Risk management presentation May 13 2013

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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
week's agenda, and what is next
Dear Member,
Lifeisbecoming morecomplex for risk
managers.We must have a ―forward-looking
perspective‖, remember?
We have all thesenew lawsand regulations…
… but wealsohave rules, proposalsand reportstoconsider.
Have you everdiscoveredthecommon elementsof thevarious
initiatives,includingthe Volcker rule in the United States, the proposalsof
theVickers Commission for the United Kingdom, the LiikanenReport to
theEuropean Commission?
LeonardoGambacorta andAdrian van Rixtel from the Monetaryand
EconomicDepartment of the BISwill help ustoday to seethecommon
elementsand the differences!
This is a great analysis! We read:
TheVolcker rule isnarrow in scope but otherwisequitestrict.
It is narrow in that it seekstocarveout onlyproprietarytradingwhile
allowingmarket-makingactivitieson behalf of customers.
Moreover,it hasseveralexemptions, includingfortransactionsinspecific
instruments,such asUS Treasuryand agencysecurities.
International Association of Risk and Compliance Professionals (IARCP)
www.risk-compliance-association.com

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It is strict in that it forbids the coexistenceof such trading activitiesand
other banking activitiesin different subsidiarieswithin thesame group.
It similarlypreventsinvestmentsin, and sponsorship of, entitiesthat
could expose institutionsto equivalent risks,such ashedgefundsand
privateequityfunds.
That said, it imposesvery few additionalrestrictionson thetransactions
of banking organisationswith other financial firmsmore generally(eg
such asthrough constraintson lendingor funding among them).
However, it is worthrememberingthat the current US legislationdoes
constrain theactivitiesof depositoryinstitutions.
TheLiikanenReport proposalsaresomewhat broader in scope but less
strict.
Theyare broader becausetheyseek to carve out both proprietarytrading
and market-making, without drawinga distinctionbetweenthe two.
Theyare lessstrict becausetheyallowtheseactivitiestocoexist with
otherbankingbusinesswithinthesamegroupaslongasthesearecarried
out in separate subsidiaries.
Theproposalslimit contagion withinthegroup by requiring, in
particular, that the subsidiaries be self-sufficient in termsof capital and
liquidityand that transactionsbetweenthe legal entitiestakeplace on
market terms.
Just like theVolcker rule, theproposalsdo not envisagesignificant
restrictionsbetweentheprotected bankingunit and other financial firms,
except that theyrequire the separation of exposuresto entitiessuchas
hedgefundsand special investment vehicles(SIVs) in thetradingentity.
TheVickersCommission proposalsare evenbroader in scope but have a
more articulatedapproachtostrictness.

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Read moreat Number 3below.
Welcometo the Top 10list.
BestRegards,
GeorgeLekatis
President of the IARCP
General Manager, ComplianceLLC
1200G Street NW Suite800,
Washington DC 20005,USA
Tel: (202) 449-9750
Email: lekatis@risk-compliance-association.com
Web: www.risk-compliance-association.comHQ:
1220N. Market Street Suite804, Wilmington DE
19801,USA
Tel: (302) 342-8828

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GovernorDaniel K. Tarullo
At the Peterson Institutefor International
Economics,Washington, D.C.
Evaluating Progress in Regulatory Reforms
to Promote Financial Stability
Morethanfive yearsafterthefailureof BearStearnsmarkedanescalation
of the financial crisis, and nearlythreeyears sincethepassageof the
Dodd-FrankAct, debate continuesover the appropriateset of policy
responsestoprotect against financial instability.
Letters…
… betweenAndrew Tyrie
MP, and theExecutive
Directorof the Prudential
RegulationAuthority, Andrew
Bailey, discussingSolvency II.
BIS Working Papers, No 412
Structural bank regulation initiatives:
approachesand implications
LeonardoGambacorta andAdrian van
Rixtel, Monetaryand Economic Department

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CIMA Statement onAIFMD
April 12, 2013TheCayman IslandsGovernment
passedan amendment on 15March, 2013, which
will allowtheCayman IslandsMonetaryAuthority (CIMA) to enter into
memorandaof understanding withitsEU counterparts, usinga model
MoU developedby the European Securities MarketsAuthority (ESMA).
Theamendment wasa responseto theEuropean Union‘sAlternative
Investment Fund ManagersDirective(AIFMD), which will require
certainconditionstobe met beforenon-EU countries can market
alternativeinvestment funds– such ashedgefunds– in theEU.
―Acomfortable position for German banks‖
TheBundesbank currentlyseesno signswhatsoeverof a credit shortage
or a tighteningof lendingstandardsin Germany.
―Germanbanksare in a pretty comfortableposition at themoment.
Remarks by the Superintendent
Julie Dickson, Office of the
Superintendent of Financial Institutions Canada (OSFI)
tothe 2013Financial ServicesInvitational Forum, Cambridge, Ontario

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Switzerland – developments and
challengesin 2012from a monetary
policy perspective
Speechby Mr ThomasJordan, Chairman of
theGoverning Board of the SwissNational Bank, at theAnnual General
Meetingof Shareholdersof theSwissNational
Bank, Berne
Challengesfor banking regulation and
supervision in the monetary union
Speechby Dr JensWeidmann, President of
theDeutsche Bundesbank, at the Deutscher
Sparkassentag2013,Dresden.
Testimonyon theImplementation of TitleII of
the JOBS Act
CommissionerElisseB. Walter
U.S. Securitiesand ExchangeCommission
BeforetheSubcommitteeonOversight andInvestigations,Committeeon
Financial Services, U.S. Houseof Representatives
―I appreciate theopportunitytotestifytodayregarding the
implementationof TitleII of the Jumpstart Our BusinessStartupsAct
(JOBSAct or theAct) by theCommission and itsstaff.‖

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MONETARY AND
FINANCIAL
DEVELOPMENTS
BankingSystem: Capitalisationremained strongunder the new Basel III
CapitalAdequacyFrameworkwithcommon equitytier1capitalratio,tier
1capital ratio and total capital ratioof 12.2%, 13.1% and 14.5%
respectively.
Thelevel of net impaired loansimproved to 1.3% of net loans,while the
loanlosscoverageremainedwell above 90%.

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GovernorDaniel K. Tarullo
At the Peterson Institutefor International
Economics,Washington, D.C.
Evaluating Progress in Regulatory
Reforms to Promote Financial
Stability
Morethan five years after thefailure of
Bear Stearnsmarked an escalation of the
financial crisis,and nearlythree years
sincethe passageof the Dodd-FrankAct,
debate continuesover the appropriateset of policy responsesto protect
against financial instability.
In recent months, there hasbeen, in particular,a renewal of interest in
additional measurestoaddressthetoo-big-to-fail problem.
In some respects,the persistenceof debate is unsurprising.
After all, theseverityof thecrisisand ensuingrecession, and the
frustratinglyslowpaceof economic recovery, have properlyoccasioned
much thought about the structure of thefinancial system and the
fundamentalsof financial regulation.
Continuingdiscussionof theseissuesispart of a protractedpolicy
debate over financial regulatory reform.
Somearguethat littlehaschanged and that theneeded reform is a
single,dramatic policy change(though that singlepolicy differs
considerablyamongthosetakingthisview).
Others argue that reformsalreadyenacted aresufficient toensure
financial stability.

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Still otherscontend that there has alreadybeen too much of a regulatory
response, whichis suppressingcredit extension and faster economic
recovery.
I think most of uswouldacknowledge, upon reflection, that a good bit
hasbeen done, or at least put in motion, tocounteract theproblemsof
too-big-to-fail and systemic riskmore generally.
At thesametime, I believethat moreisneeded, particularlyinaddressing
therisksposed by short-term wholesalefundingmarkets.
This afternoon I wouldlike both to highlight the importanceof what has
already been accomplishedand, at somewhat greater length, toidentify
what I believeto bethe keystepsthat remain.
Beforeturningtothesesubjects,though, I beginwithabrief repriseofthe
originsof thefinancial crisis,toremind ourselvesof thevulnerabilities
that ledtothe crisis and that remain of concern today.
It should, but doesnot always, gowithout saying that proposed solutions
should actuallyhelp solvetheproblems at hand, and do soin a manner
that minimizesthe coststootherwiseproductive activities.
Vulnerabilities Exposed by the Crisis
Beginningin the 1970s, the separation of traditional lendingand capital
marketsactivitiesestablishedby New Deal financial regulationbeganto
break down under the weight of macroeconomic
turbulence, technologicaland businessinnovation, and competition.
During the succeedingthreedecadestheseactivitiesbecame
progressivelymore integrated, fueling theexpansion of what hasbecome
knownastheshadow banking system, includingtheexplosivegrowthof
securitizationand derivativeinstrumentsin the first decade of this
century.
This trend entailedtwomajor changes.

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First, it diminishedtheimportance of depositsasa sourceof fundingfor
credit intermediation, in favor of capital market instrumentssoldto
institutional investors.
Over time, thesemarketsbeganto servesome of thesamematurity
transformation functionsasthe traditional banking systems, whichin turn
ledtobothanexpansionandalterationoftraditionalmoneymarkets.
Ultimately, there was a vast increase in the creation of so-called cash
equivalent instruments, which were supposedly safe, short-term, and
liquid.
Second, thistrend alteredthestructure of theindustry, both transforming
theactivitiesof broker-dealersand fosteringthe emergenceof large
financial conglomerates.
There was,in fact, a symbiotic relationship betweenthe growthof large
financial conglomeratesand the shadow bankingsystem.
Largebankssponsored shadow banking entitiessuch asStructured
Investment Vehicles(SIVs), moneymarket funds, asset-backed
commercial paper conduits,and auctionrate securities.
Thesefirmsalsodominated the underwritingof assetspurchased by
entitieswithin theshadow banking system.
Though motivated in part by regulatory arbitrage, thesedevelopments
weredriven by more than regulatory evasion.
The growth and deepening of capital markets lowered financing costs for
many companies and, through innovations such as securitization, helped
expand the availabilityof capital for mortgage lending.
Similarly, the rise of institutional investorsasguardiansof household
savingsmade a widearray of investment and savingsproductsavailable
toa much greater portion of theAmerican public.

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But thesechangesalsohelped acceleratethefracturingof thesystem
established in the 1930s.
While the increasinglyoutmoded regulation of earlier decadeswas
eroded, no new regulatory mechanismswereput in placeto control new
risks.
When, in 2007, questionsaroseabout the qualityof some of theassetson
whichthe shadowbankingsystem wasbased--notably, thosetied to
poorlyunderwrittensubprime mortgages--aclassic adversefeedbackloop
ensued.
Investorsformerlywillingto lend against almost any asset on a
short-term, secured basisweresuddenlyunwillingtolend against a wide
rangeof assets, notablyincludingthe structured productsthat had
become central to theshadowbankingsystem.
Liquidity-strained institutionsfound themselvesforced to sell
positions,whichplaced additional downwardpressure on asset
prices,therebyacceleratingmargin callson leveraged actorsand
amplifying
mark-to-market lossesfor all holders of the assets.
Themargin callsand booked losseswouldstart another round in the
adversefeedbackloop.
Severerepercussionswerefelt throughout the financial system, as
short-termwholesalelendingagainstall but theverysafest collateralfroze
up, regardlessof theidentityof theborrower.
Moreover,asdemonstratedby the intervention of the government when
Bear StearnsandAIG werefailing, and by the aftermath of Lehman
Brothers' failure, theuniverse of financial firms that appeared
too-big-to-fail during periodsof stressextendedbeyond theperimeter of
traditional safetyand soundnessregulation.
In short, the financial industryin theyears preceding the crisishad been
transformedintoonethat washighlyvulnerabletorunsontheshort-term,

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uninsured cash equivalentsthat fed thenew system's relianceon
wholesalefunding.
Therelationshipbetweenlargefirms and shadow banking meant that
strainson wholesalefundingmarketscould both reflect and magnify the
too-big-to-fail problem.
Thesewerenot the relatively slow-developingproblemsof theLatin
American debt crisis, or even the savingsand loan crisis,but fast-moving
episodesthat risked turningliquidityproblemsintoinsolvencyproblems
almost literallyovernight.
However, notethat while thepresenceof too-big-to-fail institutions
substantiallyexacerbatesthe vulnerabilitycreatedbythenew
system, they do not define itslimits.
Even in theabsenceof anyfirm that mayindividuallyseem toobig or too
interconnectedtobe allowedto fail, the financial system can be
vulnerable tocontagion.
An external shock toimportant asset classescan lead to substantial
uncertaintyastounderlying values,a consequent reluctanceby investors
toprovideshort-term fundingtofirmsholdingthoseassets,a subsequent
spateof fire salesand mark-to-market losses,and thepotential for an
adversefeedback loop.
An effectiveset of financial reforms must addressboth theserelated
problemsof too-big-to-fail and systemic vulnerability.
Regulatory Responseto Date
As is obviousfrom the scope of the Dodd-Frank Wall Street Reform and
Consumer ProtectionAct and theamount of activityat the regulatory
agencies,reform effortsto datehave been extensive.
Theyhave alsobeen significant.

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Without trying to givea full review, let me draw your attention tosome of
themore notableaccomplishments,whichcan be categorizedin three
groups.
First, the basic prudential frameworkfor banking organizationsis being
considerably strengthened, both internationallyand domestically.
Central tothis effortare theBasel III changestocapital standards, which
createa new requirement for a minimum common equitycapital ratio.
This new standard requires substantial increasesin both the qualityand
quantityof theloss-absorbingcapital that allowsafirm toremain aviable
financial intermediary.
Basel III also established for the first time an international minimum
leverage ratio which, unlike the traditional U.S. leverage
requirement, takesaccount of off-balance-sheet items.
Second, a seriesof reformshavebeen targeted at the larger financial
firmsthat are more likely tobe of systemic importance.
When fullyimplemented, thesemeasureswill have formed a distinct
regulatoryand supervisorystructure on top of generallyapplicable
prudential regulationsand supervisoryrequirements.
Thegoverning principlefor this new set of rules is that larger institutions
should be subject to more exactingregulatoryand supervisory
requirements,whichshouldbecomeprogressivelystricterasthesystemic
importanceof a firm increases.
This principlehasbeen codified in Section 165of the Dodd-Frank
Act, which requiresspecial regulationsapplicablewithincreasing
stringencytolargebanking organizations.
Under this authority, theFederal Reserve will imposecapital surcharges
on theeight largeU.S.bankingorganizationsidentified in theBasel
Committeeagreement for additional capital requirementson banking
organizationsof global systemic importance.

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Thesizeof a surchargewill vary depending on the relativesystemic
importanceof thebank.
OtherrulestobeappliedunderSection165--includingcounterpartycredit
risk limits,stresstesting, and the quantitativeshort-term liquidity
requirementsincludedin the internationally-negotiatedLiquidity
CoverageRatio (LCR)--willapplyonlytolargeinstitutions,insomecases
with stricter standardsfor firmsof greatest systemic importance.
An important, related reform in Dodd-Frank wasthecreation of orderly
liquidationauthority, under whichthe Federal Deposit Insurance
Corporation can imposelosseson a failedsystemic institution's
shareholdersand creditorsand replaceitsmanagement, whileavoiding
runsand preservingthe operationsof thesound, functioningparts of the
firm.
This authoritygivesthegovernment a real alternativeto theHobson's
choiceof bailout or disorderlybankruptcythat authorities faced in 2008.
Similarresolutionmechanismsareunderdevelopment in other
countries,and international consultationsare underwayto plan for
cooperativeeffortsto resolvemultinational financial firms.
Athird set of reforms hasbeen aimed at strengtheningfinancial markets
generally, without regard to the statusof relevant market actorsas
regulated or systemically important.
Thegreatest focus, asmandated under TitlesVII and VIII of
Dodd-Frank, hasbeenon making derivativesmarketssaferthrough
requiringcentral clearing for derivativesthat can be standardized and
creatingmargin requirementsfor derivativesthat continuetobe written
andtraded outsideof central clearingfacilities.
Therelevant U.S.agenciesare working with their international
counterpartstoproduceaninternationalarrangement that willharmonize
theserequirementssoasto promote both global financial stability and
competitiveparity.

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In addition, eight financial market utilitiesengaged in important
payment, clearing, and settlement activitieshavebeen designatedby the
FinancialStabilityOversight Council assystemicallyimportant
and, thus, will now be subject toenhanced supervision.
Asyou can tell from my description, manyof thesereformsarestill being
refined or are still in the processof implementation.
Therather deliberatepace--occasionedasit is by the rather complicated
domesticand international decisionmaking processes--maybe
obscuringthe significanceof what will be far-reachingchangein the
regulation of financial firms and markets.
Indeed, even without full implementationof all the new regulations, the
Federal Reserve hasalready used its stress-testand capital-planning
exercisestoprompt a doublingin the last four years of thecommon
equitycapital of thenation's18 largest bank holdingcompanies, which
hold more than 70percent of the total assetsof all U.S.bank holding
companies.
The weighted tier 1 common equity ratio, which compares high-quality
capital to risk-weighted assets, of these 18 firms rose from 5.6 percent at
the end of 2008 to 11.3 percent in the fourth quarter of 2012, reflecting an
increase in tier 1common equity from $393 billion to $792 billion during
thesameperiod.
Gaps in Regulatory Reform
Despitethisconsiderableprogress,wehavenot yet adequatelyaddressed
all the vulnerabilitiesthat developed in our financial system in thedecades
precedingthe crisis.
Mostimportantly, relativelylittlehasbeendonetochangethestructureof
wholesalefunding marketssoastomake them lesssusceptibleto
damagingruns.

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It is true that some of the clearlyriskyforms of wholesalefundingthat
existedbeforethe crisis,such astheinfamousSIVs, havedisappearedor
substantiallycontracted.
But significant continuing vulnerability remains, particularly in those
funding channels that can be grouped under the heading of securities
financingtransactions(SFTs).
Repo, reverserepo, securitieslendingand borrowing, and securities
margin lendingarepart of thehealthyfunctioningof the securities
market.
But, in theabsenceof sensibleregulation, theyare alsopotentially
associated withthedynamic I describedearlier of exogenousshocksto
asset valuesleadingtoan adversefeedback loop of mark-to-market
losses,margin calls,and fire sales.
Indeed, some haveargued that this dynamic is exacerbatedby a
"maturityrat race," in whicheach creditoractstoshortenthematurityof
itslendingsoastofacilitate quick and easyflight, and in which creditors
payrelativelylittleattentiontotherecoveryvalueoftheunderlyingassets.
With respect to thetoo-big-to-fail problem, asI noted earlier, actual
capital levelsare substantiallyhigher than before thecrisis,and
requirementsto extend and maintain higher levelsof capital are on the
way.
Theregularization and refinement of rigorousstresstestingmay be the
singlemost important supervisoryimprovement to strengthen the
resilienceof largeinstitutions.
Thecreation of orderlyliquidationauthority and theprocessof resolution
planningadvance prospectsfor increasingmarket discipline.
But questionsremain asto whetherall this isenough to contain the
problem.

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Theenduring potential fragility of a financial system substantially
dependent on short-term wholesalefundingis especiallyrelevant in
consideringthe impact of severe stressor failure at thevery large
institutionswithvery largeamountsof such funding.
Concernabout theadequacyof policyresponsestodateis supportedby
some recent research that attempts to quantify the implicit funding
subsidyenjoyedbycertaininstitutionsbylookingtosuchfactorsascredit
ratingsuplifts,differentialsin interest ratespaid on depositsor in risk
compensation for bank debt and equity, andpremia paid for mergersthat
wouldarguablyplacethemerged firm in thetoo-big-to-fail category.
Thecalculationof a precisesubsidyis difficult, and each such effort will
likely occasion substantial disagreement.
But several measuresprovideat least directionallyconsistent results.
KeyAdditional Reform Measures
In sketchingout thekindsof stepsneededtoaddresstheseremaining
vulnerabilities,let me begin with wholesalefunding generally, and then
circle back totoo-big-to-fail.
Short-Term Wholesale Funding.
At a conceptual level, the policygoal is fairlyeasytostate: a regulatory
chargeor other measure that appliesmore or lesscomprehensivelytoall
usesof short-term wholesalefunding, without regard to the form of the
transactionsor whetherthe borrowerwasa prudentiallyregulated
institution.
Theaspirationtocomprehensivenessis important for tworeasons.
First, the risksassociated withshort-term fundingare asmuch or more
macroprudential astheyare firm-specific.

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From a microprudential perspective, SFTsare low risk, becausethe
borrowingisshort-dated, overcollateralized, marked-to-market daily, and
subjecttoremarginingrequirements.
Thedangersariseinthetail andapplytotheentirefinancialmarket when
thenormallysafe,short-term lendingcontractsdramaticallyin thefaceof
sudden and significant uncertaintyabout asset valuesand the condition of
counterparties.
Aregulatory measureshould force some internalization by market actors
of the systemic costsof this intermediation.
Second, to the degreethat regulatory measuresapply onlytosometypes
of wholesalefunding, or only to that used by prudentiallyregulated
entities,there will be a growingrisk of regulatory arbitrage.
Ideally, the regulatorycharge should apply whethertheborroweris a
commercial bank, broker-dealer, agencyReal EstateInvestment Trust
(REIT), or hedgefund.
Statingthegoal is easy, but executingit is not, preciselybecause
short-term wholesalefunding isused in a variety of forms by a variety of
market actors.
Determiningappropriately equivalent controlsisa challengingtask
and, withrespect toinstitutionsnot subjecttoprudential regulation, there
maybe questionsasto where--if at all--current regulatory authority
resides.
And, of course, thereis the overarching problem of calibratingthe
regulation soastomitigatethe systemic risks associated withthese
fundingmarkets, while not suppressingthe mechanismsthat have
become important parts of themodern financial system in providing
liquidityand loweringborrowing costsfor both financial and
non-financial firms.
For all thesereasons, it may well be that the abstract desirabilityof a
single,comprehensive regulatorymeasure may not be achievablein the
near term.

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Still, at least asa startingpoint, wewoulddo well to consider measures
that applybroadly.
Oneoption is tochangeminimum requirementsfor capital, liquidity, or
both at all regulatedfirmssoasto realize a macroprudential, aswell as
microprudential, purpose.
In their current form, existing and plannedliquidityrequirements
produced by the Basel Committeeaim mostlytoencourage
maturity-matched books.
While maturitymismatch by core intermediariesisa keyfinancial
stability riskin wholesalefunding markets,it is not the only one.
Even if an intermediary's book of securities financingtransactionsis
perfectlymatched, a reduction in its accessto fundingcan force the firm
toengagein asset fire salesor toabruptlywithdrawcredit from
customers.
Theintermediary's customersare likelytobe highly leveragedand
maturitytransformingfinancial firmsaswell, and, therefore,may then
haveto engagein fire salesthemselves.
Thedirect and indirect contagion risksare high.
Thus, thelong-term and short-term liquidityratiosmight berefashioned
soasto addressdirectlytherisksof largeSFT books.
Similarly, existingbank and broker-dealer risk-basedcapital rules donot
reflect fullythe financial stabilityrisksassociatedwithSFTs.
Accordingly, higher, generallyapplicablecapital chargeappliedto SFTs
might be a useful pieceof a complementaryset of macroprudential
measures,though an indirect measurelike a capital chargemight haveto
bequitelargetocreateadequateincentivetotempertheuseofshort-term
wholesalefunding.

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Bydefinition, bothliquidityandcapitalrequirementswouldbelimitedto
bankingentitiesalready within the perimeterof prudential regulation.
Theobviousquestionsare whether thesefirms at present occupyenough
of the wholesalefundingmarketsthat standardsapplicableonlyto them
wouldbereasonablyeffectivein addressingsystemicriskand, evenif that
question isansweredaffirmatively, whetherthe imposition of such
standardswouldsoon lead tosignificant arbitragethrough increased
participationby thoseoutsidetheregulatory circle.
In part for these reasons,a second possibility that hasreceived
considerable attentionis a universal minimum margining requirement
applicabledirectlytoSFTs.
TheFinancialStabilityBoardhasalreadyissuedaconsultativepaper,and
receivedpublic comment, on the idea.
Under such a regime, all repolenders, for example, could be required to
take a minimum amount of over-collateralizationasdeterminedby
regulators(the amount varying withthenature of the securities
collateral), regardlessof whethertherepolender or repoborrowerwere
otherwiseprudentiallyregulated.
This kind of requirement could be an effectivetool tolimit procyclicality
in securitiesfinancingand, thereby, tocontain the risksof runsand
contagion.
Of course,it alsoraisesmany of theissuesthat make settlingon a single
policy instrument sohard toachieve, and thedecision on calibration
wouldbe particularlyconsequential.
Still, theconcept hasmuchtobesaidforit and seemsthemost promising
avenuetowardsatisfying the principleof comprehensiveness.
It is definitelyworthpursuing.
As you can tell, thereis not yet a blueprint for addressingthebasic
vulnerabilitiesin short-term wholesalefundingmarkets.

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Accordingly, the risksof runsand contagion remain.
For thepresent, wecan continuetowork on discreteaspectsof these
markets,such asthrough thediminution of reliance on intradaycredit in
tripartyrepomarketsthat isbeing achievedby Federal Reserve
supervision of clearingbanks and through the moneymarket fund
reforms that I expect will be pursued by theSecurities and Exchange
Commission.
We might alsothink about lesscomprehensivemeasuresaffecting
SFTs,such aslimitson rehypothecation, whenan institutionusesassets
that havebeen posted ascollateral by itsclientsfor itsownpurposes.
But I donotthink that thepost-crisisprogram ofregulatoryreform canbe
judgedcomplete until a more comprehensiveset of measurestoaddress
thisproblem isin place.
Too-Big-to-Fail.
Before discussingpoliciesspecificallydirected at too-big-to-fail, let me
sayawordabout thecapitalregimethat shouldbeapplicabletoall
banks,on top of whichany additional requirementsfor systemically
important institutionswouldbe built.
ThefirstorderofbusinessistocompletetheBaselIII rulemakingassoon
aspossible.
Therequired increasesin thequalityand quantity of minimum
capital, and theintroductionof an international leverageratio, represent
important stepsforwardfor bankingregulationaround theworld.
U.S. bankshave increased their capital substantiallysincethefinancial
crisisbegan, andthevastmajorityalreadyhaveTier1common risk-based
ratios greater thanthe Basel III 7percent requirements.
Thenew requirements, while big improvements, are not ashigh asI
wouldhave liked, and the agreement containssome provisionsI would
haveomitted or simplified.

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In comingyearswemay well seek changes.
Indeed, I continuetobe a strong advocateof establishing
simpler,standardized risk-basedcapital requirementsand am
encouraged at theinitial workbeingdone on the topic of simplification
in the BaselCommittee.
And wewill certainlysimplify the final capital ruleshere in the United
Statessoasto respondtothe concernsexpressed by smallerbanks.
But opposing, or seeking delay in, Basel III would simply give an excuse
tobanksthat donot meet Basel III standards toseek delayfrom their own
governments.
It wouldbe ironic indeed if thosewhofavor higher or simpler capital
requirementswereunintentionallytolend assistanceto banksthat want
toavoid strengtheningtheir capital positions.
Turningto specificpoliciesto addresstoo-big-to-fail, the first task is to
implement fullythecapital surcharge for systemically important
institutions,theLCR, resolution plans,and other relevant proposed
regulations.
But, completion of this agenda, significant asit is, wouldleavemore
too-big-to-fail risk than I think is prudent.
What more, then, should be done?
As I have said before, proposalsto imposeacross-the-boardsize capsor
structural limitationson banks--whatever their meritsand
demerits--embodybasicpolicydecisionsthat areproperlytheprovinceof
Congress.
However, that doesnot mean there is norole for regulators.
On the contrary, Section 165of theDodd-FrankAct givestheFederal
Reservethe authority, and theobligation, to apply regulationsof

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increasingstringencyto large bankingorganizationsin order tomitigate
risksto financial stability.
In any event, it isunlikely that the problemsassociated with
too-big-to-fail institutionscan be efficientlyamelioratedusing a single
regulatorytool.
Theexplicit expectationin Section 165that therewill be a variety of
enhancedstandardsseemswell-advised.
We should be consideringwaysto usethis authorityin pursuit of three
complementaryends:
(1)ensuring the lossabsorbencyneeded for a credibleand effective
resolutionprocess,
(2) augmentingthe going-concern capital of thelargest firms, and
(3)addressingthesystemic risksassociatedwiththe use of wholesale
funding.
Thereisclearneedforarequirement that largefinancialinstitutionshave
minimum amountsof long-term unsecured debt that could be converted
toequityand therebybe availabletoabsorb lossesin theevent of
insolvency.
Although the details will, as always, be important, there appears to be an
emerging consensus among regulators, both here and abroad, in support
of the general idea.
Debt subjecttothis kind of bail-in wouldsupplement the increased
regulatorycapital in order to provide greater assurancethat, should the
firm become insolvent, all lossescould beborne usingresourceswithin
thefirm.
This requirement for additional "goneconcern" capital wouldincrease
theprospectsfor orderlyresolution and, thereby, counteract themoral
hazard associatedwithexpectationsof taxpayer bailouts.

P a g e | 24
Switzerland hasalreadyadopted a requirement of this sort, and similar
proposalsare beingactively debated in the European Union.
AU.S. requirement, enacted under theFederal Reserve's Section 165
authority, wouldboth strengthenour domestic resolution mechanisms
andbe consistent with emerging international practice.
With respect to "goingconcern" capital requirements, there is a good
casefor additional measurestoincreasethechancesthat large financial
institutionsremain viablefinancial intermediarieseven under stress.
Tome, at least, the important question isnot whethercapital
requirementsfor largebanking firms need to be stronger than those
includedinBasel III andtheagreement oncapitalsurcharges,but howto
make them soand withwhat specificrisksin mind.
In this regard, I wouldobservethat our stresstestsand capital-planning
requirementshave already strengthenedcapital standardsbymaking
them more forward-lookingand more responsive to economic
developments.
As wegain experience, and asthe annual processbecomessmoother for
both thebanksand the Federal Reserve, wehave the opportunityto
enhancethestresstestsby, for example,varying thescenarioforstressing
thetrading booksof the largest firms, soasto reflect changesin the
composition of thosebooks.
As to regulatorymeasuresof capital outsidethecustomizedcontext of
stresstesting, one approachisto revisit the calibrationof twoexisting
capital measuresapplicabletothe largest firms.
Thefirst isthe leverageratio. U.S.regulatorypracticehastraditionally
maintaineda complementary relationshipbetweenthe greater sensitivity
ofrisk-basedcapitalrequirementsandthecheckprovidedbytheleverage
ratio on too much leveragearising from low-risk-weightedassets.

P a g e | 25
This relationship has obviously been changed by the substantial increase
in the risk-based ratio resulting from the new minimum and conservation
buffer requirementsof Basel III.
Theexisting U.S. leverageratiodoesnot take account of
off-balance-sheet assets,whichare significant for manyof the largest
firms.
Thenew Basel III leverageratiodoesincludeoff-balance-sheet
assets,but it may havebeen set too low.
Thus, thetraditional complementarityof the capital ratiosmight be
maintainedby usingSection 165toset a higher leverageratiofor the
largest firms.
Theother capital measurethat might berevisited is the risk-based
capital surchargemechanism.
Theamountsof thesurchargeseventuallyagreedtoin Basel wereat the
lowerend of the rangeneeded to achievethe aim of reducingthe
probabilityof thesefirms' failuresenough to offset fullythe greater
impact their failure wouldhave on thefinancial system.
At thetimethesesurchargeswerebeingnegotiated, I favoredasomewhat
greater requirement for thelargest, most interconnected firms.
Here, after all, is where the potential for negative externalitiesis the
greatest, while the marginal benefits accruing from scale and scope
economiesare hardest to discern.
While it is clearlypreferable at thispoint to implement what wehave
agreed, rather thantoseekchangesthat could delayany additional capital
requirement, it maybedesirablefortheBaselCommitteetoreturn tothis
calibration issuesooner rather than later.
The area in which the most work is needed is in addressing the risks
arising from the use of short-term wholesale funding by systemically
important firms.

P a g e | 26
Thesystemic risksassociatedwithrunson wholesalefunding
would, almost by definition, be exacerbated if a very largeuser of that
fundingwereto comeunder seriousstress.
There could alsobegreater negativeexternalitiesfrom a disruption of
large, matched SFT positionson the booksof a major financial firm than
if the same total activitywerespread among a greater number of dealers.
Thus, in keepingwiththe principleof differential and increasingly
stringent regulationfor largefirms, there is a strong casetobemade for
takingstepsbeyond anygenerallyapplicablemeasuresthat areeventually
appliedtoSFTs or short-term wholesalefundingmore generally.
Onepossibilitywouldbe tohave progressively greaterminimum
liquidityrequirementsfor larger institutionsunder theLCR and the
still-under-construction Net StableFunding Ratio (NSFR).
Thereiscertainlysomeappealtofollowingthisroute,sinceit wouldbuild
on all thework done in fashioningtheseliquidityrequirements.
Theonlysignificant additionaltaskwouldbecalibratingtheprogressivity
structure.
However,there are at least twodisadvantagestothisapproach.
First, the LCR and, at leastat this stageof itsdevelopment, the
NSFR, both restontheimplicit presumptionthat afirm withaperfectly
matchedbook is in a fundamentallystableposition.
As a microprudential matter, this isprobablya reasonableassumption.
But under some conditions,thedisorderlyunwindof a single, largeSFT
book, even onethat wasquitewell maturitymatched, could set off the
kind of unfavorabledynamic describedearlier.
Second, creatingliquiditylevelssubstantiallyhigherthan those
contemplatedin theLCR and eventual NSFR may not be themost
efficient wayfor some firms tobecome better insulated from therun risk

P a g e | 27
that can lead totheadversefeedback loop and contagionpossibilities
discussed earlier.
Amore interesting approachwouldbe totie liquidityand capital
standardstogether byrequiringhigher levelsof capital for largefirms
unlesstheir liquidityposition is substantiallystronger than minimum
requirements.
Thisapproachwouldreflectthefact that themarket perceptionof agiven
firm'spositionascounterparty dependsupon the combinationof its
fundingposition and capital levels.
It wouldalsosupplement the Basel capital surchargesystem, whichdoes
not includeuseof short-term wholesalefunding among the factorsused
tocalculatethe systemic "footprint" of each firm, and thusdetermineits
relativesurcharge.
While thereisdecidedlyaneed for solidminimum requirementsfor both
capital and liquidity, the relationship betweenthe twoalsomatters.
Whereafirm haslittleneedof short-term fundingtomaintainitsongoing
business,it is lesssusceptibleto runs.
Where, on the other hand, a firm is significantlydependent on such
funding, it may need considerablecommon equitycapital to convince
market actorsthat it is indeed solvent.
Similarly, the greater or lesser useof short-term funding helpsdefine a
firm'srelativecontribution to thesystemic risk latent in thesemarkets.
If realized, thisapproach wouldallowa firm of systemic importanceto
choosebetweenholdingcapital in greater amountsthan wouldotherwise
berequired, or changingthe amount and composition of itsliabilitiesin
order to reducethecontribution it could make to systemic risk in the
event of a shock toshort-term fundingchannels.
Theadditional capital requirementsmight be tied, for example, to
specifiedscoresunder an NSFR that had been reworked significantlyso

P a g e | 28
asto takeaccount of themacroprudential implicationsof wholesale
fundingdiscussed earlier.
If one wishedto maintain thepractice of groundingcapital requirements
in measuresof assets,another possibilitywouldbe toadd asa capital
surchargea specifiedpercentageof assetsmeasuredsoastoweight most
heavily thoseassociatedwith short-term funding.
Toprovidea meaningful counterweight to the risksassociatedwith
wholesalefunding runs, the additional capital requirement wouldhaveto
bematerial.
Thehighest requirement wouldbe at just the point wherea firm had the
minimum required level of liquidity.
Therequirement then woulddiminish asthe liquidityscore of the firm
rosesufficientlyabove minimum required levels.
If therequirement weresignificant enoughandlikelytoapplytoanylarge
institution with substantial capital market activities,it might alsobe a
substitutefor increasingthecapital surchargeschedulealreadyagreed to
in Basel.
I readilyacknowledgethat calibratingtherelationshipwouldnot be
easy,and that the stakesfor both financial stability and financial efficiency
in gettingit right wouldbe significant.
But I think this approach isworth exploring, preciselybecauseit rests
upon the link betweentoo-big-to-fail concernsand the runsand
contagion that weexperiencedfive yearsago, and towhichweremain
vulnerable today.
Whether it provesfeasible, or whetherwewouldhave to fall back on the
more straightforwardapproach of strengtheningliquidityrequirements
for systemicallyimportant firms, the keypoint is that the principleof
increasingstringencybe applied.

P a g e | 29
Conclusion
Of late I find myself of two mindson thequestionof bringingto a close
themajor elementsof regulatory changefollowingthe financial crisis.
On theonehand, I stronglybelievethat all theregulatoryagenciesshould
completeassoon aspossiblethe remainingrulemakingsgenerated by
Dodd-Frank and BaselIII.
It is important that banks and other financial market actors know the
rules that will govern capital standards, proprietary trading, mortgage
lending, and other activities.
In fact, weshould monitor whethertheserulesend up havingsignificant
unintended effectson credit availability and, if so, modify them in a
mannerconsistent withbasicaimsofsafetyandsoundnessandconsumer
protection.
On theother hand, I equallystronglybelievethat wewoulddothe
American public a fundamental disservicewereweto declarevictory
without tacklingthestructural weaknessesof short-term wholesale
fundingmarkets, both in general and astheyaffect thetoo-big-to-fail
problem.
This is themajor problem that remains,and I wouldsuggest that
additional reform measuresbeevaluated by referencetohow effective
theycould be in solving it.

P a g e | 30
Letters…
… betweenAndrew Tyrie MP, and the ExecutiveDirector of the
Prudential RegulationAuthority, Andrew Bailey, discussingSolvency II.

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BIS Working Papers, No 412
Structural bank regulation initiatives:
approachesand implications
LeonardoGambacorta andAdrian van
Rixtel, Monetaryand Economic Department
Introduction
In responseto the global financial crisis, several
advancedeconomieshave either adopted or are consideringstructural
bank regulation measures.
Thecommon element of the variousinitiatives,includingthe ―Volcker
rule‖ in theUnitedStates, the proposalsof the VickersCommission for
theUnited Kingdom, the Liikanen Report totheEuropean Commission
anddraft legislationin Franceand Germany, isamandatoryseparationof
commercial bankingfrom certain securitiesmarketsactivities.
Theproposalsmark a paradigm shift.
Sincethe 1970s,in parallelwiththe deregulationof financial
markets,restrictionson banks‘businesslineshave been relaxed.
There wasa broad consensusthat bankswhichoffer a full rangeof
financial servicescan providethe largest economicbenefitsin a rapidly
growingglobal economy.
Diversificationof businesslines,innovationsinriskmanagement, market
based pricing of risks and market disciplinewereseen aseffective
safeguardsagainst financial risksassociatedwith therapid expansion of
largeuniversal banks.

P a g e | 36
The financial crisis has triggered a reassessment of the economic costs
and benefits of universal banks‘ involvement in proprietary trading and
other securitiesmarketsactivities.
With hindsight, manylargeuniversal banksshiftedtoomanyresourcesto
tradingbooks, supportedby cheap funding.
Thecomplexityof many banks weakenedmarket discipline, whiletheir
interconnectednessincreasedsystemic risk, contributingto contagion
withinand acrossfirms.
While thecrisishasshowntheneed to strengthenmarket-basedpricing of
riskandmarketdiscipline,theheavyburdenofbank lossesimposedon
taxpayers hasraised questionsabout theseparationof certain banking
activities.
Theproposedchangesdonot goasfar asthepreviousstrict separationof
commercial from investment banking that existed in some
jurisdictions,such asthe United States.
But for many countries, notablya number of continental European
ones,restrictionson universalbanking wouldbe new.
Anumber of questionsarise.
How effectivecan thesemeasuresbe in improving financial system
soundness?
What can their impact be on banks‘profitabilityand business
models,both nationallyand internationally?
This paper explorestheseissues.
Section 2considersin more detail the rationalebehind themeasuresas
well astheir similaritiesand differences.
Section 3 providesa basisfor evaluatingtheir effectivenessin promoting
financial stability.

P a g e | 37
Section 4 discussestheir implicationsfor banks‘businessmodels and
profitability.
Thelast sectionconcludes.
2. The initiatives: basic rationale and features
Thebasic rationalefor thestructural measuresis toinsulate certain types
of financial activitiesregarded asespeciallyimportant for thereal
economy,or significant on consumer/depositorprotectiongrounds,from
therisksthat emanate from potentiallyriskier but lessimportant
activities.
The line is generally drawn somewhere between ―commercial‖ and
―investment‖ banking businesses, restricting the universal banking
model.
Such a separation can, in principle, help in several ways.
First, and mostdirectly, it can shield the institutionscarrying out the
protected activitiesfrom lossesincurredelsewhere.
Second, it can prevent any subsidiesthat support the protectedactivities
(egcentral bank lendingfacilitiesand deposit guaranteeschemes) from
loweringthecost of risk-takingand encouraging moral hazard in other
businesslines.
Third, it can reducethe complexityand possiblysize of banking
organisations,making them easier tomanage, more transparent to
outsidestakeholdersand easier to resolve;this in turn could improve risk
management, contain moral hazard and strengthenmarket discipline.
Fourth, it can prevent the aggressive risk culture of the riskier activities
from infecting that of more traditional banking business, thus reducing
thescope for conflictsof interest.
In addition, some observershave noted that smallerinstitutionswould
reducethe risk of regulatory capture.

P a g e | 38
All thesemechanismswouldalsohelp tolimit taxpayers‘exposure to
financial sector losses.
Beyond this basic similarity, structural reform initiatives differ in scope
(where they draw the separation line) and strictness (how thick that line
is);
TheVolcker rule isnarrow in scope but otherwisequitestrict.
It is narrow in that it seekstocarveout onlyproprietarytradingwhile
allowingmarket-makingactivitieson behalf of customers.
Moreover,it hasseveralexemptions, includingfortransactionsinspecific
instruments,such asUS Treasuryand agencysecurities.
It is strict in that it forbids the coexistenceof such trading activitiesand
other banking activitiesin different subsidiarieswithin thesame group.
It similarlypreventsinvestmentsin, and sponsorship of, entitiesthat
could expose institutionsto equivalent risks,such ashedgefundsand
privateequityfunds.
That said, it imposesvery few additionalrestrictionson thetransactions
of banking organisationswith other financial firmsmore generally(eg
such asthrough constraintson lendingor funding among them).
However, it is worthrememberingthat the current US legislationdoes
constrain theactivitiesof depositoryinstitutions.
TheLiikanenReport proposalsaresomewhat broader in scope but less
strict.
Theyare broader becausetheyseek to carve out both proprietarytrading
and market-making, without drawinga distinctionbetweenthe two.
Theyare lessstrict becausetheyallowtheseactivitiestocoexist with
otherbankingbusinesswithinthesamegroup aslongasthesearecarried
out in separate subsidiaries.

P a g e | 39
Theproposalslimit contagion withinthegroup by requiring, in
particular, that the subsidiaries be self-sufficient in termsof capital and
liquidityand that transactionsbetweenthe legal entitiestakeplace on
market terms.
Just like theVolcker rule, theproposalsdo not envisagesignificant
restrictionsbetweentheprotected bankingunit and other financial
firms, except that theyrequire theseparation of exposuresto entitiessuch
ashedge fundsand special investment vehicles(SIVs) in the trading
entity.
TheVickersCommission proposalsare evenbroader in scope but have a
more articulatedapproachtostrictness.
Theyare broader in that theyexcludea larger set of banking business
from theprotectedentity, includingalsosecuritiesunderwritingand
secondarymarket purchasesof loansand other financial instruments.
Avery narrow set of retail banking businessmust be withintheprotected
entity(retail deposit-taking, overdraftstoindividualsand loanstosmall
and medium-sizedenterprises(SMEs));and another set may be
conductedwithin it (egsomeother formsof retail andcorporate
banking, includingancillaryoperationsto hedge risks to support them).
Theapproach to strictnessismore articulatedbecauseit involvesboth
intragroup and inter-firm restrictions(the―ring fence‖).
As in the LiikanenReport, protected activitiescan coexistwithothersin
separatesubsidiarieswithinthe same group but subject tointragroup
constraintsthat aresomewhat tighter, includingon the size of the
linkages.
Moreover,a seriesof restrictionslimit the extent to whichthe banking
unit within the ring fencecan interact with other financial sector firms.
An in-depthexploration of theeconomicunderpinningsof the
reforms is provided in Vickers(2012).

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Recent French and German reform proposalscan be seen asadaptations
of the Liikanenproposal.
Thenew Frenchbankinglaw proposal adoptsthesubsidiarisation
model, but allowsthedeposit-takinginstitutionto carry out more
activities, includingmarket-makingwithin limits.
Anew draft law on the separation of retail and some investment banking
activitiessubmittedtothe German Parliament considersseparationof
retail banking if assetsdevoted to proprietary or high frequencytrading
and hedgefund financingoperationsare relatively largein relationtothe
banks‘balancesheet.
3. Implications for financial stability and systemic risk
Dothevariousstructural regulatoryinitiativesstrengthen financial
stability?
Themechanismslistedabove have intuitiveappeal.

P a g e | 41
The question, though, is how far the various measures would be effective
in realising the hoped-for benefitsand whether theymay have unintended
sideeffects.
While it is difficult toprovidean answer,it is possibletolayout the
relevant considerations.
From a financial stability perspective, a preconditionfor theinitiativesto
be helpful is that banks whichcombine commercial and securities
businessarelesssafeorthat their failureismorecostlytothecommunity.
Theevidencesuggeststhat the costsof failure of universal banks can be
larger, sinceuniversal banking encouragessizeand complexity.
Theevidenceon theprobabilityof failureis much more indirect and
mixedbut, on balance, pointsin a similar direction.
For instance, a general conclusion is that growingrelianceon
non-interestincome – a very rough proxy for more investment
banking-like activities– hasnot resulted in lowerearningsvolatilityor a
declinein bank systematic risk, asderived from stock market returns.
Similarly, Box 1providestentativeevidencethatprofitsofsomewhatmore
diversified banks arehigher, but alsomore volatile.
Moreover, risk diversification benefits appear to be mostly restricted to
certain ranges of income sources or to geographical and loan portfolio
diversification.
Against thisbackdrop, a number of questions about the design of
structural regulationarise.
Afirst question concernswheretheseparation lineisdrawn.
Here, the philosophybehind theproposalsis quitedifferent.
TheLiikanenReport optsfor combining proprietarytradingand
market-makingactivitieson thegroundsthat the linebetweenthe twois

P a g e | 42
toofuzzy and hard toenforce– a controversial issuewith theVolcker rule
in theUnited States.
And theVickersReport takesa very narrow view of thetypesof activity
that needtobeprotectedonthegroundsthat disruptionstherecanhavea
largeimpact on economic activity.
Moreover,while theVickers Report arguesfor more stringent capital
requirementsfor theprotected activities,on importancegrounds, the
LiikanenReport arguesfor potentiallymorestringent onesforthetrading
business(and possiblyfor real-estaterelated lending), on risk grounds.
It is not unequivocallyclearthat the concentrationof tradingactivitiesin
separateentitieswill enhancefinancial stability.
Thesefirmsmay have lessstable, wholesalemarket-basedfunding
structures,while still beinghighly interconnectedwithother parts of the
global financial system.
This could give rise toconsiderablecontagion risk, asdemonstrated by
therepercussionsof the failure of Lehman Brothers on global bank
fundingmarkets.
Asecond question concernsthethicknessof the line.
How effectiveisit in insulatingthe protected partsof the banking
business?
Onetypical criticism of allowingthe activitiesto coexist within the same
group is that, especiallyat timesof stress,the linewill provenot
sufficientlystrongasreputational considerationsloom large.
In turn, any expectation that the linewill turn out tobe ineffectivewould
weakenmarket discipline.
Moreover,onlythe Vickers Report proposesmajor additional restrictions
on theinteractionsbetweenthe protectedbanking unitsand the rest of
thefinancial system.

P a g e | 43
Their effectivenessisyet tobe tested.
Athird questionconcernsthe possibilityof sidesteppingtheline
altogether.
Theworryis that risky activitiescould migrate outsidethe regulatory
perimeter.
In fact, one reason whythe LiikanenReport optsfor subsidiarisation
rather than full separationis tolimit thisrisk.
Migrationwouldbe a worryif thoseactivitiesproved to be systemic in
nature.
All thisputsa premium on effectiveresolutionmechanisms.
While structural separation may help resolvability, thebenefitsof the
proposalsdohingeon the adequacyof the resolutionschemesin place.
TheLiikanenReport, for instance, suggestsseveral complementarysteps
in this area.
Effectiveresolution schemesare especiallyimportant if, contrary to
expectations,the businesslinesleft outsidethe protectiveumbrellaresult
in systemic disruptions.
In this case, the pressure to ―bail out‖ the legal entities involved could be
very strong: this would put taxpayers‘ money on the line ex post and raise
moral hazard concernsex ante.
Yet another questionconcernstheinteractionbetweennationalstructural
bank regulation and international bankingregulation, such asBasel III.
Thetwotypes of regulation differ in approach and scope.
Thelattertakesbanks‘businessmodelsasgivenand imposescapital and
liquidityrequirementsthat depend on theriskiness of a bankinggroup‘s
business.

P a g e | 44
Theformer imposesconstraintson specific activities and typesof
business.
From this angle, the two approachescan be seen ascomplementary.
Indeed, certain aspectsof structural regulation– restrictionson leverage
for ring-fenced institutions– may reinforceelementsof Basel III.
At the same time, there may be challenges.
Onerisk, already alluded to, is that banksmay shift activitiesoutsidethe
perimeter of consolidated regulation in responseto structural regulation.
Another riskisthatstructuralregulation, especiallyif nationalapproaches
differ, will createbusinessmodels that are difficult to supervise.
For example, resolution strategiesmay berather complextodesign for
globallyoperatingbanksthat have tofaceincreasingheterogeneityin
permittedbusinessmodelsat thenational level.
Finally, structural regulation may lead to different capital and liquidity
requirementsfor thecore banking and tradingentitieswithin a single
bankinggroup.
Although thismay be intended, in practiceit hasimplicationsfor
regulatorystandardsapplied at the consolidatedlevel.
Some new evidence on risk diversification and economies of
scope
This box presentssome new preliminaryevidenceon the impact of
combining different businesslineson therisk return profile of banking
organisations.
Anovel aspect is that the analysis allowsfor thepossibilityof non-linear
effects,sothat the benefitsmay exist only withincertain ranges.
Theevidenceis basedon a sample of 108 international diversifiedbanks.

P a g e | 45
Product differentiationis proxied by theratio of non-interest income
(traderevenues, feesand commissionsfor services) to total income.
On balance, theevidenceindicatesthat benefitsdoaccrueup toa certain
degreeof diversificationin termsof return on equity(ROE).
However,bank profitabilitytendstobe more volatile for more diversified
banks(for details of the econometric analysis, seeAnnex B).
The twolinesin the upper part of the graph below represent the result of a
panel regression of bank ROE on the ratio of non-interest to total income
(diversificationratio) and itssquare.
Theregressionincludesfixed effectsfor each bank, aswell asa country
year interactionterm tocontrol for idiosyncratic and macro factors.
Thecurvesare drawnon thebasis of thetwoestimatedparameters.
Bluereferstothepre-crisisperiod (2000–07),whileredindicatesthecrisis
period (2008–11).
Thesymbolsindicateaveragevaluesobtainedby grouping banksby
jurisdictionin the twosub-periods.
Theresultsindicatethat revenue diversificationdoesincreaseROE, but
onlyup toa point, after whichROE declines.
While the optimal mix may have shiftedsomewhat towardsa smaller
shareof non-interest income in the post-crisisperiod, the resultsof this
exercisesuggest that economies of scope do exist onlyup toa certain
degreeof product diversification.
Thegreenlinein thelowerpanel representstheresult of across-sectional
regressionof banks‘coefficientsof variation of ROE – a proxy for risk –
on thediversificationratio, itssquare and country fixed effects.
Thegreen symbolsindicateaveragevaluesobtained by groupingbanks
byjurisdictionover the period2000–11.

P a g e | 46
Theeconometric analysisfindsthat ROE volatilityalsoincreases,up toa
point, with revenue diversification, after whichit declinesagain
Toread this excellent paper:
http:/ / www.bis.org/ publ/ work412.pdf

P a g e | 47
CIMA Statement onAIFMD
April 12, 2013TheCayman Islands
Government passedan amendment on 15
March, 2013,whichwill allowthe Cayman
IslandsMonetaryAuthority (CIMA) to enter
intomemoranda of understanding withitsEU
counterparts,usinga model MoU developed by theEuropean Securities
MarketsAuthority (ESMA).
Theamendment wasa responseto theEuropean Union‘sAlternative
Investment Fund ManagersDirective(AIFMD), which will require
certainconditionstobe met beforenon-EU countries can market
alternativeinvestment funds– such ashedgefunds– in theEU.
Minister,theHon. RolstonAnglin, whohasresponsibilityfortheCayman
Islandsfinancial servicessector, stated in the LegislativeAssembly that
theamendment wasnecessaryto enablethe continued marketingof
Cayman Islandsfundsin the European market.
TheAIFMD is tobe implemented acrossEuropefrom 22July, 2013.
With the amendment, Cayman is now compliant withthethreeAIFMD
conditionsthat are of particular relevanceto this jurisdiction.
Sinceearly2012,CIMA hasbeen in discussion with ESMAon the model
requirements.
TheAuthority hasnowtaken all necessary stepstoenablethesigning of
theagreement withESMA and hasindicateditsabilityand willingnessto
enter intocooperationagreementswiththeEU securitiesregulatorsbased
on the ESMAmodel MOU.

P a g e | 48
CIMA to Host Meeting of theFinancial Stability BoardRegional
Consultative Group for theAmericas
(GRAND CAYMAN - Friday, 3 May2013)TheCayman IslandsMonetary
Authority (CIMA) will host the fourth meetingof the Regional
ConsultativeGroup for theAmericasof the Financial StabilityBoard
(FSB) on 27May, 2013.
TheFSB wasestablished in 2009tocoordinatetheworkof national
financial authoritiesand international standard setting bodiesat the
international level, and todevelop and promote the implementation of
effectiveregulatory, supervisoryand other financial sectorpoliciesin the
interest of financialstability.
It brings togethernational authoritiesresponsiblefor financial stabilityin
24countries and jurisdictions,international financial institutions,
sector-specificinternational groupingsof regulatorsand supervisors, and
committeesof central bank experts.
TheFSB Secretariat is located in Basel,Switzerland, and hosted by the
Bank for International Settlements.
Six regional consultativegroupsof theFSBwereestablishedin 2011, in
responseto a call from the G20Leaders at their TorontoSummit the
previousyear, tobringtogetherfinancial authoritiesfrom89FSB member
andnon-member countries toexchangeviewsonvulnerabilitiesaffecting
financial systems and on initiativesto promote financial stability.
Theregional groupingsare theAmericas, Asia, Commonwealth of
Independent States, Europe, MiddleEast and NorthAfrica, and
Sub-SaharanAfrica.
Throughthesesix regional groups, the FSBis able todevelop global
financial policyinitiativesthrough a more inclusiveprocess.
In additiontothe Cayman Islands,theRegional ConsultativeGroup for
theAmericas consistsof
Argentina, Bahamas, Barbados, Bermuda, Bolivia, Brazil, BritishVirgin
Islands,Canada, Chile, Colombia, Costa

P a g e | 49
Rica,Guatemala, Jamaica,Mexico, Panama, Paraguay, Peru, Uruguay
andtheUnited StatesofAmerica.
Approximately 40 representativesfrom these member countries are
expectedto come tothe Cayman Islandstoparticipatein themeeting to
behostedby CIMA.
Themeeting will focuson vulnerabilitiesand regional financial stability
issues,keyregulatoryissuesin financial stability includingthe
over-the-counterderivativesmarket reformsand theKeyAttributesof
EffectiveResolution Regimes.

P a g e | 50
A. Introduction
1.Section 34(1)(a) of the MonetaryAuthority Law (2008Revision) (as
amended) (―MAL‖) states that –
After privatesector consultationand consultationwiththe Financial
Secretary, theAuthority may –
(a) issue or amend rulesor statementsof principleor guidance
concerningtheconduct oflicenseesandtheirofficersand employees,and
anyother personstowhom and totheextent that theregulatorylawsmay
apply;
2. Requirementsspecific totheprivatesector consultation areoutlinedin
section 4(1) of theMAL asfollows:
When this Law requires private sector consultationin relationto a
proposed measure-
(a) theAuthorityshall givetoeach privatesectorassociationadraft of the
proposed measure, together with –
(i) an explanationof thepurpose of the proposedmeasure;

P a g e | 51
(ii)an explanationof theAuthority‘s reasonsfor believingthat theproposed
measureiscompatiblewiththeAuthority‘sfunctionsanddutiesunder
section6;
(iii)an explanationof the extent to whicha corresponding measurehas
been adoptedin a country or territoryoutsidethe Islands;
(iv)anestimateof anysignificant costsoftheproposedmeasure,together
with an analysisof thebenefitsthat will arise if theproposed measure is
adopted;and
(v)noticethat representationsabout theproposed measure may be made
totheAuthority within a period specified in thenotice (not being lessthan
thirty daysorsuchshorterperiod asmay bepermittedbysubsection(3));
and
(b) before proceedingwiththeproposed measure, theAuthority shall
haveregard to anyrepresentationsmade by the privatesector
associations,and shall give a writtenresponse,whichshall be copiedto
all the privatesector associations.
3.This paper outlinescorporategovernanceproposalsthat are intended
toenhanceand clarify corporategovernancestandardsand provide
greater transparencyin the financial servicesmarkets.
As is the norm, thepaper proposeschangestocurrent
guidance,regulationsor laws.
However,ascorporategovernanceconsiderationsimpact on all financial
servicessectorsand regulatory functionssuch aslicensing; fit and proper
assessment/ approval;regulatoryandsupervisorypowersoftheAuthority;
regulatoryfilingsand many regulatory lawsand regulations;this
consultation not onlymakes some proposalsbut alsoprovidesindustry
with an opportunitytofeedbackon certain issuestheAuthority is
currentlyreviewing.
4.CIMA has commissioneda corporate governanceindustrysurveyto
run concurrentlywiththis consultation.
The feedback received from this consultation will be consolidated with
the feedback received from the industry survey, providing CIMA with a
comprehensiveassessment of industryviewson corporategovernance.

P a g e | 52
5. TheAuthority wantsfeedback from all interestedpartiesand requests
that regulatedentitiessubmit their commentsvia their private sector
associations.
Due to the significance of this consultation, the Authority will allow other
interested stakeholders in the Cayman Islands financial services sector to
respond to thispaper.
However,theAuthority requeststhat wherea submission ismade by a
non-regulatedentity/ personthat the responseexplicitlystateswhat
role/interestthestakeholderhasin the industry; for examplean investor
in Cayman Islandsstructures, funds, or Cayman Islandscaptives,etc.
B. Background
6.Analysisby international organisations,includingthe Financial Stability
Board (‗FSB‘) and the Basel Committeeon BankingSupervision
(‗BCBS‘), intothecausesof the 2007/2008financial crisisrevealed
deficienciesin corporate governancepracticesof regulatedfinancial
servicesentitiesasa fundamental reasonfor the crisis.
This resulted in a renewedfocusand review of corporate governance
standardsin thefinancial servicesindustry.
As a consequence, the FSB, BSBSand the International Association of
Insurance Supervisors (‗IAIS‘) amongst others, revised their corporate
governanceexpectationsof regulated entities(seeappendix A).
Thenew expectationsadvisedregulatorsthat enhanced corporate
governancestandards wereneeded toreinforced financial stabilityand
protect the financialmarkets.
7.Regulatorsaround the worldarerespondingtotheseexpectationsby
enhancingthecorporate governancerequirementsin their respective
jurisdictions.
Theseenhanced requirementsdemand improved corporate governance
standardsfrom regulatedentities,withgreater probity, transparencyand
accountabilityexpectedfrom regulated entitiesand their boards.
8.Theglobal enhancement of corporategovernancestandards,in
conjunction withtheAuthority‘s legal objectivesand the Cayman

P a g e | 53
Islands‘standing asan international financial centre, necessitatesa
review of the jurisdiction‘scorporategovernance regulatory standards.
9.This consultationpaper focuseson clarifying corporate governance
expectations;rationalisingand modernisingtheregulatory framework;
andpresentingcorporategovernancefactorstobeconsideredsubsequent
tothis consultation.
10.Thepaper reviewscorporate governance acrossall industry sectors.
Unlessthe paper statesotherwise, all proposalswouldapplyacrossall
sectors.
C. Purposeof the Corporate Governance Review
11.Thetransition of corporategovernance intoa fundamental
considerationin theoperation of a businessoccurred in the last 25-30
years.
The2007/2008financial crisis(‗theFinancial Crisis‘) resultedin
CorporateGovernancebecoming a focal point in theglobal regulatory
reform agenda.
12.One consequenceof the Financial Crisisisthe extensivecall, by
international organisationsresponsiblefor promotingeffective
supervision of the financial servicesindustry, for enhancedCorporate
Governancestandards. In the2-3years followingtheFinancial Crisis:
a.The Basel Committee for Banking Supervision, in December
2011, consulted on the review and modernisation of its Core
Principlesfor Banking Supervision.
Theupdated Core Principlesnow incorporate a new corporate
governancestandard (seeAppendix A).
b.The Technical Committee of the International Organization of
Securities Commissions‘ (‗IOSCO‘) recently published Mitigating
Systemic Risk –ARole for SecuritiesRegulators.

P a g e | 54
This paper focuseson the rolesecuritiesregulatorsplayin addressing
systemic risk and assessescorporategovernanceconsiderationssuch as
appropriatelymanagingconflict of interestsand theincreased prevalence
of non-riskfocused incentivestructures.
c.TheIAIS published, in October 2011, its updatedCore Principles
introducingnew corporategovernanceexpectationsof regulators(see
appendixA).
d.TheOrganisationfor EconomicCo-operation and Development
reiteratedsome key messagesin itslatest report on Corporate
Governanceand theFinancial Crisis issuedin February2010.
e.TheFSB issuedCorporate Governancepapersin 2011on
compensation, improved supervisorypowersand monitoring, and
bolsteringfinancial stability through corporategovernance.
13.Theseinternational developmentsrecommend or require greater
probity, transparencyand accountability at a national level.
14.Section6(2) of theMonetaryAuthority Law (‗MAL‘) requiresthe
Authorityto:
(a) act in the best economicinterestsof the Islands;
(b) promoteand maintain a sound financial system in theIslands;…
15.In section6(3) theMAL stipulatesfurther that ―In performing its
regulatoryfunctionsand itsco-operativefunctions,theAuthority shall, in
additiontocomplying withthe requirementsof subsection(2)‖:
(a)endeavour topromote and enhancemarket confidence, consumer
protectionand the reputationof the Islandsasa financial centre;
(b)endeavour toreducethepossibilityof financial servicesbusinessor
relevant financial businessbeingused for the purposeof money
launderingor other crime;

P a g e | 55
(c)recognisetheinternationalcharacterof financial servicesand markets
andthenecessityof maintainingthe competitiveposition of the
Islands,from thepoint of view of both consumersand suppliersof
financial services, while conforming to internationallyapplied standards
insofarastheyare relevant and appropriate to thecircumstancesof the
Islands;
(d)recognise the principle that a burden or restriction which is imposed
on a person, or on the carrying on of an activity, should be proportionate
to the benefits, considered in general terms, which are expected to result
from theimpositionof that burden or restriction;
(e)recognisethe desirabilityof facilitatinginnovation in financial
servicesbusiness;and …
16.Bearingin mind theselegislativeobligationsresting on theAuthority
andthe Cayman Islands‘position asa leadinginternational financial
centre, theAuthority considersregulatingand supervisingtheCayman
Islandsfinancial servicesindustrytoobserved international standards-
insofarastheyarerelevant and appropriatetotheCayman Islands- a key
objectiveto meetingits obligationsin section 6(2)(a) and (b) and section
6(3)(a).
However,in seekingto meet these legislativeobligationstheAuthority
continuouslystrivestopropose and implement standardsthat are
proportionateto theanticipatedbenefits.
17.Thus,consideringthe developmentsemanatingfrom international
organisationsandtheresultant nationaldevelopmentsoccurring
globally, theAuthority considersthe modernising of the corporate
governancestandardsin theCayman Islandsfinancial servicessector
necessaryand beneficial tothe continued international standingof the
jurisdiction.
TheAuthority further considersthepurposeof theseproposalsbeing
compatiblewithitslegislativeobligationsand strategic objectives.

P a g e | 56
D. Implementation in other jurisdictions
18.In the 24 monthssubsequent to theonset of the Financial Crisis, the
BVI Financial ServicesCommission, the Central Bank of Ireland, the
JerseyFinancial ServicesCommission, theBermuda MonetaryAuthority,
theGuernseyFinancial ServicesCommission, the BahamasFinancial
ServicesBoard and the Isleof Man SupervisionCommissionall updated
their CorporateGovernancecodes, lawsand/ or regulationsto
accommodatethe international developments.
19.Theseamendmentsoccurred in variousforms,includinglaws,
regulations,Codesof Conduct and guidance.
Many of thesejurisdictionshave thekey directors‘duties in their
CompaniesLaw or theequivalent thereof.
Generallythesejurisdictionssupplement theselawswithguidance for
their industry.
E. The Proposals
E1 Statement of Guidance: Corporate Governance
17.TheStatement of Guidance on Corporate Governance (‗SOG‘)
currentlyappliesto licenseesonly.
However,theheightenedexpectationof investorsandprovidersofcapital
is demanding more prudent corporategovernancestandardsfrom all
financial servicesentities.
Having reviewedthefinancial servicessectors, theAuthority recognised
theimportanceof registeredand administeredentitiesapplying
appropriatecorporategovernancestandards.
18.Therefore,the proposal isto extend the current SOG to registrants.
Simultaneously, theAuthorityproposestoamend the current SOG.

P a g e | 57
Theobjectivesfor theamendmentsare:
a.to make theSOG more generic and suitablefor cross-sectoral
application, i.e. tomake the SOG relevant to the
funds,insurance,bankingand fiduciarysectorsalike; and
b.to reinforcefundamental corporate governancestandardsexpected
from entitiesregulatedand supervised by theAuthority.
Thisistobeachievedbyexplicitlyoutliningin theSOG keymanagement
oversight and corporate governanceprinciplesand the primary duties of
theboard directors.
19.Theproposed amended SOG is attached in appendix B. Your
commentsare sought on thedraft SOG.
In particular, theAuthority would like toknow whetherthe addition of key
corporate governanceprinciplesenunciated in sections3-6areuseful in
clarifying what theminimum expectationsof theboard and its directors
are.
20.TheAuthority hasrefrainedfrom proposingthe implementation of a
rule or code settingout compulsory standardsfor the industry.
TheAuthority considersthisto predominantlybe a sophisticated
financial servicesjurisdictionwith suitablyqualified participantsand
serviceproviders.
Our researchindicatesanappropriateawarenessof corporategovernance
expectationsand a suitableapplication of these standards in day-to-day
operations.
21.EachsectorlawallowstheAuthoritytotakespecifiedactionwherethe
Authority considersthedirection and management of a licensee‘s
businessnot tohavebeen conductedin a fit and proper manner.
TheAuthoritywillberecommendinglegislativeamendmentswithineach
of theselaws(in footnote 2) confirmingthat theAuthority will assessand

P a g e | 58
consider adherencewith the SOG whendeciding whethera licensee‘s
businesshasbeen conducted in a fit and proper manner.
In addition toviewson issuesraisedabovetheAuthority asksfor
industryviews on the following questions:
Question 1: Tofacilitatethe cross-sectoral application of theSOG, the
Authorityhasrestrictedthecorporategovernanceguidancein theSOG to
fundamental principlesand requirements.Doesthe industryfind this
useful and appropriateor wouldtheindustry prefer more detailed
guidance?
Question2:Doesindustryapproveof thecross-sectoralapplicationof the
SOG or wouldyou prefer sector-specific guidance?If you wouldprefer
sector-specificguidanceexplain the reasonsfor your preference.
E2 Public Database
22.TheAuthority hasbeen consideringthedevelopment of a public
database,operated and controlled by theAuthority, for accessby
interestedstakeholders.
With theinternational call for heightened disclosureand transparencywe
believethat a public databasewill not onlycomplement current due
diligenceprocessesbut alsoenhancethereputationof itsfinancial
servicesindustry.
Thedatabasewouldbe accessibleonline.
23.Toaccommodatethe cost of settingup the database,it is proposed to
grant accesstothe databaseupon thepayment of a fee.
TheAuthorityhasnot yet decidedwhetherthefeewouldbean annual fee
or a fee charged per searchor whetherboth optionswouldbe provided.
Thedatabasewouldincorporateall sectorsand wouldcontain
information relatingto licenseesand registrantsalike.

P a g e | 59
It is currentlyenvisagedthat thedatabasebe searchableusingthe
regulated entity‘s name.
Onceasearchisconducted, thedatabasewill provide, asaminimum, the
name/sof theentity‘s directorsand itsregisteredoffice.
The Authority is considering what further information could be provided
on the database and is interested in your viewson how you could benefit
from thedatabase.
24.TheAuthorityiscautiousindefiningthecriteriaandinformationtobe
provided in thedatabasetoensure that the information providedis
relevant, appropriate and useful for thoseusing the database.
25.The independent information provided by the database will facilitate
the due diligence process involved during investment or capital injection
decisions.
Theproposeddatabasewill make theduediligenceprocessmore
efficient and cost effectivefor industry.
It is anticipatedthis positivedevelopment wouldresult in investors
seekingtoinvesttheir assetsand capital tolookfavourablyuponCayman
Islands‘incorporatedentities.
26.TheAuthority alsoanticipatesthedisclosuresin the databaseto
contributeto market disciplineobjectives;thusadding a constructive
supplement to thesupervisory actionsof theAuthority.
27.We will recommend legislativeamendmentsto theMAL toexplicitly
incorporateregulatorypowersto providethepublic database.
In addition toviewson issuesraisedabovetheAuthority asksfor
industryviews on the following questions:
Question 3: Doyou consider theinformation proposed tobe availableon
thepublic databaseto be relevant and appropriateor wouldit be

P a g e | 60
beneficial toincludefurtherinformation such as(whereapplicable)
custodian, fund administrator,insurancemanager, or auditor?
E3 Application of the Companies Management Law
28.Section3(3) of theCompaniesManagement Law (‗CML‘) statesthat a
natural person shall not be deemedtobe in the businessof company
management ‗merelyby virtue of beinga director of oneof more
companies.‘.
Theintentionof this provision wastoensure that only individualswho
wereprovidingdirectorship servicesinthecourseof their businessorasa
professional director and for profit or reward wouldbe classifiedas
conducting company management business.
Theintentionof this provision wasnot the blanket exemption of
individualsactingasdirectors.
TheAuthority will recommend amendmentsto the CML that clarifythis
position.
29.TheAuthority considersclarifying thescope of applicationof the
CML beneficial totheindustry and thesupervision thereof.
The intention at all timeswas for the CML to apply to all personsor
entities who offer, provide or arrange others to act as directors, or to
personswhothemselvesact asdirectors.
30.TheCML and Mutual FundsLaw both includetheprovision of
directorsin their respectivedefinitions.
Theselawsrefer tothe ‗provision‘, ‗offering‘, ‗arranging‘ of ‗directors‘or
‗operators‘.
Having this service regulated by two separate laws, and - by extension –
two divisions in the Authority potentially obscures the understanding of
thelaw and the supervisionof this service.

P a g e | 61
In addition, thevarioustermsused todescribetheservicemaycontribute
touncertaintyin theindustry. Thus,in addition to clarifying the
application of the CML, theAuthority will alsorecommend legislative
changesthat simplifyand clarify the provision of this service and the
definitionthereof.
31. In clarifying the supervisory structure, the Authority proposes to
implement greater consistency in the regulation and supervision of
directorship services.
Complementing theremoval of section3(3), theAuthority will
recommend legislativeamendmentsconfirmingwhothe CML appliesto
(withregard totheprovisionof directorship services). Theobjectiveisto:
a.continueapplying theCML toentitiesor personswhoprovide, offer or
arrangedirectorshipservices;and
b. require personsor entitieswho:
i. act asa director;and
ii. dosofor six or more entities;and
iii. do sofor profit or reward;
torequire permissionto act or be offered or provided asa director.
We will recommend a legislativeamendment prohibitingpersonsfalling
withinthe definitionof paragraph 31(b) above from being offered or
provided or actingasdirectorswithout first beingregisteredwith the
Authority.
Toensure consistent application, thiswill apply to all personsmeeting
thedefinition in paragraph 31(b) irrespectiveof their geographical
location.

P a g e | 62
32.The intention isto better define and regulate directorship services by
allowing the Authority to assess and approve persons acting as directors
asa profession.
This approval processis toreceiveassurancethat thepersonsbeing
offeredand actingin thiscapacityhaveasoundfinancial backgroundand
are sufficientlycompetent and experiencedtoact asdirectors.
It is anticipatedthat this approval processwill contributeto the sound
andproficient provision of this service.
E4 Directors‘ registration
33.Tosupporttherealignment ofthesupervisionof directorship
services, theAuthority wantstoenhancethesupervisionof this service
and theprovision thereof.
Althoughcorporategovernanceexpectationsaredependent onthetypeof
businessan entity conductsand thenature, scaleand complexityof the
business,corporategovernancestandardsare a keyfactorin all regulated
activities.
34.TheAuthority proposesimplementinga requirement for all directors
of regulatedentities,whoare not beingapproved asdirectorsof licensees
or via the‗professional‘director route (i.e. the CompaniesManagement
Law amendment) to registerwiththeAuthority.
This registration will entail a proposeddirectorproviding personal and
contact details;informationregarding therole;the director‘sexperience
and knowledgeof thesector s/he will be overseeing;and information
regardingany previousor on-goingregulatory, legal or judicial
enforcement action against the director.
This information wouldbe submitted together withan entity‘s
registrationdocumentsor, if the appointment occursafter
registration, upon appointment.

P a g e | 63
35.TheAuthoritywill alsorecommendalegislativeamendment requiring
thedirectorstoinform theAuthority, within a certaintimeframe, of any
changesto the informationsubmitted.
This processis expectedto improvetheAuthority‘s industrydata and
should improve efficiencieswhen supervisingcorporategovernance
standards.
This information should enabletheAuthority to more readily contact
directorswhenseekingresponsestoqueries it may have.
E5 Corporate Governance Survey
36.Concurrent withthisconsultationprocess, theAuthority
commissionedan industry survey on corporategovernance
standards,includingcanvassingviewson implementing limitson the
number of directorshipsheld.
Thein-depth reviewstheAuthority hasconducted on thisissueshow
some advantagestoimplementing a limit;howeverthereviewsalso
confirm shortcomingsin imposinga limit.
Tocomplement the policy development process, theAuthority
commissionedthesurvey to collect comprehensiveindustryviewson the
topic.
37.Imposinga limit wouldbe beneficial in pronouncing what the
Authority considersan acceptablelevel of responsibilitybut it is
challengingto designa limit that takesaccountthe nature, size and
complexityof theregulatedentity.
For example; a ‗low‘ limit would not take account of the feasibility of a
director being able to sit on the boards of connected entities where the
majorityof thedecisionsmay applytoall theinterconnectedentities.
Thus, such a director adheringto a limit may bedisadvantaged
because,having a largeportion of his/ her entitiesinterlinked, would
allow him to

P a g e | 64
take on more directorshipsand yet remain able toapplyadequately
his/ hermind toall entities.
Thecorollaryof thisisthat thesamelimit maybeinappropriateforafund
directorwhoalsositson theboard of an international conglomerateas
sucharolemay notallowthedirectortoprovideadequateattentiontothe
fund directorshipss/ hemay hold.
38.Another concernis that a limit wouldonlytakeaccount of the
directorshipsheld in regulated entities.
It wouldnot be feasibleto design a limit that takesintoaccount a
director‘scommitmentsoutsidethe regulated arena.
Thus, twoindividualscould each have thesamenumber of directorships
on regulatedentitiessimilarin nature, size and complexity, but onecould,
in additiontohisdirectorshipduties,bethemanagingdirectorofa large
corporation or professional servicesfirm.
Alimit may be suitablefor theperson holdingonly the directorship
positionsbut not suitablefor the directorholdingthe directorship
positionsin additionto beingthe MD of an organisation.
39.Whether a person is ableto adequatelyapplyhis/ her mind to all the
directorshipss/ heholdsis the fundamental question tobe considered.
40.For thereasonsoutlinedabove, theAuthority hasdecided that it
wouldask industryfor itsviewson a limit through an industry survey.
41.This surveywill alsoask questionsregardingthe regulatory corporate
governanceframework, includingwhether it wouldbe advantageousto
recommend a legislativeamendment requiringthenumber of
directorshipsheld by a director tobe stipulatedin an entity‘sfounding
documents(suchasthe offeringmemorandum of a regulated fund).

P a g e | 65
E6 Corporate directorships
42.Corporatedirectorshipis not beingconsulted on in thispaper;however
theAuthority intendsto consult on this in the near future and would
welcomeanyinitial thoughtson allowingcorporatedirectorstosit on the
boardsof certain regulated entities.
43.Internationally, the acceptanceof corporatedirectorsof regulated
entitiesis fragmented with some jurisdictionsallowingit, some
prohibitingit, and some accepting it but withstringent conditions.
44.TheAuthority is particularlyinterestedin receivingviewson
apportioningaccountabilityasit relatestoa corporate director;how to
applya limit on thenumber of directorshipsto a corporatedirector;and
assessingthe fitnessand propriety of a corporate director.
This will be consultedon but initial thoughtson this wouldcontributeto
our review of the topic.
F. Estimation of significant costsand benefits
a. Costs
18.There should not be any direct costsassociated withtheamended
SOGasmostofthestandardsarein thecurrent versionoftheSOGandall
new standardsincorporatedin theSOG are current common law
principlesthat applyto Cayman Islands-registeredcompanies.
19.TheAuthority hason-going IT initiativesthat seek to enhancethe
effectivenessand efficiencyof regulatoryfilings and reports.
Theseinitiativeswillserveasaplatform fortheproposedpublic database.
Thus, themajority of the costsare incorporatedintoapproved IT
projects.

P a g e | 66
Theadditional costof settingup thedatabasewill be subsidisedby an
administrativefeefor accesstothedatabase.
This fee will be borne by usersof thedatabase.
There should be no tangibleeffect on due diligencecostsasthe database
will improveduediligenceprocessesfor many stakeholdersin the
financial servicesindustry.
20.TheCML provisionsare intended to capture individualsactingas
directors,thustheclarificationof thisrequirement doesnot impactonthe
costsof providingthis service.
Those entities currently providing operators (directors) under a Mutual
Fund Administrators Licence will have reduced registration and licence
feesunder theCML.
21.Thesurvey costswill be taken from theAuthority‘s operational
budget. Therewill nocostimplication on the industryemanatingfrom
thecommissioningof the survey.
b. Benefits
22.As outlinedin Section B, inadequatecorporategovernance standards
werea key factor in theFinancial Crisis.
Financialfailuresarecostlytotheshareholders,customers,suppliersand
creditorsof the failed entity.
Researchshowsthat better corporategovernancereducesthepossibility
of financial failures.
Modernisingthe corporategovernancestandardsin the Cayman Islands
will result in better managed entities;better board oversight of an entity;
more focused risk management practicesand enhanced controlsto
mitigaterisks.

P a g e | 67
23.This should contribute not onlyto minimising corporatefailuresbut
alsotoprotectingthereputationof theCayman Islands‘financialservices
sector.
24.Thepublic databasewill provideindustrywithan independent and
readilyavailablesource of informationthat shouldexpeditethe due
diligenceprocessfor manyinvestors.
ThecentralCIMAdatabaseshouldenableamoreefficientandtimelydue
diligenceprocessthat can contributeto reducingthe cost of theprocess.
25.Regulatingtheprovision of directorsand operatorsunder the CML
will streamlinethesupervision of thisbusiness.
It will reduceany potential for duplication of supervisorywork between
theAuthority‘sInvestment ServicesDivision and the Fiduciary Division.
This alsopromotesmore consistent treatment of regulated entities.
26.As corporategovernance standardshavea significant effect on the
strength and stabilityof the financial servicessector, it isimportant that
anyproposalsamendingthe corporategovernancestandardsare
consideredand appropriatefor this jurisdiction.
To contribute to this objective, the Authority has commissioned a survey
to receive direct feedback on certain issues from as wide a representation
of the industry aspossible.
Not onlywill this feedback contributetoour current corporate
governanceresearchand analysis, but it will providetheAuthority witha
comprehensiveand informed view from industry on theseissues.
27.TheAuthority considersthesecorporate governance amendmentsas
beneficial tothe Cayman Islands,itsstandingin the international
financial servicessector and itsreputation.
TheAuthority alsoconsiderstheseamendmentsessential tothe
continued soundnessand stabilityof theindustry.

P a g e | 68
28. TheAuthority considersthebenefitsof theseproposedmeasuresto
significantlyoutweightheir costs.
G. Commentsand Consultation
29.TheAuthority seeksconsultationthrough writtencommentsand
representationsfromtheprivatesectorassociationsconcerningtheissues
detailed above.
30.TheAuthority must receiverepresentationsby 17H00, Monday, 18th
March2012.
32.TheAuthorityshall havedueregardtoanyrepresentationmadebythe
privatesector associationsand industrystakeholders.TheAuthority shall
providea writtenresponsecollatingthe feedbackreceived and the
Authority‘s positionon thisfeedback. Thisresponseshall be copiedtoall
relevant privatesector associationsonly.
Appendix A
Enhancements of International Standards
1. Basel Committee for Banking Supervision
Principleproposedin current BCBSconsultationupdating theitsCore
Principles:
Principle 14– Corporate governance:
Thesupervisor determinesthat banks and banking groupshave robust
corporategovernance policiesand processescovering, for example,
strategic direction, group and organisational structure, control
environment, responsibilitiesof thebanks‘Boards and senior
management, and compensation.
Thesepoliciesand processesare commensurate with the risk profile and
systemic importanceof the bank.

P a g e | 69
2. International Association of Insurance Supervisors
Updated Core Principles(October 2011)
ICP 7 Corporate Governance
Thesupervisor requiresinsurerstoestablish and implement a corporate
governanceframework whichprovidesfor sound and prudent
management and oversight of the insurer‘sbusinessand adequately
recognisesand protectsthe interestsof policyholders.
Structure and governance of the Board
3.Thesupervisorrequiresthe insurer‘sBoard to have, on an on-going
basis:
- an appropriate number and mix of individualsto ensure that there is
an overall adequatelevel of knowledge,skillsand expertiseat the
Board level commensuratewiththe governance structure and the
nature, scaleand complexityof the insurer‘sbusiness;
- appropriateinternal governance practicesand procedures tosupport
theworkof theBoard in a manner that promotesthe
efficient, objectiveand independent judgment and decision making
bytheBoard; and
- adequatepowersand resources tobe able to discharge itsduties fully
and effectively.
Duties of individual Board members
4. Thesupervisor requiresthe individual membersof the Board to:
- act in good faith, honestlyand reasonably;
- exercisedue care and diligence;

P a g e | 70
- act in thebestinterestsof theinsurer and policyholders, puttingthose
interestsof the insurer and policyholders ahead of his/ her own
interests;
- exerciseindependent judgment and objectivityin his/ her decision
making, takingdueaccount of the interestsof the insurer and
policyholders;and
- not usehis/ her position to gain undue personal advantage or cause
anydetriment totheinsurer.
Transparency and communications
7.8 The supervisor requiresthe insurer‘sBoard to have systems and
controlsto ensure thepromotion of appropriate, timely and effective
communicationswiththesupervisor and relevant stakeholderson the
governanceof the insurer.
Supervisory review
7.10The supervisor hasthepower torequire the insurer to demonstrate
theadequacyand effectivenessof itscorporategovernance framework.

Risk management presentation May 13 2013

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