UK: Financial Firms Face Tougher Regulations Under New Framework

Originally published June 2003

The activities and profiles of banks are becoming increasingly complex due to the deregulation and globalisation of financial services. In this changing environment issues other than credit, interest rate and market risk can be substantial.

The growing sophistication of financial technology and recent events such as Worldcom, Enron and 9/11 have resulted in global regulators, including the Financial Standards Authority, taking a tougher stance on operational risk management industry-wide.

Operational risk presents the threat of direct or indirect loss from inadequate or failed internal processes, people and systems, or from external events.

If not properly controlled the greater use of more highly automated technology has the potential to transform risks from manual processing errors to system failure risks, as greater reliance is placed on globally integrated systems.

The FSA’s CP142 framework, to be in-place by January 2004 is set to address these issues and will provide a platform for the upcoming Basel² accord. Together these will be key regulatory systems for operational risk management.

To comply with CP142 financial institutions need to have an operational risk policy. This involves Identifying and assessing risks while implementing specific controls to be monitored continually.

Regular reports need to be made on operational risk exposures, losses and deviations from the policy. CP142 also requires escalation processes for increases in operational risk exposures, breaches of loss thresholds and unauthorised deviations from the policy.

The reports and processes are required throughout the organisation at all levels of management and must be of a consistent standard. Under CP142 specific controls must also be put in place for people, processes and systems and external events.

The Bank for International Settlements Basel Committee is working with the financial services industry to revise the existing 1988 capital the Basel accord. The new accord or Basel² will include a specific capital charge for operational risk.

Financial institutions are taking action now as Basel² requires data from January 2003 onwards and a parallel running period. Based on this data the new accord will come into force at the end of 2006.

Basel² includes ten principles of sound practice management and supervision of operational risk and other qualifying criteria that support the operational risk framework. The new accord is expected to be implemented by financial regulators on a global scale.

The principles of Basel² include issues of risk management environment aimed at boards of directors and senior management as well as identifying the role of supervisors in risk management.

Using CP142 as a platform for Basel provides a balanced tool for operational risk management targeting both operational and senior management.

For many financial institutions adherence to the guidelines of CP142 and the new Basel accord will incur implementation costs in time and resources. These costs will vary considerably based on the size and risk management needs of each organisation.

While some organisations may comply to the new standards with their existing in-house risk management staff others may consider out-sourcing risk management consultants.

The aim of the FSA in introducing the CP142 standard is to reduce the frequency and impact of operational risk management failures in a cost-effective way, furthering statutory objectives, but not placing an undue burden on firms.

An independent corporate risk consultancy offers ongoing support with risk management systems customised to the needs the business.

There are clear commercial benefits to outsourcing such as replacing the need to hire full-time staff in-house and having the assurance that the risk management standards of the organisation are in line with the FSA’s CP142 framework.

As well as having a base of valuable experience and knowledge, consultants are in the business of keeping up-to-date with changes in the industry, giving the business a competitive advantage.

A solutions oriented consultancy will provide practical solutions to complex problems with no disruptions to core business. It will detail complexities and dependencies at all stages of the project for strategic and operational managers.

The client has control throughout to have the ordered project delivered within a controlled budget to specified quality standards that meet cost and schedule performance goals.

The outcome of this valuable investment is the improved productivity, predictability and performance of the business with enhancement of reputation and lower levels of operational losses.

BSC Management is a Corporate Risk Management Consultancy with a focus on operational risk management offering all the peace of mind and cost effectiveness essential for business success. To find out more about the services they offer contact the consultancy directly.

To read the FSA’s report on CP142 visit their website. To find out more about the Basel Committee’s new accord read their report on Sound Practices for the Management and Supervision of Operational Risk, published February 2003.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.