UK: Risk and Regulation Monthly - May 2013

Last Updated: 26 June 2013
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

May was a busy month for the European Banking Authority (EBA), which launched 15 consultation papers, largely focussed on the Capital Requirements Directive and Regulation package (CRD IV/CRR), but also recovery planning requirements under the proposed Recovery and Resolution Directive (RRD). There was also a flurry of papers on structural reform of the banking sector, with growing interest at the international level. 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)

In light of concerns that macroeconomic conditions in Europe have led to a deterioration in EU banks' asset quality, and in order to bolster confidence in the EUwide stress test, the EBA agreed recommendations that supervisors conduct asset quality reviews (classification and valuation) on major EU banks. Meanwhile the next EU-wide stress test has been pushed back to 2014, with the recommendations and precise timeframes published once the timeline of the Single Supervisory Mechanism's (SSM's) balance sheet assessment is known.

The EBA launched seven consultation papers under the proposed revisions to CRD4/ CRR. Five draft Regulatory Technical Standards (RTS) were published, on own funds, the definition of market and non-delta risk of options under the standardised approach for market risk, securitisation retention rules, and the determination of the overall exposure to a client or a group of connected clients in respect of transactions with underlying assets. Also published were draft Guidelines to national authorities on capital measures for foreign currency lending to un-hedged borrowers, and an Implementing Technical Standards (ITS) paper on institution-specific prudential requirements, which aimed to establish common procedures and templates for assessing group risk.

In an interview on the Solvency II interim measures, Gabriel Bernardino, Chair of the European Insurance and Occupational Pensions Authority (EIOPA), discussed what the Guidelines could achieve. The documents are neither binding on national authorities nor empower them with additional powers to force firms to comply but it would be in both industry and supervisors' interest to use them, in their preparations for Solvency II. "If you believe the biggest challenge is to have a single rulebook then think again as the biggest challenge is to have a consistent supervisory approach on how to implement this single rulebook," Bernardino said. He also clarified that the 2015 deadline for information submission stipulated in the Guidelines will have to be revised if Pillar 1 requirements are not finalised by the end of 2013 or beginning of 2014.

The Prudential Regulation Authority (PRA) issued an update on its discussions on capital with the major UK banks. Lloyds Banking Group (LBG) and Royal Bank of Scotland (RBS) "have advanced their plans to a position where disclosure is appropriate", and more information will be provided "once discussions have concluded with all banks". The PRA said any further announcements will include confirmation that, where necessary, banks will take the actions needed to meet the recommendations of the Financial Policy Committee (FPC).

Julian Adams, Deputy Head of the PRA and Executive Director for Insurance, updated insurers on Solvency II developments: there was unlikely to be any certainty on the Solvency II timetable before the autumn. In the UK, nearly half of the firms involved in the IMAP process have asked to be part of the PRA's ICAS+ regime, which allows firms to use their Solvency II models to meet existing domestic requirements. In a separate letter, he set out the PRA's implementation plan for monitoring the capital adequacy of firms' internal models using early warning indicators. Additionally, the PRA sent requests to both life and general insurance firms for data related to Solvency II. The data requests, to be met by end July this year, will inform ICAS and ICAS+ reviews. The requirements for life and general insurers differ to a degree; broadly, requests cover information on capital and key risk variables.

Matthew Elderfield, Deputy Governor of the Central Bank of Ireland and prospective Group Director of Conduct and Compliance at LBG, spoke on Solvency II and the insurance regulatory agenda more broadly, at the European Insurance Forum in Dublin. One focus was the politically difficult issue of long term guarantees, where he said matched premium adjustments could be allowed for a wider range of products, subject to certain conditions. He also discussed EIOPA's proposed interim measures guidelines, where he said implementation will be proportionate and compliance will be expected on a best efforts basis.


The EBA published three consultation papers under the CRR: draft RTS for additional liquidity outflows; draft ITS on additional liquidity monitoring metrics; and draft ITS on institution-specific prudential requirements (liquidity reporting and assessment templates). Three methods (standard, simplified and internal-model based) were proposed to determine additional collateral outflows as a result of e.g. adverse market scenarios or a firm's derivatives positions or financing transactions. While the historical look back approach outlined in the Basel Committee's January 2013 paper on the Liquidity Coverage Ratio was not incorporated in the draft, the EBA will consider how it can be implemented (e.g. as a back stop measure) following industry feedback.

It suggested five additional liquidity monitoring metrics: contractual maturity ladders; behavioural maturity ladders; concentration of funding by counterparty; pricing for different sources of funding; and funding roll-over - to provide a toolkit for supervisors to assess liquidity risk and facilitate reviews of internal liquidity adequacy assessment processes.

"There is no evidence or expectation of any lasting or widespread scarcity of [collateral] assets in global financial markets", according to the Chairman of the Basel Committee on the Global Financial System, which published a new paper on asset encumbrance, regulation and the demand for collateral. The paper pointed to an increase in demand for collateral of up to $4 trillion resulting from new liquidity and derivatives regulation, but also noted that between 2007 and 2012, the amount of high quality government securities outstanding increased by $10.8 trillion. Although this suggests that "concerns about an absolute shortage of [high quality assets] appear unjustified", the situation "varies markedly across jurisdictions", meaning that there may be temporary supply-demand imbalances. The paper argued that responses to collateral scarcity may increase interconnectedness and procyclicality, and that policymakers look to mitigate such risks. Suggestions included standardised and regular disclosure on asset encumbrance, prudential limits on encumbrance, and further supervisory work in relation to firms' collateral management arrangements.

Governance and risk management (including remuneration)

The EBA consulted on draft RTS on the definition of material risk takers. Those covered will be subject to, in particular, the rules related to variable remuneration as part of CRD IV. Certain criteria, such as roles, decision-making power and level of remuneration, will be used to identify material risk takers: for example, employees whose total remuneration exceeds EUR 500,000 per year (in absolute terms), and those within the top 0.3 per cent remuneration bracket will be caught within scope.

The Financial Conduct Authority (FCA) published a Decision Notice against a former non-executive director at two mutual societies, deciding to fine her £154,800 and ban her from performing any role in regulated financial services for failing to disclose her conflicts of interest. The matter has been referred to the Upper Tribunal.

JP Morgan International Bank was fined just over £3 million by the FCA for systems and controls failings relating to its provision of retail investment advice and portfolio investment services. According to Tracey McDermott, FCA director of enforcement and financial crime, "the firm did not have complete records, nor did its management have the information they needed to recognise this".

Conduct of Business (including MiFID)

Following a review which found that nearly half of borrowers may not have enough money to repay their interest-only mortgages when they mature, the FCA consulted on guidance seeking to "nip this problem in the bud". Mortgage lenders agreed to contact at-risk customers to highlight the report's findings and what customers should do. The FCA expects firms to communicate early and frequently with their customers and have certain governance arrangements, such as a written strategy for managing mortgage loans that may not be repaid in full at the end of the term. Management information must be sufficient to enable firms to monitor their interest-only back book and review the performance of mitigation actions taken. Where certain interest-only customers are 'trapped' and unable to change mortgage or move to a different provider, firms should not unfairly charge them a higher rate of interest.

The European Commission proposed a Directive on the comparability of fees related to payment accounts, payment account switching and access to payment accounts with basic features. The proposal gives consumers access to documents which should make fees more transparent and comparable, establishes a 15-day procedure for switching accounts, and enables citizens of one EU member state to open an account in another member state irrespective of their financial situation.

The Government announced a plan to tackle "high and inappropriate" pension charges to protect consumers. First, it will ban consultancy charges in automatic enrolment schemes, covering both occupational and personal pension schemes. Second, a consultation on capping default fund charges in Defined Contribution schemes will be launched in the autumn. The announcement followed a six-month review which found that existing measures to prevent advisers deducting high charges from members' pension pots were inadequate. Consultancy charges were also found to have a disproportionately negative impact on people who moved jobs regularly. The Office of Fair Trading (OFT) is investigating the workplace pensions market and will act "promptly and vigorously later this year in the light of their findings".

The OFT announced it will not make a market investigation reference to the Competition Commission regarding the UK market for personal current accounts. However, it still has "significant concerns about this market" and "expects to return to this question" in 2015, if not before, in line with a recommendation by the Independent Commission on Banking.

Martin Wheatley, Chief Executive of the FCA, announced the launch of a strategic review into the claims process of general insurers, with a particular focus on household and travel claims. Whether consumer experience depends on the distribution mechanism used, and how understandable the claims process is, are examples of questions in the review. He also spoke about the FCA's approach to supervision which, "will be at least as focused on culture as controls", and will support both consumers and industry, rather than favouring one over the other.

As an initial step towards creating a single market in personal pension products (PPP), EIOPA published a discussion paper on possible approaches, putting forward two alternatives - enabling passporting or creating a new legal framework across member states, the so-called second regime. Tax, social and labour law and prudential provisions were identified as the main obstacles to passporting. Complexities related to prudential regulation exist in particular for defined benefit and defined contribution with guarantees products. Differences among member states could be accommodated via a 'second regime'. The paper also looked into possible ways of protecting PPP holders.

An Organisation for Economic Co-operation and Development (OECD) task force published its draft report on implementing the G20 high-level principles for financial consumer protection. The paper focused on the "priority principles" of disclosure and transparency, responsible business conduct, and complaints handling and redress. A series of "effective approaches" were discussed with respect to each principle, and the paper set out common practices, as well as emerging and innovative responses observed by the task force.

In light of significant increases in consumer borrowing from non-conventional sources such as payday lenders, the Public Accounts Committee's (PAC) eighth consumer credit report focussed on malpractice risks in non-mainstream lending. The OFT came under criticism for "not being effective in regulating the consumer credit market" and for being "timid rather than tough in its enforcement". It had failed to fine any of the 75,000 licensed firms, license fees charged to lenders were "ridiculously low" and the quality of OFT data also came under attack. However, the PAC described the OFT's plans to crack down on the "unscrupulous behaviour" of the 40 largest payday lenders as "encouraging".

The FCA consulted on collecting additional data about mortgages to monitor and supervise conduct in the mortgage market, given the new requirements in the Mortgage Market Review (MMR). The FCA proposed making changes to two existing returns that lenders submit once a quarter: the Product Sales Data; and the Mortgage Lending and Administration Return.

The Financial Ombudsman Service handled on average over 7,000 initial enquiries and complaints each working day in 2012-13, according to its annual review of consumer complaints. 74% of new cases were about the sale of payment protection insurance (PPI), with the number of PPI complaints rising 140%. Investment-related complaints and banking and insurance complaints, excluding PPI, rose 33% and 20% respectively.

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

With policy proposals in development, the European Commission published a roadmap for structural reform of EU banks, outlining the legislative options being considered in response to the recommendations of the Liikanen report. Three main dimensions were being considered: first, the definition of relevant activities to be separated; second the nature and extent of separation, including the governance of separated entities; and third, possible thresholds and de minimis exemptions. Following publication of the roadmap, a further consultation paper was launched, in which the Commission emphasised that bank responses should include "data to substantiate their assessment of the impact of structural reform". The consultation developed a series of options for possible measures, such as whether to require functional, legal or accounting separation; the various degrees of separation of trading activities, from narrow to broad; and the possible degree of supervisory discretion permitted.

The EBA launched two consultation papers which set out draft RTS on recovery planning scenarios and the assessment of recovery plans under the proposed RRD. The first specified the range of system-wide and idiosyncratic events banks should test their recovery plans against. Scenarios should be tailored to the institution's specific business model (e.g. size, interconnectedness, funding) and should at a minimum assess the impacts on the availability of capital and liquidity; profitability; payment systems and settlement operations; reputation; and business model. The second outlined three main areas of evaluation: completeness, specifically whether all relevant information is provided and up to date; quality, which supervisors will assess based on clarity, comprehensiveness and internal consistency; and the overall credibility of the recovery plan.

The IMF published a staff note examining EU, US and UK proposals on bank structural reform, noting that such measures "could be a useful complement to traditional prudential tools under certain conditions". However, structural reforms would need to be "appropriately designed and judiciously implemented" and their benefits evaluated against the "potentially significant global costs". The IMF also pointed to the potential for problems as a result of inconsistent national regimes, and recommended that the extra-territorial implications could be monitored by an international body such as the FSB.

Following its consultation on a possible framework for the recovery and resolution of financial institutions other than banks, the European Commission published a roadmap for launching a legislative proposal. Developing specific resolution tools for each sector was identified as the preferred approach, with a clear focus on systemic entities. In its impact assessment, the Commission stated there may be new requirements on recovery and resolution planning and there will be a transfer of resolution costs from taxpayers to market participants, although it did not specify the exact intervention powers authorities will have.

US regulators will pursue measures which increase in stringency as banks grow in size, according toDaniel Tarullo, a member of the Board of Governors of the Federal Reserve, recently appointed as Chairman of the FSB's Standing Committee on Supervisory and Regulatory Cooperation. Tarullo argued that "more is needed" to address too-big-to-fail firms and systemic risk. Discussing the issue of short-term wholesale funding markets, he raised the possibility of having "progressively greater minimum liquidity requirements" for larger institutions, or even tying liquidity and capital standards together so that large firms would be required to hold more capital unless their liquidity levels were "substantially stronger" than minimum requirements. Tarullo also suggested that a higher leverage ratio for the largest firms is being considered.

In its latest semi-annual financial stability review, the European Central Bank (ECB) identified four key risks to stability: a further fall in bank profitability within a weak macroeconomic environment; renewed tensions in sovereign debt markets due to low growth and slow reform implementations; bank funding challenges in stressed euro area countries; and an abrupt correction to under-priced risk in some segments of global markets (e.g. high-rated sovereign debt markets and several corporate bond markets).

Regulatory perimeter

ESMA (the European Securities and Markets Authority)


a consultation paper on reporting obligation guidelines for the Alternative Investment Fund Managers Directive (AIFMD). This set out expectations on reporting frequency and the information required, including breakdown of investment strategies, exposures and concentrations, and the types of instruments traded. In addition, HM Treasury published questions & answers on the transposition of the AIFMD and a summary of responses to its consultation paper on the same topic.

The European Council adopted a Regulation and a Directive changing the rules for Credit Rating Agencies (CRAs) to reduce overreliance on external credit ratings by occupational retirement providers, UCITS, and AIFMs. Issuers of structured finance products must rotate rating providers every four years and sovereign ratings should be reviewed every six months. Other provisions allow investors to claim damages from the CRA if they suffer losses as a result of an infringement, and put in place enhanced shareholder disclosure requirements.

The European Commission issued a memo on the practical implementation of EMIR, the European Market Infrastructure Regulation, to non-EU central counterparties (CCPs) which explains the relevant recognition procedure, equivalence process and its significance. Under EMIR, EU counterparties will be obliged to use only authorised or recognised CCPs to meet their clearing obligations. Furthermore, only a recognised CCP will be considered 'qualified' under CRD IV, which has significant implications on capital requirements levied on business cleared through the CCP. In June and July this year, ESMA is expected to provide technical advice on whether a number of jurisdictions, including the US and Japan, pass an equivalence assessment - one of the requirement for CCPs in these jurisdictions to be so recognised.

Rethinking the domestic and international architecture for regulation

A document setting out the FCA's corporate governance framework was launched. The paper covered the structure and composition of the FCA; the role of the Board, its committees and directors; and the process by which the Board delegates responsibilities to committees and individuals. The intention of the Board, to comply where relevant with the UK Corporate Governance Code, was also highlighted.

Andrew Bailey, Chief Executive of the PRA, spoke on the new approach to financial regulation. The role of the PRA in maintaining the safety and soundness of the banking system through ensuring the continuity of those critical services to the economy and to the public was emphasised. He highlighted perceived shortcomings of the integrated regulatory system under the FSA (Financial Services Authority), namely the inability to deliver a "stable equilibrium of conduct and prudential supervision", with one often elevated at the expense of the other. The importance of ending 'too big to fail' and having fully operational resolution plans and processes was raised, not only from a financial stability perspective but also to ensure effective competition; if market exit was too difficult, entry would need to be similarly inhibited.

The Enterprise and Regulatory Reform Act 2013 was enacted, which provides for the abolition of the Competition Commission and the OFT and the subsequent establishment in their place of the Competition and Markets Authority (CMA). The OFT's responsibilities for consumer advice will be transferred to Citizens' Advice and the Trading Institute will have responsibilities for most enforcement and consumer education activities. The CMA is expected to become fully operational in April 2014.

The FPC published a code of conduct for its members, setting out rules regarding conflicts of interest and communication; members are expected to "avoid statements and conduct that could in any way undermine public trust in the FPC or the Bank". "Beyond what appears in the public record, members should not provide details of the FPC's discussions", and only the chair can speak for the FPC. When discussing policy matters, members must make it clear that they are speaking in a personal capacity and those who are not members of the MPC "should avoid discussing UK monetary policy".

Yves Mersch, Member of the Executive Board of the ECB, gave more details on the European Banking Union and preparatory work for the SSM. There was a need to remove national biases which sometimes led to the hiding of bad assets in so-called 'national champion' banks. To that end, one of the first tasks for the SSM would be to conduct an asset quality review, followed by a balance sheet assessment. The outcomes of the reviews would be an input to stress tests, which the ECB had begun coordinating with the EBA. He also spoke about the rationale for a Single Resolution Mechanism as an entity separate from the ECB, possibly attached to the European Stability Mechanism, and the need to develop credible plans for the orderly resolution of banks.

At a public hearing on the Review of the European System of Financial Supervision (ESFS), Andrea Enria, EBA Chair, said that "avoiding a rift between Member States that will join the SSM and those that will not, requires... strengthening other components of the ESFS, for which at the moment [he does] not see the necessary political commitment". Gabriel Bernardino, EIOPA Chair, said of the ESFS, there is "no silver bullet in terms of structures", reform discussions should focus on substance. In terms of EIOPA, he identified a need for evolution to strengthen EIOPA's operational independence; reinforce its independent challenging role towards National Competent Authorities; and enhance EIOPA's mandate and powers.

Disclosure, valuation and accounting

The proliferation of "complex and hard-to-value assets" now available to collective investment schemes (CIS) prompted the International Organization of Securities Commissions (IOSCO) to publish a set of principles on CIS valuation. Some of the assets now available to CIS "did not exist a decade ago", and required mark-to-model techniques. The principles are intended as a benchmark against which industry and regulators can assess the quality of regulation and existing industry practice. Relevant entities should have documented policies governing CIS valuation, including for each type of asset in the CIS, arrangements should be disclosed appropriately to investors, and pricing errors should be detected, prevented, and corrected.

The EBA published two consultation papers on passport notifications under CRD4: draft ITS set out standard forms, templates and procedures for submitting passport notifications whilst draft RTS specified the information that should be notified to authorities.

Information security and data privacy

The Information Commissioner's Office (ICO) warned that "too many" organisations are using privacy policies to protect themselves and failing to adequately inform the public. The warning was issued on its blog, alongside a confirmation that it would be taking action to review the privacy policies published on 250 UK based websites as part of a wider "privacy sweep" being led by the Office of the Privacy Commissioner of Canada.

The Court of Appeal ruled that organisations are not required to pay compensation to consumers for distress following a breach of Data Protection rules, unless the distress caused is directly linked to the breach itself.

Financial crime

Following the publication of the Financial Action Task Force's (FATF) revised guidelines on money laundering and terrorist financing, the FATF president gave a speech to the Eurasian Group Plenary on their implementation. He emphasised the importance of mutual evaluation and financial inclusion in combating money laundering, and outlined the outcomes of the FATF's consultation with non-profit organisations (NPOs) held in April 2013 (including an update of its 2002 paper on best practices for NPOs). The speech also indicated that the FATF intends to publish new guidance in June relating to payment products and services used to facilitate financial inclusion.


In relation to resolving global banks, Bank of England Deputy Governor Paul Tucker argued that "the key policies are unavoidably international" and that "foreign countries have a stake in our banks, and vice versa". He touched on the role of discretion in the application of prudential regulation, noting that "no more can we write down hard and fast rules on bank balance sheets", with prudential supervision requiring a significant amount of judgment. He also mentioned stress testing, suggesting that in the past "neither the markets nor the public was comfortable with the degree of secrecy", and that as such, a new regime under the FPC would be more transparent, representing "quite a change" for regulated firms. Finally, he looked at the issue of policy in a global context, recognising that the time it takes to reach international agreements can frustrate firms who need to plan ahead, and that domestic and international objectives are not always compatible. However, the need for global solutions for the resolution of global banks made co-ordination and co-operation absolutely essential.

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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