UK: Risk And Regulation Monthly – December 2013

Last Updated: 22 January 2014
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

There was a flurry of activity in December for supervisors and legislators, as they looked to honour their 2013 commitments before year-end, with a compromise reached on the Recovery and Resolution Directive and the Deposit Guarantee Scheme Directive in the EU, while in the UK the Banking Reform Bill received Royal Assent and the PRA published its final rules on CRD IV and recovery and resolution planning.

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 Prudential Regulation Authority (PRA) published its final rules on implementing the revised Capital Requirements Directive (CRD IV). The publication was a follow-up to a November statement, where the PRA outlined the major changes, such as transitional provisions, and quality of capital for Pillar 2A. The December Policy Statement, which did not differ from the consultation significantly, offered further detail on these issues and on Individual Liquidity Guidance. Importantly, the PRA committed to a number of follow-up activities in 2014, including issuing rules on capital buffers, addressing the remuneration recommendations of the Parliamentary Commission on Banking Standards, and considering its approach to the Liquidity Coverage Ratio given expected EU legislation.

Alongside the final CRD IV rules, the PRA published 14 supervisory statements on areas including stress testing; credit, counterparty credit, market, and operational risk; and large exposures.

In parallel to the PRA publication, the Financial Conduct Authority (FCA) issued its final rules on how CRD IV will be applied to the investment firms under its prudential supervision. In addition to transitional provisions on capital, the FCA paper included a helpful prudential classification of UK investment fund managers. Like the PRA, the FCA will not be issuing rules on capital buffers before HM Treasury (HMT) has made the relevant legal provisions, expected in Q1 2014.

Meanwhile HMT issued its guidance on country-by-country reporting under CRD IV. This sought to explain, in 'layperson's language', the interim and ongoing reporting obligations, the interpretation of key terms and the disclosure provisions.

The Basel Committee on Banking Supervision (BCBS) issued a second consultation paper on revisions to its securitisation framework. Changes were made to the hierarchy of approaches, such that internal ratings-based approaches are permitted for banks with the capacity and supervisory approval to use such an approach, with external ratings then allowed for particular securitisation exposures and the standardised approach to be applied if neither of these approaches is possible. The BCBS also amended its calibration of capital requirements as a result of revisions to some of its modelling assumptions, and proposed a 15% risk-weight floor, rather than the original 20% proposal. The BCBS said its revised approach reflected a desire to balance risk-sensitivity, simplicity and comparability. A further quantitative impact study will also be undertaken.

The BCBS published 'phase two' of its work on the consistency of risk-weighted assets (RWAs) for market risk in the trading book. The initial work was extended to a "more representative and complex" set of trading positions across all major asset classes. The BCBS said the results "broadly confirm" its original finding that the outputs of internal models for market risk vary significantly across banks, and that in addition, variability "typically increases for more complex trading positions". Mooted policy options included improvements to Pillar 3 disclosures, narrower ranges of modelling choices for banks, and further harmonisation of supervisory practices.

The European Banking Authority (EBA) published a series of reports on the comparability of RWAs, including a report on RWAs for market risk, its third interim report on the consistency of RWAs for SME and residential mortgages, and a report focusing on the comparability of supervisory rules and practices in relation to RWAs.

The BCBS finalised its standard on the prudential treatment of banks' investments in the equity of funds. The new framework applies to all banks, irrespective of whether they use the standardised approach or internal models, and will become effective as of January 2017. Among other changes, the new framework sets a 1,250% risk weight for investments for which there is insufficient transparency about the fund's investment activities. The framework creates a hierarchy of approaches for setting capital requirements, with varying degrees of risk-sensitivity depending on the amount of information banks are able to gather about the funds in question.

The EBA published numerous technical standards and guidance, some of which are still consultative, including part three of its standards on own funds; guidance on the treatment of foreign exchange lending to unhedged borrowers; technical standards on the identification of the geographical location of credit exposures; advice on the treatment of unrealised gains; standards on securitisation retention rules; standards on information exchange between home and host supervisors; standards on market risk and CVA risk; standards on joint decisions between home and host supervisors on prudential requirements for individual firms; draft guidelines on significant credit risk transfer for securitisation transactions; on the minimum amount of professional indemnity insurance for mortgage credit intermediaries; and standards on conditions for assessing extensions and changes to internal approaches for credit and operational risk.

The EBA consulted on a methodology for identifying global systemically important institutions as part of CRD IV. The paper set out disclosure requirements for the criteria for these firms, and for other institutions with "exposures" (ie total size) above €200bn. The identification methodology and data requests are based on the BCBS framework.

The EBA published its risk assessment of the EU banking system in H2 2013. This highlighted uncertainties about the asset quality of EU banks, given evidence of continuing deterioration in loan portfolios during 2013, reinforcing the need for Member States to conduct an asset quality review, as the EBA had recommended in October. The EBA emphasized that the potential prudential impact of conduct-related issues remained a concern.

The International Association of Insurance Supervisors (IAIS) consulted on rules for a Basic Capital Requirement (BCR). The BCR will apply to the Global Systemically Important Insurers (G-SIIs), which the IAIS designates annually, and, possibly, to Internationally Active Insurance Groups as well. The IAIS proposed that the BCR rely on a 'factor-based' approach, which multiplies factors and proxy measures of major risk exposures and then sums the results to obtain the required capital. A number of details, including on valuations and the appropriate key risks, are to be clarified following a field test scheduled for early 2014. The BCR, which is to apply once it is finalised in end-2014, will eventually be the basis for calculation of a higher loss absorbency add-on for G-SIIs. The field tests conducted will also inform IAIS' work on an International Capital Standard under ComFrame.

The IAIS published brief guidance on the content of the Systemic Risk Management Plans (SRMPs) that G-SIIs are required to complete by mid-2014. The guidance provided a list of the items to be included in an SRMP and the way it should reference some of the other documents required from G-SIIs, such as Recovery Plans.

The PRA finalised its approach to the Solvency II preparatory guidelines, which the European Insurance and Occupational Pensions Authority (EIOPA) published in October. The paper is in line with the preceding consultation, but seeks to provide further detail on certain areas, such as expectations of the actuarial function. The PRA also said it would look further into industry concerns over reporting using Extensible Business Reporting Language (XBRL). Please see our publication for further details.

Speaking at a Solvency II briefing, Julian Adams, PRA Deputy Head and Executive Director of Insurance, highlighted the need for industry and supervisors to refocus their efforts on meeting the deadlines for Solvency II transposition in March 2015 and implementation in January 2016.

In a Technical Report on Standard Formula Design and Calibration for Certain Long-Term Investments, EIOPA proposed a more granular treatment of securitisations. EIOPA suggested that instead of the current 7% uniform risk charge for AAA-rated securities, the charge should change to a 4.3% to 12.5% range, depending on the risk of the particular equities, as estimated based on criteria EIOPA developed in the Report.


The EBA published a series of documents relating to liquidity, including a discussion paper on assessing liquidity and funding risk during the course of supervisory reviews; draft technical standards on metrics for additional supervisory monitoring of liquidity; guidelines on retail deposits which are subject to different outflow assumptions for liquidity reporting purposes; a report on the impact assessment for the Liquidity Coverage Ratio (LCR); and a report on uniform definitions of high quality liquid assets (HQLA) and operational requirements for liquid assets. According to the impact assessment, the new liquidity requirements are "not likely to have a material detrimental impact" on the economy or bank lending, given that the average LCR of EU banks is 115%.

See also first item in preceding section (PRA approach to CRD IV).

Governance and risk management (including remuneration)

The BCBS released a progress report on banks' adoption of its "principles for effective risk data aggregation and risk reporting", which global systemically important banks (G-SIBs) are expected to comply with by 1 January 2016. The report was based on a self-assessment survey completed by the largest banks and their supervisors. Of the 30 banks identified as G-SIBs in 2012, ten reported they would not be able to comply by the 2016 deadline, with the main reason being "large, ongoing, multi-year IT and data-related projects". The report said that "many banks are facing difficulties in establishing strong data aggregation governance, architecture and processes", and are resorting to "extensive manual workarounds". Banks would need to "significantly upgrade their risk IT systems and governance arrangements" to address these shortcomings.

The EBA agreed its final draft technical standards on the criteria for identifying staff that perform activities which have a material impact on an institution's risk profile, and so will be subject to CRD IV provisions on variable remuneration. The criteria are both qualitative, related to role and decision-making powers, and quantitative, related to total gross remuneration in absolute or relative terms.

The Joint Forum of international regulators published a paper analysing longevity risk transfer markets, noting that "their massive potential size and the growing interest from investment banks" might "raise systemic risk concerns in the future". It made eight recommendations, including that policymakers should review their policies with regard to where longevity risk should reside, as well as the rules and regulations pertaining to the measurement, management and disclosure of longevity risk.

The FCA fined the former finance director of Bradford and Bingley £30,000 for failing to provide the Board with up-to-date information about the firm's financial position ahead of its 2008 rights issue.

Conduct of Business (including MiFID)

Achieving cultural and technical transition are the two key FCA priorities for 2014, said Martin Wheatley, Chief Executive of the FCA. On the first, investor interests should be put "front and centre of firm business models". For asset managers, this priority meant the FCA would try to answer three questions: (1) "are fund managers scrutinising spending to ensure they are acting in the best interests of their clients"; (2) how can investors be helped to "better understand what they are paying for"; and (3) "does the current system of corporate access... compel asset managers to dig into their pockets more than they should, possibly at the expense of their clients' best interests".

The second priority meant the FCA needed to get the implementation of European reforms right, including the European Market Infrastructure Regulation (EMIR) and the revised Markets in Financial Instruments Directive (MiFID II / MiFIR).

EIOPA issued its annual consumer trends report. Among the trends that might warrant further investigation were new or evolving sales and marketing channels, such as social media, increased advertising via the internet and increased use of comparison websites; poor disclosure and advice; new or emerging products, for example cell phone insurance and packaged bank accounts bundled with insurance; the sale of complex products to retail investors and associated governance rules; unilateral changes in the terms of insurance contracts; and the use of telematics, or 'black box' technology, in motor insurance. Additionally, in its second half-year Financial Stability Report for 2013, EIOPA highlighted three developments related to regulation: increased clarity resulting from the Omnibus II agreement; the need for regulation of investment risks to improve the accuracy with which risk is reflected and aligned with policyholder interests; and concerns over strong flows into insurance-linked securities.

The International Organization of Securities Commissions (IOSCO) published a final report on the regulation of retail structured products, setting out 15 tools regulators could employ across the value chain. These covered an overall regulatory approach; measures on design and issuance, for example requiring assessments of the intended investor and product approval processes; disclosure and marketing, for example requiring short-form or summary disclosure documents, with full disclosure of costs; distribution, for example, with issuers taking some responsibility for how products are distributed; and post-sales practices.

Following feedback from stakeholders, the European Securities and Markets Authority (ESMA) consulted on a revision to collateral diversification provisions in the guidelines on Exchange Traded Funds (ETFs) and other Undertakings for Collective Investment in Transferable Securities (UCITS) issues, proposing to relax guidelines in relation to certain collateral, such as government debt, received by Money Market Funds (MMFs).

The EBA warned consumers of the risks associated with "virtual currencies such as Bitcoins". The EBA reminded consumers that EU regulation does not currently protect consumers from financial losses arising from currency value fluctuations, exchange platforms failures, nor does it provide refund rights for commercial transactions. Platforms could also be misused for money-laundering purposes.

HM Treasury confirmed the consumer representative bodies that will be able to submit "super-complaints" to the FCA as Which?, Consumer Council Northern Ireland, Citizens Advice and the Federation of Small Businesses. Complaints can be presented to the FCA by the bodies if they believe there are features of a financial services market that could significantly damage consumer interests and the FCA will have 90 days to respond.

In the largest fine ever imposed by UK regulators for retail conduct failings, the FCA fined Lloyds Banking Group £28mn for serious failings in their controls over sales incentive schemes between January 2010 and March 2012.

The European Commission fined eight firms a total of €1.71bn for participating in illegal cartels relating to Euro and Yen denominated interest rate derivatives. Barclays and UBS received full immunity under the Commission's 2006 Leniency Notice for revealing to the Commission the existence of the infringement, and avoided fines of €690mn and €2.5bn respectively. The others were fined as follows: Citigroup (€70mn), Deutsche Bank (€725mn), JP Morgan (€80mn), RBS (€391mn), RP Martin (€247,000) and Société Générale (€446mn).

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

The UK's Banking Reform Act entered into law following Royal Assent. The Act, originally intended as the vehicle for implementing the ring-fencing recommendations of the Independent Commission on Banking, was extended to cover a wide range of issues, from the creation of a new payments regulator to the overhaul of the approvals regime for senior management. The Act created a new criminal offence for senior bank managers, and reversed the burden of proof for non-criminal charges so that senior management will be considered responsible for any regulatory contravention that occurs on their watch unless they can demonstrate that they took reasonable steps to prevent it happening. The Act also enshrined the bail-in tool in law, although the date for activation of the tool, as with the majority of the Act, is yet to be defined by HMT. Please see our blog for further details.

HMT also published a summary of responses to the consultation on draft secondary legislation. The Government said it "remains committed" to its end-of-Parliament deadline for completing the rules, without giving further details.

The PRA published its long-awaited rules on recovery and resolution planning, accompanied by supervisory statements on recovery and resolution. The PRA made clear that the high level rules will not be their last word as resolution planning continued to evolve domestically and internationally.

While the recovery elements were not revised drastically, the resolution aspects were significantly different from the 2012 version. There will now be a two-stage process, more bespoke to individual institutions. Phase one will involve the collection of 'basic' information about structures and functions, while phase two will involve tailored information requests depending on the resolution strategy for the firm in question. The first submissions of phase one information will occur over the next 15 months, according to timelines to be specified for individual firms. Please see our blog for further details.

The Council of the European Union and the European Parliament reached political agreement on two components of the European Banking Union – the Recovery and Resolution Directive (RRD) and the revised Deposit Guarantee Scheme Directive (DGSD). The compromise RRD text is expected to be formally approved during the Parliament's plenary session on 25 February. The bail-in rules are due to enter into force in January 2016. The text confirmed that covered deposits, secured liabilities, liabilities to employees, claims on critical services and interbank liabilities with a maturity of under seven days would be excluded from bail-in. The DGSD, which proposed that deposit guarantee schemes across the EU be harmonised to include an ex-ante fund amounting to 0.8% of covered deposits, is also due to be formally agreed soon. Separately, the Council agreed its position on the Single Resolution Mechanism (SRM), proposing that resolution powers be entrusted to a resolution board, and that a €55bn Eurozone-wide resolution fund be established, financed by a bank levy. The fund will initially consist of national compartments, which will be gradually merged over a ten-year period. Proposals for the SRM are now to be negotiated in trialogues between the Council, the Parliament and the European Commission and, while still controversial, there is a commitment that the SRM will be formally agreed before May 2014.

The Committee on Payment and Settlement Systems (CPSS) and IOSCO consulted on the assessment methodology for the oversight expectations applicable to critical services provided by third-parties to Financial Market Infrastructures (FMIs), set out in the CPSS-IOSCO principles for FMIs.

Regulatory perimeter

Following stakeholder concerns, HMT said it would relax certain transitional rules for alternative investment fund managers (AIFMs). AIFMs that submit applications for authorisation or registration by the 22 July deadline, and where the FCA is unable to assess the application ahead of the end of the transitional year, will be able to continue managing AIFs, while still being expected to comply with the new rules. Please see our blog for further details.

IOSCO published a final report on regulatory issues raised by changes in market structure. It found that in many jurisdictions, competition had increased and new trading spaces had developed. However, it noted the rising trend in fragmentation of equity markets, recommending that regulators monitor the impact of fragmentation on market integrity, efficiency, trade information, order handling, best execution and access to liquidity. IOSCO also published a report on the impact of trading fee models on trading behaviour. While it considered this a "very useful fact-finding exercise", IOSCO did not propose any new recommendations, principles or further work on the topic.

Following an investigation throughout 2013, ESMA published an assessment on Credit Rating Agencies, concluding that, while there were some good practices, there were deficiencies related, in particular, to conflicts of interest, the role of senior management and the involvement of sovereign analysts, as well as to timing and confidentiality of sovereign ratings. ESMA has not established whether any of its observations constituted a breach of the CRA Regulation. ESMA also published a calculation of the market share of registered CRAs.

Rethinking the domestic and international architecture for regulation

The European Supervisory Authorities (ESAs) issued a joint opinion on the functioning of the European Systemic Risk Board (ESRB), which is currently under review. The ESAs said that the institutional design and mandate of the ESRB should not be changed, but suggested that the ESRB needed to broaden its focus beyond banking and that, in some cases, "the ESAs would have appreciated greater support from the ESRB in clarifying macro-prudential issues relevant for supervisory decisions".

The FSB published its annual update on global adherence to regulatory and supervisory standards on international cooperation and information exchange. Of the 61 jurisdictions evaluated by the FSB, 45, including the UK, demonstrated sufficiently strong adherence to the relevant standards, and 14 others were taking the actions recommended by the FSB but had yet to demonstrate sufficiently strong adherence. Elsewhere, Venezuela was identified as non-cooperative and Libya has been temporarily suspended from the evaluation process.

Danièle Nouy, until recently Secretary General of the French Prudential Supervision and Resolution Authority (Autorité de Contrôle Prudentiel et de Résolution), was formally appointed as Chair of the Supervisory Board of the Single Supervisory Mechanism (SSM) at the European Central Bank (ECB).

Disclosure, valuation and accounting

The EBA published various documents related to disclosure. These included a follow-up report on banks' Pillar 3 disclosures. There were 19 banks included, and the EBA said that some specific improvements notwithstanding, the general picture remained unchanged, with no bank fully meeting all the requirements. The EBA also consulted on disclosure of encumbered and unencumbered assets, with a view to creating a harmonised framework for information gathering, and on harmonised definitions and templates for funding plans of credit institutions. Finally, it published its draft technical standards on supervisory disclosure and on the reporting of the hypothetical capital of a Central Counterparty.

The EBA published the outcome and data of the 2013 EU-wide transparency exercise, covering capital, RWAs, and sovereign exposures of the 64 banks that were part of the 2012 recapitalisation exercise. The EBA said that the results demonstrated a "continued positive trend" in capital positions, with Common Equity Tier 1 (CET1) increasing by over €80bn between December 2011 and June 2013, and RWAs down €817bn: capital ratios thereby increased from 10% to 11.7%. However, the share of sovereign bonds held by domestic banks in countries "under stress" had increased "markedly" since December 2010.

The EBA published the XBRL taxonomy to be used for supervisory reporting by regulatory authorities. The taxonomy covered reporting requirements relating to own funds, financial information, data on losses, large exposures, leverage ratios, and liquidity ratios. The EBA noted that some regulators also used the XBRL format for gathering information from firms, and that where this was the case, the harmonised format "is therefore expected to lead to greater efficiency and lower costs" for firms.

In a final publication of a series of Mortgage Market Review (MMR) policy documents, the FCA issued its rules on data collection, to come into effect on 1 January 2015. The FCA will require product sales data to be submitted quarterly, with performance data related to product sales sent in every six months. The rules also introduced a set of changes to the existing mortgage lenders and administrators return (MLAR).

Information security and data privacy

The Information Commissioner's Office (ICO) fined First Financial, a payday loans company, £175,000 for sending millions of unlawful spam texts. In light of the fine, ICO Director of Operations, Simon Entwisle, confirmed that the regulator would continue to target companies that send unlawful spam texts and that he was "currently speaking with the government to get the legal bar lowered" allowing action to be taken "at a much earlier stage."

Bank systems are susceptible to cyber-attacks, and large numbers of businesses could face increasing costs if vulnerabilities in IT systems are exploited by hackers, according to the Bank of England's latest Financial Stability Report. The warning followed concerns the Bank raised in a survey in June last year. Within the report the Bank stated that several banks have experienced cyber-attacks over the past six months, highlighting weaknesses in information security controls.

Financial crime

The FCA fined JLT Speciality Limited, a provider of insurance broking and risk management services, over £1.8mn for failing to have in place appropriate checks and controls to manage the risk of bribery or corruption when making payments to overseas introducers.

The FCA banned a former Mizuho International trader from working in the financial services sector for misleading the authority during an investigation into alleged market abuse.


The Financial Policy Committee released a record of its meeting held on 20 November 2013, at which the housing market topped its list of concerns, and macroprudential tools in relation to mortgages, such as caps on loan to value and loan to income ratios, were discussed. One new recommendation was made, with the FPC recommending that the FCA require mortgage lenders to "have regard to" any future FPC recommendations on interest rate stress tests to use in affordability assessments. The FPC also said that on leverage the language of 'frontstops' and 'backstops' was "potentially unhelpful". Please see our blog for more details.

HMT published a UK insurance growth action plan. Within it, it committed to streamlining the authorisation process for prospective insurance applicants; proactively targeting insurers to move their domicile to the UK and considering options to grow the market in Islamic insurance and improve the attractiveness of the UK market. HMT also emphasized the importance of insurers as providers of long-term finance to the economy. Now that the treatment of long-term investments under Solvency II has become clearer, six UK insurers will be delivering £25bn of investment in UK infrastructure over the next five years.

ESMA appointed 30 new members of the Securities Markets Stakeholders Group, drawn from across 17 Member States and "representing ESMA's key stakeholder constituencies".

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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