UK: Risk And Regulation Monthly - March 2014

Last Updated: 29 April 2014
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

March saw a number of important developments in the area of conduct risk, with the FCA releasing several thematic reviews and market studies in the run up to the publication of its Risk Outlook, and taking over responsibility for consumer credit regulation. In the EU, Omnibus II was formally approved and political agreement on the Single Resolution Mechanism reached.

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 Standards (BCBS) published the results of its June 2013 monitoring exercise. The aggregate capital shortfall continued to fall, with the largest international banks facing a €57.5bn gap relative to a 7% Basel III capital ratio, 50% lower than six months earlier, although the shortfall rose at a "small number of banks". The leverage ratio at the largest banks averaged 4%, although this figure did not reflect the most recent amendments to the metric: the risk-based capital ratio was more constraining than the leverage ratio for "close to three quarters" of the 227 banks surveyed. 72% of the banks had a liquidity coverage ratio above 100%, with the aggregate shortfall standing at €536bn (0.9% of total assets). The EBA (European Banking Authority) reported on the equivalent figures for the European banking system: these too showed improvements in average capital ratios.

The BCBS finalised the standardised approach for measuring counterparty credit risk in relation to derivatives.

The new approach is intended to differentiate between margined and un-margined trades, and provide more meaningful recognition of netting. A number of adjustments from the earlier consultation were made, including more detail on complex instruments, and adjustments to the calibration of the approach for foreign exchange, credit and some commodity derivatives. The new approach is scheduled to take effect from January 2017.

The International Organization of Securities Commissions (IOSCO) published a comparative analysis of prudential standards in the securities sector, given concerns about regulatory arbitrage, level playing fields, and the supervision of cross-border groups. The report highlighted the challenge in making numerical comparisons of prudential frameworks across borders, particularly given the scope for supervisory discretion: as such the relative stringency of national regimes was difficult to assess. Comments were invited on the paper, which will be used to update IOSCO's 1989 report on capital standards.

The EBA published its final draft regulatory technical standards (RTS) on own funds, setting out harmonised criteria for including certain types of capital instruments in Core Equity Tier 1 capital. The EBA also published final draft RTS on prudent valuation, setting out a methodology to calculate "additional valuation adjustments" for determining the prudent value of fair valued positions. There are two approaches: a simplified approach for institutions with relatively low holdings of assets and liabilities that are fair valued; and a 'core approach' for other institutions. The average adjustment would be around €227mn, or 0.07% of the value of fair-valued positions on banks' balance sheets.

A Delegated Regulation supplementing the Capital Requirements Regulation (CRR) with regard to RTS for own funds was also published in the EU Official Journal.

The European Commission published nine CRD IV RTS: on material exposures and thresholds for internal approaches to specific risk in the trading book; close correspondence between the value of an institution's covered bonds and its assets; non-delta risk of options in the standardised market risk approach (also Annex 1 and Annex 2); information that home and host authorities should exchange; materiality of extensions and changes of the Internal Ratings Based Approach and the Advanced Measurement Approach (also Annex); the definition of market; the proxy spread and limited smaller portfolios for credit valuation adjustment risk; instruments that adequately reflect the credit quality of an institution as a going concern to be used for variable remuneration; and requirements for investor, sponsor, original lenders and originators relating to exposures to transferred credit risk.

The EBA consulted on draft RTS specifying conditions under which competent authorities may permit institutions to use data covering two rather than five years, when implementing the Internal Ratings-Based (IRB) approach. Data waivers may encourage migration to the IRB approach, but also increase uncertainty in the estimation of risk parameters, and so the EBA proposes to introduce conditions for their use by excluding low-default portfolios and restricting the application of the data waiver to a limited proportion of assets; applying an appropriate margin of conservatism to parameter estimates; and ensuring an enhanced data vetting process. After five years, a sufficient data history should be available and permission for the data waiver should no longer be granted.

The European Parliament adopted the Omnibus II Directive on 11 March, confirming the 1 January 2016 implementation deadline for Solvency II. In the UK, the Prudential Regulation Authority (PRA) consulted on its expectations for technical provisions and internal models for insurers. The statement covered assumptions and methods to be used in calculating technical provisions, requirements for data used, and valuation standards.

The International Association of Insurance Supervisors (IAIS) launched the first Quantitative Impact Study (QIS) for the Basic Capital Requirements (BCR) for Global Systemically Important Insurers (G-SIIs). The QIS, data for which are to be submitted between May and August 2014, provides details on the derivation of the base balance sheet, available capital resources and the stresses to be performed on the balance sheet. The IAIS also published responses to its first BCR consultation, outlining various areas for further consideration, including the definitions of non- traditional, non-insurance activities, and how BCR will feed into capital requirements under ComFrame, which will be applicable to a broader set of internationally active insurers.

The EBA reported on the different leverage definitions in Basel III and the CRR, recommending the Commission align the EU definition of the leverage exposure measure to the revised Basel III framework.

The Financial Policy Committee (FPC) agreed terms of reference for a review of the leverage ratio, to be completed by November 2014. This will examine the relationship between the leverage and risk-weighted measures, international developments, the definition and design of the ratio, and standards for ring-fenced banks.


The BCBS agreed that supervisors may allow banks to apply a 0% risk weight to claims on the European Stability Mechanism (ESM) and European Financial Stability Facility (EFSF). This treatment implies that such claims can be included as Level 1 High Quality Liquid Assets for the purpose of the Liquidity Coverage Ratio.

The EBA published final draft technical standards on aspects of the liquidity framework, including derogations for countries where demand outstrips the supply of liquid assets, and whose banks may therefore face difficulties meeting liquidity coverage requirements. It also published final draft RTS on the treatment of collateral outflows caused by the effect of adverse market conditions on banks' derivatives transactions. A historical 'look back' approach will set a floor for minimum additional collateral outflows, while an internal model-based method is available for banks with large derivatives portfolios.

Governance and risk management (including remuneration)

Katharine Braddick, the PRA's Director for Prudential Policy, outlined various challenges with respect to the overhaul of the approved persons regime. The PRA is considering how to pitch the framework at "the most senior people who can meaningfully be held responsible" for what happens in the firm. It will be a challenge to ensure minimum standards are in place while enabling firms to operate their businesses as they see fit. Transitional issues were also raised: it would be a "huge operational exercise" to re-assess all those who are senior managers under the new regime, but 'grandfathering' of the whole population would not be appropriate, as some assessments under the old framework "were inappropriate". The PRA will issue a consultation in the summer, and final rules by the end of 2014.

To strengthen the remuneration code, the PRA consulted on proposals to introduce clawback provisions in relation to vested bonus awards, for a period of up to six years. Under the proposals, clawbacks would apply in cases of a material downturn in financial performance or a material risk management failure at the firm or relevant business unit, and would also capture employee failures, including indirect responsibility through role or seniority.

In a letter to the Treasury Committee, Bank of England Governor Mark Carney said that the PRA planned to consult on implementation of a revised Remuneration Code by August 2014.

The European Commission adopted RTS on the criteria for the identification of material risk takers in banks and investment firms, who were subject to EU variable remuneration rules. The new methodology will be applied to all institutions subject to CRD IV and will capture staff members based on their role and decision-making power or the level of total remuneration in absolute or relative terms. Those with total annual remuneration exceeding €500,000 and the top 0.3% of staff with highest remuneration will be caught. The EBA also published its final guidelines on the applicable notional discount rate for variable remuneration.

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