UK: Top 10 For 2015 - Our Outlook For Financial Markets Regulation

Last Updated: 27 January 2015
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017


Will 2015 be the turning point in the post-crisis re-regulatory agenda, when the focus shifts from repairing balance sheets and reputations to the role of financial services in promoting jobs and growth? And from proposing new rules to implementing the multitude already agreed over the last few years?

There are grounds for cautious optimism. On the banking front, the vast majority of the new primary requirements are now in place (with the important exception of EU bank structural reform), although there are still reviews of various elements of the existing capital framework and a significant amount of implementing detail to come. After a very lengthy gestation, preparations for Solvency II will enter their final year. The new European Commission and Parliament will push ahead with work to decide what falls under the umbrella of the Capital Markets Union (CMU). Recognition of the need for capital markets and non-bank finance to contribute to the jobs and growth agenda could influence the approach that would otherwise have been taken to deal with concerns about shadow banking. Indeed, the Financial Stability Board (FSB) now speaks about "transforming shadow banking" into "resilient market-based finance."

There will be new institutions making a fresh start, and they will be determined to make their presence felt. The European Central Bank (ECB) via the Single Supervisory Mechanism (SSM) has taken over as the prudential supervisor of eurozone banks. The new Single Resolution Board (SRB) will look at the resolvability of the cross-border eurozone banks, informed by the lessons learned from the FSB's first set of resolvability assessments for Global Systemically Important Banks (G-SIBs). In the UK, the new Banking Standards Review Council (BSRC) will aim to draw a line under past misconduct and reset standards in banking, while the industry will also be looking ahead to the outcomes of the Fair and Effective Markets Review (FEMR). The UK parliamentary election in May will however inevitably add to uncertainty about the outlook for financial services regulation.

But there are clouds, some quite ominous, on the horizon. Standards and expectations have risen enormously across the board for all financial services firms – whether in terms of capital, liquidity, risk management or culture – and financial and other penalties for transgressions seem to be rising inexorably. The effects of this will continue to be felt, for instance through the "de-risking" which has been prompted by a number of anti-money laundering (AML) and sanctions-related enforcement cases, with some institutions reassessing their risk appetites and exiting certain markets.

Despite some aspects having been closed, residual enforcement actions by regulators, law enforcement agencies and competition authorities in relation to LIBOR and FX benchmarks appear to have some way yet to go, and some of the behaviour revealed has reignited concerns about governance, culture and the structure of remuneration. In this regard, supervisors will remain vigilant and intrusive in a year when the new Senior Managers Regime comes into effect in the UK. Further, even if the balance is shifting from policy formulation to action and implementation, regulation will continue to occupy significant resources and senior management time, including building relationships with the new institutions. In particular, although primary legislation is in place for most of the new EU Regulations and Directives initiated by the last European Commission and Parliament, the European Supervisory Authorities (ESAs) still have to publish a formidable amount of detailed implementing standards. There will be plenty of devils lurking in these details.

Against this background, firms will have to take some key strategic and business model decisions about which activities and products remain viable in a world of new, and in the case of banks, multiple regulatory constraints on balance sheets – in many cases, the finalisation of requirements will crystallise the need for action. Banks will be most affected, but Solvency II will raise similar questions for some insurers.

This new regulatory environment will create opportunities and challenges both for incumbents and newcomers. Set against that, digital innovation will be a potent force, with the potential to transform the financial services landscape – and who the winners and losers are – beyond any regulatory effect. Accompanying this opportunity is a threat – that of cyber-attack. For the Board and senior management teams all this puts an ever greater premium on the clarity and rigour of their scenario analysis and contingency planning, underpinned by high quality data, and timely decision-taking. In a world where firms may more readily be allowed to fail, and with "challengers" knocking at many doors, agility and forward-thinking will be key.

1. Structural reform and resolution in the banking sector

Sector impact: Banking, Capital Markets and Insurance

Requirements for banks to ring-fence some of their activities have been debated for several years, but relatively little progress on implementation has been demanded. In 2015 this will change. In the UK, the largest banks must in January submit preliminary plans for how they will implement ring fencing. The largest foreign banks operating in the US are required to submit plans for the implementation of Intermediate Holding Company structures.

Banks in scope of domestic structural reform requirements in France and Belgium also face important deadlines. Planning is not easy; supervisors will expect banks to demonstrate a thorough understanding of their objectives and requirements, and a credible strategy. But lack of planning will not be judged acceptable.

Restructuring to meet authorities' expectations of resolvability will also be important. The initial results of the FSB's Resolvability Assessment Process (RAP) were published at the end of 2014, providing the first assessment of the progress that has been made to date by 10 out of the 30 G-SIBs (the remainder will be reviewed by mid 2015). The FSB notes that although some G-SIBs are making their legal entity structures less complex, further structural and operational changes may be needed. We expect that booking models will need to adjust and there will be a continuing focus on operational continuity for functions judged to be critical. There is also important unfinished business for some Governments in terms of putting new resolution legislation in place. Next year will also see a second wave of filings of recovery and resolution plans (RRPs) by banks in the US, where regulators took a tough line in 2014. Resolvability planning will also get underway in the EU as the Bank Recovery and Resolution Directive (BRRD) takes effect and the SRB starts to operate. Combining ring-fencing and resolvability considerations will add a layer of complexity to the strategic challenge for banks. Banks will also need to consider how other rules (including OTC derivatives reform) and supervisory policies (such as increasing scrutiny of intra group transactions) play into their analysis.

Against this background, significant uncertainty hangs over EU requirements for bank structural reform. Proposals unveiled in January 2014 are proving contentious and are expected to remain so as the European parliamentary process continues. Fundamental questions remain unresolved and some will (continue to) argue that the proposal is unnecessary for structures that are indeed resolvable, but it would be unusual for the proposal to be withdrawn. The derogation for national frameworks looks under threat, and it is unclear whether a workable compromise can be reached.

All this makes planning very difficult, yet domestic legislative timetables in some countries will force banks to take some decisions now. The key will be to do so in a way that retains some flexibility to make future adjustments.

Structural reform also applies on a geographic basis. Although the UK's Prudential Regulation Authority (PRA) has taken steps to clarify its risk appetite for non-EEA banks operating as branches in the UK, some uncertainty remains because application of the policy will be on a case-by-case basis. We expect the PRA's first priority to be those branches of non-EEA banks which accept significant amounts of retail deposits. Those banks which find themselves outside the PRA's risk appetite will either need to reduce their activities or convert their branch into a subsidiary. Similar themes can be observed in some other jurisdictions.

It is not only banks facing resolution requirements. Financial Market Infrastructures and some insurers also face similar questions. The European Commission continues to work on its framework for central counterparty (CCP) resolution, which the new Commissioner for financial services has said will be "one of [his] first priorities". CCPs will also be faced with a new international disclosure standard, and it has even been suggested that a new loss-absorbency requirement could be looked at, although it is unclear how such a requirement would be translated from banks to CCPs. At the international level, Global Systemically Important Insurers (G-SIIs) were originally expected to have RRPs in place by end-2014, although the FSB's RAP report makes it clear that this timetable has been extended. The FSB has set out an ambitious work programme on insurance resolution for 2015, although it is still far from clear how much effort national authorities will put into this and, eventually, how much structural change emerges. One acid test will be the speed with which national authorities look to incorporate the FSB's Key Attributes for the effective resolution of insurers into their domestic legislation.

2. New institutions in action

Sector impact: Banking, Capital Markets, Insurance and Investment Management

2014 saw important institutional changes in the EU. In 2015 the implications for financial services will begin to play out. A new guard in the European Commission and Parliament, for the first time since the financial crisis, may dedicate a larger share of the financial services agenda to promoting growth through alternatives to bank financing than to the "safety and soundness" considerations that dominated their predecessors' work. A similar change in emphasis was signalled by Mark Carney, chair of the FSB, after the recent G20 meeting.

In the EU, a new focus on non-bank forms of finance to promote jobs and growth, as part of this the CMU, may influence proposals for dealing with shadow banking. What happens on the proposed Money Market Funds (MMF) Regulation will give one early indication of how this balance will be struck.

In the eurozone, the start of the SSM initiates a journey that will test banks and supervisors. The ECB will work hard to instil a new supervisory culture and good practice across the region. It will be important for banks to engender dialogue, trust and a strong understanding of their business with supervisors. New supervisory expectations will be important drivers of business strategy. We expect the first half of 2015 to be dominated by dealing with issues highlighted by the Comprehensive Assessment, with some of the more difficult or complex aspects informing longer-term supervisory actions. Consistency of risk-weighted assets, and model validation, will be important topics for thematic work by SSM supervisors in the coming year. More broadly, harmonising the discretions available to supervisory authorities across the Eurozone is high on the ECB to-do list. The Supervisory Risk Evaluation Process (SREP) will become an increasingly important part of the dialogue between banks and supervisors.

The SRB, part of the Single Resolution Mechanism (SRM) within the Banking Union, remains an unknown quantity but will wield significant power. From January 2015, it will begin working with national authorities on resolution planning, resolvability assessments and the setting of loss absorbency. This new institution has received relatively little attention to date – given the significance of its influence this needs to change in 2015.

In the UK, the Payments Systems Regulator (PSR), a subsidiary of the Financial Conduct Authority (FCA), will begin regulating in 2015. It has been established to address concerns that have been raised about a number of issues in the payments industry, including access to the UK payments systems, the terms offered for access, and the industry's pace of innovation.

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