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Monday October 1, 2012 - Top 10 Risk Management News


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Monday October 1, 2012 - Top 10 Risk Management News

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Monday October 1, 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 Top 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped the weeks agenda, and what is next George Lekatis President of the IARCPDear Member,There are some interesting job openings and descriptions:Vice President - Bank Regulatory Policy / BaselManhattan, NY, Salary $120,000-$180,000 / yr., Full -Time“This individual will assist in interpreting and developing firm policy forU.S. and international banking regulations related to capital and andother regulatory reporting matters. They are seeking individuals withprior Basel II and III and bank capital regulations experience.”Finance and Risk Solution ArchitectLondon, Salary £80,000 - £115,000 + Bonus“We are currently looking for profiles with a consulting or businessstream background in the following areas for a new business practice inthe finance sector: we are looking for individuals with the followingbackground or experience: Risk Management in Capital or Liquidityrequirements, Financial Industry Regulatory Reporting such as FSA,Dodd Frank, Basel II/III & Industry Best Practice, reporting strategies& Global Transactions. Individuals will have a Business/TechnicalArchitectural Background ideally with some Business Analysis &Consulting background.” _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  2. 2. Page |2Business Analyst with Basel III Job“We are actively seeking a contractor to lead a team in documentation,design, and traceability of requirements in support of Basel IIIimplementation. This includes defining solutions to business/systemsproblems and ensuring the integrity of delivery through customeracceptance and final disposition of solution for the Basel III project.This is a minimum 6-8 month project with strong possibility of extensionor conversion to full time” employment.”Very interesting job descriptions…… and very interesting salary.The same time, banks try hard to understand what to do with the newBasel III requirements (Number 1 of our list) and to find more investors(Tier 1 capital).Welcome to the Top 10 list. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  3. 3. Page |3BIS, Results of the Basel III monitoringexercise as of 31 December 2011This report presents the results of the BaselCommittees Basel III monitoring exercise.The study is based on rigorous reportingprocesses set up by the Committee toperiodically review the implications of theBasel III standards for financial markets; thefirst results of the exercise based on June 2011data had been published in April 2012.Financial Services Agency, TheJapanese GovernmentRecent Trend of Financial and Capital Markets,Regulatory and Supervisory ChallengesRyutaro HatanakaInvestor Protection through Audit OversightLewis H. Ferguson, Board MemberCalifornia State University 11th Annual SEC Financial ReportingConference, Irvine, CA _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  4. 4. Page |4Annual public hearing of the chairpersonsof the three European Supervisory Authorities (EBA, ESMA and EIOPA).Initial statement by Andrea Enria Chairperson of the EBA, in front of theEconomic and Monetary affairs committee of the European ParliamentChallenges to the single monetary policy andthe European Central Bank’s responseSpeech by Mr Benoît Coeuré, Member of theExecutive Board of the European CentralBank, at the Institut d’études politiques, Paris,20 September 2012.EIOPA and FINMASign a Memorandum ofUnderstandingThe European Insurance and Occupational Pensions Authority (EIOPA)and the Swiss Financial Market Supervisory Authority (FINMA) havesigned a Memorandum of Understanding (MoU) in Bern.The main objective of the MoU is to ensure optimal cooperation insupervision, in particular for insurance groups with internationalactivities in the European economic area (EEA) and Switzerland. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  5. 5. Page |5European Systemic Risk BoardESRB Risk DashboardSimon Kwan, vicepresident at theFederal Reserve Bankof San Francisco, states his views on the current economy and theoutlook.Maximum Employment andMonetary Policy"Jeffrey M. Lacker, President Federal Reserve Bank ofRichmondMoney Marketeers of New York University, Down TownAssociation, New York City, N.Y.Basel iii in SingaporeResponse to the feedbackreceived _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  6. 6. Page |6NUMBER 1BIS, Results of the Basel III monitoringexercise as of 31 December 2011Important partsThis report presents the results of the BaselCommittees Basel III monitoring exercise.The study is based on rigorous reportingprocesses set up by the Committee toperiodically review the implications of theBasel III standards for financial markets; thefirst results of the exercise based on June 2011data had been published in April 2012.A total of 209 banks participated in the study, including 102 Group 1banks (ie those that have Tier 1 capital in excess of €3 billion and areinternationally active) and 107 Group 2 banks (ie all other banks).While the Basel III framework sets out transitional arrangements toimplement the new standards, the monitoring exercise results assume fullimplementation of the final Basel III package based on data as of 31December 2011 (ie they do not take account of the transitionalarrangements such as the phase in of deductions).No assumptions were made about bank profitability or behaviouralresponses, such as changes in bank capital or balance sheet composition.For that reason the results of the study are not comparable to industryestimates.The study finds that based on data as of 31 December 2011 and applyingthe changes to the definition of capital and risk-weighted assets, theaverage common equity Tier 1 capital ratio (CET1) of Group 1 banks was7.7%, as compared with the Basel III minimum requirement of 4.5%. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  7. 7. Page |7In order for all Group 1 banks to reach the 4.5% minimum, an increase of€11.9 billion CET1 would be required.The overall shortfall increases to €374.1 billion to achieve a CET1 targetlevel of 7.0% (ie including the capital conservation buffer); this amountincludes the surcharge for global systemically important banks whereapplicable.As a point of reference, the sum of profits after tax and prior todistributions across the same sample of Group 1 banks in 2011 was €356billion.Compared to the June 2011 exercise, the aggregate CET1 shortfall withrespect to the 4.5% minimum for Group 1 banks has reduced by €26.9billion.At the CET1 target level of 7.0%, the aggregate CET1 shortfall for Group 1banks has reduced by €111.5 billion.For Group 2 banks, the average CET1 ratio stood at 8.8%.In order for all Group 2 banks in the sample to meet the new 4.5% CET1ratio, the additional capital needed is estimated to be €7.6 billion.They would have required an additional €21.7 billion to reach a CET1target 7.0%; the sum of these banks profits after tax and prior todistributions in 2011 was €24 billion.Executive summaryIn 2010, the Basel Committee on Banking Supervision1 conducted acomprehensive quantitative impact study (C-QIS) using data as of 31December 2009 to ascertain the impact on banks of the Basel IIIframework that was published in December 2010 and revised inJune 2011.The Committee intends to continue monitoring the impact of the BaselIII framework in order to gather full evidence on its dynamics. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  8. 8. Page |8For this purpose, a semi-annual monitoring framework has been set upon the risk-based capital ratio, the leverage ratio, and the liquidity metricsusing data collected by national supervisors on a representative sample ofinstitutions in each jurisdiction.This report is the second publication of results of the Basel III monitoringexercise and summarises the aggregate results using data as of 31December 2011.The Committee believes that the information contained in the report willprovide the relevant stakeholders with a useful benchmark for analysis.Information considered for this report was obtained by data submissionsof individual banks to their national supervisors on a voluntary andconfidential basis.A total of 209 banks participated in the study, including 102 Group 1banks and 107 Group 2 banks.Members’ coverage of their banking sector is very high for Group 1 banks,reaching 100% coverage for some jurisdictions, while coverage iscomparatively lower for Group 2 banks and varied across jurisdictions.The Committee appreciates the significant efforts contributed by bothbanks and national supervisors to this ongoing data collection exercise.The report focuses on the following items:- Changes to bank capital ratios under the new requirements, and estimates of any capital deficiencies relative to fully phased-in minimum and target capital requirements (to include capital charges for global systemically important banks – G-SIBs);- Changes to the definition of capital that result from the new capital standard, referred to as common equity Tier 1 (CET1), including a reallocation of deductions to CET1, and changes to the eligibility criteria for Additional Tier 1 and Tier 2 capital; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  9. 9. Page |9- Increases in risk-weighted assets resulting from changes to the definition of capital, securitisation, trading book, and counterparty credit risk requirements;- The Basel III leverage ratio; and- Two Basel III liquidity standards – the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).With the exception of the transitional arrangements for non-correlationtrading securitization positions in the trading book, this report does nottake into account any transitional arrangements such as phase-in ofdeductions and grandfathering arrangements.Rather, the estimates presented assume full implementation of the finalBasel III requirements based on data as of 31 December 2011.No assumptions have been made about banks’ profitability orbehavioural responses, such as changes in bank capital or balance sheetcomposition, since this date or in the future.For this reason, the results are not comparable to current industryestimates, which tend to be based on forecasts and consider managementactions to mitigate the impact, and incorporate estimates whereinformation is not publicly available.The results presented in this report are also not comparable to the C-QISthat was prepared using end-December 2009 data because that reportevaluated the impact of policy questions that differ in certain key respectsfrom the finalised Basel III framework.As one significant example, the C-QIS did not consider the impact ofcapital surcharges for global systemically important banks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  10. 10. P a g e | 10Key resultsCapital shortfallsAssuming full implementation of the Basel III requirements as of 31December 2011, including changes to the definition of capital andrisk-weighted assets, and ignoring phase-in arrangements, Group 1 bankswould have an overall shortfall of €11.9 billion for the CET1 minimumcapital requirement of 4.5%, which rises to €374.1 billion for a CET1 targetlevel of 7.0% (ie including the capital conservation buffer); the lattershortfall also includes the G-SIB surcharge where applicable.As a point of reference, the sum of profits after tax prior to distributionsacross the same sample of Group 1 banks in 2011 was €356 billion.Compared to the June 2011 exercise, the aggregate CET1 shortfall withrespect to the 4.5% minimum for Group 1 banks has improved by €26.9billion or 69.3%.At the CET1 target level of 7.0%, the aggregate CET1 shortfall for Group 1banks has improved by €111.5 billion or 23.0%.Under the same assumptions, the capital shortfall for Group 2 banksincluded in the Basel III monitoring sample is estimated at €7.6 billion forthe CET1 minimum of 4.5% and €21.7 billion for a CET1 target level of7.0%.The sum of Group 2 bank profits after tax prior to distributions in 2011was €24 billion.Further details on additional capital needs to meet the Basel IIIrequirements are included in Section 2.Capital ratiosThe average CET1 ratio under the Basel III framework would declinefrom 10.4% to 7.7% for Group 1 banks and from 10.4% to 8.8% for Group 2banks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  11. 11. P a g e | 11The Tier 1 capital ratios of Group 1 banks would decline, on average from11.7% to 8.0% and total capital ratios would decline from 14.2% to 9.2%.As with the CET1 ratios, the decline in other capital ratios iscomparatively less pronounced for Group 2 banks; Tier 1 capital ratioswould decline on average from 11.0% to 9.2% and total capital ratioswould decline on average from 14.3% to 11.0%.Changes in risk-weighted assetsAs compared to current risk-weighted assets, total risk-weighted assetsincrease on average by 18.1% for Group 1 banks under the Basel IIIframework.This increase is driven largely by charges against counterparty credit risk,trading book exposures, and securitization exposures (principally thoserisk-weighted at 1250% under the Basel III framework that werepreviously 50/50 deductions under Basel II).Banks that have significant exposures in these areas influence the averageincrease in risk-weighted assets heavily.As Group 2 banks are less affected by the revised counterparty credit riskand trading book rules, these banks experience a comparatively smallerincrease in risk-weighted assets of only 7.5%.Even within this sample, higher risk-weighted assets are attributedlargely to Group 2 banks with counterparty and securitisation exposures(ie those subject to a 1250% risk weighting).As discussed in Section 4.1, the increase in risk-weighted assets containscertain estimates pertaining to trading book exposures for banks thathave already adopted the Basel 2.5 enhancements.Leverage ratioThe average Basel III Tier 1 leverage ratio for all banks is 3.6%. The BaselIII average for Group 1 banks is 3.5%, and the average for Group 2 banksis 4.2%. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  12. 12. P a g e | 12Liquidity standardsBoth liquidity standards are currently subject to an observation periodwhich includes a review clause to address any unintended consequencesprior to their respective implementation dates of 1 January 2015 for theLCR and 1 January 2018 for the NSFR.Basel III monitoring results for the end-December 2011 reporting periodgive an indication of the impact of the calibration of the standards basedon the December 2010 rules text and highlight several key observations:- A total of 102 Group 1 and 107 Group 2 banks participated in the liquidity monitoring exercise for the end-December 2011 reference period.- The weighted average LCR for Group 1 banks is 91%, compared to 90% for 30 June 2011, while the weighted average LCR for Group 2 banks is 98%. The aggregate LCR shortfall is €1.8 trillion which represents approximately 3% of the €61.4 trillion total assets of the aggregate sample.- The weighted average NSFR is 98% for Group 1 banks and 95% for Group 2 banks, compared to 94% for each of the Group 1 and Group 2 samples as at 30 June 2011. The aggregate shortfall of required stable funding is €2.5 trillion.Sample of participating banksA total of 209 banks participated in the study, including 102 Group 1banks and 107 Group 2 banks.Group 1 banks are those that have Tier 1 capital in excess of €3 billion andare internationally active. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  13. 13. P a g e | 13All other banks are considered Group 2 banks.Banks were asked to provide data as of 31 December 2011 at theconsolidated level.Subsidiaries are not included in the analyses to avoid double counting.Table 1 shows the distribution of participation by jurisdiction.For Group 1 banks members’ coverage of their banking sector was veryhigh reaching 100% coverage for some jurisdictions.Coverage for Group 2 banks was comparatively lower and varied acrossjurisdictions.Not all banks provided data relating to all parts of the Basel IIIframework.Accordingly, a small number of banks are excluded from individualsections of the Basel III monitoring analysis due to incomplete data.In certain sections, data are based on a consistent sample of banks.This consistent sample represents only those banks that reportednecessary data at both the June 2011 and December 2011 reporting dates,in order to make more meaningful period-to-period comparisons. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
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  18. 18. P a g e | 18Capital shortfallsChart 5 and Table 2 provide estimates of the amount of capital that Group1 and Group 2 banks would need based on data as of 31 December 2011 inaddition to capital already held at the reporting date, in order to meet thetarget CET1, Tier 1, and total capital ratios under Basel III assuming fullyphased-in target requirements and deductions.Under these assumptions, the CET1 capital shortfall for Group 1 bankswith respect to the 4.5% CET1 minimum requirement is €11.9 billion.The CET1 shortfall with respect to the 4.5% requirement for Group 2banks, where coverage of the sector is considerably smaller, is estimatedat €7.6 billion.For a CET1 target of 7.0% (ie the 4.5% CET1 minimum plus the 2.5%capital conservation buffer, plus any capital surcharge for Group 1 G-SIBsas applicable), Group 1 banks’ shortfall is €374.1 billion and Group 2banks’ shortfall is €21.7 billion.The surcharges for G-SIBs are a binding constraint on 21 of the 27 G-SIBsincluded in this Basel III monitoring exercise.As a point of reference, the aggregate sum of after-tax profits prior todistributions for Group 1 and Group 2 banks in the same sample was €356billion and €24 billion, respectively in 2011.Compared to the June 2011 exercise, the aggregate CET1 shortfall withrespect to the 4.5% minimum for Group 1 banks has improved by €26.9billion or 69.3% (see Chart 5).At the CET1 target level of 7.0%, the aggregate CET1 shortfall for Group 1banks has improved by €111.5 billion or 23.0%.Assuming the 4.5% CET1 minimum capital requirements were fully met(ie, there were no CET1 shortfalls), Group 1 banks would need anadditional €32.5 billion of additional Tier 1 or CET1 capital to meet theminimum Tier 1 capital ratio requirement of 6.0%. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  19. 19. P a g e | 19Assuming banks already hold 7.0% CET1 capital, Group 1 banks wouldneed an additional €219.3 billion of additional Tier 1 or CET1 capital tomeet the Tier 1 capital target ratio of 8.5% (ie the 6.0% Tier 1 minimumplus the 2.5% CET1 capital conservation buffer), respectively.Group 2 banks would need an additional €2.1 billion and an additional€11.9 billion to meet these respective Tier 1 capital minimum and targetratio requirements.Assuming CET1 and Tier 1 capital requirements were fully met (ie, therewere no shortfalls in either CET1 or Tier 1 capital), Group 1 banks wouldneed an additional €100.2 billion of Tier 2 or higher quality capital to meetthe minimum total capital ratio requirement of 8.0% and an additional€224.3 billion of Tier 2 or higher quality capital to meet the total capitaltarget ratio of 10.5% (ie the 8.0% Tier 1 minimum plus the 2.5% CET1capital conservation buffer).Group 2 banks would need an additional €4.1 billion and an additional€8.6 billion to meet these respective total capital minimum and targetratio requirements.As indicated above, no assumptions have been made about bank profitsor behavioural responses, such as changes balance sheet composition,that will serve to ameliorate the impact of capital shortfalls over time. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  20. 20. P a g e | 20Impact of the definition of capital on Common Equity Tier 1capitalAs noted above, reductions in capital ratios under the Basel IIIframework are attributed in part to capital deductions not previouslyapplied at the common equity level of Tier 1 capital in most jurisdictions.Table 3 shows the impact of various regulatory adjustment categorieson the gross CET1 capital (ie, CET1 before adjustments) of Group 1 andGroup 2 banks.In the aggregate, regulatory adjustments reduce the gross CET1 of Group1 banks under the Basel III framework by 29.0%.The largest driver of Group 1 bank deductions is goodwill, followed bycombined deferred tax assets (DTAs) deductions, and intangibles otherthan mortgage servicing rights.These deductions reduce Group 1 bank gross CET1 by 14.0%, 4.3%, and3.5%, respectively. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  21. 21. P a g e | 21The category described as other adjustments reduces Group 1 bank grossCET1 by 3.8% and pertain mainly to deductions for provision shortfallsrelative to expected credit losses and deductions related to defined benefitpension fund schemes.Holdings of capital of other financial companies reduce the CET1 ofGroup 1 banks by 1.9%.The category “Excess above 15%” refers to the deduction of the amountby which the aggregate of the three items subject to the 10% limit forinclusion in CET1 capital exceeds 15% of a bank’s CET1, calculated afterall deductions from CET1.These 15% threshold bucket deductions reduce Group 1 bank gross CET1by 1.6%.Deductions for MSRs exceeding the 10% limit have no impact on Group 1CET1 in the aggregate.Table 3 also compares regulatory adjustments for Group 1 banks with theresults of the previous period for those banks which participated in bothexercises.Overall, deductions have been reduced by 2.6 percentage points, mainlydriven by lower deductions for goodwill and financials.Regulatory adjustments reduce the CET1 of Group 2 banks by 20.4%.Goodwill is the largest driver of deductions for Group 2 banks, followedby holdings of the capital of other financial companies, deductions forintangibles other than mortgage servicing rights, and combined DTAsdeductions.These deductions reduce Group 2 bank CET1 by 7.5%, 2.3%, 2.3% and1.9%, respectively. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  22. 22. P a g e | 22Other adjustments, which are driven significantly by deductions forprovision shortfalls relative to expected credit losses, result in a 3.1%reduction in Group 2 bank gross CET1.Deductions for items in excess of the aggregate 15% threshold basketreduce Group 2 bank gross CET1 by 1.2%.Deductions for mortgage servicing rights above the 10% limit have noimpact on Group 2 banks.Changes in risk-weighted assets4.1 Overall resultsReductions in capital ratios under the Basel III framework are alsoattributed to increases in risk-weighted assets.Table 4 provides additional detail on the contributors to these increases,to include the following categories:Definition of capital:These columns measure the change in risk-weighted assets as a result ofproposed changes to the definition of capital. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  23. 23. P a g e | 23The column heading “other” includes the effects of lower risk-weightedassets for exposures that are currently included in risk-weighted assetsbut receive a deduction treatment under Basel III.The column heading “50/50” measures the increase in risk-weightedassets applied to securitisation exposures currently deducted under theBasel II framework that are risk-weighted at 1250% under Basel III.The column heading “threshold” measures the increase in risk-weightedassets for exposures that fall below the 10% and 15% limits for CET1deduction;Counterparty credit risk (CCR):This column measures the new capital charge for credit valuationadjustments (CVA risk) and the higher capital charge that results fromapplying a higher asset value correlation parameter against exposures tofinancial institutions under the IRB approaches to credit risk.Banks have not been asked to provide data on the risk-weighted asseteffects of capital charges for exposures to central counterparties (CCPs)or on any impact of incorporating stressed parameters for effectiveexpected positive exposure (EEPE);Trading book:As data from most countries already include the RWA impact of theBasel 2.5 market risk rules, the incremental impact for changes in marketRWA shown in these tables has been estimated using the sum of thefollowing elements relative to elements in place under Basel II: theproportion of internally modeled general and specific risk that isattributable to stress value-at-risk, the incremental risk capital charge(IRC), capital charges for the correlation trading portfolio, and capitalcharges under the standardised measurement method (SMM) for othersecuritisation exposures and nth-to-default credit derivatives.The effect of higher capital charges for re-securitisation exposures in thebanking book and increased conversion factors for short-term liquidity _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  24. 24. P a g e | 24facilities to off-balance sheet conduits are not considered in these tablesgiven the data are no longer available for all countries.However, prior reports have shown the impact of these charges to begenerally small for both Group 1 and Group 2 banks.Risk-weighted assets for Group 1 banks increase overall by 18.1% forGroup 1 banks.This increase is to a large extent attributed to higher risk-weighted assetsfor counterparty credit risk exposures, which result in an overall increasein total Group 1 bank risk-weighted assets of 7.9%.The predominant drivers behind this figure are capital charges for CVArisk and the higher asset value correlation parameter, which is included inthe column labelled “CCR”.Trading book exposures and securitisation exposures currently subject todeduction under Basel II, also contribute significantly to higherrisk-weighted assets at Group 1 banks at 4.9% and 4.2%, respectively.Risk-weighted assets of Group 2 banks increase overall by 7.5%.Banks in this group tend to have smaller counterparty credit risk andtrading book exposures, which explains the lower increase risk-weightedassets for Group 2 banks as compared to Group 1 banks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  25. 25. P a g e | 25Securitisation exposures currently subject to deduction, CCR exposures,and exposures that fall below the 10% and 15% CET1 eligibility limits aresignificant contributors to changes in risk-weighted assets for Group 2banks.Changes in risk-weighted assets show significant variation across banksas shown in Chart 6.Again, these differences are explained in large part by the extent of banks’counterparty credit risk and trading book exposures, which attractsignificantly higher capital charges under Basel III as compared tocurrent rules. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  26. 26. P a g e | 26Liquidity6.1 Liquidity coverage ratioOne of the two standards introduced by the Committee is a 30-dayliquidity coverage ratio (LCR) which is intended to promote short-termresilience to potential liquidity disruptions.The LCR has been designed to require global banks to have sufficienthigh-quality liquid assets to withstand a stressed 30-day funding scenariospecified by supervisors.The LCR numerator consists of a stock of unencumbered, high-qualityliquid assets that must be available to cover any net outflow, while thedenominator is comprised of cash outflows less cash inflows (subject to acap at 75% of outflows) that are expected to occur in a severe stressscenario.102 Group 1 and 107 Group 2 banks provided sufficient data in the 31December 2011 Basel III monitoring exercise to calculate the LCRaccording to the Basel III liquidity framework.The weighted average LCR was 91% for Group 1 banks, compared to 90%for 30 June 2011, and 98% for Group 2 banks.These aggregate numbers do not speak to the range of results across thebanks.Chart 8 below gives an indication of the distribution of bank results; thethick red line indicates the 100% minimum requirement, the thin redhorizontal lines indicate the median for the respective bank group.47% of the banks in the Basel III monitoring sample already meet orexceed the minimum LCR requirement, an increase from 45% at the endof June 2011, and 62% have LCRs that are at or above 75%. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  27. 27. P a g e | 27For the banks in the sample, Basel III monitoring results show a shortfall(ie the difference between high-quality liquid assets and net cashoutflows) of €1.8 trillion (which represents approximately 3% of the €61.4trillion total assets of the aggregate sample) as of 31 December 2011, ifbanks were to make no changes whatsoever to their liquidity risk profile.This number is only reflective of the aggregate shortfall for banks that arebelow the 100% requirement and does not reflect surplus liquid assets atbanks above the 100% requirement. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  28. 28. P a g e | 28Banks that are below the 100% required minimum have until 2015 to meetthe standard by scaling back business activities which are mostvulnerable to a significant short term liquidity shock or by lengtheningthe term of their funding beyond 30 days.Banks may also increase their holdings of liquid assets.The key components of outflows and inflows are shown in Table 7.Group 1 banks show a notably larger percentage of total outflows, whencompared to balance sheet liabilities, than Group 2 banks.This can be explained by the relatively greater contribution of wholesalefunding activities and commitments within the Group 1 sample, whereasGroup 2 banks, as a whole, are less reliant on these types of activities. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  29. 29. P a g e | 2975% cap on total inflowsAs at 31 December 2011, no Group 1 and 16 Group 2 banks reportedinflows that exceeded the cap, compared to 19 Group 2 banks as at 30June 2011.Of the 16 Group 2 banks, three fail to meet the LCR, so the cap is bindingon them.Of the banks impacted by the cap on inflows, 12 have inflows from otherfinancial institutions that are in excess of the excluded portion of inflows. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  30. 30. P a g e | 30Composition of high-quality liquid assetsThe composition of high-quality liquid assets currently held at banks isdepicted in Chart 9.The majority of Group 1 and Group 2 banks’ holdings, in aggregate, arecomprised of Level 1 assets; however the sample, on whole, showsdiversity in their holdings of eligible liquid assets.Within Level 1 assets, 0% risk-weighted securities issued or guaranteedby sovereigns, central banks and PSEs, and cash and central bankreserves comprise the most significant portions of the qualifying pool,with the latter increasing its contribution to the overall composition to31.4% as at the end of December 2011 from 27.6% as at the end ofJune 2011.Comparatively, within the Level 2 asset class, the majority of holdings arecomprised of 20% risk-weighted securities issued or guaranteed bysovereigns, central banks or PSEs, and qualifying covered bonds. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  31. 31. P a g e | 31Cap on Level 2 assets€117 billion of Level 2 liquid assets were excluded because reported Level2 assets were in excess of the 40% cap as currently operationalised.23 banks currently reported assets excluded, of which 16 (8% of the totalsample) had LCRs below 100%.These results compare to €121 billion of Level 2 liquid assets excluded by34 banks as at 30 June 2011, of which 24% (11% of the sample) had LCRsbelow 100%.Chart 10 combines the above LCR components by comparing liquidityresources (buffer assets and inflows) to outflows.Note that the €710 billion difference between the amount of liquid assetsand inflows and the amount of outflows and impact of the cap displayedin the chart is smaller than the €1.8 trillion gross shortfall noted above as itis assumed here that surpluses at one bank can offset shortfalls at otherbanks.In practice the aggregate shortfall in the industry is likely to liesomewhere between these two numbers depending on how efficientlybanks redistribute liquidity around the system. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  32. 32. P a g e | 32Net stable funding ratioThe second standard is the net stable funding ratio (NSFR), alonger-term structural ratio to address liquidity mismatches and provideincentives for banks to use stable sources to fund their activities.102 Group 1 and 107 Group 2 banks provided sufficient data in the 31December 2011 Basel III monitoring exercise to calculate the NSFRaccording to the Basel III liquidity framework.51% of these banks already meet or exceed the minimum NSFRrequirement, compared to 46% at the end of June 2011, with 92% at anNSFR of 75% or higher as at 31 December 2011. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  33. 33. P a g e | 33The weighted average NSFR for the Group 1 bank sample is 98% while itis 95% for the Group 2 sample, compared to 94% for each of the Group 1and Group 2 samples as at 30 June 2011.Chart 11 shows the distribution of results for Group 1 and Group 2 banks;the thick red line indicates the 100% minimum requirement, the thin redhorizontal lines indicate the median for the respective bank group. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  34. 34. P a g e | 34The results show that banks in the sample had a shortfall of stablefunding of €2.5 trillion at the end of December 2011, a decrease from €2.8trillion at the end of June 2011, if banks were to make no changeswhatsoever to their funding structure.This number is only reflective of the aggregate shortfall for banks that arebelow the 100% NSFR requirement and does not reflect any surplus stablefunding at banks above the 100% requirement.Banks that are below the 100% required minimum have until 2018 to meetthe standard and can take a number of measures to do so, including bylengthening the term of their funding or reducing maturity mismatch.It should be noted that the shortfalls in the LCR and the NSFR are notnecessarily additive, as decreasing the shortfall in one standard may resultin a similar decrease in the shortfall of the other standard, depending onthe steps taken to decrease the shortfall. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  35. 35. P a g e | 35NUMBER 2Financial Services Agency, TheJapanese GovernmentRecent Trend of Financial and Capital Markets,Regulatory and Supervisory ChallengesRyutaro Hatanaka _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
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  43. 43. P a g e | 43NUMBER 3Investor Protection through AuditOversightLewis H. Ferguson, Board MemberCalifornia State University 11th Annual SEC Financial ReportingConference, Irvine, CAThank you for inviting me to speak today. I am delighted to be here insunny Southern California to share some thoughts with you aboutdevelopments in auditor oversight, the part of the financial reportinguniverse in which I now spend my time.Before I begin, I must tell you that the views I express today are my ownand do not necessarily reflect the views of the Public CompanyAccounting Oversight Board, any other Board member, or the staff of thePCAOB.Anyone involved in the financial reporting process deals daily with thehard realities of complexity and rapid change -- whether you are apreparer of financial statements, a board or audit committee member, aninvestor, an independent or internal auditor, a counselor, or a regulator.Commercial activity is increasingly global.Some financial instruments and transactions are bafflingly complex withvalues that can only be estimated.Standard setters in the United States and abroad are moving away fromhistorical cost accounting toward fair value accounting, requiring difficultestimates.There is a plethora of new rules and requirements growing out of theDodd-Frank and JOBS acts in the United States, and all of this ishappening in what since 2008 has been the most difficult global economicenvironment since the Great Depression of the 1930s. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  44. 44. P a g e | 44Much as we struggle with these rapid changes and their complexity,regulators also struggle to see around the curve, to be prepared for what iscoming tomorrow, and to have tools in their toolbox that will beappropriate for those challenges.In the next session of today’s conference, I will discuss a number ofspecific initiatives the PCAOB is undertaking to deal with some of thesechallenges, but in this address I want to focus on one specific area, thechallenge of globalization and cross-border financial reporting, auditingand audit oversight.A bit of background may be useful here.The PCAOB was created by the U.S. Congress in 2002, in response to acrisis stemming from the failures of enterprises like Enron, WorldCom,Adelphia and others.These cases all involved systemic and undetected financial andaccounting fraud.Congress concluded that these cases demonstrated that the longestablished system of auditor quality oversight by the auditing professionitself, known as peer review, was irretrievably broken.Accordingly, Congress created the PCAOB as an independent,not-for-profit body, whose five members are appointed by the UnitedStates Securities and Exchange Commission, to “oversee the audit ofpublic companies that are subject to the securities laws.”The Board’s mission is “protect the interest of investors and further thepublic interest in the preparation of informative, accurate, andindependent audit reports” for U.S. public companies.From its establishment in 2002, the PCAOB has grown to be anorganization with a projected 800 employees by the end of this yearlocated in 16 offices throughout the United States, including in Irvine andLos Angeles.To prevent capture by the accounting profession, Congress provided thatwhile two of the five PCAOB board members had to be CPAs, no morethan two could be. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  45. 45. P a g e | 45That leaves two of my fellow board members and me, including thePCAOB’s chairman, who are lawyers by training and profession.The PCAOB was assigned four principal functions by the statute:1. The first is to oversee and maintain the registration of all auditing firmswhether they are located here or abroad that file audit reports with theSEC or participate substantially in the audit of companies that file suchreports.In 2010, the Dodd-Frank Act also gave the PCAOB jurisdiction overauditors of registered brokers and dealers and required all such firms tobe registered.Today, 2,380 auditing firms are registered with the PCAOB including 570firms that audit brokers and dealers.Of the total, 1,465 firms are located in the United States and 915 firmsoutside the United States in 85 jurisdictions.The largest number of foreign registered firms are in China with 100firms, including 52 in Hong Kong and 48 in the People’s Republic ofChina, 66 in India, 64 in the U.K., 48 in Canada and 41 in Australia. 2. The second principal function of the PCAOB is periodically to inspectregistered firms that file or participate in the preparation of audit reportsof public companies and securities brokers and dealers.Any audit firm with more than 100 issuer audit clients must be inspectedannually and at least triennially if they regularly provide audit reports for100 or fewer issuers.In 2012, there are currently 9 annually inspected auditing firms.Our inspections are not randomly selected but are selected on the basis ofaudit risk, focusing on issues, industries, or firms where we believe thegreatest risk of audit failure may lie.Since its inception, the PCAOB has conducted more than 1,950inspections and examined portions of over 8,200 individual audits. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  46. 46. P a g e | 46In 2011, for example, for the 10 firms subject to annual inspection in thatyear, the PCAOB inspectors looked at portions of approximately 340audits.For the 203 firms inspected on a three-year cycle in 2011, portions ofapproximately 485 audits were examined, including 42 non-U.S. auditfirms located in 15 jurisdictions.We are scheduled to inspect approximately 80 non-U.S. firms in 2012.As part of an interim program for the inspection of brokers and dealers, in2011 and early 2012, we inspected 10 audit firms, examining portions of 23separate audits and issued a public interim report on those inspections inAugust of this year.3. Our third function is to set auditing and other professional standards.We have an ambitious standard-setting agenda that tackles old and newissues in auditing, particularly issues that surfaced after the recentfinancial crisis – from improving communications with audit committeesto reforming the auditor’s reporting model.In the next session of this conference, I will discuss in more detail thePCAOB’s standard-setting projects. 4. Our fourth and last principal function is to conduct investigations andenforcement proceedings.The Board has the authority to impose disciplinary sanctions, includingbarring auditors from public company auditing and imposing substantialmonetary penalties.Since 2003, the PCAOB has taken 55 disciplinary actions against 42registered accounting firms and 56 persons associated with registeredfirms.As part of these enforcement actions, the Board has revoked theregistration of 27 firms, barred 43 individuals, and suspended theregistration of five individuals and one firm.These are our four core functions: registration, inspections, standardsetting, and investigation and enforcement. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  47. 47. P a g e | 47Everything the Board does is in support of these functions. Other offices, particularly the Office of Research and Analysis, providesvaluable input.ORA’s staff of more than 30 economists and analysts study economictrends and the large bodies of confidential data we collect as part of ourinspection process.The broad reach of our activities gives us a unique perspective on thestate of audit practice in the United States and abroad, and on theoperations of major auditing firms.When the PCAOB was created in 2002, the United States was essentiallyalone in the world in having comprehensive regulation of the auditors ofpublic companies that was independent of the profession itself.Initially, Sarbanes-Oxley was seen by many, particularly outside theUnited States, as an effort to address something that was strictly anAmerican problem.But shortly after the failures of Enron and WorldCom, a series of majoraccounting failures were uncovered at non-U.S. companies, such asParmalat, Vivendi, Hollinger, Ahold, Royal Dutch Shell, China Aviationand others.As a result, many other countries began to adopt independent auditsupervisory regimes.Today, just 10 years after the creation of the PCAOB, almost all advancedor emerging market countries have an independent audit regulator.These regimes differ. Some like the PCAOB are independent agencies;others are housed in the local securities regulator.But they share certain common attributes: they are either governmentagencies or bodies that are independent of the audit profession; theyconduct regular inspections of audit firms; and they possess disciplinaryand sometimes licensing and standard-setting powers. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  48. 48. P a g e | 48We are grateful that the example of the PCAOB has encouraged thecreation of similar, independent audit oversight in othercountries—oversight that can only benefit the investors in our nationaland global markets.International CooperationIFIARIt is not surprising that these new regulators soon decided that theyshould form an organization for sharing views and helping each otherimprove their work.In September 2006, a group of 18 independent audit regulators formed theInternational Forum of Independent Audit Regulators, to provide a forumfor regulators to share knowledge of the audit market environment andthe practical experience gained from their independent audit regulatoryactivity.Only regulators that are truly independent of the auditing profession areeligible for membership which has grown steadily to 43 members todaywith another 13 candidate members in various stages of the applicationprocess.In addition to the United States, Canada and one South Americanregulator, most European regulators are members as well as severalregulators in the Middle East, and a number of Asian regulators,including those in Japan, Korea, Taiwan, Thailand, Malaysia, Singapore,Sri Lanka, and Australia.The United States has come to play a leadership role in IFIAR and I washonored recently to be elected Vice-Chair of the organization.IFIAR holds annual plenary meetings at which regulators from aroundthe world meet to exchange information on a variety of topics includinggeneral inspection and enforcement findings, standard-setting initiativesand cross-border cooperation.The next such meeting will be in London at the beginning of October. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  49. 49. P a g e | 49In addition, there are five working groups that meet more frequently andfocus on specific issues like standard setting, international cooperation,investor concerns, inspection training and public policy.One of the most important is the last, the Global Public Policy CommitteeWorking Group, that meets three times each year with the leadership ofthe six global network audit firms to discuss issues of concern to theregulators and the firms.IFIAR also conducts an annual inspection training workshop for auditinspectors from around the world.For the first time this year, IFIAR has surveyed its members about theiraudit inspection findings.Thirty-seven of the 43 IFIAR members responded to the survey and whilethe results are presently confidential, I can tell you that a striking result ofthe survey is that other regulators around the world seem to be finding thesame types of defects in their inspections that the PCAOB is finding,particularly deficiencies in auditing fair value measurements, testinginternal controls, revenue recognition and engagement quality controlreviews.The Global EnvironmentYou might ask why an organization like IFIAR is important.The short answer is that it enables individual regulators to get a betterwindow on the global landscape of audit practice and financial reporting.This is important because the world’s largest enterprises -- those thatrepresent the largest share of global economic activity and shareholderwealth -- operate globally.Not only do they sell products globally, but increasingly they purchaseraw and component materials, manufacture, distribute, and do researchand development globally.One only needs to look at some of the latest signature industrial products,like new automobiles, computer and smartphone products, or the Boeing787 airliner to realize that these products are produced from designs andcomponents sourced and manufactured in many different countries. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  50. 50. P a g e | 50A global company, perhaps operating in more than 100 countries, also hasfinancial reporting activities in many, if not all, of those countries.Any regulator, confined to a view within its own borders, can only see aportion, and often a small portion, of the activities and risks of such anenterprise.Cross-border regulatory cooperation, working together and sharinginformation, is vital to our common mission to improve the protection ofinvestors who rely on auditors to assure that the financial reports ofpublicly traded companies are transparent, complete and fairly stated.Just as the largest corporations in the world have become increasinglyglobal in their operations, their auditors must be able to conduct auditson a global basis.The largest audit firms have grown globally along with their clients.But unlike their corporate clients, which usually operate globally througha centrally controlled structure of parent and subsidiary entities, theglobal audit firms operate as an affiliation of individual audit firms.They are organized and operating under the laws of different political andregulatory jurisdictions joined together in networks where they shareclients, training, audit methodologies, and quality assurance practices. They operate under a common name such as Deloitte Touche Tohmatsu,Ernst & Young, PricewaterhouseCoopers, KPMG, Grant Thornton andothers.There are a number of reasons for such structures: local licensing andownership requirements; different traditions of training and practice; andnot least, concern about cross border liability exposure.The global organization of these networks provides common auditmethodologies, conducts quality assurance examinations and providesother services.But in the final analysis, the only real power the global leadership has overits individual members is the power to remove a member from thenetwork. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  51. 51. P a g e | 51This is a very different power from that of the chief executive officer of aglobal corporation over his or her far flung subsidiaries.In the audit of a major global corporation, a number of different auditingfirms, operating under a single trade name, will cooperate to perform theaudit of the corporation’s global operations.Today, the auditor’s report on such a corporation is signed by only onefirm in the network and does not reveal whether other affiliated firmsparticipated in the audit or the extent of their participation.The reality of today’s global business environment means that regulatorsaround the world must do the same thing. We must cooperate effectivelywith each other if we are to ensure that audit quality remains high andthat investors are protected.Details of the PCAOB’s Cooperative Arrangements with OtherRegulatorsThe PCAOB cooperates closely with audit regulators outside the UnitedStates, and the scope of that cooperation is extensive.Since 2005, we have conducted 338 inspections of PCAOB registeredfirms in 38 different countries.We have cooperative agreements with 14 foreign regulators in Australia,Canada, Dubai, the U.K., Germany, Israel, Japan, the Netherlands,Norway, Korea, Singapore, Spain, Switzerland, and Taiwan as a result ofwhich we either conduct joint inspections or share inspection findingswith regulators in those jurisdictions.We are also actively negotiating such agreements with regulators in anumber of other European countries.We have conducted international inspections, both alone and jointly, withthe local regulator.We have found that joint inspections are particularly useful and haveconducted them with regulators in Canada, Switzerland, the UnitedKingdom, Germany, Norway and the Netherlands. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  52. 52. P a g e | 52We will shortly conduct joint inspections with the Spanish and Koreanaudit regulators.In these inspections, we have faced and resolved difficult data protectionissues that are of great concern to regulators in the European Union.We have also resolved confidentiality concerns that Swiss regulators haveraised.The joint inspections have demonstrated that with a cooperativeapproach many obstacles can be overcome.In joint inspections each regulator learns from the other and we areconvinced that these inspections have improved regulatory oversight bothby the PCAOB and by our foreign counterparts.Limits on PCAOB Inspections and their Effects on InvestorsI want to talk now about some of the limits to the PCAOB’s ability toinspect non-U.S. audit firms registered with us and the potential risks thisposes to U.S. investors.The PCAOB currently is prevented from inspecting the U.S.-companyrelated audit work and practices of PCAOB-registered firms in certainEuropean countries, China, and – to the extent their audit clients haveoperations in China – Hong Kong.In Europe, the obstacles to inspection center around the requirement tosatisfy the individual country’s data protection requirements underEuropean Union law.After some delay, we are now making progress and have cooperativeagreements with several European Union regulators.We continue to negotiate with others.Where the PCAOB is not able to conduct inspections, investors inU.S.-traded companies who rely on the audit reports of firms in thosecountries are deprived of the potential benefits of PCAOB inspections ofthose firms. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  53. 53. P a g e | 53To better inform investors about our inspections, the PCAOB publisheson its website a list of more than 400 companies whose auditors arelocated in jurisdictions where obstacles to PCAOB inspections exist.The list is derived from annual reports filed with the PCAOB byregistered public accounting firms.ChinaNow, let me turn to China. As you are probably aware, in the past year orso, alleged serious financial frauds and attendant accounting problemshave been disclosed involving a number of China-based companieswhose securities are registered outside of China, particularly in theUnited States, Singapore and, to a lesser extent, Europe.Not more than a decade ago, Chinese firms began to access foreigncapital markets.Two types of Chinese companies sought access to U.S. capital markets,smaller enterprises that had difficulty accessing the very restrictedChinese domestic capital markets and some of the largest state-ownedenterprises in industries such as petroleum and telecommunications.At the same time some of the largest global companies, including U.Scompanies, began to engage in extensive operations in China.The smaller companies most commonly sought access to U.S. markets bymerging with existing, registered U.S. shell companies in reversemergers.The larger companies filed initial public offerings.A PCAOB Research Note showed that, in the United States alone,between January 1, 2007 and March 31, 2010, 159 Chinese companiesentered the U.S. securities markets using reverse mergers and generatedmarket capitalization of $12.8 billion.These transactions represented the largest share of the reverse mergermarket during that period. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  54. 54. P a g e | 54In the same period, 56 Chinese companies, including a number of verylarge state-owned enterprises completed U.S. IPOs and had an aggregatemarket capitalization of $27.2 billion.Seventy-four percent of these reverse merger companies were audited byU.S.-based audit firms and China-based audit firms audited the balance,but all of these firms were registered with the PCAOB.As major U.S. companies like General Motors, IBM, Microsoft, AppleComputer, Proctor & Gamble, General Electric and Walmart began tobuild extensive operations in China, the China and Hong Kong basedaffiliates of the global network audit firms began to play an increasingrole in the consolidated audits of those companies.Beginning in the latter part of 2010, alleged financial frauds and seriousaccounting issues were revealed at a number of the smaller Chinesereverse merger companies.To date, 67 of these China-based issuers have had their auditor resign,and 126 issuers have either been delisted from U.S. securities exchangesor “gone dark” – meaning that they are no longer filing current reportswith the SEC.Billions of dollars of market capitalization of such companies have beenlost in U.S. securities markets and it is fair to say that all of these smallerChina-based companies listed on U.S. securities exchanges have sufferedserious losses of both market value and investor confidence as a result ofthe problems of other companies.The number of China-based companies that have successfully filed aninitial public offering in the United States in the past year has slowed to atrickle.We understand that smaller Chinese companies have also suffered similaradverse consequences in other non-U.S. and non-Chinese markets.At present, the PCAOB does not have cooperative agreements with eitherthe China Securities Regulatory Commission or China’s Ministry ofFinance which share jurisdiction over Chinese accountants. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  55. 55. P a g e | 55The CSRC has jurisdiction over the 53 accounting firms, including theaffiliates of the global network firms that are authorized to file auditreports with respect to companies listing securities on the Chinesedomestic securities markets in Shanghai and Shenzhen.The MOF licenses all accountants in China and has jurisdiction overmore than 7,000 accounting firms in China, including some of the firmsregistered with the PCAOB.Under Chinese law, it is illegal to remove audit work papers from China.At the present time, Chinese authorities will also not permit anynon-Chinese regulator to conduct inspections on Chinese soil.As a result, it is impossible for the PCAOB or other regulators to inspectChina-based audit firms or to assess the quality of such firms registeredwith it.This limitation also applies to the affiliates of the global network firmsthat perform audit work on the audits of the Chinese operations of thelarge global companies operating in China.In an attempt to address these problems, the PCAOB has intensified itsdialogue with both the China Securities Regulatory Commission and theMOF over the past year.Both we and the Chinese regulators recognize the importance ofimproving audit quality and investor protection.For the PCAOB, an agreement with China is important not only becauseof the risks investors face, but because of the size and rapid growth of theChinese economy.Almost 5 percent of PCAOB registered firms are based either in China orHong Kong, the largest group of non-U.S. firms.Chinese authorities say that we should rely on their oversight of auditors.They have two principal concerns.The first is that any action by a foreign regulator on Chinese soil, even amere inspection, could violate Chinese sovereignty. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  56. 56. P a g e | 56This concern has deep historical roots, specifically relating to thehumiliations that China suffered at the hands of Western powers in thenineteenth and early twentieth centuries.The second concern grows out of China’s very expansive state secrecylaws.There has been a concern expressed that inspection of audit work papers,particularly work papers from the audits of state-owned enterprises, couldlead to disclosures of state secrets.The question for both countries is how to conduct inspections in waysthat respect national sovereignty and the legitimate regulatory goals ofboth countries.As mentioned earlier, we have been able successfully to navigate orbalance these seemingly competing interests in a number of countriesaround the globe.As a first step toward further cooperation, we are working toward andhave tentatively agreed on observational visits where PCAOB inspectorswould observe the Chinese authorities conducting their own auditoversight activities and the Chinese could observe the PCAOB at work.This would not be a substitute for a PCAOB inspection but would be atrust building exercise between regulators.Initially, such observations would focus on quality control examinationsof the audit firm being examined rather than a substantive review of aspecific audit.We hope such exercises will build trust and lead to further cooperation.The ultimate goal for the PCAOB is to achieve a level of cooperation withthe Chinese authorities that will enable us to have enough informationand confidence that we could issue inspection reports on thoseChina-based audit firms that prepare or participate substantially in thepreparation of audit reports filed in the United States.There is, however, a second and complicating issue with China and HongKong. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  57. 57. P a g e | 57Both the PCAOB and the SEC are in discussion with Chinese authoritiesabout cooperation in connection with investigative activities.Both agencies are seeking the cooperation of the Chinese authorities inobtaining documents in appropriate investigations.Although we remain hopeful that breakthroughs will be achieved, to datedifficulties remain.Despite our hopes, the question arises as to what happens if we are notable to achieve an agreement on regulatory cooperation with the Chinese.Any firm that registers with the PCAOB is legally obligated to cooperatewith us and provide documents and potentially testimony if requested inconnection with an inspection or investigation.A refusal to cooperate, either in an inspection or an investigation, couldsubject the firm to PCAOB sanctions even if motivated by compliancewith local laws that restrict such cooperation.One possible sanction could be revocation of a firm’s PCAOBregistration.Any company audited by such a firm would either have to get a new auditopinion signed by a firm registered with the PCAOB or risk being inviolation of SEC and stock exchange rules.The stakes in this matter are very high.But U.S. financial authorities have a primary responsibility to protect theintegrity of our capital markets and the interests of U.S. investors.We believe the Chinese authorities are aware of the seriousness of thismatter and we are hopeful that we will be able to work out satisfactoryarrangements.We continue to engage in dialogue with the Chinese authorities, but atthis time it remains uncertain where this dialogue will ultimately lead. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  58. 58. P a g e | 58Other Steps to Improve Transparency in Audit ReportsAffecting Global EnterprisesThe PCAOB has also proposed another step to increase the transparencyof the audits of global enterprises.Today, the typical audit report for a U.S-listed company is a one-pagedocument.It provides general information about how every audit must be conductedand states that the audit complied with applicable standards.It gives the firm’s opinion on the company’s financial statements,including internal controls over financial reporting where appropriate,and concludes with the signature of the firm that issued it.In this era of global networks firms, that signature does not tell the fullstory.An audit report on a multi-national company may carry the signature ofone audit firm, but gives the reader no hint about the key participants inthe audit, including whether portions of the audit were conducted by anaffiliated firm in the global network or by another auditor.The audit report also gives no information about how the audit work wasallocated among firms.In October 2011, the Board proposed amendments to PCAOB auditingstandards that would require audit reports to disclose the name of theaudit engagement partner as well as the identity of other independentaudit firms or persons that provided 3 percent or more of the total hours inthe most recent audit.These amendments, if approved by the Board and the SEC, would servetwo purposes.First, they would give investors more information about which firms areactually performing work in the audit which many investors have told usthey want; and second, they would make publicly available the names offirms that have provided more than 3 percent of the total audit hours but _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  59. 59. P a g e | 59are located in jurisdictions where the PCAOB cannot yet conductinspections.Investors can then make a more informed decision about the quality ofthe firms participating in a company’s audit.Some Issues in International Registrations and InspectionsFinally, I want to address an issue we have faced in connection with theregistration of certain non-U.S. audit firms as well as certain findings ininternational inspections.As mentioned above, U.S. securities laws require that any company withsecurities traded in U.S. markets be audited by an accounting firmregistered with the PCAOB.Registration subjects each firm to the oversight activities assigned to thePCAOB for the protection of investors including inspections andenforcement.In 2010, the PCAOB began to request additional information from certainfirms applying for registration.Essentially, we asked the firm to provide assurance -- including writtenconfirmation from its national regulatory authority -- that the PCAOBwould be able to inspect the firm.We have requested such information from applicants from China, HongKong and certain European countries.To date, one firm’s registration has been rejected by the Board because itcould not offer that assurance, and several other firms’ applications were,at the firms’ request, essentially put on hold until they are able to providethis assurance.Some of those applications have since been approved as the Boardreached agreements with the regulators.Since 2005, the PCAOB has inspected portions of more than 825 auditsperformed by 213 registered firms based outside the United States. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  60. 60. P a g e | 60Seven years of international inspections have revealed that too oftenauditors are missing some basic things and making troubling errors,including errors in the timing and documentation of a company’s revenuerecognition; overreliance on managements’ estimates of such things ascontingency and warranty reserves, allowances for doubtful accounts infinancial institutions, hard to value financial instruments, and obsolete orovervalued inventory.These problems are not confined to inspections of non-U.S. firms and wehave seen similar deficiencies in the audits of U.S.-based auditors.Many of these problems could be solved if auditors approached their jobswith a higher degree of independence, objectivity and, perhaps mostimportant, professional skepticism.Auditors are supposed to challenge management, and the PCAOB wouldlike to see more auditors do so.In the same vein, PCAOB inspections continue to find that firms aredeficient in aspects of their internal governance.More specifically, in an international context, our inspectors have founddeficiencies in the quality control mechanisms within the global networkfirms, in the supervision by the principal auditor of work performed byaffiliated firms and in their referral of work to non-affiliated firms orspecialists.We continue to pursue these issues actively directly with individual firms,with the leadership of the global auditing network firms, and through ourrole as a member of the Global Public Policy Committee Working Groupof IFIAR which meets with the leadership of the global practice firmsthree times each year.That Working Group has concentrated on questions around professionalskepticism, engagement quality control review, group audits, revenuerecognition, sovereign debt issues, the role of the audit committee andthe auditor’s reporting model. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  61. 61. P a g e | 61ConclusionIn the economic crisis that reached its nadir in 2008 we saw well-knowncompanies—notably Lehman Brothers—whose bankruptcies eclipsedthe failures of Enron and WorldCom in 2002.What is more sobering is that the economic climate remains uncertain,with weak job growth in the United States, uncertainty inside theEuropean Community and a slowing of business growth in China.Despite these uncertainties globalization of the world economy continuesapace.This is just the time that investors most need protection.We may claim a large company as our own because its headquarters iswithin our national borders, but, more likely than not, the company isdoing business globally and seeking capital in markets in other countries.As a consequence, it is the duty of all of us involved in the financialreporting process, whether as preparer, manager, audit committeemember, auditor, counselor or regulator to work to ensure that financialreports are complete, transparent, and fairly stated, wherever theoperations they reflect are located.We owe that to investors who are, after all, our fellow citizens.Thank you for your attention. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  62. 62. P a g e | 62NUMBER 4Annual public hearing of the chairpersonsof the three European SupervisoryAuthorities (EBA, ESMA and EIOPA).Initial statement by Andrea Enria Chairperson of the EBA, infront of the Economic and Monetary affairs committee of theEuropean ParliamentDear Madame Chair, Honourable Members of this Committee,The sovereign debt crisis has had serious adverse consequences on thebanking sector in the euro area and the Single Market.The interconnection between banks and their sovereigns deepened,leading to a segmentation of the Single Market along national lines and toa dangerous volatility of deposits in some Member States.The concerns of investors translated into a freeze in bank funding,especially on the longer maturities, which could have triggered a massiveand disordered deleveraging process, with potentially large effects ongrowth and employment. Since the second half of 2011, the EBA arguedfor a three-pronged approach to address this situation:(i) Strengthening banks’ capital, to put them on a stronger footing tofinance the real economy and limit deleveraging;(ii) European interventions to support bank funding and break the linkwith the sovereigns; and(iii) Actions directly remedying the sovereign debt crisis, thus takingredenomination risk off the table.As supervisors, we tackled head on the first line of intervention, whichfalls directly in our remit.If we consider the capital injected in the system, for achieving thethreshold set in the 2011 stress test, and the adjustment in capitalpositions triggered by our Recommendation, which asked banks to set up _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  63. 63. P a g e | 63a Core Tier 1 buffer equal to 9% of risk weighted assets, with a prudentvaluation of sovereign exposures, the overall strengthening alreadyrealised is above € 190 bn – an amount very close to the recommendationissued by the IMF in the Autumn of 2011.The support measures already approved for Greek and Spanish banks willbring the final figure further up, to a significant amount.We managed this complex process ensuring that banks did not achievethe capital target by cutting back on lending to households andcorporates, especially small and medium enterprises (SMEs).We also fostered close cooperation between home and host authoritieswithin supervisory colleges, to avoid that the possible capital adjustmentwas affected by a home bias.The EBA is committed to pursuing its efforts to ensure that the action ofbalance sheet repair continues.In this respect, supervisory coordination should take place to ensure thatbanks apply conservative and consistent valuation of assets and takeactions to gradually restore the smooth funding of their activities inprivate markets.The unlimited supply of term liquidity by the ECB and by otherEuropean central banks, and the decision to move towards a BankingUnion, which we strongly support, are other key components of the policypackage to restore stability in the European banking sector.The Banking Union will have an impact on the responsibilities of theEBA as it will call on the whole Union for an even stronger commitmentto the Single Rulebook and for a leap towards truly unified supervisorymethodologies - a Single Supervisory Handbook - to assess the risks atbanks and to trigger corrective actions.Without such an effort, we risk a polarisation of the Single Marketbetween the euro area, with single rules and supervisory practices, andthe rest of the Union, which would operate with a still wide degree ofnational discretion in implementing and applying the Single Rulebook. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  64. 64. P a g e | 64The EBA has put a lot of effort in contributing to the action of regulatoryrepair and the establishment of the Single Rulebook, by preparing draftstandards in a number of areas defined by the proposed CRD4-CRR.At the request of the Commission, we also finalised a report on the capitalrequirements for SME lending, a topic that is receiving great attentionalso in your discussions.I believe we established a good working method, with open channels ofcommunication with this Committee and due process of openconsultation and impact assessment.This should allow us to promptly finalise our draft standards once thelegislative texts are approved.In the final stage of the negotiations, it is essential that all policy makersmaintain a strong commitment to rigorous and consistent rules, in linewith international standards.In the EU, these rules will be applied to all banks and should thereforeacknowledge the variety of business models and cultures.Proportionality will be a key concept in this respect.But in a large number of areas, it is essential that the yardsticks to assessthe solvency and liquidity of banks are effectively the same for all banks inthe Single Market.The strong pressure we faced to address the difficult situation in bankingmarkets and in contributing to the reform of banking rules determined aslower start in the accomplishment of our tasks in the area of consumerprotection.I am aware that the Parliament attaches great importance to these tasks.The urgency of making progress in this area is confirmed by the recentepisodes of mis-selling, poor compliance with anti-money launderingrules and manipulation of market benchmarks.We are now working at a much higher speed in these areas and envisageissuing important guidelines in the area of mortgage lending - onresponsible lending and on arrears management. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  65. 65. P a g e | 65Reviews of the risks for consumers and banks from financial innovationssuch as Exchange Traded Funds, Contacts for Differences and structuredproducts are also being finalised.Further work is taking place under the aegis of the Joint Committee.In conclusion, let me touch on the delicate issue of resources.We really appreciate the efforts made by the Parliament to strengthen ourresources.Notwithstanding the generous support provided by national supervisoryauthorities, which have seconded a significant number of staff at ourpremises during the periods of our most intense workload, it remainsdifficult for us to fulfil our tasks under such stringent resourceconstraints.While the amount of staff envisaged in the steady state situation, to bereached around 2015, is still commensurate to our tasks, there is an urgentneed to accelerate the process, as the difficult challenges we are facingrequire that the resources are available as soon as possible.Thank you for your attention. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  66. 66. P a g e | 66NUMBER 5Benoît Coeuré: Challenges to the singlemonetary policy and theEuropean Central Bank’s responseSpeech by Mr Benoît Coeuré, Member of theExecutive Board of the European CentralBank, at the Institut d’études politiques, Paris,20 September 2012.Ladies and gentlemen, It is a great pleasure forme to speak here today at Sciences Po Paris.9 August this year was the fifth anniversary of the start of the financialcrisis.The past few years have been times of hardship, financial turbulence andrisks.At the same time, the crisis has exposed weaknesses in the framework ofthe economic and monetary union and provided an impetus to strengthenits foundations and to begin the process of bringing all euro areacountries back to a more sustainable fiscal and macroeconomic path.The crisis has also brought challenges and opportunities for monetarypolicy, which is going to be the focus of my remarks today.Let me elaborate on two of them.The first challenge I will describe is that after Lehman’s collapse centralbanks had to combat exceptional threats to price stability arising fromfinancial instability and recessionary forces.At that time their standard tool of monetary policy – changes to theshort-term interest rate – was losing traction due to the dislocation in thefinancial system. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  67. 67. P a g e | 67Central banks had to quickly learn that this situation required switchingfrom normal operating mode, based simply on setting short-term interestrates, to crisis mode, aimed at sidestepping the obstacles to the standardchannels of monetary policy transmission.This experience has given us an opportunity to deepen our understandingof monetary policy and, in particular, to reject the textbook dichotomythat either the central bank is able to rely on the “interest rate channel” forthe transmission of its intentions, or else the economy is condemned tolasting instability.It is now clear that additional channels and conduits are available.The second challenge I want to discuss is the sovereign debt crisis andthe associated fragmentation of credit markets across national borders.Starting in 2010, the financial crisis began to unfold in the euro area byturning into a debt crisis for some sovereign issuers.This quickly spilled across markets and countries.And more recently, it was exacerbated by investors’ fears of thereversibility of the euro.The challenge faced by monetary policy in this environment is enormousand is testing the ability of the ECB to act as the central bank of a singlemonetary area with 17 fiscal jurisdictions.It has been increasingly challenging to preserve the singleness of themonetary policy and to ensure the proper transmission of the policystance to the real economy throughout the currency area.To address this situation, the ECB has taken a number of non-standardmeasures, and two weeks ago it announced the modalities forundertaking Outright Monetary Transactions in secondary markets forsovereign bonds in the euro area. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)
  68. 68. P a g e | 68I will describe the rationale for this decision and argue that it is a keyelement to ensure a lasting “monetary dominance” in the euro area,compliant with the Treaties.Channels of monetary policy in normal times and crisis timesIn normal times, monetary policy works primarily through inter-temporalfinancial arbitrage.In the Eurosystem, this arbitrage covers two different time dimensions.There is the weekly arbitrage cycle, through which the volume of centralbank liquidity is reallocated across banks trading in the money market inthe period between two consecutive weekly Eurosystem main refinancingoperations (MROs).The reason for this reallocation is that – as a matter of routine, at least –the Eurosystem provides reserves at weekly intervals.While the banking sector’s need for reserves in the aggregate may notchange significantly within a week, the cash needs of individual banks dofluctuate at higher frequencies, probably daily.So banks with liquidity deficits in the infra-weekly period need to borrowfrom banks with liquidity surpluses.The price at which these trades of liquid reserves between banks occur,i.e. the overnight interest rate (of which a euro area average, the EONIA,is computed and published every day by the ECB), is influenced byexpectations of the cost of Eurosystem credit – the so-called MRO rate –at the next weekly monetary policy operation.A short-term inter-temporal arbitrage calculus anchors the overnightinterest rate applied on the credit transaction between banks that needliquidity and banks that have a liquidity surplus.The second dimension of the inter-temporal calculus has a longer horizonand a wider scope of application across asset classes. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)