Change amidst uncertainty: How banks are adapting to the emerging regulatory landscape

Change amidst uncertainty:how banks are adaptingto the emerging regulatorylandscapeThoughtsWritten by the Economist Intelligence Unit

Written by the Economist Intelligence Unit 2

Change amidst uncertainty: how banks are adapting to the emergingregulatory landscape Capco is pleased to present this The second, related observation is that some bank report, which explores how capital leaders may not fully understand the exposure created markets firms are dealing with by inadequate governance of trading operations within the dramatic changes that are the new environment. Laws in the United States and underway in the financial services the UK now impose stronger fiduciary and oversight industry. Based on research requirements on a firm’s board members and executives, conducted by the Economist requirements that extend to maintaining robust Intelligence Unit in March 2011, compliance around all trading operations and banking.the report provides insight into seven critical questionsregarding banks’ readiness for regulatory reform, which Whether or not their front-office moves are partwere the subject of a recent Capco white paper.* of broader corporate strategy, firms can become exposed to significant fiduciary and reputation risks byAmong the many insights the survey provides, two executing new business strategies without adequateare especially noteworthy, and potentially reasons controls, communications strategies and changefor caution. management in place. On the up-side, reorganizing quickly and purposefully, and creating complianceFirst, it is clear that the traders are driving change. programs that meet the test of global regulators, canTrading operations are taking the lead in implementing position banks to increase market share and margin,business models and processes to operate in the both in existing and emerging markets.newly regulated environment. In some cases, theyare quickly executing on geographic strategies, in We hope the findings of this report help you chartjurisdictions where regulations may be more favorable. a course to new opportunities, leveraging solidIn doing so, trading operations appear to be outpacing governance. Please let me know if you would like totheir back-office and compliance functions by a discuss the results or have any questions.wide margin. In fact, more than half of the tradingoperations surveyed could be conducting businessin an environment without the necessary obligationssupport – capabilities that simply may not exist in thelocal back office yet, or that regulators may not haveeven fully defined. Sean Culbert Partner and Co-lead of Finance, Risk and Compliance sean.culbert@capco.com* or further discussion of these questions please see the Capco F Thoughts white paper, Regulatory Reform: 7 Critical Questions for Financial Services Firms, available on capco.com. 3

About this report Change amidst uncertainty: how banks are adapting to the emerging regulatory landscape is a Capco report, written by the Economist Intelligence Unit. It examines how, in light of continuing regulatory uncertainty, financial institutions are reshaping their capital markets businesses to operate effectively in the new environment, and focuses particularly on the likely effect of regulation on overall structure as well as front, middle and back office operations. The research is based on three components: • survey of 60 senior executives at financial A institutions, half operating in the UK and half in the US. All firms had annual global revenues of more than US$5bn and all respondents work in operations, risk, trading or regulation. • Interviews with a range of industry participants and experts, as well as a follow-up qualitative questioning of survey respondents. Because of the sensitivity of the topic, interviewees spoke off- the-record. • Desk research, including a review of financial institutions’ regulatory filings. The author of the report is Geraldine Lambe and the editor is Monica Woodley.4

Executive summary Key findings from the research include:As the scale and intensity of the financial crisis Banks see more opportunities than threats inbecame clear, industry participants knew that a tough the new regulatory environment. Almost a third ofregulatory response would follow. Those expectations respondents believe that new regulations will providehave now been met. While the final rules remain opportunities to take market share as other banksuncertain in many areas, a raft of regulatory change is retrench or rethink their business models. Almostin process. two-thirds see regulatory change as an opportunity to transform their business at a systems and processThe regulations create new capital requirements, level. Some see this as a way to gain competitiveaddress liquidity and counterparty risk, and push trading edge. However, they are unsure whether the greaterof more products onto exchange and into central transparency required by regulation will have aclearing. They put in place new consumer protections positive or negative impact on competitiveness.and seek to reduce systemic risk in order to avoid theneed for future government intervention. The cumulative While preparations are well underway, the impacteffect is forcing the financial industry to fundamentally of regulations on bank structures is unclear.reassess business models and operating practices. More than half of respondents say they are at implementation stage. The US is further behind thanThis assessment is driving significant change in the UK, however, as the industry waits for manyfinancial institutions. Banks are already exiting some elements of the Dodd-Frank Act to be translated intobusinesses and are likely to shrink or exit others as regulations. Almost three-quarters have identifiednew capital rules make them less profitable. The where changes to systems need to be made in orderlocation of new or expanding businesses will be to handle the new, higher levels of data required. Arethought as firms assess the relative impact of each similar number say they have a strategy in place tojurisdiction’s regulatory constraints. New systems and communicate the impact of regulatory changes toprocesses are being put in place to meet demanding clients and counterparties.data capture, data management and stress testingrequirements. Communications with clients and However, the industry remains uncertain aboutcounterparties are being revamped, and new how to adapt business entities and operations toreporting lines put in place. Connectivity will have new regulations. More than half of respondents areto be developed and new processes established to keen to retain existing organizational structures andconnect to a swathe of new entities that will spring up operating models. However, in 13 out of the 17 areasin the clearing and settlement space. of operation covered by the survey, the majority of respondents do not know if their firms will relocate orIn this changing environment, the Economist outsource business functions, or create a shared utility.Intelligence Unit conducted research, on behalfof Capco, to find out where banks are in terms of Boards and senior management believe theypreparation for new regulations and what impact have a good understanding of regulatory impact.these are having on operations. This research The crisis has been a wake-up call for boardis based on a survey of senior executives at 60 members and senior management. With regulatorsbanks, half based in the US and half in the UK, and policy-makers taking an increasingly tough line,working in operations, risk, trading or regulation. boards and executive management will be moreThe survey results have been supplemented with accountable for a firm’s decisions. According toin-depth interviews with industry participants and the majority of respondents, they have risen to thisexperts. Because of the sensitivity around this topic, challenge and have a good understanding of theinterviewees preferred to speak off-the-record. implications increased data transparency will have at their own businesses as well as across the industry. Once changes to data infrastructure are adopted, respondents are confident that management will be able to prove they have better control over information, as required by regulators. 5

Introduction In its 10-K regulatory filing to the Securities and Exchange Commission (SEC) for the fiscal year ending in March 2011, Goldman Sachs revealed the impact that US regulations have already had on the bank’s operations. “In light of the Dodd-Frank Act, during 2010, we liquidated substantially all of the positions that had been held within Principal Strategies in our former Equities operating segment, as this was a proprietary trading business. In addition, during the first quarter of 2011, we commenced the liquidation of the positions that had been held by the global macro proprietary trading desk in our former Fixed Income, Currency and Commodities operating segment.” US regulations are shaping European institutions’ strategy too. Deutsche Bank announced in March that it would deregister its US subsidiary so that it would no longer be a bank holding company. Deutsche hopes that by changing the status of Taunus Corp – a part of which is highly leveraged and under new rules would need recapitalizing – it will take Taunus out of the scope of the Dodd-Frank Act and avoid having to raise billions of dollars in new capital. Compliance is diverting management, IT and legal resources from day-to-day operations as IT races to keep pace with front office transformations. Some firms have recruited additional expertise in specific areas. The impact assessment itself is a major task. The Dodd-Frank Act, for example, is long and complex at 2,307 pages, 16 titles and 540 sections. It is expected that regulators will create 243 new rules, conduct 67 studies and issue 22 periodic reports. Hundreds of new rules will require consultation with the industry before they can be implemented. One bank’s response to the Markets in Financial Instruments Directive (MiFID) consultation alone takes up 66 pages. The bank says its legal and compliance department has doubled in size in the last two years. So, while much of Dodd-Frank, the Financial Services Act 2010 and other regulations still need to be defined, it is clear that banks’ strategy and front office operations are already moving forward, while governance and compliance are lagging.6

Assessment, understanding andimplementationThe sales and trading functions of financial services Figure 1. At what stage is your company in preparingfirms seem to have moved quickly to determine which for changes required by regulatory reform?regulations are relevant to their businesses, consider 100% U.S.what the regulatory impact will be and even to move U.K. 90%forward with implementing changes based on theirimpact assessments. More than half of respondents 80%to the survey say they are at the implementation 70%stage. Looking at responses by geography, the UK 58% 60%is slightly ahead of the US, with 58% compared with 53%53%, respectively, already implementing changes. 50%Industry participants say that this is explained by 40% 32%the fact that there is more still to be defined in US 30% 30%regulation than there is in Europe, meaning that firmsin Europe have a head start. UK firms are also more 20% 17% 10%likely than those in the US to align the implementation 10%of their country’s main regulatory reforms with those 0%of Basel III and IFRS. (See Figures 1 and 2.) We have identiﬁed We have assessed We have begun the regulatory how regulatory implementing changes relevant changes will impact changes to ourThe UK operations of a European bank are to our business our business business based on our impactalready advanced in several areas, including those assessmentssurrounding internal transfer pricing models. These Figure 1. Q1, geographic split. At what stage is your companyare central to complying with the UK’s liquidity in preparing for changes required by regulatory reform?buffers, which were implemented in June 2010, as Figure 2. Have you or do you plan to align thewell as Basel III’s liquidity coverage ratios. The bank’s implementation of your country’s main regulatory reform with that of any of the following regulations?CEO says the bank’s decentralized business model Select all that apply.has given it a head start in such areas. 97% 100% U.S.“We introduced transfer pricing for liquidity risk to all 90% U.K.our branches in June 2009,” he says. “Each branch 80% 80%has to match-fund itself. The reason we have been 68%able to move so quickly is because we operate a 70%devolved model, where each branch is responsible for 60%setting the appropriate prices for its own market. For 50% 50%this kind of decentralized pricing model to work, it’scritical for branches to be charged the correct internal 40%cost for liquidity, so we already had the processes in 30% 27% 23%place to enable us to implement this regulation.” 20% 10% 0% IFRS Basel III FACTA Figure 2. Q2, geographic split. Have you or do you plan to align the implementation of your country’s main regulatory reform with that of any of the following regulations? Select all that apply. 7

Trading is running out in front According to the survey, by function, trading is way out in front in terms of preparation, with almost three-quarters (73%) saying they are already at implementation stage. Interestingly, the regulatory function, which may be expected to be most advanced, is the least prepared. Only 20% say they are at implementation, although a significant 60% have completed the impact assessment. (See Figure 3.) On reflection, it is unsurprising that the trading space is the most advanced in terms of preparation; theyFigure 3. At what stage is your company in are already positioning for the higher capital chargespreparing for changes required by regulatory for various products contained in Basel III and for thereform? proprietary trading ban in the Volker Rule.100% Operations Risk “If you look at the changes to the trading book90% Trading treatments, they are so substantial that people have Regulation80% had to think through urgently what is the shape of 73%70% 67% the business going forward, because the current 60% business won’t be profitable,” says the head of60% prudential advisory at a consulting firm. “And those50% 46% 46% trading book requirements hit much earlier [than40% some other changes], so in the trading area it has 27% become critical to move quickly. The treatment of30% 19% 20% 20% counterparty risks in trading books and of bank-to-20% 14% bank exposures has gone up three to four times in 8% total, and the treatment of securitization books has10% 0% gone up enormously, so people have already taken 0% We have identiﬁed We have assessed We have begun action, moving things out of trading books and into the regulatory how regulatory implementing changes relevant changes will impact changes to our banking books.” to our business our business business based on our impact assessments There are concerns, however, that implementation may be piecemeal. While many firms have created Figure 3. Q1, job function split working groups or task forces, these are typically At what stage is your company in preparing for organized at a national level, and therefore do not changes required by regulatory reform? address change at a global, enterprise-wide level. In addition, some have suggested that the amount of new regulations flooding into the market may lead banks to focus on the trees but lose sight of the forest – a criticism which has been leveled at banks, regulators, ratings agencies and politicians, and held at least partly to blame for the financial crisis. If regulators are aware of this danger, the feeling that the sense of urgency for change is already dissipating means that they want to press on while there is still a chance of getting new regulations passed. 8

A financial services partner at a consulting firm agreesthat the amount of new regulation is clearly an issue.“The message from our research is that the sheervolume of change is proving very challenging forfirms. And it gets more difficult as you move downfrom global statements of principal into regionalrule-making, and then further down into national Figure 4. Do you agree or disagree with the following statements? We are looking at the newinterpretation. We don’t see many institutions that regulatory environment as an opportunity to gainhave an overarching view of the impact on their firm. market share.They may well be doing things on a local or regional 100%level – but they do not have a consolidated view of the U.S. U.K.overarching impact.” Given the new uniform fiduciary 90%standard obligations for advisers and broker dealers, 80%that could prove problematic for US executives. 70% 60% 50% 40% 36% 32%Threat or opportunity? 30% 26% 30% 23% 20% 20% 17%If banks see the challenges posed by regulation, they 10%also see the opportunity. This is particularly true in 10% 7%the UK, where almost a third (32%) of respondents 0% 0%strongly agree that the new regulatory environment 1 2 3 4 5 Strongly agree Strongly disagreeis an opportunity to gain market share. Bankers inthe US, however, are less optimistic, with only 20%clearly positive about the potential for opportunity.(See Figure 4.) Figure 5. Do you agree or disagree with the the Figure 4. Q3a, Do you agree or disagree with following statements? Weare looking at the new regulatory following statements? We are looking at the new regulatory environmentopportunity to gain market share environment as an as an opportunity to gainAt first sight, this looks to be accounted for by the market share.banning of proprietary trading and constraints onprincipal investment – two of the most profitable 100% Operationsareas of investment banking in recent years – that Risk 90% Tradinghave been imposed on US banks by way of the Regulation 80%Volker rule. But looking into the survey results byfunction reveals that 82% of traders agreed with the 70% 64%potential to gain market share, and none of them 60%disagreed. It is the operations and risk functions 50%which see more danger than promise in the new 40% 42% 40%regulatory environment. (See Figure 5.) 40% 33% 33% 30% 24%However, it will not be easy for banks to pick a 21% 20% 18% 17% 18% 20%winning model – or to make it successful in a 10% 13% 10% 8%crowded market. “The question is, what is the shape 0% 0%0% 0% 0%of the business that will be profitable? And I think 0%the answer to that is unknown,” says the head of 1 2 3 4 5 Strongly agree Strongly disagreeprudential advisory at a consulting firm. “Moreover,if multiple banks change their business in the sameway, how many banks can be profitable with thesame type of business? How many banks can be Figure 5. Q3a, functional split Do you agree or disagree with the following statements?major flow players, for example?” We are looking at the new regulatory environment as an opportunity to gain market share 9

There is also a worry that the changes in Basel III are so big, if any provision unwittingly creates an unlevel playing field it could proffer huge advantages to certain players. Unequal treatment in just a single area of Basel III could have far-reaching effects. “For example, there has been a worry that the treatment of deferred tax assets (DTAs) might be more beneficial for US banks than for European banks and, depending on how it’s implemented, that would have a number of consequences. Firstly, it would immediately make their capital levels higher and their costs lower. Secondly, it would make it easier for an AmericanFigure 6. Do you agree or disagree with the bank to buy a bank in difficulty than for a Europeanfollowing statements? Scale of 1 to 5. bank; banks in difficulty have hitherto been bought onWe are looking at the new regulatory environment as an the basis of the benefits of the DTAs, because someopportunity to transform our business model/structure. of that tax can be clawed back. Seemingly small100% inequalities could have large ripple effects.” U.S. U.K.90%80% New regulations as an opportunity for70% transformation60% Part of the optimism surrounding the chance to50% win market share or gain some form of competitive 39%40% advantage is tied to the potential of new regulations 29% to have a transformative effect on the business. This30% 26% 27% 23% 20% has clearly been picked up by survey respondents,20% 17% 13% with more than half (57%) agreeing with this proposal 7%10% and the UK, again, markedly more optimistic than the 0% 0% US. (See Figure 6.) 1 2 3 4 5 Strongly agree Strongly disagree However, more than half (54%) of respondents were keen to maintain their current operation models and structures. But this is not as counterintuitive as it may Figure 6. Q3b, geographic split seem, as it relates to where bankers see the greatest Do you agree or disagree with the following statements? opportunity for transformation – and this is in systems Scale of 1 to 5. We are looking at the new regulatory environment as an opportunity to transform our business model/structure and processes rather than at the organizational level. “Banks have grown as groups of discrete business silos, with each silo capturing data, interrogating data and leveraging that data,” says the head of IT at a large European bank operating in London. “The industry may have gone a long way towards achieving overall efficiency, but we have never achieved information efficiency. New regulations – while onerous and costly – offer us an opportunity to take a fresh look at how we manage these and other processes, and to retool operations in a way 10

that benefits the group, rather than how it suits theindividual business. If we can break down silos, thereare clearly opportunities to generate competitiveadvantage from that.“There is an element of ‘pre-crisis’, and ‘post-crisis’thinking here, with new regulations as the catalystfor change,” he adds. “Historically, the cost-benefitof streamlining systems and processes relative tothe cost of doing nothing meant it was not worth thehassle or the tax cost. Going forward, that cost-benefit may change. Living Wills or other resolutionmechanisms, for example, will force banks to thinkthrough a more streamlined structure, and this ishelpful in the new Basel III world.”Will transparency help or hurt bankcompetitiveness?A common motif of the emerging regulatoryenvironment is the aim of shedding new light on everyarea of banks and financial markets. For example,Dodd-Frank aims for greater transparency into riskexposure across the financial system, and severalkey components of the law require financial servicesinstitutions to collect and report on risk exposurein their business. The Financial Stability OversightCouncil, in its role as systemic risk monitor, willcollect risk data from various sources includingfederal and state financial regulatory agencies andthe newly created Office of Financial Research (OFR);among other things, the OFR will be responsible forcollecting data from financial services companies.Similarly, the UK’s Financial Services Act and BaselIII both impose a high degree of transparency on keymetrics, including bank capital, liquidity, collateral andcounterparty risk, requiring such data to be reportedto bank boards and regulators. The European MarketInfrastructure Regulation, meanwhile, will try to bringtransparency to the over-the-counter markets andimpose data reporting requirements for transactionsto new trade repositories. A central plank of thereview into the Markets in Financial InstrumentsDirective, currently underway, is to increasetransparency in post-trade reporting. 11

Banks are uncertain about the effect of these transparency requirements on their competitiveness, although some have expressed concern that sensitive data about capital, liquidity and exposures could easily leak out into the marketplace. Although some of the regulations specifically aim to increase transparency in the trading arena, the trading function is the least concerned about the impact. (See Figure 7.) From data deficit to information advantage? All new regulations mandate significant additionalFigure 7. Do you agree or disagree with the data and reporting requirements. These presentfollowing statements? Rate 1 to 5. collection, integration and management challengesWe are concerned that the increased transparency for banks’ information architecture.required by new regulations will be a threat to ourcompetitiveness. Basel III, for example, aims to eliminate the kind of100% Operations regulatory arbitrage where a bank moves assets from Risk90% the banking book into the trading book in order to get Trading Regulation better capital treatment. It therefore requires banks to80% consolidate positions from all of their trading desks70% and to make their trading book compatible with their60% banking book. This requires data to be both accurate and clean, and will be a challenge for any US banks50% 46% 40% which have not been applying Basel rules up to now.40% 38% 38% 25% 27% To meet the UK’s liquidity rules, banks will be required30% 24% 25% 24% 20% 18% 20% 20% to identify, measure, monitor and stress test liquidity20% 10% 9% risk in a much more detailed way, and to process and10% 8% 5% 4% deliver the data to the Financial Services Authority 0% 0% 0% (FSA) on a regular basis. 1 2 3 4 5 Strongly agree Strongly disagree Basel III also requires a unified view of counterparties and counterparty credit risk, and the capacity to measure and process the data. In addition, the move Figure 7. Q10d, functional split to centralized collateral management, as well as the Do you agree or disagree with the following statements? Rate 1 to 5. We are concerned that the increased transparency introduction of the net stable funding ratio and the required by new regulations will be a threat to our competitiveness liquidity coverage ratio, will require new data models. To fulfill many of the requirements, banks need to collect more detailed information from the trading partners and their clients. Respondents to the survey highlighted several areas where they needed additional data from counterparties, led by collateral and transaction data. By function, there were some noticeable spikes in data requirements. (See Figures 8 and 9 on page 13.) 12

For some banks, data projects are about creatingvalue as well as compliance. “We identified informationarchitecture as the lynchpin in meeting new regulationsearly on, so we are quite a long way down the road interms of where we need to be in order to change ourinformation systems,” says the head of IT at a largeUS bank. “Because we also identified that this is an Figure 8. In what areas do you need additional orarea where we could create value for the business, we more detailed information from counterparties, due to recent regulatory reform?prioritized this over some other IT projects.” 100%There is a high cost associated with meeting new 90%requirements, however. “There is a huge impact ondata systems across multiple product and business 80%lines,” says the head of compliance at a large 70%European bank operating in London. “Estimates 60% 54%suggest that it will cost large banks around $100m 53%each to put the systems and processes in place to 50% 44% 43%comply with Basel III. We will have to find ways of 40% 33%calculating the newly introduced net stable funding 30% 26%ratio and the liquidity coverage ratio, and have the 18%capability to stress test our calculations and report 20%to our board and to regulators. Because the Basel 10%Senior Supervisors Group favors a standardized 0%centralized risk data set – the so-called single source iss ion ica lient g da al uc te ca al l ns era n s sin ta e n allo pitof truth – on the IT side, this means banks will have str ra tio ue tur etit tio tio C llat rpo en Ca sac mp Co Lic Coto integrate data sources and adopt new data un n Co Tra mmmodeling techniques.” co Figure 8. Q5, overall In what areas do you need additional or more detailed information from counterparties, due to recent regulatory reform? Figure 9. In what areas do you need additional or more detailed information from counterparties, due to recent regulatory reform? 100% 100% Operations Risk 90% Trading Regulation 80% 70% 64% 62% 62% 60% 60% 60% 54% 55% 48% 46% 50% 43% 42% 42% 42% 40% 36% 36% 40% 33% 33% 33% 30% 20% 21% 20% 17% 18% 20% 10% 9% 10% 0% 0% tio t iss ion ral da al g ica en s ca al uc e ta ns n e sin ue n str orat allo apit e tur tio etit un Cli tio llat en sac mp rp C Co Lic Co n Co Tra mm co Figure 16. Q6, “don’t know list” Due to regulatory change, which business functions do you anticipate 13 having to relocate or outsource, partly or completely?

Figure 10. Do you agree or disagree with the Figure 11. Do you agree or disagree with the following statements? Scale 1-5. following statements? Scale 1-5. We have a company-wide strategy for identifying the We have a company-wide strategy for identifying the systems that will require modification/upgrade to handle systems that will require modification/upgrade to handle the new, higher levels required by new regulation. the new, higher levels required by new regulation. 100% 100% Operations Risk 90% 90% Trading Regulation 80% 80% 70% 70% 60% 60% 60% 52% 50% 50% 46% 46% 38% 38% 40% 36% 40% 33% 30% 30% 25% 25% 20% 20% 20% 16% 20% 10% 8% 8% 9% 10% 10% 5% 2% 4% 0% 0% 0% 0% 0% 0% 0% 1 2 3 4 5 1 2 3 4 5 Strongly agree Strongly disagree Strongly agree Strongly disagree Figure 10. Q10a, overall Figure 12. you agree or disagree with the following statements? Do Do you agree or disagree with the Figure 13. Do youFigure 7. or disagree with the agree Q10d, functional split following statements? Scale 1-5. Scale 1-5. We have a company-wide strategy for following statements? Scale 1 the following statements? Do you agree or disagree with to 5. We have already identifiedrequire modification/upgrade to handle the have already identified the that the increased transparency identifying the systems that will the systems that will require We Rate 1 to 5. We are concerned systems that will require modification/upgrade to handle the new,regulation. new, higher levels required by new higher levels modification/upgrade to handle the new, higher levels required by new regulations will be a threat to our competitiveness of data required by new regulation. of data required by new regulation. 100% 100% Operations Risk 90% 90% Trading Regulation 80% 80% 70% 70% 60% 60% 60% 54% 50% 50% 44% 38% 40% 40% 40% 36% 36% 33% 28% 30% 30% 25% 19% 20% 16% 20% 18% 10% 13% 10% 10% 9% 10% 2% 4% 4% 0% 0% 0% 0% 0% 0% 0% 1 2 3 4 5 1 2 3 4 5 Strongly agree Strongly disagree Strongly agree Strongly disagree Figure 12. Q10b, overall Do you agree or disagree with the following statements? Scale 1-5. Figure 13. Q10b, functional We have a company-wide strategy for identifying the systems that will require Do you agree or disagree with the following statements?modification/upgrade to handle the new, higher levels required by new regulation Scale 1 to 5. We have already identified the systems that will require modification/upgrade to handle the new, higher levels of data required by new regulation 14

Banks are acutely aware of new datarequirementsThe survey revealed that almost three-quarters ofbanks have a strategy in place in order to identify Figure 14. Do you agree or disagree with the followingwhere changes to systems need to be made, or statements? Please rate on a scale of 1 to 5.have already identified the systems which will need Once we have adopted changes to our datamodification. Three of the four business functions infrastructure, management will be able to prove they have better control of information, as required bysurveyed are well advanced in terms of preparation, regulators.led by operations, with only the regulatory functionlagging. (See Figures 10 through 13 on page 14.) 100% 90%Banks have a strategy for communicating the impact 80%of regulatory changes to clients and counterparties.About three-quarters (74%) agree or strongly agree 70%that they have a strategy to communicate changes to 60%clients and counterparties. 50%Most banks are confident that once they have adopted 40% 36% 30%planned changes to their data infrastructure, their 30%management will be able to prove they have better 20% 20%control of information, as required by regulators. 8% 7%However, UK banks are much more confident than 10%their US counterparts. (See Figure 14 and 15.) 0% 1 2 3 4 5 Strongly agree Strongly disagree Figure 14.Q3d, overall Figure 15. Do you agree or disagree with the following Do you agree or disagree with the following statements? Please rate on a scale of 1 to 5.The shape of things to come Oncestatements? Please rate on a infrastructure, management will be able to we have adopted changes to our data scale of 1 to 5. prove they have better control of information, as required by regulators Once we have adopted changes to our dataSome banks have already taken steps to refine the infrastructure, management will be able to prove they have better control of information, as required byshape of their organizations to minimize the impact regulators.of regulations. In February, for example, the UK’sBarclays disclosed that in November 2010 it had 100% U.S.deregistered its US bank-holding company. The bank U.K. 90%said this was to better align the business with the 80%appropriate capital regimes; in doing so, the bankavoided having to inject as much as $12bn to make 70%up a capital shortfall in the US. 60% 50% 45%As a result of the change, Barclays folded a credit- 39%card operation into a new US entity that is a direct 40%subsidiary of the British parent company. The 30% 30% 27%credit-card bank is regulated by the Federal Deposit 20% 20%Insurance Corporation and needs no additional 13% 10% 10%injection of capital. Before the move, Barclays 10% 3% 3%Capital, the group’s investment bank, was held within 0%Barclays Group US Inc., which was subject to federal 1 2 3 4 5 Strongly agree Strongly disagreecapital requirements. It will now be subject to SECregulation instead. Figure 15. Q3d, geographic Do you agree or disagree with the following statements? Please rate on a scale of 1 to 5. Once we have adopted changes to our data infrastructure, management will be able to prove they have better 15 control of information, as required by regulators

While the restructuring of Barclays and other banks suggest that senior management is swiftly taking steps to reshape business entities, survey respondents across most areas of business were undecided about whether new regulations would lead firms to relocate or outsource any business functions, or create a shared utility. In 13 of the 17 areas of operation, the majority of respondents said they did not know what the impact of regulation would be on organizational structure. (See Figure 16.) However, over a third (36%) of UK and almost half (47%) of US respondents agreed or strongly agreed that they anticipate working with new back office providers due to regulatory change, compared to about a quarter of UK and over a third of US respondents who anticipate working with a new middle office provider. There are four areas (operations, risk management, financial control and IT) where new strategies are clearly being contemplated. In operations, more than a quarter (26%) of US respondents and a third of UK respondents said they anticipated the creation of shared utilities. Operations professionals were even more enthusiastic, with almost 48% suggesting this was a possible route. Similarly, the creation of a shared utility was seen as a likely choice for risk management, with a third of all respondents and 43% of risk professionals suggesting this option.Figure 16. Due to regulatory change, which businessfunctions do you anticipate having to relocate oroutsource, partly or completely? 100% 90% 80% 68% 66% 70% 66% 65% 63% 61% 61% 60% 58% 58% 60% 53% 50% 50% 48% 47% 50% 43% 39% 40% 30% 20% 10% 0% g ng t les ce tio / rch s en ry ol IT S ing ing g kin ica ng ﬁna e ge nt n ns e nt GT din ari ntr su rat lian tio Sa em na tme nc a un keti d ak an me Cle se rea l co Tra era rpo tra mp ag t-m eb Re ma nves mm mar et Op ry Co an cia Co vat rke eta rat km IR/ an ti Pri Ma rpo pri en Fin Ris co Pro Cli Co Figure 16. Q6, “don’t know list” Due to regulatory change, which business functions do you anticipate having to relocate or outsource, partly or completely? 16

By function, traders see the greatest potential for Global banks are complex entities that have typicallyregulations to shape operations strategy: 40% of evolved to satisfy a variety of drivers from growth,traders thought new regulations would lead to trading to cost cutting, to tax benefits. Often, they do notoperations being relocated; 30% thought that market- develop as standalone entities but share functionsmaking and prop trading will be relocated; 40% with other parts of the group. Business done inthought that a shared utility may be created for client one country may be transferred somewhere elseinvestment management; and a third thought that IT for management. Likewise, income generated inmay be outsourced. one location may be paid away somewhere else. The result is sprawling global institutions, oftenShared services such as regional data centers are comprising hundreds of different entities, vehiclesalready common practice at many global financial and participations, which have been made moreinstitutions, particularly at retail banks, which rely heavily efficient through the use of cross-agreements for theon gathering, processing and analyzing customer provision of services, people and funding.information in order to tailor services. The CEO of theEMEA consumer division of a major US bank says Up to now, banks have been indifferent to how theseshared services offer big advantages for bank and structures looked. But in the world of Living Wills andcustomer. But he notes that there are already forces in resolution regimes, if a crisis means a bank must ring-play which may put pressure on this business model. fence a particular business, write it down or sell it, the parent needs to know exactly how it interrelates with“Customers execute business with us through all the other parts of the jigsaw. Regulators will wantapplications hosted in our data centers. One reassurance that, if firms have transferred positionsexample is the fraud analysis we do on credit cards. from one jurisdiction to another, there is enough capitalAnother is the risk analysis we perform under the and risk management capacity to contain the risks innew requirements of various jurisdictions. Using the transferred positions. If the business has paid awayregional data centers is an advantage for several income, regulators will ask how that affects profitabilityreasons. The facilities are state of the art, present and risk management of the entity that is payinga closed circuit and have no major single points of away. Untangling this spaghetti to create an enterprisefailure within the core infrastructure. Our data centers map will prove extremely difficult for some. And theenhance the bank’s risk management, allowing us existence of shared services may make it more difficult.to mitigate or accept risks based on a compositeimpact analysis rather than through isolated and “The detail is challenging,” says the head of prudentialmarket-specific analyses. Such centers allow us to advisory at a consulting firm. “Banks have to askmaintain consistent processes across regions. We themselves if a business could be broken up and soldhave an ‘end-to-end’ view of the data, which improves off, and what they would do about critical elementsthe quality and timeliness of services provided. It that they would have to pass on to someone else?also allows us to better comply with legal/regulatory Is it standalone or is it dependent on other parts ofrequirements. Several jurisdictions are looking to the organization? If it’s not standalone, what needsrequire local data processing, however. The intentions to be done to make it saleable as a standaloneare understandable, but as outlined above, would operation? Could they provide the right informationundermine several of the same public policy goals.” to the authorities so that they can maintain critical functions such as current accounts? All of this is actually extremely difficult to achieve. In that sense, shared services could become an obstacle to a viableThe impact of resolution regimes resolution plan. If you wanted to sell a business that ison structures dependent on a shared service, how standalone is it?The push towards bank resolution regimes, or Living Can someone else buy it, or does the shared serviceWills, will also have a material impact on strategies affect the viability of the business?”in this area because the patchwork nature of manybanking groups do not lend themselves to drawingclean lines between businesses. 17

ConclusionAs financial institutions operating in the US and UKcontinue to ask themselves questions such as these,attempting to determine how best to reshape theirbusinesses in light of new regulatory requirements, theyalso await clarification from regulators on both sidesof the pond. The interim report of the IndependentBanking Commission in the UK was released mid-April, but the final report is not out until September.However, the recommendations of the Commission,such as ring-fencing retail operations and improvingcapital buffers, are just that – recommendations, whichmust be accepted by the government and implementedbefore banks have absolute clarity on the detail of newregulation. In the US, the SEC and other regulators areworking towards a July deadline for implementation ofDodd-Frank but already there is talk of a delay of upto 18 months for some parts of the Act. These delaysmay give gives banks more opportunity to work withregulators to find solutions that make the financialsystem safer while maintaining competitiveness –or they may just drag out the uncertainty. 18

AppendixFigure 1. At what stage is your company in preparing for changes required by regulatory reform? We have identiﬁed the regulatory changes relevant to our business 31%We have assessed how regulatory changes will impact our business 13% We have begun implementing changes to our business based 56% on our impact assessments 0% 20% 40% 60% 80% 100% Figure A-1. At what stage is your company in preparing for changes required by regulatory reform?Figure 2. Have you or do you plan to align the implementation of your country’s main regulatoryreform with that of any of the following regulations? Select all that apply. Basel III 89% IFRS 59% FACTA 25% 0% 20% 40% 60% 80% 100% Figure Q2. Have you or do you plan to align the implementation of your country’s main regulatory reform with that of any of the following regulations? Select all that apply 19

Figure 3. Do you agree or disagree with the following statements? Please rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree. 1 2 3 4 5 Strongly agree Strongly disagree We are looking at the new regulatoryenvironment as an opportunity 26% 25% 33% 11% 5% to gain market share We are looking at the new regulatory environment as an 25% 33% 23% 13% 7% opportunity to transform our business model/structure We aim to maintain our current operational model/structure as much as possible, only making changes 11% 43% 18% 23% 5%where explicitly required by new regulation Once we have adopted changes to our data infrastructure, management will be able to prove they have better control 30% 36% 20% 8% 7% of information, as required by regulators We have a strategy for communicating the impact of regulatory changes to 31% 43% 15% 7% 5% our clients and counterparties 0% 20% 40% 60% 80% 100% Figure Q3. Do you agree or disagree with the following statements? Please rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree. *Figures do not add to 100% due to rounding. Figures do not add to 100% due to rounding. 20

Figure 4. In what areas do you need additional or more detailed information fromclients, due to recent regulatory reform? Select all that apply. Risk tolerance 80% Areas willing to invest in/ 39% areas to avoidWillingness to lend securities 38% Demographic information 23% Household/individual 23% balance sheet 0% 20% 40% 60% 80% 100% Figure Q4. In what areas do you need additional or more detailed information from clients, due to recent regulatory reform? Select all that apply. 21

Figure 5. In what areas do you need additional or more detailed information fromcounterparties, due to recent regulatory reform? Select all that apply. Transactional data 54% Collateral 53% Corporate structure 44% Capital allocation 43% Client communications 33% Licensing 26% Competition issues 18% 0% 20% 40% 60% 80% 100% Figure Q5. In what areas do you need additional or more detailed information from clients, due to recent regulatory reform? Select all that apply. 22

Figure 6. Due to regulatory change, which business functions do you anticipatehaving to relocate or outsource, partly or completely? Select all that apply. Relocate Outsource Create shared utility Don’t know Operations 16% 16% 30% 39% Trading 19% 5% 19% 58% Market-making 12% 5% 17% 66% Proprietary trading 17% 9% 17% 58% Sales 12% 5% 18% 65%Client investment management 5% 7% 22% 66% Clearing 10% 21% 19% 50% GTS 12% 5% 14% 68% Private banking 12% 7% 18% 63% Corporate ﬁnance 9% 11% 21% 60% Risk management 11% 9% 33% 47% Compliance 10% 10% 26% 53% Financial control 12% 7% 31% 50% Corporate treasury 14% 2% 23% 61% IT 12% 28% 17% 43% IR/marketing/communications 2% 16% 21% 61% Research 9% 21% 22% 48% 0% 20% 40% 60% 80% 100% Figure Q6. Due to regulatory change, which business functions do you anticipate having to relocate or outsource, partly or completely? Select all that apply. Figures do not add to 100% due to rounding. *Figures do not add to 100% due to rounding. 23

Figure 7. What impact will relocation and/or outsourcing decisions have onattracting and retaining talent? Select all that apply. The ability to hire qualified staff is a top criterion when 34% selecting where to relocate specific business funtions We are confident that our outsourcing arrangements 33% will help us retain staff We are concerned that we are likely to lose staff 33% due to outsourcingWe are concerned that we will have difficulty hiring qualified 33% staff in the areas we are considering for relocation We are concerned that we are likely to lose staff 31% due to relocation We have a retention strategy to lock in key staff when 25% outsourcing, relocating or creating a shared utility We are confident that our relocation arrangements 18% will help us retain staff 0% 20% 40% 60% 80% 100% Figure Q7. What impact will relocation and/or outsourcing decisions have on attracting and retaining talent? Select all that apply. 24

Figure 8. Do you agree or disagree with the following statements? Please rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree. 1 2 3 4 5 Strongly agree Strongly disagree Moving utilities to other providers will save us money in the long run 8% 30% 44% 12% 7% Our plans to outsource certain business functions will create 5% 33% 36% 18% 8% significant complications for our liquidation plan We anticipate working with new middle office providers 8% 23% 41% 20% 8% due to regulatory change We anticipate working with new back office providers 12% 30% 36% 18% 5% due to regulatory change The way in which we will have to transform our legal and financialstructure in order to comply with global 8% 16% 51% 16% 8% liquidation requirements will have a significant negative effect on revenues 0% 20% 40% 60% 80% 100% Figure Q8. Do you agree or disagree with the following statements? Please rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree. Figures do not add to 100% due to rounding. 25

Figure 9. Do you agree or disagree with the following statements? Please rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree. 1 2 3 4 5 Strongly agree Strongly disagree We have a company-wide strategy for identifying the systems that will require modification/upgrade to handle the new, higher 36% 38% 16% 8% 2% levels of data required by new regulation We have already identified the systems that will require modification/upgrade 28% 44% 16% 10% 2% to handle the new, higher levels of data required by new regulationThe board and senior management have a good understanding of the changes to systems needed to handle the increased levels of 34% 34% 18% 10% 3% transparency required by new regulations We are concerned that the increased transparency required by new regulations 8% 23% 29% 30% 7% will be a threat to our competitiveness The board and senior management have a good understanding of the implications increased data transparency will have 20% 43% 30% 5% 5% across the business The board and senior management have a good understanding of the implications 15% 51% 25% 7% 3% increased data transparency will have across the industry 0% 20% 40% 60% 80% 100% Figure Q9. Do you agree or disagree with the following statements? Please rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree. *Figures do not add to 100% due to rounding. Figures do not add to 100% due to rounding. 26

About CapcoCapco, a global business and technology consultancy dedicated solely to the financial services industry. We work in this sector only. We recognize and understand the opportunities and thechallenges our clients face. We apply focus, insight and determination to consulting, technologyand transformation. We overcome complexity. We remove obstacles. We help our clients realize their potential for increasing success. The value we create, the insights we contribute and the skills of our people mean we are more than consultants. We are a true participant in the industry. Together with our clients we are forming the future of finance. We serve our clients from offices in leading financial centers across North America and Europe. Worldwide offices Amsterdam • Antwerp • Bangalore • Chicago • Frankfurt • Geneva • Johannesburg London • New York • Paris • San Francisco • Toronto • Washington DC • Zürich To learn more, contact us at +1 212 284 8600 (+44 20 7426 1500 from outside the United States or Canada), or visit our website at CAPCO.COM © 2011 The Capital Market Company NV. All rights reserved. T1054A-01-GL/A4

Change amidst uncertainty: How banks are adapting to the emerging regulatory landscape

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Change amidst uncertainty: How banks are adapting to the emerging regulatory landscape Document Transcript