Monday November 5 2012 - Top 10 Risk Management News

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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,

Year after year, new laws and regulations
require firms to undertake a forward-looking
self-assessment of risks, corresponding
capital requirements, and adequacy of
capital resources.

Year after year, it becomes critical to look into the future, to understand
what is next. Which is the new law, regulation or development? Which are
the challenges and the opportunities for firms and organizations? How
will these changes affect the competitive position of existing and new
capital warriors in the markets?

There is a great window to look into the future: The excellent
forward-looking papers of the Group of Thirty.

The Group of Thirty

The Group of Thirty is a private, nonprofit, international body composed
of very senior representatives of the private and public sectors and
academia.

The Group aims to deepen understanding of international economic and
financial issues, to explore the international repercussions of decisions
taken in the public and private sectors, and to examine the choices
available to market practitioners and policymakers.
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International Association of Risk and Compliance Professionals (IARCP)
www.risk-compliance-association.com

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Members

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Emeritus Members

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Welcome to the Top 10 list.

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Toward
Effective Governance of Financial Institutions
Weak and ineffective governance of systemically important financial
institutions (SIFIs) has been widely cited as an important contributory
factor in the massive failure of financial sector decision making that led to
the global financial crisis.

Statement on Public Meeting On
Auditor Independence and Audit
Firm Rotation

SPEAKER: James R. Doty, Chairman
EVENT: PCAOB Public Meeting
LOCATION: Houston, TX

BIS, A framework for dealing with
domestic systemically important
banks

The Basel Committee on Banking
Supervision (the Committee) issued the
rules text on the assessment methodology
for global systemically important banks
(G-SIBs) and their additional loss
absorbency requirements in November
2011.

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Mario Draghi: Opening
statement at Deutscher
Bundestag
Speech by Mr Mario Draghi,
President of the European Central
Bank, at the discussion on
ECB policies with Members of
Parliament, Berlin

Andreas Dombret: As goes
Ireland, so goes Europe?
Speech by Dr Andreas Dombret,
Member of the Executive Board of the
Deutsche
Bundesbank, at the Institute of
International and European Affairs,
Dublin

CIMA Hosts Risk Management and Internal Controls Seminar

The Cayman Islands Monetary Authority (CIMA)
hosts a seminar on Risk Management and Internal
Controls. The event, which is scheduled for 29
October to 2 November at the Grand Cayman
Marriott Beach Resort

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Goldman Sachs Group
Interesting numbers before the Basel III
deadlines

The Goldman Sachs Group, Inc. (NYSE: GS)
reported net revenues of $8.35 billion and net earnings of $1.51 billion for
the third quarter ended September 30, 2012.

Bermuda’s Insurance Solvency
Framework
The Roadmap to Regulatory
Equivalence

Planned 2012/2013 Developments

Mervyn King: Monetary policy developments
Speech by Mr Mervyn King, Governor of the Bank of
England, to the South Wales Chamber
of Commerce, Cardiff, 23 October 2012.

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Erkki Liikanen: On the structural reforms of
banking after the crisis

Speech by Mr Erkki Liikanen, Governor of the Bank of
Finland and Chairman of the Highlevel
Expert Group on reforming the structure of the EU
banking sector, at the Centre for
European Policy Studies, Brussels, 23 October 2012.

Progress note on the Global LEI
Initiative

This is the third of a series of notes on
the implementation of the legal entity identifier (LEI) initiative.

Following endorsement of the FSB report and recommendations by the
G-20, the FSB LEI Implementation Group (IG) has been tasked with
taking forward the planning and development work to launch the global
LEI system by March 2013.

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Toward
Effective Governance of Financial Institutions
Important Parts
Weak and ineffective governance of systemically important financial
institutions (SIFIs) has been widely cited as an important contributory
factor in the massive failure of financial sector decision making that led to
the global financial crisis.

In the wake of the crisis, financial institution (FI) governance was too
often revealed as a set of arrangements that approved risky strategies
(which often produced unprecedented short-term profits and
remuneration), was blind to the looming dangers on the balance sheet
and in the global economy, and therefore failed to safeguard the FI, its
customers and shareholders, and society at large.

Management teams, boards of directors, regulators and supervisors, and
shareholders all failed, in their respective roles, to prudently govern and
oversee.

On the subject of governance as it applies to FIs, much has been written
and said in the past few years.

Notable among these statements are the 2009 Walker report (A Review of
Corporate Governance in UK Banks and other Financial Industry
Entities) and the Basel Committee’s Principles for Enhancing Corporate
Governance (2010).

Many domestic regulators and stock exchanges have also weighed in with
new requirements and guidelines for governance.

The Group of Thirty (G30) applauds these prior initiatives and supports
not only the spirit of their conclusions but also many of the detailed
recommendations they contain.

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The combination of these reports, self scrutiny by the firms themselves,
and pressure from regulatory overseers has already yielded substantial
changes in governance practice across the financial services industry and
around the globe.

Why would the G30 wish to add its own voice to the body of work already
available, in light of progress being made?

First, no one should presume that FI governance is now fixed.

It is true that boards are working harder; supervisors are asking tough
questions and preparing for more intensive oversight; management
has become much more attuned to risk management and to supporting
the oversight responsibilities of the board; and shareholders, to some
degree, are taking a deeper look into their role in promoting effective
governance.

Nevertheless, as this report highlights, highly functional governance
systems take significant time and sustained effort to establish and hone,
and the G30’s input can help with that effort.

Second, in a modern economy, business leadership represents a large
concentration of power.

The social externalities associated with the business of significant
financial institutions give that power a major additional dimension and
underscore the critical importance of good corporate governance of such
entities.

Third, we note that the prior reports and guidance almost always come
from a national or regional perspective (the Basel Committee report being
a notable exception), which is understandable as a practical matter, but
curious given the distinctly global nature of the SIFIs, which are
appropriately the focus of attention.

Accordingly, in late spring of 2011, the G30 launched a project on the
governance of major financial institutions.

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The project was led by a Steering Committee chaired by Roger W.
Ferguson, Jr., with John G. Heimann, William R. Rhodes, and Sir David
Walker as its vice-chairmen.

They were supported by 11 other G30 members, who participated in an
informal working group.

Requests for interviews went out from the G30 to the chairs of 41 of the
world’s largest, most complex financial institutions— banks, insurance
companies, and securities firms.

In an extraordinary response, especially in light of the pressures on each
of these companies, 36 institutions shared their perspectives and
experiences through detailed discussions with board leaders, CEOs, and
selected senior management leaders.

In addition, the project team held discussions with a global cross section
of FI regulators and supervisors.

The majority of these interviews were conducted in person, all under the
Chatham House Rule,which encourages candor.

The report is the responsibility of the G30 Steering Committee and
Working Group and reflects broad areas of agreement among the
participating G30 members, who took part in their individual capacities.

All G30 members (aside from those with current national official
responsibilities) have had the opportunity to review and discuss
preliminary drafts.

The report does not reflect the official views of those in policy-making
positions or leadership roles in the private sector.

The report is wide-ranging in its coverage of the composition and
functioning of FI boards and the roles of regulators, supervisors, and
shareholders.

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The focus is on potentially universal core themes but acknowledges
differences in customs and practice in different parts of the world.

As regards approaches to total compensation, we do not address this
subject in detail in this report; the G30 commends the Financial Stability
Board’s Principles for Sound Compensation Practices and fully supports
their implementation.

The G30 undertook its initiative on effective FI governance in the hope
and expectation that FI board and senior management leaders could
share actionable wisdom on the essence of effective governance and what
it takes to build and nurture governance systems that work.

We hope this report provides a measure of insight and sustenance to
those with policymaking and operational responsibilities for effective
governance in the world’s great financial institutions.

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Executive Summary

What is meant by “governance” in the context of a financial institution
(FI)?

Corporate governance is traditionally defined as the system by which
companies are directed and controlled.

The OECD Principles of Corporate Governance (2004) defines corporate
governance as involving “a set of relationships between a company’s
management, its board, its shareholders and other stakeholders.

Corporate governance also provides the structure through which the
objectives of the company are set, and the means of attaining those
objectives and monitoring performance are determined.”

In the case of financial institutions, chief among the other stakeholders
are supervisors and regulators charged with ensuring safety, soundness,
and ethical operation of the financial system for the public good.

They have a major stake in, and can make an important contribution to,
effective governance.

Good corporate governance requires checks and balances on the power
and rights accorded to shareholders, stakeholders, and society overall.

Without checks, we see the behaviors that lead to disaster.

But governance is not a fixed set of guidelines and procedures; rather, it is
an ongoing process by which the choices and decisions of FIs are
scrutinized, management and oversight are strengthened and
streamlined, appropriate cultures are established and reinforced, and FI
leaders are supported and assessed.

Why governance matters

The global economic crisis, with the financial services sector at its center,
wreaked economic chaos and imposed enormous costs on society.
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The depth, breadth, speed, and impact of the crisis caught many FI
management teams and boards of directors by surprise and stunned
central banks, FI regulators, supervisors, and shareholders.

[Note: We attempt throughout the report to distinguish the regulatory
function from the supervisory function.

The regulator sets the rules and regulations within which FIs are obliged
to operate, while the supervisor oversees the actions of the board and
management to ensure compliance with those rules and regulations.

Confusion arises because both functions are often performed within the
same institution (for example, the U.S. Federal Reserve and the UK
Financial Services Authority).]

Enormous thought and debate has gone into discovering what caused the
global financial crisis and how to avoid another.

In his much-quoted 2009 report on the causes of the crisis, Lord Adair
Turner, chair of the UK’s Financial Services Authority (FSA), cited seven
proximate causes:

(1) Large, global macroeconomic imbalances;

(2) An increase in commercial banks’ involvement in risky trading
activities;

(3) Growth in securitized credit;

(4) Increased leverage;

(5) Failure of banks to manage financial risks;

(6) Inadequate capital buffers; and

(7) A misplaced reliance on complex math and credit ratings in assessing
risk.

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A critical subtext to these seven causes is a pervasive failure of
governance at all levels.

More generally, most observers have agreed that a combination of “light
touch” supervision, which relied too heavily on self-governance in
financial firms, and weak corporate governance and risk management at
many systemically important financial institutions (SIFIs) contributed to
the 2008 meltdown in the United States.

In several key markets, deregulation and market-based supervision were
the political order of the day as countries vied for global capital flows,
corporate headquarters, and exchange listings.

Regulators also missed the potential systemic impact of entire classes of
financial products, such as subprime mortgages, and in general failed to
spot the large systemic risks that had been growing during the previous
two decades.

In this context, boards of directors failed to grasp the risks their
institutions had taken on.

They did not understand their vulnerability to major shocks, or they failed
to act with appropriate prudence.

Management, whose decisions and actions determine the organization’s
risk status, clearly failed to understand and control risks.

In many cases, spurred on by shareholders, both management and the
board focused on performance to the detriment of prudence.

Effective governance is a necessary complement to rules-based
regulation.

The system needs both.

Carefully crafted rules-based regulations concerning capital, liquidity,
permitted business activities, and so forth are essential safeguards for the

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financial system, while effective governance shapes, monitors, and
controls what actually happens in FIs.

Ineffective governance at financial institutions was not the sole
contributor to the global financial crisis, but it was often an accomplice in
the context of massive macroeconomic vulnerability.

Effective governance can make a significant positive difference by
helping to prevent future crises or by mitigating their deleterious impact.

In other words, the rewards for investment in effective governance are
great.

A call to action

Each of the four participants in the governance system—boards of
directors, management, supervisors, and (to an extent) long-term
shareholders— needs to reassess their approach to FI governance
and take meaningful steps to make governance stronger.

This report offers a comprehensive set of concrete insights and
recommendations for what each participant needs to do to make FI
governance function more effectively.

The G30 is acutely aware that the agendas of FI boards and supervisors
are crowded, yet we urge them to continue to give effective governance
one of their highest priorities.

‹. The financial sector needs better methods of assessing governance and
of cultivating the behaviors and approaches that make governance
systems work well.

Board self-evaluation, especially when facilitated or led by an outside
expert, can yield important insight, but it is sobering to consider that in
2007, most boards would likely have given themselves passing grades.

‹. Supervisors now aspire to understand governance effectiveness and
vulnerabilities, but admit to having much to learn.
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‹. Governance experts often describe what good governance looks like,
but give little thought to how to measure or achieve high-performance
results.

Given the role that inadequate governance played in the massive failure of
financial sector decision making that led to the global financial crisis, it is
natural that supervisors and stock exchanges are now paying great
attention to governance arrangements.

This attention, as a practical matter, often focuses on explicit rules,
structures, and processes—best practices—that governance experts often
believe are indicative of effective governance.

Consequently, compliance with best practice guidelines has become very
important to boards and to overseers charged with monitoring and
encouraging good governance.

The G30 hopes this report will contribute meaningfully to the body of
knowledge on governance and will be a useful tool for those tasked with
shaping governance systems.

The board

Boards of directors play the pivotal role in FI governance through their
control of the three factors that ultimately determine the success of the FI:
the choice of strategy; the assessment of risk taking; and the assurance
that the necessary talent is in place, starting with the CEO, to implement
the agreed strategy.

The 2008–2009 financial crisis revealed that management at certain FIs,
with the knowledge and approval of their boards, took decisions and
actions that led to terrible outcomes for employees, customers,
shareholders, and the wider economy.

What should the boards have done differently?

To answer that question, it is helpful to consider the mandate of boards.

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Boards control the three key factors that ultimately determine the success
of an FI:

1. The choice of business model (strategy)
2. The risk profile, and
3. The choice of CEO—and by extension the quality of the
top-management team.

Boards that permit their time and attention to be diverted
disproportionately into compliance and advisory activities at the expense
of strategy, risk, and talent issues are making a critical mistake.

Above all else, boards must take every step possible to protect against
potentially fatal risks.

FI boards in every country must take a long-term view that encourages
long-term value creation in the shareholders’ interests, elevates prudence
without diminishing the importance of innovation, reduces short-term
self-interest as a motivator, brings into the foreground the firm’s
dependence on its pool of talent, and demands the firm play a palpably
positive role in society.

The importance of mature, open leadership by a skillful board chair
cannot be overemphasized.

Effective chairs capitalize on the wisdom and advice of board members
and management leaders and on the board’s interactions with supervisors
and shareholders, individually and collectively.

Good chairs respect each of these vital constituents, preside, encourage
debate, and do not manage toward a predetermined outcome.

Risk governance

Those accountable for key risk policies in FIs, on the board and within
management, have to be sufficiently empowered to put the brakes on the
firm’s risk taking, but they also play a critical role in enabling the firm to

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conduct well-measured, profitable risk-taking activities that support the
firm’s long-term sustainable success.

In the financial services sector more than in other industries, risk
governance is of paramount importance to the stability and profitability of
the enterprise.

Without an ability to properly understand, measure, manage, price, and
mitigate risk, FIs are destined to underperform or fail.

Effective risk governance requires a dedicated set of risk leaders in the
boardroom and executive suite, as well as robust and appropriate risk
frameworks, systems, and processes.

The history of financial crises, including the 2008–2009 crisis, is littered
with firms that collapsed or were taken to the brink by a failure of risk
governance.

The most recent financial crisis demonstrated the inability of many FIs to
accurately gauge, understand, and manage their risks.

Firms greatly understated their inherent risks, particularly correlations
across their businesses, and were woefully unprepared for the exogenous
risks that unfolded during the crisis and afterward.

Management

Management needs to play a continuous proactive role in the overall
governance process, upward to the board and downward through the
organization.

The vast majority of governance and control processes are embedded in
the organizational fabric, which is woven and maintained by
management.

The board is dependent on management for information and for
translating sometimes highly technical information into issues and
choices requiring business judgment.
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Governance cannot be effective without major continuing input from
management in identifying the big issues and presenting them for
discussion with the board.

Management needs to strengthen the fabric of checks and balances in the
organization.

It must deepen its respect for the vital roles of the board and supervisors
and help them to do their jobs well.

It must reinforce the values that drive good behavior through the
organization and build a culture that respects risk while encouraging
innovation.

Supervisors

Supervisors that more fully comprehend FI strategies, risk appetite and
profile, culture, and governance effectiveness will be better able to make
the key judgments their mandate requires.

Supervisors have legally defined responsibilities relating to risk control;
fraud control; and conformance to laws, regulations, and standards of
conduct.

Supervisors now seek a deeper and more nuanced understanding of how
the board works, how key decisions are reached, and the nature of the
debate around them, all of which reveal much about the firm’s
governance.

Most FI boards applaud this expansion in the supervisors’ focus from
control process details to include a broader grasp of issues and context.

To be effective, however, this expansion requires regular interaction
among senior people in supervisory agencies and boards and board
members.

Supervisors need to broaden their perspectives to include FI strategy,
people, and culture.
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They should focus their discussions with senior management and
the board on the real issues—through both formal and informal
communications.

But they must also maintain their independence and accept that they will
at best have an incomplete picture.

Similarly, supervisors must not try to do the board’s job or so overwhelm
the board and management that they cannot guide the FI.

Supervisors have a unique perspective on emerging systemic,
macroprudential risks and can compare and contrast one FI with others.

This is vital information to develop and share.

Unfortunately, in the policy-making debate, the qualitative aspect of
supervision is sometimes overshadowed by quantitative, rules-based
regulatory requirements.

Clearly, new capital, liquidity, and related standards are essential to a
more stable global financial architecture, but enhanced oversight of the
performance and decision-making processes of major FIs is also
essential.

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Statement on Public Meeting On
Auditor Independence and Audit
Firm Rotation

SPEAKER: James R. Doty, Chairman

Welcome everyone to the Public Company Accounting Oversight Board's
third public meeting on the Board's concept release on ways to enhance
auditor independence.

I want to thank Rice University and Dean Bill Glick for providing such an
inspiring venue for this meeting.

We have assembled an august set of panelists today to assist the Board in
an in-depth examination of an issue that continues to trouble many of the
most thoughtful supporters of the audit profession — the subtle (and not
so subtle) influences on the auditor's mindset, and the implication for the
integrity of the audit.

Enhancing auditor independence was one of the main goals of the
Sarbanes-Oxley Act of 2002. We have one of the draftsmen of that Act
seated to my left at the table.

In the weeks and months leading up to the enactment of Sarbanes-Oxley,
Congress considered requiring audit firm rotation to improve auditor
independence.

But the final statute as enacted stepped back. Instead, it provided for
partner rotation on public company audits. In addition, it asked for
further study of firm rotation.

Shortly thereafter, in 2003, the Government Accountability Office
embarked on a review of the arguments for and against audit firm

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rotation. The review was preliminary in light of other Sarbanes-Oxley
reforms that were only beginning to be implemented.

Thus it concluded that the SEC and the Board would need several years
to evaluate whether the Sarbanes-Oxley reforms, including audit partner
rotation, were sufficient, or whether further independence measures are
necessary to protect investors.

We are fortunate to have on the PCAOB board one of the drafters of the
GAO report to help us put it in context.

Since then, the financial crisis of 2008 has caused us as a nation to reflect
on how dependent our financial system is on high quality, unbiased
audits.

It has prompted us to look again at auditor independence, objectivity and
professional skepticism, and to ask whether features of our financial
system have allowed companies to become too close to their auditors.

And to consider whether there are ways we can improve the reliability and
usefulness of audit reports to the public.

We are not alone in this inquiry. Many other countries have commenced
their own reviews of audit practices.

We are fortunate to be able to hear from a representative of the European
Commission later today about potential reforms that are currently under
consideration in Europe.

Just last month, the United Kingdom published a regulation that would
entail mandatory retendering every ten years for FTSE 350 companies,
with corresponding disclosure requirements.

I don't mean to exclude other important actions in other countries. There
are many. The U.K.'s is just the most recent.

Given the breadth of the international debate, it is not surprising that
people disagree on what the best reforms will be, or how to implement
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them, or indeed whether reform is necessary. Or whether the costs to
those who would incur them outweigh the benefits to those who would
receive them.

I hear no doubt in any corner, however, about the importance of
independent audits.

Let me say that I believe it is the rare case in which an auditor knowingly
compromises his or her integrity. But well-intentioned auditors, as with
other people, sometimes fail to recognize and guard against their own
unconscious biases.

We are nearly ten years from the adoption of Sarbanes-Oxley, during
which we have had time to observe whether its reforms were sufficient.

Against this historical background, in August 2011, the PCAOB issued a
concept release, seeking public comment on a variety of questions about
how to improve auditor independence, objectivity and professional
skepticism.

The concept release notes the importance of auditor independence to the
viability of auditing as a profession and highlights the risk to
independence arising from the "client-pays" model.

As noted in the concept release, the PCAOB inspectors continue to find
what is to me an unacceptable level of deficient audits.

In addition, inspectors continue to find troubling suggestions of firms
showing willingness to put management's short-term interest ahead of
investors'.

The concept release seeks public comment on ways that auditor
independence, objectivity and professional skepticism can be enhanced.

In this regard, the release notes that there may be risks to professional
skepticism in both the relatively new audit that the auditor may hope to
turn into a long-term engagement, as well as the very long engagement
that no partner wants to be the one to lose.
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We have received more than 600 comment letters, primarily from auditors
and their clients. On the whole, they counsel for more time and study, and
more modest reforms.

To be sure, I want to be cautious in making any decisions, and that is why
I have asked for meetings like this and two previous meetings in
Washington, D.C., and San Francisco.

We have the benefit of the record of our first two meetings. Therefore,
although today's panelists have been invited to provide views on any of
the issues raised in the Board's concept release, they have also been asked
to comment specifically on certain themes, issues and suggestions from
the prior public meetings.

I want to thank the panelists, my fellow board members, the SEC's
Deputy Chief Accountant Brian Croteau who has joined us today, and the
PCAOB staff who have made the meeting possible. I look forward to a
thoughtful discussion that will help the Board advance its inquiry.

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Statement on Public Meeting On Auditor Independence and
Audit Firm Rotation
SPEAKER: Jeanette M. Franzel, Board Member

Thank you, Chairman Doty, for calling this public meeting to further
explore some of the principal themes that have emerged in the feedback
that the Board has received in response to the PCAOB Concept Release
on Auditor Independence and Audit Firm Rotation issued in August of
last year.

The Board has received more than 670 comment letters and heard from 77
speakers on this topic to date.

Throughout this process, the Board has received rich feedback on the
complex issues that impact auditor independence and audit quality, as
well as a range of suggestions for potential actions that could be taken.

Commenters have acknowledged the fundamental importance of auditor
independence as the underpinning of confidence in the auditing
profession.

They also expressed support for the Board's efforts to ensure or enhance
the auditor's independence, objectivity, and professional skepticism,
although suggestions for how this might be achieved varied widely.

The concept release and our related public meetings are creating a
substantive debate among the full range of stakeholders.

It is certainly public knowledge that the majority of the commenters on
this issuer were opposed to a requirement for mandatory audit firm
rotation for a variety of reasons.

We are currently conducting analyses of the feedback we have received,
as well as additional research by the PCAOB and others.

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Today we will explore a number of major themes in the comment letters
and panelist feedback, including the following suggestions:

- strengthening audit committees, including enhancing their financial
expertise, increasing their independence from management, and
enhancing and increasing interaction and communications with
investors, auditors, and the PCAOB;

- increasing emphasis on professional skepticism in standards and
education for auditors, as well as in the firms' culture and systems of
quality control.

- increasing the transparency surrounding PCAOB inspection results,
as well as making public the PCAOB's enforcement investigations
and proceedings;

- expanding PCAOB inspections in certain circumstances;

- increasing the root cause analyses by the PCAOB and the firms on the
causes of audit deficiencies;

- using mandatory "retendering" of the audit and/or a formal
re-evaluation of the auditor's tenure at given intervals;

- exploring variations on the possible use of firm rotation, including
limiting any potential rotation requirement to certain audits and
certain circumstances; and

- potentially further restricting the provision of non-audit services by
the auditor.

I am personally committed to exploring the broad range of themes and
issues that influence auditor independence, objectivity, and professional
skepticism, as well as audit quality, and advancing the Board's efforts to
protect investors and the public interest through high quality,
independent audits.

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Any methods for improving auditor independence and audit quality won't
be simple, and there will not be a "silver bullet."

Today, we will be hearing from a new group of highly qualified panelists.

I am interested in their views on the different challenges to achieving
independence, objectivity, and professional skepticism and the variety of
potential actions that could be taken to help improve auditor
independence and audit quality.

I believe that we need concerted and sustained action from the full range
of parties who have responsibility for these issues, including those
responsible for accounting education, audit firm recruitment and
training, audit firm culture and tone at the top, audit committee and
board oversight, as well as PCAOB inspections and other regulatory
activities.

It is paramount, of course, that all of the parties with responsibility
throughout the process keep the interests of investors front and center.

One of the major themes that has emerged during the Board's efforts on
auditor independence is a consensus on the importance of audit
committees in overseeing the auditor and the audit process.

PCAOB does not have regulatory jurisdiction over audit committees.

But we should not overlook the tremendous value in coordinating and
leveraging our efforts; avoiding duplication and/or fragmentation; and
providing for a seamless system of effective governance and audit
oversight.

During our outreach, PCAOB received feedback on ways that audit
committee performance can be enhanced. I'm pleased that we have a
number of audit committee members and corporate governance experts
here today to explore these issues.

Another theme emerging from the input that the Board has received is
that professional skepticism should be emphasized more in the
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education, training, and standard-setting for auditors, as well as in the
firms' cultures, tone at the top, and systems of quality control.

I'm pleased that we have a number of academicians and practitioners
here today to further explore these issues with us.

I am also very interested in the views of the investors and others here
today on these and other issues impacting auditor independence, audit
quality, and investor protection.

I believe investors will be well-served if the various organizations and
groups charged with protecting investors, the public interest, and the
integrity of the U.S. capital markets work together effectively to achieve
these goals.

The bottom line here is that we must come up with a package of actions
that will be solid and effective in protecting investors and the public
interest through independent, high quality financial audits.

We also need to carefully consider and analyze the potential costs and
benefits of various actions, as well as the risks associated with unintended
consequences, so that we are effective in protecting the interests of
investors and furthering the public interest in the preparation of
informative, accurate, and independent audit reports.

I want to thank all of the panelists, their staff, and their constituencies, for
taking the time and effort to assist us in exploring these very important
issues.

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Statement on Public Meeting On Auditor Independence and
Audit Firm Rotation
SPEAKER: Jay D. Hanson, Board Member

Good morning,

I would like to join Chairman Doty and my fellow Board members in
welcoming today's panelists and to thank the Rice University community
for their warm welcome.

I would also like to thank the PCAOB staff for their hard work in getting
all of us into this room together to discuss auditor independence,
objectivity and skepticism, which, without a doubt, is one of the most
fundamental elements in the performance of robust audits and key to
serving the needs of investors.

Fourteen months ago, we issued a concept release with the goal of
gathering information and framing a discussion about whether the Board
should take any steps to enhance auditor independence, objectivity and
skepticism.

Since then, we have received almost 700 comment letters and have heard
from dozens of panelists.

Commenters overwhelmingly support the Board's efforts to enhance
auditor independence, objectivity and skepticism, but there are widely
varying views on how to accomplish that goal.

Most commenters oppose mandatory rotation and express concern that
auditor rotation will actually decrease audit quality.

From this group, we have heard some suggestions for ways to enhance
auditor rotation, including an enhanced focus by audit committees, joint
audits, mandatory re-tendering, tenure protection for auditors, non-audit
service restrictions, increased PCAOB inspections and/or transparency
about our inspections, and several others.
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Some commenters, on the other hand, believe that auditor rotation is the
only way to overcome what some describe as an inherent conflict between
independence and the fact that auditors are paid by the companies they
audit.

Thus, we have received a lot of input, and we have much to think about.

There are a few areas, however, where I believe we would benefit from
more information, and I would like to encourage today's panelists, and
any other potential commenters, to consider whether they can help us fill
in these gaps.

For example, it has proven difficult to establish a clear correlation
between audit quality and auditor tenure.

I know some of you may address that issue today, and I look forward to
hearing your views on this subject. I look forward to hearing views on how
panelists define audit quality.

To date, we also have not delved deeply into the details and implications
of all the potential ways to enhance auditor independence that have been
suggested.

In order to fully understand all possible approaches, and to determine
how to evaluate various alternatives, I believe it is important that we do
so.

I look forward to hearing from those of you who plan to share with us
views on approaches other than rotation that could enhance both auditor
independence and audit quality.

To the extent companies, auditors or audit committees have tried any
approaches to enhance auditor independence, I encourage you to share
your experiences with us, both in terms of benefits and costs.

Finally, I have spoken a number of times on the key role played by audit
committees.
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In my experience as an auditor, I saw a transformation in audit
committee behavior and focus after implementation of the requirements
of the Sarbanes-Oxley Act.

We have heard from many audit committee members who described in
great detail their extensive efforts to evaluate and ensure their auditor's
independence.

Yet, some believe that even the most diligent audit committees cannot
sufficiently monitor auditor independence.

One question I frequently ask myself is what we can do to help audit
committees do a better job in this regard.

In August, the Board issued a new auditing standard on communications
with audit committees.

It is my hope that by arming audit committees with more information
about the audit, including audit risks, significant or difficult accounting
issues, significant unusual transactions, and other important matters,
those committees can provide better oversight over the entirety of the
audit process, including evaluating whether the auditor is approaching
difficult issues with an appropriate degree of skepticism.

Likewise, we recently issued a release to provide audit committees with
more information about PCAOB inspections and related topics that audit
committees may wish to discuss with their auditor.

This too, I trust, will assist audit committees in better evaluating their
auditors in a variety of important areas, including competence, diligence
and independence.

Although the Board does not have the authority to regulate audit
committees, we are willing to help them however we can.
I am particularly interested in your views — and those of other
commenters who may not yet have participated in this dialog — as to
what else this Board can do to enhance the ability of audit committees to
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ensure that their auditors are appropriately meeting all of their
obligations.

Thank you again for taking time out of your busy schedules to be with us
today, and I look forward to your comments.

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BIS, A framework for dealing with
domestic systemically important
banks

I. Introduction
1. The Basel Committee on Banking
Supervision (the Committee) issued the
rules text on the assessment methodology
for global systemically important banks
(G-SIBs) and their additional loss
absorbency requirements in November
2011.

The G-SIB rules text was endorsed by the G20 Leaders at their November
2011 meeting.

The G20 Leaders also asked the Committee and the Financial Stability
Board to work on modalities to extend expeditiously the G-SIFI
framework to domestic systemically important banks (D-SIBs).

2. The rationale for adopting additional policy measures for G-SIBs was
based on the “negative externalities” (ie adverse side effects) created by
systemically important banks which current regulatory policies do not
fully address.

In maximising their private benefits, individual financial institutions may
rationally choose outcomes that, from a system-wide level, are
sub-optimal because they do not take into account these externalities.

These negative externalities include the impact of the failure or
impairment of large, interconnected global financial institutions that can
send shocks through the financial system which, in turn, can harm the
real economy.

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Moreover, the moral hazard costs associated with direct support and
implicit government guarantees may amplify risk-taking, reduce market
discipline, create competitive distortions, and further increase the
probability of distress in the future.

As a result, the costs associated with moral hazard add to any direct costs
of support that may be borne by taxpayers.

3. The additional requirement applied to G-SIBs, which applies over and
above the Basel III requirements that are being introduced for all
internationally-active banks, is intended to limit these cross-border
negative externalities on the global financial system and economy
associated with the most globally systemic banking institutions.

But similar externalities can apply at a domestic level.

There are many banks that are not significant from an international
perspective, but nevertheless could have an important impact on their
domestic financial system and economy compared to non-systemic
institutions.

Some of these banks may have cross-border externalities, even if the
effects are not global in nature. Similar to the case of G-SIBs, it was
considered appropriate to review ways to address the externalities posed
by D-SIBs.

4. A D-SIB framework is best understood as taking the complementary
perspective to the G-SIB regime by focusing on the impact that the
distress or failure of banks (including by international banks) will have on
the domestic economy.

As such, it is based on the assessment conducted by the local authorities,
who are best placed to evaluate the impact of failure on the local financial
system and the local economy.

5. This point has two implications.

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The first is that in order to accommodate the structural characteristics of
individual jurisdictions, the assessment and application of policy tools
should allow for an appropriate degree of national discretion.

This contrasts with the prescriptive approach in the G-SIB framework.

The second implication is that because a D-SIB framework is still
relevant for reducing cross-border externalities due to spillovers at
regional or bilateral level, the effectiveness of local authorities in
addressing risks posed by individual banks is of interest to a wider group
of countries.

A framework, therefore, should establish a minimum set of principles,
which ensures that it is complementary with the G-SIB framework,
addresses adequately cross-border externalities and promotes a
level-playing field.

6. The principles developed by the Committee for D-SIBs would allow for
appropriate national discretion to accommodate structural characteristics
of the domestic financial system, including the possibility for countries to
go beyond the minimum D-SIB framework and impose additional
requirements based on the specific features of the country and its
domestic banking sector.

7. The principles set out in the document focus on the higher loss
absorbency (HLA) requirement for D-SIBs. The Committee would like to
emphasise that other policy tools, particularly more intensive supervision,
can also play an important role in dealing with D-SIBs.

8. The principles were developed to be applied to consolidated groups
and subsidiaries.

However, national authorities may apply them to branches in their
jurisdictions in accordance with their legal and regulatory frameworks.

9. The implementation of the principles will be combined with a strong
peer review process introduced by the Committee.

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The Committee intends to add the D-SIB framework to the scope of the
Basel III regulatory consistency assessment programme.

This will help ensure that appropriate and effective frameworks for
D-SIBs are in place across different jurisdictions.

10. Given that the D-SIB framework complements the G-SIB framework,
the Committee considers that it would be appropriate if banks identified
as D-SIBs by their national authorities are required by those authorities to
comply with the principles in line with the phase-in arrangements for the
G-SIB framework, ie from January 2016.

II. The principles

11. The Committee has developed a set of principles that constitutes the
D-SIB framework.

The 12 principles can be broadly categorised into two groups:

The first group (Principles 1 to 7) focuses mainly on the assessment
methodology for D-SIBs while the second group (Principles 8 to 12)
focuses on HLA for D-SIBs.

12. The 12 principles are set out below:

Assessment methodology
Principle 1:
National authorities should establish a methodology for assessing the
degree to which banks are systemically important in a domestic context.

Principle 2:
The assessment methodology for a D-SIB should reflect the potential
impact of, or externality imposed by, a bank’s failure.

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Principle 3:
The reference system for assessing the impact of failure of a D-SIB should
be the domestic economy.

Principle 4:
Home authorities should assess banks for their degree of systemic
importance at the consolidated group level, while host authorities should
assess subsidiaries in their jurisdictions, consolidated to include any of
their own downstream subsidiaries, for their degree of systemic
importance.

Principle 5:
The impact of a D-SIB’s failure on the domestic economy should, in
principle, be assessed having regard to bank-specific factors:

(a) Size

(b) Interconnectedness

(c) Substitutability/financial institution infrastructure (including
considerations related to the concentrated nature of the banking sector)

(d) Complexity (including the additional complexities from cross-border
activity).

In addition, national authorities can consider other measures/data that
would inform these bank-specific indicators within each of the above
factors, such as size of the domestic economy.

Principle 6:
National authorities should undertake regular assessments of the
systemic importance of the banks in their jurisdictions to ensure that their
assessment reflects the current state of the relevant financial systems and
that the interval between D-SIB assessments not be significantly longer
than the G-SIB assessment frequency.
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Principle 7:
National authorities should publicly disclose information that provides an
outline of the methodology employed to assess the systemic importance
of banks in their domestic economy.

Higher loss absorbency
Principle 8:
National authorities should document the methodologies and
considerations used to calibrate the level of HLA that the framework
would require for D-SIBs in their jurisdiction.

The level of HLA calibrated for D-SIBs should be informed by
quantitative methodologies (where available) and country-specific factors
without prejudice to the use of supervisory judgement.

Principle 9:

The HLA requirement imposed on a bank should be commensurate with
the degree of systemic importance, as identified under Principle 5.

Principle 10:
National authorities should ensure that the application of the G-SIB and
D-SIB frameworks is compatible within their jurisdictions.

Home authorities should impose HLA requirements that they calibrate at
the parent and/or consolidated level, and host authorities should impose
HLA requirements that they calibrate at the sub-consolidated/subsidiary
level.

The home authority should test that the parent bank is adequately
capitalised on a stand-alone basis, including cases in which a D-SIB HLA
requirement is applied at the subsidiary level.

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Home authorities should impose the higher of either the D-SIB or G-SIB
HLA requirements in the case where the banking group has been
identified as a D-SIB in the home jurisdiction as well as a G-SIB.

Principle 11:
In cases where the subsidiary of a bank is considered to be a D-SIB by a
host authority, home and host authorities should make arrangements to
coordinate and cooperate on the appropriate HLA requirement, within
the constraints imposed by relevant laws in the host jurisdiction.

Principle 12:
The HLA requirement should be met fully by Common Equity Tier 1
(CET1). In addition, national authorities should put in place any
additional requirements and other policy measures they consider to be
appropriate to address the risks posed by a D-SIB.

Assessment methodology
Principle 1: National authorities should establish a methodology for
assessing the degree to which banks are systemically important in a
domestic context.

Principle 2: The assessment methodology for a D-SIB should reflect
the potential impact of, or externality imposed by, a bank’s failure.
13. A starting point for the development of principles for the assessment of
D-SIBs is a requirement that all national authorities should undertake an
assessment of the degree to which banks are systemically important in a
domestic context.

The rationale for focusing on the domestic context is outlined in
paragraph 17 below.

14. Paragraph 14 of the G-SIB rules text states that “global systemic
importance should be measured in terms of the impact that a failure of a
bank can have on the global financial system and wider economy rather
than the risk that a failure can occur.
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This can be thought of as a global, system-wide, loss-given-default
(LGD) concept rather than a probability of default (PD) concept.”

Consistent with the G-SIB methodology, the Committee is of the view
that D-SIBs should also be assessed in terms of the potential impact of
their failure on the relevant reference system.

One implication of this is that to the extent that D-SIB indicators are
included in any methodology, they should primarily relate to “impact of
failure” measures and not “risk of failure” measures.

Principle 3: The reference system for assessing the impact of failure
of a D-SIB should be the domestic economy.

Principle 4: Home authorities should assess banks for their degree of
systemic importance at the consolidated group level, while host
authorities should assess subsidiaries in their jurisdictions,
consolidated to include any of their own downstream subsidiaries,
for their degree of systemic importance.
15. Two key aspects that shape the D-SIB framework and define its
relationship to the G-SIB framework relate to how it deals with two
conceptual issues with important practical implications:

• What is the reference system for the assessment of systemic impact

• What is the appropriate unit of analysis (ie the entity which is being
assessed)?

16. For the G-SIB framework, the appropriate reference system is the
global economy, given the focus on cross-border spillovers and the
negative global externalities that arise from the failure of a globally active
bank.

As such this allowed for an assessment of the banks that are systemically
important in a global context.

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The unit of analysis was naturally set at the globally consolidated level of
a banking group (paragraph 89 of the G-SIB rules text states that “(t)he
assessment of the systemic importance of G-SIBs is made using data that
relate to the consolidated group”).

17. Correspondingly, a process for assessing systemic importance in a
domestic context should focus on addressing the externalities that a
bank’s failure generates at a domestic level.

Thus, the Committee is of the view that the appropriate reference system
should be the domestic economy, ie that banks would be assessed by the
national authorities for their systemic importance to that specific
jurisdiction.

The outcome would be an assessment of banks active in the domestic
economy in terms of their systemic importance.

18. In terms of the unit of analysis, the Committee is of the view that home
authorities should consider banks from a (globally) consolidated
perspective.

This is because the activities of a bank outside the home jurisdiction can,
when the bank fails, have potential significant spillovers to the domestic
(home) economy.

Jurisdictions that are home to banking groups that engage in
cross-border activity could be impacted by the failure of the whole
banking group and not just the part of the group that undertakes
domestic activity in the home economy.

This is particularly important given the possibility that the home
government may have to fund/resolve the foreign operations in the
absence of relevant cross-border agreements.

This is in line with the concept of the G-SIB framework.

19. When it comes to the host authorities, the Committee is of the view
that they should assess foreign subsidiaries in their jurisdictions, also
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consolidated to include any of their own downstream subsidiaries, some
of which may be in other jurisdictions.

For example, for a cross-border financial group headquartered in country
X, the authorities in country Y would only consider subsidiaries of the
group in country Y plus the downstream subsidiaries, some of which may
be in country Z, and their impact on the economy Y.

Thus, subsidiaries of foreign banking groups would be considered from a
local or sub-consolidated basis from the level starting in country Y.

The scope should be based on regulatory consolidation as in the case of
the G-SIB framework.

Therefore, for the purposes of assessing D-SIBs, insurance or other
non-banking activities should only be included insofar as they are
included in the regulatory consolidation.

20. The assessment of foreign subsidiaries at the local consolidated level
also acknowledges the fact that the failure of global banking groups could
impose outsized externalities at the local (host) level when these
subsidiaries are significant elements in the local (host) banking system.

This is important since there exist several jurisdictions that are
dominated by foreign subsidiaries of internationally active banking
groups.

Principle 5: The impact of a D-SIB’s failure on the domestic
economy should, in principle, be assessed having regard to
bank-specific factors:
(a) Size;
(b) Interconnectedness;
(c) Substitutability/financial institution infrastructure (including
considerations related to the concentrated nature of the banking
sector); and
(d) Complexity (including the additional complexities from
cross-border activity).

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In addition, national authorities can consider other measures/data
that would inform these bank-specific indicators within each of the
above factors, such as size of the domestic economy.
21. The G-SIB methodology identifies five broad categories of factors that
influence global systemic importance: size, cross-jurisdictional activity,
interconnectedness, substitutability/financial institution infrastructure
and complexity.

The indicator-based approach and weighting system in the G-SIB
methodology was developed to ensure a consistent international ranking
of G-SIBs.

The Committee is of the view that this degree of detail is not warranted
for D-SIBs, given the focus is on the domestic impact of failure of a bank
and the wide ranging differences in each jurisdiction’s financial structure
hinder such international comparisons being made.

This is one of the reasons why the D-SIB framework has been developed
as a principles-based approach.

22. Consistent with this view, it is appropriate to list, at a high level, the
broad category of factors (eg size) that jurisdictions should have regard to
in assessing the impact of a D-SIB’s failure.

Among the five categories in the G-SIB framework, size,
interconnectedness, substitutability/financial institution infrastructure
and complexity are all relevant for D-SIBs as well.

Cross-jurisdictional activity, the remaining category, may not be as
directly relevant, since it measures the degree of global
(cross-jurisdictional) activity of a bank which is not the focus of the
D-SIB framework.

23. In addition, national authorities may choose to also include some
country-specific factors.

A good example is the size of a bank relative to domestic GDP.
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If the size of a bank is relatively large compared to the domestic GDP, it
would make sense for the national authority of the jurisdiction to identify
it as a D-SIB whereas a same-sized bank in another jurisdiction, which is
smaller relative to the GDP of that jurisdiction, may not be identified as a
D-SIB.

24. National authorities should have national discretion as to the
appropriate relative weights they place on these factors depending on
national circumstances.

Principle 6: National authorities should undertake regular
assessments of the systemic importance of the banks in their
jurisdictions to ensure that their assessment reflects the current state
of the relevant financial systems and that the interval between D-SIB
assessments not be significantly longer than the G-SIB assessment
frequency.
25. The list of G-SIBs (including their scores) is assessed annually, based
on updated data submitted by each participating bank, but measured
against a global sample that is largely unchanged for three years.

It is expected that the names and buckets of G-SIBs and the data used to
produce the scores will be disclosed.

26. The Committee believes it is good practice for national authorities to
undertake a regular assessment as to the systemic importance of the
banks in their financial systems.

The assessment should also be conducted if there are important
structural changes to the banking system such as, for example, a merger
of major banks.

A national authority’s assessment process and methodology will be
reviewed by the Committee’s implementation monitoring process.

27. It is also desirable that the interval of the assessments not be
significantly longer than that for G-SIBs (ie one year).

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For example, a SIB could be identified as a G-SIB but also a D-SIB in the
same jurisdiction or in other host jurisdictions.

Alternatively, a G-SIB could drop from the G-SIB list and
become/continue to be a D-SIB.

In order to keep a consistent approach in these cases, it would be sensible
to have a similar frequency of assessments for the two frameworks.

Principle 7: National authorities should publicly disclose
information that provides an outline of the methodology employed
to assess the systemic importance of banks in their domestic
economy.
28. The assessment process used needs to be clearly articulated and made
public so as to set up the appropriate incentives for banks to seek to
reduce the systemic risk they pose to the reference system.

This was the key aspect of the G-SIB framework where the assessment
methodology and the disclosure requirements of the Committee and the
banks were set out in the G-SIB rules text.

By taking these measures, the Committee sought to ensure that banks,
regulators and market participants would be able to understand how the
actions of banks could affect their systemic importance score and thereby
the required magnitude of additional loss absorbency.

The Committee believes that transparency of the assessment process for
the D-SIB framework is also important, even if it is likely to vary across
jurisdictions given differences in frameworks and policy tools used to
address the systemic importance of banks.

Higher loss absorbency
Principle 8: National authorities should document the
methodologies and considerations used to calibrate the level of HLA
that the framework would require for D-SIBs in their jurisdiction.
The level of HLA calibrated for D-SIBs should be informed by
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quantitative methodologies (where available) and country-specific
factors without prejudice to the use of supervisory judgement.
29. The purpose of an HLA requirement for D-SIBs is to reduce further
the probability of failure compared to non-systemic institutions,
reflecting the greater impact a D-SIB failure is expected to have on the
domestic financial system and economy.

30. The Committee intends to assess the implementation of the
framework by the home and host authorities for its degree of
cross-jurisdictional consistency, having regard to the differences in
national circumstances.

In order to increase the consistency in the implementation of the D-SIB
framework and to avoid situations where banks similar in terms of the
level of domestic systemic importance they pose in the same or different
jurisdictions have substantially different D-SIB frameworks applied to
them, it is important that there is sufficient documentation provided by
home and host authorities for the Committee to conduct an effective
implementation review assessment.

It is important for the application of a D-SIB HLA, at both the parent and
subsidiary level, to be based on a transparent and well articulated
assessment framework to ensure the implications of the requirements are
well understood by both the home and the host authorities.

31. The level of HLA for D-SIBs should be subject to policy judgement by
national authorities.

That said, there needs to be some form of analytical framework that
would inform policy judgements.

This was the case for the policy judgement made by the Committee on
the level of the additional loss absorbency requirement for G-SIBs.

32. The policy judgement on the level of HLA requirements should also
be guided by country-specific factors which could include the degree of

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concentration in the banking sector or the size of the banking sector
relative to GDP.

Specifically, countries that have a larger banking sector relative to GDP
are more likely to suffer larger direct economic impacts of the failure of a
D-SIB than those with smaller banking sectors.

While size-to-GDP is easy to calculate, the concentration of the banking
sector could also be considered (as a failure in a medium-sized highly
concentrated banking sector would likely create more of an impact on the
domestic economy than if it were to occur in a larger, more widely
dispersed banking sector).

33. The use of these factors in calibrating the HLA requirement would
provide justification for different intensities of policy responses across
countries for banks that are otherwise similar across the four key
bank-specific factors outlined in Principle 5.

Principle 9: The HLA requirement imposed on a bank should be
commensurate with the degree of systemic importance, as identified
under Principle 5.
34. In the G-SIB framework, G-SIBs are grouped into different categories
of systemic importance based on the score produced by the
indicator-based measurement approach.

Different additional loss absorbency requirements are applied to the
different buckets (G-SIB rules text paragraphs 52 and 73).

35. Although the D-SIB framework does not produce scores based on a
prescribed methodology as in the case of the G-SIB framework, the
Committee is of the view that the HLA requirements for D-SIBs should
also be decided based on the degree of domestic systemic importance.

This is to provide the appropriate incentives to banks which are subject to
the HLA requirements to reduce (or at least not increase) their systemic
importance over time. In the case where there are multiple D-SIB buckets

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in a jurisdiction, this could imply differentiated levels of HLA between
D-SIB buckets.

Principle 10: National authorities should ensure that the application
of the G-SIB and D-SIB frameworks is compatible within their
jurisdictions. Home authorities should impose HLA requirements
that they calibrate at the parent and/or consolidated level, and host
authorities should impose HLA requirements that they calibrate at
the sub-consolidated/subsidiary level. The home authority should
test that the parent bank is adequately capitalised on a stand-alone
basis, including cases in which a D-SIB HLA requirement is applied
at the subsidiary level. Home authorities should impose the higher
of either the D-SIB or G-SIB HLA requirements in the case where
the banking group has been identified as a D-SIB in the home
jurisdiction as well as a G-SIB.
36. National authorities, including host authorities, currently have the
capacity to set and impose capital requirements they consider appropriate
to banks within their jurisdictions.

The G-SIB rules text states that host authorities of G-SIB subsidiaries
may apply an additional loss absorbency requirement at the individual
legal entity or consolidated level within their jurisdiction.

The Committee has no intention to change this aspect of the status quo
when introducing the D-SIB framework.

An imposition of a D-SIB HLA by a host authority is no different (except
for additional transparency) from their current capacity to impose a Pillar
1 or 2 capital charge.

Therefore, the ability of the host authorities to implement a D-SIB HLA
on local subsidiaries does not raise any new home-host issues.

37. National authorities should ensure that banks with the same degree of
systemic importance in their jurisdiction, regardless of whether they are
domestic banks, subsidiaries of foreign banking groups, or subsidiaries of
G-SIBs, are subject to the same HLA requirements, ceteris paribus.
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Banks in a jurisdiction should be subject to a consistent, coherent and
non-discriminatory treatment regardless of the ownership.

The objective of the host authorities’ power to impose HLA on
subsidiaries is to bolster capital to mitigate the potential heightened
impact of the subsidiaries’ failure on the domestic economy due to their
systemic nature.

This should be maintained in cases where a bank might not be (or might
be less) systemic at home, but its subsidiary is (more) systemic in the host
jurisdiction.

38. An action by the host authorities to impose a D-SIB HLA requirement
leads to increases in capital at the subsidiary level which can be viewed as
a shift in capital from the parent bank to the subsidiary, unless it already
holds an adequate capital buffer in the host jurisdiction or the additional
capital raised by the subsidiary is from outside investors.

This could, in the case of substantial or large subsidiaries, materially
decrease the level of capital protecting the parent bank.

Under such cases, it is important that the home authority continues to
ensure there are sufficient financial resources at the parent level, for
example through a solo capital requirement.

Indeed, paragraph 23 of the Basel II rules text states “(f)urther, as one of
the principal objectives of supervision is the protection of depositors, it is
essential to ensure that capital recognised in capital adequacy measures
is readily available for those depositors.

Accordingly, supervisors should test that individual banks are adequately
capitalised on a stand-alone basis.”

39. Within a jurisdiction, applying the D-SIB framework to both G-SIBs
and non-G-SIBs will help ensure a level playing field within the national
context.

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For example, in a jurisdiction with two banks that are roughly identical in
terms of their assessed systemic nature at the domestic level, but where
one is a G-SIB and the other is not, national authorities would have the
capacity to apply the same D-SIB HLA requirement to both.

In such cases, the home authorities could face a situation where the HLA
requirement on the consolidated group will be the higher of those
prescribed by the G-SIB and D-SIB frameworks (ie the higher of either
the D-SIB or G-SIB requirement).

40. This approach is also consistent with the Committee’s standards,
which are minima rather than maxima.

It is also consistent with the G-SIB rules text that is explicit in stating that
home authorities can impose higher requirements than the G-SIB
additional loss absorbency requirement (G-SIB rules text paragraph 74).

41. The Committee is of the view that any form of double-counting should
be avoided and that the HLA requirements derived from the G-SIB and
D-SIB frameworks should not be additive.

This will ensure the overall consistency between the two frameworks and
allows the D-SIB framework to take the complementary perspective to the
G-SIB framework.

Principle 11: In cases where the subsidiary of a bank is considered to
be a D-SIB by a host authority, home and host authorities should
make arrangements to coordinate and cooperate on the appropriate
HLA requirement, within the constraints imposed by relevant laws
in the host jurisdiction.
42. The Committee recognises that there could be some concern that host
authorities tend not to have a group-wide perspective when applying
HLA requirements to subsidiaries of foreign banking groups in their
jurisdiction.

The home authorities, on the other hand, clearly need to know D-SIB
HLA requirements on significant subsidiaries since there could be
_____________________________________________________________

P a g e | 53

implications for the allocation of financial resources within the banking
group.

43. In these circumstances, it is important that arrangements to
coordinate and cooperate on the appropriate HLA requirement between
home and host authorities are established and maintained, within the
constraints imposed by relevant laws in the host jurisdiction, when
formulating HLA requirements.

This is particularly important to make it possible for the home authority
to test the capital position of a parent on a stand-alone basis as mentioned
in paragraph 38 and to prevent a situation where the home authorities are
surprised by the action of the host authorities.

Home and host authorities should coordinate and cooperate with each
other on any plan to impose an HLA requirement on a subsidiary bank,
and the amount of the requirement, before taking any action.

The host authority should provide a rationale for their decision, and an
indication of the steps the bank would need to take to avoid/reduce such
a requirement.

The home and host authorities should also discuss

(i) The resolution regimes (including recovery and resolution plans) in
both jurisdictions,

(ii) Available resolution strategies and any specific resolution plan in
place for the firm, and

(iii) The extent to which such arrangements should influence HLA
requirements.

Principle 12: The HLA requirement should be met fully by Common
Equity Tier 1 (CET1). In addition, national authorities should put in
place any additional requirements and other policy measures they
consider to be appropriate to address the risks posed by a D-SIB.

_____________________________________________________________

P a g e | 54

44. The additional loss absorbency requirement for G-SIBs is to be met by
CET1, as stated in the G-SIBs rules text (paragraph 87).

The Committee considered the use of CET1 to be the simplest and most
effective way to increase the going concern loss-absorbing capacity of a
bank.

HLA requirements for D-SIBs should also be fully met with CET1 to
ensure a maximum degree of consistency in terms of effective loss
absorbing capacity.

This has the benefit of facilitating direct and transparent comparability of
the application of requirements across jurisdictions, an element that is
considered desirable given the fact that most of these banks will have
cross-border operations being in direct competition with each other.

In addition, national authorities should put in place any additional
requirements and other policy measures they consider to be appropriate
to address the risks posed by a D-SIB.

45. National authorities should implement the HLA requirement through
an extension of the capital conservation buffer, maintaining the division
of the buffer into four bands of equal size (as described in paragraph 147
of the Basel III rules text).

This is in line with the treatment of the additional loss absorbency
requirement for G-SIBs.

The HLA requirement for D-SIBs is essentially a requirement that sits on
top of the capital buffers and minimum capital requirement, with a
pre-determined set of consequences for banks that do not meet this
requirement.

46. In some jurisdictions, it is possible that Pillar 2 may need to adapt to
accommodate the existence of the HLA requirements for D-SIBs.

Specifically, it would make sense for authorities to ensure that a bank’s
Pillar 2 requirements do not require capital to be held twice for issues that
_____________________________________________________________

P a g e | 55

relate to the externalities associated with distress or failure of D-SIBs if
they are captured by the HLA requirement.

However, Pillar 2 will normally capture other risks that are not directly
related to these externalities of D-SIBs (eg interest rate and concentration
risks) and so capital meeting the HLA requirement should not be
permitted to be simultaneously used to meet Pillar 2 requirement that
relate to these other risks.

_____________________________________________________________

P a g e | 56

Mario Draghi: Opening
statement at Deutscher
Bundestag
Speech by Mr Mario Draghi,
President of the European Central
Bank, at the discussion on
ECB policies with Members of
Parliament, Berlin

***

Dear President Lammert,

Honourable Committee Chairs,

Honourable Members of the Bundestag,

I am deeply honoured to be here today.

As President of the European Central Bank (ECB), it is a privilege for me
to come to the heart of German democracy to present our policy
responses to the challenges facing the euro area economy.

I know that central bank actions are often a topic of debate among
politicians, the media and the general public in Germany.

So I would like to thank President Lammert and all Committee Chairs
most warmly for this kind invitation – and the opportunity it gives me to
participate in that discussion.

It is rare for the ECB President to speak in a national parliament.

The ECB is accountable to the European Parliament, where we have
scheduled hearings every three months and occasional hearings on
topical matters.

_____________________________________________________________

P a g e | 57

We take these duties of accountability to the citizens of Europe and their
elected representatives very seriously.

But I am here today not only to explain the ECB’s policies. I am also here
to listen.

I am here to listen to your views on the ECB, on the euro area economy
and on the longer-term vision for Europe.

To lay the ground for our discussion, I would like to explain our view of
the current situation and the rationale for our recent monetary policy
decisions.

I will focus in particular on the Outright Monetary Transactions (OMTs)
that we formally announced in September.

Financial markets and the disruptions of monetary policy
transmission

Let me begin with the challenges facing the euro area.

We expect the economy to remain weak in the near term, also reflecting
the adjustment that many countries are undergoing in order to lay the
foundations for sustainable future prosperity.

For next year, we expect a very gradual recovery.

Euro area unemployment remains deplorably high.

In this environment, the ECB has responded by lowering its key interest
rates.

In normal times, such reductions would be passed on relatively evenly to
firms and households across the euro area.

But this is not what we have seen.

In some countries, the reductions were fully passed on.
_____________________________________________________________

P a g e | 58

In others, the rates charged on bank loans to the real economy declined
only a little, if at all.

And in a few countries, some lending rates have actually risen.

Why did this divergence happen?

Let me explain this in detail because it is so important for understanding
our policies.

A fundamental concept in central banking is what is known as “monetary
policy transmission”.

This is the way that changes in a central bank’s main interest rate are
passed via the financial system to the real economy.

In a well-functioning financial system, there is a stable relationship
between changes to central bank rates and the cost of bank loans to firms
and households.

This allows central banks to influence overall economic conditions and
maintain price stability.

But the euro area financial system has become increasingly disturbed.

There has been a severe fragmentation in the single financial market.

Bank funding costs have diverged significantly across countries.

The euro area interbank market has been effectively closed to a large
number of banks and some countries’ entire banking systems.

Interest rates on government bonds in some countries have risen steeply,
hurting the funding costs of domestic banks and limiting their access to
funding markets.

This has been a key factor why banks have passed on interest rates very
differently to firms and households across the euro area.
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P a g e | 59

Interest rates do not have to be identical across the euro area, but it is
unacceptable if major differences arise from broken capital markets or the
perception of a euro area break-up.

The fragmentation of the single financial market has led to a
fragmentation of the single monetary policy.

And in an economy like the euro area where about three quarters of firms’
financing comes from banks, this has very severe consequences for the
real economy, investment and employment.

It meant that countries in economic difficulties could not benefit from our
low interest rates and return to health.

Instead, they were experiencing a vicious circle.

Economic growth was falling. Public finances were deteriorating.

Banks and governments were being forced to pay even higher interest
rates.

And credit and economic growth were falling further, leading to rising
unemployment and reduced consumption and investment.

A number of economies could have seen risks of deflation.

All of this meant that the outlook for the euro area economy as a whole
was increasingly fragile.

There were potentially negative consequences for Europe’s single
market, as access to finance was increasingly influenced by location
rather than creditworthiness and the quality of the project.

The disruption of the monetary policy transmission is something deeply
profound.

It threatens the single monetary policy and the ECB’s ability to ensure
price stability.
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P a g e | 60

This was why the ECB decided that action was essential.

Restoring the proper transmission of monetary policy

So let me now turn directly to our recent policy announcements.

To decide what type of action was appropriate, we had to make two key
assessments.

First, we had to diagnose precisely why the transmission was disrupted.

And second, we had to identify the most effective policy tool to repair
those disruptions, while remaining within our mandate to preserve price
stability.

In our analysis, a main cause of disruptions in the transmission was
unfounded fears about the future of the euro area.

Some investors had become excessively influenced by imagined scenarios
of disaster.

They were therefore charging interest rates to countries they perceived to
be most vulnerable that went beyond levels warranted by economic
fundamentals and justifiable risk premia.

Clearly, it was not by chance that some countries found themselves in a
more difficult situation than others.

It was mainly those countries that had implemented inappropriate
economic policies in the past.

This is also why the first responsibility in this situation is for countries to
make determined reforms and convince markets that they are credible.

But many were already doing this, only for interest rates to rise even
higher.

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P a g e | 61

There was an element of fear in markets’ assessments that governments,
acting alone, could not remove.

Markets were not prepared to wait for the positive effects of reforms to
emerge.

In our view, to restore the proper transmission of monetary policy, those
unfounded fears about the future of the euro area had to be removed.

And the only way to do so was to establish a fully credible backstop
against disaster scenarios.

We designed the OMTs exactly to fulfil this role and restore monetary
policy transmission in two key ways.

First, it provides for ex ante unlimited interventions in government bond
markets, focusing on bonds with a remaining maturity of up to three
years.

A lot of comments have been made about this commitment.

But we have to understand how markets work.

Interventions are designed to send a clear signal to investors that their
fears about the euro area are baseless.

Second, as a pre-requisite for OMTs, countries must have negotiated with
the other euro area governments a European Stability Mechanism (ESM)
programme with strict and effective conditionality.

This ensures that governments continue to correct economic weaknesses
while the ECB is active.

The involvement of the IMF, with its unparalleled track record in
monitoring adjustment programmes would be an additional safeguard.

_____________________________________________________________

Monday November 5 2012 - Top 10 Risk Management News

Monday November 5 2012 - Top 10 Risk Management News

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