in the past about credit availability, preventing foreclosures, converting foreclosed properties to rental properties, and strategies for neighborhood stabilization.

Today, I would like to focus on the problems posed by an elevated level of vacant properties. I plan to draw on research conducted by Federal Reserve Board staff and would especially like to thank Raven Molloy, an economist in our macroeconomic analysis group, for her work in this area.

As I will discuss later in my remarks, the effective use of data is a common theme among success stories in neighborhood stabilization.

In the hope that the census tract data referenced in this speech might be helpful to others working to address vacancy problems, I plan to post our data on the Federal Reserve website along with this speech.

Level and Distribution of Vacant Housing

Since the beginning of this year, there have been signs of improvement in aggregate housing market conditions nationally.

Sales of new and existing homes have risen and home prices have turned upward.

So far this year, house prices have risen sufficiently to move a noticeable number of underwater households--that is, those who owe more on their mortgages than the market value of their homes--from negative equity to positive equity.

However, housing markets differ greatly both across regions and within metropolitan areas, and the positive signs in the aggregate data do not apply to all neighborhoods equally.

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For example, even within those metropolitan areas that have experienced rising average prices over the past year, one-fourth of ZIP codes saw a decrease in prices over the same period.

Moreover, those ZIP codes with falling prices have also experienced rising vacancy rates more often than in other ZIP codes.

These struggling high-vacancy areas provide evidence of the hard work that remains even as housing markets show signs of improvement.

Although many of these areas share a high level of vacancy, they differ significantly in other characteristics: the concentration of vacancies, age of the housing stock, cause of the problem, and even the demographics of the residents.

By looking more closely at the differences, we will gain a better understanding of these markets and of the policies or program solutions that will address their vacancy issues most effectively.

One measure that is frequently cited when describing recent improvements in the national housing market is the inventory of vacant homes for sale.

This measure had fallen to 1.6 million units in the second quarter of 2012, substantially below its peak of about 2 million units in 2010 and the first half of 2011.

However, many vacant homes are not on the market at all. These vacant units include properties that are in the foreclosure process, bank-owned properties that are not yet for sale, as well as properties for which the cause of vacancy has no connection to the foreclosure process.

Indeed, the stock of non-seasonal homes held off market is nearly two and a half times as large as the for-sale vacant stock.

But unlike the inventory of vacant homes for sale, this stock remains stubbornly elevated relative to pre-crisis numbers, and has not gone down at all over the past year.

Moreover, vacant units are not evenly distributed throughout the United States.

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Some neighborhoods suffer disproportionate numbers of them. Specifically, one-tenth of all census tracts account for nearly 40 percent of the entire vacant housing stock.

By comparison, the overall housing market is only half as concentrated with only 20 percent of the aggregate housing stock found in the 10 percent of census tracts with the largest total number of housing units.

Problems Posed by Vacant Properties

Why focus on vacant homes?

Vacant homes can be more than just an eye sore; they can have substantial negative impacts on the surrounding community, impacts that are felt most acutely by the neighbors and communities that must cope with the dangers and costs of vacant buildings.

Since vacant properties tend to be concentrated in a relatively few number of neighborhoods, some communities are adversely affected much more than others.

Homes that have been vacant for a long time tend to fall into severe disrepair.

Such physical blight can invite more property crime, as vacant houses are an appealing hide-out and target for criminals, and the absence of residents can mean fewer eyes in the neighborhood to look out for suspicious activity.

In fact, counties that experience a large increase in the number of long-term vacant homes tend to see an increase in burglary in the following year.

This correlation holds even after controlling for other county characteristics, such as changes in unemployment, changes in population, and changes in violent crime.8

In turn, blight and crime make these neighborhoods less attractive to potential buyers, renters, and businesses.

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Calculations by Board staff indicate that ZIP codes with a larger increase in long-term vacancy experience smaller increases--or larger decreases--in house prices in the next year.

Falling home prices can harm both neighboring homeowners as well as local municipalities that are dependent on property tax revenue.

Research conducted by the Federal Reserve Bank of Cleveland has shown that a home that is simply foreclosed, but not vacant, lowers neighboring property values by up to 3.9 percent.

However, if a home is foreclosed, tax delinquent, and vacant, it can lower neighboring property values by nearly two and a half times that amount.

Moreover, properties that have been vacant for a substantial period of time can impose even larger costs on the community, and all too often, the private market is not likely to solve the problem on its own.

In such cases, government authorities and public resources may be required.

Of course, not all vacant properties pose a problem for the local community, as some homes become briefly vacant during the usual process of changes in ownership.

But the longer a home stands vacant, the greater likelihood that poor maintenance and the associated problems that result can become serious issues for the surrounding community.

Statistics from the American Housing Survey show that properties that have been vacant for longer than two years are much more likely to have severe problems, such as cracked floors or walls, broken or boarded up windows, and a roof or foundation in disrepair, that make these properties harder to rehabilitate and less appealing to prospective buyers.

Segmenting the Inventory of Long-Term Vacancies

Analysis by Federal Reserve Board staff has calculated the fraction of housing units in each census tract that has been vacant for at least two years--which I will refer to as "long-term" vacancy--and categorized tracts that appear in the top 10 percent of this distribution into three types.

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The first category of high long-term vacancy census tract is an area where a large percentage of housing units were built post-2000, and that therefore can be thought of as "housing boom" tracts.

These locations also have a higher median income, higher median house value, and a larger fraction of residents with at least a college degree than other high long-term vacancy census tracts.

Examples of metropolitan areas with a large number of tracts in this category are Denver, Colorado; Orlando, Florida; Las Vegas, Nevada; and Phoenix, Arizona.

The second category of high long-term vacancy census tract has a large share of older housing stock built before 1960, low median income, a high poverty rate, a high unemployment rate, and a large share of residents with less than a high school degree.

These tracts can be called "low demand" locations because these characteristics are frequently associated with areas suffering from persistent job loss and a decline in housing demand.

Metropolitan areas with a large number of tracts in this category include Detroit, Michigan; Cleveland, Ohio; St. Louis, Missouri; and Baltimore, Maryland.

The third and final category of high long-term vacancy census tract has a low density of housing units per square mile, high shares of owner-occupied and single-family housing units, and a high fraction of white non-Hispanic residents.

We can think of these neighborhoods as "traditional suburban" areas. Examples of metropolitan areas with a large number of tracts in this category are Charleston, West Virginia; Des Moines, Iowa; Peoria, Illinois; and Oklahoma City, Oklahoma--locations not often mentioned in national media coverage about the housing crisis.

Matching Solutions to Neighborhood Characteristics

As I mentioned earlier, we should endeavor to achieve full recovery in all of the many diverse housing markets around the country.

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The private market will likely drive recovery in many locations and, in those locations, the appropriate role of government may be to monitor local activity and ensure that the actions of the private markets improve neighborhoods and provide opportunity for all families, regardless of income, race, ethnicity, or housing tenure.

However, some neighborhoods likely will not recover without the assistance of government, and in this time of scarce resources, it is critical that the public sector has the information and tools necessary to ensure that any assistance that is provided is effective and efficient.

Doubtless there will be costs associated with solving these problems, but it is important to also consider the costs of doing nothing.

For example, it costs local taxpayers to let vacant buildings decline, it costs money to tear them down, and it costs money to convert them to a better use.

Ultimately, a policy of neglect will be just as--or even more--costly than finding and implementing constructive solutions to the vacancy issue.

We must ask ourselves, can we create policies that fairly distribute those costs?

What are the limitations?

What innovations can create more effective, scalable solutions? With funding scarce, how can we identify solutions that will ultimately be most cost effective?

To begin to answer some of these questions, I return to the typology of vacant properties introduced earlier.

"Housing Boom" Locations

The first type, "housing boom" areas, has relatively high median incomes and new housing stock.

These characteristics are attractive to investors, and many investors are reportedly purchasing vacant homes and converting them to rental.

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Given the recent tightening of the rental market, such a strategy could be a win-win scenario for communities that need more affordable rental homes and suffer from an excess of single-family vacant units.

In fact, in January, the Federal Reserve released a staff paper on housing issues12 that went into some detail about the potential benefits of converting foreclosed properties to rental, and in April, the Board released a policy statement that outlines supervisory expectations for residential rental activities for certain banking organizations.

Phoenix, Arizona, is a good example of an area with many census tracts that fit into the "housing boom" typology.

Phoenix was one of the areas hit hard during the housing bust, with a peak-to-trough decline in prices of more than 50 percent.

More recently, however, prices in Phoenix have rebounded with a double-digit increase over the 12 months ending in July.

Reportedly, much of this demand is driven by investors who are converting vacant homes into rental properties.

Direct statistical evidence on investor activity at the local level is not available.

However, since investors tend to finance their purchases with cash or other non-mortgage financing, the level of cash purchases can provide an indicator of investor activity.

In the past two years, the fraction of home purchases financed with cash in the Phoenix area was much higher than the national average.

This is an example of the private market stepping in to purchase vacant units and in turn increasing housing values.

As encouraging as this trend may be, it is not a panacea. For example, it is possible that aggressive investor activity could crowd out potential homeowners, especially low- to moderate-income households.

In addition, investors are not interested in all markets; therefore, there will still be some areas where private investment will not step in to curb the problems associated with vacant properties.

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The problem of investors crowding out local homebuyers could be addressed through "first look" programs that provide a window, usually 15 days, during which time only prospective homebuyers and nonprofits may bid on a property.

In Phoenix, non-profit organizations and local government officials used Neighborhood Stabilization Program (NSP) funding and enlisted local real estate professionals to match vacant homes with eligible homebuyers.

These are important programs. Community leaders, banks, and real estate professionals should continue to collaborate to ensure that prospective homeowners are given a fair chance to bid on available properties.

However, most prospective homebuyers and local nonprofits cannot bid on a property if they cannot access mortgage credit. Results from the Federal Reserve's Senior Loan Officer Opinion Survey suggest that banks are less willing to provide mortgage credit now than in 2006 to borrowers with lower credit scores or smaller down payments.

We hear much the same story from community groups and housing counselors who report that low- and moderate- income and first-time homebuyers, especially, are finding it increasingly difficult to meet the requirements for a home purchase loan due to limited funds for a down payment or weaker credit scores.

While prudent lending may warrant tighter underwriting standards relative to pre-crisis levels, it is also important to ensure that tight credit does not unnecessarily dampen the housing recovery and disproportionately affect creditworthy low-income and minority homebuyers. And without the participation of owner-occupants, it will be difficult for many housing markets to recover.

Like Phoenix, Oakland, California is also reportedly experiencing a significant amount of investor activity that may be crowding out purchases by prospective homebuyers and nonprofits.

We hear complaints that many of these investors are not based in Oakland, causing residents to express concern about external ownership

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of their neighborhoods and the long-term implications of absentee landlords.

In an attempt to address these concerns and provide more homeownership opportunities to low- and moderate-income Oakland residents, a national nonprofit, Enterprise Community Partners, is working with a private real estate fund to direct some of the private dollars seeking investment properties in Oakland.

The nonprofit partnership is using a complex data-driven platform to identify targeted low- and moderate-income neighborhoods in the city, purchasing vacant properties, rehabilitating them through a local workforce development program, and converting them to rental.

The ultimate goal is to ensure that the properties remain local neighborhood assets.

To achieve this, the partnership is prioritizing rentals and sales to qualified local residents or nonprofits.

Such an innovative strategy seeks to complement local government and investor activity so that residents can share in the benefits of a housing recovery.

"Low Demand" Locations

Not all markets are equally attractive to private investors, so some governments are developing programs to attract private capital to "low demand," high-vacancy neighborhoods.

The city of Baltimore, Maryland provides a good example of such a program.

Baltimore is burdened with approximately 16,000 vacant and abandoned buildings, about a quarter of which are owned by the city.

Much of this vacancy has been caused by population loss and suburban flight--Baltimore City has lost nearly one-third of its population over the last 50 years.

However, not all parts of Baltimore have a significant number of vacant properties.

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In fact, only 5 percent of census tracts in the Baltimore metropolitan area have a long-term vacancy rate in the top decile of the national distribution.

The city of Baltimore has recognized these micro-market distinctions and initiated an innovative data-driven program to identify areas with a high concentration of vacant properties and turn these properties into valuable assets.

This initiative, called "Vacants to Value," uses data and targeted housing code enforcement to foster redevelopment in areas where there is modest private investment interest.

Using a variety of real-time data sources, this program has developed market typologies down to the census block-group level so that it can accurately determine the needs of specific neighborhoods and apply targeted programs to best meet those needs.

For example, the city is targeting approximately 700 vacant properties in weak market areas where large-scale investment--encompassing at least a city block--is necessary to catalyze private investment.

In healthier neighborhoods, the city believes that increased code enforcement and homebuyer or developer incentives should be enough to reduce vacancy and stabilize neighborhoods.

Lastly, in Baltimore's hardest hit neighborhoods, the city is demolishing, holding, or maintaining properties that are unlikely to attract any private investment in the near future.

Unfortunately, in some cases, vacant homes are beyond repair and will never be habitable again.

In these instances, demolition is often the best solution, and land banks can be a good way to hold the property until it can be converted to a better use.

A land bank is a governmental or nongovernmental nonprofit entity established, at least in part, to assemble, temporarily manage, and dispose of vacant land for the purpose of stabilizing neighborhoods and encouraging re-use or redevelopment of urban property.

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Land banks have been around since the early 1970s, but the recent foreclosure crisis has stimulated the creation of several new land banking programs, including in New York State and Kansas City, Missouri.

A key characteristic of the new generation of land banks is that they often include mechanisms to self-finance over time, including the ability to recapture a portion of the property taxes for a fixed period of time after the property is put back to productive use.

As encouraging as these new self-financing features are, land banks and municipalities are still struggling with the high costs of demolition.

For example, in Cuyahoga County, home to Cleveland, Ohio, about 80 percent of the approximately 100 properties per month that the land bank acquires need demolition, but at $10,000 in average costs per demolition, the Cuyahoga Land Bank is struggling to find the resources to fund this activity.

The state of Ohio recently dedicated $75 million of its direct payments from the Attorneys' General (AG) National Mortgage Settlement to fund a new grant program for demolition of abandoned and vacant properties statewide.

This $75 million still will not solve all of Ohio's demolition needs, but leveraging public and private funds like the AG settlement or developing new national sources of bond financing could help address this local problem.23

"Traditional Suburban" Locations

The last category of high-vacancy areas in the typology that I discussed earlier is "traditional suburban" neighborhoods.

In contrast to the other two types of high-vacancy census tracts, these neighborhoods are more evenly spread across many metropolitan areas, illustrating that vacancy can be a problem in any community.

Furthermore, ZIP codes in the "traditional suburban" tracts do not tend to have a higher share of property vacancies resulting from foreclosure than other ZIP codes, which demonstrates that some neighborhoods are

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struggling with long-term vacancy issues even though they did not experience large numbers of foreclosures.

While the vacancies faced by these suburban areas might not have been caused by foreclosure problems, the costs to neighborhoods are every bit as real. Such areas represent additional opportunities to use the lessons of the recent crisis as local leaders strive to better understand the root cause of high vacancy levels and to target limited resources.

Consider the situation faced by Oklahoma City.

Oklahoma City estimates that 8,000 urban properties have been vacant for more than three years, and that the number of vacancies is increasing.

The city's historically high housing vacancies mostly stem from cultural and demographic changes that have occurred over decades, as well as inadequate building code laws and enforcement.

Interestingly, the area did not experience the housing boom and bust that occurred in much of the nation.

Whereas national house prices rose by 89 percent between 2000 and 2006, prices in Oklahoma City rose by only 35 percent.

In addition, house prices in Oklahoma City have been flat since 2006, a sharp contrast to the large drop in national home prices.

But even though the vacancy rates in Oklahoma City are not a direct result of the housing boom and bust, it may be that newer solutions developed for "housing boom" and "low demand" areas can be combined with traditional community development policy tools to help solve a problem that developed over decades.

Indeed, city planners recently concluded that the city could not tackle neighborhood revitalization without addressing vacancies.

Increasing costs for needed city services, reduced revenues, and barriers to growth resulting from deteriorating infrastructure all combined to lend urgency to these efforts.

As has been the case in other cities, officials in Oklahoma City realized that gathering data was a necessary first step. Starting earlier this year,

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they embarked on an ambitious study to determine the total cost resulting from vacancies.

The city will then use the findings from the study to support enactment of tougher code enforcement to recover lost revenue, including assessment of fines against owners who fail to maintain their properties.

This combination of new measurements and old tools to develop solutions should serve as an example to many "traditional suburban" areas around the country that have experienced, and will continue to experience, vacancy issues.

Conclusion

The potential fallout of high rates of vacancy--blight, crime, lowered home values, and decreased property tax revenue--is the same for every neighborhood and community.

But there is no one-size-fits-all solution to the vacancy problem.

I've used some examples of communities around the country that are facing high vacancy rates in order to illustrate their different characteristics and the different origins of their vacancy problems.

Taking account of such differences will be important in crafting solutions to the problems caused by those vacancies.

Hopefully, these examples and other ideas that have been shared throughout this conference will inspire new and creative solutions to the difficult issues faced by communities.

Certainly, different housing markets will recover in different ways and at different paces. In some areas, the private market will lead the way, while in others, government will have to use precious resources wisely to catalyze recovery.

The examples I've discussed also illustrate the value of using data to understand vacancy issues, to determine which neighborhoods are experiencing which challenges, and to design appropriate policy solutions.

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Solving the problems of long-term vacancies will require the best efforts of public, private, and non-profit leaders locally and across the country.

I can assure you the Federal Reserve System will continue to support recovery through the use of all its policy tools and research capacity.

Thank you.

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NUMBER 3

NIST Selects Winner of Secure Hash Algorithm (SHA-3) Competition


The winning algorithm, Keccak (pronounced “catch-ack”), was created by Guido Bertoni, Joan Daemen and Gilles Van Assche of STMicroelectronics and Michaël Peeters of NXP Semiconductors.

The team’s entry beat out 63 other submissions that NIST received after its open call for candidate algorithms in 2007, when it was thought that SHA-2, the standard secure hash algorithm, might be threatened.

Keccak will now become NIST’s SHA-3 hash algorithm.

Hash algorithms are used widely for cryptographic applications that ensure the authenticity of digital documents, such as digital signatures and message authentication codes.

These algorithms take an electronic file and generate a short "digest," a sort of digital fingerprint of the content.

A good hash algorithm has a few vital characteristics.

Any change in the original message, however small, must cause a change in the digest, and for any given file and digest, it must be infeasible for a forger to create a different file with the same digest.

The NIST team praised the Keccak algorithm for its many admirable qualities, including its elegant design and its ability to run well on many different computing devices.

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The clarity of Keccak’s construction lends itself to easy analysis (during the competition all submitted algorithms were made available for public examination and criticism), and Keccak has higher performance in hardware implementations than SHA-2 or any of the other finalists.

“Keccak has the added advantage of not being vulnerable in the same ways SHA-2 might be,” says NIST computer security expert Tim Polk. “An attack that could work on SHA-2 most likely would not work on Keccak because the two algorithms are designed so differently.”

Polk says that the two algorithms will offer security designers more flexibility. Despite the attacks that broke other somewhat similar but simpler hash algorithms in 2005 and 2006, SHA-2 has held up well and NIST considers SHA-2 to be secure and suitable for general use.

What then will SHA-3 be good for?

While Polk says it may take years to identify all the possibilities for Keccak, it immediately provides an essential insurance policy in case SHA-2 is ever broken.

He also speculates that the relatively compact nature of Keccak may make it useful for so-called “embedded” or smart devices that connect to electronic networks but are not themselves full-fledged computers.

Examples include sensors in a building-wide security system and home appliances that can be controlled remotely.

“The Internet as we know it is expanding to link devices that many people do not ordinarily think of as being part of a network,” Polk says.

“SHA-3 provides a new security tool for system and protocol designers, and that may create opportunities for security in networks that did not exist before.”

Note

Keccak was designed by a team of cryptographers from Belgium and Italy, they are:

Guido Bertoni (Italy) of STMicroelectronics,

Joan Daemen (Belgium) of STMicroelectronics,

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Michaël Peeters (Belgium) of NXP Semiconductors, and

Gilles Van Assche (Belgium) of STMicroelectronics.

Note NIST announced a public competition in a Federal Register Notice on November 2, 2007 to develop a new cryptographic hash algorithm called SHA-3. The competition is NIST’s response to advances made in the cryptanalysis of hash algorithms. A cryptographic hash algorithm is a widely-used tool that creates a “fingerprint”, or a “message digest” of a file, message or block of data that can be used for digital signatures, message authentication codes, and many other security applications in the information infrastructure. The winning SHA-3 algorithm will augment the hash algorithms currently specified in FIPS 180-4, Secure Hash Standard. NIST received sixty-four entries from cryptographers around the world by October 31, 2008, and selected fifty-one first-round candidates in December 2008, and fourteen second-round candidates in July 2009. On December 9, 2010, NIST announced five third-round candidates – BLAKE, Grøstl, JH, Keccak and Skein, to enter the final round of the competition. The cryptographic community has provided an enormous amount of feedback throughout the competition. Most of the comments were sent to NIST and a public hash forum; in addition, many of the cryptanalysis and performance studies were published as papers in major cryptographic conferences or leading cryptographic journals. NIST also hosted three SHA-3 candidate conferences to obtain public feedback. Based on the public comments and internal review of the

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candidates, NIST announced Keccak as the winner of the SHA-3 Cryptographic Hash Algorithm Competition on October 2, 2012, and ended the five-year competition. Further details of the competition are available at the specific sites indicated in the menu on the left.

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NUMBER 4

UK FSA

Financial Crime newsletter

Welcome to Issue 16 of our Financial Crime newsletter. So far, 2012 has been particularly busy for us. We have published the findings of two significant pieces of thematic work, contacted over 75,000 potential victims of boiler room scams, and continued with our credible deterrence strategy, taking regulatory action against three financial institutions for financial crime failings and securing numerous criminal convictions for insider dealing. Throughout the remaining life of the FSA, and continuing into the Financial Conduct Authority (FCA), we will focus on tackling key financial crime risks to our objectives. This newsletter confirms that we will be taking forward our intensive and intrusive work on anti-money laundering (AML), sanctions, counter-terrorist financing and anti-bribery and corruption (ABC) systems and controls in a number of very large banks. We also give more detail about our recent thematic reviews and enforcement cases. Finally, it is vital during periods of change that we remain focused and committed in the fight against financial crime. I am delighted to be given the opportunity to lead our work in this area as director of the Enforcement and Financial Crime Division.

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I am also delighted to introduce the new Head of Department for our Financial Crime and Intelligence Department, Sharon Campbell. Sharon has been at the FSA for over seven years. Before this she was Head of Department in our Authorisation Division and she has over 20 years of industry experience. Sharon replaces Bob Ferguson, who has made a real contribution to countering financial crime and will be missed. He will be taking a few months career leave and returns in March to take up a new position in the FSA. Bob goes with all our thanks for his hard work over the years. Tracey McDermott

Director, Enforcement and Financial Crime

Anti-bribery and corruption systems and controls in investment banks

In March 2012 we published a report on how investment banks and similar firms are managing the bribery and corruption risk in their business.

We found that, although some had started work to identify and assess their bribery and corruption risks and factor them into their ABC controls, including policies, procedures and training and monitoring programmes, most had more work to do.

In particular:

- most firms had not properly taken account of our rules covering bribery and corruption, either before the implementation of the Bribery Act 2010 or after;

- nearly half the firms in our sample did not have an adequate ABC risk assessment;

- management information on ABC was poor, making it difficult for us to see how firms’ senior management could provide effective oversight;

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- only two firms had either started or carried out specific ABC internal audits;

- there were significant weaknesses in firms’ dealings with third parties used to win or retain business; and

- many firms had recently tightened up their gifts, hospitality and expenses policies, but few had processes to ensure gifts and expenses in relation to particular clients/ projects were reasonable.

We were pleased to see, however, that most firms used senior committees to drive the ABC agenda, and generally there was an appropriate level of senior management involvement in decision-making about new third-party relationships or transactions. Overall, the report concluded that the investment banking sector has been too slow and reactive in identifying, assessing and managing their bribery and corruption risk. In particular, the introduction of the Bribery Act and our visits were the main triggers for many firms in our sample to review, or consider for the first time, their approach to ABC.

Banks’ defences against investment fraud

In June 2012 we published our report on banks’ defences against investment fraud. Our review found individual staff members had a strong commitment to protecting customers, but we saw little governance of the specific issue of investment fraud. We also found that:

Resource allocation was not based on risk assessments that explicitly considered the risk of investment fraud, so resources available were not the result of informed decision-making by senior management;

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It was not clear to us that the banks we visited had fulfilled their regulatory obligation to assess investment fraud risks appropriately and counter the risk that the bank might be used to further financial crime; Banks’ ability to detect where their customers might be complicit in investment fraud was disappointing; and Ongoing monitoring of customers was often the responsibility of customer-facing staff with many other responsibilities, who often lacked the experience or knowledge to identify investment fraud. More positively, we saw a range of transaction-monitoring technologies. Some banks had used these successfully to prevent customers falling victim to investment fraud. We also saw good examples of banks maintaining intelligence on investment fraudsters, although measures were not consistent across the industry.

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NUMBER 5

EBA Work Programme 2013

1. Introduction

In accordance with Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing the European Banking Authority (EBA), the annual work programme describes and summarises the main objectives and deliverables of the EBA in the forthcoming year derived from the tasks specified in the Regulation and from the relevant EU banking sector legislation. Following a discussion of a draft version by the EBA Board of Supervisors in summer 2012, and by the Banking Stakeholder Group, the Work Programme was reviewed by the Management Board who proposed its adoption. Based on this proposal the Board of Supervisors adopted the 2013 work programme at its meeting held on 25-26 September 2012. The work programme aims to define the main objectives and corresponding priorities of the EBA for 2013 in fulfilment of its overall mandate. The fundamental objective for the EBA in the regulatory policy area will be to play a central role in the development of the single rule book, with the aim to contribute to achievement of a level playing field for financial institutions as well as to raise the quality of financial regulation and the overall functioning of the Single Market. The EBA’s work in this area relates in particular to the CRDIV/CRR legislative framework, including liquidity and remuneration, as well as to the crisis recovery and resolution legislative framework. The EBA’s oversight activities will focus on identifying, analysing and addressing key risks in the EU banking sector, including analysing the consistency of outcomes in risk weighted assets (RWAs), the

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sustainability of banks business models and reviews of banks’ asset quality, promoting supervisory cooperation and convergence and continuing its work in colleges of supervisors to strengthen European supervision of cross-border banking groups. Last but not least, the EBA is committed to enhance the consumer protection and promote transparency, simplicity and fairness for consumer financial products and services across the Single Market, and as such will focus its consumer protection activities on developing guidelines on responsible mortgage lending, and on arrears handling and forbearance in the mortgage market, and regulatory technical standards on Professional Indemnity Insurance. The above three areas - Regulation, Oversight, and Consumer Protection - are representing the core functions of the EBA that are laid down in the EBA regulation. For these, a detailed list of tasks including a breakdown of deliverables is also provided. Further, a separate horizontal unit, Policy Analysis and Coordination, provides the internal and external policy coordination between the core functions of the EBA and external stakeholders, as well as provides the legal review and assesses the impact of the EBA’s policy proposals. The support functions summarised as Operations are playing a critical role in ensuring that the EBA can perform its core functions, and thus, their main working objectives are also summarised.

The year of 2013 will be the third year of operation for the EBA as a fully-fledged EU Authority in the new European System of Financial Supervision (ESFS).

Therefore, emphasis continues to be on the continuing development and strengthening of the EBA’s institutional capabilities.

In addition, there are significant new legislative proposals in European banking regulation and supervisory architecture, including the Banking Union and the Recovery and Resolution proposals, on the EU’s agenda, some of which have already been published but not yet adopted, and

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some are expected to be published in the near future, but all having a major impact on the amount and priorities of specific tasks of the EBA in 2013 and thereafter.

The Banking Union will have important repercussions on the mandate of the EBA, as it will call on the Union for an even stronger commitment to the single rule book and unified supervisory methodologies, with a view to avoid polarisation of the Single Market between the euro area, and its application of single supervisory rules and practices, and the rest of the Union.

A detailed list of the EBA’s tasks is presented in the Annex with attached priorities. Generally, tasks deriving from a legislative proposal with a deadline falling in 2013 are assigned priority 1; priority 2 tasks will only be accomplished in as far these do not constrain the priority 1 tasks. Due to the high number of priority 1 tasks in 2013, significant increase in human resources is needed to allow the EBA to fully address priority 2 tasks. Priority 3 tasks will most probably not be accomplished in 2013. Please note that some of the items attributed to European Commission (EC)’s legislative proposals might change given these proposals are currently under discussion. In order to enable EBA to deliver its 2013 work programme, EBA will need to increase its staffing levels and budget accordingly. In 2013 staff numbers are expected to grow from 68 in 2012 to 93 Temporary Agents, in line with the approved Establishment Plan and the budget from €20.7 million in 2012 to €25 million. EBA will continue to be funded by the EC and the National Competent Authorities.

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2. Regulatory work

The main objective of the EBA in the regulatory policy area is to play a leading role in the creation of the single rule book for the EU banking system. The main focus of the EBA’s regulatory work in the coming years will be in two major areas in line with the EU legislative agenda. Tasks that are outside of these two areas have also been identified and listed in detail in the Annex. Firstly, and most importantly the ongoing financial crisis has shown deficiencies in the prudential rules regulating banks which have resulted in adverse consequences to the financial soundness of individual institutions and to the international financial system. An agreement has been reached at global level to repair the regulatory shortcomings leading to the recent set of prudential rules under the umbrella of the Basel III agreement. The EU is committed to introducing this prudential framework throughout the Single Market, and are due to adopt by end 2012 EU legislation/regulation that aim to implement Basel III in the EU on 1st January 2013. The EBA is to play a crucial role in the technical implementation and application of this new set of regulatory rules, and will therefore focus its work in this context on accomplishing the drafting of binding technical standards under the new CRDIV/CRR framework. Given these legislative proposals are still to be adopted, and hence their final details remain unknown, this presents significant uncertainty in EBA’s work programme at this juncture, together with planning and resource complexity to the EBA’s organisation given their implementation remains to be from 1 January 2013.

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On the expected CRR/CRDIV related tasks the EBA has taken a pragmatic approach and considered as a basis the Council’s proposal of May 2012.

The EBA has not included any additions or deletions proposed by the EU Parliament although it has considered a few additional tasks in the Council’s proposal that are likely to be deleted.

In addition, those deliverables with deadline of January 2013 or December 2012 that EBA expect to deliver to the EU Commission, or publish before the end of this year, have not been included.

As a result about 164 deliverables are expected from the EBA.

The majority of these products relate to the development of more detailed technical rules mostly via the development of binding regulatory or implementing technical standards.

Other types of deliverables include guidelines, reports, opinions, mediation activities, or the receipt and processing of notifications.

A summary is shown in the table below, and a detailed breakdown in the Annex.

It should be noted that this part of the work programme will need to be updated after the final text of the CRR/CRDIV becomes available.

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In addition to the high number of deliverables in relation to the CRR/ CRDIV proposals, the timing of these products is very concentrated as the implementation schedule needs to remain consistent. Most products are expected to be finalised by 2013-2014, thus, the concentration of the EBA’s regulatory work will be very high in the course of 2013. The sheer number of tasks as well as the concentration in their timing underlines the importance of prioritisation. Based upon the capacity available at both the EBA and at the national authorities, it is expected that not all activities can be undertaken as currently proposed without additional human resources at the EBA. Given the need for a strict prioritisation, the following policy areas have been identified where the EBA can provide the highest added value via extended technical rule making:

Capital: better quality capital is one of the key characteristics of the new capital framework. Following the EBA consulting on many proposals for technical standards on own funds in 2012; this area will remain of priority for EBA in 2013, with a focus in 2013 on the permanent monitoring of the quality of capital instruments. Liquidity: the crisis has shown how important it is for banks to have sufficient liquidity available, both for the short and longer term. The CRR/CRDIV will adopt the basic framework in the form of a Liquidity Coverage Ratio and a Net Stable Funding Ratio which have been agreed upon globally. This gives the EBA the task of preparing the calibration of the ratio components including assessing the consequences and impact of introducing these liquidity measures.

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Remuneration: the crisis has shown that adverse personal incentives could lead to risk prone behaviour. Therefore, specific rules on remuneration have been established. Based on EBA Guidelines already published EBA will undertake some data exercises to benchmark trends in remuneration at Union level, and in relation to disclosure on information on High-earners. Further EBA will develop Technical Standards in relation to the criteria for the identification of risk takers, and the determination of the variable and fixed aspects of the remuneration. Leverage ratio: the leverage ratio is intended as a back stop for institutions that are excessively leveraged, as excessive leverage is generally considered to have played a major part in the financial crisis. Based on the leverage ratio reporting, the impact of introducing the leverage ratio has to be assessed by the EBA. This activity will therefore build on the leverage ratio reporting framework developed at the EBA and continue in 2013, with deliverables expected from 2014 and onwards. Given EBA’s mission is to develop practical instruments and convergence tools to promote common supervisory approaches, the EBA will also take due care of implementation issues when entering the transitional phase of new legislation. In particular EBA will provide explanations when it comes to the implementation of the CRDIV/CRR and develop specific tools and policy to answer questions. In addition to its mandated regulatory technical contribution, the EBA is providing technical input to help framing targeted provisions on supervisory matters.

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Moreover, the small and medium enterprises (SMEs) sector retains a particular attention. The crisis has shown that many SMEs have difficulty to access finance, and this is viewed as an obstacle to the recovery in the European economy and has triggered several calls for action, also in the area of banking regulation. The EBA is working on a review of the prudential framework for SME lending as a contribution to legislative proposals. Secondly, the crisis has shown a need for more advanced and coordinated crisis prevention and crisis resolution arrangements and tools, so as to be able to detect a crisis event earlier, intervene more adequately and resolve troubled financial institutions more efficiently. In June 2012, the EU Commission published its legislative proposals on an EU framework for recovery and resolution of credit institutions and investment firms, which provide a key role for the EBA, both in setting further technical standards and guidelines, including in relation to the content and assessment of recovery and resolution plans; the application of early intervention measures; preventative (structural) measures to ensure resolvability; application of specific resolution powers in respect to specific resolution tools; recognition of third country resolution proceedings, and provide a role for EBA in the coordination and participation in cross border crisis events through its participation in the resolution colleges.

3. Oversight work The EBA’s oversight activities in 2013 will focus on identifying, analysing and addressing key risks in the EU banking sector. After a successful recapitalisation programme in 2012, the EBA will continue to monitor capital levels and banks capital plans to strengthen their capital position further, as they move towards the implementation of CRD IV.

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The next EBA EU wide stress test, planned for 2013, will be a key component in assessing such plans. The EBA will also continue to work with relevant competent authorities to understand the impact of deteriorating asset quality on banks’ balance sheet and to promote the ongoing process of balance sheet repair and banks’ efforts to restore sustainable funding structures will be a focus of analysis. The EBA will continue its regular thematic analysis on a number of areas including the consistency of outcomes in risk weighted assets (RWAs), the sustainability of banks business models and reviews of banks’ asset quality. Regular products will include frequent funding and liquidity updates drawing on supervisory and market intelligence, semi-annual banking sector reports to the Board of Supervisors, to the Economic and Finance Committee (EFC) - Financial Stability Table (FST), and quarterly updates to the ESRB. In the area of reporting and transparency the highest priority will be the implementation of the common reporting framework, COREP and FINREP, and providing assistance with any implementation issues as well as further assessing and strengthening transparency across the EU banking sector. In turn the EBA will use supervisory data along with market intelligence and input from colleges to prepare risk assessment reports for the European Parliament, the Commission and the ESRB. Cross sectoral risk reports will continue to be prepared in collaboration with the Joint Committee, and will be sent to the EFC-FST. The EBA will also maintain and further develop its key risk indicators and its suite of risk dashboards, including internal EBA bank level dashboards, peer group dashboards to be shared with supervisory colleges/NSAs and a sectoral dashboard for EBA and ESRB discussions.

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The EBA will also continue to promote the convergence of supervisory practices across the Single Market, by contributing to the development of the single rule book and also to the development of the supervisory handbook. This objective will be pursued through effective bilateral and multilateral exchange of information between competent authorities as well as more structured stock-takes of supervisory practices in specific areas, such as frameworks for the analysis of risks, ICAAP assessments and Pillar 2 decisions. As the result of these activities, papers summarising the best practices and guidelines will be drafted. The organisation of technical training for the supervisory staff of competent authorities will contribute to foster a common supervisory culture in the EU.

The EBA will continue its work in colleges of supervisors to strengthen European supervision of cross-border banking groups.

EBA staff will participate, support and monitor colleges.

Higher quality, more detailed feedback and advice on the functioning of colleges will be focused on a prioritised set of 40 banking groups.

The EBA will, where appropriate, apply its role in binding mediation, and actively facilitate and, where deemed necessary, coordinate any actions undertaken by the relevant national competent supervisory authorities, in case of adverse developments/crisis situations. In crisis management, in addition to its extensive regulatory role, the EBA will have a significant role in engaging in, and assisting, the discussions and agreement on recovery and resolution plans between relevant competent authorities, including in resolution colleges. Where disagreements arise, the EBA will play a role in settling them. Based on these priority tasks the EBA aims to achieve its objectives to

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(i) deliver independent and high quality analysis of EU banks and the EU banking sector, in coordination with the work of Competent Supervisory Authorities, the ESRB and EU policy making bodies, and leading to concerted policy responses (ii) ensure relevant and sound data is available for effective supervisory oversight and market discipline to (iii) further promote supervisory convergence and the building of a common supervisory culture across the single market (iv) assist and monitor Competent Supervisory Authorities in building college structures that are efficient and substantive.

4. Consumer Protection work

In the area of consumer protection, the EBA has an EU-wide responsibility and is fully committed to promoting transparency, simplicity and fairness in the market for consumer financial products or services across the Single Market.

The EBA has established an independent organisational unit for consumer protection.

In 2013 the Unit will continue to collect, analyse and report on consumer trends and analysis of banks' activities in structured products and the retailisation thereof.

Further, guidelines on responsible mortgage lending, and on arrears handling and forbearance in the mortgage market, and regulatory technical standards on Professional Indemnity Insurance will be finalised - subject to the proposed Mortgage Credit Directive.

In addition, analysis of consumer detriment issues in the area of non-mortgage credit and potentially the development of guidelines on specific risks will be performed.

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The Unit will continue monitoring new and existing financial innovation with a view to promoting the safety and soundness of markets and convergence of regulatory practice.

Finally, a Consumer Day will be organised in 2013 jointly with the consumer units of ESMA and EIOPA, following on from the EBA Day on Consumer Protection on 25 October 2012.

5. Policy Analysis and Coordination

The main objectives of the EBA’s Policy Analysis and Coordination Unit will be to provide the legal analysis of the policy and supervisory documents prepared by the regulation and the oversight clusters (technical standards, guidelines, opinions, supervisory recommendations, dispute resolution, peer review etc), the impact assessment of the same documents/actions when needed, and the internal and external coordination of the EBA’s policy and supervisory work when needed between clusters/units and with external bodies, such as BCBS and IMF, and institutions, including the EU Commission, the Council (and its EFC and FSC), and the EU Parliament (and its ECON Committee), and the EBA's contribution to the review of the ESFS.

This Unit’s work also includes the coordination of the EBA’s supervisory training activities offered to NSAs, and providing support to the EBA’s Banking Stakeholder Group, to the EBA’s Review Panel and to the ESAs’ Board of Appeal.

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6. Operations and institutional capabilities

The overall objective of the institutional development of the EBA in 2013 will be the maintenance and further enhancement of the internal control environment in a period of intensive build-up and growth of the recently established EU institution. The EBA has adopted and implemented the most important EU HR regulations and procedures and continues to operate under the general EU HR rules. In light of the expanding workload arising from the EBA’s core functions, recruitment and integration of new staff will continue to be a key priority in 2013. Detailed staffing plans for 2013 will be finalised as soon as the 2013 annual budget of the EBA is approved.

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Due to the significantly higher than expected workload resulting from the tasks related to the CRDIV /CRR and Bank recovery and resolution proposals, additional human resources have been requested compared to the establishment plan of the organisation, the approval of which is still pending. Significant new technical skills will need to be built up in the organisation in 2013 such as broadening and deepening the technical knowledge and experience of EBA’s experts. Therefore, in addition to the careful recruitment of new staff, the rollout out of the recently launched staff training program shall contribute to developing EBA staff. The EBA is expected to implement a long term solution for its office needs, after an approval in the second half of 2012. A key operational priority for 2013 will be the approval and implementation of the EBA’s medium and long term IT strategy, in line with the expanding IT requirements that are defined by the widened scope and depth of the EBA’s core functional tasks.

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NUMBER 6

Introductory Remarks at SEC’s Market Technology Roundtable

By Chairman Mary L. Schapiro, U.S. Securities and Exchange Commission

Washington, D.C.

Good morning. Thank you to all of the panelists for taking time to share your thoughts with us on market technology. And thank you to those who have already written in with your comments. You have given us a number of very thoughtful recommendations.

To an extraordinary extent, the stability of our securities markets is tied to the technological infrastructure of those markets.

As with virtually every industry, technology brings many benefits. And our markets are no different.

Thanks to technology, our securities markets are more efficient and accessible than ever before.

But we also know that technology has pitfalls. And when it doesn’t work quite right, the consequences can be severe.

Just imagine what can happen:

If an automated traffic light flashes green, rather than red.

If a wing flap on a plane goes up rather than down.

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If railroad track switches and sends the train right, rather than left.

Similarly, there can be significant consequences for technological errors in our markets as well — trading can be disrupted, investors can suffer financial loss, firms can be imperiled, and confidence in our markets broadly can erode.

Today’s roundtable will help us think through the issues and the steps we need to take to ensure that our markets remain the most robust, efficient, and stable in the world.

There are two basic concerns we need to focus on that are highly interrelated — these are:

First, the structure of our markets, such as multiple execution venues, the presence of high frequency trading, dark pools, and the like.

Second, the infrastructure of our markets, as in the technology that undergirds trading activity.

Market Structure

To provide some perspective — in January 2010, I asked the staff to begin a comprehensive review of the equity market structure.

It was a review that included getting views on everything from the impact of high frequency trading, to the continued rise of dark pools, to the complexities of a multi-venue market system.

The focus was not so much on the infrastructure of our markets but on the way the markets and market participants operate and behave.

Four months later, when disorderly trading activities in the S&P e-mini market spread to the equities market, causing what is now known as the Flash Crash, we — as an agency — were well-positioned to respond.

Working with the exchanges, we quickly put in place a series of measures that have since helped to reduce the likelihood of another event like that from occurring.

Within days of that event, I summoned the heads of every exchange to the SEC to hammer out common-sense approaches to bolster our markets.

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And as a result of our efforts:

- We now have in place single-stock circuit breakers to prevent stocks from falling too far, too fast, and we have approved a more advanced limit up/limit down mechanism to limit excessive volatility.

- We now have in place a ban on stub-quotes and rules clearly defining when a trade can be broken so as to help avoid circumstances that can lead to disorderly trading.

- We now have in place rules banning naked access and requiring rigorous pre-trade risk controls designed to help mitigate disruptive trading at the source.

- And we now have rules requiring large traders, many of whom use high frequency trading strategies, to identify themselves so that the Commission can better monitor and analyze their trades — a process that other regulators overseas are beginning to emulate.

Additionally, and perhaps most importantly, we have adopted a rule that requires SROs to develop plans for the first ever consolidated audit trail — a feature that will allow regulators to surveil and reconstruct trading across platforms.

But there are issues around market structure and the conduct of market participants that we should further examine, including the high volume of cancellations, a proliferation of order types, transparency, high frequency trading generally, potentially manipulative trading strategies, and data latencies for public investors — to name a few.

These issues still require attention and we are committed to addressing them.

Market Infrastructure

But today’s roundtable will focus more specifically on infrastructure not only because of its importance, but also because I worry that this issue is at risk of being lost and subsumed by the broader debates regarding market structure.

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After all, issues that get lost often do not get resolved. And these matters of infrastructure are essential to any holistic approach to improving how our markets operate.

IPOs

Consider for a moment the IPO of BATS on its own exchange, and the IPO of Facebook on the NASDAQ exchange.

Though there are many views regarding the fragmented nature of simultaneous trading across multiple venues, I believe these IPO events evidence a very different set of concerns.

Both events involved one of the few single-exchange processes that remain in an otherwise fragmented market — namely, building a single order book and crossing trades at a single price to open trading for a new public company.

In the case of BATS, it was a flaw in new software code designed to conduct a corporate IPO auction.

That mistake caused the matching engine for tickers in a certain range to enter into an infinite loop, making these tickers, which included the symbol for BATS itself, inaccessible on BATS.

In the case of NASDAQ, the IPO software was designed to accept cancellations submitted while the final IPO price — or the Cross — is being calculated.

Cancellations received during this time changed the order book. By design, the system recalculated the final IPO price to factor in the new state of the book.

But again, changes were received before the system could print the opening trade, which resulted in additional re-calculations. This condition persisted, resulting in further delay of the opening print.

These single-exchange problems are not a result of complexities or fragmented markets, but rather a result of more basic technology 101 issues.

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Knight Capital

Consider as well the events this summer with Knight Capital — a trading firm that had just installed trading software that was intended to send orders to the NYSE’s new Retail Liquidity Program.

Instead, the software wound up sending “a ton of orders” into the market.

As the market data that morning revealed, the software did not create patterns of rapid orders and cancels.

Rather, the data showed a massive amount of orders resulting in executed trades that caused Knight Capital to accumulate significant and unwanted positions.

This type of problem, as with the IPO mishaps, was the result of basic technology 101 issues.

Events like these demonstrate that core infrastructure and technology issues can be problematic in any market structure.

However, though for today we are focusing on infrastructure issues, it is important to recognize how the overall structure of our markets can affect how our infrastructure is designed and implemented.

For example, we have a very competitive market environment in which rapid innovation and speed-to-market may compete with diligent testing and validation of the technologies that support such innovation.

Our multi-venue, interlinked market structure also means that an infrastructure failure by one party or at one venue may cascade into other venues and affect many other parties.

And of course the inherent speed of trading, which itself is partly a result of the competitive nature of our markets, means that even small, short-lived infrastructure issues can cause drastic harm.

SEC Actions

To be sure, several of the measures we have already approved have helped to strengthen our markets even in the face of potential, and inevitable, technological errors.

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Indeed, several of the post-Flash Crash reforms such as the revisions to the clearly erroneous rules helped limit the impact of the Knight Capital episode on other market participants.

But limiting any harm resulting from technological errors is not as good as preventing the error in the first place — which is why we have instituted clear rules that require firms with access to our markets to have controls in place to reduce the chance of such errors.

But perhaps the strongest message from the Knight Capital episode is that the party committing an error may very well l end up bearing a massive financial loss.

That, more than anything, sends a wake-up call to the entire industry.

Nonetheless, our concern is not whether a single firm might fail, but whether it causes collateral damage to investors and their confidence in the integrity and stability of our markets.

So I am pleased that the industry has been working overtime in the aftermath of the Knight Capital episode to address these issues — and I am pleased our roundtable has spurred such discussion.

Conclusion

By focusing on the underlying nature of these incidents, and hearing, as we are today, from experts in technology, I hope we can address these issues in an efficient, effective, and expeditious manner.

I now will turn it over to Robert Cook, Director of the Division of Trading and Markets, and his staff who will serve as moderators of today’s discussion.

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NUMBER 7

Why we should be interested in the history of currencies

Address by Ernst Baltensperger Presentation of “Der Schweizer Franken – eine Erfolgsgeschichte”

The history of a country – and of its population and institutions – provides us with potential lessons for the present. But that is not the only reason why it is of interest to us. When we bear in mind the multitude of ways in which the present reflects events of the past it becomes clear that history is far more fundamental. Decisions by our parents, grandparents and their ancestors, along with all the events of their own times which they could not influence, are responsible for the world in which we live today. In this way, present and past are inseparably linked. The former cannot really be understood without knowing the latter. Seen from this perspective, studying history should be a necessity – something that goes without saying. Yet, above and beyond this, it is legitimate and reasonable to pose the question as to what specific insights and lessons for modern life can be derived from our study of history. Certainly, the world moves on continually and the problems of the present always differ in one way or another from those of the past. Nevertheless, many aspects remain more or less unchanged over longer periods of time, and many questions recur in slightly altered forms in later periods. In this sense, we can certainly learn from history.

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The history of the Swiss currency offers a wide variety of experiences relating to numerous questions which, especially in view of the current upheaval in worldwide money and financial markets, are once again highly topical. I would like to pick out seven different areas.

1. The vital importance of political and financial stability for the rise of the Swiss franc At its conception, the Swiss franc was not necessarily predestined to become one of the most stable and successful currencies of the world. Created through the Federal Coinage Act of 1850, two years after the foundation of the modern federal state of Switzerland, the new Swiss franc was essentially a satellite of the French franc. This continued for the first fifty years of its life until the establishment of the Swiss National Bank in 1905–07. This situation reflected not least the initial softness of the newly established currency. During this period, the Swiss franc often tended to be weak against the French franc and, in the decades before the First World War, featured an interest rate surcharge or malus with respect to the French currency, rather than the interest rate bonus which we are familiar with nowadays. Since the outbreak of the First World War, the value of the Swiss franc has risen hugely against all the major currencies. In 1914, the US dollar was worth CHF 5.18; in 2011, by contrast, it could be purchased for just over 80 Swiss centimes at times. The relative loss of value was much greater in the case of most other currencies. In 1914, the pound sterling was worth just over CHF 25; now it stands at around CHF 1.50.

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The relative loss of value is particularly pronounced in the case of the former partner currencies in the Latin Monetary Union – the French franc and, even more extreme, the Italian lira, whose value in Swiss francs at the introduction of the euro in 1999 had to be measured in terms of thousandths. The advance of the Swiss franc from a French franc satellite to an independent and strong investment currency of international importance went hand in hand with Switzerland’s political and social consolidation and its increasing economic success. Its firm determination to remain independent and to maintain financial and monetary stability – traits that have always been particularly characteristic of Switzerland when compared to other countries – played a key role in this respect. It is hard to establish and maintain a stable monetary order in a war-torn social and economic environment. And the fact that Switzerland has been spared the turbulence of war for one and a half centuries – due to both political prudence and fortuitous circumstances – has naturally been an important contributory factor in accumulating the capital of stability and trust from which the Swiss franc is now benefiting.

2. Monetary, financial and economic stability are interwoven It is certainly true to say that the currency’s stability has benefited from Switzerland’s political and economic success. At the same time, however, the focus on stability in the monetary field has made a substantial contribution to political and economic consolidation. The two go hand in hand. Steady money and well-functioning, efficient financial structures are among the most important achievements of our economic and social system.

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A stable currency, in particular, is one of our most valuable public goods, comparable with a well-functioning system of law, public security or finance and taxation. Without it, a liberal economic and social order cannot develop effectively. Economic history is full of examples that show the way in which problematic or, indeed, failing currencies have disastrously impaired the efficiency of economic systems and, in extreme situations, led to economic and political ruin. In the course of the 19th and 20th centuries, Switzerland succeeded – to some extent through painful experience – in creating institutions and systems that proved robust and resistant to this danger. The strong Swiss awareness of the fundamental social importance of the monetary order, and of its stability and reliability, has made a strong contribution to this development and thus to the economic and political success of our country since the establishment of the Confederation.

3. Metal-based versus paper-based currencies Together with many other countries, Switzerland made the transition from a metal-based currency to a purely paper-based currency during the course of the 20th century. The clearest and most definitive break in this process was the worldwide transition to flexible exchange rates after the breakdown of the Bretton Woods period at the beginning of the 1970s. The end of the traditional metal-based currency systems actually dates back to the early years of the century, when the international gold standard broke down following the start of the First World War. However, currency arrangements in the years between the two world wars and during the Bretton Woods system of the postwar decades remained strongly influenced by the gold-currency idea, and maintained important elements of the metal-based currency and a link to gold.

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The transition from fixed to flexible exchange rates at the beginning of the 1970s represented an enormous increase in power for central banks, while, at the same time, vastly extending their public accountability. Not until they were freed from the responsibility to maintain gold parity – and the obligation to subordinate monetary policy to the need for maintaining the balance of payments in equilibrium which this entailed – were they fully able to conduct an autonomous monetary policy geared to domestic targets. This brings advantages, with the disappearance of the restriction implied by a fixed link between money in circulation and the available volume of the associated currency metal, but also considerable temptations and risks. The scepticism already expressed by Niehans in the late 1970s with regard to a purely paper-based money standard is not without a certain justification. Yet – as he then wrote on commodity, or metal-based, money – “from a practical point of view, commodity money is the only type of money that, at the present time, can be said to have passed the test of history in market economies” (Jürg Niehans, The Theory of Money, 1978, p. 140). Not for nothing can the 20th century be described as the century of inflation. The experiences of the most recent financial and debt crisis, in particular, have again raised doubts about the current paper-based money system. Nevertheless, proponents of metal-based currency systems would do well to remember that even these kinds of systems can lose their stability anchors – and have often done so. The history books are full of cases where the value of coins deteriorated, or where supposedly fixed metal-based parities were abolished or changed for reasons of political expediency.

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Consequently, we should try to avoid a romantic view of metal-based currencies. These currencies are based on a self-imposed commitment on the part of monetary authorities to maintain a fixed metal content of the currency unit ‘for all eternity’. Self-imposed commitments are valuable and useful. They establish barriers that provide protection from overly opportunist changes. But ultimately they are only as valuable as the determination to comply with them. Moreover, even metal-based currencies do not provide an unlimited guarantee of price stability. Only where the real structures of an economic system remain constant is this strictly the case. However, if there are shifts in the productivity of metal mining, or if there is a growth-based increase in periodic supplementary demand for currency metal, there may be permanent alterations in the price level, even under a metal-based standard. What is more, one need only examine the history of the Swiss currency during the 19th century to find manifold illustrations of the fact that metal-based currency systems can be associated with inefficiency and instability.

4. Competition and monopoly in money and currencies The choice between competition or monopoly in the area of money and coinage is one that has been exercising minds for a very long time. Should governments be granted a monopoly over the currency, banknotes and regulation, or is it preferable that free competition exist between the issuers of currencies and money?

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The question of competition and monopoly arises at various levels. At the most basic level, it concerns the definition of the currency unit and the issuance of coins. Next, it relates to the issuance of paper money in the form of banknotes, and finally, it involves the creation of money in the form of bank deposits. The history of the Swiss currency in the 19th century provides a treasure trove of different experiences in this regard. Historically, the view became clearly established that currencies, with their strong network effects, display aspects of a public good and that they therefore naturally tend in the direction of centralisation and monopolies. In the current period, too, scholars’ assessments more or less confirm this position. The history of the Swiss currency is consistent with this point of view. After its introduction in 1850, the new Swiss franc rapidly established itself as the national currency, without any difficulties. Clearly, the transition from the previous chaos of multiple coinage and currencies to a uniform national currency met a real need, and made a long-term contribution to the efficiency of the Swiss monetary and payment system and the productive strength of the Swiss economy as a whole. In the previous period, from 1820 to 1850, Switzerland had provided a rare example of true currency competition, with a free choice between currency denominations comparable to Hayek’s proposal of 1978. The lack of any national currency unit gave independent note-issuing banks complete freedom to choose the basis on which they issued their banknotes.

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This competition was successful insofar as the purchasing power of the issued banknotes remained stable and there were no bank failures or crises. However, the money created by the issuing banks was put to relatively little use – an indication of its lack of attractiveness or efficiency in practice. This phase came to an end with the introduction of the new Swiss franc in 1850. From 1850 to 1881, the Swiss currency system – which now featured one common, dominant currency, the new Swiss franc – was characterised by competition between independent note-issuing banks (both private and public). Until the Banknote Act of 1881, however, the banking system remained largely unregulated. Measured by the criteria of financial and currency stability, this competition between issuing banks while banknotes were being freely issued did not have any negative consequences. In this respect, therefore, it can be judged to have been successful. Nevertheless, if we consider that, for a long time, banknotes played a relatively minor role in the Swiss payment system and that the resulting monetary system was characterised by major shortcomings as regards efficiency, and, in particular, the acceptance and reciprocal recognition of banknotes, this conclusion is put in perspective. The shortcomings meant that there was a tendency for common quality requirements to be introduced, either through regulatory interventions or via cartel-type agreements (‘concordats’, compacts). From 1881, statutory requirements placed severe restrictions on the reserve, liquidity, encashment and issuance policies of banks. Until 1905, a policy of limited banking freedom prevailed.

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This featured a system with a joint currency – now compulsory – as well as heavily regulated banknote transactions, but as yet no state banknote monopoly. Although the banknote ‘homogenisation’ achieved through this regulation promoted the acceptance of banknotes as well as the efficiency of the monetary and payment system, competition was no longer in a position to carry out its disciplinary function in this environment. As a result, too many banknotes were issued and the monetary and currency system was weakened. This was the situation which finally led to the establishment of the Swiss National Bank and the centralisation of banknote issuance. Ultimately, therefore, the cause of the move towards centralisation was the pursuit of efficiency and stability – consistent with the idea of money as a natural monopoly. Although the system based on competition worked, it displayed shortcomings in terms of efficiency. Consequently it gave rise to regulatory interventions which, in their turn, destroyed the foundation for the disciplinary effect of competition and finally led to centralisation.

5. The importance of monetary stability as the main target of central bank policy in a paper money system Through the transition to a purely paper-based currency lacking a link to gold or any other currency metal, the position and importance of the central bank and its policy changed fundamentally. This applies to Switzerland just as it does to other countries. Previously, the rules of the metal-based currency, under which money in circulation was tied to the available supply of the associated currency

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metal, automatically ensured the long-term stability of the value of money (the price level). Once this link disappeared, this was no longer the case. Ensuring and reinforcing the stability of the value of money became the overriding, central task of central banks. In a purely paper-based money system, the central bank’s capacity for creating money is, in principle, unlimited. Monopolies can give rise to misuse, even in the case of state currency monopolies. It is not hard to find examples of this if we look back through the history books, although luckily none have occurred in our own country. How can we ensure that the central bank will meet its responsibilities, withstanding the temptation to abuse its powers and over-issue? From today’s vantage point this can best be achieved with clear constitutional and statutory standards and specifications which commit the central bank to a precise mandate in its policymaking, and are associated with a duty of accountability with respect to the general public and the world of politics. In the past, central banks often pursued a large number of targets (as specified by their mandates) including price stability, full employment, growth, a stable exchange rate and equilibrium in the balance of payments. However, over time, it became evident that through the simultaneous determination of a large number of – often irreconcilable – targets, monetary policy was being overloaded. Fundamentally, this approach was making the central banks’ monetary policy task arbitrary and meaningless.

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It is obvious and logical that ensuring the long-term stability of the price level be established as the main task of monetary policy, in other words, that the central focus of monetary policy should be the task which only the central bank and no other political or economic institution can perform. In a paper-based money system, ensuring price stability is the intrinsic and primary task of monetary policy. Ensuring a balanced economy can be added to this as a subsidiary, secondary task. However, at the same time, in avoiding inflationary and deflationary processes and thereby preventing the associated expectations, the framework is created within which monetary policy has the greatest possible scope for fulfilling this additional task. Typically, modern central bank mandates, including the Swiss mandate, have appropriated these insights. The Swiss National Bank’s monetary policies in the era of flexible exchange rates since 1973 which, by comparison with other countries, have been exceptionally successful, can provide us with some important examples.

6. The importance of central bank independence from politics and social interest groups Switzerland is also an example of why it is important that the central bank be independent of politics and interest groups. At the same time, it is obvious that central bank independence can never be more than relative in a democratic state. Although it can be granted by the legislator, it can always be repealed again.

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Independence removes the central bank from everyday political life, although at the same time it implies a clear responsibility towards politicians and the general public and presupposes a precise mandate for central bank policy. Theoretical arguments and empirical evidence demonstrate that there is a clear connection between the independence of a central bank and the quality of its policies – measured by the degree of monetary stability. At the same time there is no indication that, in long-run average terms, this is achieved at the cost of below- 3 If, for instance, central banks are required to pursue long-term employment and growth targets in addition to their price stability goals, they are being asked to achieve the unachievable. The result is often that neither of the targets is met. Average performance in the real economy or a higher level of instability in real economic variables. Central bank independence is a key instrument for the creation of credibility, and for ensuring a policy of money value and monetary stability. Here, too, Swiss monetary policy over the past four decades provides us with compelling examples. What is particularly important here is the independence of monetary policy from government financial policies. From a historical point of view, the possibility that monetary policy might be overshadowed by financial policy and subordinated to fiscal considerations is the greatest threat to ensuring stable monetary conditions. In Switzerland, the condition of independence has always been completely fulfilled, apart from a short period at the time of the First World War. It is to be hoped that this will remain the case in future.

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7. Fixed versus flexible exchange rates, and the value of monetary sovereignty Switzerland has had extensive experience with both fixed and flexible exchange rates throughout its history. There are considerable advantages to a system of fixed exchange rates as long it works smoothly. This was the case during the era of the classical gold standard, but also for the early years of the Bretton Woods system. However, a fixed exchange rate system presupposes that the main parties involved are prepared to conduct mutually consistent monetary policies. They must agree on a joint stance with regard to the possibilities, targets and procedures of monetary policy for it to be functional and viable. Ultimately a system of this kind calls for agreement not just in the monetary field but also as regards certain economic policy parameters in other areas, particularly with respect to fiscal stability and flexibility of goods and factor markets. Insufficient willingness to respect these conditions leads to the development of untenable international imbalances in the long term and to efforts to stabilise the system by means of administrative measures. These measures might either be trade impediments and restrictions on capital movements or the establishment of international transfer mechanisms. Inevitably, this means that the system becomes unstable. In the absence of these conditions, a system of fixed exchange rates may develop considerable potential for tension and turbulence. Switzerland has experienced this on several occasions, to its cost – during some of the Latin Monetary Union period in the 19th century, particularly

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extensively in the Great Depression of the 1930s, and again during the final years of the Bretton Woods system. Our country learned that, under such conditions, life with fluctuating exchange rates is the lesser of two evils, and a regime of flexible exchange rates can be the more attractive alternative. Where it is impossible to achieve reliable, internationally well-anchored belief in and commitment to a community of stability it is better (when in doubt) to live with the possibility of occasional turmoil in a system of fluctuating exchange rates than to exist with the dangers of a non-credible system whose coordination is only skin-deep. In this situation, the maintenance of monetary sovereignty is to be recommended as a valuable good, an option that should never be relinquished thoughtlessly or frivolously. In principle, even where fixed exchange rate commitments are entered into, such sovereignty allows for a return to an autonomous, self-determined monetary policy course at any time. The dangers and risks that can be linked to the premature surrender of monetary sovereignty to a higher community level – without prior credible agreement on joint political and economic values – have been clearly documented by the current confusion in the euro area. This is clearly seen if we compare the European Monetary Union of today with the Latin Monetary Union of the 19th century. At that time, there was no surrender of monetary sovereignty at union level. Both the definitions and the statutory basis of the participant nation currencies remained national. The union was no more than an international agreement for the joint adoption of a given metal currency standard.

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In principle, members could leave and return to a different currency policy at any time, and this was relatively easy to do – very unlike the situation in the present currency union in Europe.

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NUMBER 8

High-level Expert group on reforming the structure of the EU banking sector presents its report

The Commission has today received the report prepared by the High-level Expert Group on reforming the structure of the EU banking sector (MEMO/12/129). The Group chaired by Erkki Liikanen presented the main findings to Michel Barnier, Commissioner for internal market and services. Governor Erkki Liikanen said "The report contains the Group's recommendations for further reforms of the banking sector, including structural reform. Building on the substantial measures already under way, I believe that the Group's recommendations would if implemented provide for a safer, more stable and efficient banking system serving the needs of citizens, the EU economy and the internal market." Internal Market and Services Commissioner Michel Barnier said "I would like to extend my thanks to Erkki Liikanen and the members of the group. This is an important report that will inform our policy on regulating the financial sector. The report underlines the excessive risks taken by banks in the past, and makes important recommendations to make sure that banks work in the interest of their customers". He continued: "This report will feed our reflections on the need for further action.

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I will now consider the next steps, in which the Commission will look at the impact of these recommendations both on growth and on the safety and integrity of financial services. We need to look at these questions also in light of the financial reforms that I have already put on the table of the European Parliament and the Council". In brief, the Group recommends actions in the five following areas:

- Mandatory separation of proprietary trading and other high-risk trading activities,

- Possible additional separation of activities conditional on the recovery and resolution plan,

- Possible amendments to the use of bail-in instruments as a resolution tool,

- A review of capital requirements on trading assets and real estate related loans,

- A strengthening of the governance and control of banks.For further information, an executive summary of the report is also available (see link hereafter).

Background Commissioner Michel Barnier announced his decision to set up the Group in November 2011. He then appointed Erkki Liikanen, Governor of the Bank of Finland and a former member of the European Commission, as Chairman. The members were appointed in February 2012.

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They were chosen on the basis of their technical expertise and professional background, and were appointed in a personal capacity. The Group held monthly meetings, inviting different stakeholders, and organised a public consultation in May. Its mandate was to determine whether, in addition to ongoing regulatory reforms, structural reforms of EU banks would strengthen financial stability and improve efficiency and consumer protection, and if that is the case to make recommendations as appropriate.

High-level Expert Group on reforming the structure of the EU banking sector Chaired by Erkki Liikanen

LETTER FROM THE CHAIRMAN Commissioner Michel Barnier established a High-level Expert Group on structural bank reforms in February 2012. Our task has been to assess whether additional reforms directly targeted at the structure of individual banks would further reduce the probability and impact of failure, ensure the continuation of vital economic functions upon failure and better protect vulnerable retail clients. We organised hearings with a large number of stakeholders who represented providers of banking services, consumers of such services, investors in banks, policymakers and academics. The Group has furthermore held a public consultation of stakeholders, the responses to which are published together with this report. In evaluating the European banking sector, the Group has found that no particular business model fared particularly well, or particularly poorly, in the financial crisis.

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Rather, the analysis conducted revealed excessive risk-taking – often in trading highly-complex instruments or real estate-related lending – and excessive reliance on short-term funding in the run-up to the financial crisis. The risk-taking was not matched with adequate capital protection, and strong linkages between financial institutions created high levels of systemic risk. A number of regulatory reforms have been initiated to address these and other weaknesses that endanger financial system stability. The Group has reviewed these on-going regulatory reforms, paying particular attention to capital and liquidity requirements and to the recovery and resolution reforms. Stronger capital requirements will enhance the resilience of banks. The implementation of the new Capital Requirement Regulation and Directive (CRR/CRDIV) will constitute a major improvement in this respect. Connected to its mandate, the Group also expects the on-going fundamental review of the trading book by the Basel Committee to improve the control of market risk within the banking system. The Group sees the Commission's proposed Bank Recovery and Resolution Directive as an essential part of the future regulatory structure. This proposal is a significant step forward in ensuring that a bank, regardless of its size and systemic importance, can be transformed and recovered, or be wound down in a way that limits taxpayer liability for its losses. The Group then had to assess, whether additional structural reforms are needed.

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As the work progressed, the Group considered two possible avenues in more detail. The first avenue was based on the important role of recovery and resolutions plans and left the decision on the possible separation of banks’ activities conditional on the assessment of these plans; it also included proposals to tighten capital requirements. The second avenue was based on the mandatory separation of banks’ proprietary trading and other risky activities. Both avenues are presented in the report. The Group assessed pros and cons of both avenues at length. Also, well-known events in the banking sector that happened during the work of the Group had an impact. The Group´s conclusion is that it is necessary to require legal separation of certain particularly risky financial activities from deposit-taking banks within a banking group. The central objectives of the separation are to make banking groups, especially their socially most vital parts (mainly deposit-taking and providing financial services to the non-financial sectors in the economy), safer and less connected to high-risk trading activities and to limit the implicit or explicit stake of taxpayer in the trading parts of banking groups. The Group's recommendations regarding separation concern businesses which are considered to represent the riskiest parts of trading activities and where risk positions can change most rapidly. Separation of these activities into separate legal entities within a group is the most direct way of tackling banks’ complexity and interconnectedness.

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As the separation would make banking groups simpler and more transparent, it would also facilitate market discipline and supervision and, ultimately, recovery and resolution. In the discussions within the Group, some members expressed a preference for a combination of measures: imposing a non-risk-weighted capital buffer for trading activities and leaving the separation of activities conditional on supervisory approval of a recovery and resolution plan, rather than a mandatory separation of banking activities. In the spirit of transparency both basic alternatives and their motivation are presented in the report. However, the choice was made to recommend mandatory separation of certain trading activities. The report also makes other recommendations, for example concerning the use of designated bail-in instruments, the capital requirements on real estate lending, consistency of internal models and sound corporate governance. The Group presents its report to Commissioner Michel Barnier. We are fully aware that this gives a great responsibility to the Commission. It is now the task of the Commission to assess the report, organise the appropriate consultation of stakeholders and, finally, make the decision on whether to present proposals on the basis of our Group´s recommendations. The proposals would also require an impact assessment according to Commission practices. The Group was assisted by a competent secretariat from the Commission Services. We are grateful for their contribution. Erkki Liikanen The Chairman of the High-level Expert Group

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SUMMARY OF THE PROPOSAL The High-level Expert Group was requested to consider whether there is a need for structural reforms of the EU banking sector or not and to make any relevant proposals as appropriate, with the objective of establishing a stable and efficient banking system serving the needs of citizens, the economy and the internal market. The Group recommends a set of five measures that augment and complement the set of regulatory reforms already enacted or proposed by the EU, the Basel Committee and national governments. First, proprietary trading and other significant trading activities should be assigned to a separate legal entity if the activities to be separated amount to a significant share of a bank's business. This would ensure that trading activities beyond the threshold are carried out on a stand-alone basis and separate from the deposit bank. As a consequence, deposits, and the explicit and implicit guarantee they carry, would no longer directly support risky trading activities. The long-standing universal banking model in Europe would remain, however, untouched, since the separated activities would be carried out in the same banking group. Hence, banks' ability to provide a wide range of financial services to their customers would be maintained. Second, the Group emphasises the need for banks to draw up and maintain effective and realistic recovery and resolution plans, as proposed in the Commission's Bank Recovery and Resolution Directive (BRR). The resolution authority should request wider separation than considered mandatory above if this is deemed necessary to ensure resolvability and operational continuity of critical functions.

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Third, the Group strongly supports the use of designated bail-in instruments. Banks should build up a sufficiently large layer of bail-inable debt that should be clearly defined, so that its position within the hierarchy of debt commitments in a bank's balance sheet is clear and investors understand the eventual treatment in case of resolution. Such debt should be held outside the banking system. The debt (or an equivalent amount of equity) would increase overall loss absorptive capacity, decrease risk-taking incentives, and improve transparency and pricing of risk. Fourth, the Group proposes to apply more robust risk weights in the determination of minimum capital standards and more consistent treatment of risk in internal models. Following the conclusion of the Basel Committee's review of the trading book, the Commission should review whether the results would be sufficient to cover the risks of all types of European banks. Also, the treatment of real estate lending within the capital requirements framework should be reconsidered, and maximum loan-to-value (and/or loan-to-income) ratios included in the instruments available for micro- and macro-prudential supervision.

Finally, the Group considers that it is necessary to augment existing corporate governance reforms by specific measures to

1) strengthen boards and management;

2) promote the risk management function;

3) rein in compensation for bank management and staff;

4) improve risk disclosure and

5) strengthen sanctioning powers.

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EXECUTIVE SUMMARY The High-level Expert Group was requested to consider in depth whether there is a need for structural reforms of the EU banking sector or not and to make any relevant proposals as appropriate, with the objective of establishing a safe, stable and efficient banking system serving the needs of citizens, the EU economy and the internal market. In evaluating the European banking sector, the Group has found that no particular business model fared particularly well, or particularly poorly, in the financial crisis. Rather, the analysis conducted revealed excessive risk-taking – often in trading highly-complex instruments or real estate-related lending – and excessive reliance on short-term funding in the run-up to the financial crisis. The risk-taking was not matched with adequate capital protection and high level of systemic risk was caused by strong linkages between financial institutions. A number of regulatory reforms have been initiated to address these and other weaknesses that endanger financial system stability. The Group has reviewed these ongoing regulatory reforms, paying particular attention to capital and liquidity requirements and to the recovery and resolution reforms. Stronger capital requirements, in general, will enhance the resilience of banks; correct, to some extent, the incentives of owners and managers; and, will also help reduce the expected liability of taxpayers in the event of adverse shocks to bank solvency. The implementation of the new Capital Requirement Regulation and Directive (CRR/CRDIV) will constitute a major improvement in all these respects.

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Connected to its mandate, the Group also expects the on-going fundamental review of the trading book by the Basel Committee to improve the control of market risk within the banking system. The Group sees the Commission's proposed Bank Recovery and Resolution Directive (BRR) as an essential part of the future regulatory structure. This proposal is a significant step forward in ensuring that a bank, regardless of its size and systemic importance, can be transformed and recovered, or be wound down in a way that limits taxpayer liability for its losses. The preparation and approval of recovery and resolution plans (RRPs) is likely to induce some structural changes within banking groups, reducing complexity and the risk of contagion, thus improving resolvability. However, despite these important initiatives and reforms, the Group has concluded that it is necessary to require legal separation of certain particularly risky financial activities from deposit-taking banks within the banking group. The activities to be separated would include proprietary trading of securities and derivatives, and certain other activities closely linked with securities and derivatives markets, as will be specified below. The Group also makes suggestions for further measures regarding the bank recovery and resolution framework, capital requirements and the corporate governance of banks. The objective is further to reduce systemic risk in deposit-banking and investment-banking activities, even when they are separated. The central objectives of the separation are to make banking groups, especially their socially most vital parts (mainly deposit-taking and providing financial services to the non-financial sectors in the economy) safer and less connected to trading activities; and, to limit the implicit or explicit stake taxpayer has in the trading parts of banking groups.

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The Group's recommendations regarding separation concerns businesses which are considered to represent the riskiest parts of investment banking activities and where risk positions can change most rapidly. Separation of these activities into separate legal entities is the most direct way of tackling banks’ complexity and interconnectedness. As the separation would make banking groups simpler and more transparent, it would also facilitate market discipline and supervision and, ultimately, recovery and resolution. The proposal is outlined in more detail below. In the discussion within the Group, some members expressed a preference for a combination of measures: imposing a non-risk-weighted capital buffer for trading activities and a separation of activities conditional on supervisory approval of a RRP, as outlined in Avenue 1 in Section 5.4.1, rather than a mandatory separation of banking activities. In the discussions, it was highlighted that the ongoing regulatory reform programme will already subject banks to sufficient structural changes and that Avenue 1 is designed to complement these developments and could thus be implemented without interfering with the basic principles and objectives of those reforms. It was also argued that this approach specifically addresses problems of excessive risk-taking incentives and high leverage in trading activities; the risks in complex business models combining retail and investment banking activities; and, systemic risk linked to excessive interconnectedness between banks. Moreover, it was argued that Avenue 1 avoids the problems of having to define ex ante the scope of activity to be separated or prohibited. Against the backdrop of the ongoing financial crisis and the fragility of the financial system, it was also seen that an evolutionary approach that limits the risk of discontinuities to the provision of financial services could be warranted.

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Mandatory separation of proprietary trading activities and other significant trading activities The Group proposes that proprietary trading and all assets or derivative positions incurred in the process of market-making, other than the activities exempted below, must be assigned to a separate legal entity, which can be an investment firm or a bank (henceforth the “trading entity”) within the banking group. Any loans, loan commitments or unsecured credit exposures to hedge funds (including prime brokerage for hedge funds), SIVs and other such entities of comparable nature, as well as private equity investments, should also be assigned to the trading entity. The requirements apply on the consolidated level and the level of subsidiaries. The Group suggests that the separation would only be mandatory if the activities to be separated amount to a significant share of a bank’s business, or if the volume of these activities can be considered significant from the viewpoint of financial stability. The Group suggests that the decision to require mandatory separation should proceed in two stages:

- In the first stage, if a bank’s assets held for trading and available for sale, as currently defined, exceed (1) a relative examination threshold of 15-25% of the bank’s total assets or (2) an absolute examination threshold of EUR100bn, the banks would advance to the second stage examination.

- In the second stage, supervisors would determine the need for separation based on the share of assets to which the separation requirement would apply.

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This threshold, as share of a bank’s total assets, is to be calibrated by the Commission. The aim of the calibration is to ensure that mandatory separation applies to all banks for which the activities to be separated are significant, as compared to the total balance sheet. In calibrating the threshold, the Commission is advised to consider different bases for measuring trading activity, including, for example, revenue data.

Once a bank exceeds the final threshold, all the activity concerned should be transferred to the legally-separate trading entity. The proposal should require a sufficient transition period to be assessed by the Commission. Finally, the smallest banks would be considered to be fully excluded from the separation requirement.

All other banking business except that named above, would be permitted to remain in the entity which uses insured deposits as a source of funding (henceforth “deposit bank”), unless firm-specific recovery and resolution plans require otherwise.

These permitted activities include, but need not be limited to, lending to large as well as small and medium-sized companies; trade finance; consumer lending; mortgage lending; interbank lending; participation in loan syndications; plain vanilla securitisation for funding purposes; private wealth management and asset management; and, exposures to regulated money market (UCITS) funds. The use of derivatives for own asset and liability management purposes, as well as sales and purchases of assets to manage the assets in the liquidity portfolio, would also be permitted for deposit banks. Only the deposit bank is allowed to supply retail payment services.

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Provision of hedging services to non-banking clients (e.g. using forex and interest rate options and swaps) which fall within narrow position risk limits in relation to own funds, to be defined in regulation, and securities underwriting do not have to be separated. These can thus be carried out by the deposit bank. The Group acknowledges the potential risks inherent in these activities and suggests that the authorities need to be alert to the risks arising from both of them. The trading entity can engage in all other banking activities, apart from the ones mandated to the deposit bank; i.e. it cannot fund itself with insured deposits and is not allowed to supply retail payment services. The legally-separate deposit bank and trading entity can operate within a bank holding company structure. However, the deposit bank must be sufficiently insulated from the risks of the trading entity. Transfer of risks or funds between the deposit bank and trading entity within the same group would be on market-based terms and restricted according to the normal large exposure rules on interbank exposures. Transfers of risks or funds from the deposit bank to the trading entity either directly or indirectly would not be allowed to the extent that capital adequacy, including additional capital buffer requirements on top of the minimum capital requirements, would be endangered. The possibility of either entity having access to central bank liquidity depends on the rules of the counterparty status in different jurisdictions. The deposit bank and trading entity are allowed to pay dividends only if they satisfy the minimum capital and capital buffer requirements. To ensure the resilience of the two types of entities, both the deposit bank and the trading entity would each individually be subject to all the

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regulatory requirements, such as the CRR/CRDIV and consolidated supervision, which pertain to EU financial institutions. Hence they must, for example, be separately capitalized according to the respective capital adequacy rules, including the maintenance of the required capital buffers and possible additional Pillar 2 capital requirements. The specific objectives of separation are to 1) limit a banking group’s incentives and ability to take excessive risks with insured deposits; 2) prevent the coverage of losses incurred in the trading entity by the funds of the deposit bank, and hence limit the liability of taxpayer and the deposit insurance system; 3) avoid the excessive allocation of lending from the deposit bank to other financial activities, thereby to the detriment of the non-financial sectors of the economy; 4) reduce the interconnectedness between banks and the shadow banking system, which has been a source of contagion in a system-wide banking crisis; and 5) level the playing field in investment banking activities between banking groups and stand-alone investment banks, as it would improve the risk-sensitivity of the funding cost of trading operations by limiting the market expectations of public protection of such activities. While pursuing these key objectives related to financial stability, separation also aims to maintain banks’ ability efficiently to provide a wide range of financial services to their customers. For this reason, the separation is allowed within the banking group, so that the same marketing organisation can be used to meet the various customer needs.

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Benefits to the customer from a diversity of business lines can therefore be maintained. Moreover, as the proposal allows hedged trading and securities underwriting to continue, it also leaves sufficient room and flexibility for deposit banks to service corporate customers and thus fulfil their role in financing the real economy. Similarly, the trading entity can engage in a broad range of activities. The proposal addresses the core weaknesses in the banking sector, while retaining the key benefits of the universal banking model and allowing for business model diversity. Finally, it is important that the proposal is sufficiently simple so as to ensure harmonised implementation across Member States. The Group suggests that banking activities which naturally belong together can be conducted within the same legal entity. In particular, the proposed separation concerns both proprietary trading and market-making, thus avoiding the ambiguity of defining separately the two activities. Similarly, the assets which are part of the separation do not include any loans to non-financial firms, because differentiating among these (for example, according to loan size) would be equally challenging at the EU level and important scale economies in corporate lending might be lost.

Additional separation of activities conditional on the recovery and resolution plan The BRR proposal of the Commission in June 2012 grants powers to resolution authorities to address or remove obstacles to resolvability. The Group emphasises the importance of two elements of the proposal in particular, namely the recovery and resolution plan and the bail-in requirements for debt instruments issued by banks (see the next section).

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In the Group’s view, producing an effective and credible RRP may require the scope of the separable activities to be wider than under the mandatory separation outlined above. The proposed BRR gives the resolution authority the powers to require a bank to change its legal or operational structure to ensure that it can be resolved in a way that does not compromise critical functions, threaten financial stability or involve costs to the taxpayer are given to the resolution authority in the proposed BRR. The Group emphasises the need to draw up and maintain effective and realistic RRPs. Particular attention needs to be given to a bank’s ability to segregate retail banking activities from trading activities, and to wind down trading risk positions, particularly in derivatives, in a distress situation, in a manner that does not jeopardize the bank’s financial condition and/or significantly contribute to systemic risk. Moreover, it is essential to ensure the operational continuity of a bank’s IT/payment system infrastructures in a crisis situation. Given the potential funding and liquidity implications, transaction service continuity should be subject to particular attention in the RRP process. The Group supports the BRR provision that the EBA plays an important role in ensuring that RRPs and the integral resolvability assessments are applied uniformly across Member States. The EBA would, accordingly, be responsible for setting harmonised standards for the assessment of the systemic impact of RRPs; as well as the issues to be examined in order to assess the resolvability of a bank and trigger elements that would cause a rejection of the plans. The triggers should be related to the complexity of the trading instruments and organisation (governance and legal structure) of the trading activities, as these features materially affect the resolvability of trading operations.

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The trigger elements should also be related to the size of the risk positions and their relation to market size in particular instruments, as large positions are particularly difficult to unwind in a market stress situation.

Possible amendments to the use of bail-in instruments as a resolution tool In addition to the use of RRPs, the Group also strongly supports the use of designated bail-in instruments within the scope of the BRR, as it improves the loss-absorbency ability of a bank. The power to write down claims of unsecured creditors or convert debt claims to equity in a bank resolution process is crucial to ensure investor involvement in covering the cost of recapitalisation and/or compensation of depositors. It also reduces the implicit subsidy inherent in debt financing. This additionally improves the incentives of creditors to monitor the bank. A number of features of bail-in instruments have been outlined in the proposed BRR. For instance, the bail-in tool would only be used in conjunction with other reorganisation measures, and the ex-ante creditor hierarchy is to be respected. However, the Group has come to the conclusion that there is a need to further develop the framework, so as to improve the predictability of the use of the bail-in instrument. Specifically, the Group is of the opinion that the bail-in requirement ought to be applied explicitly to a certain category of debt instruments, the requirement for which should be phased in over an extended period of time.

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This avoids congestion in the new issues market and allows the primary and the secondary market to grow smoothly. However, banks should be allowed to satisfy any requirement to issue bail-inable debt instruments with common equity if they prefer to do so. This could be especially useful for smaller institutions, whose bail-in instruments could face particularly narrow markets. The Group is also of the opinion that a clear definition would clarify the position of bail-in instruments within the hierarchy of debt commitments in a bank’s balance sheet, and allow investors to know the eventual treatment of the respective instruments in case of resolution. Detailing the characteristics of the bail-in instruments in this way would greatly increase marketability of both new bail-inable securities and other debt instruments and facilitate the valuation and pricing of these instruments. In order to limit interconnectedness within the banking system and increase the likelihood that the authorities are eventually able to apply the bail-in requirements in the event of a systemic crisis, it is preferable that the bail-in instruments should not be held within the banking sector. This would be best accomplished by restricting holdings of such instruments to non-bank institutional investors (e.g. investment funds and life insurance companies). Bail-in instruments should also be used in remuneration schemes for top management so as best to align decision-making with longer-term performance in banks. The Group suggests that this issue should be studied further.

A review of capital requirements on trading assets and real estate related loans

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Model-based capital requirements related to risks in trading-book assets may suffer from modelling risks and measurement errors. In particular, tail-risks and systemic risks (including the impact on market liquidity of failures of major players) are not well-accounted for. Significant operational risks are related to all trading activities as demonstrated by several incidents of substantial loss events. The current operational risk capital charges are derived from income-based measures and do not reflect the volume of trading book assets. Moreover, significant counterparty and concentration risks can be related to all trading activities. The mandatory separation proposed by the Group leaves substantial room for customer-driven and hedged trading and risk management activities in deposit banks so as to ensure the ability of these entities to service the real economy. On the other hand, the significant risks of the separated or stand-alone trading entities warrant robust capital rules to control the risk posed to the parent group and financial system as a whole. Thus, the weaknesses in the capital requirements presented above have implications for both the deposit bank and trading entity. The Basel Committee has launched an extensive review of trading-book capital requirements. The Group welcomes this review. In its work, the Group has identified two approaches to improve the robustness of the trading book capital requirements: - setting an extra, non-risk based capital buffer requirement for all

trading-book assets on top of the risk-based requirements as detailed under Avenue 1 in Section 5.4.1; and/or

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- introducing a robust floor for risk-based requirements (i.e. risk weighted assets (RWA)).

The benefit of the first approach (an extra capital buffer) is that it would improve protection against operational risks and reduce leverage, and it would not interfere with banks’ incentives to use and further develop internal models – as it would come on top of the risk-based requirements. The benefit of the second approach (a robust floor for RWAs) is that it would more directly address the possibility of model errors in modelling market risks. The Group suggests that the Basel Committee takes into account in its work the shortcomings of the present capital requirements as identified by the Group and that an evaluation be carried out by the Commission, after the outcome of the Basel Committee’s review, as to whether the proposed amendments to the trading-book capital requirements would be sufficient to cover the risks of both deposit banks and trading entities. The Group also acknowledges that the RWAs calculated by individual banks’ internal models (IRB) can be significantly different for similar risks. Supervisors are currently working on this issue. The Group encourages them to take strong and coordinated action to improve the consistency of internal models across banks. The treatment of risks should be more harmonised in order to produce greater confidence in the adequacy and consistency of the IRB-based capital requirements. This work should be one key step towards a common European supervisory approach. The Group suggests that the Commission should consider further measures regarding the treatment of real estate-related lending within the capital requirement framework.

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History has shown that many systemic banking crises resulting in large commitments of public support have originated from excessive lending in real estate markets. This has often been coupled with funding mismatches and over-reliance on wholesale funding. The current levels of RWAs based on banks’ internal models and historical loss data tend to be quite low compared to the losses incurred in past real estate-driven crises. The EBA and the new single euro area supervisory authority should make sure that capital adequacy framework includes sufficient safeguards against substantial property market stress (e.g. via robust floors on the RWAs calculated by internal models). Moreover, insufficient attention was given to macro-prudential issues preceding the financial crisis. In the current European System of Financial Supervision, the European Systemic Risk Board (ESRB) has been given the responsibility for macro-prudential supervision at the EU level, whereas the institutional structures at a national level are still to be defined in most European countries. Effective macro-prudential policy needs appropriate tools. As a direct measure to limit the risks stemming from real estate markets, the ESRB recommends that loan-to-value (LTV) and/or loan-to-income (LTI) caps are included in the macro-prudential toolbox. The Group fully supports this recommendation and further recommends that strict caps to the value of these ratios should be provided in all Member States and implemented by national supervisors.

The Group welcomes the implementation of the minimum leverage ratio requirement as a backstop to the risk-weighted capital requirement.

The monitoring of the leverage ratio as defined in the CRR/CRDIV will provide vital information to be used in the calibration.

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In due course, consideration should be given as to whether the requirement currently planned for the leverage ratio is sufficient.

The Group also considers that the adequacy of the current large exposure limits should be assessed regarding inter-institution and intra-group exposures.

In particular, the adequacy of the current maximum limit on inter-institution exposures effectively to limit excessive interconnectedness between financial institutions and systemic risks should be assessed.

It should also be considered whether the same tightened limit should be applied to intra-group exposures (in section 5.5.1 it is suggested that the same exposure limits ought to apply to intra-group exposures).

The latter could be important to limit the extent of exposure of the deposit bank to the trading entities within the same banking group.

Strengthening the governance and control of banks Governance and control is more important for banks than for non-banks, given the former's systemic importance, ability quickly to expand and collapse; higher leverage; dispersed ownership; a predominantly institutional investor base with no strategic/long-term involvement; and, the presence of (underpriced) safety nets. A bank's board and management are responsible for controlling the level of risk taken. However, the financial crisis has clearly highlighted that the governance and control mechanisms of banks failed to rein in excessive risk-taking. The difficulties of governance and control have been exacerbated by the shift of bank activity towards more trading and market-related activities. This has made banks more complex and opaque and, by extension, more difficult to manage.

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It has also made them more difficult for external parties to monitor, be they market participants or supervisors. As regards the former, the increase in size and the advent of banks that are too-big-to-fail have further reduced market participants' incentives to monitor banks effectively. As regards the latter, supervisors' ability to monitor banks has proven inadequate, in particular when it came to understanding, monitoring and controlling the complexity and interconnectedness of banks that expanded increasingly in trading activities. Accordingly, strengthening governance and control is essential. Building on the corporate governance reforms currently under consideration and in addition to the reform proposals outlined above, it is necessary further to: (i) strengthen boards and management; (ii) promote the risk management function; (iii) rein in compensation; (iv) facilitate market monitoring; and, (v) strengthen enforcement by competent authorities. More specifically:

Governance and control mechanisms: Attention should be paid to the governance and control mechanisms of all banks.

More attention needs to be given to the ability of management and boards to run and monitor large and complex banks.

Specifically, fit-and-proper tests should be applied when evaluating the suitability of management and board candidates;

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Risk management:

In order to improve the standing and authority of the risk management function within all banks, so as to strengthen the control mechanism within the group and to establish a risk culture at all levels of financial institutions, legislators and supervisors should fully implement the CRD III and CRD IV proposals.

In addition, while the CRD often remains principles-based, level 2 rules must spell out the requirements on individual banks in much greater detail in order to avoid circumventions.

For example, there should be a clear requirement for Risk and Control Management to report to Risk and Audit Committees in parallel to the Chief Executive Officer (CEO);

Incentive schemes: One essential step to rebuild trust between the public and bankers is to reform banks' remuneration schemes, so that they are proportionate to long-term sustainable performance.

Building on existing CRD III requirement that 50% of variable remuneration must be in the form of the banks' shares or other instruments and subject to appropriate retention policies, a share of variable remuneration should be in the form of bail-in bonds.

Moreover, the impact of further restrictions (for example to 50%) on the level of variable income to fixed income ought to be assessed.

Furthermore, a regulatory approach to remuneration should be considered that could stipulate more absolute levels to overall compensation (e.g. that the overall amount paid out in bonuses cannot exceed paid-out dividends).

Board and shareholder approvals of remuneration schemes should be appropriately framed by a regulatory approach;

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Risk disclosure: In order to enhance market discipline and win back investor confidence, public disclosure requirements for banks should be enhanced and made more effective so as to improve the quality, comparability and transparency of risk disclosures.

Risk disclosure should include all relevant information, and notably detailed financial reporting for each legal entity and main business lines.

Indications should be provided of which activities are profitable and which are loss-making, and be presented in easily-understandable, accessible, meaningful and fully comparable formats, taking into account ongoing international work on these matters; and

Sanctioning: In order to ensure effective enforcement, supervisors must have effective sanctioning powers to enforce risk management responsibilities, including sanctions against the executives concerned, such as lifetime professional ban and claw-back on deferred compensation.

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NUMBER 9

A Statement by His Excellency the Governor of Saudi Arabian Monetary Agency, Dr. Fahad bin Abdullah Almubarak

On the occasion of the National Day of the Kingdom of Saudi Arabia

The 7th of Dhual-Qa’dah 1433H marks the National Day of the Kingdom of Saudi Arabia.

It is a historic day on which King Abdul Aziz Bin Abdul Rahman Al-Saud - may Allah bless his soul- unified this homeland, which is dear to all of us. By the grace of Allah, we started to enjoy prosperity, welfare, well-being, security and safety.

The celebration of this day every year reminds us of the evolution witnessed by our country at all levels since its unification by King Abdul Aziz – may Allah bless his soul.

Education, health, water, and electricity services, as well as, roads have spread over all parts of the Kingdom of Saudi Arabia.

One of the most important achievements in the past decades is the magnificent investment made in human resources, particularly in the education sector.

At the end of 2011, the number of general education male and female students, in the Kingdom, amounted to 6.4 million, receiving education at 26.6 thousand schools, and taught by 453.2 thousand female and male teachers.

During the same period, the number of university male and female students went up to 925.0 thousand, apart from more than 125 thousand female and male students on scholarships abroad under the program of the Custodian of the Two Holy Mosques King Abdullah Bin Abdul Aziz.

In the economic field, the Kingdom plays a great and effective role in the global economy. It is a member of G20 since its establishment.

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This group includes the largest and most important economies in the world, and it produces about 85 percent of the global GDP, and represents two-thirds of the world population.

The Kingdom is also an effective member of the IMF, the World Bank, the Bank for International Settlements, the Basel Committee on Banking Supervision, and the Financial Stability Board.

Moreover, the Kingdom is one of the largest contributors to a number of regional institutions, such as the Islamic Development Bank, the Arab Monetary Fund, the Arab Fund for Economic and Social Development, the Arab Bank for Economic Development in Africa, the Arab Authority for Agricultural Investment and Development, the Arab Investment and Export Credit Guarantee Corporation, and the OPEC Fund.

Banking services have witnessed considerable development and expansion.

At the end of the second quarter of 2012, the number of domestic banks operating in the Kingdom stood at 12 with 1661 operating branches and that of the branches of foreign banks 11.

Total credit provided by domestic banks to the private sector amounted to Rls 933.4 billion.

Money supply amounted to more than Rls 1.3 trillion at the end of the same period and commercial banks’ assets went beyond Rls 1.6 trillion, maintaining their marked solvency.

The number of automated teller machines (ATMs) in the Kingdom was 12.2 thousand during the second quarter of 2012, and that of ATM cards issued to citizens and residents exceeded 15.0 million.

The number of points of sale (POS) terminals exceeded 87.2 thousand.

Banking services have developed tremendously in line with recent international standards, particularly in the area of financial payment and settlement systems such as the Automated Clearing House (ACH) System, Saudi Payment Network (SPAN) and the Saudi Arabian Riyal Interbank Express System (SARIE).

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Many banking services are being carried out via the internet, Telephone Banking, and other electronic systems such as “SADAD” System for paying public utilities bills and fees, contributing to smooth and easy performance of financial transactions by citizens and residents at a very reasonable cost.

The great achievements made by our country make it incumbent upon us to maintain and enhance them and exert further efforts to protect them.

On this happy occasion, I am pleased to extend my highest congratulations to His majesty the Custodian of the Two Holy Mosques, King Abdullah Bin Abdul Aziz, His loyal Crown Prince, the honorable Royal Family, and the Saudi faithful people, praying to Allah to always return this occasion with our country enjoying security, stability and prosperity.

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NUMBER 10

German banks successfully complete EU-wide recapitalisation exercise

After deduction of the "sovereign capital buffer", all 12 German institutions in the sample achieved the minimum core tier 1 capital ratio of 9% as at 30 June 2012. The average ratio is 10.7%, which means all institutions taken together exceed the EBA minimum capital requirement by €15.5 billion. The five banks which were found to need an additional €12.9 billion as at 30 September 2011 have covered this requirement.

Results per bank According to the Recommendation issued by the European Banking Authority’s (EBA) regarding banks’ recapitalisation, participating institutions were to have a core tier 1 capital ratio less the sovereign capital buffer, expressed in terms of risk-weighted assets, of at least 9%. The sovereign capital buffer is the capital buffer for fair value losses on exposures to member states of the European Economic Area. All German banks participating in the recapitalisation exercise achieved this capital ratio.

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Background In order to strengthen the capital base of European banks given the shadow cast by the European sovereign debt crisis, on 26 October 2011 the European heads of state or government adopted a bank recapitalisation programme for the member states of the European Union. In light of the exceptional market situation, the programme is designed to restore the confidence of investors in banks’ ability to withstand further shocks. In November 2011, the EBA worked together with the national supervisory authorities in coordinating the collection of data and the calculation of the capital needed by the 71 banks surveyed.

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Germany was represented by the same 13 banks that had already been surveyed as part of the EU-wide stress test in the summer of 2011.

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D. The Dodd Frank Act and the new Risk Management Standards (976 slides, included in the 3285 slides) The US Dodd-Frank Wall Street Reform and Consumer Protection Act is the most significant piece of legislation concerning the financial services industry in about 80 years. What does it mean for risk and compliance management professionals? It means new challenges, new jobs, new careers, and new opportunities. The bill establishes new risk management and corporate governance principles, sets up an early warning system to protect the economy from future threats, and brings more transparency and accountability. It also amends important sections of the Sarbanes Oxley Act. For example, it significantly expands whistleblower protections under the Sarbanes Oxley Act and creates additional anti-retaliation requirements. You will find more information at: www.risk-compliance-association.com/Distance_Learning_and_Certification.htm

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Monday October 15, 2012 - Top 10 Risk Compliance News Events

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