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Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
Frontiers in finance magazine - February 2012
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Frontiers in finance magazine - February 2012

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  • 1. Frontiers in Finance Rogue trading BrazilFor decision makers in The factors necessary The new hot spot forfinancial services to form an effective investment managementFebruary 2012 control framework Page 8 Page 12Frontiersin FinanceForging forward:Financial servicesin 2012InsuranceFinding growth opportunitiesin uncertain timesPage 22
  • 2. FOREWORDFORGING FORWARD:FINANCIAL SERVICESIN 2012From theEditorial teamAt frontiers in finance, we have always tried The turmoil in our industry shows noto live up to the promise of the magazine’s sign of abating. The worst dangers of thetitle: to present for the benefit of our clients financial crisis have given way to politicaland other readers leading opinions and analysis and regulatory reaction on perhaps anaddressing issues at the cutting edge of the unprecedented scale. But major uncertaintiesfinancial services industry. We have also remain. Banks, insurers, investment managerstried to do this in the most succinct and – all face a future which will be as different asaccessible manner. it is currently obscure. The articles in this issue of frontiers review regulatory developmentsA change of editorial responsibility is from a number of perspectives; we look attraditionally a time to take stock, to review growth prospects in the insurance sector andand to refresh a publication, and this is what in the massive but still emerging market ofwe have been doing. We have sought Brazil; operational issues addressed includefeedback from the tens of thousands of how to guard against rogue trading and howreaders we serve, both within KPMG and in to implement effective customer remediationthe wider financial services community. It is when things do go wrong.gratifying to find that in the main we have been living up to our promise. Many of you have There is more. But we hope you find it aemphasized the value of the magazine. stimulating and helpful guide through the complexity of today’s, and tomorrow’s,At the same time, just as the financial financial services industry.world is changing, there are ways in whichfrontiers needs to evolve as well. We stillaim to provide a commentary on the keyfinancial services topics of the day whichis both relevant to your business and yourchallenges and also offers practical guidanceand solutions. In future, we hope to be a littlemore forward-looking, perhaps clearer andmore concise, and to pay greater attentionto cutting through the complexity whichcan bedevil financial services. We shall beincluding two or three more regular features,and trying to provide a rather stronger thematicunderpinning to each issue.© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 3. FRONTIERS IN FINANCE FEBRUARY 2012 CONTENTS FEATURES COLUMNS 02 Chairman’s message Global Financial Services Chairman points out that while western markets face several challenges, there are opportunities and growth in many parts of the world. 04 Regulation matters Regulation of the global financial services industry is evolving rapidly, on many fronts and in complex, overlapping ways. 20 Cutting through concepts A new recurring section which seeks to bring clarity around complex and often misunderstood financial services concepts or issues. 14 8 22Produced by KPMG’s Global FinancialServices Practice Brazil InsuranceDesigned by Mytton Williams The new investment Finding growth opportunitiesPublication date: February 2012 management hot spot. in uncertain times.Publication number: 120182 18Printed on recycled material 12The information contained herein is of a general Rogue trading 8nature and is not intended to address the The actions and approach tocircumstances of any particular individual or entity.Although we endeavour to provide accurate and reduce the risk.timely information, there can be no guaranteethat such information is accurate as of the date it 14is received or that it will continue to be accurate in Customer remediationthe future. No one should act on such informationwithout appropriate professional advice after a Getting it right once youthorough examination of the particular situation. have got it wrong. INSIGHTS© 2012 KPMG International Cooperative (“KPMG 18International”), a Swiss entity. Member firmsof the KPMG network of independent firms 26 Basel IIIare affiliated with KPMG International. KPMG Updates from KPMG member The issues and implications of theInternational provides no client services. No firms, thought leadership and capital adequacy guidelines.member firm has any authority to obligate or bind contacts. KPMG International or any other member firm vis-à-vis third parties, nor does KPMG Internationalhave any such authority to obligate or bind anymember firm. All rights reserved. Printed in theUnited Kingdom.The KPMG name, logo and “cutting throughcomplexity” are registered trademarks ortrademarks of KPMG International. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 4. COLUMNSCHAIRMAN’S MESSAGEKPMG’s Global Financial Services Chairman points outthat while western markets face several challenges, thereare opportunities and growth in many parts of the world.Opportunities ina Changing World A s we publish this issue of In addition to adapting to new regulation, banks frontiers in finance, the financial continue to face the perennial challenges of and economic environment managing operational risk and implementing remains fragile in many parts transparent and robust remuneration policies. of the world. Financial sector Both areas continue to come under significant firms face an unprecedented combination scrutiny from governments and regulators. of threats from the lack of GDP growth, a Amidst the despondency in Europe it isJeremy Anderson lack of confidence in the European bank easy to forget that many countries are growingGlobal Financial Services Chairman and sovereign debt markets, and calls for apace. There are tremendous opportunities to additional capital and liquidity as part of the grow in Asia, South America, India, and also on sweeping changes impacting many parts the African continent, where the convergence of the financial sector globally. We remain a of banking and mobile telephony is creating long way from durable solutions to the crisis. unprecedented opportunity. While policymakers around the world As financial institutions rise to the have responded differently to these threats, challenge of providing banking and insurance on balance the global response has been to services to more than two billion ‘unbanked’ increase austerity measures. What is not yet people globally, a key focus will be how to clear is whether austerity objectives will be achieve this sustainably, so that the financial able to deliver the renewal in confidence and sector is seen as a partner in responsible growth that are needed to emerge from the development. To this end, KPMG is organizing current crisis. At the same time the banks are a global conference to articulate a Business being required to hold more capital with the Perspective on Sustainable Growth ahead of attendant risk to new credit origination. the Rio+20 summit in June 2012. The pace of regulatory change this last Whether your immediate focus is on the year has been relentless, driven primarily Eurozone and regulatory developments or on by the G20 Financial Stability Board, in the tremendous opportunities in high-growth the form of requirements for G-SIFIs, the markets, I hope you will find this edition of implementation of Dodd Frank in the frontiers in finance stimulating and useful as United States, multiple European Union you launch into 2012. regulations, and an emerging focus on consumer protection. Rarely have we seen executive teams spend so much of their time grappling with regulatory issues. Change programs, impacting people, processes and technology, need to be implemented in parallel, across multiple regions and jurisdictions and under different regulatory frameworks. This is a profound challenge for even the most agile financial institutions. 2©/ 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No Frontiers in Finance / February 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 5. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 6. COLUMNSREGULATION ROUND TABLERegulation of the global financial services industry is evolving rapidly,on many fronts and in complex, overlapping ways. In this new recurringsection, the heads of KPMG’s three Regulatory Centers of Excellence –Giles Williams (EMA), Simon Topping (ASPAC) and Jim Low (Americas)– recently reviewed the major issues companies in each of their regions arefacing from a regulatory perspective in 2012.Global Round Table:Regulation hots upGiles Williams: We’re going to talk in a GW: So turning to the ‘heat map’, the G20 CEO ISSUESmoment or two about the KPMG ‘Regulatory regulatory agenda is intended to:Heat Map’ [Page 6/7] which captures the – create a new framework for banks, OTCcurrent impacts of regulation. But first I derivatives, compensation practices andthought it would be helpful if we put it into a credit rating agencies; H ow will regulatory change impactbroader context. During the global financial – address the too big to fail issue; ‘fill in the on our business model?crisis, complete catastrophe was averted gaps’ in regulation and supervision of the W hat strategic changes will bepartly by luck and partly by concerted action by financial sector; necessary for us to pursue maximumgovernments and regulators. The G20 rapidly – tackle tax havens and non-cooperative growth and profitability?moved to the forefront of action to restore jurisdictions.stability and began the process of building W hat impact will regulatory changea more resilient global financial services The ‘heat map’ locates the principal regulatory have on the most appropriate legalstructure. Markets and economies began to initiatives currently being implemented on entity structure for the group?recover. However, I think all of us would agree a grid relating five key themes – financialthat the global recovery has weakened in stability, conduct, market infrastructure, tax H ow should our operationalrecent months and new trends are emerging. and finance and governance – to the three configuration evolve: onshore?The regulatory debate is broad; with the primary industry segments of investment offshore? shared service centers?systematic risk arguments, the role of capital management, banking and insurance. H ow can risk best be controlledand need for liquidity. This is in the context The color key reflects the main geographic and minimized in the firm in future?of the wider political dimension focusing on regional impacts.the role of financial services in the rest of the D o we have an effective recoveryeconomy, the protection of consumers and the Simon Topping: What really comes across and resolution plan?contentious issue of executive pay. to me from our analysis is that we’ve seen a A re all our stakeholders signed up significant change in the regulatory landscape to the same view of the future?Jim Low: Right, and this is being felt, to a over recent months. One of the most obviousgreater or lesser extent, across all advanced points to note is that the three industrycountries. The specter of ‘double dip’ segments look really quite similar. There arerecessions is looming closer. In the USA, some differences of emphasis, for sure; but itthe economy remains weak, and consumer is now clear that the impact of new regulationconfidence continues to be weighed down will be widespread and comparativelyby a moribund housing market. In Europe, intolerant of special interests. In early 2011 itas you know well, sovereign debt concerns was still possible to argue that hedge fundsare spreading, and the risk of default by one should be spared the most draconian newor more members is calling the structure of requirements because they played no rolethe eurozone into doubt. Across the globe, in creating the crisis; or that insurers operateexcessive debt – and concomitant deleveraging a fundamentally more stable business– are dragging down economic performance model and require different treatment. Now,already hit by increased commodity prices. however, there is little distinction; this is a real And this is the key background to the G20’s change.commitment, in November 2011, to worktowards a more stable and resilient international JL: I think that’s exactly right. The politicalmonetary system and to improve systemic agenda has ensured that the financial servicesstability in the global economy. sector as a whole is going to share the pain.4©/ 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No Frontiers in Finance / February 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 7. Contacts (from left) Giles Williams Simon Topping Jim LowDuring the global financialcrisis, complete catastrophewas averted partly by luckand partly by concertedaction by governmentsand regulators. The G20rapidly moved to theforefront of action to restorestability and began theprocess of building a moreresilient global financialservices structure.But what we have now is a remarkably IMPLEMENTATION PROGRESScomplex and ambitious agenda.GW: The G20 would no doubt argue that it is Reform Policy Key policy datesdeliberately comprehensive and consistent. ‘11 ‘12 ‘13 ‘14 ‘15 ‘16–’19I have a quote from the final declaration fromthe Cannes Summit in November 2011, J A S O N Dwhere they emphasized: Capital Basel III“We are determined to fulfill the commitmentwe made in Washington in November CRD32008 to ensure that all financial markets, CRD4products and participants are regulated or Liquidity Basel 3subject to oversight as appropriate to theircircumstances in an internationally consistent Systemic risk FSB – GSIFIsand non-discriminatory way.” EU Crisis mgtST: Well yes, but a more pragmatic UK ICBassessment also raises a number of areas of Supervision ESAsconcern notably:– scale and cost of the additional the UK architecture regulatory burden, all of which will be Governance EU green paper borne, in the end, by financial services Remuneration CRD3 companies and their customers– scope for inefficiency, duplication, the Customer EU access/lending inconsistency and contradiction treatment PRIPS– the opportunities for regulatory arbitrage– damage to global GDP which may the SEPA follow the imposition of a more costly, UK RDR less profitable, less responsive financial Traded OTC derivatives services sector. markets MiFID2JL: Our three Regulatory Centers of Accounting/ EU green paperExcellence are uniquely placed to compare disclosureand contrast the impact in different CRAgeographic regions. Where are the agendasmost strongly correlated across the three Policy development Implementation In forceregions? Clearly, the most obvious area iswhere firms are truly global in the first place:regulation has to impose a consistent globalframework. But there is a deeper area wherethe end-game itself implies convergence. Forexample, the pressure for structural reform inthe banking sector may be stronger and more © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no in Finance / 5 February 2012 / Frontiers client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 8. COLUMNSREGULATORY HEATMAP European Union Global – G20 UK National United StatesInvestment management Hot AIFMD CRD 3/4 PRIPs AIFMD UCITS AIFMD UCITS DFA RDR DFA DFA Consumer Protection MiFD 2 EMIR COREP FTT Cool Financial Stability Conduct of Business Agenda Market Infrastructure Tax and Finance and Investor Protection and TradingBanking industry Hot CRD 3/4 Short Selling Credit Default Swaps Structural DFA Consumer BASEL 2.5/3 Reform DFA Protection DFA RDR (RRPs) Deposits MAD Schemes Investor Directive Compensation Directive MiFD 2 EMIR COREP MMR ICB FTT Cool Financial Stability Conduct of Business Agenda Market Infrastructure Tax and Finance and Investor Protection and TradingInsurance industry Hot DFA Solvency DFA DFA Investor RDR Living Wills Compensation Consumer Schemes Protection DMD Pensions MiFD 2 Directive COREP FTT Cool Financial Stability Conduct of Business Agenda Market Infrastructure Tax and Finance and Investor Protection and Trading6©/ 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No Frontiers in Finance / February 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 9. explicit in the UK and elsewhere in the EU. But the consequences will inevitably be felt here in the US, and in Asia, and will drive change So a key question is how towards comparable ultimate goals. far, and in which directions, Corporate Governance ST: Indeed. For instance, recovery and will these regional agendasFATCA resolution planning is now a significant influence each other in regulatory agenda item in Australia, impacting future. How far will the on companies which remained untouched by the crisis. So to a significant extent a common US begin to reflect European agenda is emerging, and common themes are concerns? Will the US IFRS extending across all geographical regions. But although the G20 emphasizes the international agenda be increasingly and global nature of the framework it reflected in Europe? believes is necessary, there are differences in emphasis, and the balance between the five themes is different. Corporate Governance GW: Some of the marked contrasts can be and Decision Making seen in the conduct agenda. This is not an especially significant imperative in Asia. It is evidence seems to show that policymakers of some relevance in the USA, but there it and regulators are acting in a responsible and remains heavily colored by a strong caveat thoughtful manner, seeking to be proportionate emptor principle: the customer needs to and achieve the broad objectives of restoring recognize and assume an appropriate degree stability and increasing resilience without unduly of risk, and so the emphasis is on supporting damaging competitiveness or economic value. Corporate Governance information provision and understanding.FATCA In Europe, however, it is a key theme of ST: Nevertheless, financial services will cost the regulatory agenda: the cultural and more, and deliver lower returns, to the extent policy mind-set is that the consumer needs that greater regulation imposes higher costs protection, and cannot – or should not – be and lower profitability. The main problem arising exposed to excessive risk. from this is there is little evidence as yet that consumers accept the implications for the costs IFRS ST: Nevertheless, despite such differences, and benefits they receive. This is going to make I think we are seeing a kind of creeping the challenge for CEOs all the greater. But there convergence in individual regional agendas. are clearly some key questions they need to be Issues of governance run across all asking themselves. three regions, although the strength of implementation necessarily varies, from Corporate Governance very prescriptive in the EU to – as yet – and Decision Making more consensual in the Far East. There is MORE INFORMATION convergence too in the way the objective Giles Williams of strengthening financial stability is being Partner, Financial Services extended into insurance through Solvency II; Regulatory Center of Excellence and in the way that protection against systemic EMA Region impacts is leading to resolution and recovery KPMG in the UK planning for insurance companies. T: +44 20 7311 5354 E: giles.williams@kpmg.co.uk Corporate Governance JL: So a key question is how far, and inFATCA which directions, will these regional agendas Simon Topping influence each other in future. How far will Partner, Financial Services the US begin to reflect European concerns? Regulatory Center of Excellence Will the US agenda be increasingly reflected ASPAC Region in Europe? KPMG in China T: +852 2826 7283 IFRS GW: Yes, and one of the largest areas of E: simon.topping@kpmg.com uncertainty, and one which interests me in particular, is the extent to which the balance Jim Low will change in future between returns Partner, Financial Services to shareholders, customers, executives Regulatory Center of Excellence and employees. There are constant, and Americas Region Corporate Governance understandable, pressures from politicians KPMG in the US and Decision Making and the public they represent to impose more T: +1 212 872 3205 drastic and punitive changes. So far, the limited E: jhlow@kpmg.com © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no in Finance / 7 February 2012 / Frontiers client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 10. FEATUREINVESTMENT MANAGEMENTBrazil –The new hotspotin investmentmanagementBy Marco Andre Almeida and Lino JuniorB razil is now a major economic power, one of the top-10 global economies by purchasing Unlike many other large power parity1. It ranks ahead of economies, Brazil has a its ‘BRIC’ counterparts Russiaand India (although it is smaller than China). comparatively welcomingThe country enjoys a relatively stable macro- attitude to investmenteconomic environment, with consumer and funds and hedge funds –investor confidence continuing to strengthen.Inflation has been brought down since the recognizing the need toearly years of the new millennium, although it attract foreign investmentremains around 6.5 percent in 2011. However,interest rates remain high – the short-term to underpin continuedrisk-free rate currently stands at 10.5 percent. economic and infrastructure Unlike many other large economies, development.Brazil has a comparatively welcomingattitude to investment funds and hedgefunds – recognizing the need to attractforeign investment to underpin continuedeconomic and infrastructure development.The combination of high returns and a favorableregulatory regime is driving a massive wave ofinterest in investment in Brazil: it is indeed the daily updates of asset values and portfolionew hotspot in investment management. details being posted on the internet. Although the investment managementInvestment management sector is large, it faces competition fromindustry in Brazil certificates of deposit and savings accounts.Brazil’s investment management industry The total investment portfolio is concentratedis mature, well-managed and effectively- in Brazilian assets, with 60 percent of totalregulated. All funds – including those which investment in government bonds.would be described as hedge funds – mustbe registered with the Comissão de Valores Alternative investment industry in BrazilMobiliários (CVM) – Brazil’s equivalent of the There is increasing interest in the alternativeSecurities and Exchange Commission. The investment market in Brazil. A number ofcapital markets association, ANBIMA, operates different classes of investment vehicles exist.a system of self-regulation which is generally These are all summarized in the panel on thewell-regarded. The market is transparent, with next page.8©Frontiers in FinanceKPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No 2012 KPMG International. / February 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 11. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 12. FEATURE ALTERNATIVE INVESTMENT VEHICLES 395bnFrom topHigh returns and a favorableregulatory regime is makingBrazil the new hotspot ininvestment management.Infrastructure investmentin Brazil is pressing as Brazilprepares to host the WorldCup in 2014 and the Olympicsin 2016. The most attractive emerging as where income is taxed at less than 20 market for private equity percent and/or where there are restrictions“As a country and an A recent survey by Coller Capital and the on disclosure of shareholder composition or economy, we need private Emerging Markets Private Equity Association beneficial ownership). equity and venture shows that Brazil has overtaken China as the most attractive market for fund managers’ FIP investments are subject to certain restrictions: capitalists to invest and to deal-making in the coming year2. Brazil offers – The portfolio company is usually a help our entrepreneurs,” a number of fiscal incentives for inward Sociedade Anonima (S.A.), and is investment in private equity funds (Fundos de required to have its financial statements Maria Helena Santana, Chair Investimento em Participações – FIPs): audited by an independent auditor of the Comissão de Valores registered with the Brazilian CVM. The Mobiliários (CVM) – Brazil’s – Income and capital gains received by the funds are usually not subject to FIP must have influence in strategic decisions and its management. SEC4 taxation in Brazil; – The investment must adhere to the existing – There is no withholding tax on disposal of foreign exchange regime for investments in FIP quotas for non-residents as long as they Brazil’s capital market. hold, together with related parties, less than – The financial tax (IOF) is levied on the inflow 40 percent of the shares of the FIP and are of foreign funds into the FIP at a 2 percent not located in a low tax jurisdiction (defined rate (reduced to zero on 1 December 2011).102012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012 member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 13. Contacts (from left) Marco Andre Almeida Lino Junior Private Equity Funds (FIPs) FIDCs (Credit Receivables Investment Funds) Size in September 2011: R$ 78.4 billion. Taxation: 15 percent. Non-resident Size in September 2011: R$ 65.7 billion. investors (other than those located in Taxation: generally from 15 percent to ‘low tax jurisdictions’) which hold up to 22.5 percent. 40 percent of the fund are exempted. Comments: At least 50 percent of Comments: Minimum subscription of resources should be invested in credit R$100,000. Invested companies must receivables. Derivatives are optional, comply with certain corporate provided the objective is to hedge governance rules. spot positions. Most funds value credit receivables at cost plus accrued Multi-Strategy Funds income, less allowance for losses as determined by the Brazilian Central Size September 2011: R$ 395 billion. Bank. New rules effective from 2011 Taxation: from 15 percent to 22.5 are consistent with IFRS approach. percent (some exemptions). Comments: Portfolios can include any 78.4bn financial investment, in accordance with limits established in the by- laws and CVM regulation. Overseas investments are allowed in funds with minimum subscription of R$1 million up to 100 percent and in other funds up to 20 percent. Evolution: Brazilian Industry of Investment Funds (R$ Billion) 1,800 65.7bn 1,600 1,400 1,200 1,000 800 600 400 200 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Investing in the Brazilian financial market: Cup in 2014 and the Olympic Games in 2016,Non-resident investors may invest in Brazil’s both of which require major investment in the MORE INFORMATIONfinancial and capital markets on level terms country’s infrastructure. It has been estimated Marco Andre Almeidawith resident investors. They need simply to that Rio de Janeiro alone needs $36 billion of Partner, Financial Services and Nationalhire a legal representative in Brazil (a financial investment to prepare for these two events3. Head of Private Equityinstitution), and complete the necessary Brazil’s investment management industry is KPMG in Brazilpaperwork. However, getting the structure most definitely open for business. T: +55 213 515 9404right and optimizing the balance sheet to take E: maalmeida@kpmg.com.bradvantage of the favorable tax opportunities 1. CIA World Factbook, February 2011as well as to comply with domestic legislation 2. EMPEA/Coller Capital Emerging Markets Private Equity Survey – Lino Juniorand regulation is complex. Where purchases 18 April 2011 Partner, Financial Servicesof local companies are concerned – as they 3. Financial Times, ‘Rio eyes ‘Olympic bonds’ to fund 2016 games’, and Hedge Funds 2 February 2011have been with sovereign wealth fund 4. As quoted in The Economist, 17 February 2011 KPMG in Brazilinvestments – the necessary due diligence T: +55 213 515 9441can be time-consuming. E: lmjunior@kpmg.com.br Having said this, the requirement in Brazilfor infrastructure investment, especially, ispressing, particularly in the transport sector.In addition, Brazil is to host the football World © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate2012 any member firm. All rights reserved. February or bind / Frontiers in Finance / 11
  • 14. FEATURECAPITAL MARKETSA reactive approach to a rogue trading can have direconsequences for a firm. The right actions and approachcan defend against this threat.Rogue Trading:Controlling the riskBy Bill MichaelR ogue traders have always existed companies need to understand if they are to in one form or another. The combination of breach of faith, NOTORIOUS institute effective controls. The first key point to note is that no company betrayal of trust and deception LOSSES is immune. Wherever large sums of money is common to most areas of flow through large institutions, there will alwaysfinancial crime. What tends to mark out the be the potential for rogue trading to emerge.contemporary rogue trader is a particular set Constant vigilance and defense in depth areof circumstances and characteristics: essential. Furthermore, it is usually not the most high-profile, complex or apparently risky– he individual involved is normally not t motivated by personal greed, at least directly– deception starts small but spirals out his of control $2.3bn Kweku Adoboli areas of activity which are most susceptible. The majority of rogue trading occurs in comparatively humdrum or presumed safe parts of the business, out of the spotlight.– he sums involved can reach astronomical t UBS, 2011 Problems can start small but rapidly escalate to proportions. threaten the whole firm. There are also a number of institutional andIt is unsurprising that the actions of such individual features which contribute to rogueindividuals hit the headlines. Among themost notorious instances in recent years:– weku Adoboli is alleged to have caused UBS K €4.9bn Jérôme Kerviel trading. These are the subject of increasing debate in the industry. It is perhaps a cliché to point to the excessive risk-taking mentality and aggressiveness of mainly-young, mainly- to lose $2.3 billion trading on market futures Société Générale, 2008 male traders. But there is no doubt that there in 2011. is a tendency for companies to hire as traders– Jérôme Kerviel lost Société Générale €4.9 people who tend to be more prone to such billion over three years to 2008, again as a activity. When traders are speculating with $6.5bn result of trading stock market futures. other peoples’ money, the need for external– rian Hunter lost $6.5 billion for B controls is clear. Amaranth Advisors in 2006, trading on Secondly, a corporate culture which natural gas futures. Brian Hunter encourages (acceptable) risk-taking can easily– erhaps most famously, Nick Leeson brought P Amaranth Advisors, 2006 become one where excessive risk-taking is about a loss of £827 million, and caused the tolerated, or where those involved become collapse of Barings Bank after 233 years blind to it. When trades which push the bounds of existence, through his trading on the of what is permissible come off, and the firm £827m Nikkei Index. makes a large profit, there is an obvious danger that improper behavior is reinforced. ManySuch stories receive sensational media rogue traders have subsequently claimed thatcoverage, and it is always dramatic to depict Nick Leeson their activities were condoned because theira single individual being responsible for such Barings Bank, 1994 superiors also enjoyed the rewards which camecatastrophic consequences. However, the real with success.reasons behind, and causes of, rogue trading It is rarely the case that a trader starts outare more complex. It is these features which by intending to commit fraud. Rarely also is the122012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 15. Contacts Bill Michael of repeatedly doubling up in a desperate of suspense accounts, fictitious trades whichMotivating factors: attempt to recover the situation, all the while lack counter-party recognition, cancelledthe environment engaging in increasingly elaborate deceptions trades, excessive gross versus net exposureWhat are the typical factors that to disguise his true position. and so on. Acceptable profiles for all of thesecreate the environment for rogue It is much easier to hide transgressions characteristics can be developed, with events when a large volume of transactions is taking outside the established parameters triggeringtrading activity? place against a background of fragmented an alarm. IT systems and complex processes. Where There are also a range of non-technical middle- and back-office responsibility is factors which need to form part of an Aggressive culture compartmentalized, no-one may be in a effective control framework. These range of PL and revenue performance rather position to see the whole picture. Complex from mandatory training to appropriately- than wider risk and control based metrics trades can be very difficult to value accurately disciplined controls on access to systems by anyone other than the front-office and records. It has been well-publicized in Remuneration expert who is carrying them out. If senior a number of cases that rogue traders have linked to short term performance management or supervisors don’t fully tended to work odd hours, and have been understand the nature of products being reluctant to take vacations in case their Repeated control breaches traded or their inherent risk profile, it is much positions were exposed. Profiles for these tolerated by senior management easier for the rogue trader to disguise the true characteristics should also be established, nature of his position. and divergence flagged up. Correlation Insufficient challenge It follows from these features that an between suspicious activities in a number to (by control functions) and within effective defense needs two mutually- of areas can be especially valuable. (by supervisors) front office reinforcing strands: adequate and appropriate Systems and controls are typically controls and the right tone being set from the introduced and/or strengthened in the wake High volumes of trades top. It has been well-said that there are bold of a rogue trading disaster – if the firm has supported by fragmented IT systems traders and old traders, but there are very managed to survive it. But the risk of adopting and complex processing environment few old, bold traders. Senior management a reactive strategy is clear. By contrast, firms need to instill a strong culture of respect for should be adopting a strategy of continual Poor understanding controls – which still promote acceptable review, stress testing, monitoring and of complex products and trading risk-taking – while explicitly prohibiting the development, to ensure that their defense is activities by senior management occasional tolerance of breaches. Turning a as strong as possible. blind eye from time to time to an unauthorized gamble which pays off risks undermining the whole control framework.motivation personal gain, except in the sense In such a culture, it is then much easier tothat successful trading may bring kudos and institute effective systems and controls anda bigger bonus. Rather, a trade at the limit of to make sure they are respected. Most cover- MORE INFORMATIONacceptability may go wrong. Instead of closing up strategies are comparatively simple. The Bill Michaelout the position and triggering a loss, the trader most obvious course, if closing out a trade is UK Head of Financial Servicesmay try to recoup the loss the next day. All goes going to crystallize a loss, is to avoid booking KPMG in the UKwell until a loss cannot be recovered. Then it in the first place. So systems need to look T: +44 (0) 207 311 5292the trader embarks on the disastrous course for long settlement dates, late bookings, use E: bill.michael@kpmg.co.uk © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG2012 / Frontiersno client services. 13 February International provides in Finance / No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 16. FEATUREHEADING HEREBANKINGCustomer RemediationGetting itright onceyou’ve gotit wrongBy Scott Cohen and Dan Thomas,with contributions from Edwige SaccoW arren Buffett famously likes to say that, ‘Only when the tide goes out do you discover who’s been swimming naked’. The straitened economic environment following the financial crisis has contributed to the exposure of frauds such as the‘Ponzi’ scheme run by Bernard Madoff in the US, or various buy-to-let property frauds in the UK. Similarly, when asset values sufferserious reverses and liquidity dries up, investors and customers beginscrutinizing much more closely the soundness of investments theyhave made or been sold. Some of the malpractice which has emergedin the last few years on the part of the financial services industry hasbeen profound and far-reaching. In the US, the foreclosure crisis which emerged in 2010 remainsunresolved, despite tremendous regulatory scrutiny and notableindustry reform. It has revealed a widespread epidemic of foreclosuresthat were inappropriately initiated and inappropriately handled.Many have involved a lack of understanding of the legal/regulatoryrequirements and often been coupled with poor or in some casesfraudulent processes:– ortgagees have foreclosed on homes with no outstanding debt, M employed ‘robo-signing’ methods to expedite thousands of false affidavits and foreclosed on the homes of servicemen and women on active duty in express violation of federal law.– here have been significant failures of the controls intended to T safeguard the positions of both the borrower and the lender.– nsufficient attention has been paid to borrowers and to the I overall borrower experience.– nstitutions placed excessive reliance on third parties – I especially attorneys – to do the right thing. »142012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 17. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 18. FEATURE » JPMorgan Chase was one of the first major out of employee pension schemes for worse- banks to halt foreclosures completely, affecting performing private schemes.An increasingly intensive proceedings against 56,000 borrowers in 23 As demonstrated through the examplesand intrusive regulatory states; in a sworn deposition, a JPM employee above, these crises can cost the industrylandscape, together with admitted that she and her team signed off on about 18,000 foreclosures a month without billions of dollars in redress and operational costs, requiring onerous, resource-intensivegrowing media and checking whether they were justified1. Bank remediation infrastructures to be built andpolitical pressure, make it of America, Wells Fargo and Citigroup were subsequently decommissioned. Many providers among other major banks to follow suit. The fifth have faced quality and consistency concernsalmost inevitable that the largest lender in the US, Ally Financial, halted that have in turn invited regulatory scrutinyremediation burden will evictions and resale of repossessed homes and increased reputational risk as a result. Ancontinue to rise over the once a document processor for the company admitted that he had signed off on 10,000 increasingly intensive and intrusive regulatory landscape, together with growing media andmedium to longer term. pieces of foreclosure paperwork a month political pressure, make it almost inevitable without reading them2. that the remediation burden will continue to In the UK, the continuing issue over the rise over the medium to longer term. Firms widespread mis-selling of payment protection should consider it a business imperative to be insurance (PPI) by banks and other providers better prepared. was dramatically thrust back into the spotlight Many of the principles are consistent with in 2010. In a volte-face from its earlier stance, the crisis management discipline. Prevention is the BBA (British Banking Association) decided better than cure: not to appeal the judicial review decision. This resulted in a need for the UK banking industry to – void capping innovative product development A calculate provisioning requirements to cover the by designing flexible risk-based frameworks anticipated costs of millions of customer claims. to deliver robust management, analysis Lloyds Banking Group was the first to and reporting aligned to different products/ announce a provision of £3.2 billion. As a services. consequence, the bank reported a £3.4 billion – reate a business culture that focuses on C loss for the financial quarter concerned, and customer outcome as well as commercial shareholders saw 8 percent wiped off the gain, with early identification and rectification market value of their investment. Other banks of failings being a key requirement. quickly followed suit, with Barclays setting aside – nsure compliance: interpretation of regulation E £1 billion and RBS £950 million. The estimated and statute needs to be thorough, systematic total cost to the industry could be £9 billion. and up-to-date. Avoid technical and tenuous The PPI issue followed in the wake of legal interpretations of regulatory rules by the systematic mis-selling of endowment maintaining a pragmatic, principle-led ‘treating mortgages to more than five million UK customers fairly’ approach – get it right. customers. Millions more were advised to opt – ntroduce standards, policies and controls to I162012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 19. Contacts (from left) Scott Cohen Dan Thomas throughout the process. If a product or service fails to deliver the right customer outcome, the firm should: Create a business culture that focuses on customer – dentify the population of customers affected. I – etermine the level of detriment based on D outcome as well as the customers’ situations and experiences. commercial gain, with – aking the above step may allow the T early identification and population to be segmented based on likely detriment and appropriate actions for specific rectification of failings customer groups (previously paid/declined being a key requirement. claims, arrears customers, open/closed policies, ineligible, etc). – f a customer raises concerns directly, the I firm takes into account the identified failings when investigating and assessing the customer’s allegations. – edressing the customer should always R reflect a desire to put them back in the position they would otherwise have been had the failing not occurred. – ny customer impact should be rectified in A culture, product and sales development. a timely and consistent manner to reduce If, for example, the issues arose as a result further adverse customer impact. of the incentives and drivers in place, the business should review whether these existing For most firms, their existing operations and incentives encourage the right behaviors and resources cannot absorb the requirements outcomes. They may choose to weight future of the remediation activity. As a result, there incentives towards suitability, persistency and is a need for large numbers of temporary quality, not just volumes. resources, with limited time for robust training The final piece in the jigsaw is the and competency frameworks. This in turn governance and reporting structure. The support compliance: even small problems results in subjectivity when assessing and firm should be able to access and provide in distant corners of the business can have redressing complaints leading to inconsistent transparent material that informs all areas catastrophic results. outcomes, high levels of rework and regulatory of the business – such as compliance,– ontrols need to be designed in an C scrutiny. complaints, product design and marketing. appropriate manner to mitigate and manage Most large financial institutions can Engaging all relevant business areas and the risk (i.e. control design needs to clearly demonstrate at least one such experience in driving accountability for necessary change is correlate with a robust risk assessment). the past. The key to avoiding this is to develop key to reaping the benefits of remediation and– ontrols need to be tested and re-designed C a consistent approach to the upfront work in reducing future liability and failings. regularly to ensure they reflect the regulatory understanding and identifying the impact of the In summary, a firm’s ability to deliver environment and requirements. failing. The findings should be used to inform successful remediation projects and use– he provider must always assume T the scope of the remediation activity and drive the learnings from them to shape its future accountability for the quality of outcomes population segmentation. Once this has been business model is completely within its grasp. and delivery, irrespective of the level of third established, an automated approach to triaging However, time will tell whether the industry party involvement. the customer population for mailing and continues to view remediation as an expensive– nformation sharing (industry forums) I responses can be developed. The rules used and inevitable result of identified failings, or between financial institutions can help to drive the system will reflect the customer grasps the opportunity to use the learnings for companies understand what other key segmentation defined by the upfront work long-term financial and reputational gain. players are doing and how they measure up. undertaken by the firm, driving objective and consistent outcomes that are right the firstHowever, in the event an issue and/or control time. 1. New York Times, 29 September 2010failure is discovered, immediate action is The extent of an automated solution is 2. Washington Post, 22 September 2010imperative: dictated by the complexity of the customer– f a problem does emerge, address I remedy. For example, a customer with an open it head on. policy may want to maintain the policy and the– evelop a clear, explicit project and action D benefits therein, making it more appropriate MORE INFORMATION plan to tackle it. to relax the terms. However, a customer with Dan Thomas– ocument all critical decisions and how D a closed policy may simply wish to receive Head of Banking and Head of you got there. financial compensation. There are many Remediation, UK Risk Consulting– dentify the root cause and make sure your I potential outcomes; it’s never a case of one KPMG in the UK solution is not just a quick fix. size fits all. T: +44 (20) 76945575– lways be transparent. A While the main focus of remediation E: dan.thomas@kpmg.co.uk activity is to rectify any customer detriment inIt is important to avoid the checklist mentality, a compliant and timely manner, a key benefit is Scott Cohenand ensure the focus is on understanding how often missed. Understanding the core reasons Director – Financial Management,consumers are affected. Ultimately, the world for the failings provides the firm with a window US Management Consultingwill be more forgiving if a financial institution of opportunity. Not only can the failings be KPMG in the UScan demonstrate that it did its best to consider used to design a more robust risk framework, T: +1 973 912 6320the impact and outcome for its customers they can also help to inform and mold business E: secohen@kpmg.com © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG2012 / Frontiersno client services. 17 February International provides in Finance / No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 20. FEATUREREGULATIONIn the aftermath of the financial crisis, the Basel Committee onBanking Supervision embarked on a program of substantiallyrevising its existing capital adequacy guidelines; the resultingframework is known as ‘Basel III’.Basel IIIIssues and implicationsBy Jitendra Sharma and José A. Baráybar I n September of 2010, the Basel Committee on Banking Supervision specified additional details for capital requirements. These focused on target ratios and the transition periods during which financial institutions need to comply with the new regulations. The resulting framework, known as Basel III, was endorsed by the G20 at its November 2010 meeting in Seoul. While some areas continue to be fleshed out – most notably in relation to the regulation of systemic institutions – the core principles are in place to encourage banks to strengthen their underlying risk management capabilities. Basel III was developed as a response to the deficiencies in banking and financial regulation revealed by the global financial crisis. Specifically, the third of the Basel accords aims to correct the following: – uild up of excessive on and off-balance B sheet leverage by the banking sector along with a decrease in the level and quality of the capital base – ignificant contraction of liquidity and S credit availability resulting from the spread of the banking crisis through the rest of the financial sector – nterconnectedness of systemic financial I institutions through various complex transactions – he use of short-term and wholesale funding, T used by the financial sector as a cause of de-leveraging and flight to quality. The reforms under Basel III are designed to increase the resilience of banks during periods of stress and address system-wide risks that can severely impact the financial sector.182012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 21. Contacts (from left) Jitendra Sharma José A. Baráybar transparency of capital, with all elements of of banks to rebalance their asset portfolio will a bank’s capital required to be disclosed. be limited and this cannot be a good policyBanks are already cleaning Some banks are already adjusting their outcome.up their balance sheets, balance sheets; however, raising newbut raising new capital and capital and retaining more earnings will continue to be challenging and impose a Longer-term funding Partly as a result of liquidity requirements,retaining more earnings double strain on shareholders who will see banks may tend to change their funding profile,will be a continuing process. dividends constrained alongside calls for with a demand for additional longer-term additional capital. funding. The Net Stable Funding Ratio (NSFR)This will impose a double is designed to encourage banks to use stablestrain on shareholders Reduced on and off-balance sheet leverage funding sources and reduce their dependencewho will see dividends Banks need to constrain build up of excessive on and off-balance sheet leverage to avoid on short-term funding. The NSFR compares available funding with required funding, usingconstrained alongside destabilizing their deleveraging processes. weighting factors to reflect the stability of thecalls for additional capital. Accordingly, banks will be expected to funding available and the duration of the asset. reinforce their risk-based capital requirements Banks will need to increase the proportion with a backstop measure based on gross of wholesale deposits with maturities greater exposure to be incorporated into Pillar 1. than one year; this is likely to lead to higher This backstop measure is designed to funding costs. Stronger banks with a higher prevent the build-up of excessive leverage in NSFR will be able to influence the market the banking system. The implications are as price of assets, while weaker banks will see yet unclear, in particular as to how individual their competitiveness reduced. While this institutions will be impacted. It could lead to could be read as a description of one of the reduced lending or it could incentivize banks core objectives of Basel III, it also implies that to focus on high-risk/higher-return lending. competition may in fact decrease as a result. Ironically, this raises the wider issue of shadow banking. There have been a number of public Counterparty risk management comments notable from the FSB on this issue.  Significant strengthening of the framework for As banks deleverage it is likely that a public trading book and securitization risk has already policy response will follow that brings these been introduced as part of Basel 2.5 (JulyThese reforms are broken down into four key assets back within the scope of regulation.   2009). Basel III will introduce further changesproposals: to the treatment of exposure to financial– ncreasing the quality, consistency and I Short-term liquidity institutions and counter-party risk on derivative transparency of the capital base to ensure a As a result of the crisis, global regulators and exposures. In addition, the committee more resilient banking sector policymakers have realized that liquidity is will be imposing greater pressure to drive– mproving risk coverage of the capital I potentially as significant as solvency for the standardized derivative trading onto regulated framework to strengthen the resilience of stability of the financial system. The Basel exchanges. banks and minimizing the risk of shocks being Committee has strengthened its liquidity transmitted between financial institutions framework by developing new minimum Conclusion through complex transactions standards for funding liquidity: Basel III represents more than just another– upplementing capital requirements with a S set of regulatory requirements for financial leverage ratio to help contain concentration of – 30-day Liquidity Coverage Ratio (LCR) will A institutions across the globe. The policy too much leverage in the banking sector help ensure that banks have sufficient high- makers are trying to find a balance between– owering procyclicality and promoting L quality liquid assets to withstand a stressed financial stability and economic growth. countercyclical buffers that can be applied funding scenario specified by supervisors. For management, the proposals will have in stressed environments, contributing to a – ssets get a liquidity-based weighting A fundamental impacts on capital allocation, more stable banking system. varying from 100 percent for government pricing of products for customers and the bonds and cash, to weightings in the range wider business model and the returns toDevelopment of these new proposals has of 0 to 50 percent for corporate bonds. shareholders. Banks with a vision to excel inbeen continuing with extreme urgency and a post crisis world are taking action now toon a very tight timescale. Individual national Because the introduction of the LCR will address Basel III requirements, strengthenagencies in Europe along with the EU are require banks to hold significantly more their profit-making capacity and manage thecurrently in the process of translating the liquid, low-yielding assets, there will be new reality that Basel III will place on them.proposals into domestic legislation, even as a correspondingly negative impact oncore details on systemic risk are still evolving.profitability.Implementation is designed to begin in 2013 There is a debate about whether the liquid,and despite the fact that some fundamental low-yielding assets i.e. sovereign debt shouldissues are yet to be resolved, banks cannot attract a risk weight under the Basel III formula.  MORE INFORMATIONafford to be idle. Recommended areas for The irony is that this would reduce the amount Jitendra Sharmaaction include: of capital available to support credit origination Head of Global Financial Risk Management and the knock on impact on national and the KPMG in the USIncreased quality, consistency and global economy. The political reality of this is T: +1 212 872 7604transparency of the capital base that the ongoing debate between growth and E: jitendrasharma@kpmg.comBanks are expected to improve the consistency financial stability will continue. A further marketof their common equity component of Tier 1 development is the increasing use of covered José A. Baráybarcapital as regulatory adjustments will generally bonds to generate longer dated liquidity. Up Director, Financial Risk Managementbe applied to this component. Additionally, to a point this will be successful but at some KPMG in the USTier 2 capital is to be simplified and Tier time these instruments will absorb so many T: +1 617 988 56813 eliminated. The goal is to improve the good quality assets as collateral that the ability E: jbaraybar@kpmg.com © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG2012 / Frontiersno client services. 19 February International provides in Finance / No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 22. COLUMNSCUTTING THROUGH CONCEPTSA new recurring section which seeks to bringclarity around complex and often misunderstoodfinancial services concepts or issues.ExtraterritorialityBy Giles Williams and Kara Cauter “When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.” T he ability of words to change their meaning in response to social and environmental change is one of the main sources of the power and flexibility of language. At the same time, it can also lead to ambiguity and confusion. In specialized contexts such as the world of financial services, words and concepts can acquire particular significance; they can also be used in incorrect or contradictory ways. In this, the first of a series of regular columns, we take a look at a concept which is attracting increasing attention: extraterritoriality. Traditionally, the concept of extraterritoriality focused on an individual, an institution or a location being exempt from the legal jurisdiction which would generally apply to a particular location. A classic case is diplomatic immunity, where a diplomat serving his nation overseas is not liable to the legal framework of his host country but remains accountable to his native law. To give a comparatively trivial example, diplomatic missions and international organizations in the UK typically refuse to pay up to £500,000 in parking fines each year1. Extraterritoriality can also apply to physical locations: The headquarters of the United Nations in New York, and the International Court of Justice in the Hague enjoy extraterritorial status; the extraterritorial status of the US base at Guantánamo Bay is disputed by Cuba. However, although the core emphasis of the concept in this view is on removal from particular jurisdiction, this also implies the extension of some other jurisdiction outside its normal scope. This is the sense in which it is applied increasingly commonly in areas of international law. More correctly termed extraterritorial jurisdiction, it describes the efforts of national legislatures to impose their202012 KPMG International. KPMG International2012 cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © Frontiers in Finance / February is a Swissmember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 23. Contacts (from left) Giles Williams Kara Cauter Any state can, in principle, claim legal powers over persons or places external to it. However, the force of law depends in the end on two factors: the consent of those to whom it applies, and the ability of the legislature in question to impose its authority, by force if necessary.laws and regulations on governments and our US counterparts, hoping to find mutually impose the rules and those who are subjectcitizens outside their borders. convenient solutions.”2 to them. It is important that policymakers and In the financial services world, in the wake of – The chairman of the International Swaps legislators can find agreed routes throughthe financial crisis, the G20 has taken a strong and Derivatives Association said, “With these difficulties. If not, the world could retreatlead in promoting new systems of financial regard to extraterritoriality, there are today into self-interest, protectionism and regulatoryregulation. Leaders recognized that a single large and growing concerns regarding the arbitrage.set of global regulations would be impractical applicability of the Dodd-Frank Act outside For individual financial services firms,given differences in local market structures and the US. These concerns have been raised extraterritoriality brings a different setlegal frameworks. Instead the emphasis is on both by US and non-US entities. There is of complexities. It means that in somedeveloping agreed principles which individual a great deal of uncertainty among market jurisdictions they will find themselvesnational legislatures commit to incorporating participants about whether and how to complying with two sets of rules – home andwithin their domestic legal codes. implement a new regulatory framework that host. And it probably adds duplication. Much Nevertheless, the boundaries between might duplicate or conflict with that of their of the push for extraterritoriality reflects a lackdomestic and extraterritorial jurisdiction are parent country.”3 of confidence by home supervisors in thebecoming blurred, and there is an inevitable – Eight trade associations wrote to the effectiveness of the rules proposed in the hosttemptation for legislators to seek to impose European Commission and the US Treasury jurisdiction, so recognition of similar reportingtheir will beyond the national boundary. expressing concern that regulatory change and practices is limited.Such attempts can be seen in the European may create conditions that will lead toCommission’s increasing use of Regulations “fragmentation of markets, protectionismrather than Directives to legislate for member and regulatory arbitrage”.4 1. Hansard, HC Deb, 19 July 2011states’ behavior. These developments give rise – The European Commission has complained 2. Paulina Dejmek, speaking at the Association forto tricky issues of jurisdiction, legal competence to US Treasury Secretary Timothy Geithner Financial Markets in Europe’s annual post-trade conference in London 11 May 2011and national sovereignty. and to Commissioner of the IRS Doug 3. Thomson Reuters Dodd-Frank Watch, 26 October 2011 Any state can, in principle, claim legal Shulman about the “severe impact” 4. FX Week 11 Jul 2011powers over persons or places external to it. that FATCA will have in terms of costs 5. STEP Journal www.stepjournal.orgHowever, the force of law depends in the end of compliance and penalties in cases of 6. KPMG Canada 20 September 2011on two factors: the consent of those to whom non-compliance. The Commission alsoit applies, and the ability of the legislature in points out that FATCA may conflict withquestion to impose its authority, by force if EU member states’ internal data protectionnecessary. Hence the most powerful source laws.5 MORE INFORMATIONof contemporary extraterritorial ambition is the – Flaherty, Federal Minister of Finance in Jim Giles WilliamsUSA. The implications of legislation such as Canada has expressed concern both about Partner, Financial Servicesthe Dodd-Frank Act or FATCA are increasingly FATCA and about the “nerve-wracking” Regulatory Center of Excellence,controversial. Disputes over extraterritoriality effect that the Foreign Bank Account Report EMA regionhave the potential to disrupt progress towards a (FBAR) reporting rules have on Canadians, KPMG in the UKmore stable international financial structure. complaining that the US legislation would T: +44 20 7311 5354 Recent serious concerns which have been essentially cause Canadian banks to E: giles.williams@kpmg.co.ukraised include: become extensions of the IRS6. Kara Cauter– spokesperson for Michel Barnier, Internal A It may seem a rather technical concept. But Director, Financial Services Market and Services Commission at the extraterritoriality is actually at the heart of the Regulatory Center of Excellence, European Commission, said, “We are aware current debate about constructing a sounder, EMA region of the extraterritorial application of the Dodd- more consistent global framework for financial KPMG in the UK Frank Act; we are not happy with it and this services regulation. It gives rise to inevitable T: +44 20 7311 6150 is something we are discussing closely with tensions between those who seek to make and E: kara.cauter@kpmg.co.uk © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG2012 / Frontiersno client services. 21 February International provides in Finance / No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 24. FEATUREGLOBAL PERSPECTIVESInsurance:Finding growthopportunities inuncertain timesBy Frank Ellenbürger, Gary Reader, Laura Hay,Simon Donowho, and Mary Trussell © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 25. Transformational regulatory changes, national austerity measures on government provisions, and a challenging economic environment are all issues senior leaders of global insurers now face. It is a future complicated with different changes and pressures in different regions. How can insurance companies grow in this current environment? I nsurers worldwide face a range of challenges that may seem to threaten prospects for growth. But, as our global insurance leaders point out, change is often accompanied by opportunity. Companies who can adopt a strategic approach, with clear goals and a well-articulated vision of what success will look like, can secure a competitive advantage from the current uncertainty. Doing business in fraught and uncertain national, regional and global economies is not easy for anyone. Insurers in mature North American and European markets in particular face challenging economic conditions, disruptive regulatory changes, and cuts in public spending. These are significant challenges to growth. Historically, for example, there has been a high correlation between Gross Domestic Product and non-life insurance volumes. So a sustained period of zero or low economic growth will act as a major brake. Equally, the attractiveness of some products depends on the performance of the capital markets, which are under severe pressure. Depressed share prices and low price/ earnings ratios also mean that some market capitalizations of European and North American insurers are below book value. In these conditions attracting investment to fund growth plans is another challenge. If many European and North American economies are in well-publicized deficit, many Asian economies are in surplus. But this superficially benign condition throws up its own challenges for local insurers. In particular, these surpluses mean there is no large or well developed debt market and the lack of such long-term investment opportunities increases interest rate risk, complicates duration-matching – especially for products with a mortality risk – and constrains the insurance industry’s ability to create the innovative and attractive longer-term products that are increasingly in demand. However, some Asian and Latin American markets have the enormous advantage that economic growth, rising living standards, and the » February 2012 / Frontiers in Finance / No© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. 23member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 26. FEATURE So, while closeness to the customer and speed of innovation will be important, more than ever quality of management and consistency of execution will be vital to deliver profitable growth. The leading insurers of the future are likely to be those that integrate risk and performance management in an effective and timely fashion. We are in a period of sustained transformational change; and doing nothing is not a winning strategy. There are important lessons for Western insurers, especially those seeking to take advantage of growth opportunities in the East. In particular, strategies have to recognize that to win in Asia or other developing markets, insurers – wherever they originate – need detailed, hands-on local knowledge so they can identify which markets to target, how to approach them and, crucially, how to access distribution networks.242012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 27. Contacts (from left) Frank Ellenbürger Gary Reader Laura Hay Simon Donowho Mary Trussell» emergence of a financially more sophisticated, recognized that success lies in being nimble asset-rich middle class mean that insurers are and efficient: they decide on a target operating Keys to Growth for Insurers not competing for a share of a finite market. In model and then grow into it. For example, in today’s environment principle, everyone can grow in these dynamic, having identified IT as an important enabler emergent economies – if they have access to of growth, they are actively avoiding creating efficient and effective distribution channels. large infrastructures in each country in favor of With agency distribution dominant in Asia, shared services. the ability of insurers to attract existing agencies There are important lessons here for E ffective distribution channels, with a strong network is key. And, although Western insurers, especially those seeking to especially in Asian markets distribution deals with banks may appear take advantage of growth opportunities in the to be a fast-track route to the customer, in East. In particular, strategies have to recognize O perational efficiency and flexibility, practice most Asian markets have many more that to win in Asia, insurers – wherever they for example effective use of IT and insurers than banks. Consequently, the banks originate – need detailed, hands-on local shared services can command high rates of commission and knowledge so they can identify which markets tie-up fees. Overall, the successful growth to target, how to approach them and, crucially, L ocal knowledge of regulatory and strategies and business models in Asia are the how to access distribution networks. other trends in individual markets ones that are able to manage relationships with The extent of economic and social change distributors effectively. also requires insurers in all markets to pay more Product innovation based on a In Latin America, meanwhile, the trend attention than ever to the needs of customers. good understanding of changing towards banking distribution has driven In major Asian markets, populations are customer needs consolidation of the insurance industry over the becoming wealthier, more urbanized and more past few years. Future success is likely to be sophisticated in their approach to financial ffective post-MA integration E more dependent on innovation in products and services. Similarly, the growing wealth of Latin distribution channels. America is increasing consumption – so people Regulatory developments such as Solvency have more goods and properties to insure – II in Europe or the Solvency Modernisation and driving more conscious savings behavior. Initiative in the US are also transforming the way In Europe and North America, meanwhile, insurers operate – from capital requirements, to austerity measures are cutting into public risk management, to transparency of reporting provision of pensions, healthcare and welfare and provision of information, to distribution benefits, which will inevitably lead to increased arrangements and sales processes. Not only interest in self-provision. are these changes absorbing large amounts of The winners will be the ones who management time and energy, they are also understand these changes and offer the right threatening to introduce additional structural savings and protection products at the right focus on ‘core’ business. Given the regulatory costs. This places an intense focus on the time, crafting products that match people’s barriers to entry, MA may also be essential need for insurers – especially in Europe and requirements with their ability to pay. The for both Eastern and Western insurers to gain North America – to take active steps to review winners will also maintain close contact with sustainable access to high-growth Asian their business models, reduce their cost base customers, supporting people with appropriate markets. In North America, companies currently and become more efficient, for example by products at every stage of their life – from tend to be well-capitalized in relation to today’s investing in back office systems and moving savings, to life products to non-life products requirements, but the uncertainty around even further and more quickly towards shared – and pursuing conservation activity to track future requirements means they are perhaps services. funds as policies mature and go off-book. concentrating more on strategic, focused But this focus on efficiency is also an In this new world recruiting and retaining acquisitions than on some of the larger scale opportunity. There is no one-to-one correlation creative, energetic talent will be crucial. China deals of the past. However, leveraging financial between growth in revenues and growth in will need to attract back the skilled people, strength alone will not be enough to guarantee profitability. Anyone with experience trying to like actuaries, who are currently working on success. Effective post-MA integration will do business in India and China, for example, will European insurers’ Solvency II programs. be needed to ensure the fundamental goals testify to that. In the current climate, business European and North American insurers, for of efficiency, flexibility and low cost are not strategies and models have more than ever to their part, will have to address their inability compromised. focus in an integrated way on profit growth, to compete successfully for top talent with So, while closeness to the customer and rather than simply pursuing volumes for their superficially more glamorous industries like speed of innovation will be important, more than own sake. investment banking. ever quality of management and consistency For European and North American insurers Insurers in Europe and North America of execution will be vital to deliver profitable – and indeed those insurers in relatively mature whose business strategies are currently growth. The leading insurers of the future markets like Australia, Japan and Korea – the defensive and heavily focused on compliance are likely to be those that integrate risk and Asian and Latin American markets may seem will need to look beyond regulatory change to performance management in an effective and rich in opportunities for growth. But challenges identify the markets, customers, products and timely fashion. We are in a period of sustained remain. There is, for example, no ‘Asian’ business models that will deliver profitable transformational change; and doing nothing is market as such. There are instead a number growth in the face of increased global not a winning strategy. of different markets in different stages of competition. The recent investment by a state- economic and social development, each with owned Chinese reinsurer in Lloyd’s of London their own evolving regulatory challenges in is just a hint of the potential for Asian insurers MORE INFORMATION such areas as capital requirements, data privacy to leverage the strength of their domestic Frank Ellenbürger and customer protection. This complexity business by expanding into global markets. Global Sector Leader creates a massive potential burden for anyone MA may appear to be an attractive route Insurance attempting to create a pan-Asian business. to growth in Western markets – especially KPMG in Germany Regulatory change in these new markets can as banks sell off their insurance assets to T: +49 89 9282 1867 happen quickly and local insurers have already boost capital reserves and enable a tighter E: fellenbuerger@kpmg.com February 2012 / Frontiers in Finance / No © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. 25 member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 28. INSIGHTSPublicationsKPMG member firmsprovide a wide-rangingoffering of studies, analysesand insights on the financialservices industry. For moreinformation please go towww.kpmg.com/ New World for Insurance – Frontiers in Finance Supplement:frontiersinfinance Progress Report on Phase II November 2011 Defined contributions September 2011 pensions: A global solution to pension Following up on the New World for funding challenges Insurance publication that was launched Increasing life expectancy coupled with in March 2011, this update examines how a proportionately smaller working age far the International Accounting Standards population around the world is creating Board (IASB) and the Financial Accounting challenges for maintaining unfunded Standards Board (FASB) have come in social security and defined benefit (DB) addressing technical concerns with the pensions in many countries. insurance accounting proposals as well as providing a view on what might lie ahead. The Architecture of Integration: Monetizing mobile A guide to MA in Financial Services July 2011 September 2011 The era of mobile banking and A guide which focuses on strategic priorities payments is dawning. Around the that have been driving FS companies to world and across the banking value dispose and acquire while pinning down the chain, everyone is waking up to the key factors that can distinguish between huge potential of a market that is rapidly successful transactions from potential and changing the way that customers actual failures. It will help you understand interact with their financial institutions. what’s driving the new market, who the This report looks at how banks are buyers are now – and show you how to responding to this evolution and who avoid making the mistakes that have slowed we think will be winners. and derailed so many FS mergers and integrations during the past few years.262012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 29. FATCA and the funds industry: Wholesale Markets – The Agile Asset Manager:Defining the path under the spotlight Organizational strategies andJune 2011 October 2011 competencies to outmanoeuvreKPMG surveyed leading fund promoters in Following the financial crisis the US$600 the competition12 countries to look at the key challenges trillion global ‘Over The Counter’ (OTC) August 2011the industry needs to address as a derivatives market received widespread Why agility is becoming an increasinglymatter of urgency to prepare for FATCA criticism for its complexity and opacity critical competence and how agility canimplementations. - and as a result is facing a fundamental be created and deployed in developing industry shake up. Current proposals on and operationalising strategy. OTC derivatives will fundamentally change the marketplace. This report explores the key challenges and critical areas of focus for financial institutions. It also looks at how the industry should start to position itself ahead of final rules.RRPs – Insurers Evolving Banking Regulation Frontiers in taxAugust 2011 – the outlook for 2012 November 2011The financial services industry has December 2011 In the latest edition of frontiers in taxfaced much criticism and fallout from The journey to re-shape the banking sector KPMG’s Global Financial Servicesthe global financial crisis. Subsequent continues, in a time fraught with uncertainty. Tax practice focuses on some of thedebate and developments have focused The ever-expanding set of regulatory and many regulatory issues facing financialon the causes of the crisis and how to related reform initiatives at global, regional institutions today.avoid a recurrence in the future. This and national levels, pose substantialdiscussion paper highlights the need challenges for banks. Particularly whenfor the industry to be more engaged in combined with the European sovereign debtthe question of whether insurers are crisis which is in danger of creating instabilitysystemically important - and focuses and dragging down economic growth. Inon the application of recovery and the second edition of Evolving Bankingresolution planning for insurers. Regulation, KPMG’s Global Financial Services Regulatory Centres of Excellence, along with KPMG firms’ professionals, explore some of the key challenges and areas of focus for banks facing the implementation of the “first wave” of regulatory reforms and a new, “second wave” of reforms. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG2012 / Frontiersno client services. 27 February International provides in Finance / No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 30. INSIGHTSGlobal leadersJeremy Anderson Scott Marcello Simon GleaveGlobal Chairman, Financial Services Regional Coordinating Partner Joint Regional Coordinating PartnerRegional Coordinating Partner Financial Services Financial ServicesEMA region Americas region ASPAC regionKPMG in the UK KPMG in the US KPMG in ChinaT: +44 20 7311 5800 T: +1 212 954 6960 T: +86 10 8508 7007E: jeremy.anderson@kpmg.co.uk E: smarcello@kpmg.com E: simon.gleave@kpmg.comWm. David Seymour David Sayer Michael ConoverGlobal Sector Leader Global Sector Leader Global Sector LeaderInvestment Management Retail Banking Capital MarketsKPMG in the US KPMG in the UK KPMG in the UST: +1 212 872 5988 T: +44 20 7311 5404 T: +1 212 872 6402E: dseymour@kpmg.com E: david.sayer@kpmg.co.uk E: mconover@kpmg.comFrank Ellenbürger Hugh von BergenGlobal Sector Leader Global Head of TaxInsurance Financial ServicesKPMG in Germany KPMG in the UKT: +49 89 9282 1867 T: +44 20 7311 5570E: fellenbuerger@kpmg.com E: hugh.von.bergen@kpmg.co.uk282012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 31. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  • 32. Missed an issueof Frontiers in Finance?Back issues are available to download from:www.kpmg.com/frontiersinfinanceThe information contained herein is of a general nature and is not intended to address the circumstances of any particular individualor entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such informationis accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such informationwithout appropriate professional advice after a thorough examination of the particular situation.© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independentfirms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority toobligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any suchauthority to obligate or bind any member firm. All rights reserved. Printed in the United Kingdom.The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.Produced by KPMG’s Global Financial Services PracticeDesigned by Mytton WilliamsPublication name: Frontiers in FinancePublication number: 120182Publication date: February 2012Printed on recycled material

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