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

_____________________________________________________________ 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

Monday, March 12, 2012 - 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

George Lekatis President of the IARCP

Dear Member,

Do you have “definitional authority? The European Central Bank (ECB) tries hard to understand the Dodd Frank Act (so do we). In Number 1 we have an interesting “we would therefore appreciate some clarification from you” letter from the European Central Bank to the US Commodity Futures Trading Commission.

The part of the letter I like: “We therefore respectfully ask the

Commissions to exercise their definitional authority…” In Number 2 we have the developments in the Cayman Islands – environment, Basel ii, Basel iii … Welcome to the Top 10 list. Enjoy!

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



NUMBER 1

A letter to

What is the letter about?



The point? “We are therefore concerned about how Title VII of the Dodd-Frank Act will apply to the official operations of the ECB and the Eurosystem, and we would therefore appreciate some clarification from you in this regard. To the extent that your agency is preparing implementation rules to the Dodd-Frank Act, we would with all due respect seek from you due consideration to the above arguments, as well as to international comity, so that the case of International Organizations (such as the ECB) and of foreign central banks are addressed in the final regulations in a manner fitting with their official status and tasks. In that direction, please note that the ECB's -and the Eurosystem's- mandate requires them to perform public tasks that are broadly comparable to those attributed in the United States to the Federal Reserve System, which necessarily require the ECB to conduct operations in the financial markets, including OTC derivatives. These are activities that would, if conducted by a private sector entity, necessarily fall within the ambit of Title VII of the Dodd-Frank Act. In contrast, we note that if those same transactions were entered into by the Federal Reserve System, they would be expressly excluded from the



definitions of "swap" and "security-based swap" contained in the Dodd-Frank Ad. We set out attached some considerations on the ECB and its mandate, and its status under U.S. Law. The point on which we seek regulatory clarification is whether official transactions such as those entered into by the ECB and by the national central banks of the Eurosystem would be captured by the definitions of "swap" and "security-based swap" contained in the Dodd-Frank Act. Clearly, our practice to date has been to transact with private sector entities on market standard documentation for swaps, but given that we have so far and would in the future only be entering into such transactions purely in execution of our public mandate - and it is to be noted that we are not authorised to enter into such transactions on any other basis - we suggest that the transactions that we enter into should not be interpreted and legally defined in the same way as otherwise similar transactions entered into by private commercial entities: • First, the considerations involved in the management of foreign reserves are not amenable to control and supervision in the same way as private-sector profit-maximising transactions. Indeed, as an institution of the European Union, we are not subject to supervision or licensing requirements and suggest' that it would be inappropriate to be subjected to supervisory requirements by a non-EU authority in respect of a part of our activities. In particular, we are concerned that external control of our activities might not be sufficiently sensitive to the practice of managing foreign reserves and could thus frustrate the ECB's performance of the mandate that it has been given by the TFEU. • Second, performance of our mandate can require us to act confidentially in certain circumstances.



Please note that in certain occasions central banks market activities, if subject to public disclosure and external supervision, may cause signalling effects to other market players and finally hinder the policy objectives of such actions (the CCP itself would also have a privileged view on the whole set of cleared central bank transactions). This is probably the reason behind the exemption given by Dodd-Frank Act to the Federal Reserve System (a similar exemption to the ECB and other central banks and comparable international institutions is foreseen in the proposed draft EU Regulation on Central Clearing of OTC derivatives in course of definition in Europe). Certain of the requirements of the Dodd Frank Act, if applicable to the ECB, could compromise the ECB's ability to take such actions. In this regard, it is noted that the ECB has worked closely with the Federal Reserve System in responding to the financial crisis, and should not be compromised by implementation of the Dodd-Frank Act in its ability to respond similarly in the future. • Third, the specificity of role and functions of central banks make their use of CCPs, and other private financial market infrastructures for that matter, a very sensitive issue, particularly in times of crisis. For instance, if a central bank were to become a clearing member of a CCP it would need to contribute to the CCP default procedures. In case of crisis, this could force a central bank to eventually absorb other participants' and possible the CCP's losses, thereby raising sensitive moral hazard issues. • Fourth, this may introduce inconsistency between EU and US legislation concerning the central bank obligations to use designated CCPs The abovementioned arguments apply mutatis mutandis to the national central banks of the Eurosystem.



As you of course know, Congress has vested the Commissions with the rulemaking authority to further define certain terms, including "swap" and "security-based swap, and such joint rulemaking on the definition of the terms "swap" and "security-based swap" is to be done in consultation with the Board of Governors. In light of the above, we therefore respectfully ask the Commissions to exercise their definitional authority under the Dodd-Frank Act to define the terms "swap" and "security-based swap", as used in the Commodity Exchange Act and Securities Exchange Act, respectively, to exclude any agreement, contract or transaction a counterpatty of which is a Public International Organisation such as the ECB, or indeed a national central bank of a market economy. We stand ready to elaborate on any of the matters raised above, including with respect to the size and risk management of our US dollar interest rate derivatives portfolio activities to the extent that this would be helpful to you.”



NUMBER 2

Cayman Islands – An Overview The three Cayman Islands, Grand Cayman, Cayman Brac and Little Cayman, are located in the western Caribbean about 150 miles south of Cuba, 460 miles south of Miami, Florida, and 167 miles northwest of Jamaica. George Town, the capital, is on the western shore of Grand Cayman. Grand Cayman, the largest of the three islands, has an area of about 76 square miles and is approximately 22 miles long with an average width of four miles. Its most striking feature is the shallow, reef-protected lagoon, the North Sound, which has an area of about 35 square miles. The island is low-lying, with the highest point about 60 feet above sea level. Cayman Brac lies about 89 miles northeast of Grand Cayman. It is about 12 miles long with an average width of 1.25 miles and has an area of about 15 square miles. Its terrain is the most spectacular of the three islands. The Bluff, a massive central limestone outcrop, rises steadily along the length of the island up to 140 ft. above the sea at the eastern end.



Little Cayman lies five miles west of Cayman Brac and is approximately ten miles long with an average width of just over a mile. It has an area of about 11 square miles. The island is low-lying with a few areas on the north shore rising to 40 ft. above sea level. There are no rivers on any of the islands. The coasts are largely protected by offshore reefs and in some places by a mangrove fringe that sometimes extends into inland swamps.

Geographically, the Cayman Islands is part of the Cayman Ridge, which extends westward from Cuba. The Cayman Trench, the deepest part of the Caribbean at a depth of over four miles, separates the three small islands from Jamaica. The islands are also located on the plate boundary between the North American and Caribbean tectonic plates. The tectonic plates in Cayman’s region are in continuous lateral movement against each other. This movement, with the Caribbean plate travelling in an eastward direction and the North American plate moving west, limits the size of earthquakes and there has never been an event recorded of more than magnitude 7. It is not unusual for minor tremors to be recorded. Many residents don’t even notice them. However in December 2004 a quake of 6.8 magnitude rocked Grand Cayman and everyone noticed. The earthquake, short in duration, opened some small sinkholes but otherwise didn’t cause any damage.



Christopher Columbus first sighted Cayman Brac and Little Cayman on 10 May 1503. On his fourth trip to the New World, Columbus was en route to Hispaniola when his ship was thrust westward toward "two very small and low islands, full of tortoises, as was all the sea all about, insomuch that they looked like little rocks, for which reason these islands were called Las Tortugas." A 1523 map show all three Islands with the name Lagartos, meaning alligators or large lizards, but by 1530 the name Caymanas was being used. It is derived from the Carib Indian word for the marine crocodile, which is now known to have lived in the Islands. Sir Francis Drake, on his 1585-86 voyage, reported seeing "great serpents called Caymanas, like large lizards, which are edible." It was the Islands' ample supply of turtle, however, that made them a popular calling place for ships sailing the Caribbean and in need of meat for their crews. This began a trend that eventually denuded local waters of the turtle, compelling local turtle fishermen to go further afield to Cuba and the Miskito Cays in search of their catch. The first recorded settlements were located on Little Cayman and Cayman Brac during 1661-71. Because of the depredations of Spanish privateers, the governor of Jamaica called the settlers back to Jamaica, though by this time Spain had recognised British possession of the Islands in the 1670 Treaty of Madrid. Often in breach of the treaty, British privateers roamed the area taking their prizes, probably using the Cayman Islands to replenish stocks of food and water and careen their vessels. The first royal grant of land in Grand Cayman was made by the governor of Jamaica in 1734. It covered 3,000 acres in the area between Prospect and North Sound. Others followed up to 1742, developing an existing settlement, which included the use of slaves.



On 8 February 1794, an event occurred which grew into one of Cayman's favourite legends -- The Wreck of the Ten Sail. A convoy of more than 58 merchantmen sailing from Jamaica to England found itself dangerously close to the reef on the east end of Grand Cayman. Ten of the ships, including HMS Convert, the navy vessel providing protection, foundered on the reef. With the aid of Caymanians, the crews and passengers mostly survived, although some eight lives were lost. The first census of the Islands was taken in 1802, showing a population on Grand Cayman of 933, of whom 545 were slaves. Before slavery was abolished in 1834, there were over 950 slaves owned by 116 families. Though Cayman was regarded as a dependency of Jamaica, the reins of government by that colony were loosely held in the early years, and a tradition grew of self-government, with matters of public concern decided at meetings of all free males. In 1831 a legislative assembly was established. The constitutional relationship between Cayman and Jamaica remained ambiguous until 1863 when an act of the British parliament formally made the Cayman Islands a dependency of Jamaica. When Jamaica achieved independence in 1962, the Islands opted to remain under the British Crown, and an administrator appointed from London assumed the responsibilities previously held by the governor of Jamaica The constitution currently provides for a Crown-appointed Governor, a Legislative Assembly and a Cabinet. Unless there are exceptional reasons, the Governor accepts the advice of the Cabinet, which comprises three appointed official members and five ministers elected from the 15 elected members of the Assembly.



The Governor has responsibility for the police, civil service, defence and external affairs but handed over the presidency of the Legislative Assembly to the Speaker in 1991.

Cayman Islands, Banking Statistics Overview

There were a total of 234 banks under the supervision of the Banking Supervision Division at the end of December 2011. The fundamentals of the banking sector remain sound and the industry in general has been relatively resilient in a very challenging market environment. Banks continue to consolidate and restructure in search of cost efficiencies, and improvements in operational risk management and governance.

As of September 2011, total assets were reported at US$1.607 trillion down from the same period of the previous year where total assets stood at US$1.725 trillion.





The Cayman Islands is recognised as one of the top 10 international financial centres in the world, with over 40 of the top 50 banks holding licences here. Over 80 percent of more than US$1 trillion on deposit and booked through the Cayman Islands, represents inter-bank bookings between onshore banks and their Cayman Islands branches or subsidiaries. These institutions present a very low risk profile for money laundering.

Basel II

The Cayman Island Monetary Authority (CIMA) is implementing the Basel II Framework.

The Basel II Framework describes a more comprehensive measure and minimum standard for capital adequacy that seeks to improve on the existing Basel I rules by aligning regulatory capital requirements more closely to the underlying risks that banks face.

The Framework is intended to promote a more forward looking approach to capital supervision that encourages banks to identify risks and to develop or improve their ability to manage those risks.

As a result, it is intended to be more flexible and better able to evolve with advances in markets and risk management practices.

A key objective of the revised Framework is to promote the adoption of stronger risk management practices by the banking industry.

Banks to Which Basel II Applies

The Basel II Framework applies to banks that are locally incorporated in the Cayman Islands (Category A and B banks), all home regulated banks and host regulated banks (subsidiaries of foreign banks), with or without a physical presence. Branches of foreign banks operating the Cayman Islands, will not be required to maintain a separate capital requirement, and as such will be excluded from the local Basel II requirements.



However, these foreign banks including the operations of the Cayman Islands branches must maintain the minimum capital adequacy requirements as stipulated by their home jurisdictions.

Implementation Phases

CIMA proposes to apply the Basel II Framework in two phases leveraging a practical measured approach.

First Phase

The first phase of the implementation was completed on December 31, 2010 and comprised the following Pillar 1 approaches:

• Credit Risk – Standardized • Market Risk – Standardized • Operational Risk – Basic Indicator Approach and The Standardized Approach The first phase of the Basel II implementation includes Pillar 2 – Supervisory Review Process and Pillar 3 - Market Discipline.

Second Phase

The second phase of the CIMA Basel II implementation will be considered for implementation after 2012.

It will include considering the implementation of advanced approaches, specifically Pillar 1 – Credit Risk – Advanced Approaches (IRB), Operations Risk – Advanced Measurement Approaches (AMA) and Market Risk – Internal Risk Management Models.

Industry Input

Since the majority of banks impacted by the application of the Basel II Framework are members of the Cayman Island Bankers Association (CIBA), CIMA has established a joint CIMA/CIBA Basel II Working Committee.

The primary objective of the working committee is to provide banks and CIMA a forum for consultation, discussion and agreement on Basel II related issues. CIMA proposes to obtain the majority of feedback on Basel II related issues from the CIBA/CIMA Basel II Working Committee.



CIMA also proposes to communicate directly with those banks that are not members of CIBA or those banks that have principal agents that are not members of CIBA.

However, these banks will not have the benefit of consultation or participation in discussions on Basel II issues with the majority of impacted banks.

Banks wishing to participate in the CIBA consultations and discussions should contact CIBA directly.

Basel iii

This is the next step, but we have no timeline yet.

According to Reina Ebanks, Head of Banking Supervision, Cayman Islands Monetary Authority at the Opening of the FSI & CGBS Seminar - Regional Seminar on Capital Adequacy & Basel III George Town, Grand Cayman, Cayman Islands February 22-24, 2011:

“It is good that so many of our colleagues from regulatory bodies in the Caribbean region have seen the value of this seminar and have seized this opportunity to participate. I also appreciate the involvement of our local industry partners who will serve as presenters. We all have experiences to share, and by sharing those experiences we will learn from each other. The Cayman Islands Monetary Authority believes strongly in the necessity and benefits of professional training. We have always sought to ensure that our own staff members have every opportunity to enhance the skills that are necessary for the Authority to effectively carry out its role. The regulatory reform package of the Basel Committee addresses identified weaknesses of the pre-crisis banking sector and outlines several measures to promote a more resilient banking sector.



The objective of the reforms is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, thus reducing the risk of spill over from the financial sector to the real economy. The new global standards referred to a “Basel III” cover both firm-specific and broader, systematic risks. At this 3 day seminar our presenters who are experts in their field are expected to cover specific aspects of Basel III. One of the things you learn quickly as a regulator is how rapidly changes occur within today’s financial systems and how interconnected and interdependent they are. The international financial crisis underscored this forcefully, but it is not going to change it. Products will continue to evolve; markets will continue to change; ways of doing business will continue to be constantly challenged by new innovations despite the new regulations and standards put in place as a result of the crisis.

However, one of the strong lessons which it has taught us as regulators is that, in order to stay ahead of the curve, we must expand our knowledge of the markets and products we are charged with regulating and the role of the different jurisdictions, large and small, that are part of the global marketplace.

We must apply that knowledge efficiently in our day-to-day operations.

We must cooperate as regulators at the organizational level.

We must engage in dialogue and we must take joint action.

This is necessary if we are to regulate effectively without stifling legitimate business and economic growth.”





NUMBER 3

SPEECHES & TESTIMONY

"Please Listen Carefully, Some Menu Options Have Changed" Speech of Commissioner Bart Chilton, Trade Tech 2012, New York, NY March 8, 2012 Important parts It is amazing if you think about the elaborate, intricate and inter-related global financial markets of gargantuan size and breadth—churning, burning, millisecond-splitting, markets operating nearly every day all day. It is amazing that it all works so well. But then again, it hasn’t always done so, right? We have banks and other institutions (think AIG) which were so large that just a few years ago when they were toppling, or about to topple, we—all of us—had to fork over hundreds-of-billions of dollars in a hideous, budget-busting bailout. There isn't much doubt about the causes of the economic crash, and complexity had a whole lot to do with it. The Financial Crisis Inquiry Commission (FCIC) was established to look at what happened (always a good thing to do after you spend hundreds of billions of dollars. Hey, why did we have to spend that loot?). FCIC concluded the Troubled Asset Relief Program or TARP was needed



due to two culprits to the crisis. One culprit: regulators. People like me. You see, in 1999, Congress and the President deregulated banks. Banks were no longer bound by that pesky Depression-era Glass-Steagall Act that cramped their style and limited what they could do with the money in their institutions. With the repeal of Glass-Steagall, regulators got the message to let the free markets roll. And, roll they did. They rolled right over the American people. The second culprit: The captains of Wall Street. FCIC concluded that since they were allowed to do so much more without those rules and regulations, they devised all sorts of creative, exotic and, yes-complex-financial products. Some of these things were so multifaceted hardly anyone knew what was going on or how to place a value upon them. Here’s an example. Exhibit A: Credit Default Swaps (CDSs)—bizarre bets upon bets that certain things would actually fail. And these CDSs were sold and resold around the Street to the point that nobody really understood what they had and how much it was worth. It was all way too complicated. The value of CDSs was in the eye of the beholder. Folks were over-leveraged if their books called for it to be so. Make it so Number One. A case in point would be Lehman Brothers. They were leveraged 30 to 1, according to the last annual financial statement. That data showed the firm held $691 billion in assets divided by only $22 billion in actual shareholder equity.



If all those mind-altering financial products weren’t enough to fuel-inject the festivities, as a special bonus to the traders, it was completely and unreservedly unregulated. “Party on Garth.” CDSs were part and parcel to creating this humongous dark market with no oversight by regulators. When I say humongous, I mean it. We at the CFTC currently oversee roughly $5 trillion in annualized trading on regulated exchanges, but the over-the-counter (OTC) market is roughly—wait for it—$708 trillion. In fact, there are well over 160 million financial transactions taking place each day. Like I said, it is humongous. Bottom line: the 2008 economic disaster was created due to - (1) crappy or non-existent oversight and regulation; and

- (2) Wall Street creativity and a penchant for the exotic that created

financial products so complex they would give Rubik a migraine.

The Fixers: Dodd-Frank As a result of the monstrous economic mess, a mess of which we are still crawling out, in 2010, Congress passed and President Obama signed into law the Wall Street Reform and Consumer Protection Act—otherwise known as Dodd-Frank. The Act is over 2,000 pages long, and has over 300 provisions requiring rulemakings, 80% of which are to be promulgated by the SEC, the CFTC, the Fed, and the CFPB (Consumer Financial Protection Bureau). To fix a complex problem, sometimes there isn’t an easy fix, and that has been the case with financial reform. It isn’t that Members of Congress had voices in their heads telling them to legislate. Nope, their action was a detailed response to the economic crisis.



For those that say Dodd-Frank should be repealed, I guess I don’t understand why they’d want to go back to the set of circumstances that led to the ultimate demise of our economy. I just don’t get that. Dodd-Frank generally imposed a 360-day deadline for approval of all the regulations, and while we’ve obviously missed that, we’re working hard to get the regulations in place. A few times we proposed a rule, yet when we received the comments, realized we had totally missed the target and we had to re-propose. For those that follow every move we make, every breath we take, this is all part of the process: getting the rules right and ensuring they are balanced. But I understand that people have to be diligent to keep up here. I have a lot of sympathy. This is very complex. Like I said, people may want to listen carefully, some menu options may have changed. So far, the CFTC has issued 28 final rules, and it’s my hope and expectation that we will meet our Congressional mandate within the next few months and finish the 21 additional final rules that we are required to write.

Certain “T’ However, just because I expect us to finish all the rules, that doesn’t tell people when they will be implemented, or when compliance is necessary. Aside from complexity and changing menu options, one of the worst things for our industry, from anyone’s perspective, is uncertainty. Regulators don’t like it. Market participants don’t like it. Members of Congress don’t like it, and the public certainly doesn’t like it. When we aren’t clear about exactly what we’re doing, when rules are to go into effect, and when people have to comply with those rules, that creates uncertainty with a capital “T.” Let me explain.



One of the refrains we keep hearing is that we need to identify what “T” is. In other words, we’ve said that we will give folks time to comply with our rules—T+90 days, T+180 days, T+270. The legitimate question is: what the heck is T? Just like the robotic phone tree, people have pushed an options button, and they keep getting an answer, but it either isn’t the answer they want or it’s not the fulsome answer they need. They may be pushing one for English and then saying “agent” or “operator” but they never get to something or someone who can actually help them out. We all know that feeling, and it can be maddening. So now, it’s time we provide another “menu option,” and answer this timing question. We hear folks, and here’s a way to get there. First, we need to get the review of swaps for mandatory clearing rule done. Second, we need to finalize the implementation timetable rule. This will give all of us—market participants, regulators, Congress, the public—firm compliance dates and it will all seem a lot less complex. We should give folks a visual of what we are doing and update that as menu options change. I have seen some firms that have these. I’ve urged that we simply put all these expected rule dates on a chart so that people can see them in concert with each other.



When is the rule expected to be completed? What might be the implementation timetable? It seems like a fairly modest thing to do, yet we haven’t done so yet. I mean, “Got rudimentary technology?” Does anyone have PowerPoint in the house? Uncertainty is not just an irritation. It’s bad government, and it’s time we make sure everyone gets the certain “T” with a capital “T” they need, and firm answers when they “push the button.”

Position Limits—The Time is Now One of the rules that has been very difficult to get a visual upon is position limits. Remember when I said that most of the rules were to be completed within 360 days? That would have been last July. Well, there were just a few exceptions to that, and position limits was one. Congress wanted limits done sooner, and told us very specifically so in the law. We were supposed to start implementing them a year ago January. But guess what? On one of these charts that a firm showed me a few weeks ago, position limits were actually the last regulation to be implemented. I think their chart was actually wrong. I hope it was wrong, but I can understand why they might think limits would be delayed. The Commission passed a final position limits rule in October, but it has yet to be implemented. We are actually waiting, of all things, for a joint rule with the SEC on definitions to be approved before the implementation clock—the T—starts ticking. The problem is this: we need these limits now. I’ve been calling for them since 2008. We have needed them for years. If you’ve been to the gas station lately or watched the news, you know people are experiencing a lot of pump price pain.



The CFTC is not a price-setting agency. That isn’t our job. However, we do have a mission to ensure that the price discovery process is fair. Position limits can assist in ensuring prices they are fair. If we look back to 2008 when there was relatively stable supply and demand for crude oil, we saw prices ride a rough-and-tumble roller coaster—going from below a hundred dollars-a-barrel early in the year to nearly $150 in June, then moving all the way down to just over $30-a-barrel in December. There was no justification for such a price swing based upon the fundamentals of supply and demand. The only good explanation is what many researchers and prominent economists and others have said about the link to excessive speculation. And guess what? We are seeing something similar this year. The supply of oil and gasoline is greater today than it was in 2008 and demand for oil in the U.S. is at its lowest level since April of 1997 (so, says the Energy Information Administration). Yet, we see what is happening to prices. They are once again rising sharply. The increased cost of fuel can also dampen the economic recovery. Data confirms the economy is on the mend, but there is no question the recovery is still fragile. According to the International Monetary Fund, for every $10 increase in the price of a barrel of crude oil, the entire U.S. GDP is reduced by a half percent. We all know fuel prices have a direct impact upon individuals, but think about the enormous drain on businesses large and small. The airlines, for example, will spend billions more this year than they had anticipated due to higher fuel costs. A few days ago, I spoke with Delta Air Lines executives Ben Hirst (the General Counsel) and Jon Ruggles (the Vice President for fuel). They tell me that each incremental dollar per barrel of crude impacts their fuel prices by $96 million per year.



They are now expecting to spend at least $1 billion more in 2012 than initially budgeted. Do they believe speculators are having an impact on rising prices? You bet they do, and they are not alone. In fact, the association that represents all of the major air carriers has been urging us to impose positions limits for years. They urged even more restrictive limit levels that the Commission approved. And by the way, federal, state and local governments are also impacted very directly by fuel costs, so this is a drain on taxpayers not just with regard to their family budget but because it increases the costs of government. Here is an example: the U.S. Department of Defense spent $17.3 billion on fuel in 2011. Now, before some of you who have an opposing view about speculation get too worked up, let me say unequivocally that markets need speculators. There are no markets without them. Speculators are good. But like a lot of good things, too much can be problematic. Therefore, it is the excessive speculation that can cause problems, contort markets, and result in consumers and businesses paying an unfair price. Some people say: “Well these markets have worked pretty well over the years. How can you really tag speculation with being a problem in 2008 and is it more than just a guess that excessive speculation is a problem today?” Well, good question Grasshopper. Between 2005 and 2008 we saw over $200 billion come into futures markets from non-traditional investors. I call them “Massive Passives.” They are the likes of pension funds, index funds, hedge funds and mutual funds. These funds are very large—massive—and have a fairly price-insensitive, passive trading strategy.



When I say this, I’m talking generally. I realize that all these traders aren’t passive all the time, but we do see a pattern. In fact, new CFTC data says that massive passive long speculators have shorts outnumbered 12 to 1. Like a rising tide lifts all boats, when we see this unprecedented increase in speculation, it has an impact. I’m not suggesting that the Massive Passives, or speculators in general, are actually driving prices. Let me be clear. I’m not suggesting that they were all in cahoots and decided to raise oil prices. What I am saying is that they contribute to price swings, and have a proportional impact in markets based upon their size as a whole, and certainly individual traders can push prices around if they have a large enough concentration. When prices are on the rise, like now, and the Massive Passives and others get into markets, they push prices to levels that may be uneconomic—certainly not tied directly to supply and demand—and the prices stay higher longer than they normally would. By the way, although it isn’t as interesting to the media and others, the same takes place when speculators exit markets. That’s why prices shot down so far in 2008 by the end of the year. Every trader was bailing from the markets because of the bottom falling out of the economy and prices for a lot of things tumbled. Now, if people believe there was a lot of speculation with that $200 billion infusion back in 2008, guess what? It is even higher this year. In energy markets, it’s 43 percent higher than in June of 2008. And remember, it’s pretty early in the year for gas prices to be this high. It was even higher last year and not just a little higher. From June of 2008 until January of last year, speculation in energy



markets had increased by 64 percent. In the metals and agricultural complexes, it had increased by roughly 20 percent. Is that speculation excessive speculation and is it impacting prices? I think so and so do many members of the U.S. House and Senate. In fact, in the last two weeks, we have received numerous letters from dozens of members of the House and Senate—those that actually voted for the reform law—telling us to get with it and implement position limits. Earlier this week, we received a letter from 23 Senators and 45 Members of the House. They were clear: get on with position limits already. We gave you that tool. Use it now. Also, last week President Obama said, “When uncertainty increases, speculative trading on Wall Street can drive up prices even more.” But you don’t have to take it from me, from Senators or U.S. Representatives, or from the President of the United States. In fact, you don’t have to take it at all. There are many who don’t. I can continue to explain all this to people, but I can’t comprehend it for them. Nonetheless, let me lay one more piece of research on you with regard to speculation. This one doesn’t come from some lefty progressive group. It comes from one of the big Wall Street banks. In fact, I met with them again yesterday. Their researchers said that each million barrels of net speculative length adds as much as 10 cents to the price of a barrel of crude oil. The speculative length is a known quantity. With a little math, you can determine that the “speculative premium” on oil these days is around $23 a barrel—and that translates into about an extra 56 cents for a gallon of gas. What that means is this: if you drive a Honda Civic, the speculative premium costs $7.39 every time you filler-up. If you drive a Ford Explorer



or F-150, the total is $10.41 and $14.56, respectively. I don’t know how often you fill up, but over the course of a year we’re talking real money—hundreds of dollars. Imagine a trucker who pays a speculative premium of $112 more to fill up a Freightliner, driving 120,000 miles per year at 6 miles per gallon. The annual cost to the trucking industry: $29.1 billion. For the airline industry: $9.8 billion. Our position limits rule is one of the only tools regulators have in our utility belt to combat unfair prices. We need to use it. We need to implement the rule as soon as possible and I’m working to do just that. But there is another fly in the ointment on this, and a lot of you know about it. Certain Wall Street interests are suing the government in an effort to stop the rule from going into effect. They contend, among other things, that we didn’t do an appropriate Cost Benefit Analysis—a CBA. I suppose they want the ability to speculate with no limits whatsoever. That’s not good for markets, for the economy or for businesses or consumers. Will position limits take us back to the days of $1.00- per-gallon gasoline? Oh, heck no. Limits will, if we can survive the court challenges and implementing delays—help reduce the pump price pain.

A More Perfect Regulation? We live in not only a complex, but a litigious society. Sure people have the right to go to court and challenge things. But regulators need to keep our eye on the ball and not be scared into making rules and regulations weak or ineffective because we are overly concerned about what we call “litigation risk.”



This is an issue that has troubled me for a while, and I’m going to use this forum as an occasion to talk a little about something that is significant. Bear with me a little here. In the preamble to the Constitution of the United States, there is this wonderful aspirational language: We the people of the United States, in order to form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity, do ordain and establish this Constitution for the United States of America. “In order to form a more perfect union.” Those words, “in order to”—they meant that our forefathers were working toward, hoping, aspiring, to form a more perfect union. It wasn’t perfect, and it might not reach perfection, but they were trying to get there. So, here’s something to think about: those wonderful “planks” toward making that “more perfect union”—establishing justice, insuring domestic tranquility, promoting the general welfare—each one of those distinct factors didn’t in and of itself create the more perfect union. Rather, each facet was a building block that the Founding Fathers intended to use to “get there,” to become that more perfect union. In other words, “providing for the common defense,” wasn’t the be all and end all, but instead it was one of the important pieces used to get to the ultimate goal: a more perfect union. Now I’m going to take what you may think is an odd turn. In a similar fashion, Cost Benefit Analyses, like the CBA I mentioned a moment ago with regard to the position limits lawsuit, in regulatory rulemaking are analogous to those discrete building block factors in the Constitution’s preamble. A CBA is not the ultimate goal of rulemaking, although if you listen to some you might think it so. A CBA is an important piece of reaching the



ultimate goal: a “more perfect regulation.” Like the framers of our Constitution, regulators aspire to reach objectives that protect the commonweal. That’s our job. In the recent past, however, our jobs have been made significantly more difficult by a contortion—but I’ll call it as I see it: a bastardization—it is a bastardization of the conduct and use of CBAs in regulatory rulemaking. This by no means is a new phenomenon. It has cropped up over the years, time and again, as a convenient tool to scuttle regulatory initiatives. Its use at this moment in history is, however, particularly galling to me, given the focus of the regulations that are being decelerated and the harm that was caused to the public as a result of the economic crisis of 2008. There are those who bellow about the “costs” of regulation. To those catcalls, I would simply ask, what were the “costs” of that multi-hundred billion dollar taxpayer-funded bailout? What are the “costs” of families losing their homes? What are the “costs” to our economy of skyrocketing oil and gas prices, fueled by unbridled excessive speculative activity? CBAs are being used as a Sword of Damocles over regulatory agencies. Some regulators live in constant fear and are virtually paralyzed by the threat—or, indeed, the actuality—of lawsuits brought (spuriously, in my opinion) on the bases of allegedly poor CBAs. When this happens, rulemaking activity slows, or grinds to a halt—and that is the precise intent of some who threaten, design, and bring, these lawsuits. And at the same time, American consumers and taxpayers continue to pay more at the pump for a gallon of gas. The airlines will pay billions more. Our Department of Defense and state and local governments will pay more. We will continue to see the devaluation of homes, and continue to face



high unemployment rates. How do we measure those “costs?” It’s time to put some sense (and cents) back into CBAs, and to criticisms of rules. By that I mean, I’d like to see reasonable, accurate, and well-supported analyses, and those who criticize our CBAs should be required to provide, not “masked data,” with no clear or hard figures, but real, verifiable dollars and cents to rebut our analyses. For example, we put out a proposal, ask for comments and ask what the costs might be. Then we either aren’t provided with costs of the regulation, or what we get from the commenters isn’t very helpful. We develop the rule and do the best job we can with all the data we have and go final. Then, opponents of the rules say, “Hey, you didn’t do an adequate CBA.” Give me a break. Then, some talk about or take the government to court. People have a right to go to court, but there is a point at which it seems to me some might be taking advantage of the system. If we are all held to the same reasonable standards on providing and developing good thoughtful data, and not just throwing mud to try and slow the process down, CBAs might actually be a whole lot more useful—as they were intended: as a factor in forming “more perfect regulations.” Ah, good. That feels better. Helen, Mike and MF Global Finally, I don’t want to leave here without discussing a little bit about MF Global and the mysterious missing millions. Let’s be clear: this was a fresh slap-in-the-face reminder that we need appropriate regulations in place now. MF Global is the new poster child for why thoughtful financial regulation is needed more than ever. No matter how I talk about this horrific set of circumstances with regard



to MF Global, I can’t express what a sorry situation this has caused for many MF Global customers. I have a one paragraph letter I received in January and I want to share it with you. It said: “I am 75 years old and my husband is 76 years old. We take care of our brain injured son who is 55 years old. All of our money—over $900 thousand—was invested in commodities with MF Global. We have no income except for a small Social Security check for both of us and some for my son. We will be losing our home we have lived in for 30 years if these funds aren’t returned to us soon. We really made a mistake by trusting too much. We are too old to work anymore. All of our strength we have goes to caring for our son. Can someone please help? We are desperate!” I’m not going to use their last name or tell you where they are from because I didn’t check with them, but I have it right here and I’ve been carrying it around for the last few days to remind me that the MF Global matter isn’t some esoteric policy issue. It is a real and dire matter for thousands of people like Helen and Mike. For us, job one is always—no excuses—to ensure that customer funds are held sacrosanct in what are called “segregated accounts,” and that they are safe and secure. In this case, those funds were not secure. Hundreds of millions of dollars isn’t where it should have been. Aside from trying to find and claw back all the funds and conducting our investigation and going after anyone who broke the law, we also need to ensure that we do all we can to avoid this happening in the future. In that regard I have suggested several things that can be done, although there are others: One, we need to engage in regular and robust deep data dives. By that I mean we need to regularly ensure that customer funds are where they are



supposed to be. Rather than taking a firm’s word at face value that the money is where it is supposed to be, we need to do the Jerry Maguire and insist that they “show us the money.” Two, we should allow customers a choice of how or if their funds in segregated accounts are used. People make choices about the types of investment that can be made with their money in their pension funds. They should be able to do the same with segregated funds. They should also be able to say: “My money sits there as margin and nothing can be done with it.” By the way, customer choice is something that is already done in the United Kingdom, so we should look to them for guidance on how best to formulate such a plan, and; Three, Congress should approve legislation to establish an insurance fund to serve as a backstop for customers like Helen and Mike should there be a loss in the future. The securities world has such an insurance fund. We all know the banking world has the Federal Deposit Insurance Corporation. We need such an insurance fund in the futures world.

Conclusion—Some Menu Options I am grateful for your attention. We live in a complex world and these are all complicated issues. Here is what I know: we are in a rapidly changing environment. Markets are morphing. Laws from less than two years ago don’t even mention things—like high frequency traders — that are clearly issues for regulators today — something we didn’t have time to discuss.



It is all moving and changing fast, fast, fast. We can’t do the job we need to do as regulators without the serious and thoughtful help of people involved in these markets. We need to know what you think. That is why I’ll be very pleased to take your comments and questions if there is time. If we have gotten something wrong, you need to tell us. If something needs changed, shout it out. Here is my personal promise to you: I will listen carefully, because I understand that some menu options may have changed. Thank you. March 8, 2012



NUMBER 4

Remarks before the Institute of International Bankers, Annual Washington Conference

Commissioner Jill E. Sommers, March 5, 2012

Important parts

I would like to touch on a few developments and give my thoughts on the current state of derivatives regulation both here in the US and abroad.

Since September of 2010, the Commission has held 24 public meetings to vote on various Dodd-Frank matters and has issued nearly 60 proposed rules, notices, or other requests seeking public comment, and has completed 28 final rules, interim final rules, and exemptions.

I think we are about at the half-way mark with at least twenty more rules to go, including the most significant rules like definitions of a swap dealer and swap.

We have one meeting scheduled for March and four more meetings scheduled for April and May.

The Process

When it comes to the rulemaking process, I believe a reasonable, measured approach is critical.

Swap markets developed without our involvement, and we have little experience with these markets. The truth is we don’t know what the full impact of our rules will be, and we don’t know whether the assumptions we operate under are valid.



Given this knowledge gap, it makes sense to start with a broader, more flexible approach, and become narrower and more restrictive only as necessary and after we have sufficient experience and data to make these decisions.

Unfortunately the Commission has not taken this sensible approach.

By way of example, last month the Commission held an open meeting to consider a final rule related to business conduct standards and a proposed rule related to block trading.

Dodd-Frank mandates that the Commission specify the criteria for determining what constitutes a large notional swap transaction—or block trade— for particular markets and contracts.

In determining appropriate block trade sizes, Congress has directed that the Commission take into account whether public disclosure of transactions will reduce market liquidity.

This requires a balancing act—if the block threshold is set too low, there will be reduced transparency in the market.

If the block threshold is set too high, there will be reduced liquidity in the market.

Setting block sizes for swaps is not an easy task, and absent robust data, comprehensive analysis, and the benefit of market experience, we could severely harm liquidity at this critical regulatory juncture where we seek to bring more swaps onto swap execution facilities.

The proposal, which passed by a 3-2 vote, recommends utilizing a formula to determine block size whereby only the largest 6% of all interest rate swaps and credit default swaps would be block trades.

This proposal ignores Congress’ mandate that we take into account the impact of public disclosure on liquidity.

We now run the risk of sacrificing liquidity at the altar of transparency.

More troubling, the rule writing team only had access to 3 months’ worth of transaction data, and that transaction data dates back to the summer of 2010.



In writing these rules we are relying on stale data, and far too little of it.

This is just one instance where we have proposed rules without sufficient data, robust analysis, and complete knowledge of their impact.

Extraterritoriality

I am guessing that the issue first and foremost on many of your minds is extraterritoriality.

As everyone in this room knows, the swaps market is a global market.

Harmonizing our rules to the greatest extent possible with the SEC, other US regulators and our foreign counterparts is absolutely crucial for ensuring that we accomplish the overall global objectives of reducing systemic risk and limiting opportunities for regulatory arbitrage.

As required by Dodd-Frank, and in keeping with the commitments reached by the G-20 leaders in Pittsburgh in September of 2009, Commission staff has been in constant contact with our counterparts in London, the European Union and Asia.

These issues are very complex, and the possibility of divergent views among international regulators is very real.

The challenge lies in building a consistent philosophy for how the regulatory frameworks of many nations fit together to ensure cross-border swap activities are not disrupted.

In Dodd-Frank Congress expressed intent for the statute to apply to activities abroad in certain circumstances, but was not crystal clear on the parameters.

While the statute gives us some direction, the Commission is considering how broadly or narrowly it intends to interpret the scope of this limitation.

Setting the precise scope of Dodd-Frank with respect to the cross-border activities of foreign entities is necessary to preserve the continuity of global business operations and the risk management tools that swaps provide.



To that end, I expect the Commission to issue proposed guidance on this issue in the coming weeks; however, it is my understanding the scope of the guidance will only speak to who will be required to register as a US swap dealer or major swap participant.

The Commission intends to tackle other issues such as clearing and market infrastructure in subsequent guidance.

I am deeply concerned that there has not been adequate coordination with the SEC and the international regulatory community.

Of even greater concern to me is that the Commission appears to be considering a piecemeal approach to issues of extraterritoriality by proposing guidance in stages rather than by proposing one comprehensive rule that will give market participants some degree of certainty and the entire framework we are considering.

I cannot imagine the global consequences of an inconsistent approach to these issues by the SEC and CFTC.

I have spoken to many foreign entities and foreign regulators who are very interested in how far the CFTC intends to reach into the operations of entities located overseas.

I believe this is one of the single most important issues the Commission will address during the implementation of Dodd/Frank.

There has been an enormous amount of congressional interest and if we do not get this one right, I am confident Congress will step in. I would like to see the CFTC propose a joint rule or at the least a coordinated rule with the SEC.

The CFTC has a long history of international cooperation and recognition for comparable foreign regulatory regimes.

This is not the time for us to abandon policies that have worked well for us over decades of international practice.



Volcker

I am also going to guess that the other important issue on your mind is the much discussed “Volcker rule”.

The CFTC waited until January of this year to put out its Volcker proposal, notwithstanding the fact that other US regulators put out their version of Volcker last October.

The proposal is lengthy and extremely complex and I do not think we spent sufficient time to fully consider all of its implications. I am troubled that this is the path the Commission has chosen.

Given that we waited until January to propose our version of Volcker, well after other regulators issued proposals and received comments, we had a unique opportunity to take into consideration the comments filed with those other agencies.

Unfortunately, even with the lag time and the benefit of comment letters we proposed a rule that is virtually identical to the other agencies’ proposed Volcker rule.

I had concerns about what the CFTC would do if other agencies re-propose their rules.

I hope we will be prepared to withdraw our proposal and join a re-proposed Volcker Rule with the other agencies.

Otherwise, it seems as if we have put ourselves on a separate track, which I fear will needlessly complicate an already convoluted and likely unworkable set of rules.

Central bankers and regulators from around the world have expressed concern that the rule, which as proposed would apply to the US operations of foreign banks, may also extend to a firms’ operations outside the US.

Many countries in Europe and Asia have weighed in, and many industry bodies such as yours have filed helpful comment letters too.

In fact, the CFTC, Treasury and other regulators received over 17,000 comment letters. We have seen these concerns voiced by high ranking



officials, such as Bank of Canada Governor Mark Carney, EU Financial Services Commissioner Michel Barnier, and FSA chairman Lord Adair Turner.

For example, the UK and Japanese finance ministers weighed in saying that, without an exemption from the rule, their governments’ borrowing costs would rise.

Japan and Britain have called on the US to rewrite the Volcker rule given concerns that it could reduce liquidity in sovereign debt markets at a crucial moment for some European governments.

Japanese Finance Minister Jun Azumi and his British counterpart George Osborne pointed out that Volcker may be the "wrong prescription," with unintended consequences.

Of particular concern to other nations is the fact that, while the new rule may adversely impact market liquidity in stocks and corporate and government bonds, there is an exemption that allows the banks to buy US government securities -- but not other sovereign debt instruments.

As a consequence, explained Azumi and Osborne, "it could reduce liquidity in non-US sovereign markets, making it more difficult, costlier and riskier for countries to issue and distribute debt."

Government debt and related obligations are a major part of the banking sector’s liquid assets.

I believe that we need to really consider, especially at this troubled time in the sovereign debt markets, whether this exclusion should be applied in a broad manner that allows banks, especially those outside the US, to engage in liquidity management using assets accepted as liquid reserves such as foreign sovereign debt.

Second, after reviewing the many critical comments we should re-evaluate the foreign banking entities exemption.

I do not believe this exemption should be narrower than is required by Dodd-Frank.



At a minimum, we could clarify that use of US financial infrastructure (e.g. clearing, settlement, and trade facilitation) would not make the transaction subject to the rule.

It is critical for US regulators to come together and form a reasonable approach to the many difficult issues included in the prohibitions and restrictions on proprietary trading.

The implications of this rule will most definitely be felt around the globe.

International Update

As you know, I chair the Commission’s Global Markets Advisory Committee and have participated for the last three years in the Technical Committee meetings of IOSCO and so am particularly sensitive to international regulatory issues.

As a quick recap on other jurisdictions, we continue to monitor the progress of the European Market Infrastructure Regulation (EMIR), the Markets in Financial Instruments Directive (MIFID) and the related Markets in Financial Instruments Regulation (MIFIR), as well as the proposed revisions to the Market Abuse Directive (MAD) and the Basel Committee on Banking Supervision and IOSCO joint working group on margin requirements for uncleared derivatives.

A political agreement on EMIR was reached last month; however, an official version has yet to be released publicly.

Based on conversations with our European Commission (EC) counterparts, EMIR will come into force on January 1, 2013, but will not be applied until later in 2013.

More specifically, authorization of CCPs will not occur until mid-2013 and we do not have an estimated date for when trade repositories will enter into force.

With regard to MiFID and MiFIR, we expect that the European Parliament will consider them at some point this summer.

All three of these proposals are the EU’s responses to the commitments made by G-20 leaders in 2009 to address less regulated parts of the



financial system, such as OTC derivatives, and to improve the oversight and transparency of commodity derivative markets.

MAD/MAR: The European Commission has also proposed regulations to increase the number of commodity derivatives and OTC derivatives that are covered by the market abuse regime.

The proposals extend the market manipulation prohibition to instruments whose value relates to exchange traded instruments.

So for instance, an OTC derivative referenced to a contract traded on ICE Futures Europe would fall within the new Directive.

These updated regulations now include prohibitions against attempted manipulation, where the old rules only covered actual manipulation.

I should also point out that the new regulation gives the member states more enforcement tools and criminalizes certain insider trading and market manipulation offenses.

We expect these proposals will also be taken up by the European Parliament this summer.

The IOSCO Task Force on OTC derivatives (TF) has been busy. Here’s a sense of where various work is in the pipeline:

- the report on requirements for mandatory clearing;

- the TF’s “Follow on analysis to the report on trading”; and

- the report on OTC Derivatives Data Reporting and Aggregation Requirements, which is the joint work of the TF and the Committee on Payment and Settlement Systems (CPSS)

were all approved before or during the Feb. 2012 Tokyo Technical Committee Meeting.

The last report left for the task force to take up, the report on OTC Derivatives Market Intermediaries’ oversight, is nearly finished and likely to be approved at the May IOSCO Annual meeting in Beijing.



Lastly, on the international front, I would like to report that the Basel Committee on Banking Supervision and IOSCO has established a joint working group on margin requirements for uncleared derivatives.

The group includes representatives from more than twenty regulatory authorities, including the CFTC, and has held two in-person meetings and numerous conference calls.

The topics discussed have included:

- the purposes of margin;

- the instruments subject to margin;

- entities subject to margin;

- categorization of counterparties;

- calculation of margin;

- eligible collateral;

- segregation of collateral;

- treatment of affiliates; and

- cross-border issues.

The group is working toward issuing a consultative paper mid-year.

US regulators will coordinate with the international effort, and my hope is that US regulators will not take up the final rulemaking on margin requirements for uncleared derivatives until after the international standards have been settled.

Finally, I will turn to recent developments in Asia.

Japan

The Japanese legislature passed the Amendment to the Financial Instruments and Exchange Act (“FIEA”) in May 2010.

This amendment gave the Japanese financial regulator, the JFSA, the authority to regulate OTC derivatives.



The JFSA expects the implementing cabinet ordinance and other measures to be finalized by November 2012.

Hong Kong

The Hong Kong Monetary Authority (“HKMA”) and Hong Kong Securities and Futures Commission (“SFC”, together with the HKMA, the “Hong Kong Authorities”) released a consultation paper on their proposed OTC regulatory regime in October 2011.

The Hong Kong Authorities propose amending the Securities and Futures Ordinance to set out a general framework for the regulation of the OTC derivatives market, which includes providing relevant rulemaking powers to the HKMA and SFC.

Hong Kong is working to adopt these regulations by the end of 2012.

Singapore

On February 13, 2012 the Monetary Authority of Singapore (“MAS”) published a consultation paper with proposals to meet the G20 mandate on the trading, clearing and reporting of OTC derivatives.

To implement the recommendations of the international standard setting bodies, MAS proposed to expand the scope of the Securities and Futures Act (“SFA”) to mandate central clearing and reporting of OTC derivatives contracts, as well as regulate market operators, clearing facilities, trade repositories and market intermediaries for OTC derivatives contracts.

Generally there is a fair amount of consistency between jurisdictions. Of course there are some areas where coordination and cooperation are essential.

I know the concept of indemnity in the context of swap data repositories is an issue, as well as the desire by some for a central bank exemption from the registration, public reporting and clearing requirements of Dodd-Frank.

There is also a conflict regarding the open access to CCP’s rules which we finalized in October of last year.



The rules prohibit a DCO from setting a minimum adjusted net capital requirement of more than $50million for any person that seeks to become a clearing member in order to clear swaps.

This very low number has generated concern from other authorities.

As you all know very well, market regulators around the globe are working diligently to respond to the commitments made at the G-20 level. Considering the scope of the work for all of these jurisdictions, I think the progress made up to this point has been remarkable.

We will continue our efforts at the Commission coordinating with our global counterparts and will probably be working to establish appropriate rules and regulations for many years to come.

Conclusion

In closing, I would like to convey my persistent grief regarding the process the Commission is using to finalize these very important rules.

I believe we should be crafting all of our regulations in a way that will allow them to stand the test of time and to not favor one market segment over another.

I believe that it is crucial for the marketplace and for market participants that we get these rules right and that we finalize them in a way that is reasonable and to not politicize them.

It would not be a good outcome if we are re-writing most of these rules in the next couple of years because the rules do not reflect the useful input we have received from the market.

We consistently reject reasoned comments from industry professionals with little justification in our cost benefit analysis to support those rejections.

I have been hopeful for the past year that things would change when we started finalizing rules, and especially the rules that are so integral to the new regulatory framework, but things have not changed.

I am no longer optimistic; I do not believe that these rules have a chance of withstanding the test of time but instead believe that this Commission



will be consumed over the next few years using our valuable resources to rewrite rules that we knew or should have known would not work when we issued them.

March 7, 2012



NUMBER 5

7 March 2012

Technical features of the Legal Entity Identifier (LEI) The FSB LEI Expert Group has made significant progress in identifying the key issues and developing framework solutions to be presented in the report to the FSB Plenary by the end of April, to enable the Board to meet the G-20 mandate provided at the Cannes Summit. Work is proceeding intensively under five workstreams - each having its own mandate and deliverables: - governance; - operational model; - scope, confidentiality and access; - funding; and - implementation and phasing.

The Expert Group is supported by an Industry Advisory Panel composed of 34 representatives from different sectors and regions to help provide important industry input into the global public-private LEI initiative. The Expert Group is determining the regulatory interests that must be protected within the framework of the global LEI system and is continuing to review the resulting regulatory requirements for the LEI that form a key component of the G-20 mandate. The FSB has, however, decided to provide early clarity on two technical points. This clarity is provided in order to give early guidance to industry, to help with expected forthcoming proof of concepts and to provide initial direction on the work of the Expert Group.



At the same time, this early guidance is subject to final confirmation as the Expert Group completes its work. First, the Expert Group has agreed that a 20-character alphanumeric code is a good basis for the global LEI code. Second, the Expert Group is continuing to review the LEI eligibility criteria as well as the reference data that the regulatory community views as essential and, consequently, would require to be associated with the identifier. In the first round of discussion, the Expert Group agreed that the following six data elements will all form part of the minimum set of reference data attributes that will be required by the regulatory community on the launch of the LEI: - The official name of the legal entity;

- The address of the headquarters of the legal entity;

- The address of legal formation;

- The date of the first LEI assignment;

- The date of last update of the LEI;

- The date of expiry, if applicable.

It should be noted that this limited minimum set of the reference data is the product of the first round of regulatory discussions. As the Expert Group completes its work, it expects to propose additional elements both for reference data attributes, and for the audit trail of changes and updates to the LEI, in order to meet various regulatory needs. Work continues on all other aspects of the LEI framework with the aim of completing an internal report to the agreed deadline.



This report will provide concrete recommendations on the protection of public interests and structures sought in the LEI system. The final report will be published in due course.



NUMBER 6

Interesting developments

Mario Draghi, President of the ECB, Vítor Constâncio, Vice-President of the ECB, Frankfurt am Main, 8 March 2012

Important parts

Ladies and gentlemen, the Vice-President and I are very pleased to welcome you to our press conference. We will now report on the outcome of today’s meeting of the Governing Council.

Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged.

The information that has become available since the beginning of February has confirmed our previous assessment of the outlook for economic activity.

Available survey indicators confirm signs of a stabilisation in the euro area economy.

However, the economic outlook is still subject to downside risks. Owing to rises in energy prices and indirect taxes, inflation rates are now likely to stay above 2% in 2012, with upside risks prevailing.

Nevertheless, we expect price developments to remain in line with price stability over the policy-relevant horizon.

The underlying pace of monetary expansion remains subdued, consistent with contained inflationary pressures over the medium term.

Looking ahead, we are firmly committed to maintaining price stability in the euro area, in line with our mandate.

To this end, the continued firm anchoring of inflation expectations – in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term – is of the essence.



Over recent months, a wide range of additional non-standard monetary policy measures has been implemented by the Eurosystem.

These measures, including in particular two three-year longer-term refinancing operations, were decided upon against the background of exceptional circumstances in the last quarter of 2011.

The first impact of these measures has been positive.

Together with fiscal consolidation and stepped-up structural reforms in several euro area countries, as well as progress towards a stronger euro area economic governance framework, they have contributed to a significant improvement in the financial environment over recent months.

We expect that the three-year longer-term refinancing operations will provide further support for the ongoing stabilisation in financial markets and, in particular, for lending activity in the euro area.

All our non-standard monetary policy measures are temporary in nature. Furthermore, all the necessary tools to address potential upside risks to medium-term price stability are fully available.

Let me now explain our assessment in greater detail, starting with the economic analysis.

Real GDP contracted by 0.3% in the euro area in the fourth quarter of 2011.

According to recent survey data, there are signs of a stabilisation in economic activity, albeit still at a low level.

Looking ahead, we expect the euro area economy to recover gradually in the course of this year.

The outlook for economic activity should be supported by foreign demand, the very low short-term interest rates in the euro area, and all the measures taken to foster the proper functioning of the euro area financial sector.

However, the remaining tensions in euro area sovereign debt markets and their impact on credit conditions, as well as the process of balance sheet



adjustment in the financial and non-financial sectors, are expected to continue to dampen the underlying growth momentum.

This assessment is also reflected in the March 2012 ECB staff macroeconomic projections for the euro area, which foresee annual real GDP growth in a range between -0.5% and 0.3% in 2012 and between 0.0% and 2.2% in 2013.

Compared with the December 2011 Eurosystem staff macroeconomic projections, the ranges have been shifted slightly downwards.

This outlook remains subject to downside risks. They notably relate to a renewed intensification of tensions in euro area debt markets and their potential spillover to the euro area real economy.

Downside risks also relate to further increases in commodity prices.

Euro area annual HICP inflation was 2.7% in February 2012, according to Eurostat’s flash estimate, slightly up from 2.6% in January.

Looking ahead, inflation is now likely to stay above 2% in 2012, mainly owing to recent increases in energy prices, as well as recently announced increases in indirect taxes.

On the basis of current futures prices for commodities, annual inflation rates should fall again to below 2% in early 2013.

Looking further ahead, in an environment of modest growth in the euro area and well-anchored long-term inflation expectations, underlying price pressures should remain limited.

The March 2012 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation in a range between 2.1% and 2.7% in 2012 and between 0.9% and 2.3% in 2013. In comparison with the December 2011 Eurosystem staff macroeconomic projections, the ranges for HICP inflation have been shifted upwards, notably the range for 2012.

Risks to projected HICP inflation rates in the coming years are seen to be still broadly balanced, with upside risks in the near term mainly stemming from higher than expected oil prices and indirect tax increases.



However, downside risks continue to exist owing to weaker than expected developments in economic activity.

The monetary analysis indicates that the underlying pace of monetary expansion remains subdued.

The annual growth rate of M3 was 2.5% in January 2012, up from 1.5% in December 2011.

Loan growth to the private sector also remains subdued. However, its annual rate (adjusted for loan sales and securitisation) picked up slightly in January to 1.5% year on year from 1.2% in December.

The annual growth rates of loans to non-financial corporations and loans to households (adjusted for loan sales and securitisation) stood at 0.8% and 2.1% respectively in January.

The volume of MFI loans to non-financial corporations declined only slightly in January, following the pronounced decline in December. By contrast, the flow of loans to households in January was positive.

Following the signs of improvement in the financial environment, it is essential for banks to strengthen their resilience further, including by retaining earnings.

The soundness of banks’ balance sheets will be a key factor in facilitating an appropriate provision of credit to the economy.

To sum up, the economic analysis indicates that price developments should remain in line with price stability over the medium term. A cross-check with the signals from the monetary analysis confirms this picture.

Looking ahead, in order to deliver a favourable environment for sustainable growth and to support confidence and competitiveness, the Governing Council stresses the urgent need for governments to make further progress towards restoring sound fiscal positions and implementing the structural reform agenda.

Regarding fiscal consolidation, many governments in the euro area are making progress. Continuing with comprehensive fiscal consolidation



and complying with all commitments remains essential. In this respect, the 2012 European Semester should be used to enforce rigorously the reinforced fiscal surveillance mechanism.

Equally important are structural reforms to increase the adjustment capacity and competitiveness of euro area countries and to strengthen growth prospects and job creation.

In this area, more progress is desirable.

The Governing Council strongly welcomes the European Commission’s Alert Mechanism Report on macroeconomic imbalances and expects the proposed in-depth country reviews to actively support the reform processes under way in euro area countries.

We are now at your disposal for questions.

* * *

Transcript of the questions asked and the answers given by Mario Draghi, President of the ECB, and Vítor Constâncio, Vice-President of the ECB

Question: Two questions, as permitted. One: I have heard or many heard your message clearly about LTROs, the temporary measure and the temporary nature of it, but for those who have not heard it, can you tell us about the chances of a third LTRO or something further down the line?

And the second question, maybe along the same lines: how concerned or upset were you by that leaked letter from the Bundesbank or, more notably, from Jens Weidmann and, in that context also, how concerned are you that the ECB is not necessarily speaking with one voice at a time when it is most critical?

Draghi: On your first question: the LTRO, both operations, I would say, are an unquestionable success.

The risk environment has improved enormously, markets have reopened, both senior and secure markets, covered bond markets, and even the interbank market – although still limited to the short term and to national boundaries – has also started working a little better.



Certainly, we see many signs of a return of confidence in the euro.

So-called real money investors have, to some extent, come back. We see the presence of money market funds, which were the first to take flight from the euro a year and a half ago.

We see again pension funds, we see investment funds – so, all in all, we see that great progress has been achieved. I don’t really need to spend much more time on this; you only need to compare the situation in November of last year with that today.

Let me also add that this is not only the effect of the LTRO, but also of the serious reform effort that has been undertaken by several governments in the euro area and of the improved governance of the whole euro area; here I am referring especially to the fiscal compact.

But basically, the LTRO had the powerful effect of removing what is called “tail risk” from the environment.

Now I think the ball is in the court of governments and other actors, especially banks, to continue their reforms, to repair their balance sheets so that they – especially banks – can actually support the recovery.

The LTRO has created a situation where these efforts can certainly be undertaken, but certainly neither governments nor banks nor the other key actors ought to be complacent.

On the other issue, let me say what I say all the time: I think we all – when I say “we”, I mean the Governing Council – we all have to do the right things and we have to do them together.

So let me first, incidentally, say that my personal and professional relationship with Jens is excellent. So that is one thing I want to say.

I would also like to add that nobody, contrary to what some journals, newspapers and magazines have said, nobody is isolated in the Governing Council.

And the Bundesbank especially is not isolated, and there are several reasons for this, besides its being a very important central bank.



As I have had many opportunities to say, I really cherish the culture and the tradition of the Bundesbank, of maintaining price stability. I think we all collectively owe a lot of what we have learned about the stability culture to the Bundesbank and to Germany.

But now we are all custodians of stability, there is not one specific custodian of the stability culture. We all share the same view, the same ideals. So I think that ought to be kept in mind.

The other thing that is related to the letter – and, incidentally, I don’t think that the leak came from Jens himself, I am certain that it was not him – is that the substance, the content of that letter is present in all our minds: the possible risks of our monetary policy, the complications – which are largely communication-related, I would say – created by the use of additional credit claims, and the TARGET2 balances as well.

We always say that it is normal in a monetary area to have TARGET2 balances.

We say that it is within the Treaty, that these balances are a normal product, especially when interbank markets don’t function. But it is also true that these TARGET2 balances reveal structural differences and structural weaknesses in some parts of the euro area, and this is therefore not something that can be ignored.

We ought to think about it and reflect on it. And I think that on this, we completely share these views. Finally, let me say: we are all in the same boat. And I think that there is nothing to be gained by fighting or arguing publicly outside the Governing Council.

Question: First, last month you said that you didn’t even discuss interest rates at your monetary policy meeting. Did you discuss them this month?

Second, based on the latest information that you might have, how confident are you that the Greek private sector involvement (PSI) will be a success?

And finally, you said in Mexico that a special bank lending survey is being conducted to assess the impact of the first LRTO. Could you perhaps tell



us what the results are and whether you are actually intending to publish that survey?

Draghi: In answer to your first question, no, we did not discuss interest rate changes.

As for the Greek PSI, the operation is unfolding as we speak, and so it would be completely inappropriate for me to comment on it.

Lastly, the bank lending survey I referred to in Mexico is an ad-hoc survey for internal use and we do not plan to publish it immediately.

However, it certainly shows that from the very, very negative trends in credit and money that we saw in the last three to four months of last year – for the first time in history and the history of the euro, the absolute level of M3 declined for three consecutive months and the volume of loans to the private sector, non-financial corporations, also declined for two consecutive months – there has been a modest pick-up in credit and bank lending since the first LRTO.

Question: Two questions relating to the same subject. Did the Governing Council discuss the issue of a possible restructuring of the Anglo Irish Bank’s promissory notes?

And second, do you think that such a restructuring or any kind of concession on the promissory notes would help Ireland to return to the bond markets next year as planned and would also perhaps help the Irish government in its quest to pass the referendum on the fiscal compact?

Draghi: On your last question, let me say that I am really confident that the referendum will pass and that the fiscal compact will be approved, because Ireland is probably one of the programme countries that has made most progress, under conditions that have been very harsh.

And, in spite of these conditions, it has really delivered. We are also aware that there are certain fragilities that need to be taken care of.

On your first question, we didn’t discuss it. It is being examined, but it was not part of the Governing Council’s discussions.



Question: On the topic of growth, you mentioned that you expect a gradual recovery over the course of this year. Can you give us an idea as to where the ECB sees the sources of this growth coming from? If you look at austerity, higher oil prices, rising unemployment, none of these things seem to bode well for a recovering economy? Can you give us a sense of how you all assess where this growth is going to come from?

Second, back to the letter and the issue with the Deutsche Bundesbank, one thing that it seems to raise is the fact that these debates within the ECB aren’t really published in any kind of way, e.g. meeting minutes or vote counts. Now that you are President of the ECB, would you maybe consider making these internal debates public – even without mentioning names – so that they do not create such a drama when they do become public?

Draghi: Before I answer your two questions, let me say that I read everything that you write very carefully. You recently wrote a piece on the risks that are in the ECB’s balance sheet because of the LTRO.

In that article, you compare the size of the balance sheet, which is now around 3 trillion euro or something to GDP and conclude that the expansion has been greater in the euro area than in the United States or the United Kingdom. I am dealing with this now because I have also seen this mentioned elsewhere.

Now, one has to look at the balance sheet for what it is. The comparison of the overall amount does not really relate to the issue of whether risks have increased or not.

The Eurosystem has a very large volume of assets that have nothing to do with monetary policy, e.g. gold, foreign exchange reserves, among other things.

If you compare the ECB’s balance sheet with that of the Federal Reserve System or the Bank of England, the latter are very lean, they do not have the same volume of assets.

You have to make the comparison in terms of the additional risks caused by the two LRTOs. You have to compare the ratio of monetary policy instruments to GDP in the three different areas of the world.



If you do that, the ratio is actually 15% for the ECB, 19% for the Federal Reserve System and 21% for the Bank of England.

Therefore, at the present time, to say that the risks for the ECB’s balance sheet are higher than those for Federal Reserve System and the Bank of England is not correct.

The same conclusion can be reached if you look at the rates of change.

The balance sheets of the other major central banks have expanded in a short period of time by much more than that of the ECB. That was a point I wanted to make, because it also clarifies some of the concerns that have been expressed in various quarters, not only in the Wall Street Journal.

Now, in answer to your questions, the recovery in growth is going to be very gradual.

But there are reasons for that: foreign demand, the very low level of short and medium-term interest rates, and the extraordinary improvement in the risk environment, which if it is maintained, is probably going to be the main factor that we can count on. There are also the structural reforms.

We have always assumed that structural reforms have an impact on growth in the long term, but that is not always true for all reforms.

There is first of all a signalling effect, there is a confidence effect, but in the case of some reforms, there are also some reforms that have an impact on growth, even in the short term.

With regard to your last question on transparency, I think it is stretching it a bit to say that if there are leaks, you need to be more transparent. In any case, the ECB is very transparent.

We have regular press conferences, we have hearings in parliament, we have press releases, we have publications – we are transparent.

It must also be kept in mind that we are not – either politically or economically – in the same situation as the United States or the United Kingdom, namely we are not one country. To some extent, you want to keep the deliberations of the Governing Council as separate as you can from the national identity of its members.



I will never forget a conversation in which Hans Tietmeyer said that we should “remove the name plates, which in the first meetings of the Governing Council used to say “Germany”, “Italy”, etc.

He said that “we are here in our personal competence; we are not here to represent our countries”. This common action for the stability of the euro is well protected now. However, we will certainly think about it, it is a subject of ongoing discussion.

Question: I have two questions. The first regarding the criticism of the Brazilian president that monetary policy in the United States and the euro area might have negative impacts on Brazil and other developing countries. I think the terms used were “monetary tsunami” and “currency war”. Do you have any moral scruples about imposing monetary policy measures that have negative spillover effects on other countries, especially poorer countries?

Secondly, you said that nobody in the ECB Council is isolated. My impression is that at the Deutsche Bundesbank this is seen a little bit differently. Obviously, you do not even agree on the question of whether you agree. So, is it not time to think about whether the whole thing, a currency union without political union, is working when the central bank of the largest country is so opposed to the ECB?

Draghi: On the first point, I think we are doing the right thing with our monetary policy. Originally this argument started between some emerging countries and the United States.

Now it has somehow expanded to involve Europe. The reason this argument is raised is the fear that the exchange rate could actually be affected by these monetary policies.

Now, speaking on behalf of the ECB – I cannot speak for the US Federal Reserve System – we do not run our monetary policy for exchange rate reasons or with exchange rate objectives, we do this only in line with our primary remit, namely price stability in the medium term.

When you look at the data, if anything, the euro exchange rate has appreciated since we conducted the two LTROs. As I was saying before, we are observing a significant inflow, renewed interest or confidence in



the euro by real money investors, by investors not resident in the euro area. So this criticism does not seem to be grounded, at least as far as we are concerned.

On the second point, as I said before, I do not think the Bundesbank is isolated. Do not forget, the decision on the LTRO was unanimous.

So, it is not isolated. And even when there are differences of opinion, it is not just Germany against everybody else or the Bundesbank against everybody else. There are always differences of opinion.

And if I remember correctly, the Bundesbank has never been alone in its opinion. So, I do not think that isolation belongs to our way of working; it certainly does not belong to mine, and I am determined, as I said before, to do the right things and to do them together.

Question: The staff projections were revised downwards for growth and upwards for inflation. What does this mean for monetary policy in the future?

And second, if the desired effect of the LTROs that you mentioned earlier is not realised, what can you do? What else can the ECB do? Can you force banks to lend or would you maybe even consider quantitative easing?

Draghi: On the first point, we have to keep our eyes squarely on our primary remit, namely price stability in the medium term.

When you look at that, we see upward risks, coming from the higher than expected oil prices, from indirect taxation that has been widely used by governments in their fiscal consolidation efforts and from administered prices.

But we can also see downside risks to staff inflation projection coming from an environment which remains weak, from a labour market which, as you can see, remains slack with unemployment actually going up. So, basically, that is the outlook.

And on the second question, so far, the two LTROs have had a very powerful effect, but it is also a complex one, which means that we have to look at how exactly the economic and financial landscape has changed



following these two operations. And there are many, many complexities that have to be thoroughly analysed.

Question: And would you consider quantitative easing?

Draghi: We never pre-commit. Now that we have conducted the LTROs, we want to see exactly what the effects are.

Question: In recent years, also under your predecessor, Mr Trichet, we have heard many declarations and statements and then we have seen a very interesting history of ECB interventions made in spite of these or in opposition to them, that have been forced by real economic developments.

You have tried to voice confidence, but if it is based only on monetary policy approaches, it is very risky. I am just pointing to the fact that, to a large extent, financial markets have already priced into their investment decisions the possible or potential effects of the crisis in Syria and, with regard to Iran, we all know where this might lead to in terms of turning things upside down.

Have you taken these aspects into account and, if not, when will you begin to do so?

Draghi: Well, you can never be certain of how much the global environment is going to change following developments as dramatic as the ones you mention.

In answer to your question, when I said that we see some upside risks for inflation developments, I mean that the oil price could end up being higher than expected and this is linked to these risks.

Question: You talk about the LTROs as being another temporary measure, but we have seen the ECB engaging in these extraordinary measures since 2007.

As of today we have seen the Bank of England with its interest rate at an all-time low for three years and we continue to see extremely low rates from all the major central banks. Is this the way that you thought this would pan out when central banks began easing and were doing coordinated easing several years ago?



Did you think that it would last this long? How do you see this environment changing, or are we in a period of long, stable rates? Do you think that markets have become overly dependent on or addicted to the notion of global liquidity and lower rates?

Draghi: I think we called them non-standard measures for the very reason that they are taken for non-standard situations.

They are temporary in nature. In a sense, we have to go back to normal, classical central bank policy. We should not forget that when we decided on the two LTROs, the market conditions were as I described them earlier.

So when people say that the LTRO could make the banking system more dependent on the ECB, they forget that there were no interbank markets before, because they were completely clogged up. If anything, we are actually witnessing the opposite, as we can see that markets are gradually improving their liquidity situation.

We will watch what happens carefully. As I have said before, these operations have been successful, but they are also very complex in their effects.

Also, one cannot deny that monetary policy cannot do everything – governments have to do their bit in terms of undertaking complete fiscal consolidation and implementing structural reforms and, as I mentioned in the Introductory Statement, the banks have to improve the resilience of their balance sheets, because that is essential for credit and for lending.

We address the aspects that relate to liquidity and funding, and we cannot and do not want at all to replace either the fiscal actions of the governments or to address a possible lack of capital held by the banks. That is not our job.

Question: Two questions please. From a risk management point of view, do you think it is appropriate for Eurosystem central banks to prepare for the possibility of the exit of one euro zone member, since it does not seem to be something totally impossible or unlikely?



Secondly, we are now in the third week of the SMP without any purchases by the European Central Bank. Could you perhaps say if the SMP is now art of the history of the ECB and, more generally, if you think that engaging the SMP back in May 2010 was the right thing to do, or was it a policy mistake by the ECB?

Draghi: On the first question: no, we don’t prepare, we don’t have any plan B. I have often said that to have a plan B means to admit defeat and we do not want to be defeated.

To me, it is equivalent to conceiving a reality which goes beyond the Treaty. The ECB staff knows how to manage risk, but this is not something we foresee.

As regards your second point you are right: the SMP has been quite inactive in the last few weeks. Again, as I said at the very beginning of my mandate, the SMP is neither eternal nor infinite.

Question: Two questions. First of all, Jürgen Stark described the quality of the ECB’s balance sheet today as “shocking”. Can you explain why he said that? He must know what is in the books, probably more than we do. Shouldn’t we be worried about comments such as that from a former Executive Board member?

My second question is about the LRTO of last time; something has been picked up in the market is the idea that banks operating across Europe were actually obtaining liquidity from national central banks in individual countries so that they could match liabilities and assets by country as a hedge against a possible euro zone break-up. Is that something you observed?

Draghi: I don’t know exactly what Jürgen meant by that. Incidentally, he was still a Board member when he voted in favour of the LRTO, of both LTROs. But then he left when the actual collateral was provided. So I don’t know exactly.

He certainly didn’t see the collateral or anything like that. I think they must have all read Brian Blackstone’s article and decided that.



The ratio that matters is 3.5 trillion euro divided by the GDP of the euro area and not 1 trillion euro divided by the GDP of the euro area. But I will talk to him and I will ask him what he means.

On your second point, let me say one thing. There is one big difference between the first and the second LRTO, which I don’t think I have mentioned. The number of participants went up from 500 and something – keep in mind that the participation in these tenders is something over 100 or even less, on average.

The first LRTO had 500 and something and the second LRTO had 800 banks. Of these, 460 are German banks, even though I should hasten to add the overall amount borrowed by German banks is lower, or much lower, than the overall amount borrowed by other countries.

And here I come to your point. Comparisons by country are actually appropriate up to a point, I am not talking about the 430 small German banks – incidentally I would love to review the places, the towns and villages where these banks are, but I cannot do it because often they would probably be the only bank in town and so they could be recognised.

But that, to me, says one thing: that this money is now closer to the small and medium-sized enterprises (SMEs) than it was before. Which you remember was one of the reasons, one of the arguments, for involving a very large number of participants.

I am not saying that this money will necessarily go to the SMEs, but it is certainly one step closer. We have this in mind because 80% of euro area employment depends on the SMEs. But going back to your point: there are some large banks that have borrowed money through their avatars in different parts of the Union.

That’s why it is kind of difficult to make an exact attribution of borrowings and drawings on the facilities and countries. Whether they do this to match their assets and liabilities in the single countries, I don’t know.

There was one banker – actually a British banker – who said that he was doing it for this reason. But I do not know about the others. Some of



them, for example, do not want to be seen borrowing too much under the name of the parent company and they borrow under different names.

Question: You mentioned several factors before behind the stabilisation of the European economic and financial landscape. You did not really stress the point of the firewall which has been prepared for Greece and, more generally, the European firewall. How do you judge the progress being made towards implementing this firewall for Greece?

And, second, do you see sufficient progress towards building up larger IMF resources against global instability at the next IMF meeting in April?

Draghi: I think the two things are actually linked. The IMF has made it quite clear, or, rather, some members of the IMF have made it quite clear, that they would be ready to give more resources to the IMF’s General Resources Account, and indirectly, some of them, to the euro area, only if an adequate firewall were in place.

At the same time, the building of an adequate firewall has to take into consideration the fact that there are many different countries, many different governments, and many different budget situations. That’s why it has taken so long.

But at the European Council on 9 December, and at the European Council at the end of January, two things were basically restated.

The first thing is that the adequacy of the EFSF resources would be reviewed in March.

The second is that the creation of the ESM would be brought forward to, I think, May or June.

Then it was said in a subsequent statement that the ESM would be capitalised at a faster pace than had been originally stated.

So, all in all, one has to be confident that the adequate efforts, although slowly, will bear fruit. Actually, there will be an adequate firewall in place and, following that, I think we will be able to have the IMF resources in the General Resources Account.



Question: My question concerns Greece. The markets have been rather nervous during the last few days as far as the consent of the private investors to the debt cut is concerned. Do you think this is justified? What are you expecting? And you said before that you do not have a plan B. But what if not enough investors give their consent to a debt cut?

Draghi: Markets were nervous two days ago. Today they are not nervous and are actually quite positive.

They seem to be happy with what is going on – and they certainly know more about what is going on than I do.

Having said that, it would not be proper for me to make comments about something that is currently unfolding. And it is very market sensitive.



NUMBER 7

National Consumer Protection Week, a coordinated campaign by government and non-profit entities, encourages consumers nationwide to protect themselves and make better informed decisions by taking advantage of available resources.

As a steering committee member, the FDIC presents:

Ten Things You Should Know About Debit, Credit, or Prepaid Cards Debit, credit and prepaid cards are widely used to pay for a variety of goods and services, and consumers often use them interchangeably. However, there are significant differences between these cards in how they work and the consumer protections provided for each card.



That's why the Federal Deposit Insurance Corporation has created a list of things you should know before using your credit, debit, or prepaid card. When deciding which card to use, keep in mind how they work. A credit card is essentially a loan. When you borrow funds using the card, you must pay the money back in addition to any interest that may be charged. You may have to pay interest if you do not pay the entire amount by a certain date. On the other hand, debit cards are issued by your bank and when you use them, the money spent is taken directly from your bank account. Prepaid cards can seem very similar to debit cards in the way that they work. They generally allow consumers to spend only the money deposited onto them, and include products such as “general purpose reloadable” (GPR) cards, gift cards, and payroll cards. GPR cards carry a network brand, such as Visa, MasterCard, or American Express, and may be used anywhere that other cards on that network are accepted. However, the consumer protections regarding prepaid cards are very different. As discussed further below, the major federal protections that would cover you if you used a debit card do not apply to most prepaid cards. Be aware of debit card overdraft fees. Overdraft fees can occur if you don’t have enough funds in your account when you swipe your debit card but the transaction is still processed. However, you must provide your bank with written permission in order for it to be able to charge you a fee for allowing you to continue to use your debit card when you do not have enough funds in your account. If you have overdrawn your account in the past, try to avoid these costly fees in the future by keeping track of your debit card purchases and other transactions and knowing your account balance.



A credit card issuer cannot charge you a fee for going over your credit limit unless you agree to allow for over-the-limit transactions. A card issuer cannot permit you to go over your credit limit and then charge a penalty fee for having done so unless you explicitly agree to it (“opt-in”). You must tell your credit card company that you want it to allow transactions that will take you over your credit limit. If you do not, then any transaction that puts you over your credit limit may be turned down. Your liability for an unauthorized credit card transaction is generally limited to $50. Federal law limits your losses to a maximum of $50 if your credit card is lost or stolen, although industry practices may further limit your losses. Your liability for an unauthorized debit card transaction may vary. The maximum legal liability is $50 if you notify the bank within two business days after learning of the loss or theft of your debit card. Otherwise, your losses could be greater. You must also notify your bank within 60 days of your bank’s transmittal of your periodic statement on which an unauthorized transfer appears, in order to avoid liability for subsequent unauthorized transfers. Certain prepaid cards are covered by consumer protection laws and regulations but others are not. For example, payroll cards must disclose any fees associated with the card as well as the error resolution process, limit liability in a manner akin to that for debit cards, and provide 21 days notice before making changes to the terms of use of the card. On the other hand, general purpose reloadable cards do not have any of these requirements. While gift cards must disclose certain fees that may be charged and whether the card has an expiration date, there are no federal requirements limiting liability for unauthorized transactions or for providing notice of changes to the terms of use of the card.



The funds linked to a prepaid card may or may not be FDIC-insured. If an employer, government agency or other organization places money with an insured institution to hold for use in connection with consumers’ prepaid cards, and the bank holding the money fails, the funds will be considered deposits of the cardholders (as opposed to deposits of the organization) if certain specific requirements have been followed. One requirement is that the account must be set up so that the organization is documented as acting as the custodian of the funds, on behalf of the consumer cardholders, rather than as the owner of the funds. If the requirements for pass-through deposit insurance have been met, the individual consumer cardholder will be protected by deposit insurance up to applicable limits. Make sure you know about all fees associated with your prepaid card. Possible fees include those to activate (start using) the card, add money onto the card, make purchases, withdraw cash, inquire about your balance at an ATM (in addition to any fee charged by the company that operates the ATM you use), receive a statement in the mail or speak with a customer service representative. As a result, most prepaid cards end up costing more than the advertised monthly fee. A “hold” may be placed on funds in your bank account for debit card transactions. At the time of purchase, merchants immediately place a temporary hold or “block” on funds for the transaction as protection against fraud, errors or other losses. The hold will be removed when the final transaction is processed, nearly immediately or perhaps a day or two later, but until then, you won’t have access to that amount in your account. Credit card issuers must give cardholders 45 days notice of changes. Under the Credit Card Accountability Responsibility and Disclosure Act of 2009 — the Credit CARD Act – the card issuer must generally provide a



45-day advance notice of any interest rate increase, fee increase, or any other significant changes in account terms. In contrast, debit cards and prepaid cards vary in the amount of notice required for changes to the terms of use of the card. For example, banks must provide 21 days notice before making certain changes to the terms of debit card usage, while payroll cards also must provide 21 days notice. However, general purpose reloadable cards and gift cards are not required to do so.



NUMBER 8

Statement by Commissioner Michel Barnier, following the agreement in trilogue of new European rules to regulate financial derivatives "I congratulate the European Parliament and the Council on reaching today an important agreement on a regulation for more stability, transparency and efficiency in derivatives markets. It is a key step in our effort to establish a safer and sounder regulatory framework for European financial markets. This matters because we need to restore trust in the financial sector, and because we need the financial sector to operate on a sound footing to ensure a return to sustainable growth of the real economy. The regulation ensures that information on all European derivative transactions will be reported to trade repositories and be accessible to supervisory authorities, including the European Securities and Markets Authority (ESMA), to give policy makers and supervisors a clear overview of what is going on in the markets. The era of opacity and shady deals is over. The regulation also requires standard derivative contracts to be cleared through central counterparties (CCPs) and establishes stringent organisational, business conduct and prudential requirements for these CCPs. This will considerably increase financial stability and safety in the EU by preventing the situation where a collapse of one financial firm can cause the collapse of other financial firms. We are clearly learning the lessons of the 2008 crisis. Negotiations in the European Parliament and the Council have not always been easy but we have reached a very good result. And I trust it



will be confirmed shortly by both the European Parliament in its plenary session. I would like to thank all parties involved, and in particular the rapporteur Mr Langen, as well as the Danish and Polish Presidencies, for their willingness to finalise adoption in first reading and their readiness to reach a compromise. With this agreement, we are making a big step for financial stability. And we are substantially reducing the risk of a future financial crisis, with all its consequences on the real economy, growth, jobs and public budgets. The EU has now also fulfilled its G20 commitments in this field, and on time. I call on all other jurisdictions around the globe, which have not yet done so, to take the appropriate steps to meet our shared G20 commitments. I also call on the co-legislators to now focus on complementary European rules that we need to agree on quickly to continue strengthening financial markets; in particular we need a swift revision of MIFID (rules on markets in financial instruments)".

Notes What are derivatives? A derivative is a financial contract linked to the future value or status of the underlying to which it refers (e.g. the development of interest rates or of a currency value, or the possible bankruptcy of a debtor). Over-the-Counter (OTC) derivative contracts are not traded on an exchange (for example the London Stock Exchange) but instead privately negotiated between two counterparts (for example a bank and a manufacturer). The definition of OTC derivatives in EMIR refers to all derivatives contracts which are not "executed on a regulated market".



As a result all derivatives contracts executed on a venue of execution which is not a regulated market (e.g. a Multilateral trading facility), is considered as an OTC derivative contract under EMIR. What is the size of the market? What kinds of products are comprised? OTC derivatives account for almost 95% of the derivatives markets. In June 2011, the notional value of outstanding OTC derivatives was around $707 trillion or €540 trillion. The OTC derivatives market comprises a wide variety of product types across several asset classes (interest rates, credit, equity, foreign exchange (FX) and commodities) with widely differing characteristics and levels of standardisation. OTC derivatives are used in a variety of ways, including for purposes of hedging, investing, and speculating. Contrary to derivatives traded on exchanges, OTC derivatives are not automatically cleared through Central Clearing Parties (cf next question) or subject to reporting rules. What are market infrastructures? Central Counterparties (CCP) A CCP is an entity that interposes itself between the two counterparties to a transaction, becoming the buyer to every seller and the seller to every buyer. A CCP's main purpose is to manage the risk that could arise if one counterparty is not able to make the required payments when they are due –i.e. defaults on the deal. CCPs are commercial firms. There are currently about a dozen CCPs, all but one located in Europe or the USA, clearing interest rates, credit, equity and commodities OTC derivatives. There is currently no CCP clearing FX OTC derivatives.



Trade repositories A trade repository is a central data centre where details of derivatives transactions are reported. Trade repositories are commercial firms. There are global trade repositories for credit, interest rate and equity OTC derivatives, and soon for commodities and FX. Why did the Commission propose legislation on OTC derivatives? Derivatives play an important role in the economy. But they are also associated with certain risks. The financial crisis, including the default of Lehman Brothers and the bail out of AIG, highlighted that these risks were not sufficiently mitigated, particularly in the OTC market where almost 95% of derivatives are traded. The European Commission committed to deliver, in its Communication on Driving European Recovery of March 2009, appropriate initiatives to increase transparency in the derivatives market and to address financial stability concerns. In September 2009, at the G-20 Pittsburgh Summit, the leaders of the 19 biggest economies in the world and the European Union agreed that "all standard OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. " Furthermore, they acknowledged that "OTC derivative contracts should be reported to trade repositories and that non-centrally cleared contracts should be subject to higher capital requirements." The Commission's proposal meets the G20 commitments on OTC derivatives markets.



What are the objectives of the new rules? The new rules objectives are to increase transparency in the OTC derivatives market and to make it safer by reducing counterparty credit risk and operational risk. To increase transparency, the new rules requires that

i) detailed information on OTC derivative contracts entered into by EU financial and non-financial firms are reported to trade repositories and made accessible to supervisory authorities, and that

ii) trade repositories publish aggregate positions by class of derivatives accessible to all market participants. In the course of the negotiations the scope of the proposal has been widened to cover the reporting of both listed (i.e. non-OTC) and OTC derivatives.

To reduce counterparty credit risk, the new rules introduce

(i) stringent rules on prudential (e.g. how much capital they need hold), organisational (e.g. role of risk committees) and conduct of business standards (e.g. disclosure of prices) for CCPs,

(ii) mandatory CCP-clearing for contracts that have been standardised (i.e. they have met predefined eligibility criteria), (iii) risk mitigation standards for contracts not cleared by a CCP (e.g. exchange of collateral)

To reduce operational risk. Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. The proposal requires the use of electronic means for the timely confirmation of the terms of OTC derivatives contracts. This allows counterparties to net the confirmed transaction against other transactions and ensure accurate book keeping.



How does the proposal make the derivatives market more transparent? Currently, there is little reliable information on what is going on in the OTC derivatives market. There are no public prices available, no public information as to who is entering deals with whom, over what period of time, relating to what underlying asset or for which amounts. Under the final text agreed in the negotiation process, detailed information on each derivatives contract traded by a financial or a non-financial firm will have to be reported to trade repositories. The data in these trade repositories will then be available to regulators, giving them a much better overview of who owes what to whom so they can spot any potential problems early and be in a position to take action if need be. In addition, trade repositories will have to publish aggregate positions by class of derivatives, providing market participants with a clearer view of the derivatives market. However, trade repositories will not publish data at trade level as the type of information is commercially sensitive. To whom will the clearing and reporting obligations apply to? The obligation to clear OTC derivatives contracts through a CCP and report derivatives to trade repositories will apply to financial firms (banks – both universal banks and investment banks, insurance companies, funds etc.) and to non-financial firms (energy companies, airlines, manufacturers etc.) that have large positions in OTC derivatives. Are any exemptions foreseen from the clearing and reporting obligations? The proposal provides for some limited exemptions from clearing and reporting requirements for non-financial firms.



- contracts by non-financial firms: Contracts by non-financial firms below a 'clearing threshold' will not have to be cleared through a CCP. "Commercial and Treasury hedging activities", i.e. when these firms use OTC derivatives to hedge risks related to their activities, will be subtracted from the firm's overall position which means that they will not count towards the threshold set for the clearing obligation. These activities do not need to be cleared. For example, commercial hedging could be when airlines using OTC derivatives to secure the price at which they buy fuel, or when exporters who use OTC derivatives to shield themselves from fluctuations of exchange rates. These thresholds are not set out in the proposal. ESMA, the European Securities and Markets Authority, together with ESRB, the European Systemic Risk Board and other relevant authorities will draft technical standards on what these thresholds should be. When setting these thresholds, ESMA will have to take into account the systemic relevance of the sum of net position and exposures by counterparty per class of derivatives (i.e. looking at how much overall risk they pose to the system). A hypothetical example of hedging: a plane manufacturer has a contract to build 6 planes in the next 6 months and will need 10 tonnes of steel per plane. He may want to guarantee that whatever the fluctuations in the market of the price of steel, he gets steel at a certain fixed price for the next 6 months so as to be able to deliver the planes on budget. To cover for the risk of steel rising, the plane manufacturer could enter into an OTC contract with a bank for example. They could agree on a set price for a set quantity of steel for 6 months. If, after 6 months, when the contract matures, the market price turned out to be lower, the bank would make a profit; but if the market price turned



out to be higher, then the plane manufacturer would be able to purchase the steel a price lower than the market price and thus save money. - financial institutions involved in the management of public debt Members of the European System of Central Banks (ESCB), public bodies charged with or intervening in the management of the public debt, and the Bank for International Settlements will not be subject to the clearing, reporting or bilateral risk mitigation obligations in order to avoid limiting their powers to intervene to stabilise the market, if and when required. - pension funds Besides, a temporary exemption from central clearing for pension funds has been introduced in the course of the negotiations. This is aimed at ensuring that pension funds do not incur disproportionate costs that could ultimately impact EU pensioners. Once the industry has developed the appropriate technical solutions for the provision of non-cash collateral as variation margins by pension funds they will be subject to central clearing. In the interim pension funds will have to exchange collateral for their OTC derivatives. - intra-group transactions In addition, an exemption from the clearing obligation for transactions entered within a group of financial firms, non-financial firms or a mix of financial and non-financial firms has been introduced ('intra-group exemption'). This exemption is necessary because requiring clearing of intra-group transactions could substantially increase the capital and liquidity required by firms that centralise risk management in certain entities as well as increase operational complexity.



However, to ensure that the exemption does not increase systemic risk, EMIR will require that intra-group exempted transactions will be subject to bilateral collateralisation unless two conditions are met: there is no current or foreseen practical or legal impediment to the prompt transfer of own funds and repayment of liabilities between the counterparties, and the risk management procedures of the counterparties are adequately sound, robust, and consistent with the level of complexity of the derivative transactions. Which OTC derivatives contracts will be eligible for mandatory clearing? To have as many OTC contracts as possible cleared through a CCP, the Regulation introduces two approaches to determine which contracts must be cleared: a 'bottom-up' approach - Where a competent authority has authorised a CCP to clear a class of derivatives, it will inform ESMA who will assess whether a clearing obligation should apply to that class of derivatives in the EU, and develop draft Regulatory technical standards which will have to be adopted by the Commission. The procedure originally proposed by the Commission which gave power to ESMA to decide on the application of a clearing obligation to a specific class of derivatives has been modified, in order to take into account the jurisprudence of the Court of Justice which strictly frames the ability of agencies to adopt individual decisions. a 'top-down' approach - ESMA, on its own initiative and in consultation with the European Systemic Risk Board, will identify contracts that should be subject to the clearing obligation but for which no CCP has yet received authorisation. The 'top down' approach will ensure that if no CCP clears a product that should be subject to the clearing obligation, there are tools available to regulators to get this product cleared through a CCP. It will also ensure that new products will not fall through the net.



ESMA will use the following criteria when determining eligibility for the clearing obligation: the degree of standardisation of the contract and operational processes, liquidity and the volume of contracts, availability of fair, reliable and generally accepted pricing information. Why does the proposal not envisage mandating clearing for all OTC derivatives? Because they are customised to meet particular counterparty or end-user needs, some bespoke OTC derivatives products will not have the level of standardisation required for central clearing. How will the proposal reduce counterparty credit risk in OTC derivatives trading? Currently, participants in the OTC derivatives market do not collect sufficient collateral (i.e. guarantees; usually they are in the form of cash or securities) to mitigate counterparty credit risk, which refers to the risk of loss arising from one party not making the required payments when they are due. The Commission's proposal requires that OTC derivatives that are standardised will have to be cleared through central counterparties (CCPs). Since an OTC derivative contract cleared by a CCP usually involves the posting of higher amounts of collateral than an equivalent contract that is not cleared by a CCP, this will increase the amount of collateral held in the system. As collateral will be held in a few places, there is an argument that risk will be concentrated there. To avoid CCPs becoming a source of risk to the financial system in themselves, the proposal introduces stringent conduct of business, organisational and prudential requirements so that CCPs manage risk properly and are therefore safe to use.



The final text defines stringent requirements on CCPs liquidity risk management, which will be specified in technical standards. CCPs' access to liquidity could result from access to central bank or to creditworthy and reliable commercial bank liquidity, or a combination of both. If a contract is not deemed eligible (e.g. prices are not available or the contract is not liquid), or if one of the parties to an eligible contract is not subject to the clearing obligation, then that contract will in all likelihood not be cleared by a CCP. For such contracts, the proposal will require the institutions subject to the clearing obligation to apply robust bilateral risk management technique, including marked-to-market on a daily basis of outstanding contracts and holding of additional capital. Are commodity derivatives and foreign exchange included in the proposal? The proposal covers all segments of the OTC derivatives market (interest rate, credit, equity, foreign exchange and commodities). At this stage, while the segments differ in their characteristics, the Commission considers that there is no strong evidence to exclude any of them from the scope of the proposal. There is, on the contrary, a strong incentive to adopt a comprehensive policy on OTC derivatives, as the failures uncovered by the financial crisis are present in all segments of the OTC derivatives market. Furthermore, there is a risk that excluding any segment from the outset would create a loophole that could be exploited by market participants. This is because any derivative contract can be partitioned and reconstructed into different but economically equivalent contracts. For example, if a specific contract is eligible for clearing but can be reconstructed into two other types of derivatives that are not covered by



the Regulation and do not have to be cleared through a CCP, market participants would be able to avoid clearing requirements by modifying the original contract. However, there will be a need to look at what other G20 jurisdictions do and ensure consistency at a global level. What will be the role of European Securities and Markets Authority (ESMA)? What will be the role of national financial supervisors? The proposal gives ESMA a key role. ESMA will be responsible for the identification of contracts that will be subject to the clearing obligation, i.e. those that are standardised and must then go through CCPs. It will also be responsible for the supervision of trade repositories and will be a member of the colleges supporting national authorities supervising CCPs operating in several members states. Finally, it will be required to draft a large number of specific binding technical standards for the application of the Regulation, for example with respect to the clearing thresholds. The members of those CCPs, who bear the financial risk for the contracts cleared, are largely major internationally operating financial firms such as banks and investment firms. In view of its cross-border activities and the involvement of large international financial firms, the continued health and viability of a CCP is therefore not only of interest to the authorities of the Member State of its establishment, but also to authorities from other Member States. Therefore the proposal from the Commission envisaged that during the authorisation process of a CCP, there would be strong cooperation between all of the public authorities concerned (supervisory authorities, central banks, etc) from all of the Member States involved. This principle has been retained in the final agreement.



It has been agreed that in the event that the public authorities have legitimate concerns about the authorisation of a CCP, the Regulation will include a mechanism that allows those authorities to raise their concerns and, if necessary, to request ESMA to take a final decision using a procedure of binding mediation. The mechanism to request binding mediation by ESMA is balanced and takes into account the interests and concerns of both the home authorities (authorities of the Members States in which the CCP is established) and the host authorities (authorities of the Member States in which the CCP provides its services). Host authorities cannot request binding mediation by ESMA against the opinion of a home country authority unless the host authorities agree to do so unanimously, or if a significant number (two-thirds) of the host authorities are concerned with the proposed authorisation and agree to request binding mediation What about data protection for trade repositories? The proposal will require those trade repositories that wish to be used for the purpose of the reporting obligation to register with ESMA. In order to obtain registration, a trade repository will have to comply, among other things, with strict requirements aimed at ensuring the confidentiality, integrity and protection of the information it receives and maintains. How will the regulation interact with third countries? Recognition of a third country CCP by ESMA will first require that the European Commission has ascertained the legal and supervisory framework of that third country as equivalent to the EU's, that the CCP is authorised and subject to effective supervision in that third country and that ESMA has established co-operation arrangements with the third country competent authorities. A CCP of a third country will not be allowed to perform activities and services in the EU if these conditions are not met.



Recognition of a third country trade repository will be subject to similar conditions as for CCPs in terms of equivalent legal regime and supervision. In addition, it will be subject to an international agreement being in place between the European Commission and that third country with regard to mutual access to data and exchange of information on OTC derivatives contracts held in trade repositories. The final text also introduces important tools to manage the risks of market participants being subject to two sets of potentially conflicting requirement on OTC derivatives (EMIR and the rules of a third-country). The text also contains an anti-avoidance clause: if market participants deliberately structure a contract outside of the EU to avoid EMIR then EMIR rules still apply What does the proposal say with respect to interoperability of CCPs? Interoperability is an essential tool to achieve an effective integration of the post-trading market in Europe. However, interoperability may expose CCPs to additional risks. For this reason, regulatory approval is required before entering into an interoperable arrangement. CCPs should carefully consider and manage the extra risks that interoperability entails and satisfy the competent authorities about the soundness of the systems and procedures adopted. In view of the complexity of derivatives markets and the early stage of development of CCP clearing for OTC derivatives, the proposal does not extend the provisions on interoperability to instruments other than cash securities. A new article on the access of CCPs to venues of executions opens an access right of CCPs to the transactions traded on a venue of execution. This provision may result in a venue of execution being cleared by several CCPs but this does not imply the implementation of interoperability arrangements between those CCPS.



What has been done at the global level on OTC derivatives? In line with the EU's G20 commitments there have been a number of initiatives both by individual jurisdiction and international bodies. At national level, both the US (Dodd-Frank Act) and Japan have passed OTC derivatives legislation in 2010. The Commission's proposal uses different approaches at times, but is very much in line with the legislation being adopted in other parts of the world. This is essential to ensure no regulatory arbitrage. At international level, the Financial Stability Board set up a work stream, co-chaired by the Commission, in order to address the challenges related to the implementation of the G20 commitments. In addition, the OTC Derivatives Regulators' Forum was established to promote cooperation between regulators. Finally, CPSS/IOSCO has published guidance on the application of its 2004 recommendations for CCPs to OTC derivatives, and is currently in the process of reviewing these recommendations and preparing recommendations for trade repositories. The Commission has also regular bilateral discussion with the US authorities in order to identify the possible issues raised by the cross-border effects of Dodd-Frank act's provisions on derivatives and EMIR. What additional proposals are foreseen in the OTC derivatives space? Other measures relevant to OTC derivatives have been taken, notably the revision of the Capital Requirements Directive (e.g. differentiation of capital charges between CCP cleared and non-CCP cleared contracts), the Market in Financial Instruments Directive (e.g. ensuring trading of standardised contracts on organised trading venues, enhancing trade and price transparency across venues and OTC markets as appropriate) and



the Market Abuse Directive (extending the scope of the Directive to OTC derivatives). What are the next steps? The European Parliament needs to vote in plenary session on the regulation and the Council will then need to formally adopt the rules. The regulation will then be published in the Official Journal and the rules will enter into force. In line with G20 commitments, the new rules should be fully in place by the end of 2012. The ESAs will submit technical standards to the Commission in due course.



NUMBER 9

Regulation of the production and distribution of financial products

In its discussion paper on regulating the production and distribution of financial products to retail clients dated October 2010 (“FINMA Distribution Report”), FINMA noted that the law as it stands does not adequately protect clients. In FINMA’s view, the following measures should be taken to improve client protection: Rules for financial products 1. To improve client protection on the Swiss financial market, a prospectus requirement should be introduced for all standardised financial products offered in Switzerland. Prospectuses should be drawn up in accordance with a prescribed format and should contain all the key in-formation about the producer and the product itself. 2. Clients should be provided with a clear and concise product description before acquiring com-pound financial products.



The product description should set out the key product characteristics, risks and costs. To increase comparability between the different product types, the legislature should enact regulations governing the composition of the document. 3. The prospectus requirement and the obligation to draw up a product description should apply primarily to products aimed at retail clients.

4. Financial services providers have to inform clients about their own business activities and their authorisation status before they carry out a financial transaction. 5. Financial services providers should be obliged to inform clients of the content of their specific service. They may only describe themselves as being independent if they do not accept incentives from third parties when performing services for their clients. 6. Financial services providers must inform clients of the characteristics, risks and costs of the type of transaction under discussion before they perform the service in question. 7. Financial services providers must provide product documentation. In particular, they must provide retail clients with a product description for compound financial products. Prospectus documents are only to be made available on request. During contact with the client, advertising material should be clearly separated from the documents required under supervisory law. 8. Before carrying out a transaction for a retail client, financial services providers should be obliged to determine the client’s experience and knowledge of the type of product in question or the service to be provided.



If they regard a transaction as being inappropriate, they should warn the client. 9. Before issuing personal advice, financial services providers should determine whether a transaction is suitable for the client. For this purpose, they must ascertain their clients’ experience and knowledge, investment objectives and financial situation. Before taking on portfolio management mandates, they must also ascertain whether the client has understood the significance of issuing the order and whether the chosen investment strategy is suitable for the

client.

10. Financial services providers may only carry out transactions with financial products for a retail client without an appropriateness test if the client instructs the provider to carry out the transaction on their own initiative and the products in question qualify as simple financial products.

Simple financial products are readily understandable, do not impose any obligation on the client over and above the acquisition costs, and may be regularly sold on the market or returned to the producer.

11. Financial services providers should document the scope and subject matter of the agreed service. They should also duly account for the services provided.

12. All portfolio managers that are not supervised under current law should be made subject to supervision. They must comply with the rules of business conduct and must have an appropriate organisation and adequate capital.



13. Those who have contact with clients should prove in a test that they have sufficient knowledge of the rules of business conduct, the principles of financial planning and the products distributed. Their specialist expertise should be improved through regular further training. Clients should also be able to check via a publicly accessible register whether their client advisor or product distributor meets the corresponding quality standards. 14. Cross-border services may only be provided to clients in Switzerland from other countries if those clients enjoy the same protection as they would if the financial services provider were based in Switzerland. The Swiss regulations on the distribution of financial products should therefore be extended to cover activities from abroad. 15. Enforcement of the claims of retail clients against financial services providers should be im-proved.

16. Implementation of the measures will require the creation of a new statutory basis. To ensure that the conduct and product rules at the point of sale apply across all sectors and without exception, they should be firmly established in a new law (financial services act). 17. The rules on the authorisation and supervision of portfolio managers should be incorporated into the Swiss Stock Exchange Act. 18. The introduction of cross-sector business conduct and product regulations necessitates changes to the applicable financial market laws and the Swiss Code of Obligations. Existing provisions on the documentation and distribution of financial products should continue to apply only when sector-specific circumstances require special arrangements.



The proposed measures are mutually complementary. Improved documentation on a financial product can only be effective if providers forward that information to their clients. Furthermore, financial services providers can only advise their clients with due care if they are aware of those clients’ financial situations, investment objectives, experience and knowledge. Finally, rules of business conduct only offer clients comprehensive protection if they have to be adhered to by all financial services providers. The proposals that follow are therefore always to be placed in the overall context of client protection and not viewed in isolation.

Background Swiss financial market law aims at safeguarding the functionality of the Swiss financial market and protecting clients, i.e. creditors, investors and policy holders. These two goals are supported by ensuring an adequate flow of information between market participants. An efficient financial market, and the trust of market participants in that market, can only exist if the key information on products traded and services offered is available to all market participants in a timely, comprehensive and easily comprehensible form. Creating transparency for all market participants is therefore vital to the implementation of the goals that are firmly established in law. In its discussion paper on regulating the production and distribution of financial products to retail clients dated October 2010 (“FINMA Distribution Report”), FINMA noted that the law as it stands does not ensure that all market participants have appropriate access to key information, with the result that clients are not adequately protected.



The report invited discussion on a number of regulatory measures to rectify the shortcomings identified. In their comments on the FINMA Distribution Report, many of the consultation respondents also called for regulatory adjustments to strengthen client protection (see FINMA consultation report dated February 2012). In this position paper, FINMA sets out specific policy proposals designed to improve the protection offered to clients under Swiss law. The proposals aim to redress the information imbalance between clients and providers of financial products, ensuring that Swiss clients are aware of the opportunities and risks associated with a financial product or service before they purchase or use it. The proposals relate to the production and distribution of financial products by banks, insurance companies, fund management companies, portfolio managers and other market participants. The term “financial products” is in principle deemed to include all products issued and traded on the Swiss financial market. Primary focus is in particular on financial products with investment character, including savings products; they do not cover consumer credit and mortgage products. The proposals to improve client protection follow a threefold approach. First, requirements on financial product documentation are to be incorporated into supervisory law. Second, the requirement for providers to supply information to clients is to be strengthened via rules of business conduct: financial services providers are to be compelled to inform their clients about the service offered and their interest in it, and to treat their clients fairly.



Third, client protection is to be enhanced via supervision of portfolio managers, improved knowledge on the part of client advisors, and in-creased regulation of cross-border services. Regulatory measures in this area extend be-yond mere requirements on transparency: they ensure that those who have contact with clients are competent, and that supervisory measures can be taken to deal with any inappropriate conduct. The proposed measures are mutually complementary. Improved documentation on a financial product can only be effective if providers forward that information to their clients. Clients must be familiar with the service and the interests of the provider if they are to interpret correctly the statements made by that provider concerning various products. Furthermore, financial services providers can only advise their clients with due care if they are aware of those clients’ financial situations, investment objectives, experience and knowledge. Finally, rules of business conduct only offer clients comprehensive protection if they have to be adhered to by all financial services providers. Hence, protection should also be extended to clients using financial services supplied by foreign providers. The comments that follow are therefore always to be placed in the overall context of client protection and not viewed in isolation. This is the only way to compensate adequately for existing information asymmetries without drastically curtailing the freedom of action enjoyed by market participants.



Rules on financial products Problem: inadequate compliance with the obligation to provide information on financial products The law as it stands imposes widely differing requirements concerning documentation of the characteristics of the numerous types of product on offer. Not all product types are subject to rules governing the composition of prospectuses. Only in isolated cases are there rules on drawing up a concise information document setting out the key characteristics and risks of a product (“product description”). Inconsistent and incomplete compliance with the obligation to provide prospectuses Swiss regulations on prospectuses for financial products differ widely and contain gaps. For example, unlisted shares in a Swiss company can be offered for public sale without any requirement to inform the investors addressed about the opportunities and risks of the investment. Where issues of foreign securities are concerned, opinion is divided as to whether there is a prospectus requirement at all. There are also different requirements for prospectuses for structured products, bonds and collective investment schemes. These discrepancies in the regulatory requirements are especially problematic if different product types are similar from an economic perspective. This is especially true for structured products and collective investment schemes.



Additionally, the distinction between simple derivatives, structured products and bonds with a variable interest rate is not always clear. An example of inconsistent compliance with the obligation to provide prospectuses: bonds and structured products Under Article 1156 of the Swiss Code of Obligations, issuing prospectuses for unlisted bonds are re-quired to contain only rudimentary information about the issuing company and the products them-selves. Current law does not require the prospectus to point out the risks associated with acquiring the bond. In the case of listed bonds, the documentation provided to investors is substantially more comprehensive. Moreover, different requirements apply in respect of debt securities that constitute structured products within the meaning of Article 5 of the Collective Investment Schemes Act. The distinction between the various types of debt securities is not always clear. The wide range of prospectus requirements means that investors receive different information when acquiring debt securities. This makes it more difficult to compare the various products and can render it impossible for a client to assess the impact on their assets of acquiring a product. As a result of the varying requirements concerning prospectuses for standardised financial products, the information available to clients differs depending on the type of product involved. With many products, issuers are also free to use the prospectus chiefly as advertising material or to shield them against any claims by investors.



Additionally, the differing prospectus requirements lead to variations in the liability conditions for issuers and other persons involved in drawing up a prospectus. Finally, current law takes insufficient account of the changes that products undergo during their term. Inadequate regulation of sales documentation The purpose of prospectuses is to inform investors. For many clients, however, these documents are too detailed and insufficiently clear. Particularly where compound financial products are concerned, it is difficult for clients to appreciate their characteristics and profit and loss prospects on the basis of a detailed prospectus. As a result, when acquiring financial products clients are generally guided not by the detailed prospectus but by the accompanying documentation supplied by the product provider. However, providers design this advertising material in different ways. Swiss law contains no minimum standards governing the documentation on financial products that providers supply to their clients. This omission leads to misunderstandings and false expectations on the part of clients and complicates the task of comparing different products. Finally, clients are often unable to tell from the sales documentation what costs are involved in acquiring a financial product. An example of inadequate sales documentation: the costs of structured products Structured products are generally created by a bank’s investment banking unit. The issuance of these products is linked to a whole range of financial incentives for producers.



In most cases, producers are permitted to dispose freely of investors’ money once a product has been issued, and they can also charge their clients fees for the distribution and management of the products. Moreover, they make a profit on the structuring of the product. The price of structured products containing an option component, for instance, is routinely calculated using a volatility that differs slightly from the producer’s own expectations. Finally, producers also generate income by acting as a market maker for their products on the secondary market (via the bid-ask spread). Not only producers but also mere distributors of structured products receive remuneration that is charged directly or indirectly to investors. Under current law, only a fraction of the income from the production and distribution of structured products is disclosed to the client. This means that clients do not know exactly what the acquisition of a compound product is actually costing them. Moreover, the incentives for the production and distribution of such products are often not apparent to them. This lack of transparency is particularly unsatisfactory because producers take account of these sources of income in their internal earnings calculations and thus in determining the salaries of their staff. This increases the incentive to sell clients the products that have the highest possible margin.

Prospectus requirement for all standardised financial products

The gaps in client information detailed above can be closed by introducing a uniform prospectus requirement for all standardised financial products.



The term “standardised financial products” applies in particular to equities, bonds or structured products issued on a large scale. For collective investment schemes, by contrast, there are already detailed regulations governing prospectus requirements under current law. It is not the intention to abandon these fund-specific regulations. Rather, the aim is to ensure that the new prospectus requirement results in clients having a comparable level of information on fund-like standardised financial products. Equally, there is no intention to impose a prospectus re-quirement for insurance products. The existing insurance-specific documentation already ensures that clients are informed about such products. Finally, there will not be a prospectus requirement for pure savings products. In principle, the requirement to compile a prospectus is to apply to all products distributed in Switzerland. It should essentially be immaterial whether the producer or distributor has their registered office in Switzerland or abroad, or whether or not a product is listed on an exchange. Prospectuses are to be drawn up in accordance with a prescribed format and should contain all the key information about the producer, third parties involved – such as guarantors – and the product itself. They should also include a clear indication of the risk factors associated with the issuer or products. When determining the prospectus requirements, the characteristics of particular product types are to be taken into consideration.



As far as possible, however, the prospectuses of all standardised financial products should have a uniform structure. If a given issuer issues a large number of similar products, the prospectus documentation could be provided in the form of a basic prospectus, with specific information on the individual issues being contained in separate documents. Appropriate checks must be carried out before the offer is published, to ensure that the prospectuses comply with the legal requirements. In cases where financial products can change after they are issued, clients must be constantly in-formed of such changes. The requirement for this follow-up publicity is particularly acute in the case of compound products that are actively managed and whose composition and risks can change substantially during their term.



NUMBER 10

Press Conference by Shozaburo Jimi, Minister for Financial Services (Japan)

(Excerpt) Questions & Answers

Q. I will ask you some questions on behalf of the entire press corps.

In the case of AIJ Investment Advisors, I understand that many employee pension fund operators will suffer losses.

On the other hand, many of the companies affected are small and medium-size companies that are not financially strong enough to cover their losses, so the need to consider rescue measures has been pointed out.

Until now, it has been the consensus that the asset management of pension funds should be conducted on the premise of self-responsibility.

However, this time, given that AIJ Investment Advisors did not provide accurate information to customers, there is the view that the premise of self-responsibility does not apply.

What is your view on the necessity of rescue measures?

A. It is very regrettable that a situation like this has arisen.

As to the cause of this situation, the Securities and Exchange Surveillance Commission (SESC) is conducting inspection, so we will need to wait until facts are clarified.

I suppose that how to cover losses will depend on the cause.

However, as this case concerns corporate pension funds, that is basically a matter that should be discussed between the parties concerned, as I understand it.

All the same, as you pointed out, this case could affect the financial conditions of pension fund operators and companies, so the Financial



Services Agency (FSA) is closely cooperating with the Ministry of Health, Labour and Welfare, which has administrative jurisdiction over pensions.

Q. A media report said that the FSA is considering imposing restrictions on investment advisory companies' efforts to encourage customers to buy their own products.

Could you tell me about the status of consideration on that?

A. As the SESC is conducting inspection, we will deal with this case based on its results.

In accordance with the principle of “no comment before investigation,” the inspection should first be completed, and then we will move on to the stage of examining the case and taking measures to prevent a recurrence of cases like this, as I often say.

In any case, we will conscientiously listen to various opinions and, as I have repeatedly said, the FSA and the SESC will make every possible effort to prevent a recurrence of cases like this, without ruling out any option.

Q. You said that the Liberal Democratic Party (LDP) and the Democratic Party of Japan (DPJ) have established their respective investigative teams. What is your thought on cooperation with those teams?

A. In the Diet, which is the highest organ of state power, Diet members constitute political parties, and the parties have established various committees, from what I have learned from newspaper and other media reports. I will conscientiously listen to various opinions.

Q. Yesterday, some DPJ lawmakers expressed hopes to include an institutional revision in the bill to amend the Financial Instruments and Exchange Act, which is scheduled to be adopted by the cabinet as early as March 9.

Could you comment on that?

A. As I mentioned earlier, it is important to clarify facts.

We will accept various criticisms sincerely and deal with this case without ruling out any option, and I also hope that political parties will express various opinions, as I said earlier.



It is important that the FSA and the SESC make every possible effort to prevent a recurrence of cases like this. First and foremost, it is important to make every possible effort to clarify facts.

Q. Regarding the case of AIJ Investment Advisors, you said earlier that although how to cover losses incurred by pension fund operators will depend on the cause, that is basically a matter that should be discussed between the parties concerned.

You also said that as this case could affect the financial conditions, the FSA is cooperating with the Ministry of Health, Labour and Welfare.

How is the FSA cooperating with the Ministry of Health, Labour and Welfare?

A. As I am a doctor by profession, I belonged to the (LDP's) Social Division for a long time. Previously, trust banks and life insurance companies between them monopolized the management of pension funds for several decades.

However, in Japan-U.S. financial negotiations held in the 1990s, it was agreed that a relevant law should be amended so as to permit investment advisory companies to move into this business, so that was abruptly put on the agenda of the Social Division, causing much controversy.

I remember that well. As it is important that pension funds are invested in safe and secure assets, I strongly opposed this liberalization.

Even so, investment advisory companies were eventually permitted to move into this business.

In addition, in the deregulation-friendly atmosphere that dominated the era of the Koizumi cabinet, a shift from the authorization system to the registration system was made.

However, while how to cover losses will depend on the cause that is a matter that should be discussed between the parties concerned, in principle.

Even so, as this case could affect the financial conditions of pension fund operators and companies, as you pointed out, it is necessary for the FSA to maintain close communications with the Ministry of Health, Labour and Welfare, since some corporate pension funds were entrusted to AIJ



Investment Advisors, which manages customers' assets based on discretionary investment contracts and which is under the FSA's jurisdiction.

Pension funds are basically under the jurisdiction of the Ministry of Health, Labour and Welfare, so we are already communicating closely with that ministry. The government will properly deal with this case.







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