Monday November 5 2012 - Top 10 Risk Management News

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Monday November 5 2012 - Top 10 Risk Management News

  1. 1. Page |1 International Association of Risk and Compliance Professionals (IARCP) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the weeks agenda, and what is nextDear Member,Year after year, new laws and regulationsrequire firms to undertake a forward-lookingself-assessment of risks, correspondingcapital requirements, and adequacy ofcapital resources.Year after year, it becomes critical to look into the future, to understandwhat is next. Which is the new law, regulation or development? Which arethe challenges and the opportunities for firms and organizations? Howwill these changes affect the competitive position of existing and newcapital warriors in the markets?There is a great window to look into the future: The excellentforward-looking papers of the Group of Thirty.The Group of ThirtyThe Group of Thirty is a private, nonprofit, international body composedof very senior representatives of the private and public sectors andacademia.The Group aims to deepen understanding of international economic andfinancial issues, to explore the international repercussions of decisionstaken in the public and private sectors, and to examine the choicesavailable to market practitioners and policymakers. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  2. 2. Page |2Members _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  3. 3. Page |3 _____________________________________________________________International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  4. 4. Page |4Emeritus Members _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  5. 5. Page |5Welcome to the Top 10 list. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  6. 6. Page |6TowardEffective Governance of Financial InstitutionsWeak and ineffective governance of systemically important financialinstitutions (SIFIs) has been widely cited as an important contributoryfactor in the massive failure of financial sector decision making that led tothe global financial crisis.Statement on Public Meeting OnAuditor Independence and AuditFirm RotationSPEAKER: James R. Doty, ChairmanEVENT: PCAOB Public MeetingLOCATION: Houston, TXBIS, A framework for dealing withdomestic systemically importantbanksThe Basel Committee on BankingSupervision (the Committee) issued therules text on the assessment methodologyfor global systemically important banks(G-SIBs) and their additional lossabsorbency requirements in November2011. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  7. 7. Page |7Mario Draghi: Openingstatement at DeutscherBundestagSpeech by Mr Mario Draghi,President of the European CentralBank, at the discussion onECB policies with Members ofParliament, BerlinAndreas Dombret: As goesIreland, so goes Europe?Speech by Dr Andreas Dombret,Member of the Executive Board of theDeutscheBundesbank, at the Institute ofInternational and European Affairs,DublinCIMA Hosts Risk Management and Internal Controls SeminarThe Cayman Islands Monetary Authority (CIMA)hosts a seminar on Risk Management and InternalControls. The event, which is scheduled for 29October to 2 November at the Grand CaymanMarriott Beach Resort _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  8. 8. Page |8Goldman Sachs GroupInteresting numbers before the Basel IIIdeadlinesThe Goldman Sachs Group, Inc. (NYSE: GS)reported net revenues of $8.35 billion and net earnings of $1.51 billion forthe third quarter ended September 30, 2012.Bermuda’s Insurance SolvencyFrameworkThe Roadmap to RegulatoryEquivalencePlanned 2012/2013 DevelopmentsMervyn King: Monetary policy developmentsSpeech by Mr Mervyn King, Governor of the Bank ofEngland, to the South Wales Chamberof Commerce, Cardiff, 23 October 2012. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  9. 9. Page |9Erkki Liikanen: On the structural reforms ofbanking after the crisisSpeech by Mr Erkki Liikanen, Governor of the Bank ofFinland and Chairman of the HighlevelExpert Group on reforming the structure of the EUbanking sector, at the Centre forEuropean Policy Studies, Brussels, 23 October 2012.Progress note on the Global LEIInitiativeThis is the third of a series of notes onthe implementation of the legal entity identifier (LEI) initiative.Following endorsement of the FSB report and recommendations by theG-20, the FSB LEI Implementation Group (IG) has been tasked withtaking forward the planning and development work to launch the globalLEI system by March 2013. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  10. 10. P a g e | 10TowardEffective Governance of Financial InstitutionsImportant PartsWeak and ineffective governance of systemically important financialinstitutions (SIFIs) has been widely cited as an important contributoryfactor in the massive failure of financial sector decision making that led tothe global financial crisis.In the wake of the crisis, financial institution (FI) governance was toooften revealed as a set of arrangements that approved risky strategies(which often produced unprecedented short-term profits andremuneration), was blind to the looming dangers on the balance sheetand in the global economy, and therefore failed to safeguard the FI, itscustomers and shareholders, and society at large.Management teams, boards of directors, regulators and supervisors, andshareholders all failed, in their respective roles, to prudently govern andoversee.On the subject of governance as it applies to FIs, much has been writtenand said in the past few years.Notable among these statements are the 2009 Walker report (A Review ofCorporate Governance in UK Banks and other Financial IndustryEntities) and the Basel Committee’s Principles for Enhancing CorporateGovernance (2010).Many domestic regulators and stock exchanges have also weighed in withnew requirements and guidelines for governance.The Group of Thirty (G30) applauds these prior initiatives and supportsnot only the spirit of their conclusions but also many of the detailedrecommendations they contain. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  11. 11. P a g e | 11The combination of these reports, self scrutiny by the firms themselves,and pressure from regulatory overseers has already yielded substantialchanges in governance practice across the financial services industry andaround the globe.Why would the G30 wish to add its own voice to the body of work alreadyavailable, in light of progress being made?First, no one should presume that FI governance is now fixed.It is true that boards are working harder; supervisors are asking toughquestions and preparing for more intensive oversight; managementhas become much more attuned to risk management and to supportingthe oversight responsibilities of the board; and shareholders, to somedegree, are taking a deeper look into their role in promoting effectivegovernance.Nevertheless, as this report highlights, highly functional governancesystems take significant time and sustained effort to establish and hone,and the G30’s input can help with that effort.Second, in a modern economy, business leadership represents a largeconcentration of power.The social externalities associated with the business of significantfinancial institutions give that power a major additional dimension andunderscore the critical importance of good corporate governance of suchentities.Third, we note that the prior reports and guidance almost always comefrom a national or regional perspective (the Basel Committee report beinga notable exception), which is understandable as a practical matter, butcurious given the distinctly global nature of the SIFIs, which areappropriately the focus of attention.Accordingly, in late spring of 2011, the G30 launched a project on thegovernance of major financial institutions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  12. 12. P a g e | 12The project was led by a Steering Committee chaired by Roger W.Ferguson, Jr., with John G. Heimann, William R. Rhodes, and Sir DavidWalker as its vice-chairmen.They were supported by 11 other G30 members, who participated in aninformal working group.Requests for interviews went out from the G30 to the chairs of 41 of theworld’s largest, most complex financial institutions— banks, insurancecompanies, and securities firms.In an extraordinary response, especially in light of the pressures on eachof these companies, 36 institutions shared their perspectives andexperiences through detailed discussions with board leaders, CEOs, andselected senior management leaders.In addition, the project team held discussions with a global cross sectionof FI regulators and supervisors.The majority of these interviews were conducted in person, all under theChatham House Rule,which encourages candor.The report is the responsibility of the G30 Steering Committee andWorking Group and reflects broad areas of agreement among theparticipating G30 members, who took part in their individual capacities.All G30 members (aside from those with current national officialresponsibilities) have had the opportunity to review and discusspreliminary drafts.The report does not reflect the official views of those in policy-makingpositions or leadership roles in the private sector.The report is wide-ranging in its coverage of the composition andfunctioning of FI boards and the roles of regulators, supervisors, andshareholders. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  13. 13. P a g e | 13The focus is on potentially universal core themes but acknowledgesdifferences in customs and practice in different parts of the world.As regards approaches to total compensation, we do not address thissubject in detail in this report; the G30 commends the Financial StabilityBoard’s Principles for Sound Compensation Practices and fully supportstheir implementation.The G30 undertook its initiative on effective FI governance in the hopeand expectation that FI board and senior management leaders couldshare actionable wisdom on the essence of effective governance and whatit takes to build and nurture governance systems that work.We hope this report provides a measure of insight and sustenance tothose with policymaking and operational responsibilities for effectivegovernance in the world’s great financial institutions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  14. 14. P a g e | 14Executive SummaryWhat is meant by “governance” in the context of a financial institution(FI)?Corporate governance is traditionally defined as the system by whichcompanies are directed and controlled.The OECD Principles of Corporate Governance (2004) defines corporategovernance as involving “a set of relationships between a company’smanagement, its board, its shareholders and other stakeholders.Corporate governance also provides the structure through which theobjectives of the company are set, and the means of attaining thoseobjectives and monitoring performance are determined.”In the case of financial institutions, chief among the other stakeholdersare supervisors and regulators charged with ensuring safety, soundness,and ethical operation of the financial system for the public good.They have a major stake in, and can make an important contribution to,effective governance.Good corporate governance requires checks and balances on the powerand rights accorded to shareholders, stakeholders, and society overall.Without checks, we see the behaviors that lead to disaster.But governance is not a fixed set of guidelines and procedures; rather, it isan ongoing process by which the choices and decisions of FIs arescrutinized, management and oversight are strengthened andstreamlined, appropriate cultures are established and reinforced, and FIleaders are supported and assessed.Why governance mattersThe global economic crisis, with the financial services sector at its center,wreaked economic chaos and imposed enormous costs on society. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  15. 15. P a g e | 15The depth, breadth, speed, and impact of the crisis caught many FImanagement teams and boards of directors by surprise and stunnedcentral banks, FI regulators, supervisors, and shareholders.[Note: We attempt throughout the report to distinguish the regulatoryfunction from the supervisory function.The regulator sets the rules and regulations within which FIs are obligedto operate, while the supervisor oversees the actions of the board andmanagement to ensure compliance with those rules and regulations.Confusion arises because both functions are often performed within thesame institution (for example, the U.S. Federal Reserve and the UKFinancial Services Authority).]Enormous thought and debate has gone into discovering what caused theglobal financial crisis and how to avoid another.In his much-quoted 2009 report on the causes of the crisis, Lord AdairTurner, chair of the UK’s Financial Services Authority (FSA), cited sevenproximate causes:(1) Large, global macroeconomic imbalances;(2) An increase in commercial banks’ involvement in risky tradingactivities;(3) Growth in securitized credit;(4) Increased leverage;(5) Failure of banks to manage financial risks;(6) Inadequate capital buffers; and(7) A misplaced reliance on complex math and credit ratings in assessingrisk. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  16. 16. P a g e | 16A critical subtext to these seven causes is a pervasive failure ofgovernance at all levels.More generally, most observers have agreed that a combination of “lighttouch” supervision, which relied too heavily on self-governance infinancial firms, and weak corporate governance and risk management atmany systemically important financial institutions (SIFIs) contributed tothe 2008 meltdown in the United States.In several key markets, deregulation and market-based supervision werethe political order of the day as countries vied for global capital flows,corporate headquarters, and exchange listings.Regulators also missed the potential systemic impact of entire classes offinancial products, such as subprime mortgages, and in general failed tospot the large systemic risks that had been growing during the previoustwo decades.In this context, boards of directors failed to grasp the risks theirinstitutions had taken on.They did not understand their vulnerability to major shocks, or they failedto act with appropriate prudence.Management, whose decisions and actions determine the organization’srisk status, clearly failed to understand and control risks.In many cases, spurred on by shareholders, both management and theboard focused on performance to the detriment of prudence.Effective governance is a necessary complement to rules-basedregulation.The system needs both.Carefully crafted rules-based regulations concerning capital, liquidity,permitted business activities, and so forth are essential safeguards for the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  17. 17. P a g e | 17financial system, while effective governance shapes, monitors, andcontrols what actually happens in FIs.Ineffective governance at financial institutions was not the solecontributor to the global financial crisis, but it was often an accomplice inthe context of massive macroeconomic vulnerability.Effective governance can make a significant positive difference byhelping to prevent future crises or by mitigating their deleterious impact.In other words, the rewards for investment in effective governance aregreat.A call to actionEach of the four participants in the governance system—boards ofdirectors, management, supervisors, and (to an extent) long-termshareholders— needs to reassess their approach to FI governanceand take meaningful steps to make governance stronger.This report offers a comprehensive set of concrete insights andrecommendations for what each participant needs to do to make FIgovernance function more effectively.The G30 is acutely aware that the agendas of FI boards and supervisorsare crowded, yet we urge them to continue to give effective governanceone of their highest priorities.‹. The financial sector needs better methods of assessing governance andof cultivating the behaviors and approaches that make governancesystems work well.Board self-evaluation, especially when facilitated or led by an outsideexpert, can yield important insight, but it is sobering to consider that in2007, most boards would likely have given themselves passing grades.‹. Supervisors now aspire to understand governance effectiveness andvulnerabilities, but admit to having much to learn. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  18. 18. P a g e | 18‹. Governance experts often describe what good governance looks like,but give little thought to how to measure or achieve high-performanceresults.Given the role that inadequate governance played in the massive failure offinancial sector decision making that led to the global financial crisis, it isnatural that supervisors and stock exchanges are now paying greatattention to governance arrangements.This attention, as a practical matter, often focuses on explicit rules,structures, and processes—best practices—that governance experts oftenbelieve are indicative of effective governance.Consequently, compliance with best practice guidelines has become veryimportant to boards and to overseers charged with monitoring andencouraging good governance.The G30 hopes this report will contribute meaningfully to the body ofknowledge on governance and will be a useful tool for those tasked withshaping governance systems.The boardBoards of directors play the pivotal role in FI governance through theircontrol of the three factors that ultimately determine the success of the FI:the choice of strategy; the assessment of risk taking; and the assurancethat the necessary talent is in place, starting with the CEO, to implementthe agreed strategy.The 2008–2009 financial crisis revealed that management at certain FIs,with the knowledge and approval of their boards, took decisions andactions that led to terrible outcomes for employees, customers,shareholders, and the wider economy.What should the boards have done differently?To answer that question, it is helpful to consider the mandate of boards. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  19. 19. P a g e | 19Boards control the three key factors that ultimately determine the successof an FI:1. The choice of business model (strategy)2. The risk profile, and3. The choice of CEO—and by extension the quality of thetop-management team.Boards that permit their time and attention to be diverteddisproportionately into compliance and advisory activities at the expenseof strategy, risk, and talent issues are making a critical mistake.Above all else, boards must take every step possible to protect againstpotentially fatal risks.FI boards in every country must take a long-term view that encourageslong-term value creation in the shareholders’ interests, elevates prudencewithout diminishing the importance of innovation, reduces short-termself-interest as a motivator, brings into the foreground the firm’sdependence on its pool of talent, and demands the firm play a palpablypositive role in society.The importance of mature, open leadership by a skillful board chaircannot be overemphasized.Effective chairs capitalize on the wisdom and advice of board membersand management leaders and on the board’s interactions with supervisorsand shareholders, individually and collectively.Good chairs respect each of these vital constituents, preside, encouragedebate, and do not manage toward a predetermined outcome.Risk governanceThose accountable for key risk policies in FIs, on the board and withinmanagement, have to be sufficiently empowered to put the brakes on thefirm’s risk taking, but they also play a critical role in enabling the firm to _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  20. 20. P a g e | 20conduct well-measured, profitable risk-taking activities that support thefirm’s long-term sustainable success.In the financial services sector more than in other industries, riskgovernance is of paramount importance to the stability and profitability ofthe enterprise.Without an ability to properly understand, measure, manage, price, andmitigate risk, FIs are destined to underperform or fail.Effective risk governance requires a dedicated set of risk leaders in theboardroom and executive suite, as well as robust and appropriate riskframeworks, systems, and processes.The history of financial crises, including the 2008–2009 crisis, is litteredwith firms that collapsed or were taken to the brink by a failure of riskgovernance.The most recent financial crisis demonstrated the inability of many FIs toaccurately gauge, understand, and manage their risks.Firms greatly understated their inherent risks, particularly correlationsacross their businesses, and were woefully unprepared for the exogenousrisks that unfolded during the crisis and afterward.ManagementManagement needs to play a continuous proactive role in the overallgovernance process, upward to the board and downward through theorganization.The vast majority of governance and control processes are embedded inthe organizational fabric, which is woven and maintained bymanagement.The board is dependent on management for information and fortranslating sometimes highly technical information into issues andchoices requiring business judgment. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  21. 21. P a g e | 21Governance cannot be effective without major continuing input frommanagement in identifying the big issues and presenting them fordiscussion with the board.Management needs to strengthen the fabric of checks and balances in theorganization.It must deepen its respect for the vital roles of the board and supervisorsand help them to do their jobs well.It must reinforce the values that drive good behavior through theorganization and build a culture that respects risk while encouraginginnovation.SupervisorsSupervisors that more fully comprehend FI strategies, risk appetite andprofile, culture, and governance effectiveness will be better able to makethe key judgments their mandate requires.Supervisors have legally defined responsibilities relating to risk control;fraud control; and conformance to laws, regulations, and standards ofconduct.Supervisors now seek a deeper and more nuanced understanding of howthe board works, how key decisions are reached, and the nature of thedebate around them, all of which reveal much about the firm’sgovernance.Most FI boards applaud this expansion in the supervisors’ focus fromcontrol process details to include a broader grasp of issues and context.To be effective, however, this expansion requires regular interactionamong senior people in supervisory agencies and boards and boardmembers.Supervisors need to broaden their perspectives to include FI strategy,people, and culture. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  22. 22. P a g e | 22They should focus their discussions with senior management andthe board on the real issues—through both formal and informalcommunications.But they must also maintain their independence and accept that they willat best have an incomplete picture.Similarly, supervisors must not try to do the board’s job or so overwhelmthe board and management that they cannot guide the FI.Supervisors have a unique perspective on emerging systemic,macroprudential risks and can compare and contrast one FI with others.This is vital information to develop and share.Unfortunately, in the policy-making debate, the qualitative aspect ofsupervision is sometimes overshadowed by quantitative, rules-basedregulatory requirements.Clearly, new capital, liquidity, and related standards are essential to amore stable global financial architecture, but enhanced oversight of theperformance and decision-making processes of major FIs is alsoessential. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  23. 23. P a g e | 23Statement on Public Meeting OnAuditor Independence and AuditFirm RotationSPEAKER: James R. Doty, ChairmanEVENT: PCAOB Public MeetingLOCATION: Houston, TXWelcome everyone to the Public Company Accounting Oversight Boardsthird public meeting on the Boards concept release on ways to enhanceauditor independence.I want to thank Rice University and Dean Bill Glick for providing such aninspiring venue for this meeting.We have assembled an august set of panelists today to assist the Board inan in-depth examination of an issue that continues to trouble many of themost thoughtful supporters of the audit profession — the subtle (and notso subtle) influences on the auditors mindset, and the implication for theintegrity of the audit.Enhancing auditor independence was one of the main goals of theSarbanes-Oxley Act of 2002. We have one of the draftsmen of that Actseated to my left at the table.In the weeks and months leading up to the enactment of Sarbanes-Oxley,Congress considered requiring audit firm rotation to improve auditorindependence.But the final statute as enacted stepped back. Instead, it provided forpartner rotation on public company audits. In addition, it asked forfurther study of firm rotation.Shortly thereafter, in 2003, the Government Accountability Officeembarked on a review of the arguments for and against audit firm _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  24. 24. P a g e | 24rotation. The review was preliminary in light of other Sarbanes-Oxleyreforms that were only beginning to be implemented.Thus it concluded that the SEC and the Board would need several yearsto evaluate whether the Sarbanes-Oxley reforms, including audit partnerrotation, were sufficient, or whether further independence measures arenecessary to protect investors.We are fortunate to have on the PCAOB board one of the drafters of theGAO report to help us put it in context.Since then, the financial crisis of 2008 has caused us as a nation to reflecton how dependent our financial system is on high quality, unbiasedaudits.It has prompted us to look again at auditor independence, objectivity andprofessional skepticism, and to ask whether features of our financialsystem have allowed companies to become too close to their auditors.And to consider whether there are ways we can improve the reliability andusefulness of audit reports to the public.We are not alone in this inquiry. Many other countries have commencedtheir own reviews of audit practices.We are fortunate to be able to hear from a representative of the EuropeanCommission later today about potential reforms that are currently underconsideration in Europe.Just last month, the United Kingdom published a regulation that wouldentail mandatory retendering every ten years for FTSE 350 companies,with corresponding disclosure requirements.I dont mean to exclude other important actions in other countries. Thereare many. The U.K.s is just the most recent.Given the breadth of the international debate, it is not surprising thatpeople disagree on what the best reforms will be, or how to implement _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  25. 25. P a g e | 25them, or indeed whether reform is necessary. Or whether the costs tothose who would incur them outweigh the benefits to those who wouldreceive them.I hear no doubt in any corner, however, about the importance ofindependent audits.Let me say that I believe it is the rare case in which an auditor knowinglycompromises his or her integrity. But well-intentioned auditors, as withother people, sometimes fail to recognize and guard against their ownunconscious biases.We are nearly ten years from the adoption of Sarbanes-Oxley, duringwhich we have had time to observe whether its reforms were sufficient.Against this historical background, in August 2011, the PCAOB issued aconcept release, seeking public comment on a variety of questions abouthow to improve auditor independence, objectivity and professionalskepticism.The concept release notes the importance of auditor independence to theviability of auditing as a profession and highlights the risk toindependence arising from the "client-pays" model.As noted in the concept release, the PCAOB inspectors continue to findwhat is to me an unacceptable level of deficient audits.In addition, inspectors continue to find troubling suggestions of firmsshowing willingness to put managements short-term interest ahead ofinvestors.The concept release seeks public comment on ways that auditorindependence, objectivity and professional skepticism can be enhanced.In this regard, the release notes that there may be risks to professionalskepticism in both the relatively new audit that the auditor may hope toturn into a long-term engagement, as well as the very long engagementthat no partner wants to be the one to lose. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  26. 26. P a g e | 26We have received more than 600 comment letters, primarily from auditorsand their clients. On the whole, they counsel for more time and study, andmore modest reforms.To be sure, I want to be cautious in making any decisions, and that is whyI have asked for meetings like this and two previous meetings inWashington, D.C., and San Francisco.We have the benefit of the record of our first two meetings. Therefore,although todays panelists have been invited to provide views on any ofthe issues raised in the Boards concept release, they have also been askedto comment specifically on certain themes, issues and suggestions fromthe prior public meetings.I want to thank the panelists, my fellow board members, the SECsDeputy Chief Accountant Brian Croteau who has joined us today, and thePCAOB staff who have made the meeting possible. I look forward to athoughtful discussion that will help the Board advance its inquiry. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  27. 27. P a g e | 27Statement on Public Meeting On Auditor Independence andAudit Firm RotationSPEAKER: Jeanette M. Franzel, Board MemberEVENT: PCAOB Public MeetingLOCATION: Houston, TXThank you, Chairman Doty, for calling this public meeting to furtherexplore some of the principal themes that have emerged in the feedbackthat the Board has received in response to the PCAOB Concept Releaseon Auditor Independence and Audit Firm Rotation issued in August oflast year.The Board has received more than 670 comment letters and heard from 77speakers on this topic to date.Throughout this process, the Board has received rich feedback on thecomplex issues that impact auditor independence and audit quality, aswell as a range of suggestions for potential actions that could be taken.Commenters have acknowledged the fundamental importance of auditorindependence as the underpinning of confidence in the auditingprofession.They also expressed support for the Boards efforts to ensure or enhancethe auditors independence, objectivity, and professional skepticism,although suggestions for how this might be achieved varied widely.The concept release and our related public meetings are creating asubstantive debate among the full range of stakeholders.It is certainly public knowledge that the majority of the commenters onthis issuer were opposed to a requirement for mandatory audit firmrotation for a variety of reasons.We are currently conducting analyses of the feedback we have received,as well as additional research by the PCAOB and others. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  28. 28. P a g e | 28Today we will explore a number of major themes in the comment lettersand panelist feedback, including the following suggestions:- strengthening audit committees, including enhancing their financial expertise, increasing their independence from management, and enhancing and increasing interaction and communications with investors, auditors, and the PCAOB;- increasing emphasis on professional skepticism in standards and education for auditors, as well as in the firms culture and systems of quality control.- increasing the transparency surrounding PCAOB inspection results, as well as making public the PCAOBs enforcement investigations and proceedings;- expanding PCAOB inspections in certain circumstances;- increasing the root cause analyses by the PCAOB and the firms on the causes of audit deficiencies;- using mandatory "retendering" of the audit and/or a formal re-evaluation of the auditors tenure at given intervals;- exploring variations on the possible use of firm rotation, including limiting any potential rotation requirement to certain audits and certain circumstances; and- potentially further restricting the provision of non-audit services by the auditor.I am personally committed to exploring the broad range of themes andissues that influence auditor independence, objectivity, and professionalskepticism, as well as audit quality, and advancing the Boards efforts toprotect investors and the public interest through high quality,independent audits. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  29. 29. P a g e | 29Any methods for improving auditor independence and audit quality wontbe simple, and there will not be a "silver bullet."Today, we will be hearing from a new group of highly qualified panelists.I am interested in their views on the different challenges to achievingindependence, objectivity, and professional skepticism and the variety ofpotential actions that could be taken to help improve auditorindependence and audit quality.I believe that we need concerted and sustained action from the full rangeof parties who have responsibility for these issues, including thoseresponsible for accounting education, audit firm recruitment andtraining, audit firm culture and tone at the top, audit committee andboard oversight, as well as PCAOB inspections and other regulatoryactivities.It is paramount, of course, that all of the parties with responsibilitythroughout the process keep the interests of investors front and center.One of the major themes that has emerged during the Boards efforts onauditor independence is a consensus on the importance of auditcommittees in overseeing the auditor and the audit process.PCAOB does not have regulatory jurisdiction over audit committees.But we should not overlook the tremendous value in coordinating andleveraging our efforts; avoiding duplication and/or fragmentation; andproviding for a seamless system of effective governance and auditoversight.During our outreach, PCAOB received feedback on ways that auditcommittee performance can be enhanced. Im pleased that we have anumber of audit committee members and corporate governance expertshere today to explore these issues.Another theme emerging from the input that the Board has received isthat professional skepticism should be emphasized more in the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  30. 30. P a g e | 30education, training, and standard-setting for auditors, as well as in thefirms cultures, tone at the top, and systems of quality control.Im pleased that we have a number of academicians and practitionershere today to further explore these issues with us.I am also very interested in the views of the investors and others heretoday on these and other issues impacting auditor independence, auditquality, and investor protection.I believe investors will be well-served if the various organizations andgroups charged with protecting investors, the public interest, and theintegrity of the U.S. capital markets work together effectively to achievethese goals.The bottom line here is that we must come up with a package of actionsthat will be solid and effective in protecting investors and the publicinterest through independent, high quality financial audits.We also need to carefully consider and analyze the potential costs andbenefits of various actions, as well as the risks associated with unintendedconsequences, so that we are effective in protecting the interests ofinvestors and furthering the public interest in the preparation ofinformative, accurate, and independent audit reports.I want to thank all of the panelists, their staff, and their constituencies, fortaking the time and effort to assist us in exploring these very importantissues. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  31. 31. P a g e | 31Statement on Public Meeting On Auditor Independence andAudit Firm RotationSPEAKER: Jay D. Hanson, Board MemberEVENT: PCAOB Public MeetingLOCATION: Houston, TXGood morning,I would like to join Chairman Doty and my fellow Board members inwelcoming todays panelists and to thank the Rice University communityfor their warm welcome.I would also like to thank the PCAOB staff for their hard work in gettingall of us into this room together to discuss auditor independence,objectivity and skepticism, which, without a doubt, is one of the mostfundamental elements in the performance of robust audits and key toserving the needs of investors.Fourteen months ago, we issued a concept release with the goal ofgathering information and framing a discussion about whether the Boardshould take any steps to enhance auditor independence, objectivity andskepticism.Since then, we have received almost 700 comment letters and have heardfrom dozens of panelists.Commenters overwhelmingly support the Boards efforts to enhanceauditor independence, objectivity and skepticism, but there are widelyvarying views on how to accomplish that goal.Most commenters oppose mandatory rotation and express concern thatauditor rotation will actually decrease audit quality.From this group, we have heard some suggestions for ways to enhanceauditor rotation, including an enhanced focus by audit committees, jointaudits, mandatory re-tendering, tenure protection for auditors, non-auditservice restrictions, increased PCAOB inspections and/or transparencyabout our inspections, and several others. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  32. 32. P a g e | 32Some commenters, on the other hand, believe that auditor rotation is theonly way to overcome what some describe as an inherent conflict betweenindependence and the fact that auditors are paid by the companies theyaudit.Thus, we have received a lot of input, and we have much to think about.There are a few areas, however, where I believe we would benefit frommore information, and I would like to encourage todays panelists, andany other potential commenters, to consider whether they can help us fillin these gaps.For example, it has proven difficult to establish a clear correlationbetween audit quality and auditor tenure.I know some of you may address that issue today, and I look forward tohearing your views on this subject. I look forward to hearing views on howpanelists define audit quality.To date, we also have not delved deeply into the details and implicationsof all the potential ways to enhance auditor independence that have beensuggested.In order to fully understand all possible approaches, and to determinehow to evaluate various alternatives, I believe it is important that we doso.I look forward to hearing from those of you who plan to share with usviews on approaches other than rotation that could enhance both auditorindependence and audit quality.To the extent companies, auditors or audit committees have tried anyapproaches to enhance auditor independence, I encourage you to shareyour experiences with us, both in terms of benefits and costs.Finally, I have spoken a number of times on the key role played by auditcommittees. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  33. 33. P a g e | 33In my experience as an auditor, I saw a transformation in auditcommittee behavior and focus after implementation of the requirementsof the Sarbanes-Oxley Act.We have heard from many audit committee members who described ingreat detail their extensive efforts to evaluate and ensure their auditorsindependence.Yet, some believe that even the most diligent audit committees cannotsufficiently monitor auditor independence.One question I frequently ask myself is what we can do to help auditcommittees do a better job in this regard.In August, the Board issued a new auditing standard on communicationswith audit committees.It is my hope that by arming audit committees with more informationabout the audit, including audit risks, significant or difficult accountingissues, significant unusual transactions, and other important matters,those committees can provide better oversight over the entirety of theaudit process, including evaluating whether the auditor is approachingdifficult issues with an appropriate degree of skepticism.Likewise, we recently issued a release to provide audit committees withmore information about PCAOB inspections and related topics that auditcommittees may wish to discuss with their auditor.This too, I trust, will assist audit committees in better evaluating theirauditors in a variety of important areas, including competence, diligenceand independence.Although the Board does not have the authority to regulate auditcommittees, we are willing to help them however we can.I am particularly interested in your views — and those of othercommenters who may not yet have participated in this dialog — as towhat else this Board can do to enhance the ability of audit committees to _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  34. 34. P a g e | 34ensure that their auditors are appropriately meeting all of theirobligations.Thank you again for taking time out of your busy schedules to be with ustoday, and I look forward to your comments. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  35. 35. P a g e | 35BIS, A framework for dealing withdomestic systemically importantbanksI. Introduction1. The Basel Committee on BankingSupervision (the Committee) issued therules text on the assessment methodologyfor global systemically important banks(G-SIBs) and their additional lossabsorbency requirements in November2011.The G-SIB rules text was endorsed by the G20 Leaders at their November2011 meeting.The G20 Leaders also asked the Committee and the Financial StabilityBoard to work on modalities to extend expeditiously the G-SIFIframework to domestic systemically important banks (D-SIBs).2. The rationale for adopting additional policy measures for G-SIBs wasbased on the “negative externalities” (ie adverse side effects) created bysystemically important banks which current regulatory policies do notfully address.In maximising their private benefits, individual financial institutions mayrationally choose outcomes that, from a system-wide level, aresub-optimal because they do not take into account these externalities.These negative externalities include the impact of the failure orimpairment of large, interconnected global financial institutions that cansend shocks through the financial system which, in turn, can harm thereal economy. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  36. 36. P a g e | 36Moreover, the moral hazard costs associated with direct support andimplicit government guarantees may amplify risk-taking, reduce marketdiscipline, create competitive distortions, and further increase theprobability of distress in the future.As a result, the costs associated with moral hazard add to any direct costsof support that may be borne by taxpayers.3. The additional requirement applied to G-SIBs, which applies over andabove the Basel III requirements that are being introduced for allinternationally-active banks, is intended to limit these cross-bordernegative externalities on the global financial system and economyassociated with the most globally systemic banking institutions.But similar externalities can apply at a domestic level.There are many banks that are not significant from an internationalperspective, but nevertheless could have an important impact on theirdomestic financial system and economy compared to non-systemicinstitutions.Some of these banks may have cross-border externalities, even if theeffects are not global in nature. Similar to the case of G-SIBs, it wasconsidered appropriate to review ways to address the externalities posedby D-SIBs.4. A D-SIB framework is best understood as taking the complementaryperspective to the G-SIB regime by focusing on the impact that thedistress or failure of banks (including by international banks) will have onthe domestic economy.As such, it is based on the assessment conducted by the local authorities,who are best placed to evaluate the impact of failure on the local financialsystem and the local economy.5. This point has two implications. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  37. 37. P a g e | 37The first is that in order to accommodate the structural characteristics ofindividual jurisdictions, the assessment and application of policy toolsshould allow for an appropriate degree of national discretion.This contrasts with the prescriptive approach in the G-SIB framework.The second implication is that because a D-SIB framework is stillrelevant for reducing cross-border externalities due to spillovers atregional or bilateral level, the effectiveness of local authorities inaddressing risks posed by individual banks is of interest to a wider groupof countries.A framework, therefore, should establish a minimum set of principles,which ensures that it is complementary with the G-SIB framework,addresses adequately cross-border externalities and promotes alevel-playing field.6. The principles developed by the Committee for D-SIBs would allow forappropriate national discretion to accommodate structural characteristicsof the domestic financial system, including the possibility for countries togo beyond the minimum D-SIB framework and impose additionalrequirements based on the specific features of the country and itsdomestic banking sector.7. The principles set out in the document focus on the higher lossabsorbency (HLA) requirement for D-SIBs. The Committee would like toemphasise that other policy tools, particularly more intensive supervision,can also play an important role in dealing with D-SIBs.8. The principles were developed to be applied to consolidated groupsand subsidiaries.However, national authorities may apply them to branches in theirjurisdictions in accordance with their legal and regulatory frameworks.9. The implementation of the principles will be combined with a strongpeer review process introduced by the Committee. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  38. 38. P a g e | 38The Committee intends to add the D-SIB framework to the scope of theBasel III regulatory consistency assessment programme.This will help ensure that appropriate and effective frameworks forD-SIBs are in place across different jurisdictions.10. Given that the D-SIB framework complements the G-SIB framework,the Committee considers that it would be appropriate if banks identifiedas D-SIBs by their national authorities are required by those authorities tocomply with the principles in line with the phase-in arrangements for theG-SIB framework, ie from January 2016.II. The principles11. The Committee has developed a set of principles that constitutes theD-SIB framework.The 12 principles can be broadly categorised into two groups:The first group (Principles 1 to 7) focuses mainly on the assessmentmethodology for D-SIBs while the second group (Principles 8 to 12)focuses on HLA for D-SIBs.12. The 12 principles are set out below:Assessment methodologyPrinciple 1:National authorities should establish a methodology for assessing thedegree to which banks are systemically important in a domestic context.Principle 2:The assessment methodology for a D-SIB should reflect the potentialimpact of, or externality imposed by, a bank’s failure. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  39. 39. P a g e | 39Principle 3:The reference system for assessing the impact of failure of a D-SIB shouldbe the domestic economy.Principle 4:Home authorities should assess banks for their degree of systemicimportance at the consolidated group level, while host authorities shouldassess subsidiaries in their jurisdictions, consolidated to include any oftheir own downstream subsidiaries, for their degree of systemicimportance.Principle 5:The impact of a D-SIB’s failure on the domestic economy should, inprinciple, be assessed having regard to bank-specific factors:(a) Size(b) Interconnectedness(c) Substitutability/financial institution infrastructure (includingconsiderations related to the concentrated nature of the banking sector)(d) Complexity (including the additional complexities from cross-borderactivity).In addition, national authorities can consider other measures/data thatwould inform these bank-specific indicators within each of the abovefactors, such as size of the domestic economy.Principle 6:National authorities should undertake regular assessments of thesystemic importance of the banks in their jurisdictions to ensure that theirassessment reflects the current state of the relevant financial systems andthat the interval between D-SIB assessments not be significantly longerthan the G-SIB assessment frequency. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  40. 40. P a g e | 40Principle 7:National authorities should publicly disclose information that provides anoutline of the methodology employed to assess the systemic importanceof banks in their domestic economy.Higher loss absorbencyPrinciple 8:National authorities should document the methodologies andconsiderations used to calibrate the level of HLA that the frameworkwould require for D-SIBs in their jurisdiction.The level of HLA calibrated for D-SIBs should be informed byquantitative methodologies (where available) and country-specific factorswithout prejudice to the use of supervisory judgement.Principle 9:The HLA requirement imposed on a bank should be commensurate withthe degree of systemic importance, as identified under Principle 5.Principle 10:National authorities should ensure that the application of the G-SIB andD-SIB frameworks is compatible within their jurisdictions.Home authorities should impose HLA requirements that they calibrate atthe parent and/or consolidated level, and host authorities should imposeHLA requirements that they calibrate at the sub-consolidated/subsidiarylevel.The home authority should test that the parent bank is adequatelycapitalised on a stand-alone basis, including cases in which a D-SIB HLArequirement is applied at the subsidiary level. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  41. 41. P a g e | 41Home authorities should impose the higher of either the D-SIB or G-SIBHLA requirements in the case where the banking group has beenidentified as a D-SIB in the home jurisdiction as well as a G-SIB.Principle 11:In cases where the subsidiary of a bank is considered to be a D-SIB by ahost authority, home and host authorities should make arrangements tocoordinate and cooperate on the appropriate HLA requirement, withinthe constraints imposed by relevant laws in the host jurisdiction.Principle 12:The HLA requirement should be met fully by Common Equity Tier 1(CET1). In addition, national authorities should put in place anyadditional requirements and other policy measures they consider to beappropriate to address the risks posed by a D-SIB.Assessment methodologyPrinciple 1: National authorities should establish a methodology forassessing the degree to which banks are systemically important in adomestic context.Principle 2: The assessment methodology for a D-SIB should reflectthe potential impact of, or externality imposed by, a bank’s failure.13. A starting point for the development of principles for the assessment ofD-SIBs is a requirement that all national authorities should undertake anassessment of the degree to which banks are systemically important in adomestic context.The rationale for focusing on the domestic context is outlined inparagraph 17 below.14. Paragraph 14 of the G-SIB rules text states that “global systemicimportance should be measured in terms of the impact that a failure of abank can have on the global financial system and wider economy ratherthan the risk that a failure can occur. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  42. 42. P a g e | 42This can be thought of as a global, system-wide, loss-given-default(LGD) concept rather than a probability of default (PD) concept.”Consistent with the G-SIB methodology, the Committee is of the viewthat D-SIBs should also be assessed in terms of the potential impact oftheir failure on the relevant reference system.One implication of this is that to the extent that D-SIB indicators areincluded in any methodology, they should primarily relate to “impact offailure” measures and not “risk of failure” measures.Principle 3: The reference system for assessing the impact of failureof a D-SIB should be the domestic economy.Principle 4: Home authorities should assess banks for their degree ofsystemic importance at the consolidated group level, while hostauthorities should assess subsidiaries in their jurisdictions,consolidated to include any of their own downstream subsidiaries,for their degree of systemic importance.15. Two key aspects that shape the D-SIB framework and define itsrelationship to the G-SIB framework relate to how it deals with twoconceptual issues with important practical implications:• What is the reference system for the assessment of systemic impact• What is the appropriate unit of analysis (ie the entity which is beingassessed)?16. For the G-SIB framework, the appropriate reference system is theglobal economy, given the focus on cross-border spillovers and thenegative global externalities that arise from the failure of a globally activebank.As such this allowed for an assessment of the banks that are systemicallyimportant in a global context. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  43. 43. P a g e | 43The unit of analysis was naturally set at the globally consolidated level ofa banking group (paragraph 89 of the G-SIB rules text states that “(t)heassessment of the systemic importance of G-SIBs is made using data thatrelate to the consolidated group”).17. Correspondingly, a process for assessing systemic importance in adomestic context should focus on addressing the externalities that abank’s failure generates at a domestic level.Thus, the Committee is of the view that the appropriate reference systemshould be the domestic economy, ie that banks would be assessed by thenational authorities for their systemic importance to that specificjurisdiction.The outcome would be an assessment of banks active in the domesticeconomy in terms of their systemic importance.18. In terms of the unit of analysis, the Committee is of the view that homeauthorities should consider banks from a (globally) consolidatedperspective.This is because the activities of a bank outside the home jurisdiction can,when the bank fails, have potential significant spillovers to the domestic(home) economy.Jurisdictions that are home to banking groups that engage incross-border activity could be impacted by the failure of the wholebanking group and not just the part of the group that undertakesdomestic activity in the home economy.This is particularly important given the possibility that the homegovernment may have to fund/resolve the foreign operations in theabsence of relevant cross-border agreements.This is in line with the concept of the G-SIB framework.19. When it comes to the host authorities, the Committee is of the viewthat they should assess foreign subsidiaries in their jurisdictions, also _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  44. 44. P a g e | 44consolidated to include any of their own downstream subsidiaries, someof which may be in other jurisdictions.For example, for a cross-border financial group headquartered in countryX, the authorities in country Y would only consider subsidiaries of thegroup in country Y plus the downstream subsidiaries, some of which maybe in country Z, and their impact on the economy Y.Thus, subsidiaries of foreign banking groups would be considered from alocal or sub-consolidated basis from the level starting in country Y.The scope should be based on regulatory consolidation as in the case ofthe G-SIB framework.Therefore, for the purposes of assessing D-SIBs, insurance or othernon-banking activities should only be included insofar as they areincluded in the regulatory consolidation.20. The assessment of foreign subsidiaries at the local consolidated levelalso acknowledges the fact that the failure of global banking groups couldimpose outsized externalities at the local (host) level when thesesubsidiaries are significant elements in the local (host) banking system.This is important since there exist several jurisdictions that aredominated by foreign subsidiaries of internationally active bankinggroups.Principle 5: The impact of a D-SIB’s failure on the domesticeconomy should, in principle, be assessed having regard tobank-specific factors:(a) Size;(b) Interconnectedness;(c) Substitutability/financial institution infrastructure (includingconsiderations related to the concentrated nature of the bankingsector); and(d) Complexity (including the additional complexities fromcross-border activity). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  45. 45. P a g e | 45In addition, national authorities can consider other measures/datathat would inform these bank-specific indicators within each of theabove factors, such as size of the domestic economy.21. The G-SIB methodology identifies five broad categories of factors thatinfluence global systemic importance: size, cross-jurisdictional activity,interconnectedness, substitutability/financial institution infrastructureand complexity.The indicator-based approach and weighting system in the G-SIBmethodology was developed to ensure a consistent international rankingof G-SIBs.The Committee is of the view that this degree of detail is not warrantedfor D-SIBs, given the focus is on the domestic impact of failure of a bankand the wide ranging differences in each jurisdiction’s financial structurehinder such international comparisons being made.This is one of the reasons why the D-SIB framework has been developedas a principles-based approach.22. Consistent with this view, it is appropriate to list, at a high level, thebroad category of factors (eg size) that jurisdictions should have regard toin assessing the impact of a D-SIB’s failure.Among the five categories in the G-SIB framework, size,interconnectedness, substitutability/financial institution infrastructureand complexity are all relevant for D-SIBs as well.Cross-jurisdictional activity, the remaining category, may not be asdirectly relevant, since it measures the degree of global(cross-jurisdictional) activity of a bank which is not the focus of theD-SIB framework.23. In addition, national authorities may choose to also include somecountry-specific factors.A good example is the size of a bank relative to domestic GDP. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  46. 46. P a g e | 46If the size of a bank is relatively large compared to the domestic GDP, itwould make sense for the national authority of the jurisdiction to identifyit as a D-SIB whereas a same-sized bank in another jurisdiction, which issmaller relative to the GDP of that jurisdiction, may not be identified as aD-SIB.24. National authorities should have national discretion as to theappropriate relative weights they place on these factors depending onnational circumstances.Principle 6: National authorities should undertake regularassessments of the systemic importance of the banks in theirjurisdictions to ensure that their assessment reflects the current stateof the relevant financial systems and that the interval between D-SIBassessments not be significantly longer than the G-SIB assessmentfrequency.25. The list of G-SIBs (including their scores) is assessed annually, basedon updated data submitted by each participating bank, but measuredagainst a global sample that is largely unchanged for three years.It is expected that the names and buckets of G-SIBs and the data used toproduce the scores will be disclosed.26. The Committee believes it is good practice for national authorities toundertake a regular assessment as to the systemic importance of thebanks in their financial systems.The assessment should also be conducted if there are importantstructural changes to the banking system such as, for example, a mergerof major banks.A national authority’s assessment process and methodology will bereviewed by the Committee’s implementation monitoring process.27. It is also desirable that the interval of the assessments not besignificantly longer than that for G-SIBs (ie one year). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  47. 47. P a g e | 47For example, a SIB could be identified as a G-SIB but also a D-SIB in thesame jurisdiction or in other host jurisdictions.Alternatively, a G-SIB could drop from the G-SIB list andbecome/continue to be a D-SIB.In order to keep a consistent approach in these cases, it would be sensibleto have a similar frequency of assessments for the two frameworks.Principle 7: National authorities should publicly discloseinformation that provides an outline of the methodology employedto assess the systemic importance of banks in their domesticeconomy.28. The assessment process used needs to be clearly articulated and madepublic so as to set up the appropriate incentives for banks to seek toreduce the systemic risk they pose to the reference system.This was the key aspect of the G-SIB framework where the assessmentmethodology and the disclosure requirements of the Committee and thebanks were set out in the G-SIB rules text.By taking these measures, the Committee sought to ensure that banks,regulators and market participants would be able to understand how theactions of banks could affect their systemic importance score and therebythe required magnitude of additional loss absorbency.The Committee believes that transparency of the assessment process forthe D-SIB framework is also important, even if it is likely to vary acrossjurisdictions given differences in frameworks and policy tools used toaddress the systemic importance of banks.Higher loss absorbencyPrinciple 8: National authorities should document themethodologies and considerations used to calibrate the level of HLAthat the framework would require for D-SIBs in their jurisdiction.The level of HLA calibrated for D-SIBs should be informed by _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  48. 48. P a g e | 48quantitative methodologies (where available) and country-specificfactors without prejudice to the use of supervisory judgement.29. The purpose of an HLA requirement for D-SIBs is to reduce furtherthe probability of failure compared to non-systemic institutions,reflecting the greater impact a D-SIB failure is expected to have on thedomestic financial system and economy.30. The Committee intends to assess the implementation of theframework by the home and host authorities for its degree ofcross-jurisdictional consistency, having regard to the differences innational circumstances.In order to increase the consistency in the implementation of the D-SIBframework and to avoid situations where banks similar in terms of thelevel of domestic systemic importance they pose in the same or differentjurisdictions have substantially different D-SIB frameworks applied tothem, it is important that there is sufficient documentation provided byhome and host authorities for the Committee to conduct an effectiveimplementation review assessment.It is important for the application of a D-SIB HLA, at both the parent andsubsidiary level, to be based on a transparent and well articulatedassessment framework to ensure the implications of the requirements arewell understood by both the home and the host authorities.31. The level of HLA for D-SIBs should be subject to policy judgement bynational authorities.That said, there needs to be some form of analytical framework thatwould inform policy judgements.This was the case for the policy judgement made by the Committee onthe level of the additional loss absorbency requirement for G-SIBs.32. The policy judgement on the level of HLA requirements should alsobe guided by country-specific factors which could include the degree of _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  49. 49. P a g e | 49concentration in the banking sector or the size of the banking sectorrelative to GDP.Specifically, countries that have a larger banking sector relative to GDPare more likely to suffer larger direct economic impacts of the failure of aD-SIB than those with smaller banking sectors.While size-to-GDP is easy to calculate, the concentration of the bankingsector could also be considered (as a failure in a medium-sized highlyconcentrated banking sector would likely create more of an impact on thedomestic economy than if it were to occur in a larger, more widelydispersed banking sector).33. The use of these factors in calibrating the HLA requirement wouldprovide justification for different intensities of policy responses acrosscountries for banks that are otherwise similar across the four keybank-specific factors outlined in Principle 5.Principle 9: The HLA requirement imposed on a bank should becommensurate with the degree of systemic importance, as identifiedunder Principle 5.34. In the G-SIB framework, G-SIBs are grouped into different categoriesof systemic importance based on the score produced by theindicator-based measurement approach.Different additional loss absorbency requirements are applied to thedifferent buckets (G-SIB rules text paragraphs 52 and 73).35. Although the D-SIB framework does not produce scores based on aprescribed methodology as in the case of the G-SIB framework, theCommittee is of the view that the HLA requirements for D-SIBs shouldalso be decided based on the degree of domestic systemic importance.This is to provide the appropriate incentives to banks which are subject tothe HLA requirements to reduce (or at least not increase) their systemicimportance over time. In the case where there are multiple D-SIB buckets _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  50. 50. P a g e | 50in a jurisdiction, this could imply differentiated levels of HLA betweenD-SIB buckets.Principle 10: National authorities should ensure that the applicationof the G-SIB and D-SIB frameworks is compatible within theirjurisdictions. Home authorities should impose HLA requirementsthat they calibrate at the parent and/or consolidated level, and hostauthorities should impose HLA requirements that they calibrate atthe sub-consolidated/subsidiary level. The home authority shouldtest that the parent bank is adequately capitalised on a stand-alonebasis, including cases in which a D-SIB HLA requirement is appliedat the subsidiary level. Home authorities should impose the higherof either the D-SIB or G-SIB HLA requirements in the case wherethe banking group has been identified as a D-SIB in the homejurisdiction as well as a G-SIB.36. National authorities, including host authorities, currently have thecapacity to set and impose capital requirements they consider appropriateto banks within their jurisdictions.The G-SIB rules text states that host authorities of G-SIB subsidiariesmay apply an additional loss absorbency requirement at the individuallegal entity or consolidated level within their jurisdiction.The Committee has no intention to change this aspect of the status quowhen introducing the D-SIB framework.An imposition of a D-SIB HLA by a host authority is no different (exceptfor additional transparency) from their current capacity to impose a Pillar1 or 2 capital charge.Therefore, the ability of the host authorities to implement a D-SIB HLAon local subsidiaries does not raise any new home-host issues.37. National authorities should ensure that banks with the same degree ofsystemic importance in their jurisdiction, regardless of whether they aredomestic banks, subsidiaries of foreign banking groups, or subsidiaries ofG-SIBs, are subject to the same HLA requirements, ceteris paribus. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  51. 51. P a g e | 51Banks in a jurisdiction should be subject to a consistent, coherent andnon-discriminatory treatment regardless of the ownership.The objective of the host authorities’ power to impose HLA onsubsidiaries is to bolster capital to mitigate the potential heightenedimpact of the subsidiaries’ failure on the domestic economy due to theirsystemic nature.This should be maintained in cases where a bank might not be (or mightbe less) systemic at home, but its subsidiary is (more) systemic in the hostjurisdiction.38. An action by the host authorities to impose a D-SIB HLA requirementleads to increases in capital at the subsidiary level which can be viewed asa shift in capital from the parent bank to the subsidiary, unless it alreadyholds an adequate capital buffer in the host jurisdiction or the additionalcapital raised by the subsidiary is from outside investors.This could, in the case of substantial or large subsidiaries, materiallydecrease the level of capital protecting the parent bank.Under such cases, it is important that the home authority continues toensure there are sufficient financial resources at the parent level, forexample through a solo capital requirement.Indeed, paragraph 23 of the Basel II rules text states “(f)urther, as one ofthe principal objectives of supervision is the protection of depositors, it isessential to ensure that capital recognised in capital adequacy measuresis readily available for those depositors.Accordingly, supervisors should test that individual banks are adequatelycapitalised on a stand-alone basis.”39. Within a jurisdiction, applying the D-SIB framework to both G-SIBsand non-G-SIBs will help ensure a level playing field within the nationalcontext. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  52. 52. P a g e | 52For example, in a jurisdiction with two banks that are roughly identical interms of their assessed systemic nature at the domestic level, but whereone is a G-SIB and the other is not, national authorities would have thecapacity to apply the same D-SIB HLA requirement to both.In such cases, the home authorities could face a situation where the HLArequirement on the consolidated group will be the higher of thoseprescribed by the G-SIB and D-SIB frameworks (ie the higher of eitherthe D-SIB or G-SIB requirement).40. This approach is also consistent with the Committee’s standards,which are minima rather than maxima.It is also consistent with the G-SIB rules text that is explicit in stating thathome authorities can impose higher requirements than the G-SIBadditional loss absorbency requirement (G-SIB rules text paragraph 74).41. The Committee is of the view that any form of double-counting shouldbe avoided and that the HLA requirements derived from the G-SIB andD-SIB frameworks should not be additive.This will ensure the overall consistency between the two frameworks andallows the D-SIB framework to take the complementary perspective to theG-SIB framework.Principle 11: In cases where the subsidiary of a bank is considered tobe a D-SIB by a host authority, home and host authorities shouldmake arrangements to coordinate and cooperate on the appropriateHLA requirement, within the constraints imposed by relevant lawsin the host jurisdiction.42. The Committee recognises that there could be some concern that hostauthorities tend not to have a group-wide perspective when applyingHLA requirements to subsidiaries of foreign banking groups in theirjurisdiction.The home authorities, on the other hand, clearly need to know D-SIBHLA requirements on significant subsidiaries since there could be _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  53. 53. P a g e | 53implications for the allocation of financial resources within the bankinggroup.43. In these circumstances, it is important that arrangements tocoordinate and cooperate on the appropriate HLA requirement betweenhome and host authorities are established and maintained, within theconstraints imposed by relevant laws in the host jurisdiction, whenformulating HLA requirements.This is particularly important to make it possible for the home authorityto test the capital position of a parent on a stand-alone basis as mentionedin paragraph 38 and to prevent a situation where the home authorities aresurprised by the action of the host authorities.Home and host authorities should coordinate and cooperate with eachother on any plan to impose an HLA requirement on a subsidiary bank,and the amount of the requirement, before taking any action.The host authority should provide a rationale for their decision, and anindication of the steps the bank would need to take to avoid/reduce sucha requirement.The home and host authorities should also discuss(i) The resolution regimes (including recovery and resolution plans) inboth jurisdictions,(ii) Available resolution strategies and any specific resolution plan inplace for the firm, and(iii) The extent to which such arrangements should influence HLArequirements.Principle 12: The HLA requirement should be met fully by CommonEquity Tier 1 (CET1). In addition, national authorities should put inplace any additional requirements and other policy measures theyconsider to be appropriate to address the risks posed by a D-SIB. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  54. 54. P a g e | 5444. The additional loss absorbency requirement for G-SIBs is to be met byCET1, as stated in the G-SIBs rules text (paragraph 87).The Committee considered the use of CET1 to be the simplest and mosteffective way to increase the going concern loss-absorbing capacity of abank.HLA requirements for D-SIBs should also be fully met with CET1 toensure a maximum degree of consistency in terms of effective lossabsorbing capacity.This has the benefit of facilitating direct and transparent comparability ofthe application of requirements across jurisdictions, an element that isconsidered desirable given the fact that most of these banks will havecross-border operations being in direct competition with each other.In addition, national authorities should put in place any additionalrequirements and other policy measures they consider to be appropriateto address the risks posed by a D-SIB.45. National authorities should implement the HLA requirement throughan extension of the capital conservation buffer, maintaining the divisionof the buffer into four bands of equal size (as described in paragraph 147of the Basel III rules text).This is in line with the treatment of the additional loss absorbencyrequirement for G-SIBs.The HLA requirement for D-SIBs is essentially a requirement that sits ontop of the capital buffers and minimum capital requirement, with apre-determined set of consequences for banks that do not meet thisrequirement.46. In some jurisdictions, it is possible that Pillar 2 may need to adapt toaccommodate the existence of the HLA requirements for D-SIBs.Specifically, it would make sense for authorities to ensure that a bank’sPillar 2 requirements do not require capital to be held twice for issues that _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  55. 55. P a g e | 55relate to the externalities associated with distress or failure of D-SIBs ifthey are captured by the HLA requirement.However, Pillar 2 will normally capture other risks that are not directlyrelated to these externalities of D-SIBs (eg interest rate and concentrationrisks) and so capital meeting the HLA requirement should not bepermitted to be simultaneously used to meet Pillar 2 requirement thatrelate to these other risks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  56. 56. P a g e | 56Mario Draghi: Openingstatement at DeutscherBundestagSpeech by Mr Mario Draghi,President of the European CentralBank, at the discussion onECB policies with Members ofParliament, Berlin***Dear President Lammert,Honourable Committee Chairs,Honourable Members of the Bundestag,I am deeply honoured to be here today.As President of the European Central Bank (ECB), it is a privilege for meto come to the heart of German democracy to present our policyresponses to the challenges facing the euro area economy.I know that central bank actions are often a topic of debate amongpoliticians, the media and the general public in Germany.So I would like to thank President Lammert and all Committee Chairsmost warmly for this kind invitation – and the opportunity it gives me toparticipate in that discussion.It is rare for the ECB President to speak in a national parliament.The ECB is accountable to the European Parliament, where we havescheduled hearings every three months and occasional hearings ontopical matters. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  57. 57. P a g e | 57We take these duties of accountability to the citizens of Europe and theirelected representatives very seriously.But I am here today not only to explain the ECB’s policies. I am also hereto listen.I am here to listen to your views on the ECB, on the euro area economyand on the longer-term vision for Europe.To lay the ground for our discussion, I would like to explain our view ofthe current situation and the rationale for our recent monetary policydecisions.I will focus in particular on the Outright Monetary Transactions (OMTs)that we formally announced in September.Financial markets and the disruptions of monetary policytransmissionLet me begin with the challenges facing the euro area.We expect the economy to remain weak in the near term, also reflectingthe adjustment that many countries are undergoing in order to lay thefoundations for sustainable future prosperity.For next year, we expect a very gradual recovery.Euro area unemployment remains deplorably high.In this environment, the ECB has responded by lowering its key interestrates.In normal times, such reductions would be passed on relatively evenly tofirms and households across the euro area.But this is not what we have seen.In some countries, the reductions were fully passed on. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  58. 58. P a g e | 58In others, the rates charged on bank loans to the real economy declinedonly a little, if at all.And in a few countries, some lending rates have actually risen.Why did this divergence happen?Let me explain this in detail because it is so important for understandingour policies.A fundamental concept in central banking is what is known as “monetarypolicy transmission”.This is the way that changes in a central bank’s main interest rate arepassed via the financial system to the real economy.In a well-functioning financial system, there is a stable relationshipbetween changes to central bank rates and the cost of bank loans to firmsand households.This allows central banks to influence overall economic conditions andmaintain price stability.But the euro area financial system has become increasingly disturbed.There has been a severe fragmentation in the single financial market.Bank funding costs have diverged significantly across countries.The euro area interbank market has been effectively closed to a largenumber of banks and some countries’ entire banking systems.Interest rates on government bonds in some countries have risen steeply,hurting the funding costs of domestic banks and limiting their access tofunding markets.This has been a key factor why banks have passed on interest rates verydifferently to firms and households across the euro area. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  59. 59. P a g e | 59Interest rates do not have to be identical across the euro area, but it isunacceptable if major differences arise from broken capital markets or theperception of a euro area break-up.The fragmentation of the single financial market has led to afragmentation of the single monetary policy.And in an economy like the euro area where about three quarters of firms’financing comes from banks, this has very severe consequences for thereal economy, investment and employment.It meant that countries in economic difficulties could not benefit from ourlow interest rates and return to health.Instead, they were experiencing a vicious circle.Economic growth was falling. Public finances were deteriorating.Banks and governments were being forced to pay even higher interestrates.And credit and economic growth were falling further, leading to risingunemployment and reduced consumption and investment.A number of economies could have seen risks of deflation.All of this meant that the outlook for the euro area economy as a wholewas increasingly fragile.There were potentially negative consequences for Europe’s singlemarket, as access to finance was increasingly influenced by locationrather than creditworthiness and the quality of the project.The disruption of the monetary policy transmission is something deeplyprofound.It threatens the single monetary policy and the ECB’s ability to ensureprice stability. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  60. 60. P a g e | 60This was why the ECB decided that action was essential.Restoring the proper transmission of monetary policySo let me now turn directly to our recent policy announcements.To decide what type of action was appropriate, we had to make two keyassessments.First, we had to diagnose precisely why the transmission was disrupted.And second, we had to identify the most effective policy tool to repairthose disruptions, while remaining within our mandate to preserve pricestability.In our analysis, a main cause of disruptions in the transmission wasunfounded fears about the future of the euro area.Some investors had become excessively influenced by imagined scenariosof disaster.They were therefore charging interest rates to countries they perceived tobe most vulnerable that went beyond levels warranted by economicfundamentals and justifiable risk premia.Clearly, it was not by chance that some countries found themselves in amore difficult situation than others.It was mainly those countries that had implemented inappropriateeconomic policies in the past.This is also why the first responsibility in this situation is for countries tomake determined reforms and convince markets that they are credible.But many were already doing this, only for interest rates to rise evenhigher. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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