UK: Risk and Regulation Monthly - October 2012

Last Updated: 12 December 2012
Article by Deloitte LLP

Most Read Contributor in UK, August 2017

A number of important documents were issued in October, including on Basel III implementation progress internationally, on banking structural reform in the EU and the UK, on how the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) will approach supervision, and the final instalment of the Mortgage Market Review.

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 Basel Committee on Banking Supervision (BCBS) published a progress report on Basel III implementation: only eight of the 27 member countries of the BCBS have issued final Basel III related regulations. The report also noted that the EU's Capital Requirements Regulation (CRR) and the revised Capital Requirements Directive (CRD4) are "materially non-compliant" against the Basel III framework in two areas: definition of capital; and the internal ratings based (IRB) approach to credit risk. Preliminary findings also suggested key differences between jurisdictions and individual banks on the calculation of risk weighted assets (RWA) for both banking and trading book exposures. The BCBS is expected to publish a report containing detailed findings in early 2013.

The European Banking Authority (EBA) issued its final report on the European bank recapitalisation exercise following its 2011 recommendation on the creation of temporary capital buffers to restore market confidence. The report revealed that 27 initially undercapitalised banks have increased their overall capital position by ,¬116 billion and 24 of them now have a core tier one ratio (CT1) above 9%. The EBA indicated its intention to adopt new recommendations on capital conservation once the CRR and CRD4 texts are finalised.

Wayne Byres, Secretary General of the BCBS, defended the Basel 2.5 and III risk-based approach to calculating capital requirements; adding risk sensitivity to the regulatory regime has increased complexity, but this is necessary to reflect the increasing complexity of the banking system itself, and to ensure bank incentives are firmly aligned with prudent risk management. The Basel requirements avoid unnecessary complexity; some aspects of the Basel requirements have been made simpler such as the composition of capital and the introduction of the leverage ratio as a "backstop for the risk-based framework".

EIOPA, the European Insurance and Occupational Pensions Authority, published the first part of its updated technical specification for the Solvency II valuation and Solvency Capital Requirements calculations.

The Financial Services Authority (FSA) updated its website on the Solvency II internal model approval process (IMAP) to include interim findings from its assessment of the quality of data inputs firms used in internal models.

Amidst speculation that Solvency II would not be implemented until 2016, Gabriel Bernardino (Chair of EIOPA) wrote to Michel Barnier (European Commissioner) regarding his concern with the delay to OMNIBUS II negotiations, and the uncertainty it was causing for the Solvency II timetable. He called for a "sound and realistic timetable" to be drawn up "as soon as possible"; the lack of certainty was "undermining the EU credibility in international discussions".


No new developments.

Governance and risk management (including remuneration)

The FSA fined Sun Life Assurance Company of Canada (UK) Limited £600,000 for failings in the governance of its with-profits business, which it concluded had led to a high risk that policyholders' interests would not be protected properly.

Conduct of Business (including MiFID)

The FSA published a Policy Statement on the Mortgage Market Review (MMR) confirming that it is taking forward the majority of its proposals, which include: the removal of the non-advised sales process; strengthened arrears charging rules; responsible lending reforms, in particular, that lenders must undertake an "affordability assessment"; and enhanced prudential requirements for non-banks. In response to consultation, the FSA has relaxed some of its initial proposals through introducing exceptions relating to: the removal of the non-advised sales process, in particular, related to non-interactive sales or where there is a variation in a contract with no increase in balance; the affordability assessment to prevent some customers becoming "trapped" with an existing lender; and the responsible lending and interactive sales process for high net worth customers.

The UK Government accepted in full the recommendations of the Wheatley Review of LIBOR. For those recommendations that require primary legislation, such as bringing LIBOR activities within the scope of statutory legislation, the Government will amend the Financial Services Bill, which is currently before Parliament. Baroness Hogg will chair a panel of independent experts tasked with identifying a successor to the British Bankers' Association (BBA) as operational LIBOR administrator.

The FSA issued a 'Dear CEO' letter to life insurers and networks/IFA firms expressing concern that some firms may be looking for ways to circumvent existing inducements rules and the prospective Retail Distribution Review (RDR) adviser charging rules through soliciting or providing payments that may have the same effect as traditional commission. The FSA is concerned that such activity may not be in the best interests of the client and may give some distributors an unfair competitive advantage over others.

Steven Maijoor, Chair of the European Securities and Markets Authority (ESMA), spoke at the BBA Annual Conference. He focused on: investor protection and how inducements and incentive schemes for sales staff may not lead to outcomes that are in the client's best interests; the development of the single rule book for securities markets; ESMA's work on interest rate benchmarks; and supervision of Credit Rating Agencies (CRAs).

The Office of Fair Trading (OFT) consulted on the use of its new power to suspend consumer credit licences with immediate effect or from a date specified in the notice, if necessary for the protection of consumers. The new power is provided by way of an amendment to the Financial Services Bill.

The FSA consulted on guidance concerning Self- Invested Personal Pensions (SIPP) operators following a thematic review which found that SIPP operators have the potential to lead to significant consumer detriment through failing to control their businesses adequately. The FSA expects SIPP operators to demonstrate, in particular: the effectiveness of senior management oversight and their understanding of regulatory requirements; and the application of the FSA's Client Money and Assets rules (CASS) to the firm's business model and, where applicable, the effectiveness of systems and controls to comply with the rules.

The FSA fined Bank of Scotland (BOS) £4.2 million for failures in its mortgage records system. BOS had relied upon inaccurate mortgage records for 250,000 of its customers for considerable periods of time between 2004 and 2011.

The FSA fined and banned an individual at Topps Rogers Financial Management for mis-selling Unregulated Collective Investment Schemes (UCIS).

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

The High-level Expert Group (HLEG) published its recommendations for reforming the structure of the EU banking sector (the Liikanen report). Proprietary trading and market-making activities should be assigned to a separate legal entity from the deposit-taking side of the business (if such activities amount to a significant share of a bank's business). Resolution authorities should have the power to request further separation as part of their assessment of a firm's resolvability. Banks should build up a suitable amount of bail-in debt (or an equivalent amount of equity) which should be held outside the banking system. The EC launched a consultation on the recommendations.

HMT published the draft Banking Reform Bill, enabling it to take forward the Independent Commission on Banking's recommendations on structural and non structural reforms to the banking sector. The draft Bill gives the PRA and the FCA a new objective to protect the uninterrupted provision of vital banking services. It introduces the concepts of "core activities" and "excluded activities" and puts provisions in place to ensure deposits eligible for protection under the Financial Services Compensation Scheme (FSCS) are "preferential debts".

The European Commission published a consultation paper on a possible recovery and resolution framework for non-bank financial institutions. The paper investigated how and under what circumstances the failure of non-banks could threaten financial stability and the suitability of applying a resolution regime to non-banks. Containing over 50 open questions, it is a "working document" and does not set out concrete proposals for any sector. However, the paper focused on insurers and central counterparties (CCPs). The circumstances under which insurers could cause systemic risk were discussed - significant non-traditional or non-insurance activity and a dominant market position in compulsory or trade credit insurance were identified as relevant. Possible policy measures include: run off; portfolio transfer; bridge institution; restructuring liabilities; and compulsory winding up. Possible resolution tools for CCPs include: hair-cuts to initial and variation margin; bridge institution; and liquidity calls.

Her Majesty's Treasury (HMT) issued responses to its consultation on broadening the UK's Special Resolution Regime. HMT outlined its intention to pursue a full resolution regime for CCPs, deposit-taking institutions and investment firms and parent undertakings of investment firms. The case for a full resolution regime for non-CCP financial market infrastructure and insurers was considered to be less clear-cut, requiring additional consideration.

BCBS published a framework for identifying domestic systemically important banks (D-SIBs), and applying higher loss absorbency (HLA) requirements to them. National authorities should take into consideration: size; interconnectedness; substitutability; and complexity when deciding a bank's D-SIB status. HLA requirements are expected to be set on the basis of an individual bank's systemic importance relative to other banks operating in that country. Host supervisory authorities will be able to set HLA at both the subsidiary and branch level (subject to their legal and regulatory framework). In the case where a D-SIB has also been identified as a global systemically important bank (G-SIB), authorities will be required to impose the higher of the two HLA requirements.

The International Association of Insurance Supervisors (IAIS) launched a consultation on policy measures to address global systemically important insurers (G-SIIs) including enhanced supervision, HLA requirements and recovery and resolution regimes.

Paul Tucker, Deputy Governor for Financial Stability at the Bank of England talked about the importance of deposit insurance in international efforts to build a stronger, more resilient financial system. Deposit insurance was discussed as vital for boosting market confidence and for supporting the smooth implementation of recovery and resolution requirements, e.g. the bridge institution tool. For deposit insurance to be effective it is important for the general public to understand it and feel able to rely on rapid payout in the event of a bank's failure.

Regulatory perimeter

The Financial Stability Board (FSB) published its fourth six-monthly progress report on the implementation of over-the-counter (OTC) derivatives market reforms, pointing to regulatory uncertainty as the most significant impediment to further progress. To this end, the FSB reiterated its end-2012 deadline for jurisdictions to identify inconsistencies, conflicts and gaps in national, as well as cross-border, regulation.

The International Organization of Securities Commissions (IOSCO) published its final 15 Policy Recommendations for Money Market Funds (MMFs). In contrast to the 2010 reforms, these recommendations focused on risks on the liability side of MMFs, such as run risk, as well as valuation, recommending that regulators require a conversion to variable net asset value (NAV) or safeguard against the risks of using a constant NAV. IOSCO did acknowledge that the recommendations may be applied with varied rigour in different jurisdictions and their implementation may have to be phased in.

IOSCO published the outcomes of a survey on the implementation of its 2011 Commodity Derivatives Markets Principles. While most respondents indicated that they were broadly compliant, shortcomings were noted in the following areas: supply and stock information collection; reporting on large positions in on-exchange commodity derivative contracts; detection of market manipulation across markets; and the publication of aggregate positions of different classes by large traders. IOSCO will target these shortcomings in any future work.

Ahead of the 1 November implementation deadline for the EU Short Selling Regulation, ESMA issued a number of documents, including net short position notification thresholds for sovereign issuers, a list of exempted shares, an updated Q&A and links to national websites where the net short positions in shares are disclosed.

The European Commission recognised the legal and supervisory framework for CRAs in the United States, Canada and Australia as equivalent to the EU, allowing for ratings issued by CRAs in these jurisdictions to be used for regulatory purposes in the EU. It also adopted rules enabling ESMA to fine CRAs.

Rethinking the domestic and international architecture for regulation

The FSA and the Bank of England jointly published two documents outlining the future PRA's intended approach towards banking and insurance supervision respectively. For the most part, the documents consolidated previously published material and re-emphasised some of the core PRA messages. Of note, risk appetite is expected to be integral to firms' strategies and risk management, and insurers, as well as banks, will need to provide all the information needed by the PRA to perform a resolvability assessment. The FSA also published a document outlining the FCA's intended approach. The document addressed, in particular, the FCA's use of its product banning power and how it will interpret its competition mandate.

The European Supervisory Authorities (ESAs), namely EBA, ESMA and EIOPA, published their 2013 working programmes. Similarly to 2012, the ESAs have committed to an ambitious work plan. A large number of technical standards are scheduled for completion in 2013, with the EBA focusing on developing the new CRD4/CRR framework, EIOPA maintaining focus on Solvency II and ESMA prioritising work on market infrastructure and asset management-related initiatives. The ESAs will also increase their focus on supervision and supervisory convergence, beginning to move away from their current policy-making role on a number of regulatory initiatives. The EBA and EIOPA will conduct EU-wide stress tests for banks and insurance firms, respectively.

Mario Draghi, chair of the European Systemic Risk Board (ESRB), made a statement before the European Parliament. He pointed to a number of upcoming ESRB initiatives, including identifying sources of systemic risks associated with complex funding instruments, e.g. synthetic ETFs, and ways to mitigate them. In light of the new Single Supervisory Mechanism (SSM) proposals, the ESRB will also develop a framework for the coordination of macro-prudential policies in the EU. The ESRB mission and organisation is also to be revised next year.

HMT consulted on draft secondary legislation that will underpin the Financial Services Bill, in particular relating to provisions covering: the allocation of regulatory responsibility between the PRA and the FCA; threshold conditions for dual-regulated firms; transferring regulation of mutual societies to the PRA and the FCA; criteria for designating super-complainants to the FCA; the allocation of responsibility for rule-making with regard to the FSCS between the FCA and the PRA; and the regulators' power of direction and information gathering rules over parent undertakings of authorised persons.

The FSA, in consultation with the Bank of England, consulted on proposed changes to existing regulatory rules and guidance related to approved persons in order to align the new PRA and FCA rulebooks with their objectives and functions.

The FSA announced that its Authorisations department is implementing an internal twin-peaks structure designed to mirror the future authorisation procedures in the PRA and FCA.

Disclosure, valuation and accounting

The EBA published its follow-up to a review of banks' transparency in their 2010 Pillar 3 reports. While the EBA generally commended the industry on its disclosure efforts, a number of areas for further improvement were identified, including the provision of CRD specific data as well as disclosure harmonisation.

The FSB's Enhanced Disclosure Task Force (EDTF) published a report identifying seven principles for enhancing the risk disclosure of banks. A need for more transparency was identified in a number of areas, including: banks' business models; liquidity positions; RWA calculations; and the relationship between market and other risk measures and the bank's balance sheet. The EDTF intends for the majority of its recommendations to be adopted in 2012-2013.

Information security and data privacy

The Article 29 Data Protection Working Party, an EU advisory body, said that cookie identifiers and IP addresses that can be used to single out and treat individuals differently should be classed as 'personal data'; it called for broad changes to the types of information the term 'personal data' should apply to within the European Commission's proposed General Data Protection Regulation.

The Federal Bureau of Investigation (FBI) found that a gap within Citibank's electronic transaction systems had permitted fourteen individuals to steal more than $1 million (£628,000). The security flaw appears to have enabled the alleged conspirators to collectively withdraw "several times the amount of money" they had deposited into Citibank accounts by making multiple withdrawals from advance cash kiosks located within casinos across the US, all within one minute.

Financial crime

The FSA charged four men with conspiracy to commit insider dealing between 2006 and 2010. The charges arise out of Operation Tabernula, the FSA's largest and most complex insider dealing investigation to date. A number of individuals remain under investigation.

The FSA banned and imposed a fine of £100,000 on the Managing Director at Welcome Financial Services, a subsidiary of Cattles Plc, for engaging in market abuse. The individual was found to have provided misleading statements about the quality of the subprime lender's loan book.

The Serious Fraud Office (SFO) reviewed its policies on facilitation payments, business expenditure (e.g hospitality) and corporate self-reporting in order to restate its primary role as an investigator and prosecutor of serious crime and ensure consistency with other prosecuting bodies. The review was undertaken following the appointment of David Green as Director of the SFO and takes forward recommendations made by the OECD Working Group on Bribery.

The Financial Action Task Force (FATF) agreed a set of actions at its October plenary meeting, including a decision to suspend Turkey's membership in mid-February if it does not enact adequate counter terrorism financing legislation.

Other items

The BBA appointed Sir Nigel Wicks as its new Chair.

A new international insurance trade body, the Global Federation of Insurance Associations (GFIA), was formed. Comprising 31 national or regional insurance associations, its mandate is to respond to key areas of concern to the global insurance industry.

The FSA consulted on changes to the policy for fees and levies for the FSA, the Financial Ombudsman Service, the Money Advice Service and the FSCS for 2013-14. In particular, the FSA proposed to introduce separate PRA fee-blocks as well as a FCA prudential fee-block to enable it to recover costs related to prudential regulation of 'solo-regulated' firms. It also proposed to revise the fees discount for European Economic Area firms that passport into the UK through undertaking branch activities to reflect the fact that the home state is primarily responsible for prudential regulation and the host state is primarily responsible for conduct regulation.

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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