Frontiers in finance magazine - February 2012

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Frontiers in finance magazine - February 2012

  1. 1. Frontiers in Finance Rogue trading BrazilFor decision makers in The factors necessary The new hot spot forfinancial services to form an effective investment managementFebruary 2012 control framework Page 8 Page 12Frontiersin FinanceForging forward:Financial servicesin 2012InsuranceFinding growth opportunitiesin uncertain timesPage 22
  2. 2. FOREWORDFORGING FORWARD:FINANCIAL SERVICESIN 2012From theEditorial teamAt frontiers in finance, we have always tried The turmoil in our industry shows noto live up to the promise of the magazine’s sign of abating. The worst dangers of thetitle: to present for the benefit of our clients financial crisis have given way to politicaland other readers leading opinions and analysis and regulatory reaction on perhaps anaddressing issues at the cutting edge of the unprecedented scale. But major uncertaintiesfinancial services industry. We have also remain. Banks, insurers, investment managerstried to do this in the most succinct and – all face a future which will be as different asaccessible manner. it is currently obscure. The articles in this issue of frontiers review regulatory developmentsA change of editorial responsibility is from a number of perspectives; we look attraditionally a time to take stock, to review growth prospects in the insurance sector andand to refresh a publication, and this is what in the massive but still emerging market ofwe have been doing. We have sought Brazil; operational issues addressed includefeedback from the tens of thousands of how to guard against rogue trading and howreaders we serve, both within KPMG and in to implement effective customer remediationthe wider financial services community. It is when things do go wrong.gratifying to find that in the main we have been living up to our promise. Many of you have There is more. But we hope you find it aemphasized the value of the magazine. stimulating and helpful guide through the complexity of today’s, and tomorrow’s,At the same time, just as the financial financial services industry.world is changing, there are ways in whichfrontiers needs to evolve as well. We stillaim to provide a commentary on the keyfinancial services topics of the day whichis both relevant to your business and yourchallenges and also offers practical guidanceand solutions. In future, we hope to be a littlemore forward-looking, perhaps clearer andmore concise, and to pay greater attentionto cutting through the complexity whichcan bedevil financial services. We shall beincluding two or three more regular features,and trying to provide a rather stronger thematicunderpinning to each issue.© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  3. 3. FRONTIERS IN FINANCE FEBRUARY 2012 CONTENTS FEATURES COLUMNS 02 Chairman’s message Global Financial Services Chairman points out that while western markets face several challenges, there are opportunities and growth in many parts of the world. 04 Regulation matters Regulation of the global financial services industry is evolving rapidly, on many fronts and in complex, overlapping ways. 20 Cutting through concepts A new recurring section which seeks to bring clarity around complex and often misunderstood financial services concepts or issues. 14 8 22Produced by KPMG’s Global FinancialServices Practice Brazil InsuranceDesigned by Mytton Williams The new investment Finding growth opportunitiesPublication date: February 2012 management hot spot. in uncertain times.Publication number: 120182 18Printed on recycled material 12The information contained herein is of a general Rogue trading 8nature and is not intended to address the The actions and approach tocircumstances of any particular individual or entity.Although we endeavour to provide accurate and reduce the risk.timely information, there can be no guaranteethat such information is accurate as of the date it 14is received or that it will continue to be accurate in Customer remediationthe future. No one should act on such informationwithout appropriate professional advice after a Getting it right once youthorough examination of the particular situation. have got it wrong. INSIGHTS© 2012 KPMG International Cooperative (“KPMG 18International”), a Swiss entity. Member firmsof the KPMG network of independent firms 26 Basel IIIare affiliated with KPMG International. KPMG Updates from KPMG member The issues and implications of theInternational provides no client services. No firms, thought leadership and capital adequacy guidelines.member firm has any authority to obligate or bind contacts. KPMG International or any other member firm vis-à-vis third parties, nor does KPMG Internationalhave any such authority to obligate or bind anymember firm. All rights reserved. Printed in theUnited Kingdom.The KPMG name, logo and “cutting throughcomplexity” are registered trademarks ortrademarks of KPMG International. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  4. 4. COLUMNSCHAIRMAN’S MESSAGEKPMG’s Global Financial Services Chairman points outthat while western markets face several challenges, thereare opportunities and growth in many parts of the world.Opportunities ina Changing World A s we publish this issue of In addition to adapting to new regulation, banks frontiers in finance, the financial continue to face the perennial challenges of and economic environment managing operational risk and implementing remains fragile in many parts transparent and robust remuneration policies. of the world. Financial sector Both areas continue to come under significant firms face an unprecedented combination scrutiny from governments and regulators. of threats from the lack of GDP growth, a Amidst the despondency in Europe it isJeremy Anderson lack of confidence in the European bank easy to forget that many countries are growingGlobal Financial Services Chairman and sovereign debt markets, and calls for apace. There are tremendous opportunities to additional capital and liquidity as part of the grow in Asia, South America, India, and also on sweeping changes impacting many parts the African continent, where the convergence of the financial sector globally. We remain a of banking and mobile telephony is creating long way from durable solutions to the crisis. unprecedented opportunity. While policymakers around the world As financial institutions rise to the have responded differently to these threats, challenge of providing banking and insurance on balance the global response has been to services to more than two billion ‘unbanked’ increase austerity measures. What is not yet people globally, a key focus will be how to clear is whether austerity objectives will be achieve this sustainably, so that the financial able to deliver the renewal in confidence and sector is seen as a partner in responsible growth that are needed to emerge from the development. To this end, KPMG is organizing current crisis. At the same time the banks are a global conference to articulate a Business being required to hold more capital with the Perspective on Sustainable Growth ahead of attendant risk to new credit origination. the Rio+20 summit in June 2012. The pace of regulatory change this last Whether your immediate focus is on the year has been relentless, driven primarily Eurozone and regulatory developments or on by the G20 Financial Stability Board, in the tremendous opportunities in high-growth the form of requirements for G-SIFIs, the markets, I hope you will find this edition of implementation of Dodd Frank in the frontiers in finance stimulating and useful as United States, multiple European Union you launch into 2012. regulations, and an emerging focus on consumer protection. Rarely have we seen executive teams spend so much of their time grappling with regulatory issues. Change programs, impacting people, processes and technology, need to be implemented in parallel, across multiple regions and jurisdictions and under different regulatory frameworks. This is a profound challenge for even the most agile financial institutions. 2©/ 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No Frontiers in Finance / February 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  5. 5. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  6. 6. COLUMNSREGULATION ROUND TABLERegulation of the global financial services industry is evolving rapidly,on many fronts and in complex, overlapping ways. In this new recurringsection, the heads of KPMG’s three Regulatory Centers of Excellence –Giles Williams (EMA), Simon Topping (ASPAC) and Jim Low (Americas)– recently reviewed the major issues companies in each of their regions arefacing from a regulatory perspective in 2012.Global Round Table:Regulation hots upGiles Williams: We’re going to talk in a GW: So turning to the ‘heat map’, the G20 CEO ISSUESmoment or two about the KPMG ‘Regulatory regulatory agenda is intended to:Heat Map’ [Page 6/7] which captures the – create a new framework for banks, OTCcurrent impacts of regulation. But first I derivatives, compensation practices andthought it would be helpful if we put it into a credit rating agencies; H ow will regulatory change impactbroader context. During the global financial – address the too big to fail issue; ‘fill in the on our business model?crisis, complete catastrophe was averted gaps’ in regulation and supervision of the W hat strategic changes will bepartly by luck and partly by concerted action by financial sector; necessary for us to pursue maximumgovernments and regulators. The G20 rapidly – tackle tax havens and non-cooperative growth and profitability?moved to the forefront of action to restore jurisdictions.stability and began the process of building W hat impact will regulatory changea more resilient global financial services The ‘heat map’ locates the principal regulatory have on the most appropriate legalstructure. Markets and economies began to initiatives currently being implemented on entity structure for the group?recover. However, I think all of us would agree a grid relating five key themes – financialthat the global recovery has weakened in stability, conduct, market infrastructure, tax H ow should our operationalrecent months and new trends are emerging. and finance and governance – to the three configuration evolve: onshore?The regulatory debate is broad; with the primary industry segments of investment offshore? shared service centers?systematic risk arguments, the role of capital management, banking and insurance. H ow can risk best be controlledand need for liquidity. This is in the context The color key reflects the main geographic and minimized in the firm in future?of the wider political dimension focusing on regional impacts.the role of financial services in the rest of the D o we have an effective recoveryeconomy, the protection of consumers and the Simon Topping: What really comes across and resolution plan?contentious issue of executive pay. to me from our analysis is that we’ve seen a A re all our stakeholders signed up significant change in the regulatory landscape to the same view of the future?Jim Low: Right, and this is being felt, to a over recent months. One of the most obviousgreater or lesser extent, across all advanced points to note is that the three industrycountries. The specter of ‘double dip’ segments look really quite similar. There arerecessions is looming closer. In the USA, some differences of emphasis, for sure; but itthe economy remains weak, and consumer is now clear that the impact of new regulationconfidence continues to be weighed down will be widespread and comparativelyby a moribund housing market. In Europe, intolerant of special interests. In early 2011 itas you know well, sovereign debt concerns was still possible to argue that hedge fundsare spreading, and the risk of default by one should be spared the most draconian newor more members is calling the structure of requirements because they played no rolethe eurozone into doubt. Across the globe, in creating the crisis; or that insurers operateexcessive debt – and concomitant deleveraging a fundamentally more stable business– are dragging down economic performance model and require different treatment. Now,already hit by increased commodity prices. however, there is little distinction; this is a real And this is the key background to the G20’s change.commitment, in November 2011, to worktowards a more stable and resilient international JL: I think that’s exactly right. The politicalmonetary system and to improve systemic agenda has ensured that the financial servicesstability in the global economy. sector as a whole is going to share the pain.4©/ 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No Frontiers in Finance / February 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  7. 7. Contacts (from left) Giles Williams Simon Topping Jim LowDuring the global financialcrisis, complete catastrophewas averted partly by luckand partly by concertedaction by governmentsand regulators. The G20rapidly moved to theforefront of action to restorestability and began theprocess of building a moreresilient global financialservices structure.But what we have now is a remarkably IMPLEMENTATION PROGRESScomplex and ambitious agenda.GW: The G20 would no doubt argue that it is Reform Policy Key policy datesdeliberately comprehensive and consistent. ‘11 ‘12 ‘13 ‘14 ‘15 ‘16–’19I have a quote from the final declaration fromthe Cannes Summit in November 2011, J A S O N Dwhere they emphasized: Capital Basel III“We are determined to fulfill the commitmentwe made in Washington in November CRD32008 to ensure that all financial markets, CRD4products and participants are regulated or Liquidity Basel 3subject to oversight as appropriate to theircircumstances in an internationally consistent Systemic risk FSB – GSIFIsand non-discriminatory way.” EU Crisis mgtST: Well yes, but a more pragmatic UK ICBassessment also raises a number of areas of Supervision ESAsconcern notably:– scale and cost of the additional the UK architecture regulatory burden, all of which will be Governance EU green paper borne, in the end, by financial services Remuneration CRD3 companies and their customers– scope for inefficiency, duplication, the Customer EU access/lending inconsistency and contradiction treatment PRIPS– the opportunities for regulatory arbitrage– damage to global GDP which may the SEPA follow the imposition of a more costly, UK RDR less profitable, less responsive financial Traded OTC derivatives services sector. markets MiFID2JL: Our three Regulatory Centers of Accounting/ EU green paperExcellence are uniquely placed to compare disclosureand contrast the impact in different CRAgeographic regions. Where are the agendasmost strongly correlated across the three Policy development Implementation In forceregions? Clearly, the most obvious area iswhere firms are truly global in the first place:regulation has to impose a consistent globalframework. But there is a deeper area wherethe end-game itself implies convergence. Forexample, the pressure for structural reform inthe banking sector may be stronger and more © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no in Finance / 5 February 2012 / Frontiers client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  8. 8. COLUMNSREGULATORY HEATMAP European Union Global – G20 UK National United StatesInvestment management Hot AIFMD CRD 3/4 PRIPs AIFMD UCITS AIFMD UCITS DFA RDR DFA DFA Consumer Protection MiFD 2 EMIR COREP FTT Cool Financial Stability Conduct of Business Agenda Market Infrastructure Tax and Finance and Investor Protection and TradingBanking industry Hot CRD 3/4 Short Selling Credit Default Swaps Structural DFA Consumer BASEL 2.5/3 Reform DFA Protection DFA RDR (RRPs) Deposits MAD Schemes Investor Directive Compensation Directive MiFD 2 EMIR COREP MMR ICB FTT Cool Financial Stability Conduct of Business Agenda Market Infrastructure Tax and Finance and Investor Protection and TradingInsurance industry Hot DFA Solvency DFA DFA Investor RDR Living Wills Compensation Consumer Schemes Protection DMD Pensions MiFD 2 Directive COREP FTT Cool Financial Stability Conduct of Business Agenda Market Infrastructure Tax and Finance and Investor Protection and Trading6©/ 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No Frontiers in Finance / February 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  9. 9. explicit in the UK and elsewhere in the EU. But the consequences will inevitably be felt here in the US, and in Asia, and will drive change So a key question is how towards comparable ultimate goals. far, and in which directions, Corporate Governance ST: Indeed. For instance, recovery and will these regional agendasFATCA resolution planning is now a significant influence each other in regulatory agenda item in Australia, impacting future. How far will the on companies which remained untouched by the crisis. So to a significant extent a common US begin to reflect European agenda is emerging, and common themes are concerns? Will the US IFRS extending across all geographical regions. But although the G20 emphasizes the international agenda be increasingly and global nature of the framework it reflected in Europe? believes is necessary, there are differences in emphasis, and the balance between the five themes is different. Corporate Governance GW: Some of the marked contrasts can be and Decision Making seen in the conduct agenda. This is not an especially significant imperative in Asia. It is evidence seems to show that policymakers of some relevance in the USA, but there it and regulators are acting in a responsible and remains heavily colored by a strong caveat thoughtful manner, seeking to be proportionate emptor principle: the customer needs to and achieve the broad objectives of restoring recognize and assume an appropriate degree stability and increasing resilience without unduly of risk, and so the emphasis is on supporting damaging competitiveness or economic value. Corporate Governance information provision and understanding.FATCA In Europe, however, it is a key theme of ST: Nevertheless, financial services will cost the regulatory agenda: the cultural and more, and deliver lower returns, to the extent policy mind-set is that the consumer needs that greater regulation imposes higher costs protection, and cannot – or should not – be and lower profitability. The main problem arising exposed to excessive risk. from this is there is little evidence as yet that consumers accept the implications for the costs IFRS ST: Nevertheless, despite such differences, and benefits they receive. This is going to make I think we are seeing a kind of creeping the challenge for CEOs all the greater. But there convergence in individual regional agendas. are clearly some key questions they need to be Issues of governance run across all asking themselves. three regions, although the strength of implementation necessarily varies, from Corporate Governance very prescriptive in the EU to – as yet – and Decision Making more consensual in the Far East. There is MORE INFORMATION convergence too in the way the objective Giles Williams of strengthening financial stability is being Partner, Financial Services extended into insurance through Solvency II; Regulatory Center of Excellence and in the way that protection against systemic EMA Region impacts is leading to resolution and recovery KPMG in the UK planning for insurance companies. T: +44 20 7311 5354 E: giles.williams@kpmg.co.uk Corporate Governance JL: So a key question is how far, and inFATCA which directions, will these regional agendas Simon Topping influence each other in future. How far will Partner, Financial Services the US begin to reflect European concerns? Regulatory Center of Excellence Will the US agenda be increasingly reflected ASPAC Region in Europe? KPMG in China T: +852 2826 7283 IFRS GW: Yes, and one of the largest areas of E: simon.topping@kpmg.com uncertainty, and one which interests me in particular, is the extent to which the balance Jim Low will change in future between returns Partner, Financial Services to shareholders, customers, executives Regulatory Center of Excellence and employees. There are constant, and Americas Region Corporate Governance understandable, pressures from politicians KPMG in the US and Decision Making and the public they represent to impose more T: +1 212 872 3205 drastic and punitive changes. So far, the limited E: jhlow@kpmg.com © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no in Finance / 7 February 2012 / Frontiers client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  10. 10. FEATUREINVESTMENT MANAGEMENTBrazil –The new hotspotin investmentmanagementBy Marco Andre Almeida and Lino JuniorB razil is now a major economic power, one of the top-10 global economies by purchasing Unlike many other large power parity1. It ranks ahead of economies, Brazil has a its ‘BRIC’ counterparts Russiaand India (although it is smaller than China). comparatively welcomingThe country enjoys a relatively stable macro- attitude to investmenteconomic environment, with consumer and funds and hedge funds –investor confidence continuing to strengthen.Inflation has been brought down since the recognizing the need toearly years of the new millennium, although it attract foreign investmentremains around 6.5 percent in 2011. However,interest rates remain high – the short-term to underpin continuedrisk-free rate currently stands at 10.5 percent. economic and infrastructure Unlike many other large economies, development.Brazil has a comparatively welcomingattitude to investment funds and hedgefunds – recognizing the need to attractforeign investment to underpin continuedeconomic and infrastructure development.The combination of high returns and a favorableregulatory regime is driving a massive wave ofinterest in investment in Brazil: it is indeed the daily updates of asset values and portfolionew hotspot in investment management. details being posted on the internet. Although the investment managementInvestment management sector is large, it faces competition fromindustry in Brazil certificates of deposit and savings accounts.Brazil’s investment management industry The total investment portfolio is concentratedis mature, well-managed and effectively- in Brazilian assets, with 60 percent of totalregulated. All funds – including those which investment in government bonds.would be described as hedge funds – mustbe registered with the Comissão de Valores Alternative investment industry in BrazilMobiliários (CVM) – Brazil’s equivalent of the There is increasing interest in the alternativeSecurities and Exchange Commission. The investment market in Brazil. A number ofcapital markets association, ANBIMA, operates different classes of investment vehicles exist.a system of self-regulation which is generally These are all summarized in the panel on thewell-regarded. The market is transparent, with next page.8©Frontiers in FinanceKPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No 2012 KPMG International. / February 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  11. 11. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  12. 12. FEATURE ALTERNATIVE INVESTMENT VEHICLES 395bnFrom topHigh returns and a favorableregulatory regime is makingBrazil the new hotspot ininvestment management.Infrastructure investmentin Brazil is pressing as Brazilprepares to host the WorldCup in 2014 and the Olympicsin 2016. The most attractive emerging as where income is taxed at less than 20 market for private equity percent and/or where there are restrictions“As a country and an A recent survey by Coller Capital and the on disclosure of shareholder composition or economy, we need private Emerging Markets Private Equity Association beneficial ownership). equity and venture shows that Brazil has overtaken China as the most attractive market for fund managers’ FIP investments are subject to certain restrictions: capitalists to invest and to deal-making in the coming year2. Brazil offers – The portfolio company is usually a help our entrepreneurs,” a number of fiscal incentives for inward Sociedade Anonima (S.A.), and is investment in private equity funds (Fundos de required to have its financial statements Maria Helena Santana, Chair Investimento em Participações – FIPs): audited by an independent auditor of the Comissão de Valores registered with the Brazilian CVM. The Mobiliários (CVM) – Brazil’s – Income and capital gains received by the funds are usually not subject to FIP must have influence in strategic decisions and its management. SEC4 taxation in Brazil; – The investment must adhere to the existing – There is no withholding tax on disposal of foreign exchange regime for investments in FIP quotas for non-residents as long as they Brazil’s capital market. hold, together with related parties, less than – The financial tax (IOF) is levied on the inflow 40 percent of the shares of the FIP and are of foreign funds into the FIP at a 2 percent not located in a low tax jurisdiction (defined rate (reduced to zero on 1 December 2011).102012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012 member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  13. 13. Contacts (from left) Marco Andre Almeida Lino Junior Private Equity Funds (FIPs) FIDCs (Credit Receivables Investment Funds) Size in September 2011: R$ 78.4 billion. Taxation: 15 percent. Non-resident Size in September 2011: R$ 65.7 billion. investors (other than those located in Taxation: generally from 15 percent to ‘low tax jurisdictions’) which hold up to 22.5 percent. 40 percent of the fund are exempted. Comments: At least 50 percent of Comments: Minimum subscription of resources should be invested in credit R$100,000. Invested companies must receivables. Derivatives are optional, comply with certain corporate provided the objective is to hedge governance rules. spot positions. Most funds value credit receivables at cost plus accrued Multi-Strategy Funds income, less allowance for losses as determined by the Brazilian Central Size September 2011: R$ 395 billion. Bank. New rules effective from 2011 Taxation: from 15 percent to 22.5 are consistent with IFRS approach. percent (some exemptions). Comments: Portfolios can include any 78.4bn financial investment, in accordance with limits established in the by- laws and CVM regulation. Overseas investments are allowed in funds with minimum subscription of R$1 million up to 100 percent and in other funds up to 20 percent. Evolution: Brazilian Industry of Investment Funds (R$ Billion) 1,800 65.7bn 1,600 1,400 1,200 1,000 800 600 400 200 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Investing in the Brazilian financial market: Cup in 2014 and the Olympic Games in 2016,Non-resident investors may invest in Brazil’s both of which require major investment in the MORE INFORMATIONfinancial and capital markets on level terms country’s infrastructure. It has been estimated Marco Andre Almeidawith resident investors. They need simply to that Rio de Janeiro alone needs $36 billion of Partner, Financial Services and Nationalhire a legal representative in Brazil (a financial investment to prepare for these two events3. Head of Private Equityinstitution), and complete the necessary Brazil’s investment management industry is KPMG in Brazilpaperwork. However, getting the structure most definitely open for business. T: +55 213 515 9404right and optimizing the balance sheet to take E: maalmeida@kpmg.com.bradvantage of the favorable tax opportunities 1. CIA World Factbook, February 2011as well as to comply with domestic legislation 2. EMPEA/Coller Capital Emerging Markets Private Equity Survey – Lino Juniorand regulation is complex. Where purchases 18 April 2011 Partner, Financial Servicesof local companies are concerned – as they 3. Financial Times, ‘Rio eyes ‘Olympic bonds’ to fund 2016 games’, and Hedge Funds 2 February 2011have been with sovereign wealth fund 4. As quoted in The Economist, 17 February 2011 KPMG in Brazilinvestments – the necessary due diligence T: +55 213 515 9441can be time-consuming. E: lmjunior@kpmg.com.br Having said this, the requirement in Brazilfor infrastructure investment, especially, ispressing, particularly in the transport sector.In addition, Brazil is to host the football World © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate2012 any member firm. All rights reserved. February or bind / Frontiers in Finance / 11
  14. 14. FEATURECAPITAL MARKETSA reactive approach to a rogue trading can have direconsequences for a firm. The right actions and approachcan defend against this threat.Rogue Trading:Controlling the riskBy Bill MichaelR ogue traders have always existed companies need to understand if they are to in one form or another. The combination of breach of faith, NOTORIOUS institute effective controls. The first key point to note is that no company betrayal of trust and deception LOSSES is immune. Wherever large sums of money is common to most areas of flow through large institutions, there will alwaysfinancial crime. What tends to mark out the be the potential for rogue trading to emerge.contemporary rogue trader is a particular set Constant vigilance and defense in depth areof circumstances and characteristics: essential. Furthermore, it is usually not the most high-profile, complex or apparently risky– he individual involved is normally not t motivated by personal greed, at least directly– deception starts small but spirals out his of control $2.3bn Kweku Adoboli areas of activity which are most susceptible. The majority of rogue trading occurs in comparatively humdrum or presumed safe parts of the business, out of the spotlight.– he sums involved can reach astronomical t UBS, 2011 Problems can start small but rapidly escalate to proportions. threaten the whole firm. There are also a number of institutional andIt is unsurprising that the actions of such individual features which contribute to rogueindividuals hit the headlines. Among themost notorious instances in recent years:– weku Adoboli is alleged to have caused UBS K €4.9bn Jérôme Kerviel trading. These are the subject of increasing debate in the industry. It is perhaps a cliché to point to the excessive risk-taking mentality and aggressiveness of mainly-young, mainly- to lose $2.3 billion trading on market futures Société Générale, 2008 male traders. But there is no doubt that there in 2011. is a tendency for companies to hire as traders– Jérôme Kerviel lost Société Générale €4.9 people who tend to be more prone to such billion over three years to 2008, again as a activity. When traders are speculating with $6.5bn result of trading stock market futures. other peoples’ money, the need for external– rian Hunter lost $6.5 billion for B controls is clear. Amaranth Advisors in 2006, trading on Secondly, a corporate culture which natural gas futures. Brian Hunter encourages (acceptable) risk-taking can easily– erhaps most famously, Nick Leeson brought P Amaranth Advisors, 2006 become one where excessive risk-taking is about a loss of £827 million, and caused the tolerated, or where those involved become collapse of Barings Bank after 233 years blind to it. When trades which push the bounds of existence, through his trading on the of what is permissible come off, and the firm £827m Nikkei Index. makes a large profit, there is an obvious danger that improper behavior is reinforced. ManySuch stories receive sensational media rogue traders have subsequently claimed thatcoverage, and it is always dramatic to depict Nick Leeson their activities were condoned because theira single individual being responsible for such Barings Bank, 1994 superiors also enjoyed the rewards which camecatastrophic consequences. However, the real with success.reasons behind, and causes of, rogue trading It is rarely the case that a trader starts outare more complex. It is these features which by intending to commit fraud. Rarely also is the122012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  15. 15. Contacts Bill Michael of repeatedly doubling up in a desperate of suspense accounts, fictitious trades whichMotivating factors: attempt to recover the situation, all the while lack counter-party recognition, cancelledthe environment engaging in increasingly elaborate deceptions trades, excessive gross versus net exposureWhat are the typical factors that to disguise his true position. and so on. Acceptable profiles for all of thesecreate the environment for rogue It is much easier to hide transgressions characteristics can be developed, with events when a large volume of transactions is taking outside the established parameters triggeringtrading activity? place against a background of fragmented an alarm. IT systems and complex processes. Where There are also a range of non-technical middle- and back-office responsibility is factors which need to form part of an Aggressive culture compartmentalized, no-one may be in a effective control framework. These range of PL and revenue performance rather position to see the whole picture. Complex from mandatory training to appropriately- than wider risk and control based metrics trades can be very difficult to value accurately disciplined controls on access to systems by anyone other than the front-office and records. It has been well-publicized in Remuneration expert who is carrying them out. If senior a number of cases that rogue traders have linked to short term performance management or supervisors don’t fully tended to work odd hours, and have been understand the nature of products being reluctant to take vacations in case their Repeated control breaches traded or their inherent risk profile, it is much positions were exposed. Profiles for these tolerated by senior management easier for the rogue trader to disguise the true characteristics should also be established, nature of his position. and divergence flagged up. Correlation Insufficient challenge It follows from these features that an between suspicious activities in a number to (by control functions) and within effective defense needs two mutually- of areas can be especially valuable. (by supervisors) front office reinforcing strands: adequate and appropriate Systems and controls are typically controls and the right tone being set from the introduced and/or strengthened in the wake High volumes of trades top. It has been well-said that there are bold of a rogue trading disaster – if the firm has supported by fragmented IT systems traders and old traders, but there are very managed to survive it. But the risk of adopting and complex processing environment few old, bold traders. Senior management a reactive strategy is clear. By contrast, firms need to instill a strong culture of respect for should be adopting a strategy of continual Poor understanding controls – which still promote acceptable review, stress testing, monitoring and of complex products and trading risk-taking – while explicitly prohibiting the development, to ensure that their defense is activities by senior management occasional tolerance of breaches. Turning a as strong as possible. blind eye from time to time to an unauthorized gamble which pays off risks undermining the whole control framework.motivation personal gain, except in the sense In such a culture, it is then much easier tothat successful trading may bring kudos and institute effective systems and controls anda bigger bonus. Rather, a trade at the limit of to make sure they are respected. Most cover- MORE INFORMATIONacceptability may go wrong. Instead of closing up strategies are comparatively simple. The Bill Michaelout the position and triggering a loss, the trader most obvious course, if closing out a trade is UK Head of Financial Servicesmay try to recoup the loss the next day. All goes going to crystallize a loss, is to avoid booking KPMG in the UKwell until a loss cannot be recovered. Then it in the first place. So systems need to look T: +44 (0) 207 311 5292the trader embarks on the disastrous course for long settlement dates, late bookings, use E: bill.michael@kpmg.co.uk © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG2012 / Frontiersno client services. 13 February International provides in Finance / No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  16. 16. FEATUREHEADING HEREBANKINGCustomer RemediationGetting itright onceyou’ve gotit wrongBy Scott Cohen and Dan Thomas,with contributions from Edwige SaccoW arren Buffett famously likes to say that, ‘Only when the tide goes out do you discover who’s been swimming naked’. The straitened economic environment following the financial crisis has contributed to the exposure of frauds such as the‘Ponzi’ scheme run by Bernard Madoff in the US, or various buy-to-let property frauds in the UK. Similarly, when asset values sufferserious reverses and liquidity dries up, investors and customers beginscrutinizing much more closely the soundness of investments theyhave made or been sold. Some of the malpractice which has emergedin the last few years on the part of the financial services industry hasbeen profound and far-reaching. In the US, the foreclosure crisis which emerged in 2010 remainsunresolved, despite tremendous regulatory scrutiny and notableindustry reform. It has revealed a widespread epidemic of foreclosuresthat were inappropriately initiated and inappropriately handled.Many have involved a lack of understanding of the legal/regulatoryrequirements and often been coupled with poor or in some casesfraudulent processes:– ortgagees have foreclosed on homes with no outstanding debt, M employed ‘robo-signing’ methods to expedite thousands of false affidavits and foreclosed on the homes of servicemen and women on active duty in express violation of federal law.– here have been significant failures of the controls intended to T safeguard the positions of both the borrower and the lender.– nsufficient attention has been paid to borrowers and to the I overall borrower experience.– nstitutions placed excessive reliance on third parties – I especially attorneys – to do the right thing. »142012 KPMG International. KPMGFebruary is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No © / Frontiers in Finance / International 2012member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  17. 17. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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