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Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
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Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
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Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
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Risk management presentation May 20 2013
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Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
Risk management presentation May 20 2013
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Risk management presentation May 20 2013

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International Association of Risk and Compliance Professionals (IARCP) …

International Association of Risk and Compliance Professionals (IARCP)
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  • 1. P a g e | 1International Association of Risk and ComplianceProfessionals (IARCP)1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750 www.risk-compliance-association.comTop 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped theweeks agenda, and what is nextDear Member,Whichisthe differencebetween triggersandvulnerabilities?Dear Mr Bernanke, can you clarifyplease?He did, at the 49thAnnual Conferenceon Bank Structure andCompetition sponsored by theFederal Reserve Bank ofChicago, Chicago, IllinoisHe said:―Torespond tothispoint, I will distinguish, asI haveelsewhere,betweentriggersand vulnerabilities.Thetriggers of anycrisis aretheparticular eventsthat touch off thecrisis--theproximatecauses, if you will.For the2007-09crisis,a prominent trigger wasthe lossessufferedbyholdersof subprime mortgages.In contrast, the vulnerabilities associated with a crisis are preexistingfeatures of the financial system that amplify and propagate the initialshocks.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 2. P a g e | 2Examplesof vulnerabilitiesincludehigh levelsof leverage, maturitytransformation,interconnectedness, andcomplexity, all ofwhichhavethepotential tomagnify shocksto the financial system.Absent vulnerabilities,triggersmight produce sizablelossestocertainfirms, investors,orassetclassesbut wouldgenerallynot leadtofull-blownfinancial crises;thecollapseof the relativelysmall market for subprimemortgages,for example, wouldnot havebeen nearly asconsequentialwithout preexistingfragilitiesin securitizationpracticesand short-termfundingmarketswhichgreatly increased its impact.‖Did you addressvulnerabilitiesthis week?Mr Bernanke continued:―Moreover, attemptsto addressspecific vulnerabilitiescan besupplementedby broader measures--suchasrequiring banksto holdmore capital and liquidity--that makethesystem more resilient toarangeof shocks.‖Read moreat Number 1below.Welcometo the Top 10list.BestRegards,GeorgeLekatisPresident of the IARCPGeneral Manager, ComplianceLLC1200G Street NW Suite800,Washington DC 20005,USATel: (202) 449-9750Email: lekatis@risk-compliance-association.comWeb: www.risk-compliance-association.comHQ: 1220N. Market Street Suite804,Wilmington DE 19801,USATel: (302) 342-8828International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 3. P a g e | 3ChairmanBen S.BernankeAt the 49thAnnual Conferenceon Bank Structure andCompetition sponsored by theFederal Reserve Bankof Chicago, Chicago, IllinoisMonitoring the Financial System―We are now more than four years beyond themost intensephaseof thefinancial crisis,but itslegacyremains.Our economy hasnot yet fullyregained the jobslost in the recession thataccompaniedthe financial near collapse.And our financial system--despite significant healing over the past fouryears--continues to struggle with the economic, legal, and reputationalconsequencesof theeventsof 2007to2009.‖Erkki LiikanenBanking structure and monetary policy –what have we learned in the last 20 years?Presentation by Mr Erkki Liikanen, Governor oftheBank of Finland and Chairman of theHighlevel Expert Group on the structure of theEU banking sector, at the conference―Twentyyears of transition – experiencesand challenges‖,arranged by theNational Bank of Slovakia, Bratislava.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 4. P a g e | 4The impact of the crisison financial integrationin Central and Eastern EuropeSpeechby Mr IgnazioVisco, Governor of theBank ofItaly, at the conference―Twentyyearsof transition – experiencesand challenges‖, hostedbytheNational Bank of Slovakia, Bratislava―Thetransitioncountriesof Central and Eastern Europe werenoexception:their quiterapid financial integration over thepasttwenty-yearsbrought about lastingeconomicbenefits,but alsoleft themrelativelyexposedtothe global financial turmoil, in particular throughtheir linkswithWestern European bankswhichhold dominant stakesintheregion‘smarkets.‖Revised rulesfor markets in financialinstruments (MiFID/ MiFIR)a)Proposal for a Directiveof the EuropeanParliament and of theCouncil on marketsin financial instrumentsrepealingDirective2004/ 39/ EC of theEuropean Parliament and of the Council (Recast) (MiFID)b)Proposal for a Regulation of the European Parliament and of theCouncilon marketsin financial instrumentsand amending Regulation[EM IR] onOTC derivatives,centralcounterpartiesandtraderepositories(MiFIR)International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 5. P a g e | 5APRA releasessecondconsultation package for thesupervision of conglomerate groupsTheAustralian Prudential RegulationAuthority (APRA) hasreleased forconsultationproposed risk management and capital adequacyrequirementsfor thesupervision of conglomerategroups.Conglomerategroups, referredto asLevel 3 groups,are groupscomprisingAPRA-regulated institutionsthat perform material activitiesacrossmore thanoneAPRA-regulated industry and/ orin oneor morenon-APRA-regulated industry.GovernorElizabethA. DukeAt the Housing PolicyExecutiveCouncil, Washington, D.C.AView from the Federal Reserve Board:The Mortgage Market and HousingConditions―Sincejoiningthe Board in 2008amid a crisiscentered on mortgagelending, I have focusedmuch of my attentionon housingand mortgagemarkets,issuessurrounding foreclosures,and neighborhoodstabilization.In Marchof this year, I laid out my thoughtson current conditionsin thehousing and mortgagemarketsin a speechto theMortgageBankersAssociation.‖International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 6. P a g e | 6TheNeedfor Robust SEC Oversight of SROsBy CommissionerLuisA. AguilarU.S. Securitiesand ExchangeCommissionWashington, D.C.Proposal for a structuralreform of EU banks―There are concernsthat largeEU banking groups, are difficult tomanage, monitor, and supervise.Furthermore, theymay alsobe difficult to resolve, due to theircomplexity, interconnectedness, geographic scope, and abilityto expandrapidly.Also, theunrestricted co-minglingof depositssubject to governmentguaranteeswith market and tradingactivitiesmay subject depositorstoadditional risks.‖International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 7. P a g e | 7APRA releasessecond consultationpackage on Basel III liquidity reformsTheAustralian Prudential RegulationAuthority (APRA) hastodayreleaseda second consultationpackageoutliningits proposedimplementationof theBasel III liquidityreformsfor authoriseddeposit-takinginstitutions(ADIs) inAustralia.Thepackage includesa discussionpaper, a reviseddraft PrudentialStandardAPS210Liquidity(APS210) and a draft Prudential PracticeGuideAPG 210Liquidity.OTC derivatives statisticsat end-December2012Monetary and Economic DepartmentMay 2013―Notional amounts for interest rate derivatives, thelargest segment of the market, stood at $490 trillionat end-2012.While the overall figure wasmore or lessunchanged from end-June2012,breakdownsshowedoffsettingmovements.For swaps,notional amountsdropped in thesecond half of 2012by about2% to$370trillion, owingin part to the compressionof tradesthroughcentral counterparties(CCPs).‖International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 8. P a g e | 8ChairmanBen S.BernankeAt the 49thAnnual Conferenceon Bank Structure andCompetition sponsored by theFederal Reserve Bankof Chicago, Chicago, IllinoisMonitoring the Financial SystemWe are now more than four yearsbeyond the most intensephaseof thefinancial crisis,but itslegacyremains.Our economy hasnot yet fullyregained the jobslost in the recession thataccompaniedthe financial near collapse.And our financial system--despite significant healing over the past fouryears--continues to struggle with the economic, legal, and reputationalconsequencesof theeventsof 2007to2009.Thecrisisalsoengenderedmajor shifts in financial regulatorypolicyandpractice.Not sincetheGreat Depression have weseen suchextensivechangesinfinancial regulationasthose codifiedin the Dodd-Frank Wall StreetReform and Consumer ProtectionAct (Dodd-FrankAct) in theUnitedStatesand, internationally, in theBasel III Accord and a rangeof otherinitiatives.Thisnewregulatoryframeworkisstill underconstruction, but theFederalReservehasalreadymade significant changestohow it conceptualizesand carries out both itsregulatoryand supervisoryroleand itsresponsibilityto foster financial stability.In my remarkstoday I will discusstheFederal Reserves effortsin anareathat typicallygetslessattentionthanthewritingandimplementationof new rules--namely, our ongoing monitoring of thefinancial system.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 9. P a g e | 9Of course,the Fed hasalwayspaid closeattentiontofinancialmarkets,for both regulatory and monetary policy purposes.However,in recent years, wehavebothgreatlyincreasedtheresourceswedevotetomonitoring and taken a more systematic and intensiveapproach,ledbyourOffice ofFinancialStabilityPolicy andResearchanddrawingonsubstantial resourcesfrom acrosstheFederalReserveSystem.This monitoring informs the policy decisions of both the Federal ReserveBoard and the Federal Open Market Committee as well as our work withother agencies.Thestep-up in our monitoring is motivatedimportantlybya shift infinancial regulationand supervisiontoward a more macroprudential, orsystemic, approach, supplementingour traditional microprudentialperspectivefocused primarily on thehealth of individual institutionsandmarkets.In thespirit of thismore systemic approachtooversight, theDodd-FrankAct created the Financial Stability Oversight Council (FSOC), whichiscomprised of theheadsof a number of federal and state regulatoryagencies.TheFSOC hasfostered greater interactionamong financial regulatoryagenciesaswell asa senseof common responsibilityfor overall financialstability.Councilmembersregularlydiscussriskstofinancial stability andproducean annual report, whichreviewspotential risksand recommendsways tomitigatethem.TheFederal Reserves broad-based monitoring effortshave beenessential for promotinga closeand well-informedcollaborationwithother FSOC members.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 10. P a g e | 10AFocus on VulnerabilitiesOngoingmonitoringof the financial system isvital to themacroprudential approach to regulation.Systemic riskscan onlybe defused if theyare first identified.That said, it is reasonable to ask whether systemic risks can in fact bereliably identified in advance; after all, neither the Federal Reserve noreconomistsin general predicted the past crisis.Torespond tothis point, I will distinguish, asI have elsewhere,betweentriggersand vulnerabilities.Thetriggers of anycrisis aretheparticular eventsthat touch off thecrisis--theproximatecauses, if you will.For the2007-09crisis,a prominent trigger wasthe lossessufferedbyholdersof subprime mortgages.In contrast, the vulnerabilities associated with a crisis are preexistingfeatures of the financial system that amplify and propagate the initialshocks.Examplesof vulnerabilitiesincludehigh levelsof leverage, maturitytransformation,interconnectedness, andcomplexity, all ofwhichhavethepotential tomagnify shocksto the financial system.Absent vulnerabilities,triggersmight produce sizablelossestocertainfirms, investors,orassetclassesbut wouldgenerallynot leadtofull-blownfinancial crises;thecollapseof the relativelysmall market for subprimemortgages,for example, wouldnot havebeen nearly asconsequentialwithout preexistingfragilitiesin securitizationpracticesand short-termfundingmarketswhichgreatly increased its impact.Of course, monitoring can and doesattempt to identify potentialtriggers--indicationsof an asset bubble, for example--but shocks of onekind or another are inevitable,soidentifying and addressingInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 11. P a g e | 11vulnerabilitiesis keyto ensuringthat thefinancial system overall isrobust.Moreover,attempts toaddressspecific vulnerabilitiescan besupplementedby broader measures--suchasrequiring banksto holdmore capital and liquidity--that makethesystem more resilient toarangeof shocks.Twoother related pointsmotivate our increasedmonitoring.Thefirst isthat the financial system is dynamic and evolving not onlybecauseof innovation and the changingneedsof the economy, but alsobecausefinancial activitiestend to migrate from more-regulatedtoless-regulatedsectors.An innovativefeatureof the Dodd-FrankAct isthat it includesmechanismsto permit the regulatorysystem, at leastin somecircumstances, to adapt tosuchchanges.For example, theact givesthe FSOC powerstodesignatesystemicallyimportant institutions,market utilities,and activitiesfor additionaloversight.Such designationisessentiallya determinationthat an institutionoractivitycreatesor exacerbatesa vulnerability of thefinancial system, adeterminationthat canonlybemadewithcomprehensivemonitoring andanalysis.Thesecond motivation for more intensivemonitoring is the apparenttendencyfor financial market participantsto take greater riskswhenmacro conditionsare relatively stable.Indeed, it may be that prolonged economic stability isa double-edgedsword.Tobe sure, a favorableoverall environment reducescredit riskandstrengthensbalancesheets,all elsebeingequal, but it could alsoreduceInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 12. P a g e | 12theincentivesfor market participantsto take reasonableprecautions,which may lead in turn toa buildup of financialvulnerabilities.Probablyour best defenseagainst complacencyduring extendedperiodsof calm is careful monitoring for signsof emergingvulnerabilitiesand, whereappropriate,the development of macroprudential and otherpolicytoolsthat can be used to addressthem.TheFederal Reserves Financial StabilityMonitoring ProgramSo, what specificallydoesthe Federal Reserve monitor?In the remainderof my remarks, Ill highlight and discussfourcomponentsof the financial system that are among thosewefollowmostclosely: systemicallyimportant financial institutions(SIFIs), shadowbanking, asset markets, and thenonfinancial sector.Systemically Important Financial InstitutionsSIFIs are financial firms whosedistressor failure hasthepotential tocreatebroaderfinancialinstabilitysufficient toinflict meaningful damageon thereal economy.SIFIs tend tobe large, but sizeisnot theonlyfactor used to determinewhethera firm is systemically important; other factorsincludethefirmsinterconnectednesswith the rest of the financial system, the complexityand opacityof itsoperations, thenature and extent of itsrisk-taking, itsuseof leverage, its reliance on short-term wholesalefunding, and theextent of its cross-border operations.Under the Dodd-Frank Act, the largest bank holding companies aretreatedasSIFIs; in addition, asI mentioned, theact givestheFSOC thepowertodesignate individual nonbank financial companiesassystemicallyimportant.This designationprocessis under way.Dodd-Frank alsoestablishesa framework for subjectingSIFIstocomprehensivesupervisoryoversight andenhancedprudential standards.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 13. P a g e | 13For all such companies, the Federal Reserve will have accesstoconfidential supervisoryinformation and will monitorstandard indicatorssuch asregulatory capital, leverage, and fundingmix.However,some of thesemeasures, such asregulatory capital ratios, tendtobe backward lookingand thusmay be slow to flagunexpected, rapidchangesin the condition of a firm.Accordingly, wesupplement the more standard measureswithothertypesof information.Onevaluablesourceof supplementaryinformation is stresstesting.Regular, comprehensivestresstestsare an increasinglyimportantcomponent oftheFederalReservessupervisorytoolkit, havingbeenusedin our assessment of largebank holdingcompanies since2009.Toadminister a stresstest, supervisorsfirstconstruct a hypotheticalscenario that assumesa set of highly adverseeconomicand financialdevelopments--for example, a deep recessioncombined withsharpdeclinesin thepricesof housesand other assets.Thetestedfirmsandtheir supervisorsthenindependentlyestimatefirmsprojectedlosses, revenues,and capital under the hypotheticalscenario, and the resultsare publicly disclosed.Firms are evaluatedboth on their post-stresscapital levelsand on theirabilityto analyze their exposuresand capital needs.Stresstestingprovidesa number of advantagesover more-standardapproachestoassessingcapital adequacy.First, measuresof capital based on stresstestsare both more forwardlookingand more robust to"tail risk"--that is,toextremelyadversedevelopmentsof the sort most likely tofoster broad-basedfinancialinstability.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 14. P a g e | 14Second, becausetheFederalReserveconductsstresstestssimultaneouslyon themajor institutionsit supervises, theresultscan be used both forcomparativeanalysesacrossfirmsand tojudge thecollectivesusceptibilityof major financial institutionstocertaintypes of shocks.Indeed, comparativereviewsof largefinancial institutionshave becomean increasinglyimportant part of the Federal Reserves supervisorytoolkit more generally.Third, the disclosureof stress-testresults,whichincreasedinvestorconfidenceduring the crisis, can alsostrengthen market disciplineinnormal times.Thestressteststhusprovidecritical informationabout keyfinancialinstitutionswhile alsoforcing thefirms toimprovetheir abilitytomeasure and managetheir risk exposures.Stress-testingtechniquescan alsobeused in more-focusedassessmentsof thebankingsectors vulnerability tospecificrisksnot captured in themain scenario, such asliquidityrisk or interest rate risk.Like comprehensivestresstests, such focused exercisesare an importantelement of our supervisionof SIFIs.For example, supervisors are collecting detailed data on liquidity thathelp them compare firms susceptibilities to various types of fundingstressesand toevaluate firms strategiesfor managingtheir liquidity.Supervisorsalsoareworking with firms toassesshow profitability andcapital wouldfare under variousstressful interestrate scenarios.Federal Reserve staff members supplement supervisoryand stress-testinformation with other measures.For example, though supervisorshave long appreciated thevalue ofmarket-basedindicatorsin evaluatingtheconditionsof systemicallyimportant firms(or, indeed, any publicly traded firm), our monitoringInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 15. P a g e | 15program usesmarket information toa much greater degreethan in thepast.Thus, in addition tostandard indicators--suchasstock pricesand thepricesof credit default swaps,whichcapture market viewsaboutindividual firms--weuse market-basedmeasuresof systemic stabilityderivedfrom recent research.Thesemeasuresusecorrelationsof asset pricestocapture themarketsperceptionof agivenfirmspotential todestabilize thefinancialsystem ata timewhenthebroader financial marketsare stressed; other measuresestimatethe vulnerability of a given firm to disturbancesemanatingfromelsewherein the system.Thefurther development of market-based measuresof systemicvulnerabilitiesand systemic riskis a lively area of research.Networkanalysis, yet another promisingtool under activedevelopment, hasthepotential tohelp usbetter monitor theinterconnectednessof financial institutionsand markets.Interconnectednesscan arisefrom common holdingsof assetsor throughtheexposures of firms to their counterparties.Networkmeasuresrely on conceptsused inengineering, communications,and neurosciencetomap linkagesamong financial firmsand market activities.Thegoalsare toidentify keynodesor clustersthat could destabilizethesystem andtosimulatehowashock, suchasthesuddendistressofafirm, could be transmitted and amplified through the network.Thesetoolscan alsobe usedtoanalyze the systemic stabilityeffects of achangein thestructure of a network.For example, margin rules affect the sensitivity of firms to the conditionsof their counterparties; thus, margin rulesaffect the likelihood of financialcontagion through various firms and markets.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 16. P a g e | 16Shadow BankingShadowbanking, a second area wecloselymonitor, wasan importantsourceof instability during the crisis.Shadowbanking comprisesvariousmarketsand institutionsthat providefinancial intermediationoutsidethetraditional, regulated bankingsystem.Shadowbanking includesvehiclesfor credit intermediation, maturitytransformation, liquidityprovision, and risksharing.Such vehiclesaretypicallyfunded on a largely short-term basisfromwholesalesources.In the run-up to the crisis, theshadowbankingsector involved a highdegreeof maturitytransformation and leverage.Illiquid loanstohouseholdsand businessesweresecuritized, and thetranchesof thesecuritizationswith thehighestcredit ratingswerefundedbyvery short-termdebt, such asasset-backedcommercial paper andrepurchaseagreements(repos).Theshort-term fundingwasin turn provided by institutions,such asmoneymarket funds, whoseinvestorsexpected payment in full ondemand and had littletolerance for risk toprincipal.As it turned out, theultimateinvestorsdid not fullyunderstand thequalityof theassetsthey werefinancing.Investorswerelulledby triple-Acredit ratingsand by expected supportfrom sponsoring institutions--support that was, in fact, discretionaryandnot alwaysprovided.When investorslostconfidencein the qualityof the assetsor in theinstitutionsexpected to provide support, theyran.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 17. P a g e | 17Their flight createdseriousfunding pressuresthroughout thefinancialsystem, threatenedthesolvency of many firms, and inflictedseriousdamageon thebroader economy.Securitiesbroker-dealersplay a central role in many aspectsof shadowbankingasfacilitatorsof market-basedintermediation.To finance their own and their clients securities holdings, broker-dealerstend to rely on short-term collateralized funding, often in the form of repoagreementswithhighly risk-averselenders.Thecrisisrevealed that thisfundingis potentiallyquitefragile if lendershavelimitedcapacityto analyze the collateral or counterpartyrisksassociated withshort-term secured lending, but rather look at thesetransactionsasnearlyrisk free.As questionsemerged about the nature and value of collateral, worriedlenderseithergreatlyincreasedmargin requirementsor,morecommonly, pulledback entirely.Borrowersunableto meet margin callsand financetheir asset holdingswereforced to sell, drivingdown asset pricesfurther and settingoff acycle of deleveragingand further asset liquidation.Tomonitorintermediationbybroker-dealers,theFederalReservein 2010created a quarterlySenior Credit Officer OpinionSurvey on DealerFinancingTerms,whichasksdealersabout thecredit theyprovide.Modeledon the long-established Senior Loan Officer Opinion Survey onBank LendingPracticessent to commercial banks,the survey of seniorcredit officers at dealerstracks conditionsin marketssuch asthoseforsecuritiesfinancing, prime brokerage, and derivativestrading.Thecredit officer survey isdesigned to monitor potential vulnerabilitiesstemmingfrom thegreater use of leverageby investors(particularlythrough lendingbacked by less-liquid collateral) or increasedvolumesofmaturitytransformation.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 18. P a g e | 18Beforethefinancialcrisis, wehad onlyverylimitedinformationregardingsuch trends.We have other potential sourcesof informationabout shadow banking.TheTreasuryDepartments Officeof Financial Research and FederalReservestaff are collaboratingto construct data setson triparty andbilateral repotransactions,which should facilitatethedevelopment ofbetter monitoring metrics for repoactivityand improvetransparencyinthesemarkets.We alsotalk regularlyto market participantsabout developments,payingparticular attention tothe creationof new financial vehiclesthat fostergreater maturity transformation outsidethe regulatedsector, providefundingfor less-liquid assets,or transform risksfrom formsthat are moreeasilymeasuredtoforms that are more opaque.Afair summary isthat, while the shadow banking sector is smaller todaythan beforethecrisisand some of its least stablecomponentshave eitherdisappeared or been reformed, regulatorsand theprivatesector need toaddressremainingvulnerabilities.For example, although money market fundswerestrengthenedbyreforms undertakenby the Securitiesand ExchangeCommission (SEC)in 2010,thepossibilityof a run on thesefundsremains--forinstance, if afund should "break thebuck," or report a net asset value below99.5cents, astheReservePrimary Fund did in 2008.Theriskisincreasedbythefactthat theTreasurynolongerhasthepowertoguarantee investors holdingsin money funds, an authoritythat wascritical for stoppingthe 2008run.In November 2012, the FSOC proposed for public comment somealternativeapproachesfor the reform of money funds.TheSEC iscurrentlyconsideringtheseand other possiblesteps.With respect to thetripartyrepoplatform, progresshasbeen made inreducingthe amount of intradaycredit extendedbytheclearingbanks inInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 19. P a g e | 19thecourse of the dailysettlement process,and, asadditionalenhancementsare made, the extension of such credit should be largelyeliminated by the end of 2014.However,important risks remain in theshort-term wholesalefundingmarkets.Oneof the keyrisksis how the system wouldrespond to the failure of abroker-dealer or other major borrower.TheDodd-Frank Act hasprovidedimportant additional toolstodeal withthisvulnerability, notablytheprovisionsthat facilitatean orderlyresolutionof a broker-dealeror a broker-dealer holding companywhoseimminent failure posesa systemic risk.But, ashighlightedin the FSOCsmost recent annual report, more workisneededtobetterprepareinvestorsandothermarket participantstodealwith the potential consequencesof a default by a largeparticipant in therepo market.Asset MarketsAsset marketsare a third area that wecloselymonitor.We followdevelopmentsin marketsfor a widerangeof assets, includingpublic and private fixed-incomeinstruments,corporateequities, realestate,commodities,and structured credit products,amongothers.Foreign as well as domestic markets receive close attention, as do globallinkages, such as the effects of the ongoing European fiscal and bankingproblemson U.S.markets.Not surprisingly, wetry toidentifyunusual patternsin valuations,suchashistoricallyhigh or low ratios of pricesto earningsin equitymarkets.We usea varietyof modelsand methods;for example, weuseempiricalmodelsof default risk and risk premiumsto analyze credit spreadsincorporatebond markets.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 20. P a g e | 20Theseassessmentsare complementedby other information, includingmeasuresof volumes, liquidity, and market functioning, aswell asintelligencegleanedfrom market participantsand outsideanalysts.In light of the current lowinterest rate environment, wearewatchingparticularlycloselyfor instancesof "reaching for yield" and other formsof excessiverisk-taking, whichmay affect asset pricesand theirrelationshipswithfundamentals.It is worthemphasizingthat lookingfor historicallyunusual patternsorrelationshipsin asset pricescan be useful even if you believe that assetmarketsare generallyefficient in setting prices.For thepurposeof safeguarding financial stability, weare lessconcernedabout whether a given asset price isjustified in some averagesensethanin thepossibilityof a sharpmove.Asset pricesthat arefar from historicallynormal levelswouldseem tobemore susceptibletosuch destabilizingmoves.From a financial stability perspective, however, theassessment of assetvaluationsis onlythefirst step of theanalysis.Also to be considered are factorssuchasthe leverageand degree ofmaturitymismatch beingusedby theholdersof the asset, the liquidityoftheasset, and the sensitivityof the assetsvaluetochangesin broadfinancial conditions.Differencesin thesefactorshelp explainwhythecorrection in equitymarketsin 2000and2001didnot inducewidespreadsystemicdisruptions,while the collapsein housepricesand in thequalityofmortgagecredit during the2007-09crisis had much more far-reachingeffects:Thelossesfrom thestockmarket declinesin 2000and 2001werewidelydiffused, while mortgagelosseswereconcentrated--and, through variousfinancial instruments,amplified--incriticalparts of the financialsystem, resultingultimatelyin panic, asset fire sales,and the collapseofcreditmarkets.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 21. P a g e | 21Nonfinancial SectorOur financial stabilitymonitoring extendsto thenonfinancialsector, includinghouseholdsand businesses.Researchhasidentified excessivegrowthin credit and leveragein theprivatenonfinancial sector aspotential indicatorsof systemic risk.Highlyleveragedorfinanciallyfragile householdsandbusinessesare lessableto withstand adversechangesin incomeor wealth, includingthosebrought about bydeterioratingconditionsin financialandcredit markets.Ahighly leveraged economy isalsomore pronetoso-calledfinancialacceleratoreffects,aswhenfinanciallystressed firms are forced to layoffworkerswho, in turn, lackingfinancial reserves,sharplycut their ownspending.Financial stressin the nonfinancial sector--for example, higher defaultrateson mortgagesor corporatedebt--canalsodamage financialinstitutions,creatinga potential adversefeedback loop astheyreducetheavailability of credit and shed assetsto conserve capital, therebyfurtherweakeningthefinancial positionsof householdsand firms.The vulnerabilities of the nonfinancial sector can potentially be capturedby both stock measures (such as wealth and leverage) and flow measures(such asthe ratio of debt serviceto income).Sector-widedata are available from a number of sources,importantlytheFederal Reservesflowof fundsaccounts,whichis a set of aggregateintegratedfinancial accountsthat measuressourcesand usesof fundsformajor sectorsaswell asfor the economy asa whole.Theseaccountsallowustotrace the flow of credit from itssources,suchasbanks or wholesalefundingmarkets,tothehousehold and businesssectorsthat receiveit.TheFederal Reservealsonowmonitorsdetailed consumer- andbusiness-leveldata suitedfor pickingup changesin the nature ofInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 22. P a g e | 22borrowingand lending, aswell asfor trackingfinancial conditionsofthosemost exposedtoa cyclical downturnor a reversal of fortunes.For example, duringthehousing boom, the aggregate data accuratelyshowedthe outsized pace of home mortgageborrowing, but it could notreveal the pervasivedeterioration in underwritingthat implied asubstantial increasein the underlying credit riskfrom that activity.Morerecently, gainsin household net worthhave been concentratedamongwealthier households, whilemany householdsin themiddleorlowerpartsof the distribution have experienceddeclinesin wealthsincethecrisis.Moreover,many homeownersremain "underwater," with their homesworthlessthan theprincipal balanceson their mortgages.Thus, more detailed information clarifiesthat many householdsremainmore financiallyfragile than might be inferred from theaggregatestatistics alone.ConclusionIn closing, let me reiteratethat while the effectiveregulation andsupervision of individual financial institutionswill alwaysbe crucial toensuring a well-functioningfinancial system, the Federal Reserve ismovingtowardamoresystemic approachthat alsopayscloseattentiontothevulnerabilitiesof thefinancial system asa whole.Towardthat end, weare pursuing an activeprogram of financialmonitoring, supportedby expanded researchand data collection, oftenundertaken in conjunction with other U.S.financial regulatoryagencies.Our stepped-up monitoring and analysisis alreadyprovidingimportantinformation for the Board and the Federal Open Market Committeeaswell asfor thebroader regulatory community.We will continue to worktoward improving our ability to detect andaddressvulnerabilitiesin our financial system.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 23. P a g e | 23Erkki Liikanen: Banking structureand monetary policy – what havewe learned in the last 20 years?Presentation by Mr ErkkiLiikanen, Governor of the Bank ofFinland and Chairman of theHighlevel Expert Group on thestructure of the EU bankingsector, at the conference―Twentyyears of transition –experiencesand challenges‖,arranged bytheNational Bank ofSlovakia, Bratislava.How is today‘s perspectiveon monetarypolicy different from whatprevailed 20 years ago?Twentyyears ago, the worldof todaywasbeingformed in manyways.1993wasthe year whenthe Economic and MonetaryUnion project wasbecomingpolitical reality: theMaastricht treatyhad been signedand wasin theprocessof beingratified.It wasalsothetime whenthe mainstream approach to monetary policywasbeginningto convergetothe flexibleinflationtargetingframework.Anumber of countrieshad then just adopted an explicit inflationtargetingstrategy.In the sphere of banking regulation, too, a new era wasbeginning.Asignificant reorientationwasgoingon, awayfrom regulating theconduct of banks and towardsthe new risk-basedapproach.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 24. P a g e | 24Theregulatory trend, based on increasedfreedom for banksbut subjecttorisk based capital requirements, wouldcontinueall the wayto theeruption of the financial crisisin 2008.In theEU, thesecondbankingdirectivetookeffectfrom thebeginningof1993,creatinga singlemarket in banking.Thedirectivesought to prevent discriminationand to increase efficiencythrough competition.There wasdiscussionontheimplicationsof thisfor supervision, but littleaction.So, whileEuropean bankingmarketswerebeingintegrated, financialsupervision remained a national competence.In the U.S., deregulation wasalsomoving forward.For instancethe Glass-SteagallAct, separatingbanking from securitiesand insurance, wasunder growingcriticism and wouldbe ultimatelyrepealedin 1995.One reason for the dissatisfaction with the Glass-Steagall system in theUS was competition from European banks which were less restricted inwhat theycould do.Twentyyears ago, the striking improvement in macroeconomicperformance,laternamed―thegreat moderation‖ bychairmanBernanke, wasspreadingtothewholedeveloped world.Thealmost surprising successof monetary policy in improving pricestability and reducingfluctuationsin economic activity, while alsokeepinginterest ratesat historicallylowlevels, wasinterpretedasa majorvictoryfor theart of economicpolicymaking.Now weknow that there wastroublebrewingunder the surface.Theunderpinningsof global financial stabilitywerebecoming weaker.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 25. P a g e | 25Global indebtednessincreased, fuelledby current account balancesandthe―deepening‖ of international financial markets(read: recycling thesamefundsseveral timesover).Thedecline of inflation wasnot only due to monetary policy, but alsotheavalancheof cheap consumer goodsfrom theemerging economiessuchasChina contributed to it.For banks, the new financial environment wascharacterizedby lowinterest ratesand low perceivedrisks.It alsoturned out that the new risk-basedcapital requirementsallowedthe banks to expand their balancesheetsenormouslywithout increasingtheir equitycapital in the same proportion.So, graduallythe largebanking groupsstarted to increasetheir tradingportfolios.This development happened in a gradual fashion in the 1990‘sbutaccelerateddramaticallyfrom about 2004.Banks redirected their businessfocusfrom interest marginstofee-basedandtrading activities.Universal banking, asit had been knownin Europe, startedtochange.Theasset mix of thelargest banks changedsothat securitiesportfoliosactivitiesgrew more and more important.Onlynow, from theperspectivegiven by theworstfinancial crisis sincetheSecond World War, doweseeclearlythefragility and weaknessof theregulatoryarrangementswhichcame intoforce in the 1990s.From today‘spoint of view, theyperformed wellonly aslong asnomajorsystemic risksmaterialized.Even worse,theyallowedriskstoaccumulate in the financial systemwhichwereonly waitingtobe realized.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 26. P a g e | 26Thencame 2007andthecollapseof theUS property market;2008and thecollapseof interbank moneymarketsfollowingthe Lehman Brotherscrisis;and 2009withThe Great Recession.Thepainful processof competitivedeleveragingstarted.Thereassessment of economicpoliciesfollowedin the lasttwodecadeshasalsostarted.Especiallyfinancial regulationhasbeenreconsideredand is beingstrengthened.We needto think of monetary policy, too, especiallyin itsconnection tofinancial stability.Monetary policy and financial stabilityThere is a common dictum that a stable financial system is a necessarycondition for successful monetary policy, and that price stability in turncreatesthe best preconditionsfor financial stability.I agree.Still, the experienceof this crisishasthought usa lot more.First of all, wenow know that pricestability doesnot by itself guaranteefinancial stability.Riskscan accumulate in thebankingsystem even if monetary policysucceedsin maintainingprice stability and controllinginflationaryexpectationsreallywell.Second, wealsoknow that central bankscan maintain an admirabledegreeof pricestabilityeven whenfinancial stabilityis under a lot ofstrain.Dothesetwopointsmean that financial stability and monetary policyarenot connected after all?International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 27. P a g e | 27No.Theyare very closelyrelated.Independence of monetary policyOneof the lastinglessonslearned in thelast decadesis the value of theindependenceof monetary policy.The independence of central banks has been essential keeping inflationexpectations as well anchored as they have been in this crisis despite alltheturmoil in the financial markets.Independencehasalsomade it easierfor central banksto act quicklywhenit hasbeen necessaryin order tomaintainfinancial stability.It is especiallyimportant to avoid twothreats toindependence:fiscaldominanceand financial dominance.Fiscaldominanceisthe older concept of thetwo.It wouldarise if thegovernment financing constraint wouldbecome anoverridinginfluenceon monetary policy.Theideaof fiscal dominancewasformalizedby Tom Sargent and NeilWallacein 1981,but of coursethe worrythat deficit financingmay causeinflationhasmuch longer rootsin monetarythought.Theideathat tight monetary policy may become impossiblewithoutaccompanyingfiscal adjustment wasalsowellunderstood whentheblueprintsfor the EMU werebeingprepared.ThisiswhytheMaastrichttreatyhaditsfiscalpolicyclausesandalsowhytheStabilityand GrowthPact wasconcluded.Also the prohibitionof direct central bank credit to the government andtheinstitutional independenceof thecentral banks are in effectprotectionsagainst fiscal dominance.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 28. P a g e | 28Now weknow, of course,that the fiscalframeworkasput in placebeforethestart of the EMU wasnot strong enough to prevent fiscal problemsfrom emerging.Somehave argued that fiscaldominancehas takenhold in thein thebigindustrializedcountries during the crisiswhen thecentral banks haveused government bond purchasesin order tostabilize the markets(astheECB) or to produceadditional monetary stimuluswhenthe interest rateinstrument hasalreadybeen used tothemaximum (like theFederalReserveand the Bank of Japan).As to the euroarea, for me there is nownoevidenceof fiscaldominance.Fiscaldominanceimpliesthat monetary policy wouldbreak its pricestability objectivefor the sakeof maintainingthesolvencyof thegovernment sector.This is not the case.Price stabilityhasnot and will not be abandoned.We have well knownfiscal problemsin some of the euro area countries.Still, theECB‘sability togoon maintainingprice stabilityhasnot beenweakened.In particular theinflation expectations,whichare themost essentialindicatorsof thecredibility ofmonetarypolicy, haveremainedwellin linewith the pricestability objective.Theparallel ideaof financial dominanceis more recent than fiscaldominance.Financial dominancerefers tothepossibilitythat thecondition of thebankingsystem could become a constraint, or dominant influence,onmonetary policy, effectivelyforcing the central bank topursuesecond- orthird-best monetary policiesin order tomaintainfinancial stability.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 29. P a g e | 29Is thespill-over from financial instabilityto monetary policy a realisticthreat?Can financial stabilityconsiderationslead the central bankstotoleratetoohigh inflation, just to keep the banking sector afloat?In principleit is easyto see whyit could be.Onecanimagineacentralbank whichwouldhavetotightenitsmonetarypolicy for pricestabilityreasons,but isprevented from doing sofor thefearthat thevalueof theassetsof thebankingsystem woulddecreaseanda financial crisiscould ensue.Episodeswhichfit the description of financial dominancehave beenobserved in emergingeconomiesafter some banking crisesin thepast.But lookingat recent experience, thishasnot been the casein thedeveloped economies.Thebust of thecredit boom hasnot ledmonetary policy totolerate ahigher-than-mandatedrate of inflation.Instead, in the largedeveloped economiesat least, theburstingof thebubblehascoincidedwith a sudden contractionof privatedemand and adeep recession.Thenegativeeffect of thebust on economicactivityhasactuallyreducedinflationarypressuresand in some cases(such asin Japan in the1990‘s)created a real danger of deflation.Themain problem hasthenbecomehowtoprevent thecredit contractionfrom startinga deflationaryspiral.In such conditions,the same monetarypolicy will then both easethestrain onthe bankingsector and support price stability.Thisobservationdoesnotmeanthat financialinstabilitywouldnotposeaseriouschallengetomonetary policy.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 30. P a g e | 30On the contrary, thedownwardimpact of a bust, if it is large, may bemore difficult tocontrol than the precedingperiod of credit expansion.There was a famous discussion on how monetary policy should relate toasset prices in the Jackson Hole conference of 2007, where Rick Mishkinintroduced thetopic.At that time, the prevalent thinkingin central bankingcircleswaswhatprofessor Issinglater called ―theJacksonHole consensus‖, meaning thatit is better for monetary policy onlyto ―clean‖ (up afterwards)than to―lean‖ (againstthe wind).After thehard lessonswelearned over thelast five years thecaseforbenign neglect of asset boomsand only pickingup the piecesafterwardsis not sostrong anymore.Thecrisisexperiencesupportsrather theidea that financial excessesarebetter prevented astheyhappen than onlymanaged after theyhavecauseda recession.This wouldbe thebest wayto prevent ―downwardfinancialdominance‖whichcould ariseif monetary policy could not effectivelycounteractcredit contraction.Unconventional toolsand the independence of monetary policyRecent experienceshowsthat thecentral banks‘box of potential toolsisactuallyvery deep, and if it hasbecomenecessarytoutilizeunconventional tools,asin thepresent crisis, thesenew toolshave beendeveloped and deployed.In the caseof theECB, the new toolshave included the transitiontofullallotment auctions,thelong term refinanceoperationsup tothreeyears, wideningof the scope of eligible collateral, and the variousbondpurchaseprogrammes.Themost recent oftheseistheOMT programmeannouncedlastsummerbut not yet commenced in practice.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 31. P a g e | 31Thedevelopment of new toolshasbeen justified.The slip of the depressed economies to dangerous deflation has beenaverted, and the debt and banking problems have not developed intosystemic financial meltdownsin the affected countries.We have seen that central bankscan pursuesuccessful price stabilitypolicy alsounder very difficult conditions.Theeventsaround the worldsincethecollapseof Lehman Brothersareevidenceof that.Deflationhasbeen avoided despitea severe recession in many countries.However,there are alsocertain problemswithrelying on theenlargedtoolkit of the central banks.Theabilitytoact in crisishasled to thecentral banksbeingeven called―theonlygame in town‖.We should resist thisideaand bewareof thedanger that problemswhichare fundamentallypolitical could be pushedtocentral banksto solve.Adivision of responsibilitiesbetweenappointed officialsand electedpoliticiansshould be preserved.Monetarypolicycannot administer the needed structural transformationin thereal sector of theeconomy or solve excessivedeficit problemsofgovernments.There aresituationswherethe central banks just haveto act and do theirbest to stabilize the economy, even if they wouldhave to use tools whichgobeyond just adjustingthe short rate of interest or the aggregateliquidityof thebanking system.Thepresent financial crisishasconstitutedone such situation.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 32. P a g e | 32Avoiding the bustswhichseem to followcredit boomsand periodsof―financial exuberance‖wouldmake thetasksof monetary policy mucheasierand protect the independenceof central banks.But there are alsodifficultieswith theleaningagainst the wind.Onehasto dowiththe problem of detectingthe credit cycle in time, andcorrectlytiming themonetary policy response.Another problem is that price stability might get lessattention.To mitigate these problems, something else besides more vigilant interestrate policy is needed to prevent low and stable interest rates from leadingtoexcessesin banksand financial markets.Onedevelopment can be thedevelopment of macro-prudentialinstrumentswhichare designed to improve the stability of the financialsystem asa whole.Themajor workin this fieldwasdonebythedeLarosière group.Otmar Issingwasa member of thegroup.Especially interesting are those macro-prudential instrumentswhich havea time dimension so that they can be adjusted according to the changingsituationin the credit markets.Such instrumentsinclude, in particular, thecountercyclical capitalrequirements,aswell astheadjustablerestrictionson Loan-to-Valueratios.TheCRD IV directivewill make theformer instrument obligatoryin theEU countries; implementationof the latter is left to national discretion.Now it is very important to establishan effectivetoolkit for bothEuropean and national authorities.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 33. P a g e | 33We must alsocreateinstitutional conditionswhichdonot prevent thesetoolsto beused when needed.Therefore, weneed cleardecision makingcompetencesat all levels.Theconnectionbetweenmacro-prudential policy and itstime dimensionwith monetary policyis sointimatethat central banksmust be closelyinvolved in macro-prudential analysis and decisionmaking.Macro-prudential policy is important, but it needsto be supportedbystructural reformswhichwouldmake thebanking system moreresilient, and - I emphasise- lesspronetounstablebehaviour.The Structural reform proposalsIn order toprevent the present crisisfrom being everrepeated, governmentsand authoritieshave started a large-scaleoverhaul of financial regulation.Theregulatory agenda can be broadly dividedintothe followingareas:•Strengtheningof the prudential regulation of solvencyand liquidity• Improvingtheinstitutionalbasisforsupervisionandcrisismanagement•Introduction of macro-prudential instrumentstoprevent systemic risksin thebankingsystem and financial markets• Regulatingthe structureof the banking sectorThestructural reform proposalswhichappear asthe last item on thislistaim toseparate the riskiest securitiesand derivativesbusinessfrom thedeposit banking activities.This is theessential content of theproposalsby theEU High LevelExpert Group, whichI chaired, publishedlast autumn.It is alsoat thecore of the Volcker rule whichis beingimplemented inInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 34. P a g e | 34theUS, and the Vickersproposal in theUK.Thecurrent legislativeproposalswhichare underwayin FranceandGermanyare alsoin thesamevein.Aparticular concern of theseproposalshasbeen tolimit theextent ofexplicit or implicit public guarantees,sothat theywouldnot induceadditional risk taking.This kind of competitivedistortion could result in securitiestradinggettingconcentratedin the largest deposit banks, and thesedepositbanksbecoming enormousrisk concentrations built on implicit or evenexplicit public guarantees.Separation proposalstry to isolatesecurities businessfrom thesourcesofthisdistortion and reducethe incentivesto excessiverisktaking and riskconcentration.In must be emphasized that the structural reform weproposed is not acure-all but should be seen asa part of a comprehensive regulatoryagendawhich isalreadymoving forward.This includesbetter solvencyand liquidityrules.Also, theEU will finallyget supervisionand resolution frameworksat theunion level.Thedifferent componentsof thecurrent regulatory agendacomplementand support each other.In thisEuropean context, thestructureandstabilityof thebankingsectoris of vital importanceto the economy.It is imperativeto improve itsresiliency.TheHigh Level Expert Group report containsfive mainrecommendationson how to reform thebankingsector.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 35. P a g e | 35I will just refer tothreeof them here:•Thefirst is toseparate any significant proprietary tradingin securitiesandderivativesfrom deposit banks.These activities could be carried out in a separately capitalized andfunded subsidiary, a trading entity, which could belong to the samebankinggroup asthedeposit bank.We proposed that alsomarket making be allocated to thetradingsubsidiary in order toprevent the useof tradinginventoryto circumventthe prohibition on proprietary trading.•The use of trading subsidiaries would allow the banking groups to offer―one-stop banking‖ to their clients, but without the possibility of fundingtradingactivitieswithinsuredretail deposits.Financial linkagesbetweenthe deposit bank and the trading unit wouldhaveto be restrictedin accordancetonormal largeexposure rules.•Another of our proposalsisto develop specific, designatedbail-ininstrumentsto improve the lossabsorbencyof banks.Arequirement to issuesuch bail-in debt wouldhelp ensure theparticipationof investorstothe recapitalizationof a bank if this shouldbecomenecessary.Such designatedbail-in instrumentswouldclarifythe hierarchyof debtcommitmentsand allowinvestorstopredict theeventual treatment of therespectiveinstrumentsin caseof recapitalizationor resolution.•Thegroup alsoproposedthat thecapitalrequirementsontradingassetsand real estaterelated loansbe reviewed.Both of theseasset categoriescame to have very low risk weightsin theBasel II regime, mostlybecausethewayinternal models wereapplied.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 36. P a g e | 36Whybanking structure mattersfor monetary policyLet me recapitulatemy main points.First, for monetary policy, financial stabilityis very important.While monetarypolicyhasproventobeabletopursuepricestabilityevenunder rather strained financial conditions,the central banksare not abletoinsulatethe real economy completelyfrom theafter-effectsof financialcrises.Amore stablebanking sector whichis lessprone tocrisiswill reducethelikelihoodof crisesand thereforeprotect thebalancesheetsof the centralbank from financial risksand therebyprotect itsindependenceandcredibility.Second, themost important part of stability policy is crisisprevention.Improvinglossabsorbencyof banks and thecrisismanagement powersof the authorities arenecessary, but it is even more important to makesure that excessivegrowthof credit and indebtednesscan bebettercontrolledin the future.In this way, credit crunchesand bankingcrisescan be made lesslikely –andmilder, should theyhappen.Third, financial stability wouldbenefit from structural reform of thebankingsystem.By separatingthe most riskysecurities and derivativeactivitiesfromdeposit banking, thespill over from deposit protection tospeculativerisktakingwouldbe prevented.This would reducethe distorted incentivestoexpand tradingactivitiesand concentraterisksin deposit banksbecauseof their privilegedpositionin the deposit market.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 37. P a g e | 37Finally,thestructural reform ofbankingisacomplement, not asubstitutefor other regulatory improvements.For central banks, thedevelopment of macro-prudential policiesandinstrumentsisespeciallyrelevant.Thosemacro-prudential instrumentswhich can be adjustedover time tomanagethe conditionsin the credit market will offer a waytobettercontrol the accumulation of excessriskand help prevent future crises.Theseinstrumentsoperatesocloseto monetary policythat central banksshould be very closelyinvolved, if not themselvesresponsible, indeveloping and using them.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 38. P a g e | 38Theimpact of the crisison financialintegration in Central and Eastern EuropeSpeechbyMr IgnazioVisco, Governor of theBankof Italy, at theconference―Twentyyearsoftransition– experiencesandchallenges‖, hostedbythe National Bank of Slovakia, Bratislava.I wishtothank for useful discussion and helpEmidio Cocozza, PaoloDel Giovane and ValeriaRolli.IntroductionTheglobal financialcrisishasbeen severeand widespread, and hasaffected different economiesin different and long-lastingways.Thetransition countries of Central and Eastern Europe werenoexception:their quiterapid financial integration over thepasttwenty-yearsbrought about lastingeconomicbenefits,but alsoleft themrelativelyexposedtothe global financial turmoil, in particular throughtheir linkswithWestern European bankswhichhold dominant stakesintheregion‘smarkets.Financial stability hasonce again become a fundamental objectiveofpolicy making, and central banksare beingheavily involved in thisendeavor.This callsfor a substantial overhaul in financial regulation andsupervision.Thefinancial system of tomorrow will be different from theone that hasdeveloped over the last twodecades.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 39. P a g e | 39Global financial integration during the past decadeIn the decadebeforethefinancial crisisboth the sizeof the financialsystem and itsroleand pervasivenessin the economy increaseddramatically.Theprocesshasonlysloweddown sincethe crisis.In theeuroarea,theoverall amount offinancialresourcescollectedbytheprivate sector(bank credit, bondsissued domesticallyand stock marketcapitalization) rosefrom 160per cent of GDP in 1996to240in 2007, andthen declinedto230in 2011.Asimilar pattern is found for theUnitedStates,wherethe ratio rose from230percent in1996to330in 2007andthendeclinedto260in 2011(Fig. 1).Driven by thebreakthroughsin informationtechnologyandtelecommunicationsand theprocessof financial integration, thesupplyof derivativesproducts, the securitizationof banks‘assets,together withthegrowth of so-calledstructured financial instruments, expandedconsiderably.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 40. P a g e | 40Thetotal outstandingnotional amount of over-the-counter(OTC) andexchange-tradedderivativeshasrisenfromabout 94trillionU.S.dollarsattheend of 1998to around 670trillion at the end of 2007, hovering aroundthat level afterwards(Fig. 2).An important dimensionof thisprocesshasbeen the increasedinternational financial integration.In the last decade industrial countries‘ gross external financial assets andliabilities more than doubled in proportion to GDP, reaching 440 per centat the end of 2007(Fig. 3).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 41. P a g e | 41Thedevelopment of financial marketsin emerging economieshasalsobeen dramatic.Theoverall amount of financial resourcescollectedby the private sector(outstandingstocksof bank credit, domestic debt securitiesand equitymarket capitalization) increased from about 120to230per cent of GDPbetween1996and 2007for the averageof emergingAsia, and from about40toalmost 100per cent for the averageof CEE countries (Fig. 4).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 42. P a g e | 42International financial integration – withforeign direct and portfolioinvestmentsand theinvolvement of foreign banks in domesticfinancialsystems– washelped bythe removal of earlier obstacles: macroeconomicinstability, vulnerableexternal positionsand inefficient institutional andregulatorysetups.Sincethe mid 2000s,this processwashugely supportedby exceptionallyfavorableglobal financial conditions,withabundant liquidity, lowriskaversion, and fallinglong-term interest rates.Financial integration in Central and Eastern EuropeThetransition countries in Central and Eastern Europe weretherecipientsof a largeinflux of internationalcapital, mostly flowingin fromWestern Europe.Between 2003 and 2008 capital inflows reached sustained levels – morethan 12 percent of GDP on average – well above the overall average foremergingmarket countries (about 6 percent) (Fig. 5).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 43. P a g e | 43Transition countrieswereperceivedasattractiveoutlets:potential highreturns,underpinnedby relatively lowwagesand capital-outputratios,weremagnified bythe prospectsfor faster income convergenceentailedby theeconomicand institutional developmentsin thecontextof EU membership, and by theexpectationsof rapid interest rateconvergencelinkedtothe eventual euro adoption.Financial integration in the CEE hastended tobe quiteunique.International banksplayed a fundamental role indeed in spurringfinancial integrationin the region.In the years running up tothe global financial crisis, Western Europeanbanksexpanded rapidly, gaininglarge market sharesthrough theirsubsidiariesand branches,up to about 80 percent of total banking assetsby2008.Theentryof foreign intermediarieswithlong-term strategicgoalsandtheensuingprofound transformation of theownership structure of bankingsystemsin CEE countrieswasacrucialelement of disciplineandstabilityin breaking theviciouscycle of systemic bankingcrisesandmacroeconomicvolatility that had characterizedthe earlyyearsoftransition.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 44. P a g e | 44It isgenerallyacceptedthat internationalfinancialintegrationhastendedtoplay a positiverolein the long-term economicconvergenceprocessinCEE transition countries:Long-term per capitaGDP growth in theregion beforethe crisiswaspositivelycorrelatedwith conventional measuresof financialintegration, such asthe ratio of grossforeign assetsand liabilitiestoGDP(Fig. 6).Thecorrespondingevidencefor other emergingareastendsto be lessclear cut.Theaforementionedfavourablefeature possiblyreflectsthe interactionwith institutional convergence, implicit in theEU accessionprocess, asakey contributingfactor.Thankstothis uniqueand favourablecombination, financial integrationin itselfmostlikelyactedasacatalystforthedevelopment ofthedomesticfinancial sector and the adoption of structural reformsto strengthen theinstitutional framework.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 45. P a g e | 45Yet a balancedaccount of the processof financial integrationin thisregion should not overlook its drawbacksin termsof excessive, cheaplending, currencymismatchesand demand overheatingin theyearsrunningup tothe crisis.Between2003and 2008, many economiesrecordedrapid importgrowth, real estatebubblesand wageincreaseswell above productivitygains– sometimesrooted in overly optimistic expectationsof fastincomeconvergence.Inflationarypressuresspilled over intothetradablesector and worsenedexport performance.Balanceof paymentscurrent account deficitswidened(Fig. 7).Several countriesbuilt up high external debt levels (Fig. 8), largely privateand denominated in foreign currency, making them vulnerable to capitalflowreversalsand currencydepreciation.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 46. P a g e | 46When theeffectsof the global crisisreachedthe CEE countries, theireconomieswerehit by a sharp declinein capital inflowsand the ensuingslowdownin bank credit (Fig. 9).Notwithstandingconcernsregarding a possiblemeltdownof domesticfinancial systems drivenby a run for theexit of foreign banks, aInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 47. P a g e | 47fully-fledgedfinancial crisis– similar to the oneswhichoccurred in EastAsia in 1997–98– did not materialize.Overall, theregion even experienced, in the first phaseof thecrisis, a lessseverereversalof capital flowsthan other emergingareas.In some cases(Hungary, Latvia and Romania) largeinternationalfinancial support by theEU and themain international financialinstitutions(IFIs) wasa key factor in avoidingthe worst;coordinationeffortsby home and host country authorities, IFIs and multinationalbanks,in the context of theVienna Initiative, alsohelped preventcollectiveaction problemsthat could have triggered the dreadedmassivewithdrawal from thesemarketsby foreign banks.There is evidencethat foreign banksthat participated in the ViennaInitiativewererelativelystablelenders.Moreover,thedistinctivemodel of financial integrationin the CEE region– whereforeign banks operatemainlythrough their localsubsidiariesandbranchesin the retail market – probablyprovided a high degreeof risksharingandstabilityduringthecrisis, asparent banksweregenerallylesssensitivetoinformation asymmetry and counterparty credit risk and morecommitted tolong-term market prospects,given theimportant sunk costsassociatedtothesestructures.This comparesfavourably tothepattern prevailingin the other EUcountries,whereexternalborrowingbydomestic banksoccursmainlyviacrossborder wholesalemarkets.Thedifferent intensityof the boom-bust cycle observed acrossthe CEEcountriessuggeststhat, in addition totheinfluenceof specificstructuralfeatures(such asdifferencesin startingincome levels,international tradeand financial links),domestic policy had a role, although capital inflowsofthemagnitudesobserved in theregionin therun uptotheglobal crisiswouldcertainlyhavestrainedany toolkit availabletonational policymakers.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 48. P a g e | 48Monetaryand exchangerate regimesmost likely played a critical roleindeterminingthe country‘sabilityto counteract the effectsof capitalinflows, asthere weredifferencesin the size of the internal and externalimbalancesbetweenfixed and floatingexchangerate countries.Indeed, countriesadoptinga fixed exchangeregime experiencedmorepronouncedcredit booms, higher inflationratesand larger accountdeficitsthan the averagefor floatingexchangesregimecountries.Yet, the assessment of thecontribution of the exchangerateregimeremainsan open issue, asit isunclear towhat extent themostpronouncedboom-bust cycle wasmainlydriven by thefixedexchangeregimeper seor by the inconsistencyof theoverall policy mix pursued incountrieswherethissettingwasin place;in particular, a stricter fiscalstanceand a better framework of macroprudential policy could have atleast partlycompensated for theabsenceof exchangerate flexibility.As for monetarypolicy, theexperienceof CEE countriestendstoconfirmthat in small, financiallyopen economiesit is a lesseffectivelever forrestraining credit booms.This is thecaseeven for floatingexchangeregimes, asanumbers offactors– currencysubstitutionin the form of balancesheet effectsassociated withinitial high euroization, or theshiftstoforeign-currency-denominatedlending– could restrain the effectivenessof monetarypolicy tightening, or even reverseitsintended effects.This underscorestheimportanceof maintainingprudent fiscal stancesduring credit booms.Indeed, in the run up to thecrisis,headlinefiscal positionsremainedbroadlybalanced in most CEE countries; yet theseoutcomeswerefrequentlythe result of exceptional revenuesassociatedtocyclicaldemand and asset price booms.Onceadjusted for thelatter underlying fiscal positionslooked much lesshealthy.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 49. P a g e | 49Onerecognizes, in retrospect, theneed for aconservativeapproachin theassessment of tax revenuesduring a boom phase,and theuseful roleofautomatic stabilizers(particularlyincome taxesand welfarespending) inorder to increasefiscal policy flexibilityand dampen economicfluctuations.In additiontostandard macro policy tools,CEE countriesalsoadoptedawiderangeof prudential actionsbeforethe last global crisis.Prudential instrumentshave the potential to prevent or contain systemicfinancial risksin theupswings(affectingtheincentivesassociatedwithasset pricebooms, foreign exchangelending, excessiverisk takingandthe erosion of lendingstandards) and alsoto build buffersthat cancushionthe impact of downturns.In general the evidenceisthat thesemeasuresproduced theintendedeffectsin the short run, but theysometimesfailed to have a long lastingimpact on credit dynamics.Indeed, in some instancescircumventionthrough direct cross-borderfinancingand/ or lendingfrom nonbank (unregulated) financialintermediariesproved to be a major issue; this hasbeen thecaseforexamplefor measuresconsisting in direct limitson credit growth.Amore effectiverolein containing systemic financial riskshasbeenplayed by measuresspecificallydevisedtobuild liquidityandloss-absorbingcapital buffers,such asreserve and capital requirements.Moreover, when appropriately formulated, prudential regulations helpedto curb the growth of foreign exchange loans and to keep related defaultrateslowerduring thecrisis.Lessons learnt from the global crisis: in search of betterregulationGlobal financial deepeningand international integrationhasallowedgreaterrisk sharingandhasmadefinanceaccessibletolargernumbersofInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 50. P a g e | 50countries,householdsand firms, thusbeinginstrumental to broadeningeconomicdevelopment.But an interlinkedand more connectedfinancial system heightenstherisk that contagion setsoff and spreadsmore widely.Most importantly, thecrisishasshownthat market participantswerenotcapableof masteringtheinherent complexityof the system that theythemselveshad contributedto develop.And it hashighlightedthelimitsof the ideathat self-regulationandmarket disciplineare sufficient to ensure stablefinancial systems.In thisregard, acceptingtheideathat benign neglectwastheright courseof action wasa critical mistakeon the part of regulators.Rather, financial regulation and supervision must keep pacewithdevelopmentsin the financial industry.Moreover,national authoritiesneed to beawareof the risk that theirpowersmay become narrow compared tothe sphere of influenceof theglobal financial players.Thecoordinationof financial supervisionacrossbordersand acrosssectorsis a key condition for the stabilityof theglobal financial system.Amajor effort is required, at a national but especiallyat an internationallevel, in order tostrengthenthe regulatory and supervisory framework.At the international level, under the politicalimpulseof theG-20, theFinancial Stability Board (FSB) and theBasel Committeeon BankingSupervision(BCBS) have introducedsubstantial regulatorychangestoprevent new financial crisesand increasetheresilienceof economicsystems.Much hasbeen alreadyachieved.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 51. P a g e | 51Thequantityand qualityof capital that banksneed to hold hasbeensignificantlyenhancedto ensure that theyoperateon a safeand soundbasis.There alsohavebeen introducedinternational standardsfor bankliquidityand funding, designed to promote the resilienceof bankstoliquidityshocks.Initiativeshave been promoted to strengthenthe regulationof the OTCderivativesmarket, aimed at reinforcingmarket infrastructures,in ordertominimize contagion and spill-over effectsamong players that havebecome more and more interconnected.However,further progressis needed in important areas,asbank capitaland liquidityregulation must be accompaniedby improvementsininternalrisk control arrangementsand actionsaimed at correctingincentivestoexcessiverisk-taking.Moreover,a level playing field must beachieved, ascountriesrelaxingrules in order toattract financial intermediariesgeneratenegativeexternalitiesfor other countries.Thetransition to a uniform system of rulesand oversight of the financialsectormust be hastened.In the euro area, and in theEuropean Union at large, theplan for abankingunion is ambitious,but it goesin the right direction.It would, among other things, limit regulatoryarbitrage, help removenational bias in supervision, reducethephenomenon of ―regulatorycapture‖bypowerful cross-borderbanks, at thesametimereducingcostsof compliancefor cross-borderbanks and enhancingthe functioningoftheSinglemarket for financial services.TheenvisagedEuropean banking union wouldalsobenefit CEEeconomies:it wouldworkagainst thefragmentationof the Europeanfinancial marketsalongnational lines;moreover – by enhancingthefinancialresilienceof theeuroarea – it wouldreducetherisksof negativeInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 52. P a g e | 52spill-overeffectsfrom the euro area to CEE banking systems.Final remarksTherecovery of CEE economies remainsfragile.With few exceptions, output hasnot yet returned to pre crisislevels,dragged by debt overhang and direct and indirect exposuretotheeurozonedebt crisis.Import demand by theeuro area remainsat depressed levels. Financialconditions, although improved comparedtotheend of 2011,remain volatile.Bankcredit dynamicsremain weak,reflectingsubdueddomesticdemandandhigh non-performingloans.Thebanking systemsof most CEE countries, however, remain wellcapitalized and can thereforewithstandthe lingeringdeterioration oftheir asset quality.Moreover,the financial legacyof the crisiswill not be transitory.Theevolution of theinternational banking sector over the comingyearswill continuetoshape financial conditionsalsoin CEE countries.Theregulatory and supervisory responsesadopted at global level willimplymore stringent prudential requirementsfor capital and liquidity.In responseto thesemore demandingrules,aswell asto spontaneousmarket forces,international banksare adapting their businessstrategies,unwindingpre-crisisunsustainablepracticesand shiftingtolonger-termfinancingsources.In this context themain European bankswithlargestakesin CEEmarketsare graduallyswitchingtomore decentralizedbusinessmodels,International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 53. P a g e | 53wheresubsidiarieswouldhave to relymore on localsourcesoffunds,settinglendingconditionsaccordingly.Although orderlyand evendesirablefor the resiliencyof theglobalfinancial system, thisprocessmay exert significant pressureson emergingcountriesthat are highlydependent on external financingowingtounderdevelopeddomestic financial systemsand structurallylownationalsavingsrates.Indeed, this processcallsfor decisivereforms tobolster the developmentanddeepeningof localmoney and capital markets, includinglocalcurrencydenominatedbonds.This is a long-term and complexprocess, whichinvolvesa suitablelegalframework,adequateinfrastructures,a largeinstitutional investorbase,stablemacroeconomicconditionsand predictablepolicymaking, asexemplifiedin extensiveanalysis and ensuing guidelinescarriedout at theBank of InternationalSettlements(BIS), theWorldBank andtheG20.Several of theseconditionshave alreadybeen achieved in the processofintegration in theEU.Against thischangingfinancial environment, there is the riskthat, on thegroundsof preservingfinancial stability at domestic level, nationalregulatorscould adopt ring fencing measures,hamperingthesmoothfunctioningof theEU singlemarket.As thelong-term benefitsof free capital mobilityand internationalfinancial integrationremain sizable, this risk callsfor a stronger rolebytheEU institutions,notablytheEuropean Commission (EC) and theEuropean BankingAuthority (EBA), in monitoring thesemeasuresandenhancingcoordination among national regulators,in order toavoid afragmentation of theEuropean financial markets.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 54. P a g e | 54Revised rulesfor markets infinancial instruments(MiFID /MiFIR)a)Proposal for a Directive of theEuropean Parliament and of theCouncilon marketsin financialinstrumentsrepealingDirective2004/39/ EC of theEuropean Parliament and of the Council (Recast) (MiFID)b)Proposal for a Regulation of the European Parliament and of theCouncilon marketsin financial instrumentsand amending Regulation[EM IR] on OTC derivatives,centralcounterpartiesandtraderepositories(MiFIR)I. INTRODUCTION1.TheCommission transmittedtheabovementionedproposalstoamendthecurrent MiFID to the Council on 20October 2011.Theobjectiveof this legislativepackageis, inter alia, to furthertheintegration, competitiveness, and efficiencyof EU financial marketsbyrespondingtothechallengescreatedbydevelopmentsin financialmarkets,and dealingwiththe weaknessesthe financial crisishasexposed.2.ThelegislativepackageamendingMiFID has twoparts:- ARegulationsetsout requirementsin relationtothedisclosure of tradetransparencydata to thepublic and transaction data tocompetentauthorities, removingbarriers to nondiscriminatory accessto clearingfacilities,themandatory tradingof derivativeson organisedvenues,specificsupervisoryactionsregardingfinancialinstrumentsandpositionsin derivatives.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 55. P a g e | 55- ADirectiveamendsspecific requirementsregarding the provision ofinvestment services, thescope of exemptionsfrom the currentDirective,organisational and conduct of businessrequirementsforinvestment firms, organisationalrequirementsfor tradingvenues, theauthorisationand ongoing obligationsapplicabletoprovidersof dataservices, powersavailabletocompetent authorities, sanctions,and rulesapplicableto third-country firmsoperatingvia a branch.3.Intensivenegotiationshave been going on during the PL, DK, CY andIE Presidenciesaimingat an agreement on theCouncils generalapproach,whichwouldallowthePresidencytostart negotiationswiththeEuropean Parliament witha view toreachinga first readingagreement.TheEPECON Committeevoted onitsreportson26September2012,andtheEP positionwasfurther confirmed bythePlenaryon 26October 2012.4.During the discussions at the Working Party on Financial Services thePresidencies have tabled several overall compromise proposals and othertextsin order tomake progresson the file.II. STATE OF PLAY5.While significant progresshasbeen madetowardsachievingagreementon a Council general approach, during the latestmeeting of theWorkingPartyon Financial Services(Attachés) on 11April 2013,therewasnot yet aqualifiedmajority supporting an overall compromise in particular becauseof the key outstandingissue of accessto tradingvenuesand centralcounterparties(CCP) (MiFIR, Articles 28-30).6. Access(Articles 28-30MiFIR)Toavoid anydiscriminatorypracticesand toremovevariouscommercialbarriers that can be used to prevent competitionin the clearingoffinancial instruments,the Commission Proposal provided in theRegulation (MiFIR) that CCPs should accept to clear transactionsexecutedin different tradingvenues, to theextent that thosevenuescomplywiththe operational and technical requirementsbythe CCP.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 56. P a g e | 56Accessshouldonlybedeniedif certainaccesscriteriaarenot met (Article28MiFIR).Trading venues should also be required to provide access including datafeeds on a transparent and non-discriminatory basis to CCPs that wish toclear transactionsexecuted on thetradingvenue (Article 29MiFIR).In addition, accesstolicencesof, and information relatingto, benchmarksthat areused to determinethe value of financial instrumentsshould beprovidedto CCPs and tradingvenues(Article 30MiFIR).Thenon-discriminatoryclearingaccessfor financial instrumentshasproved tobe a difficult issuethroughout thenegotiationson MiFIR, withdelegationsbeingsplit into twogroups.Onegroup isin favor of maintainingtheprovisionsofArticles28and29,asproposed by theCommission, for thereasonsmentionedabove, whereasthe other group isin favor of deletingtheseArticlesasthey believethat non-discriminatoryaccesswill lead to fragmentation atthetradinglevel and toreduction in liquidity.Furthermore,somedelegationshave doubtson the relationship betweenArticle 30 (nondiscriminatoryaccessand obligationto licencebenchmarks) and intellectual property rightswhereasother delegationsconsider that Article 30is necessaryasit tacklesthe issueof monopoliesandthusenhancescompetition.ThePresidencyhasproposed a compromisesolution in Articles 28-30ofMiFIR (doc. 7743/ 13REV 2), whichis basedon a non-discriminatoryaccesstoCCPs, tradingvenuesand licencebenchmarks, providingat thesametime necessarysafeguardsrelated toorderly functioningof themarketsand liquidityfragmentation.This solution is acceptable to several delegations, but thereare, however, a number of delegations which have outstandingconcerns, and to whom the deletion of Articles 28-30 would be thepreferred option.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 57. P a g e | 577.In thesecircumstances,the Presidencyconsidersthat itscompromisesolution isthe onlyviableoption toaddressthis issue.However,the Presidencyacknowledgesthat there are still seriousconcerns.If theseconcernsarenot resolvedthePresidencysuggeststhat at thetimeof the agreement on the general approach, a statement asset out in theAnnex wouldbe enteredintothe minutesof Coreper.8.Apart from theabovementionedissuetherearecertain otherissuesthatrequirefurther work.ThePresidencyconsidersthat thisworkcan becompleted at WorkingParty level, if an agreement onArticles 28-30in MiFIR can beachievedatCoreper.III. CONCLUSION9. The Presidencythereforesuggeststhat thePermanent RepresentativesCommittee:-agreesonArticles28-30in MiFIR asset out in doc. 7743/13REV 2;-in theevent that agreement isnot reachedon articles28-30MiFIR, agreeson the content of thestatement set out in Annex, whichistobeentered intothe minutesof Coreper at thetimeof final agreementon thegeneral approach, and-invitestheWorkingPartyonFinancial Services(Attachés) tofinalisethethetext, and submit the general approach for agreement by Coreper in thevery near future .Statement by the CouncilThe Council notes the divergent positions of Member States on certainaspects of the Presidencys proposed general approach, in particular asregards toclearing accessprovisions(articles28-30).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 58. P a g e | 58It invitesthePresidencytostart negotiationswiththeEuropeanParliament on the basisof this general approach, takingintoaccount theneed for further work totry toresolve outstandingissues.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 59. P a g e | 59APRA releasessecondconsultation package for thesupervision of conglomerategroupsTheAustralian Prudential RegulationAuthority (APRA) hastodayreleasedfor consultation proposed risk management and capitaladequacyrequirementsfor the supervisionof conglomerategroups.Conglomerategroups, referredto asLevel 3 groups,are groupscomprisingAPRA-regulated institutionsthat perform material activitiesacrossmore thanoneAPRA-regulated industry and/ orin oneor morenon-APRA-regulated industry.Theconsultationpackagereleased todayincludesa response tosubmissionsreceived onAPRA‘s March2010discussionpaper on thesupervision of conglomerategroupsand a set of draft prudentialstandards.Thepackage, on risk management and capital adequacy, complementstheconsultation packagereleasedin December 2012on proposedrequirementsfor group governance and risk exposures.Theproposed Level 3 framework will assistAPRA toensure that itssupervision adequatelycapturesthe risksto whichAPRA-regulatedinstitutionswithin Level 3 groupsare exposed and which arenotadequatelycovered by existingprudential arrangementsfor stand-aloneentities(Level 1supervision) and singleindustry groups(Level 2supervision).APRA Chairman Dr John Laker said that theintroduction of a Level 3frameworkinAustralia is a significant progression ofAPRA‘s prudentialregime.‗Oneof thekey lessonsfrom theglobal financial crisis is theneed toInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 60. P a g e | 60enhancesupervisoryregimes tobetter capture the risksfacingregulatedinstitutionsthat arepart of a widerconglomerategroup.‘‗By implementinggroup-widerequirementson governance, exposuremanagement, risk management and capital adequacy, APRA‘sproposedLevel 3 supervision frameworkwill underpin asafer financial system inAustralia,‘ Dr Laker said. ‗At this stage, potential Level 3 groupsareunlikelyto need additional capital to meet the proposedLevel 3requirements.‘Submissionson theproposed risk management and capital adequacyprudential standardsaredueby 5 July2013.Over thecourseof 2013,APRA will consult on a set of prudential practiceguides,reportingstandards, reportingforms and instructions,andconsequential amendmentsto other prudential standardsthat give effecttothe Level 3 framework.The Level 3prudential standards are expectedtotake effect from 1January 2014.Theresponsepaper and draft prudential standardscan be found on theAPRA websiteat:www.apra.gov.au/ CrossIndustry/ Consultations/ Pages/ Supervision-of-conglomerate-groups-2013.aspxTheAustralian Prudential RegulationAuthority(APRA) istheprudentialregulator of thefinancial servicesindustry. It overseesbanks, creditunions,buildingsocieties, general insuranceand reinsurancecompanies, life insurance, friendlysocieties, andmost membersof thesuperannuation industry. APRAis fundedlargely bytheindustries that itsupervises. It wasestablished on 1July1998. APRAcurrentlysupervisesinstitutionsholding$4.2trillion in assetsforalmost 23millionAustraliandepositors, policyholders and superannuation fund members.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 61. P a g e | 61To all Chief Executive Officersof potential Level 3 groupsAPRA hastoday releasedthe second consultationpackageon thesupervision of conglomerategroups(Level 3 groups).This packageincludesa responsepaper totheMarch 2010discussionpaper and draft prudential standards, whichfocuson requirementsforgroup risk management and capital adequacy.This packagecomplementsa first consultationpackage, releasedinDecember 2012,regardingproposed requirementsfor group governanceand risk exposures.APRA hasalsoreleaseda consultation packageon harmonisingandenhancingcross-industryriskmanagement requirements,whichcontainsa new cross-industryrisk management prudential standard and anupdatedgovernancestandard.Thesestandardsare proposed to applytoall Level 1ADIs, generalinsurers,life companies, Level 2 groupsand Level 3 groups.Aseparate letter on this consultationpackagehasbeen issued to allaffected institutions.However,proposalsin therisk management prudential standard whichaffect Level 3 groupsare addressed aspart of thesupervisionofconglomerate groupsresponse paper.During the courseof developing theseproposals,APRA hashad anumber of positivediscussionswithpotential Level 3 groupsand havetaken intoconsideration many of the issuesraisedin thosediscussions.Consultationon theproposed risk management and capital adequacyprudential standardscloseson 5 July2013.Over thecourseof 2013,APRA will consult on a set of prudential practiceguides,reportingstandards, reportingforms and instructions,andInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 62. P a g e | 62consequential amendmentsto other prudential standardsto give effect totheLevel 3 framework proposals.Theconsultationpackageis available on theAPRA websiteat:http:/ / www.apra.gov.au/ CrossIndustry/ Consultations/ Pages/Supervision-of-conglomerate-groups-2013.aspxTheLevel3prudentialstandardsandthecross-industryriskmanagementprudential standard are expected to take effect from 1January 2014.Queriesin relationtothe Level 3 project should be directedtoyourResponsibleSupervisoror the dedicated Level3Framework@apra.gov.auemail address.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 63. P a g e | 63GovernorElizabethA. DukeAt the Housing PolicyExecutiveCouncil, Washington, D.C.AView from the Federal ReserveBoard: The Mortgage Market andHousing ConditionsSincejoiningthe Board in 2008amid acrisiscentered onmortgagelending, I havefocused much of my attentionon housingandmortgage markets,issuessurroundingforeclosures,and neighborhood stabilization.In Marchof this year, I laid out my thoughtson current conditionsin thehousing and mortgagemarketsin a speechto theMortgageBankersAssociation.Today I will summarize and update that information witha focusonmortgagecredit conditions.Before I proceed, I should note that the viewsI expressare my own andnot necessarily those of my colleagueson the Board of Governors or theFederal Open Market Committee.Asustained recoveryin thehousing market appearsto be under way.Houseprices,asmeasuredbyavarietyofnationalindexes,haverisen6to11percent sincethe beginningof 2012(figure 1).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 64. P a g e | 64The recovery of house prices has been broad based geographically, with90 percent of local markets having experienced price gains over the yearendingin February.Also since the beginning of 2012, housing starts and permitshave risen bynearly 30 percent (figure 2), while new and existing home sales have alsoseen double-digit growthrates.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 65. P a g e | 65Homebuilder sentiment hasimprovednotably, and real estate agentsreport stronger trafficof people shoppingfor homes(figure 3).In national surveys, householdsreport that low interestratesand housepricesmake it a good time to buy a home; they alsoappear more certainthat house pricegainswill continue(figure 4).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 66. P a g e | 66International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 67. P a g e | 67Despitetherecent gains,thelevel ofhousingmarket activityremainslow.Existinghome salesare currentlyat levelsin linewiththoseseen in thelate 1990s,while single-familystartsand permitsare at levelscommensuratewiththe early1990s.And applicationsfor home-purchasemortgages, asmeasuredby theMortgageBankersAssociation index, wereat a level in linewiththat ofthemid-1990s(figure 5).Thesubdued level of mortgage purchaseoriginationsis particularlystrikinggiven therecordlow mortgageratesthat haveprevailedin recentyears.Thedrop in originationshasbeen most pronounced amongborrowerswith lowercredit scores.For example, between2007and 2012,originationsof prime purchasemortgagesfell about 30 percent for borrowerswithcredit scoresgreaterInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 68. P a g e | 68than 780, comparedwith a drop of about 90percent for borrowerswithcredit scoresbetween620and 680(figure6).Originationsarevirtuallynonexistent for borrowerswith credit scoresbelow 620.Thedistribution of credit scoresin thesepurchaseoriginationdata tellsthesamestoryin a different way:The median credit score on these originationsrose from 730 in 2007 to770in 2013, whereas scores for mortgages at the 10th percentile rose from 640to690(figure 7).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 69. P a g e | 69Many borrowerswhohave faced difficultyin obtaining primemortgageshaveturned to mortgagesinsured or guaranteed by the Federal HousingAdministration(FHA), theU.S.Department of VeteransAffairs (VA), ortheRural Housing Service(RHS).Data collectedunder the Home MortgageDisclosureAct indicatethattheshare of purchasemortgagesguaranteedor insured by theFHA, theVA, or theRHS rosefrom 5 percent in 2006tomore than 40percent in2011(figure 8).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 70. P a g e | 70But here, too, loanoriginationsappear tohave contracted for borrowerswith low credit scores.Themedian credit score on FHApurchaseoriginationsincreasedfrom625in 2007to690in 2013,whilethe10thpercentile hasincreasedfrom 550to650(figure 9).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 71. P a g e | 71Part of the contraction in loan originationsto householdswithlowercredit scoresmay reflect weakdemand among thesepotentialhomebuyers.Although wehave littledata on thispoint, it may be the casethat suchhouseholdssuffereddisproportionatelyfrom thesharp riseinunemployment duringtherecessionandthushavenot beenin afinancialpositionto purchasea home.There is evidencethat tight mortgage lendingconditionsmay alsobe afactorin thecontraction in originations.Data from lender ratequotessuggest that almost all lendershavebeenofferingquotes(through thedaily "ratesheets" providedtomortgagebrokers) on mortgageseligiblefor saletothegovernment-sponsoredenterprises(GSEs) toborrowerswithcredit scores of 750over the pasttwoyears.Mostlendershave been willingto offer quotestoborrowerswith creditscoresof 680aswell.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 72. P a g e | 72Fewer than two-thirdsof lenders,though, arewillingto extend mortgageoffersto consumerswithcredit scores of 620(figure 10).And thisstatistic mayoverstate theavailability of credit toborrowerswithlowercredit scores:Therateson many of these offersmight be unattractive, and borrowerswhosecredit scoresindicateeligibilitymay not meet other aspectsof theunderwritingcriteria.Tight credit conditionsalsoappear tobepart of the story forFHA-insured loans.In theFederal Reserves October 2012Senior LoanOfficer Opinion Survey on Bank LendingPractices(SLOOS), one-half totwo-thirdsof respondentsindicatedthat they werelesslikelythan in 2006tooriginate an FHAloanto a borrowerwith a credit score of 580or 620(figure 11).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 73. P a g e | 73Standardshave tighteneda bit further since: In theApril 2013SLOOS, about 30percent of lendersreported that theywerelesslikelythan a year agotooriginateFHAmortgagestoborrowerswithacreditscoreof 580or 620(figure 12).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 74. P a g e | 74TheApril SLOOS offerssome cluesabout whymortgagecredit issotight for borrowerswith lowercredit scores.Banks participatingin the survey identifieda familiar assortment offactorsasdamping their willingnessto extend any type of loan to theseborrowers:the riskthat lenderswill be required torepurchasedefaultedloansfrom theGSEs("putback" risk), the outlook for housepricesandeconomicactivity, capacityconstraints,the risk-adjustedopportunitycostof such loans,servicing costs,balancesheet or warehousingcapacity,guaranteefeeschargedbytheGSEs,borrowersabilitytoobtainprivatemortgageinsuranceor second liens,and investorappetiteforprivate-label mortgage securitizations.Respondentsappeared to put particular weight on GSE putbacks,theeconomicoutlook, and the risk-adjustedopportunitycost.In addition, several largebankscited capacityconstraintsand borrowersdifficultiesin obtainingprivatemortgage insuranceor second liensasatleast somewhat important factorsin restrainingtheir willingnesstoapprovesuch loans.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 75. P a g e | 75Over time, some of thesefactorsshould exert lessof a drag on mortgagecredit availability. For example, asthe economic and housingmarketrecoverycontinues,lendersshould gain confidencethat mortgage loanswill perform well, and theyshould expand their lending accordingly.Capacityconstraintswill likely alsoease. Refinancingapplicationshaveexpanded much moreover thepast year and ahalf than lenders ability toprocessthese loans.For example, one measureof capacityconstraints--thenumber of realestatecredit employees--hasonlyedgedup over thisperiod (figure 13).When capacityconstraintsare binding, lendersmay prioritize theprocessingof easier-to-completeor more profitableloan applications.Indeed, preliminaryresearch by theBoards staff suggeststhat theincreasein the refinanceworkloadduring the past 18monthsappears tohavebeen associatedwitha 25to 35percent decreasein purchaseoriginationsamongborrowerswithcredit scoresbetween620and680anda 10 to 15percent decreaseamong borrowerswithcredit scoresbetween680and 710.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 76. P a g e | 76Any such crowding-out effect should start to unwindasthe currentrefinancingboom decelerates.Other factorsholdingback mortgagecredit, however, may be slowertounwind.As the SLOOS resultsindicate, lendersremain concerned about putbackrisk.Theabilitytohold lendersaccountablefor poorlyunderwrittenloansis asignificant protection for taxpayers.However,if lendersareunsureabout theconditionsunder whichtheywillberequired torepurchaseloanssoldtotheGSEs,theymayshyawayfromoriginatingloansto borrowerswhoserisk profiles indicatea higherlikelihoodof default.TheFederal Housing Finance Agency launched an important initiativelast year toclarify the liabilitiesassociatedwithrepresentationsandwarranties, but, sofar, putback risk appearsto still weigh on themortgagemarket.Mortgageservicingstandards,particularlyfordelinquent loans,aremorestringent than in thepastdue to settlement actionsand consent orders.Servicing rulesrecentlyreleased by the Consumer Financial ProtectionBureau (CFPB) will extend many of thesestandardstoall lenders.Thesestandardsremedypast abusesand provideimportant protectionstoborrowers,but alsoincreasethecostof servicingnonperformingloans.This issueis compounded by current servicingcompensationarrangementsunder whichservicersreceivethesame feefor the routineprocessingof current loansasthey dofor the more expensive processingof delinquent loans.This model--especiallyin conjunction withhigher default-servicingcosts--giveslendersan incentivetoavoid originatingloansto borrowerswhoaremore likelytodefault.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 77. P a g e | 77Achangeto servicer compensationmodelsfor delinquent loanscouldalleviatesome of theseconcerns.Government regulationswill alsoaffect the cost of mortgagecredit. InJanuary, the CFPB released rules, in additionto thosefor servicingstandards,on ability-to-repayrequirements,thedefinition of a qualifiedmortgage(QM), and loanoriginatorcompensation.TheFederal Reserve and other agenciesare in theprocessof movingforwardon proposed rulemakingsthat wouldimplement revisedregulatorycapital requirementsand therequirementsfor risk retentionmandatedby the Dodd-Frank Wall Street Reform and ConsumerProtectionAct of 2010, whichincludeanexemption for mortgagesthatmeet the definitionof qualified residential mortgages(QRM).As the regulatorycapital and risk retention requirementsare still underdeliberation, I wont comment on theseregulationstoday.However,I will share a few thoughtson thepossibleeffectsof theQMrulemakingon accessto credit.As background, theQM rule is part of a larger ability-to-repayrulemakingthat requires lendersto makea reasonableand good faithdeterminationthat the borrowercan repay the loan.Therulemakingaddressesthe lax underwritingpracticesthat flourishedduring thehousingboom by settingminimum underwritingstandardsandby providingborrowerswithprotectionsagainst lendingabuses.In particular, borrowerscan suethelender for violationsof theability-to-repayrulesand claim monetary damages.If the original lender sellsor securitizes the loan, the borrower can claimthese damages at any time in a foreclosure action taken by the lender oranyassignee.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 78. P a g e | 78If the mortgage meetsthe QM standard, however,the lender receivesgreater protection from such potential lawsuitsbecauseit ispresumedthat the borrowerhad theability torepaythe loan.Loansthat fall outsidethe QM standard may be more costlytooriginatethan loansthat meet thestandard for at leastfour reasons,all elsebeingequal.Thefirst reasonisthepossibleincreasein foreclosure lossesandlitigationcosts.Although thesecosts,in theaggregate, are expectedtobesmall, their fullextent will not be knownuntil the courts settle anyability-to-repaysuitsthat may bebrought forward.The second reason is that mortgages that do not meet the QM definitionwill also not qualify as QRMs, so lenders will be required to hold some oftheriskif theseloansare securitized.Thethird reasonisthat loan originatorswill have better informationthaninvestorson the qualityof the underwritingdecision.Investorsmay demand apremium tocompensatethem for the concernthat originatorsmight sell them theloansmost vulnerabletoability-to-repaylawsuits.Thefourth reason isthat the non-QM market, at least initially, may besmall and illiquid, whichwouldincreasethe cost of theseloans.Thehigher costsassociatedwith non-QM loansshould havevery littleeffect on accessto credit in thenear term becausealmost all currentmortgageoriginationsmeet the QM standard.Thevast majorityof current originationsare eligibleto bepurchased, insured, orguaranteedbyFannie Mae, Freddie Mac, theFHA, theVA, or theRHS. Theseloansare classified asQMs under therule.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 79. P a g e | 79Thesmall proportion of mortgagesoriginated at present outsideof theseprograms, for the most part, are beingunderwrittento tight standardsconsistent withthe QM definition.As lender risk appetiteincreasesand private capital returnstothemortgagemarket, a larger non-QM market should start to develop.Twoaspectsof the QM rule, though, may make thismarket slowtodevelop for borrowerswithlowercredit scores.First, the QM requirement that borrower paymentson all debtsand somerecurring obligations must be 43 percent or less of borrower income maydisproportionatelyaffect less-advantagedborrowers.Board staff tabulationsbased on theSurvey of Consumer Financesindicatethat suchhouseholdstendtohavelowerincomes,fewerfinancialassets,and higher mortgageloan-to-valueratiosthan householdswithlowerpayment ratios(figure 14).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 80. P a g e | 80Second, theQM definitionaffects lenders abilityto charge for the risksof originatingloansto borrowerswhoare more likely todefault.For example,lendersmay in generalcompensatefor thisrisk bycharginga higher interest rate on the loan.However,if lendersoriginatea first-lienQM withan annual percentagerate that is150 basispointsor more above therateavailabletothehighest-qualityborrowers,lendersreceivelessprotectionagainst lawsuitsclaimingviolation of the ability-to-repayand QM rules.Lenderswhoprefer toprice for risk through pointsand feesfacetheconstraint that pointsand feeson a QM loanmay not exceed3 percent oftheloan amount, withhigher capsavailablefor loanssmallerthan$100,000.Theextent towhichtheserulesregardingrates,points, and feeswilldamp lender willingnessto originatemortgagestoborrowerswithlowercredit scoresis still unclear.Tosummarize, thehousing market is improving, but mortgage creditconditionsremain quitetight for borrowerswithlowercredit scores.And the path toeasier credit conditionsissomewhat murky.Some of the forces damping mortgage credit availability, such as capacityconstraints and concerns about economic conditions or house prices, arelikely tounwindthrough normal cyclical forces.However,resolutionof lender concernsabout putback riskor servicingcost seemslessclear.Theseconcernscould be reduced by policychanges.For example, thestructure of liability for representationsand warranteescould be modified. Or servicingcompensation could be changedtoprovidehigher compensation for theservicingof delinquent loans.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 81. P a g e | 81Or lendersmight find waysto reducetheir exposure toputback risk orservicingcostby strengtheningoriginationand servicingplatforms.New mortgage regulationswill provideimportant protectionstoborrowersbut may alsolead to a permanent increasein the cost oforiginatingloansto borrowerswithlower credit scores.It will be difficult todetermine theultimate effect of the regulatorychangesuntil theyhaveall been finallydefined and lendersgainfamiliarity with them.Theimplicationsfor the housingmarket are alsomurky.Borrowerswithlower credit scoreshave typically representedasignificant segment of first-timehomebuyers.For example, in 1999, more than 25percent of first-timehomebuyers hadcredit scoresbelow 620compared withfewer than 10percent in 2012(figure 15).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 82. P a g e | 82Although I expect housing demand toexpand along withthe economicrecovery, if credit is hard toget, much of that demand may bechanneledintorental, rather than owner-occupied, housing.At the Federal Reserve, wecontinueto foster more-accommodativefinancial conditionsand, in particular, lowermortgage ratesthrough ourmonetary policy actions.We alsocontinuetomonitor mortgagecredit conditionsand consider theimplicationsof our rulemakingsfor credit availability.Foryour part, I urgeyoutocontinuetodevelopnewandmoresustainablebusinessmodelsfor lendingto lower-credit-scoreborrowersthat lead tobetter outcomesfor borrowers,communities,and the financial systemthan wehave experiencedover thepast few years.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 83. P a g e | 83TheNeed for Robust SEC Oversightof SROsBy CommissionerLuisA. AguilarU.S. Securitiesand ExchangeCommissionWashington, D.C.Thestaff of theU.S.SecuritiesandExchangeCommission (―Commission‖ or―SEC‖) is planningtohold an SRO Outreach Conference(the―Conference‖) this month.In anticipation of theConference, I wouldlike to addressthechallengesfaced by self-regulatoryorganizations(―SROs‖) asa result of thesignificant changesthat thesecuritiesmarketshaveundergonein thelastdecade, and theneed for robust Commission oversight of SRO activitiestoenhanceinvestor protection, maintain fair, orderly, and efficientmarkets,and facilitatecapital formation.Therolesof SROshavea long tradition in our securitiesmarkets.Asapractitionerinthesecuritiesindustryforover30years,I‘veinteractedwith SROs asa member of theprivate sector aswellasa Commissioner.I fullyappreciatetheir rolein theregulationof our marketplacebysettingstandards,conductingexaminations,and enforcingrulesamong theirmembers.Challengesof Self-RegulationSelf-regulationof market intermediaries through a system of SROs is oneof the coreelementsof our existingregulatoryframework.SROs areprimarily responsiblefor establishingthestandardsunderwhichtheir membersconduct businessand for monitoringthewaystheirmembersconduct business.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 84. P a g e | 84SROs are also required to enforce compliance by their members with thefederal securitieslaws, and discipline their membersfor violationsof suchlawsand theSRO‘sownrules.During the last few years, SROs have faced increased competition in themarketswheretheyoperate.For example, SROs facecompetitivechallengesfrom electroniccommunicationsnetworksand foreign tradingmarketsthat haveslowlychippedawayat theSROs‘market share.There alsohavebeen tremendousadvancesin tradingsystems that relyalmost exclusively on fully-automated technologyto processtrades.In additiontothese competitivechallenges,there continuestobe inherentconflictsofinterestsbetweentheSROs‘regulatoryfunctionsand itsmembers,market operations,issuers,and shareholders.Tostayin business,SROshavetoattractorderflows,andthismayleadtoSROs being lessinclined to enforcerulesvigorously against financiallysupportivemembers, issuers,and shareholders.In the past, there have been instanceswhereSROs have favored onemember or customer over another;for example, by sharing market datawith paying subscribersbeforereleasingsuch data to thepublic.Theadvent of thesenew competitivechallengesand continued conflictsof interestsrequire, amongother things,a closerworkingrelationshipbetweenSROs andtheSEC, andfortheCommissiontore-evaluatehowitcan best provideappropriateoversight over SROs.SEC Oversight of SROs Is Necessary and IndispensableBecauseof the inherent conflict of interestsinvolved in self-regulation, robust SEC oversight over SROs is indispensable.As a result, Congresshasvested in the Commissionthe power tosuperviseSROs asa matter of public interest.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 85. P a g e | 85And to accomplish this, Congresshasprovidedthe Commission withseveral toolstooversee SROs.For example, exchanges,clearingagencies, and national securitiesassociationsmust registerwiththeCommission, and SROsmust filetheirrule changeswiththeCommission.In addition, theCommission hasthe authoritytoinspect and examineSROs.I recognize that many SROs workdiligentlytomeet their obligations.Unfortunately, however,that isn‘t alwaysthe caseand, in such cases,theSEC is required toact.Overtheyears, therehavebeenagrowingnumber ofenforcement actionsbythe Commissionagainst SROs, whofailedto meet their legal andregulatoryobligationsunder thelaw.For instance:In 1999, the Commission found that the New York Stock Exchange(―NYSE‖) failedtodetectandhalt unlawfulproprietarytradingbycertainindependent floor brokers.In 2000, the Commissionsued all four of the optionsexchanges– theAmerican Stock Exchange, theChicago Board OptionsExchange, thePacific Exchange, and thePhiladelphia Stock Exchange– for inadequatesurveillanceof their marketsfor potential violations,for failuretoconductthorough investigations,and for failure toenforce rulesapplicabletomemberson their floors.In 2005, the Commissionbrought a second action againstNYSE forfailure to detect, investigate,and disciplinewidespreadunlawfulproprietarytradingby specialistson the floorof the exchange.That year, the Commission alsobrought an action against the NationalStock Exchangefor failure to enforcecomplianceby itsdealer firms withthemarket order exposure rule and thecustomer priority rule.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 86. P a g e | 86In 2006, the Commissionsued the Philadelphia Stock Exchange forfailure to enforcerulesrelatingto optionsand equitiestrading, aswell asorder handlingrules.In 2007, the Commissionsued theAmerican Stock Exchangeagain forfailure to enforceorder handling rulesand complywith recordkeepingobligationsbecauseof critical deficienciesin itssurveillance,investigative,and enforcement programs.That year, the Commission alsochargedthe Boston StockExchangefor, among other things,failure to enforce rulestoprevent specialistsfromtradingin a waythat benefitedthemselvesat the expenseof theircustomers.In 2011, the Commissionsanctioned theDirect Edge exchangesforviolatingthe federal securitieslawsbecauseof weaknessesin theirsystems, processes,and controlsthat resulted in a systemsoutage andmillionsof dollarsin tradinglosses.Finally, in September 2012,the Commission charged NYSE for thethirdtimefor compliancefailures that gave some of its customersan improperadvantageon tradinginformation.TheCommission found that the NYSE sentdata to some customersthrough twoof itsproprietary feedsbeforesendingdata to theconsolidatedfeeds.The$5million penaltyimposed against NYSE marked the firsttime theCommissionhasever imposeda financial penaltyagainst an exchange.Obviously, these eventsundercut investor confidence.There is nodoubt that thesuccessor failure of the securitiesindustrydependson itsreputation, public perception, and itsabilitytoearninvestors‘confidence.Investorparticipation in thecapital marketsdependson themarketsbeingfair and transparent.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 87. P a g e | 87An orderlyand efficient market requiresthat all of usmaintaina watchfuleye on market activities.SROs must have strong complianceculturesand adequateand dedicatedcomplianceresourcesto provide thefirst lineof defense;however,whenSROs fall short, theSEC needstostand ready totake action.TheSEC‘soversight of SROsis an important component toinstill publicconfidencein thesecurities industry.ConclusionI support the spirit behind the SRO Outreach Conference.It is a pro-activestep in theSEC‘soversight of SROsfor theSEC tomeetregularlywithSROs toshare collectiveviewson mattersaffectingSROsandthemarkets.In particular, it is my expectation that the Conference will address thoseareas where SROs and the SEC can improvecollaboration, cooperation, and oversight.In the end, the protection of investorsand theeffectivenessof our capitalmarketsare best served whentheSEC and SROs havea strong workingrelationship.I commend thestaffsof theSEC andtheSROs forcomingtogether,andIlookforwardto their hard workin protectinginvestorsand maintainingfair, orderly, and efficient markets.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 88. P a g e | 88Proposal for a structuralreform of EU banksA. Context and problem definition(1)What is thepolitical context of theinitiative?There areconcernsthat largeEU bankinggroups, are difficult tomanage, monitor, and supervise.Furthermore, theymay alsobe difficult to resolve, due to theircomplexity, interconnectedness, geographic scope, and abilityto expandrapidly.Also, theunrestricted co-minglingof depositssubject to governmentguaranteeswith market and tradingactivitiesmay subject depositorstoadditional risks.Thebroad-based international reform agenda wasinitiallyfocused onurgent measuresto stabilisethefinancial system (see point 2 below).However,attentionisturning towardsstructural reformsin order tomitigatemoral hazard arising from the needstoprovide a safetynet todepositors,to addressinherent conflictsof interest and excessivecomplexityof themodern banking system, toensurethat thebankingsectorservesthefinancingneedsof thereal economy asa preconditionfor sustainablegrowth, and to prevent or at leastminimisetheincidenceanddepth of any future crisis.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 89. P a g e | 89Asaresult, internationalinstitutionssuchastheFinancialStabilityBoard(FSB), theInternational MonetaryFund (IM F), and theOECD havecalledfor a broad and global debate on bank businessmodels.In additiontosupranational callsfor action, several EU MemberStates(UK, FR, DE, NL, etc.) aswell asthird countries(US) have alreadyembarkedon structural reforms.The High-level expert group (HLEG) on reforming the structure of theEU banking sector, chaired by Erkki Liikanen, has set the tone for thisdebate at European level in itsreport published in October 2012.It concludedthat theon-goingreformsdo not addressall the underlyingproblemsin theEU bankingsector, astheydonot fullycorrectincentivesforexcessiverisk-taking, complexity, interconnectednessandintra-groupsubsidies.Thegroups report accordinglystatesthat reformingthe structure ofbanksis necessarytocomplement the existingreforms.TheCommission accordinglyconsidersit urgent toassessthedifferentstructural reform optionstoaddressthe aforementioned issuesand todevise a European framework for action topreservetheintegrityof thesinglemarket.(2) How doesit relate topast and possiblefuture initiatives, andtootherEU policies?TheEU and itsMember Stateshave engagedin a fundamental overhaulof bank regulation and supervision.This overhaul exerciseis based, to a largeextent, on the reformstostrengthenglobal financial marketsagreed upon by global leadersat theG20summitsin Londonin April 2009and thereafter,and implementedincooperation withtheFinancial Stability Board (FSB) and theBaselCommitteeof Banking Supervisors(Basel Committee).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 90. P a g e | 90In the area of banking, the EU hasinitiateda number of reforms toincreasetheresilienceof banks and toreduce theimpact of potentialbank failure.Thesereformsincludein particular thecapitalandliquidityrequirementstobe implementedaspart of thenew Capital Requirement Regulationand Directive (CRR/ CRDIV) and the proposed Bank Recovery andResolution Directive(BRR).Additionally, in order tobreak thenegativefeedback cycle betweensovereign and bankingrisks and restore confidencein the euro and thebankingsystem, theCommission hascalledfor further development ofBankingUnion, buildingonthesinglerulebookthat will beapplicabletoall banks in the wholeEU.This progresswouldtake theform of a SingleSupervisory Mechanismand a SingleResolution Mechanism, whichwouldbe mandatory formembersof the euroarea, but open to voluntary participation of all otherMemberStates.Structural bank reform wouldtakeplace in addition totheon-goingreform measures.What arethemain problemswhich this initiativewill address?TheEU bankingsector remainsaffected by severalproblems/ shortcomings:implicit bail-out expectations,moralhazard, excessiveleverageand balancesheet expansion, lack of marketdiscipline,lack of bank resolvability, economy-wideresourcemisallocation, competition distortions,etc.Theseproblems add to public concernswiththe fact that whereasprofitsin thebankingsystem are privatised, lossesincurredduring thecurrentcrisishave been largely socialised.Given that insured deposit-takingbanksare currentlylargelyunrestrained in the scope of their activitiesand unrestrictedin theirintra-group legal and economicstructures,a reform of largebankingInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 91. P a g e | 91groups structureswill aim at addressingtheabove problemsand atenhancingtheeffectivenessof existingand forthcoming reformproposals.Whowill beaffected byit?Therelevant bankinggroups,bank creditorsandinvestors,thecustomersof banking services(depositors,borrowers,retail and corporateclients, includingSMEsetc.), supervisorsand resolutionauthorities,central banksand governments(asprovidersof the publicsafetynet), taxpayers, and thewidereconomy (includingreal economy).Thevast majorityof the approximately 8000banks authorised in theEUwill not be affectedby thelegislation, astheywill fall below de minimisthresholds.Is EU action justified ongroundsof subsidiarity?Whycan MemberStatesnot achieve theobjectivesof theproposedaction sufficientlybythemselves?Can theEU achieve theobjectivesbetter?Structural reform proposalsare intrinsicallylinked to theregulatoryoverhaul of bank regulation and the wider financial system that iscurrentlyunderwayat EU and international level.An EU-wideapproach to regulation and international coordinationisnecessarygiventhecross-borderoperationsofmanybanksandtheglobalnature of the financial system.Divergingproposalsofstructural reformsofbanksarealreadyapparent indifferent MemberStates,and there isa lack of coordination, whichmaylead to competitivedistortionsinsideand out of the EU.Acommon framework for structural reform at European level is thereforerequiredto reinforcethe foundationsof an effectivebankingunion andpreservetheintegrityof the internal market in financial services.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 92. P a g e | 92B. Objectivesof the initiativeWhat arethemain policy objectives?Thegeneral objectivesare to establish a stableand efficient bankingsystem, preservingitsdiversity, that servesthe needsof EU citizensandtheeconomy, toincreaseeconomicgrowthby reducingfinancialinstability and improving the allocationof scarcecapital to itsbestuse,and to provide a EU-coordinatedresponsetoeliminatethe risksoffragmentation of financial markets.Someof the more specific objectiveswill addressthe conduct-relatedproblems(excessiverisk-taking, conflictsof interest, etc.), aim atreducingrisk of failure and enhancingeffectiveresolutionin theevent offailure, and prevent excessivebalancesheet growthand resourcemisallocation.Dotheobjectivesimplydeveloping EU policy in newareas?Yes.Theproposal on bank recovery and resolutionwouldempower resolutionauthoritiestorequire an individual bank to changeitslegal andoperational structureif deemed necessary toimprove resolvability.However,the EU regulatoryframeworkdoesnot includeprovisionsthatdirectlyaffect theorganisational structureof a broader set of banksandthat targetsa broader set of policyobjectives,such astheneed to set theappropriateeconomic incentivestoensure that banks contribute in anoptimalwaytothefinancetherealsectoroftheeconomy, thusenhancingeconomicgrowth.C. Options(1)What arethepolicyoptionsbeing(includingexemptions/ adaptedregimese.g. forSMEs) considered?International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 93. P a g e | 93The"baselinescenarioor―nopolicyaction" optionwillbecomparedandevaluated against theoption of pursuing bank structural reform.Assuch, the"noaction" option representsthebaselineagainst whichthevalue-added or incremental impact of structural reform will be evaluated.This baselinereflectsthe current regulatoryand supervisoryframeworkaswell ason-goingreforms, basedon expected implementationofCRR/ CRDIV, BRR and other outstanding reform proposals, aswell asstructural reformsbeingpursued in an independent manner in differentMemberStates.At the general level, structural reform refersto theseparation (orprohibition) of different bankingactivitiesthat canbeconductedwithinabankinggroup.However,anumberof different optionswillbeconsideredthat varyalongvariousdimensions.At this stage, three main dimensionsare consideredof particularrelevance:Definition of relevant activitiesto be separated:subject tofurther legalspecificationand calibrations,theoptionsto be considered includetheseparation of certain activitiesfrom deposit-takingentities currentlyengagingin retail and commercial banking activities.Theseactivitiescould include, amongst others,proprietarytrading, market-makingactivitiesmore generally, securitiesunderwriting, and potentiallyother activities.Considerationwill alsobe given to thetreatment of derivativesbusiness(asprincipal or asagent), the treatment of non-EU assets(and otherjurisdictional considerations), aswell asexposurestohedgefunds,private equityfunds,etc.Nature and extent of separationand governanceof separatedentities:themain option to be considered is separation in the form of ―functionalInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 94. P a g e | 94separation‖, also referred to as "ring-fencing" or"subsidiarisation", whereby the activities to be separated can still beconductedwithina bankinggroup.Theseactivitieswouldthenbe conducted in a separatelegal entity that isexplicitlylimitedin theeconomic and financiallinksit can maintain withthedeposit-takingentity in the group, and that is separatelycapitalisedand funded.Other formsof separationwill beconsideredagainstwhichtobenchmarkring-fencing/ subsidiarisation,ranging from accountingseparationtofullownership separation, wherebythe relevant activitiestobe separatedareeffectivelyprohibited and cannot be undertaken withina bankinggroupthat is authorisedtotake customer deposits.Thresholdsand deminimisexemptions:reflectingthe proportionalityprinciple,banksmay be exempted from separation requirementsif theymeet certain de minimiscriteria and conduct the relevant activitiesat alevel that fallsbelow a certain threshold, e.g. bank balancesheet size orshareof trading activitieswithin the bank‘sbalancesheet.Thevast majorityof the approximately 8000banks authorised in theEUwill not be affectedby this initiative, astheywill fall below de minimisthresholds.In particular, small regional and localbanks offeringservicesto localeconomy wouldnot be subject to separation.(2) What legislativeorsoft law instrumentscould beconsidered?Soft law policy instruments,such asrecommendation, arenot consideredsufficient, given their non-binding nature and thecloselink betweenstructural reform and theregulatoryand supervisoryframework(includingon-goinglegislativereforms).Theappropriate legal instrument i.e. whethertousea regulation or adirective, or a combination of both, will be assessedin theImpactAssessment.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 95. P a g e | 95In this assessment, particular attentionneedstobe paid to thepreservation of theSingleMarket.(3) How dotheoptionsrespect theproportionalityprinciple?EU actionwill not gobeyond whatisnecessarytoachievetheobjectivetoestablisha stableand effectivebanking system and toprotect andenhancethe functioningof the SingleMarket.In addition, a de minimis criterion exempting banksunder a certainthreshold from the separation requirementswill be considered.D. Initial assessment of impactsWhat arethebenefitsandcostsof each of thepolicy options?At agenerallevel,bank structural reformswouldyieldbenefitsin termsoffinancial stability, asit wouldreduceintra-group subsidiesthat havefuelledexcessivetradingactivity, thuscontributingto banksbeingtoo-big-to-fail.Bank structural reform will alsoalign economic incentivesto ensure thatbankscontribute in an optimal waytothe financethe real sector of theeconomy, thusenhancingeconomic growth.Such reformscould alsoyield costs, if theywouldundulyrestrict banks‘abilityto provide servicesthat are useful for the real economy.Thebalancebetweenthesebenefitsand costsdependson choicesmadeasregardse.g. thescopeof activitiessubjecttoseparation, thestrengthofseparation, and thenumber of banksrequired toseparate.Whereasseparatinga largescopeof activitiestoa strong degree ofseparation and applying thisseparationtoa largenumber of bankscouldproducesignificant benefitsin termsof financial stability, it could alsoundulyimpact the provision of real economyservicesand thusincreasecosts.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 96. P a g e | 96Theimpact assessment will weighthe costsand benefitsin order toidentify a balanced package.At a more detailed level, it is premature at this stage to report theprecisebenefitsand costsfor the different policyoptions.There is a largeand expanding literatureon this topicthat CommissionServicesarecurrentlyanalysing, and Commission Servicesare alsoperforming their own qualitativeand quantitativeanalysis.Couldanyorall of theoptionshave significant impactson(i) simplification,(ii) administrativeburden and(iii) onrelationswith other countries,(iv) implementationarrangements?And(v) couldanybedifficult totranspose forcertain Member States?It is premature toreport impactsof different optionson these issues.Thechosen scope of application, level of harmonisation and degreeofdetails will have aneffect onthe impact on relationswithother countriesandthepotential transpositiondifficultiesfor certain Member States.As an exampleit needsto be assessed how the EU initiativeaffectstheon-goingnational reforms.(1)Will an IAbecarried out forthis initiativeand/ orpossiblefollow-upinitiatives?(2) Whenwill theIAworkstart?(3)Whenwill you set up theIASteeringGroupand howoften will itmeet?International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 97. P a g e | 97(4) What DGswill beinvited?Theinitiativeon structural reform will be accompanied by an IA.Preparation started followingthepublicationof the Liikanenreport.Thefirst twomeetingsof the steeringgroup wereheld on 20Marchand26April 2013.TheSteeringGroup is expected to meet at leastthree times.Directoratesgeneral and servicesinvited include:Competition, EconomicandFinancialAffairs, Employment, Health and Consumers,EnterpriseandIndustry, Joint Research Centre, Justice, Taxation and CustomsUnion, Trade, Secretariat General and Legal Service.Is anyoption likely tohave impactson theEU budget above €5m?At this stageit is foreseen that theoptionswill not have such impactsontheEU budget.E. Evidence base, planning of further work and consultation(1)What information and data arealreadyavailable? Will existing IAandevaluation workbeused?(2) What further information needsto begathered, howwill this bedone(e.g. internallyorbyan external contractor), andbywhen?(3)What isthetimingfortheprocurement process& thecontract foranyexternal contractsthat you areplanning(e.g. for analyticalstudies, information gathering, etc.)?(4)Is anyparticular communication orinformation activity foreseen?Ifso,what, andbywhen?CommissionServiceswill draw upon publicly-available(notablypublicbalancesheetdata) analysisand research (academic, industry) and willInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 98. P a g e | 98conduct their ownqualitativeand, to theextent possible, quantitativeanalysis.The Commission Serviceswill not rely on external contractors to gatherinformation. Quantitative analysis of the impacts of the different policyoptionswill be done withthe help of JRC using availabledatabases.Whichstakeholders& expertshavebeenorwillbeconsulted, how,andatwhat stage?TheHigh-level expert group chaired byErkki Liikanenorganisedhearingswitha largenumber of stakeholders,whorepresentedprovidersof banking services, consumersof such services,investorsinbanks,policy makers, and academics.TheGroup furthermoreheld a public consultationof stakeholders,theresponsestowhichare published together with the Groups report.TheCommissionservicesheld a stakeholderconsultation on theGroupsrecommendations.The individual responsesreceived, aswell asasummary of responses,werepublished in December 2012.A further public consultation will be launched in early May. Stakeholderswill also have the opportunity to voice their views at a meeting organisedbytheCommissionserviceson 17 May.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 99. P a g e | 99APRA releasessecond consultationpackage on Basel III liquidity reformsTheAustralian Prudential RegulationAuthority (APRA) hastodayreleaseda second consultationpackageoutliningits proposedimplementationof theBasel III liquidityreformsfor authoriseddeposit-takinginstitutions(ADIs) inAustralia.Thepackage includesa discussionpaper, a reviseddraft PrudentialStandardAPS210Liquidity(APS210) and a draft Prudential PracticeGuideAPG 210Liquidity.Thepackageaddressesthemain issuesraised in submissionstoAPRA‘spreviousdiscussionpaper released in November 2011, and incorporatesrevisionsto the Basel III liquidityreformspublished by theBaselCommitteeon BankingSupervision (Basel Committee) in January2013.In the 2011discussion paper,APRA outlinedproposalstoimplement theBasel III liquidityreforms.Theseproposalsincluded twonew quantitativemeasures— a 30-dayLiquidityCoverageRatio(LCR) toaddressan acutestressscenarioand aNet StableFundingRatio(NSFR) to encourage longer-term fundingresilience.TheserequirementswouldapplytothoseADIsthat arecurrentlyrequiredtoconduct scenario analysisof their liquidityneedsunder differentoperatingcircumstances.This approach is unchangedin the updateddraft APS 210.In the 2011paper,APRA alsoproposed thatADIscurrentlysubject to thesimplequantitativeliquidityratio requirement, the minimum liquidityholdings(MLH) regime, wouldnot be subject to either of thetwonewBasel III global standards.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 100. P a g e | 100In responseto submissions,APRA hasmade minor adjustmentstotheMLH regime.Therecent revisionsto the LCR announcedby theBasel Committeeincludediscretionfor national authoritiesto includea widerrange ofliquidassetsin thedefinitionof high-qualityliquidassets(HQLA), somerefinementstothe assumed cash inflowand outflowrates,and a revisedtimetablefor phase-in of the LCR.In the packagereleasedtoday, APRA is not proposingto exercisediscretiontowidenthe definition of HQLA; hence,the definitionofHQLA in theupdated draft APS210is unchanged.In addition,APRA isproposingtoimplement theliquidityreforms onthepreviouslypublishedtimetable.APRA acknowledgesthisis a conservative approach, but one that is fullyconsistent withthe capabilitiesand needsof theAustralian bankingsystem.Accordingly, the LiquidityCoverageRatio will become effectivefrom 1January 2015and theNet StableFundingRatio from 1January 2018.The discussion paper released today also includes responses to the mainissues raised in submissionson APRA‘s 2011 proposals that have not beenaffected by the BaselCommittee‘srecent revisions.APRA Chairman Dr John Laker said that, in implementingtheBasel IIIliquidityreforms,APRA‘sobjectivesaretostrengthentheresilienceoftheAustralian banking system and improveAPRA‘s ability toassessandmonitorADIs‘ liquidityrisk.‗APRA believesADIsare well-placedto meet the new liquidityrequirementson theoriginal timetableand doing sowill send a strongmessageabout thesoundnessof theAustralian bankingsystem.‘Thediscussionpaper, draft prudential standard and draft prudentialpractice guidecan befound onAPRA‘s websiteat:International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 101. P a g e | 101www.apra.gov.au/ adi/PrudentialFramework/Pages/Implementing-Basel-III-liquidity-reforms-in-Australia-May-2013.aspxTheAustralian Prudential RegulationAuthority (APRA) is theprudentialregulator of thefinancial servicesindustry. It overseesbanks, creditunions,buildingsocieties, general insuranceand reinsurancecompanies, life insurance, friendlysocieties, andmost membersof thesuperannuation industry. APRAis funded largely bytheindustries that itsupervises. It wasestablished on 1July1998. APRAcurrentlysupervisesinstitutionsholding$4.2trillion in assetsforalmost 23millionAustraliandepositors, policyholders and superannuation fund members.Discussion PaperImplementing Basel III liquidity reformsin AustraliaMay 2013In November 2011,APRA released a discussion paper and draft prudentialstandardoutliningitsproposalstostrengthen theliquidityriskmanagement frameworkfor authoriseddeposit-takinginstitutions (ADIs)in Australia.The discussion paper gave effect to reforms, announced by the BaselCommittee on Banking Supervision (Basel Committee) in December2010, to strengthen liquidity buffers so as to promote a more resilientglobal banking system.In January 2013,theBasel Committeereleased amendmentstoone of thekey elementsof these reforms— the LiquidityCoverageRatio (LCR) —in itsdocument Basel III: The LiquidityCoverageRatio and LiquidityRiskMonitoring Tools.APRA is now in a position tocompleteitsconsultationson themainelementsof the Basel III liquidityframework.This consultationpackage outlinesAPRA‘s proposed amendmentstoits2011proposalson the implementationof the LCR in Australia.It alsoaddressesthemain issuesraisedin submissions,and in otherdialoguewithindustry and other interestedparties,on those ofAPRA‘sInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 102. P a g e | 102earlier proposalsthat have not been affectedby theBasel Committee‘srecent revisions.Theconsultationpackageincludesan updated draft of PrudentialStandardAPS210Liquidity(APS210)and draft Prudential PracticeGuideAPG 210Liquidity(APG 210).Qualitative requirementsTheBasel III liquidityframeworkis underpinnedby qualitativerequirementsfor liquidityriskmanagement, based on theBaselCommittee‘sPrinciplesfor Sound LiquidityRisk Management andSupervision(Sound Principles) (2008).APRAproposedtoincorporatethesequalitativerequirementsin arevisedAPS 210.Theyincluded requirementsfor enhanced Board oversight of anADI‘sliquidityrisk management framework, for an articulationof the Board‘stolerancefor liquidityrisk, for quantificationand allocation of liquiditycostsand benefits,and other matters.SubmissionsweresupportiveofAPRA‘s qualitativerequirementsand they areunchanged in theupdateddraft APS210.Quantitative requirements: scenario analysisADIsTheBasel III liquidityframeworkinvolvestwonew minimum globalstandards:- a 30-dayLCR to addressan acutestressscenario;and- a Net StableFundingRatio (NSFR) to encourage longer-termfundingresilience.APRA proposedtoapplythesequantitativeliquidityrequirementstothoseADIsthat arecurrentlyrequired toconduct scenarioanalysisoftheir liquidityneedsunder different operatingcircumstances(‗scenarioanalysis‘ADIs).This approach isunchangedin theupdateddraft APS 210.TheBasel Committeeis continuingto review theNSFR, which doesnotcomeintoeffect until 1January 2018.APRA hasnot made any amendmentstoits proposedimplementationoftheNSFR, but will ensure that concernsraisedin submissionsare fedintothe Basel Committee‘sdeliberations.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 103. P a g e | 103TherevisionstotheLCR recentlyannounced by theBasel Committeeinvolve:- discretionfor national authoritiestoincludea wider rangeof liquidassetsin the definitionof high-qualityliquid assets(HQLA);- some refinementstotheassumed cash inflowand outflow rates;and- a revised timetablefor phase-in of the LCR.Definition of HQLANational authoritieshave discretion to include certain additional assetsina new ‗Level 2B‘ category of HQLA, subject to haircuts and provided theassetsfullycomplywith thequalifying criteria.These assets are residential mortgage-backed securities (RMBS) with along-term credit rating of AA or higher, corporate debt securitieswith along-term credit rating betweenA+ and BBB–, and certain listednon-financial equities.APRA is not proposing to exercisethis discretion.Accordingly, the definitionof HQLA in the updated draft APS210isunchanged.APRA hasconsidered themarket characteristicsofAustralian dollar debtsecuritiespotentiallyeligible asLevel 2B assetsagainstthe qualifyingcriteria that such assetsmust tradein large, deep and activemarkets,beliquidduring a time of stressand, in most casesbe eligiblefor useincentral bank operations.In APRA‘s view, therelevant securitiesdonot meet all of thesecriteria.Further,APRA doesnot consider that theinclusion of equitiesasLevel2B assetswouldcontributeto the resilienceof theAustralian bankingsystem.Equities arenot repo-eligiblewiththe Reserve Bank ofAustralia (RBA);hence, a large-scaleforced saleof equityportfoliosby one or moreAustralian bankscould significantlyexacerbatea stressevent.However,some of the debt securities includedin the definition of Level2Aand Level 2B assetsare repo-eligiblewith theRBAfor normal marketoperationsand areeligible collateralfor theCommittedLiquidityFacility(CLF).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 104. P a g e | 104ADIswithaccesstothe CLF are likelytohold thoseassetsaspart of awell-diversifiedliquid assetsportfolio.Cash inflow and outflow ratesAPRA is proposing toadopt the revisedBasel III assumed cash inflowand outflowrates,withonlyone minor modification relatedto maturingcentral bank fundingtransactions.In its2011discussionpaper,APRA proposedsomeother modificationstotheBasel III assumed cash inflowand outflowrates.Theserelatedtothetreatment of self-managedsuperannuationfunds,high run-off lessstableretail and qualifying small and mediumenterprise(SME) deposits,contingent fundingobligations,andrecognition of head officeliquiditysupport toAustralian branchesofforeign banks. Thesemodificationshavenot been materiallychangedintheupdateddraft APS210.Quantitative requirements: minimum liquidity holdingsADIsIn its 2011discussion paper,APRA proposed that ADIscurrentlysubjecttoa simplequantitativeliquidityratiorequirement, theminimumliquidityholdings(MLH) regime, wouldnot be subject to either of theBasel III global standards.APRA proposedtoleavethe MLH regime broadlyunchangedbut torevisethe definitionof assetsthat are eligiblefor inclusion in anADI‘sminimum liquidityholdings.Submissionsraisedconcerns about thetreatment of industrysupportschemesandthereviseddefinitionofassetseligibleforinclusioninMLHportfolios.APRAhasmade some amendmentsin updateddraft APS210in responsetothesesubmissions.Reporting and prudential disclosure requirementsReportingrequirementsfor scenario analysisADIshavebeen thesubjectof a separateconsultation process, basedonAPRA‘s November 2012discussion paper, Liquidityreportingrequirementsfor authoriseddeposit-takinginstitutions.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 105. P a g e | 105Since the Basel Committee is continuing to review the NSFR, APRA hasdecided to remove the NSFR from the standardised reporting frameworkat this stage.TheBasel Committeeis alsocontinuingto develop disclosurerequirementsfor bank liquidityand fundingprofiles.APRA intendstoconsult separately on its disclosure requirementsonce global disclosurestandardsare finalised.Implementation timetableIn its 2011discussion paper,APRA proposed tointroducetheLCRrequirement from 1January2015,in linewith the-then internationallyagreedtimetable.As noted above, therevisedtimetablerecentlyannounced bythe BaselCommitteeallowsfor a phase-inof the LCR, with a minimumrequirement of 60per cent from the original start-daterisingin equalannual stepsof 10percentagepointsto reach 100per cent on 1January2019.Thegraduated approach isdesignedtoensure that the LCR can beintroduced ‗…without disruption to theorderly strengtheningof bankingsystems.‘APRA is not proposing to adopt the phase-in arrangements.Thesearrangementswereintroduced in light of theconsiderable stressfacingbankingsystems in some regions.Australia, however, is not one of thoseregions.Moreover,most largeinternationallyactivebanks arealreadycompliantwith the LCR.Finally,APRA is cognisant of concerns,raisedby the InternationalMonetaryFund in its2012Financial System Stability Assessment ofAustralia4, that the continued relianceofAustralian banks on offshorefundingleavesthem exposed to disruptionstofunding markets.Accordingly, APRA proposestoretain itsoriginal implementationtimetablefor theLCR.This is a conservative approach, but one that is fullyconsistent withthecapabilitiesand needsof theAustralian bankingsystem.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 106. P a g e | 106ADIsare, in anyevent, wellplaced tomeet therequirement and, in doingso, will send a strongmessage about thesoundnessof theAustralianbankingsystem.APRA invites written submissions on its proposed response to the BaselCommittee‘s recent revisions to the Basel III liquidity framework, as setout in theupdateddraft APS 210.It alsoinviteswrittensubmissionson the draft APG 210.Followingconsiderationof submissionsreceived, APRA intendsto issuethefinalAPS210andAPG 210in mid-2013.Thenew prudential standard is intendedto come intoforce on 1January2014; theLCR and NSFR requirementsareintended to commenceon 1January 2015and 1January2018,respectively.Chapter 3 – LCR — high-quality liquid assetsThedetermination of the LCR hastwocomponents:- thevalue of thestock of HQLA in stressedconditions;and- total net cashoutflows, calculatedaccordingtospecifiedscenarioanalysis.This chapter dealswiththe first of thesecomponents.3.1Original Basel Committee measuresUnder the BaselIII liquidityframework,assetsqualifying asHQLA forLCR purposesmust beunencumbered, easilyand immediatelyconvertedintocash withlittleor nolossof value under stressed market conditionsand, ideally, be eligiblefor repurchaseagreementswith thecentral bank.In theBaselCommittee‘soriginal measures,HQLAwerecategorisedintotwobucketsbasedon the liquiditycharacteristicsof the assets8.Thehighest qualityliquid assets,whichAPRA will refer toasHQLA1,can comprise an unlimitedportion of thetotal stock of HQLA.Theseassetsare limitedto:- cash;International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 107. P a g e | 107- central bank reserves(tothe extent that thesereservescan bedrawndownin timesof stress);and- marketablesecuritiesrepresentingclaimson or claimsguaranteed bysovereigns, quasi-sovereigns,central banksand multilateraldevelopment banks, that have undoubtedliquidity, even duringstressed market conditions,and that areassigned a zero risk-weightunder the Basel II standardised approach to credit risk.HQLA2 are assetswitha proven record asa reliable source of liquidityeven during stressed market conditions,and comprise:- marketablesecuritiesrepresentingclaimson or by sovereigns,quasi-sovereigns, central banks and multilateral developmentbanks, whichare assigneda 20per cent risk-weight under the BaselII standardisedapproach;- corporatebonds(not issued by a financial institution or anyof itsaffiliatedentities)witha credit rating from a recognised externalcredit assessment institutionof at least AA-; and- coveredbonds(not issuedby theADI itself or any of itsaffiliatedentities)witha credit ratingof at leastAA-.HQLA2 are limitedto40per cent of the total shock of HQLA and attracta minimum 15per cent haircut.Following a review of a range of marketable instruments denominated inAustralian dollars (AUD) against the Basel III criteria for HQLA, APRAadvised that:- theonly assetsthat qualify for HQLA1 are cash, balancesheld withtheRBA, and CommonwealthGovernment and semi-governmentsecurities;and- thereare no assetsthat qualify asHQLA2.APRAalsoadvisedthat it willkeepthispositionunderreview, takingintoaccount relevant market developments10.3.2 Recent Basel Committee revisionsRecent revisionsto theLCR announced by theBasel Committeeintroduced a third bucket (Level 2B assets) for categorisingHQLA,International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 108. P a g e | 108whichnational authoritieshave discretionto includein LCR calculationsif the assetsfullycomplywiththe qualifying criteria. Level 2B assetsarelimitedto:- RMBS ratedAA or higher not issued by the bank itselfor any of itsaffiliatedentities;- corporatedebt securitiesrated betweenA+ and BBB- not issuedby afinancial institutionor anyof itsaffiliatedentities;and- ordinarysharesnot issuedby a financial institution or any of itsaffiliatedentities.Level 2B assetsare subject tohigher haircutsthan HQLA2, and toa limitof 15per cent of total HQLA.Thequalifying criteria includethat the assetsmust tradein large, deepand activerepoor cashmarketscharacterisedby a lowlevel ofconcentration, and must have a proven record asa reliablesource ofliquidityevenduring stressedmarket conditions.Consistent withitsreview of the eligibility of marketableinstrumentsforHQLA2, APRA hasconsideredthe rangeof possibleAustralian dollarLevel 2B debt securities against the qualifying criteria.Thishastakenintoaccounttheamount oftheseinstrumentsonissue,thedegreetowhichtheinstrumentsarebroadlyor narrowlyheld, and thedegreetowhichtheinstrumentsaretraded in large, deep and activemarkets.APRA hasgiven particular attentionto the liquidityof theseinstrumentsduring themarket disruptionsof 2007–2009in themore acutephasesoftheglobal financial crisis.Basedonthisreview,APRAhasconcludedthattherearenoeligible Level2B debt securitiesin Australia.APRA notes,however, that sometypes of debt securities included in thedefinitionof Level 2Aand Level 2B assetsare repo-eligiblewiththe RBAfor normal market operationsand areeligiblecollateral for the CLF fromtheRBA.Theseincludecertainsovereign, supranational and foreign agencyAustralian dollar-denominatedbonds, RMBSratedAAA or higher, andsome corporatedebt securities.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 109. P a g e | 109ADIswithaccesstothe CLF are likelytohold these assetsaspart of awell-diversifiedliquid assetsportfolio.APRA hasalsoreviewedtheeligibilityof unencumbered non-financialequitiesfor inclusionin Level 2B assets.Although themarket for manylistedequities inAustralia is liquid, APRA doesnot consider that theinclusionof equities asLevel 2B assetswouldcontribute to the resilienceof theAustralian banking system.Equities arenot repo-eligiblewiththe RBA and any large-scaleforcedsaleof equityportfolios by one or moreAustralian bankscouldsignificantlyexacerbate a stressevent.Accordingly, APRA isnot proposing to exercise the discretion available toit to introduce the third bucket of HQLAand it hasnot included Level 2Bassetsin the definitionof HQLA in theupdateddraft APS210.However,aswithHQLA2 assets,APRA will keep this position underreview, taking into accountrelevant market developments.HQLAfor a consolidated banking groupAPRA acknowledgesthat other national authoritiesmay exercisetheirdiscretiontoincludeLevel 2B assetsfor LCR purposesin theirjurisdictions.In such cases, APRA may allowanADI withmaterial bankingsubsidiariesin such jurisdictionsto hold some amount of Level 2B assetstomeet theLCR requirementsimposedby thehost supervisor. Nochangeto draft APS210is required.However,until it isable to gain confidencein the liquidityof foreigncurrencyLevel 2B assetsin stressedcircumstances,APRA doesnotbelievethat such assetsshould be recognised in LCR calculationsfor theconsolidated(Level 2) bankinggroup.At the group level,ADIs will be required to hold sufficient liquid assetsthat satisfy the HQLA1, HQLA2 and, whererelevant, Alternative LiquidAssetscriteriatoensure that theminimum LCR level of 100per cent ismet.This approach is set out inAttachment Aof updateddraft APS 210.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 110. P a g e | 110Use of HQLAin a time of stressIn its recent revisionsto the LCR, the BaselCommitteere-affirmedthatthestock of HQLA isavailablefor useduring a period of financial stress.APRA endorsesthisapproach, whichis reflectedin updateddraft APS210.APRA acknowledgesthat, in a timeof stress,anADI may need toliquidatepart ofitsstockofHQLA and/ ordrawonitsCLF withtheRBA, using the cash generatedto cover cashoutflowsand, thereby, fallingbelow the 100per cent LCR requirement.Theupdated draft APS 210 requiresthat anADI must inform APRAimmediatelyin the event that it becomesawareof the circumstancesthatwill result in a breach of its LCR requirement.APRA‘s supervisoryresponseto a breach of anADI‘s LCR requirementwill be appropriatetothecircumstances.Operational requirements for the management of HQLATheBaselCommittee‘soriginalLCR measures,whichAPRAproposedtoadopt, imposed operational requirementsfor the management of HQLA.Theseincluded that thestock must be under control of thespecificfunctionor functionschargedwithmanagingthe liquidityriskof thebank.In its recent revisions,the BaselCommitteehasrefinedand clarified itsoperational requirements.Theamendedwordingis that thestock of HQLA must be under thecontrol of the function charged withmanaging the liquidityof thebank, meaningthe function hasthecontinuousauthority, and legal andoperational capability, tomonetise any asset in thestock.APRA proposestoadopt the amended wording.This is expected to result in some assetsthat werepreviouslyexcludednowbecomingeligible for inclusion in the stock of HQLA.3.3 Other mattersraised in submissionsAlternative liquid assettreatment — The CLF review processInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 111. P a g e | 111In recognitionof jurisdictionswithan insufficient supplyof HQLA, theBasel III liquidityframeworkincorporatesscopefor alternativetreatmentsfor theholdingof HQLA.Onealternativetreatment is toallowbankinginstitutionstoestablishcontractual committedliquidityfacilitiesprovided by their centralbank, subject toan appropriate fee, with such facilitiescounting towardstheLCR requirement.As the current supply of HQLA inAustralia is not adequatetosatisfyADIs‘LCR requirements,APRA and theRBA announced in December2010that anADI will beabletoestablisha secured CLF withtheRBAforthepurposesof meeting itsLCR requirement inAustralian dollars.TheCLF will besufficient insizetocover anyshortfall betweentheADI‘sholdingsof HQLAand itsLCR needs(both inAustralian dollars).APRA haspreviously statedthat ADIs will be requiredto demonstratethat theyhavetakenall reasonablestepstowardsmeeting their LCRrequirementsthrough their own balancesheet management, beforerelying onthe CLF.APRAwillbereviewingeachADI‘sliquidityriskmanagement frameworkand funding practicesasthebasisfor approving the size of the CLF forLCR purposes.Comments receivedSubmissionssought further information onAPRA‘smethod of approvingaccessto theCLF.Submissionsalsoraisedconcern that overlyconservativefundingobligationswouldlimit the industry‘sability toprovide maturitytransformation, shiftingliquidityriskintounregulated partsof thefinancial servicessector.Submissionsalsorequestedfurtherguidanceonthepracticaldefinitionofa ‗minor LCR shortfall‘for CLF and self-securitisationpurposes. APRAhadpreviouslyproposedthatwhereanADI expectedtohaveonlyaminorLCR shortfall without a CLF, theADI wouldneedtomanage itsliquidityrequirementson its own resources,rather than relying on a CLF.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 112. P a g e | 112Somesubmissionsraised the concern that this approachmay createcompetitivedisadvantagesfor some scenario analysisADIsin regard toCLF access.Other submissionsargued that the useof self-securitisedassetsascollateral for the CLF may createcompetitivedisadvantagesfor MLHADIs, sincesuchassetsarenot countedaspart of their minimumliquidityholdings.APRA‘sresponseAPRA does not propose to elaborate on the processfor providing accessto, or the appropriate composition of eligible assets for, the CLF in APS210.Theseissueswill be dealt withunderAPRA‘s supervision framework.APRA hascommenced itsengagement withADIson theprocessforsettingCLF size and composition withinthe LCR and will expand thisengagement over coming months.APRA will alsoconsider the need topublish further guidanceon accesstotheCLF in duecourse.Chapter 4 – LCR — net cash outflowsThesecond component inthedeterminationof theLCR requiresADIstocalculate their total net cash outflowsover thenext 30 calendar daysundera stressscenario.Theoriginal Basel III liquidityframework providedmany of thecashflowassumptionstobe usedfor this purposeandAPRA proposedtoadopttheseassumptions,except for minor modificationsor clarifications.TheBasel III cashflowassumptionsare based onthebehaviour, duringastressedperiod, ofthecounterpartiesprovidingfundingtotheADI andofthosetowhichtheADI providesfacilities(either credit, liquidityorcontingency).In its recent revisions,the BaselCommitteehasmade a number ofamendmentstothecalculationof net cashoutflows. Theseincludeadditionalcashoutflowcategories, revisionstothecashoutflowratesandsome reviseddefinitions.This chapter discussesAPRA‘sproposed responseto theseamendments.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 113. P a g e | 113It alsoprovidesAPRA‘s responsetosubmissionson its2011proposalsonnet cash outflowsthat are unchanged bytheBasel Committee‘srecentrevisions.4.1Recent Basel Committee revisionsThis section addressesthemain Basel Committeerevisionstothecashoutflowassumptions. Anumber of minorrevisions,which arenotdiscussed here, havebeen incorporated intotheupdated draft APS210.Fully guaranteed retail depositsThe revised Basel III liquidity framework includes an additional retaildeposit category for deposits that are fully insured under a pre-fundeddeposit insurancescheme.Thedeposit insuranceschemein Australia, the Financial ClaimsScheme(FCS), is not pre-fundedand, assuch, thiscategoryisnot relevant fordomesticdepositsNon-financial corporate, sovereigns, central banksand publicsector entity (PSE) depositsTherevised framework hasreducedthe assumed cash outflow rate fornon-operationalnon-financialcorporate,sovereign,centralbank andPSEdepositsfrom 75 per cent to40per cent.APRA proposestoadopt this amendment.Liquidity facilitiesfor non-financial corporatesTherevised frameworkhasreducedthecash outflowrate for liquidityfacilitiesprovidedtonon-financial corporate customersfrom 100per centto30per cent. APRA proposesto adopt thisamendment.Collateral outflowsattributable to market movesTheoriginal Basel III liquidityframework gave national authoritiesdiscretionin settingthemethodology for thecalculationof collateraloutflowsrelated to market movementsof derivativepositions.Therevised frameworkhasremoved thisdiscretionand providesastandardisedmethod for thiscalculation.APRA proposestoincorporatethe standardisedmethod intoAPS 210.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 114. P a g e | 114This method requiresADIsto take the largest absolute net 30-daycollateralflowrealisedinthepast 24monthsandmodel thisbalanceasanoutflow.TherevisedBaselIII rulestext alsostatesthat ‗supervisorsmayadjustthetreatment flexiblyaccordingto circumstances‘.APRA acknowledgesindustry arguments, discussedlater in thischapter,that a liquiditystressevent ismuch more likely tobe associatedwith a fallingAustralian dollar than a rising one.Accordingly, APRA invites feedback from industry as to an alternativeoutflow treatment that would acknowledge this probable direction butwouldbe consistent with the Basel Committee‘sintent.Committed but unfunded inter-financial liquidity and creditfacilitiesTherevised frameworkhasreducedthecash outflowrate for committedbut unfunded liquidityand credit facilitiesprovided tobankinginstitutionsthat areprudentiallysupervisedfrom 100per cent to 40percent.APRA proposestoadopt this amendment.Additional derivativesrisksTherevised frameworkincludesanumber of additional collateral outflowcategoriesdesignedtoensure that risksassociatedwithderivativepositionsare correctlycaptured in the LCR.Thecash outflowratefor these categoriesis 100per cent of the measuredvalue.APRA proposestoadopt theseamendments.Derivatives secured by HQLATherevised frameworkhasclarifiedthat wherea derivativecashflow issecuredwithHQLA1,acashoutflowrateof zeropercent istobeapplied.APRA proposestoadopt this amendment.Maturing secured funding transactionsTherevised framework hasreduced theoutflowrateon maturing securedfundingtransactionswithacentralbank from 25percent tozeropercent.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 115. P a g e | 115In the event that a secured funding transactionbacked by CLF eligiblecollateralmaturesduring astressevent, anADI withaCLF willbeabletore-executethesecured funding transactionbecauseof theRBA‘scommitment under the CLF.This will result in an outflowagainst this transactionof zero per cent.However,if thesame transactionmatured for anADI that did not have aCLF, thatADI wouldhave noguaranteed abilitytoroll thetransaction, resultingin a possibleoutflowrateof 100per cent.APRA proposes to include an additional category for maturing securedfunding transactions backed by CLF eligible debt securities (where theADI has capacity available under its CLF limit) with an outflow rate ofzero per cent.Followingconsultationswiththe RBA, APRA proposesthat all othermaturing securedfunding transactionswith the RBAthat are not backedbyHQLAwill receivean outflow rateof 100per cent.Fully insured unsecured wholesalefundingTherevised frameworkincludesan additional outflowcategoryfor fullyinsurednon-operational, non-financial, unsecured wholesaledeposits.APRA proposestoadopt the outflowrateof 20 per cent.4.2 Other mattersraised in submissions4.2.1 Cash outflowsRetail and qualifying small and medium enterprises(SME) depositrun-offWithinthe LCR, retail deposit balancesare classified aseither ‗stable‘or‗lessstable‘.Stable deposit balances are those that are considered to have the lowestpropensity to be withdrawn during times of stress and, hence, receive alowthreeor five per cent cash outflowrate.Lessstabledepositsare consideredtohave a higher propensityto bewithdrawnand asaresult, dependingondeposit characteristics,receivea10per cent or higher cashoutflow rate.APRA proposedtoadopt the Basel III treatment of stabledepositsand, consistent withthe BaselIII approach, tointroducetwohigherrun-offInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 116. P a g e | 116categoriesfor lessstabledeposits, withrun-off ratesof 10per cent and 30per cent, respectively.APRAproposedasimplescorecardapproachtodeterminewhichof thesetworun-off ratesapplied.SME deposits that satisfycertain criteriaregarding balanceandbehaviour, asoutlinedin draft APS 210, are consideredretail for LCRpurposes.Comments receivedClarificationwasrequested on thetreatment of depositswitha totalbalanceabovethe guaranteelimit of theFCS, whichisAUD 250,000foraccount-holderperADI.Submissionssought tounderstand whetherthe amount below the limitwouldreceiveastableoutflowrateandtheamountabovethelimit receivea lessstableoutflowrate.Submissionssuggestedincludingclient relationship characteristics,suchasthe term of a relationship, the number of productsand theuseof arelationship manager, to assist categorisationof the deposit.Theyalsoproposed that dormant accountsbe classified asstabledue totheir expected inactivityin a stressevent and that self-managedsuperfund (SMSF) depositsbeeligible tobe classified asstabledepositsasthetrusteeoverseeing the SMSF deposit account is not necessarilyafinanciallysophisticatedindividual.Somesubmissionsargued that the categoriesfor stableand lessstabledepositsweretoo broad and proposed thatAPRA providemore precisedefinitionsof thevariouscriteriathat definethese categories.It wassuggestedthat theoutflowrate of30percentforhigher run-offlessstabledepositswastoohigh asit did not reflect industryexperienceorassessmentsof expected run-off under stress.Alternatives proposed were that the outflow rate be lowered or that anadditional lower cash outflow category between 10 per cent and 30 percent be introduced.Anumber of submissionsobjectedtotheinclusionof internet accessasacriterion in the lessstabledeposit scorecard.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 117. P a g e | 117Thesesubmissionsarguedthat meansof accesswasnot a strongindicatorof withdrawal propensityand it should be removedfrom thescorecard;instead, greater emphasisshould be placed on deposit size asthiswasmore consistent withADI experience.Somesubmissionsconsidered that the FCSlimit should be the soledeterminant of a higher outflow rate asdepositsbelow the limit would beexpectedto be withdrawnat a much lowerrate giventhat theyareguaranteed.Other submissionsopposed the implicationin thescorecardthat adeposit couldgeta30percent outflowrateevenwhencoveredbytheFCSif it met the other scorecard criteria.Concernwasalsoexpressedthat all New Zealandtransactional accountswhereestablishedcustomer relationshipscannot be evidenced wouldneed to be classifiedashigher run-off lessstabledeposits underAPRA‘sproposed approach asthe New Zealandgovernment guaranteeis nolonger available.Anumber of submissionsargued for amendmentsto thetreatment offundsreceived via an intermediaryasthat treatment wouldresult indifferential outflow ratesbeingapplied byADIsto an equivalentcustomer dependingon the source of thedeposit.Thisissuewasraised, in particular, in relationtodeposits receivedfromSMSF customersrather thanvia APRA-regulated superannuation funds.Another issueraisedwasthat SME customerswithno depositscould notbeclassifiedunderAPRA‘s proposed approach asthedefinition of SMEin draft APS210is linked to deposit size.This is an issuefor SME customerswhodonot havedeposit productswithanADI but haveotherdealingswiththeADI that wouldbecapturedbytheLCR.Another issueraisedconcerned the possibleofferingof thematuring31-daynotice period term deposit whichhasrecentlybeen thesubject ofanAustralian Securities and InvestmentsCommission consultation, andwhetherthe abilityof a depositortowithdraw a deposit in theproposedterm deposit grace period wouldresult in the entire portfolio beingconsideredin breach of the requirementsfor retail fixed-term depositsinAttachment Atodraft APS 210, and needingto be modelled asat-calldeposits.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 118. P a g e | 118APRA‘sresponseAPRA agreesthat theFCS limit may be a determinant of customerbehaviour.Consistent withthis,for any deposit meetingthe criteria of paragraph 36in Attachment Aof updateddraft APS210,that portion of thedepositcoveredby the FCScan be treated asstableand any balanceabove thelimit is tobe treated aslessstable.For stable deposits, APRA considers that paragraph 36 of Attachment Aadequately describes the characteristics of stable deposits and does notneed amending.For definingthedifferencebetweenlessstableand higher run-off lessstabledeposits,APRA agreesthat client relationship characteristicsmayplaya part but it doesnot proposetoincludethesein the scorecardastheyare alreadyused in thedefinition of stabledepositsand theirinclusionin the scorecard wouldintroduceambiguitiesbetweenlessstableand stabledeposits.For dormant accounts, APRA considers that a depositor‘s response to aliquidity stress situation is uncertain at best and that dormant accountsare not necessarily a good indicator of a stabledeposit.Hence, dormant depositsare tobe treated equivalentlyto other deposits.As explained in itsNovember 2011discussion paper,APRA considersSMSFdepositorstobeself-selected, financiallysophisticatedindividuals,whichis an indicator of a greater propensityto withdraw fundsin a stresssituation.As such, SMSFdepositsare appropriatelycategorised aslessstable.APRA hasconsidered its proposed scorecardcriteria for lessstabledepositsagainst theargumentsmade in submissionsbut hasnotidentifiedcompellingreasonstochangethesecriteria.However,APRA will amend the wordingof the scorecard category‗Deposit is primarilyinternet accessed‘to‗Deposit is an on-lineaccount‘in order to better reflect itsobjective.Depositsthat wouldbe expectedto fall intothiscategoryarethosewheretheinternet is integraltothedesign, marketingand usageof theproduct.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 119. P a g e | 119It is not intendedtocapture depositswherethe internet issimplyone ofseveral meansof accessingand transactingon the account.Further guidanceon thesedeposit classificationscan be found in thedraft APG 210.In thecaseof depositsin jurisdictions(suchasNew Zealand) that donothavegovernment deposit guarantees,the absenceof a deposit guaranteeeffectivelyremovesa size criterion from thescorecard and lowersthehurdlefor higher run-off deposits.APRA considersthat having a size criterion in thescorecard isappropriate.Hence, the first categoryof thescorecard will be alteredtoread ‗Depositbalanceis greater than any government deposit guarantee limit whereitexistsand, in itsabsence, wherethedeposit balanceis greater than theequivalent ofAUD 250,000‘.This will alsoaddressthe concernsregardingNew Zealand depositsmentioned above.In addition, APRA hasreduced the outflowrate for higher run-off lessstabledepositsfrom 30per cent to 25per cent.This providesa more appropriatecalibrationwithother categoryoutflowrates, such asoperational deposits.For depositssourced via an intermediary, wherethe intermediary retainsinvestment responsibility or hasa fiduciaryduty tothe underlyingcustomer,APRA considersit is appropriate to assume the intermediarywill observe theresponsibilityand duty in a time of liquiditystress.This fiduciaryduty isnot removed whencustomershave an investmentdiscretionwhen initiatingan intermediateddeposit.Accordingly, these depositsare most appropriatelyclassifiedasbeingsourcedfrom a financial institution, regardlessof thenature of thecustomer placingfundswiththe intermediary.This interpretation will not affect SMSF deposits;SMSF depositsareconsideredtobe thoseof a natural person and not sourced via anintermediaryWhere an SME client hasnodepositswithanADI, APRA proposesforcontingent obligationpurposesto usethedefinitionof an SME inInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 120. P a g e | 120Prudential StandardAPS 113CapitalAdequacy: Internal Ratings–basedApproach to Credit Risk (APS113).Paragraph 47 ofAPS113statesthat ‗Toberegarded asa retailexposure, thetotal business-relatedexposure of theLevel 2 group to asmall-businessobligor or group of connected small-businessobligorsmust be lessthan $1million.‘For 31-daynotice period term depositsthat are in a grace period, anADIwill be expected to model theterm deposit on an equivalent basistoademand deposit, consistent with the requirementsof paragraphs40and41in Attachment Aof updated draft APS210.In addition, a 100per cent outflow rateis to apply to any31-daynoticeperiod deposit that hasbeen called.Unsecured wholesalefunding run-offIn the LCR, unsecured wholesalefundingis fundingprovided bynon-financial corporate, sovereigns,central banks and PSEson anunsecuredbasis.Thecash outflowratesagainst thesecategoriesof depositsare set out intheBasel III liquidityframeworkandAPRA proposestoimplement themwithout amendment.Comments receivedSomesubmissionsraised the concern that industry experienceofunsecuredwholesalerun-off ratesin a stressscenario in Australia islackingand availableinternational data suggest a lowerrun-offexperiencethan theLCR assumptions.Thesesubmissionsarguedthat cash outflowratesshould be identifiedthrough empirical calibration.The issue was also raised that small changes in the size of an account orinterpretation of account type will have a material impact on the outflowassumption to be applied in the LCR, particularly given the difference inthe cash outflow assumptions for operational deposits and other types ofdeposit from corporations.It wassuggestedthat whereaccountsaremanaged through theactiveparticipationof a relationship manager, this should significantlyreducethepropensity for deposit withdrawal in a stressevent.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 121. P a g e | 121Clarity wasalsorequestedon the definitionof operationaldeposits,particularlyon thepossibleinclusionof definingcriteria suchastransactionvolume, interest rate level and customer relationship.Submissionsalsoarguedthat correspondent banking (Vostro) accountsare operational depositsand shouldbe includedin this category.APRA‘sresponseTheBasel III cash outflowratesare intended toprovidea globallyconsistent representation of an idiosyncratic and/ or systemic liquiditystressevent.Thecashoutflowratesrepresent aplausibleestimateofbehavioursacrossa rangeof categoriesthat are intentionallyspecified at a conservativelevel.TheBasel III liquidityframeworkprovidessimplicityand ensuresagloballyconsistent application.APRA acknowledgesthe significant differencein outflow ratesfor anindividual deposit dependingon its classification.However,in APRA‘s view, theoutflow categories and outflowrateswillachievean appropriate outcome from a total portfolioperspective.Recent Basel Committeerevisionstothecash outflowratesof unsecuredwholesalefunding, whichAPRA proposestoadopt, werediscussedearlierin this chapter.TheBasel Committeehasdetermined that Vostro accountsdonot haveoperational deposit statusandAPRA agrees.Thecriterion for an operational deposit isthat the depositorhasasubstantivedependencyon the continued operationof theaccount thatactsasa practical impediment toclosingor moving the account.That is, the account is sointegral to thebusinessoperationsof thedepositorthat it isunlikely the depositorwouldbe ableto transferthisactivityto anotherADI within30days.This is not consistentlythe casewith correspondent bankingaccountsand, for this reason, they are not included.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 122. P a g e | 122Unsecured financial institution funding run-offUnsecured financial institution fundingin the BaselIII liquidityframeworkis divided intothree categories:operational depositsthatreceiveeither a fiveor 25per cent cash outflow rateand other depositsthat receivea 100per cent cash outflowrate.Comments receivedA number of submissions sought clarity on the definition of a financialinstitution, expressing concern that the definition in draft APS 210 wastoobroad.Submissionsalsoarguedthat lowercashoutflowratescould be includedfor certain types of financial institutionssuch ashealth insurersorgovernment sector financial institutions,astheseentitiesareperceived tobelesssophisticated than others such asbanks.Submissionsnoted theomission of a Basel III run-off rate for financialinstitutionoperational deposits in thecash outflowtableinAttachment Aof draft APS210.Submissionsalsoarguedthat financial institutionintercompanydemanddepositswouldnot be withdrawn in a crisisand should receivea cashoutflowrate of lessthan 100per cent.APRA‘sresponseAPRA hasrecentlyreleased Prudential StandardAPS 001Definitions,which includesa definitionof financial institutions.Mostentitiesnoted asbeingfinancialinstitutionsin thepreviousdraft APS 210arecovered in that definition.APRA will use that definitioninAPS210but, for thesake of clarity, willmake specific referencetomoneymarket corporations, financecompanies, superannuation / pension funds, public unit trusts/ mutualfunds,cash management trustsand friendlysocieties.Amendmentshavebeenmade to ‗Table3 – Cash outflow categories‘inAttachment Aof theupdated draft APS210toclearlyidentify operationaland non-operationaldepositsof financial institutionsand their cashoutflowrates.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 123. P a g e | 123APRA doesnot proposetoincludeadditionalfinancial institutionrun-offcategories;all financial institutionnon-operationaldepositsreceivea 100per cent cashoutflowrate if their residual maturityor noticeperiod iswithin30days.Other liabilitiesTheBasel III framework identifiesspecific cash outflowassumptionsforother liabilities, committed credit and liquidityfacilitiesprovidedtotheADI‘s customers, and itemswhereincreasedliquidityneedsare likely toberequired under theLCR scenario.APRA proposed toadopt theseassumptions.Comments receivedSomesubmissionssuggestedthat thedefinitionof a liquidityfacility wastoobroad and could be interpretedtoincluderevolving creditfacilities,which wasinconsistent with theBasel III liquidityframework.Concernswereraised that the cashoutflowrate for a financial institutioncommitted and uncommittedliquidityfacility wastoohigh in itself andhigh in comparison to the equivalent cash outflowratesfor othercounterpartytypes.Thesesubmissionsarguedthat the cash outflowratesdid not reflect theexpectedbehaviour of thesetypesof facilitiesduring a period of stress.APRA‘sresponseTherecent BaselCommitteerevisionsincludeaminor clarificationtothedefinitionof a committed liquidityfacilitytoensure that facilitiesprovided to hedge funds,money market fundsand special purposefundingvehicles arecaptured in their entiretyasliquidityfacilities.APRAproposestoincorporatethefull definitionof aliquidityfacility intoAPS 210.This inclusion will alsoprovideclarityon itemsthat should be modelledasliquidityfacilitiesandthosethat shouldbemodelledascredit facilities.Financial institutionsgenerallyhave more exposure toliquidityrisk thannon-financial corporations.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 124. P a g e | 124Afacility provided to a financial institution would represent a ‗wrong-way‘risk during a systemic crisis and would be subject to a greater propensityfor drawdown.This justifiesa higher cash outflowratefor such a facility.4.2.1.1Other contingent funding obligationsTheBasel III frameworkleavesto national discretionthe run-offassumptionstobe applied to contingent funding obligationsthat arenotcommitted credit and liquidityfacilities.In its 2011discussion paper,APRA proposed to requireADIsto includethefollowingcontingent obligationsasa cashoutflow:Revocablecredit and liquidityfacilities;Guarantees, lettersof credit and other trade financeinstruments;Debt buybacks – domestic Australian debt securities;Structured products,managed fundsand other non-contractualobligations;andIssuerswithan affiliateddealer or market maker.APRA received a number of submissionson contingent fundingobligationswhichare addressed in this section.Buyback of debt securitiesComments receivedSubmissionson thebuyback of securitiesargued for relief from theapplication of a cash outflowratewherethere is a policy enforced by theADI to either not honour debt buyback requestsin timesof stress,placelimitson thequantum of debt buybacks, or require that Group Treasurysign-offon buybacksover a certain threshold.Thesesubmissionsarguedthat these criteria should be sufficient toevidencea behaviour of not honouring buybacks in all circumstances.APRA‘sresponseAPRA expectsthat in a time of stress, even with apolicy tolimit debtbuybacks in place, some buyback requestsmay still be honoured due toreputationalconsiderationsorbecauseit maytakeaperiodoftimefor theInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 125. P a g e | 125full extent of theliquiditystressto be realisedand restrictionson debtbuybacks activated.APRA will maintain itsbuyback assumptionsof 10per cent of short-termdebt securitiesand 5per cent of long-term debt securitiesissuedin thedomesticAustralian market.An ADI can applytoAPRA for an agreedlowerdebt buyback rate wheretheADI can demonstrate that:(a)it has adopted tangible measures in policy and practice (e.g. throughthe implementation of hard limits on buybacks) to reduce the incidenceof buybacks; and(b) thesemeasures are operating effectively on an ongoing basis.Unconditionally revocable uncommitted facilitiesComments receivedConcernswereraised that the cashoutflowassumptionsforunconditionallyrevocableuncommitted facilitiesweretoohigh for allcategoriesof borrowersand that thedifferencebetweenretail/non-financial wholesalecustomersand financial institutionswaslarger than expectedbehaviour in a stressevent wouldsuggest.Somesubmissionsargued that wherethere are contractual termsthatconstrain drawdown, a loweroutflowrateshould be applied; wherethetermsexcludedrawdownin 30days, thesefacilitiesshould receivea zeroper cent cashoutflowrate.Submissionsalsoarguedthat applying thesame outflowrateforuncommitted and committed facilitiesisunreasonableasADIs havetheabilitynot to honour thedrawdownrequest on unconditionallyrevocableuncommitted facilities.In a liquiditystresssituation, it wasargued, suchfacilitieswouldbecancelledby the provider;hence nocash outflow assumptionshould beapplied.APRA‘sresponseAPRA remainsof theview that reputational considerations,businessbudget targetsand thepossibilityof a delayed responsetoan emergingInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 126. P a g e | 126liquiditystressmay mean that ADI lendingstaff and treasurerswill notnecessarilyrespond to a liquiditystressevent by cancellingorwithdrawingthesefacilities.Nevertheless, from a liquiditycost-benefit perspective,APRA acceptsthatsome uncommitted facilitiescould require a smaller liquidityreservethancommittedfacilities.APRA will thereforeamend the cashoutflow rate for unconditionallyrevocableuncommittedfacilitiesto fiveper cent for all categories.TradefinanceAPRA proposedthat ADIs includea cash outflowin the LCR for tradefinancefacilitiesbased on actual monthly experienceover 12monthsofdata, tobeupdatedon at least an annual basis.Submissionsexpressedconcern that holdingliquid assetsagainstuncommitted tradefacilitiesfor typical Asian businesses,based onoutflowsmodelledon the past 12 monthsof goingconcernbehaviour, wouldbe excessiveand unnecessary.It wasargued that in a liquiditystressevent, thesefacilitieswouldbewithdrawn or suspended; hence, a zeroper cent outflowshould beapplied.APRA‘sresponseTherecent BaselCommitteerevisionsincludeguidancethat the cashoutflowratesmodelledagainsttrade financefacilitiesshould be betweenzero and fiveper cent.APRA expectsthat itsproposedmethodologyfor the modellingof cashoutflowsagainst thesefacilitieswill result in a cashoutflowrateconsistent withthe BaselCommittee‘sguidance.As such, no amendment to the methodology is proposed.Guarantees not related to trade financeAPRA proposedthat cash outflowsfor guaranteesnot relatedtotradefinancebe modelledin the LCR using the averageof actual monthlyoutflowsover a recent 12-month period.Comments receivedSubmissionsexpressedconcern thatAPRA‘s proposed methodology didnot recognisethat the cash outflowcan be contingent upon a non-ADIInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 127. P a g e | 127relatedcredit default event, rather than aliquiditystressevent for theADI.APRA‘sresponseAPRA considersthat this argument is reasonable.It will amendAPS 210 to reflect that whereoutflowsunder suchguaranteesarewhollycontingent oneventsindependent of theADI (i.e. adefault by a third party), the outflowrateis to bemodelled as50per centof the averageof actual monthly outflowsin a recent 12-month period.Structured products,managed funds(that are marketed withtheobjectiveof maintaininga stablevalue) and other non-contractualobligations.APRA proposedthat thesenon-contractual obligationsbe modelledintheLCR witha minimum fiveper cent cash outflow rate.Comments receivedSubmissionsrequestedclarificationon theparticularobligationsthiscategoryisseekingtocapture.APRA‘sresponseThis categoryis intended tocaptureADI-sponsored investment vehiclesor structured productsthat may require liquiditysupport.Theglobal financialcrisishasprovided many examplesof specialisedinvestment vehicles,previously consideredto be remote from thesponsoringbank, that required support.Managedfundsneedingtomaintain a stablevaluecan alsofall intothiscategory.In addition, some structured investment productsmay require additionalliquidityin timesof stressascustomersseek toliquidatetheirinvestmentsdue totheimpact of market volatilityon the valueof theseinvestments.APRA acknowledgesthat theseinvestment vehicles and structuredproductsare not widespreadinAustralia and thiscategorymay not berelevant for manyADIs.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 128. P a g e | 128Market valuation changeson derivative transactionsThis outflow categoryseekstocapture thepotential for substantialcollateral outflowsrelatingto changesin the market valueof derivativepositionsduring a liquiditystress.APRA had proposedthat ADIs must model a cash outflowagainst thesepositions.As noted earlier in this chapter, the recent Basel Committeerevisionshaveremoved national discretion for thiscategoryand haveset out astandardisedapproachfor liquidityriskfor market value changesinderivativespositions.ADIsare alsorequired to consider the additional collateral that wouldneed to be postedin theevent of a 3-notchcredit rating downgrade.Submissionsargued that in a systemic liquiditystressevent inAustralia, theAustralian dollar wouldbe more likely todepreciatethantoappreciate.This would result in cash inflowsforADIsthat source offshore fundingdenominatedin major currenciesand that have currencyswapswith‗Credit SupportAnnex‘ agreementsagainstthem.Therefore, a conservative liquidityapproach wouldmodel no cashoutflowsfor such an event.Submissionsalsosuggestedthat thestresseventsmodelledin the LCRshould be consistent witha liquiditystress, not themarket risk stressscenarios outlined in Reporting StandardARS116.0 Market Risk, whichAPRA had proposed.APRA‘sresponseAPRA agreesthat anAustralian dollar depreciationisa plausibleassumption for a systemic liquiditystressevent specific totheAustralianbankingsystem.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 129. P a g e | 129As noted above,APRA proposestoadopt theBasel Committee‘sstandardisedapproachto the calculationof outflowsagainst marketvaluation changes.However,APRA invitesfeedback from industry astoan alternativeoutflowtreatment that wouldacknowledgetheprobabledirection of theAustralian dollar during a stressevent but wouldbe consistent withtheBasel Committee‘sintent. APRA alsoadvisesthat, astheLCR stressscenario coversboth systemic and idiosyncratic events, the3-notchdowngradeisto be considered asan idiosyncraticevent and modelledassuch.4.2.2 The LCR and currency mismatchesIn its 2011discussion paper,APRA proposed that ADIs be ableto meettheir liquidityneedsin each material currencyand maintain HQLAconsistent withthe distribution of their liquidityneedsby currency.APRA alsoproposedthat ADIs must specificallyaddresscurrencymismatchesin their Board-approvedstatement of liquidityrisk tolerance.Comments receivedSubmissionsrequestedthat APRA clarify itsrequirementswithrespect tocurrencymismatches.In addition, submissionssuggested that theCLF should be allowedtocover someportion of foreign currencycash outflowsand liquidityneedsin theconsolidated(Level 2) banking group aslocallyincorporatedADIsoperatingin foreign jurisdictionsmay have limited abilitytosell liquidassetsin thosejurisdictionsin a time of stress.This could be the caseasa result of limitedability toparticipate in themarket operationsof the relevant central bank.APRA‘sresponseAPRAconfirmsthat theLCR istobemetbyanADI onbothaLevel 1andconsolidated(Level 2) bankinggroup basis.Forbranchesofforeignbanks,theLCR must bemet onadomestic booksbasis.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 130. P a g e | 130This minimum requirement isto incorporate exposuresin all currencies.APRA alsoconfirmsthat ADIs must be ableto meet their liquidityneedsin each material currencyand maintain HQLA consistent withthedistribution of their liquidityneedsby currency.APRA doesnot see it asappropriate for the CLF to cover non-Australiandollar outflows;other supervisorswill defineHQLA specific totheirjurisdictionand domestic currencythat ADIs will be abletohold to meetnet cash outflowsin that currency.4.2.3 Home/host liquidity requirements for the LCRAPRA‘s 2011discussion paperproposed that, in arriving at theirconsolidated(Level 2) bankinggroup LCR, ADIsapplythehostjurisdictioncashflow treatmentsfor retail and SME deposits in thosejurisdictionsasthis reflectsthebehaviour of localdepositors.This wasspecifiedin theBasel III liquidityframework.In addition, wherethehost regulator electstouse one of the alternativeliquidassetstreatmentsallowedbyBaselIII,APRA statedthat it is likelytorecognisethisfor thepurposesof calculatingthe localcurrencyLCR.Where anADI hasa material banking subsidiary in a jurisdictionthatdoesnot implement the BaselIII framework,APRA proposed to applythecashflowassumptionsoutlinedin draft APS 210.Comments receivedConcernwasexpressedthat theuseofAPRA‘s cashflowassumptionsinnon-Basel III jurisdictionsmeant that different assumptionswouldneedtobe applied tothesamedeposit to meet the requirementsof differentregulators.Submissionsstated a preferencetoapplytheassumptionsof thenon-Basel III jurisdictionhost regulator tocalculatethe consolidatedbankinggroup LCR, soasto avoid complexityand inefficienciesinliquidityrisk modellingin that jurisdiction.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 131. P a g e | 131It wasalsoclaimed that thisproblem could extend toBasel IIIjurisdictionsthat have not clarified their proposed rulesforimplementationof theLCR.APRA‘sresponseTheBasel Committeeexpectsthat all Basel III jurisdictionswill havetheir LCR requirementsin placeby 1January2015.Hence, there should be no concerns regarding unclarified rules amongstBasel III jurisdictions. APRA also considers that it would be inconsistentto allow stressed cash outflow rates to apply for deposits in non-Basel IIIjurisdictionsthat are different to the LCR stressscenario.Hence,APRA doesnot see anyreason todepart from itsproposedapproach.4.2.4 LCR requirement for foreign bank branchesIn its 2011discussion paper,APRA proposed that foreign-ownedADIsinAustralia that are subjecttothe scenario analysisapproach will need tomeet the LCR requirementson a stand-alonebasis.However,in arrivingat a balanced approach for foreign bankbranches,APRA proposedtorecognisea committedfunding linefromhead office for inclusion asa cashinflowfrom day16 of theLCRscenariounder certain circumstances.Comments receivedSome submissions argued that it would be unduly restrictive not torecognise head office support until day 16, noting that APRA allowsrecognition of head office support in a shorter timeframe within the‗namecrisis‘scenarioin thecurrent APS210.Thesesubmissionsarguedthat it wouldbe reasonableto expect headoffice to provideliquiditysupport on a muchshorter noticeperiod.It wasalsoclaimedthat it wasunfair not toextendtherecognitionofheadoffice support toforeign-ownedADIs that operate inAustralia asboth asubsidiary and a branch.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 132. P a g e | 132Other submissionssuggestedthat theLCR for foreign branchesshouldbelowerthan 100per cent and that APRA should recognisethat branchesdepend on globallymanaged liquidity.Somesubmissionsalsoarguedthat foreign bank branchesshould beexempt from ‗goingconcern‘reportingasthisis a lessmeaningful taskduetothenature of some operationsand imposed a significant reportingburden.Somesubmissionssought clarity on functions,tasksand rolesthat maybecompleted at theglobal level rather than at theforeign branch level astheypertain to thequalitativerequirementsofAPS 210.APRA‘sresponseUnderAPRA‘s LCR requirement, all ADIs, includingbranchesof foreignbanks,must have sufficient Australian dollar liquidityto meet potentialAustralian dollar cash outflows.Therecognition of head office support for branchesfrom day16isintendedto ensure a minimum level of liquidityself-relianceby thesebranches.APRA doesnot believeit isprudent to placerelianceon a centrallymanaged liquiditypool aloneasthismay result in insufficient liquiditybeingavailablefor the localoperation.APRA is awareof practicesthat have thepotential totransferliquidityneedsbetweena local subsidiary and a relatedbranch, whichcouldpossiblyresult in increasedlevelsof relianceon parental support thanwouldotherwisebe thecase.Submissionsreceived did not addressthisissue. Consequently, APRAconfirmsthat it will not extend the recognition of head office support toforeign-ownedADIs that operateinAustralia under both asubsidiaryanda branch bankingauthority.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 133. P a g e | 133Local staff responsiblefor liquiditymanagement and oversight in foreignbank branchesmay fulfil liquidityriskmanagement governancerolesbyhavingtheappropriatelyapproved job mandatesand delegatedauthorities.As per paragraph 47 of updated draft APS210, APRA intends to continueto require the production of going concern reports by all ADIs, includingforeign bank branches.Theproductionof goingconcern reportsbyall ADIswill enableAPRA tomore fullyunderstand the maturitymismatch and funding task of theADIindustry inAustralia.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 134. P a g e | 134Statistical release:OTC derivatives statisticsatend-December 2012Monetary and Economic DepartmentMay 2013Important partsInterest rate derivativesNotional amountsfor interestratederivatives,the largest segment of themarket, stood at $490trillion at end-2012.While the overall figure wasmore or lessunchanged from end-June2012,breakdownsshowedoffsettingmovements.For swaps,notional amountsdropped in thesecond half of 2012by about2% to$370trillion, owingin part to the compressionof tradesthroughcentral counterparties(CCPs).This wasoffset by an increasein forward rate agreements(FRAs) to$71trillion.Contractsbetweenreportingdealersfell 16% to $117trillion, while thosewith other financial institutionsincreasedto $338trillion.Maturitiesshiftedtotheintermediatepart ofthespectrum, withcontractsmaturing in one to fiveyearsrisingto 36.8% of notional amountsatend-2012from 34.4% at end-June2012.Grossmarket valuesasa share of notional amountsoutstandingwerealmost unchanged in aggregate at 3.8%.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 135. P a g e | 135In the US dollar segment, the value of outstandinginterestrate contractsdropped from 4.5% to4.0% of amountsoutstanding.Thiscontrastedwithanincreasefrom 4.4% to4.8% in themarket valueofcontractson euro interestratesrelativetonotional amountsoutstanding.Foreign exchange derivativesNotionalamountsofFX derivativesroseslightlyinthesecondhalf of2012(+1%), to $67trillionat end-December 2012.Thisreflectedincreasesin medium-termmaturities(+7%) and dealswithother financial institutions(+5%).Contractswith the reportingdealer sector declined.Thecurrencycompositionof contractsremained broadlystable, with theUS dollar on oneside of 85.5% of all contracts, followedby theeuroat35.3%.Grossmarket valuesof FX derivativesremained almost unchangedasashareof notional amountsoutstanding, at 3.4% at end-2012.For euro contracts, the ratio decreased from 3.6% to 3.2%, but this movewas largely offset by a jump in the ratio of yen contract market values tonotional amountsoutstanding, from 3.7% to 5.9%.Theincreasein thegrossmarket valueof FX contractsreferencingtheyen wasdriven by renewedvolatilityin the yen exchangerate.Themarket valueof contractsreferencingthe Swissfranc continuedtodecline, to$154billionoutstanding at end-December2012.This brought to $167 billion the cumulative decline in notional amountsoutstanding from the $321 billion peak reported in June 2011, prior to theannouncement by the Swiss National Bank of a ceiling on the EURCHFexchangerate.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 136. P a g e | 136Contractsreferencingthe Swissfrancwerebroadly stablein termsof theratio of market valueto amountsoutstanding, at 4.0%.Equity-linked and commodity derivativesFor equity-linkedderivatives,notional amountsoutstanding werealmostunchanged at $6.3trillion at the end of 2012,after a 6% expansion in thefirst half of 2012.An increasein forwardsand swapsalmost offset the5% declineinoutstandingoptions.Market valuesof equity-linkedcontractsslipped another 6% in thesecond half of 2012,to$605billion;this wasmore than accountedfor bythe drop registeredfor options(–10%).Amountsoutstandingofcommodityderivativesfell 14%from $3trillionto$2.6 trillion, although market valuescontracted by substantiallyless(–8%), implying that the remainingcontracts increased in averagevalue.Notional amountsoutstandingon gold declined to $486billion.While gross market values on gold and other commodity contracts hadboth fallen by almost 20% in the first half of the year, in the second halfthe slide in the value of gold contractswas relatively bigger (–15%) thanthat in other commodity contracts(–7%).Credit default swaps(CDS)CDSnotional amountsoutstandingcontinuedtodeclineduring thesecond half of 2012,to$25trillion at end-2012.Thisbrought thecumulativereductionsinceJune2011to$7trillion,partlyduetoongoingcontract compression.During thehalf-year to end-2012,the reduction wasconcentrated amongreportingdealers(–10%) and in maturitiesover five years (–37%).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 137. P a g e | 137Contractswith special purposevehicle (SPVs), however, moved in theoppositedirection, growing28% to$0.6trillion.Thesectoral shareof CDScounterpartieswasdivided mainlybetweenreporting dealers(56%) and other financial institutions(43%), whilenon-financial customerscontinued tobe almost entirelyabsent (1%).Thenotional amountsoutstanding referencingsovereignsdeclined byonly2% to $2.9 trillion.Thedecline in grossmarket valueswasmore pronounced than that innotional amountsoutstanding.Market valuesfell to $0.8trillion at end-2012,equivalent to3.4% ofnotional amounts.Thiswasdownfrom 4.4% of notional amountsat end-June2012and 5.5%at end-2011.Although all segmentsdeclined, there wassome differentiationbycounterparty.Theratioof market valuetooutstandingamountsslid themost withSPVcounterparties (from 10%to4.6%) and theleast withother financialcustomers(largely unchanged at 4.7%).Theshare of total CDSnotional amountsthat wascentrallyclearedremainedabout 20%.Non-rated CDSclearedwithCCPsweredown 28%, whichmore thannegatedthe 27% increasein the previoushalf-year.Thecompression of contractscontributed to thesechanges.In contrast notional amountsof non-investment grade CDScleared withCCPsincreased24%, offsettingthe 20% declinein the half-year up toJune2012.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 138. P a g e | 138ThegeographicaldivisionofCDScounterpartiesonanultimateriskbasisindicatesthat activityconcentratedon counterpartiesin thedealers‘homecountry.Notional amountsof CDSvis-àvisforeign counterpartiesdropped to$19trillion, whereasthosevis-à-viscounterparties headquarteredin thereporters‘home country increased to $6 trillion.At end-2012,counterpartiesin the home country accounted for 24.4% ofnotional amountsoutstanding, up from 19.4% a year earlier.Concentration indicesHerfindahl indicescalculatedon thebasisof responsesfrom individualdealersprovide a measure of size concentrationfor dealersin OTCderivativesmarkets.In the interest rate swap segment, which is the single largest segment inOTC derivatives markets, concentration is highest for Swiss franc swapsand lowest for euro and yen swaps.Concentrationin Canadian dollar interest rate optionscontinuedtoriseand reached thehighest level among all OTC interest rate derivativescontractsat end-2012, driven by developmentsin inter-dealer business.In contrast, concentrationin yen FRAsdeclinedfrom thehigh levelsthathadbeen buildingup sinceend-2010.For FX derivatives,Herfindahl indicesshowed increasedconcentrationfor optionsin particular, whichincreasedto a newhigh (Table9b).Increasedconcentration wasevident for contractswithother reportingdealersaswell asnon-reportingcounterparties.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 139. P a g e | 139International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 140. P a g e | 140International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 141. P a g e | 141DisclaimerThe Association tries to enhancepublic accessto information about risk andcompliancemanagement.Our goal is to keep this information timely and accurate. If errorsarebrought to ourattention, wewill tryto correctthem.This information:- is of a general nature only and isnot intended to addressthe specificcircumstances of any particular individual or entity;- should not be relied on in the particular context of enforcement or similarregulatoryaction;- is not necessarily comprehensive, complete, or up to date;- is sometimeslinked to external sites over which theAssociation has no controland for which theAssociation assumesnoresponsibility;- is not professional or legal advice (if you need specific advice, you shouldalwaysconsult a suitably qualified professional);- is in no wayconstitutive of an interpretative document;- doesnot prejudge the position that the relevant authoritiesmight decidetotake on the same mattersif developments, including Court rulings, wereto lead it torevisesomeof the viewsexpressedhere;- doesnot prejudgetheinterpretationthat theCourtsmight place onthemattersat issue.Pleasenote that it cannot be guaranteed that theseinformation and documentsexactly reproduce officially adopted texts.It isour goal to minimize disruption causedby technical errors.However some data or information may have been created or structured in files orformats that are not error-free and we cannot guarantee that our service will not beinterrupted or otherwiseaffectedby such problems.The Association acceptsno responsibility with regard to such problemsincurred asaresult of using this site or any linked external sites.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 142. P a g e | 142Certified Risk and Compliance Management Professional(CRCMP) distance learning and online certification program.Companies like IBM, Accenture etc.consider the CRCMP a preferredcertificate. You may find more if yousearch (CRCMP preferred certificate)using any search engine.The all-inclusive cost is $297.What is included in the price:A. The official presentations we usein our instructor-led classes (3285 slides)The 2309 slides are needed for the exam, as all the questions arebased on these slides. The remaining 976 slides are for reference.You can find the course synopsis at:www.risk-compliance-association.com/Certified_Risk_Compliance_Training.htmB. Up to 3 Online ExamsYou have to pass one exam.If you fail, you must study the officialpresentations and try again, but you do not need to spend money. Upto 3 exams are included in the price.To learn more you may visit:www.risk-compliance-association.com/Questions_About_The_Certification_And_The_Exams_1.pdfwww.risk-compliance-association.com/CRCMP_Certification_Steps_1.pdfC. Personalized Certificate printed in full colorProcessing, printing, packing and posting to your office or home.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  • 143. P a g e | 143D. The Dodd Frank Act and the newRisk Management Standards (976slides, included in the 3285 slides)The US Dodd-Frank Wall Street Reformand Consumer Protection Act is themost significant piece of legislationconcerning the financial servicesindustry in about 80 years.What does it mean for risk andcompliance management professionals?It means new challenges, new jobs, newcareers, and new opportunities.The bill establishes new riskmanagement and corporate governanceprinciples, sets up an early warningsystem to protect the economy from future threats, and brings moretransparency and accountability.It also amends important sections of the Sarbanes Oxley Act. Forexample, it significantly expands whistleblower protections under theSarbanes Oxley Act and creates additional anti-retaliationrequirements.You will find more information at:www.risk-compliance-association.com/Distance_Learning_and_Certification.htmInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com

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