UK: Risk And Regulation Monthly - August 2012

Last Updated: 19 October 2012
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

It was rather busier in August than usual, as the LIBOR story rumbled on, Basel III faced delay, and anticipation grew of the announcement of "banking union" as an accompaniment to monetary union in Europe.

As usual this note is produced for information only, on a best efforts basis, and does not constitute advice of any kind.

Capital (including stress testing)

The FSA issued a statement on CRD IV implementation, saying that since the legislation would not be adopted until autumn at the earliest, "it does not appear feasible that the legislation can enter into force in line with the implementation date of 1 January 2013". Even so, firms should continue with their preparations, and build capital to protect against the "currently heightened risk of losses". Shortly afterwards the European banking associations wrote to legislators to request "a reasonable period of time" between finalization of the proposals and implementation, which "cannot possibly be achieved within a timeframe of one or two months", and the US extended the comment period on its Basel III proposals.

The European Supervisory Authorities consulted on the capital adequacy of financial conglomerates, looking at mechanisms that eliminated double-gearing and intra-group creation of capital; and took account of constraints on the transferability of capital, and on the eligibility of capital in particular sectors.


No new developments.

Governance and risk management (including remuneration)

The Basel Committee on Banking Supervision consulted on seven guidelines for the management of foreign exchange settlement risk, to cover governance; principal, replacement cost, operational, legal and liquidity risk; and capital. There had been "significant strides" in this area since the last guidance in 2000, not least in the development of payment versus payment mechanisms, with their scope to eliminate principal risk: nevertheless "substantial" risks remained.

Following the work by the European Banking Authority (EBA) in this area, the FSA published a consultation paper on remuneration data reporting, in which it proposed to comply with the EBA guidelines in full, rather than seek to make changes and hence need to explain any differences.

Conduct of business (including MiFID)

The Wheatley Review of LIBOR issued an initial discussion paper, covering possible reforms or alternatives to LIBOR, sanctions for misuse, and implications for other global benchmarks. As volumes in the unsecured interbank market fell, LIBOR calculations became increasingly reliant on expert judgment (which "involves a discretion which can be misused") rather than on transactions, with opportunities for abuse. Retaining LIBOR in its present form was "not a viable option" as it had "lost credibility": it needed reforms to methodology (eg via centralised trade-reporting, though this too was not immune to misuse); to internal controls and governance (both within contributors and centrally); and to regulatory oversight and sanctions, perhaps by bringing LIBOR "submitters" under the "approved persons" regime.

The paper also considered alternatives to LIBOR, especially since for some purposes it might not be the best measure conceptually (eg in its inclusion of credit risk). Any switchover would need to be carefully managed and coordinated internationally: "the UK authorities should take a leading role in these reforms". Similar principles might also apply to other benchmarks, such as those for spot oil prices.

The Treasury Select Committee issued "some preliminary findings" on fixing LIBOR. Among the more policy-related issues were that the FSA should consider greater transparency and flexibility in its fining policy (to encourage self-reporting and penalise the uncooperative), that the Bank of England should review its note-keeping arrangements, that the Governor's involvement ("eyebrows") in decisions on senior banking executives requires "a much stronger governance framework", and that consideration be given to widening the definition of criminality for rate-fixing (with in addition a greater willingness to prosecute such cases).

In response the Bank of England referred to the Committee's remark that "judgment-led regulation will require the regulator to be resolutely clear about its concerns to senior figures in systemically important firms" which it said it had been in the Barclays' case. It added that it had already commissioned an internal audit review of its note-keeping (and storage) arrangements.

The FSA consulted on banning the promotion of unregulated collective investment schemes and similar arrangements to ordinary retail investors (ie those not judged as sophisticated or high net worth, though even in this latter case the products might be unsuitable). At present only a quarter of sales seemed suitable for the consumer, and the current restrictions were widely misapplied.

The FSA issued a consultation paper on the client money rules for insurance intermediaries. Among the issues covered were non-statutory trusts, which required appropriate controls over credit advanced; in addition client money calculations and reconciliations should normally be done every 7 working days (rather than 25 at present). There were also proposals to simplify the distribution and transfer of client money after the failure of a firm; improve diversification (with no more than 20% to be held in a group bank), deal with unclaimed client money and write-backs; and other issues such as governance and audit.

The FSA announced further thematic work with wealth management firms – its earlier exercise identified widespread failings particularly on record-keeping and/or suitability. It would be "acutely interested" in whether firms had heeded previous warnings.

The Sergeant Review of simple financial products issued its interim report on devising a suite of simple products for consumers, that would offer a fair deal in meeting basic needs, and be understandable, helpful as a benchmark for other products, commercially viable and "badged" (ie accredited) by an independent body, perhaps supported by the Money Advice Service. The report proposed beginning with three products: an easy access savings account; a 30-day notice savings account; and life cover, with the possibility of adding a fourth (a simple income replacement product for loss of income due to sickness).

The FSA issued a "special short selling edition" of Market Watch, setting out how it will implement the Short Selling Regulation, which will supersede the UK regime from 1 November. Under this it has the right (but not the obligation) to use temporary suspension powers to prevent a disorderly decline in the price of particular instruments: proposals for a framework for such decisions appeared later in a consultation paper.

Crisis management (including special resolution, systemically important firms, and business continuity)

HMT issued a consultation paper on broadening the UK resolution regime, to cover investment firms and parent undertakings of systemic firms; central counterparties (eg if otherwise business lines critical to financial stability would close); some other parts of the financial market infrastructure; and insurers (where the case "is less clear cut" but where HMG needed to ensure that current arrangements could deal with complex groups with large portfolios and/or dominant positions in products essential to economic activity). Final proposals would reflect work carried out at global and EU level but the Bank of England was likely to act as resolution authority for eg central counterparties. Although the Special Administration Regime had strengthened the UK's ability to manage the failure of investment firms the paper said it was not designed to deal with a systemic firm. Later in the month HMT published draft legislation including clauses to enable resolution regimes for investment firms, financial holding companies and central counterparties, but not for instance for insurers.

Regulatory perimeter

The FSA issued its latest six-monthly survey of hedge funds and systemic risk. Although assets under management had risen, leverage and size remained relatively low (funds were of greatest important in convertible bonds, interest rate derivatives and commodity derivatives). As for counterparty exposures, these were concentrated in five (unnamed) prime broker banks that had tightened financing terms post-crisis.

Rethinking the domestic and international architecture for regulation

The European Commission said it would issue proposals for "a single banking supervision mechanism in the euro area" on 11 September (later postponed a day). It would be "built around the European Central Bank", with arrangements to bridge "the interface with the non-euro countries"; it would also clarify the role of the European Banking Authority. Steps on deposit guarantee schemes and bank resolution would follow.

The Chairman of the Board of the International Organisation of Securities Commissions (IOSCO) said that "while refraining from directly commenting" on the statement by the Securities and Exchange Commission on money market fund reform, IOSCO's work in this area would continue.

Disclosure, valuation and accounting

No new developments.

Information security and data privacy

No new developments.

Financial crime

The New York State Department of Financial Services announced an agreement to settle with Standard Chartered, under which the latter paid $340mn as a civil penalty and agreed to enhanced monitoring of money-laundering procedures.

The FSA fined Turkish Bank (UK) £294k for money laundering failings related to correspondent banking services to banks based outside the EEA (in Northern Cyprus and Turkey).

The Office of Fair Trading announced it had revoked the consumer credit licence of a payday lender, fining it nearly £545k for money-laundering and other failings.

Other items

The private sector preparatory group for the Legal Entity Identifier exercise run by the FSB (Financial Stability Board) issued a press release. 129 firms had expressed interest in getting involved in three workstreams – governance and legal; operations; and data on ownership and relationships between entities. The FSB later asked for views on the location of the operation.

In his latest speech ("the dog and the frisbee") Andy Haldane (Bank of England) argued for greater simplicity in regulation (a dog used a simple rule to catch a frisbee, not advanced physics). Such rules performed better than complex tools in predicting financial problems at the world's top 100 banks (though not at small US banks). This was typical for complex systems such as sports forecasting, crime, medicine or stock-picking – it was no better to fight complexity with complexity than fire with fire. This might reflect uncertainty (as opposed to probabilistic risk); the prohibitive costs of collecting all relevant data; over-fitting explanations based on short data samples; or replacing judgment with box-ticking. Basel I (at 30 pages) was a simple and transparent backstop to a firm's risk assessment – it was less easy to see Basel III at 616 pages as that, still less Dodd Frank (which "could comprise 30,000 pages of rulemaking") or the equivalent EU regime. He suggested scrapping internal risk models as a basis for regulatory capital, making simple leverage rules as important as risk-weighted capital, emphasising Pillar 2, supervisory judgment and disclosure (by cutting back on the "haystack of information"), taxing complexity, and structural change (the Volcker Rule should be implemented with fewer "commas, semi-colons and sub-clauses" and "a few more full stops").

Tracey McDermott was confirmed as head of the FSA enforcement and financial crime function.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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