UK: Risk And Regulation Monthly – February 2013

Last Updated: 9 April 2013
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

February was a busy month, with provisional agreement reached between the European Council and Parliament on the revision to the Capital Requirements Directive (CRD4) and Regulation (CRR), and the introduction of the UK Banking Reform Bill to take forward the recommendations of the Independent Commission on Banking (ICB).

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)

Provisional agreement was reached between the European Council and European Parliament on CRD4 and CRR. Commissioner Barnier issued a press statement emphasising the importance of these rules in making banks more robust and transparent, the significance of a single rule book in Europe, and the importance of a cap on bonuses in order to prevent excessive risk taking.

The European Banking Authority (EBA) released interim results from its work on risk-weighted assets in the banking book, highlighting differences between banks and a number of drivers of these differences. However, the paper emphasised that "no policy conclusions can be drawn from the analysis" at this stage. Further work will be conducted during 2013, including a more detailed hypothetical portfolio exercise which will draw on specific data requests from individual banks. The EBA will conduct similar exercises on the trading book by the end of 2013.

Wayne Byres, Secretary General of the Basel Committee on Banking Supervision (BCBS), defended the use of banks' internal models to calibrate the capital requirements for credit and market risk. He rejected fully standardising the models, which some other policymakers have called for, because the result would be "a complex system, but without necessarily reaping any of the benefits that come from using internal models". The BCBS's approach aimed at improving the comparability of banks' risk-based capital ratios via a combination of enhanced disclosure, more robust and transparent modelling, and supplementary measures beyond the risk-based ratio and the leverage ratio, such as a requirement to disclose capital requirements using both internal models and the standardised approach.

The Financial Services Authority (FSA) published a statement regarding the deadline for entry into force of CRD4 and CRR. The FSA noted that the Basel III implementation deadline had been missed. Nevertheless, it expected firms to 'take all action they can to prepare for implementation of CRD IV', and intends to begin collecting data under common reporting standards beginning 1 January 2014.


The EBA published a discussion paper on the definition of liquid assets in the Liquidity Coverage Ratio (LCR) (part of the CRR). It outlined its proposed methodology for defining "high" and "extremely high" liquidity and credit quality and set out its intention to assess a range of asset classes against the definitions of liquid assets in the draft CRR. Quantitative assessments will be carried out using a series of market-based metrics (such as trading volume, outstanding amounts, bid-offer spreads and price stability): the characteristics of individual securities within each asset class will also be tested. The output of the analysis will be a ranking of the liquidity of different asset classes. The EBA also launched a discussion paper setting out its thinking on those retail deposits to be subject to higher outflow rates than the "standard" 5% and 10% assumptions. Eight factors were listed: nominal value; currency and location; rate-driven deposits or those having preferential conditions; maturing fixed term or notice period deposits; deposits from high risk distribution channels, such as internet only or brokered; non-resident deposits; sophisticated or high-net-worth individuals; and product linked deposits (e.g. required to obtain a loan). A scorecard methodology was proposed for calculating outflow rates; three potential outflow rates were suggested: 15%, 20% and 25%.

The European Systemic Risk Board (ESRB) published a Recommendation on the funding of credit institutions. National supervisors should "intensify their assessments of the funding and liquidity risks incurred by credit institutions, as well as their funding risk management" and monitor and assess the viability of banks' plans to reduce reliance on public sector funding sources. They should also monitor asset encumbrance and collateral management and ensure firms had risk management policies in place to define their approach to asset encumbrance including contingency plans for stress situations.

Governance and risk management (including remuneration)

The Financial Stability Board (FSB) published the findings of its thematic peer review on risk governance, setting out a list of sound risk governance practices. "National authorities need to strengthen their ability to assess the effectiveness of a firm's risk governance, and more specifically its risk culture to help ensure sound risk governance through changing environments". The FSB noted there should be consistent national guidance on the key elements for effective risk appetite frameworks, as well as a common nomenclature for terms used in risk appetite statements.

The BCBS published final guidance for managing risks in the settlement of foreign exchange transactions, setting out seven principles: on governance; principal risk; replacement cost risk; liquidity risk; operational risk; legal risk; and capital for FX transactions.

While improvements had been made, "substantial FX settlement-related risks remain due to rapid growth in FX trading activities" and efforts should concentrate on "increasing the scope of currencies, products and counterparties that are eligible for settlement through PVP (payment-versus-payment) arrangements".

The European Securities and Markets Authority (ESMA) published final guidelines on remuneration policies under the Alternative Investment Fund Managers Directive (AIFMD). Most amendments were aimed at tailoring the requirements more closely to the specificities of the asset management industry.

Mark Carney, Governor of the Bank of Canada and incoming Governor of the Bank of England, spoke on rebuilding trust in global banking. While the G20's financial reforms were an important step in safeguarding financial stability, they were not sufficient to rebuild trust; bankers must live the right values. Bank boards and senior management should define clearly the purpose of their organisations and promote a culture of ethical business, while employees "need a sense of broader purpose, grounded in strong connections to their clients and their communities".

Conduct of Business (including MiFID)

The International Organization of Securities Commissions (IOSCO) consulted on eight principles intended to help regulators enhance their supervision of intermediaries holding client assets and address "risks to client assets and determine how to transfer or return client assets in default, resolution or insolvency scenarios". The principles related to client asset reporting and disclosure; the safeguarding of clients' rights, including in relation to clients waiving or opting out of certain client asset protections; and client assets placed in a foreign jurisdiction.

The FSA announced that Allied Irish Bank (UK), Bank of Ireland, Clydesdale and Yorkshire Banks, Co-operative Bank and Santander UK will review sales of interest rate hedging products (IRHPs) to small businesses and provide redress to customers where appropriate. The FSA's results of the pilot review of sales of IRHPs to small businesses for these banks were broadly comparable to the FSA's findings from the pilots for Barclays, HSBC, Lloyds and RBS. All banks will adopt the same approach when carrying out their reviews.

The FSA published the results of a mystery shopping exercise which reviewed the quality of investment advice provided by banks and building societies. It found that in 11% of cases the adviser gave unsuitable advice and in a further 15% the adviser did not gather sufficient information to make sure the advice was suitable.

The FSA published a letter following its August 2012 proposal to ban the promotion of unregulated collective investment schemes (UCIS) and close substitutes to ordinary retail investors.

It is now considering amendments to exclude certain investment vehicles from the scope of these restrictions, and to allow firms to promote schemes that allow high-net-worth individuals to benefit from Business Property Relief and Business Premises Renovation Allowance. The FSA intends to publish a policy statement in late April.

The FSA fined the Royal Bank of Scotland (RBS) £87.5 million for failing to comply with FSA principles in relation to LIBOR. RBS was accused of manipulating its own submissions which factored in the calculations of Japanese Yen and Swiss Franc LIBOR, for taking into account the impact of its LIBOR submissions on its money market trading books, as well as collusion with panel banks and broker firms. RBS and RBS Securities Japan were also fined $325m (c£218) by the US Commodity Futures Trading Commission (CFTC) for successful manipulation, attempted manipulation and false reporting related to Yen and Swiss Franc LIBOR.

The EU Commission summarised responses to its consultation on benchmarks and market indices and set out next steps. The Commission stated that "there is not a clear consensus" on the need or desirability of a regulatory framework for all types of benchmarks but found strong support for "the highest level of transparency possible" with respect to governance, processes and methodologies used to calculate benchmarks. Commissioner Barnier stated that interbank interest rates are of "systemic importance", and indicated that participation in some interbank rate setting panels, such as Euribor, will become mandatory for some banks.

The Treasury Select Committee (TSC) published the FSA's response to the TSC's report on LIBOR fixing, in which the FSA indicated that an internal investigation would be completed in Q1 2013. HM Treasury also announced that an independent committee, the Hogg Tendering Advisory Committee, had been formed in order to recommend a new LIBOR administrator to succeed the British Bankers' Association in the role.

The FSA fined UBS AG £9.45 million for failing to take reasonable care to ensure the suitability of advice relating to sales of the AIG Enhanced Variable Rate Fund. UBS also failed to address customer complaints adequately.

The FSA fined Lloyds Banking Group (LBG) £4.3 million for delays to payment protection insurance (PPI) redress payments between May 2011 and March 2012. LBG was found to have failed to establish adequate processes for preparing redress payments and customers' payment details were subject to poor data governance.

The Ministry of Justice (MoJ) published a report on its activities in the PPI claims market, saying it would continue to tackle poor conduct of some claims management companies.

There had been "a fall in compliance standards and an increase in poor practices", such as a failure to obtain sufficient information to corroborate mis-selling claims, and unsolicited text messages and phone calls from firms which constituted "a nuisance to the general public".

The FSA consulted on guidance related to super-complaints, as well as the procedure for firms and the Financial Ombudsman Service to bring issues to the attention of the Financial Conduct Authority (FCA). The guidance set out regulatory expectations in terms of information that should be provided alongside such a complaint. The FCA will be required to respond to a complaint within 90 days, explaining whether regulatory action will be taken.

The Office of Fair Trading (OFT) published guidance on how it is likely to use its new power to suspend consumer credit licences. The OFT can use this power, for a maximum of one year from the date of notice, when it is urgently necessary for the protection of consumers.

The FSA published its final newsletter on the retail distribution review (RDR), setting out its plans for thematic reviews to assess compliance and to understand how the new rules are being applied in practice. In late 2013 and early 2014, the FSA will expect firms to have embedded the new rules and taken on board the findings from the first part of its review.

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

The UK Government introduced the Banking Reform Bill to Parliament, which will implement some of the key recommendations of the ICB. Also published was the Government's response to the first report of the PCBS, the Parliamentary Commission on Banking Standards. The Bill included a number of significant changes, primarily in response to recommendations from the PCBS in its pre-legislative scrutiny of the draft bill. Notably, the Chancellor said the Government will "electrify the ring-fence" so that "if a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether – full separation, not just a ring fence". Other additions included specification of areas in which operational and economic independence must be established, and strengthened governance requirements, particularly in relation to directors of ring-fenced banks.

The Financial Markets Law Committee published two papers highlighting a number of legal uncertainties arising from the Banking Reform Bill and the EU Recovery and Resolution Directive (RRD). In relation to the Banking Reform Bill, the paper noted that certain provisions in the Bill are "potentially incompatible" with EU law, and suggested the definition of "core services" would cause considerable legal uncertainty, unless amended.

The German Government published a draft law which included rules for recovery and resolution planning (RRP) for systemically important banks and supervisory powers to require banks to address identified impediments to resolution. In addition the law included proposals to 'cage' the risky trading activities of banks from their retail arms (partially implementing the Liikanen report recommendations) for banks with total assets of over €90 billion and proprietary trading greater than 20% of the balance sheet. Banks with trading-related assets in excess of €100 billion would be required to separate their proprietary trading business regardless of its size vis-à-vis the rest of the group.

Following a paper by the FSA on the implications of non-EEA national depositor preference regimes, the US Federal Deposit Insurance Corporation (FDIC) issued a proposed rule clarifying the limits of its deposit insurance regime in relation to foreign branches of US banks. Deposits held in a foreign branch would not be FDIC insured, even if they were "dually payable" (that is, payable in both the foreign branch and an office of the bank in the United States). However, dually-payable deposits would receive preferred status over general creditors should the bank fail.

The FSA published an update on its Recovery and Resolution Plan (RRP) framework, which will be finalised soon after the formation of the Prudential Regulation Authority (PRA), including a revised RRP information pack for firms, which will reflect "lessons learned and our evolving information requirements". Further updates will be made to align UK requirements with EU and global requirements. Firms will be expected to update their recovery plan annually.

HM Treasury consulted on changes to the cash ratio deposit scheme, proposing to increase its level from 0.11 per cent to 0.18 per cent. These funds are placed interest-free at the Bank of England, paying for its monetary policy and financial stability operations, and the paper says the scheme "continues to be a suitable method" of funding.

Regulatory perimeter

The BCBS and IOSCO published a second consultation on margin requirements for non-centrally cleared derivatives, with more detail on how non-standardised derivative products will be collateralised and traded on a bilateral basis. They recommended universal two-way exchange of collateral, with an exemption for non-systemically significant non-financial counterparties. The document set baseline minimum amounts and methodologies for calculating margins and favoured use of a broad eligible collateral pool. Re-use of margin under strict criteria was explored and framed as a question for industry response. The BCBS and IOSCO are looking to introduce posting of variation margin from January 2015 and phase-in posting of initial margin on a complex schedule, extending to 2019 for some smaller counterparties. The treatment of physically settled forwards remains under consideration.

The European Parliament Committee on Economic and Monetary Affairs (ECON) initially adopted a resolution rejecting two of the European Market Infrastructure Regulation (EMIR) technical standards, due to concerns these diverged from the overarching requirements in the Regulation, and Parliament had not been given sufficient time for its deliberations. Eventually this resolution was withdrawn and all technical standards adopted unchanged. Taking into consideration the Committee's reservations, the Commission pledged to "make sure that when it adopts its decision on mandatory clearing for specific classes of OTC derivatives, the obligation for non-financial firms to clear will be phased in over an appropriate period of time".

Following the decision of the Parliament and Council to approve the EMIR technical standards, the FSA published further detail on the main notifications and exemptions process under EMIR. By 15 March, notification processes will be in place for non-financial counterparties whose OTC derivative contracts exceed the exemption thresholds and for financial counterparties reporting unconfirmed transactions. Future notification procedures will be available for the exemptions applicable to pension schemes and intragroup transactions, as well as for reporting disputes.

ESMA published a final report on exemptions for market making activities and primary market operations under the Short Selling Regulation (SSR). These will be granted on a per instrument basis and available only to firms that are members of a trading venue where it makes markets in the instrument for which the exemption is claimed – a requirement which excludes instruments not traded on a venue, or admitted to trading. ESMA also detailed how the relevant competent authority is defined and notified, especially for notifying entities from third countries, and published a call for evidence on the evaluation of the SSR.

The ESRB issued recommendations for EU legislation of money market funds (MMFs). Suggestions included requiring MMFs to have fluctuating net asset values; fair value accounting with amortised accounting restricted to a "limited number of predefined circumstances"; and strengthened monitoring of and tools for liquidity risk. The ESRB also recommended MMFs be subject to increased regulatory reporting requirements, and to make the absence of capital guarantees clear to their investors. These recommendations are broadly consistent with IOSCO policy recommendations for MMFs published in October 2012.

ESMA undertook a shortened consultation on technical standards for the regulation of fees for Trade Repositories (TRs). ESMA considered introducing a registration fee and an on-going supervisory fee, as well as categorising TRs in fee bands proportionate to their turnover. ESMA also consulted on having a minimum supervisory fee.

Rethinking the domestic and international architecture for regulation

The European Central Bank's (ECB) Vice-President, Vítor Constâncio, spoke about the Single Supervisory Mechanism (SSM) and ECB preparation for supervision of euro area banks. The SSM was a system with the ECB at its centre, operating through "very close cooperation arrangements" with national authorities, which nevertheless had to act in line with ECB guidelines and a manual of supervisory practices to be developed with the EBA. The ECB would also have the power to transfer the supervision of any bank to the centre of the SSM. Recruitment of skilled staff "will be a priority". One of the first tasks for the SSM will be a "comprehensive review" of the banks brought under its responsibility, and the ECB will work with national authorities to assess the state of bank balance sheets.

The International Monetary Fund (IMF) published a paper supporting moves towards Banking Union as the "logical conclusion" of the idea that an integrated banking system needs integrated prudential oversight. The paper urged progress "on all elements" including the SSM, a single resolution authority, and common deposit insurance. The IMF also noted that while a Banking Union may be "essential", it is "no panacea", and that "merely reorganising supervisory structures" would not have prevented the financial crisis from occurring.

Andrew Bailey, CEO-designate of the PRA, discussed its approach to insurance regulation. One of its main challenges was how to use more judgement in supervision while not increasing uncertainty for firms. He was also concerned about the "frankly indefensible" costs and unclear timelines of Solvency II.

The FSA issued an update letter to firms on the transition to the PRA. With respect to existing regulatory guidance, firms should review all individual FSA guidance against the PRA's statutory objectives within 18 months of the legal cutover. Items not referred to the PRA for review by 30 September 2013 will cease to have status as formal PRA individual guidance from that date.

The Bank of England consulted on its supervision of financial market infrastructures, addressing the use of its power of direction over qualifying parent undertakings of UK Recognised Clearing Houses (RCH), and financial penalties. It also consulted on rules for RCHs and approved operators, proposing to be able to recover charges incurred when commissioning expert reports. It also proposed notification to the supervisor before an operator introduced rules that imposed liabilities, restrictions or reporting requirements on market participants.

The FSA consulted on amendments to the FCA's handbook relating to the enforcement guide, to revise disciplinary powers, own-initiative powers, and skilled person reports.

Disclosure, valuation and accounting

Following a request by the FSA that the Chartered Institute of Internal Auditors (CIIA) develop a code to set out expectations of internal audit functions in the financial sector, the CIIA published a consultation. The paper set out 33 recommendations in 9 areas, covering mandates, scope and priorities for internal audit, reporting, independence, and resources. It said the high level recommendations were intended to provide a benchmark for effective internal audit in UK financial services, and should be viewed as "incremental guidance to existing standards".

Information security and data privacy

The Court of Appeal ruled that while Credit Reference Agencies (CRAs) were subject to accuracy requirements under the Data Protection Act, these rules "do not impose an absolute and unqualified obligation on CRAs to ensure the entire accuracy of the data they maintain". Those agencies that take "reasonable steps" to ensure accuracy of credit data should not be subject to compensation claims from individuals if their data turned out to be incorrect.

The FSA is set to review cyber security standards across 30 major firms, according to a statement by Greg Clark, Financial Secretary to the Treasury. The review was taking place to "ensure that cyber risks are better understood and to promote cyber security in the finance sector", and will culminate in the production of a good practice guide.

Financial crime

The European Commission adopted proposals for a Directive and a Regulation to reinforce its rules on anti-money laundering (AML) and fund transfers, aligning them with the latest recommendations of the Financial Action Task Force (FATF), with further detail around customer due diligence, the treatment of politically exposed persons and the identification of beneficial owners, as well as expanding coverage from casinos to the wider gambling sector. The Directive goes beyond FATF requirements by bringing in scope all persons dealing in goods or providing services for cash payment of €7,500 or more, compared with €15,000 at present.

FATF adopted a new methodology for assessing compliance with its recommendations and the effectiveness of AML and counter terrorism financing (CTF) systems. This combined a technical assessment with an outcomes effectiveness assessment, analysing how far a country's legal and institutional framework produced the desired results. It also updated its guidelines on AML/CTF and financial inclusion and published a new guide on national risk assessment. It welcomed the Organization for Security and Cooperation in Europe as an observer and resolved not to suspend Turkey's membership, as it had previously threatened to do, due to a new law on terrorist financing passed in the country.

The FSA, with the assistance of the Metropolitan Police, arrested three men in connection with an investigation into insider dealing and market abuse.

Other items

Andrew Bailey, Managing Director of the FSA's Prudential Business Unit, was appointed as a Bank of England Deputy Governor and Chief Executive of the PRA.

The EU Commission published a proposal for a Financial Transaction Tax Directive, on the basis of requests by eleven Member States following enhanced cooperation procedures. The proposal would apply in these eleven countries, and to transactions between any two entities where one of them is established in one of these states, irrespective of where the transaction takes place. The tax covers a variety of instruments, including money market instruments, shares in collective investments including UCITS, derivatives contracts, repurchase agreements, and other types of financial contract. Non-derivatives transactions will be taxed at a rate of 0.1%, while derivatives contracts will be taxed at a rate of 0.01%.

The G20 published a communique after a meeting of finance ministers and central bank governors in Moscow, re-affirming its commitment to timely implementation of Basel III and stressing the need for prompt implementation of OTC derivative reforms. It also asked the FSB to report on progress on ending "too-big-to-fail" by September 2013.

The FSB wrote to the G20 on regulatory reform, outlining its timetable for delivering regulatory reports, reviews and assessment results for OTC derivative reforms, RRPs, systemically important financial institutions, shadow banking and Basel III. It also published a report assessing regulatory factors that could negatively impact the availability of long-term finance. A study group on financing for investment has been established to determine a work plan for the G20, considering the role of the private sector and official sources of long-term financing.

ESMA published its first report on trends, risks and vulnerabilities in EU securities markets, and its risk dashboard for Q4 2012. Market conditions had improved in the second half of 2012, following the ECB's announcement of Outright Monetary Transactions, but risk indicators remained high due to the on-going sovereign debt and banking crisis, funding risks, and the long-term implications of the low interest rate environment. ESMA highlighted credit risks as very high, noting a concentration of outstanding bank and sovereign debt on securities with high risk premia and short maturities. The increased demand for collateral would make collateral relatively scarcer, and might also prompt some financial market participants to use lower quality collateral, heightening financial stability risks.

Gabriel Bernardino, chair of the European Insurance and Occupational Pensions Authority (EIOPA), spoke about better policy protection, financial stability and consistency in regulatory practices, particularly relating to Solvency II and IMD II. EIOPA will consult on guidelines for Solvency II interim measures to ensure that national authorities will start implementing certain aspects of Solvency II by 2014. The Guidelines are expected in Q2 2013. On IMD II, Bernardino said on-request, rather than mandatory, remuneration disclosure is more suitable for non-life insurers, and that a complete ban on tying may lead to consumer detriment.

The Financial Services Compensation Scheme published its budget and plan for 2013-14. The annual levy for 2013/14 will be £311 million.

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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