A quarterly round-up of key announcements and developments in UK financial risk and regulation: covering 1st June to 26th August 2016.
Links to underlying source stories or documents are contained within individual articles in this blog.
The British EU referendum (‘Brexit’) vote on 23rd June 2016 was the most significant political and economic event in the UK and Europe for many years. So inevitably this bulletin contains some Brexit coverage. We try to avoid speculative treatment and broader political comment, and instead just summarise key announcements and developments relating to risk and regulatory aspects of Brexit.
Against the background of Brexit, the regulators pushed on with their technical agenda in a number of areas during the period. This included MiFID, structural reform (ring-fencing) and various aspects of capital regulation. The new Head of the Financial Conduct Authority warned that Brexit would not give rise to a “bonfire” of existing regulations. In other words regulated firms should expect – at least in the short term – a continuation of existing and proposed supervisory practice irrespective of Brexit.
Still, three themes seem to predominate in the post-Brexit environment for financial services firms:
(1) There will be ongoing uncertainty over both timing and substance.
(2) It is likely there will be some impact on passporting rights, into and out of the remaining EU. This will be covered in a future Prism-Clarity blog.
(3) Firms now have to plan and prepare intensively for a range of uncertain scenarios, while continuing to maintain both BAU and already-known implementations.
The articles in this blog do not constitute advice, but please contact Prism-Clarity for further information, including where to get the best advice.
Immediate aftermath: 24th June 2016
Statement from the Governor of the Bank of England
The Governor of the Bank of England responded to the Brexit vote with an immediate statement on the morning of Friday 24th June. In particular he sought to reassure financial markets amid tumultuous market reaction to what was a generally unexpected Leave vote. The Governor noted that a few months previously the Bank had reached a judgement that the risks around the referendum were the most significant near-term domestic risks to financial stability in the UK. Accordingly, to mitigate those risks, the Bank had put in place extensive contingency plans. These included plans to ensure that the core of the UK financial system remained well-capitalised, liquid and strong.
UK Treasury announcement: 27th June 2016
Statement from the UK Chancellor of the Exchequer
The former Chancellor followed up on the Monday after the post-referendum weekend with some comments on the Treasury’s view of the post-Brexit path. He reiterated the Governor’s comment that the authorities had in place detailed and effective contingency plans. And he sought to reassure markets that Britain stood ready to confront the challenges of the Brexit implementation and the necessary adjustments to the economy.
The Chancellor had been in contact with fellow European finance ministers, central bank governors, the managing director of the IMF, the US Treasury Secretary and the Speaker of Congress, and the CEOs of major financial institutions. Collectively this group was keeping a close eye on developments. He acknowledged the uncertainty but stated that no one should doubt the British government’s resolve to maintain fiscal stability, or that the economy was fundamentally strong, competitive and open for business.
Financial Stability Report: 5th July 2016
FPC Financial Stability Report
The Financial Policy Committee (FPC) published its first Financial Stability Report (FSR) after the Brexit vote. The FPC had identified several channels through which the referendum could increase risks to financial stability. (i) The current account deficit, which relied on inflows of portfolio and foreign direct investment. (ii) The UK commercial real estate (CRE) market, which had seen significant foreign inflows but where valuations were stretched in places. (iii) The high level of UK household indebtedness, capacity of some households to service debts, and potential for buy-to-let investors to behave pro-cyclically, amplifying movements in the housing market. (iv) Subdued growth in the global economy, including the euro area, which a period of heightened uncertainty could exacerbate. And (v) fragility in financial markets, which could increase in a period of higher market activity and volatility.
The FPC had been monitoring these channels of risk closely, and there was evidence that some risks had begun to crystallise. Furthermore we could expect increased market and economic volatility as the post-vote process unfolded. The degree of uncertainty and nature of adjustment was evident in financial market prices, which had moved sharply following the referendum.
The resilience of the UK financial system would depend on substantial capital and liquidity buffers and a framework that promoted co-ordinated responses to risks. This framework had assisted in the development of contingency plans in advance of the referendum.
On the same day as the release of the FSR, the PRA issued an announcement confirming that – in response to the FPC’s recommendations – the PRA would be reducing the UK countercyclical capital buffer rate to zero, so far as possible and as soon as practicable.
FCA Annual Public Meeting: 19th July 2016
In the immediate aftermath of the Brexit vote (24th June) the FCA had made a holding announcement, noting that much financial regulation currently applicable in the UK was derived from EU legislation. Consequently firms needed to continue to abide by their obligations under UK law, including those derived from EU law. And to continue with implementation plans for legislation that was still to come into effect. The FCA added that consumer rights and protections, including any derived from EU legislation, were unaffected by the result of the referendum. These too would remain unchanged unless and until the Government changed the applicable legislation.
Senior FCA personnel then explored these themes further in subsequent speeches and comments. Notably the FCA CEO, at the regulator’s Annual Public Meeting on 19th July, indicated that it was unlikely the vote to leave the EU would lead to deregulation. The FCA did not expect to be distracted from its regulatory obligations: “our objectives will not change and, as such, no one should expect a bonfire of regulation.”
UK House of Commons Library report: 1st August 2016
The UK House of Commons Library issued a briefing report summarising responses and reactions to the Brexit vote from official UK bodies, major UK financial institutions, law firms and think-tanks. [We cover some of these announcements in their own right in this section. However we also include the Commons Library report as a curation of responses from a wide range of prominent UK institutions, and given the provenance of its source.]
E&Y Brexit tracker update: 22nd August 2016
E&Y sounded a more optimistic note towards the end of the period. Based on its latest Brexit tracker analysis, and views from major Financial Services firms E&Y is working with, the suggestion was the immediate impact of the referendum result had not been as stark as many had feared. It seems from E&Y’s work that EU passporting rights are the most important post-Brexit issue for the majority of financial services firms, in particular investment banks and asset managers. But policy priorities across the industry differ, given the differing needs and nuances across the wide variety of companies that make up the sector. Also E&Y acknowledged that second order economic impacts of the referendum result – lower interest rates for longer and the prospect of slower economic growth – are still to feed through into companies’ earnings.
The key issue for retail banks appears to be EU workers’ rights. Two of the Big Five high street banks, according to E&Y, had explicitly called for clarification on EU workers’ rights in the UK following the referendum. In the insurance sector, meanwhile, many large companies operating in the UK had publicly said that the Brexit vote would not have a material impact on their business, with over 10% identifying potential positives and opportunities for the companies. Only 16% had voiced concerns over the potential negative impact on their business performance. Broadly, E&Y said, firms seem confident in their ability to weather the initial storm and respond with the pragmatism, ingenuity and day-to-day focus on serving customers that has underpinned the UK’s longstanding success in financial services. And some firms are beginning to highlight areas of opportunity.
EBA, FCA and PRA announcements
PRA: UK Bank Ring-fencing: 7th July 2016
The Prudential Regulation Authority published a raft of notices relating to structural reform (ring-fencing) during July 2016. See the above link. First, on 7th July, a consultation paper on reporting and two policy statements on different technical aspects of the UK ring-fencing implementation. These included prudential requirements, intragroup arrangements and use of financial market infrastructures (PS20/16) and ensuring operational continuity in resolution (PS21/16). Then, on 29th July, consultation papers on operational continuity reporting requirements (CP28/16) and implementation of the systemic risk buffer, which will apply to ring-fenced banks with effect from 2019 (CP27/16).
PRA: Market and Counterparty Risk Capital Requirements: 7th July 2016
The PRA published some small but important changes to its key Supervisory Statements covering market risk and counterparty risk capital treatment.
On market risk, the PRA said it had updated SS13/13 in two main respects. These were to adjust expectations on the validation of firms’ Risks Not in VaR (RNiV) frameworks, and concerning reporting of extensions and changes to RNiV. Also the regulator clarified its reporting requirements around Internal Model Approach (IMA) model changes and extensions, and the process for informing the PRA with regard to non-compliance. Finally there were amendments relating to three other issues. First, the use of firms’ own estimates of delta in the standardised approach for options. Second, the use of sensitivity models under Article 331 of the CRR. Third, the exclusion of positions from the calculation of net open currency positions under Article 352(2) of the CRR.
On counterparty risk, the PRA clarified the reporting requirements for model changes and the process for informing the PRA of non-compliance. It also highlighted a few amendments in respect of qualifying central counterparties (CCPs).
The PRA included one interesting comment with both the above sets of changes, in the context of Brexit. “The policy contained in [the] supervisory statement[s] has been designed in the context of the current UK and EU regulatory framework. The PRA will keep the policy under review to assess what changes would be required due to intervening changes in the UK regulatory framework, including as a result of the referendum on 23 June 2016.”
FCA: MiFID2: July 2016
Formal notification of a one-year delay in MiFID2 implementation (now 3rd January 2018) was published in the EU Official Journal on 30th June. Subsequently the European Commission pressed ahead with a range of Regulatory Technical Standards implementing the new directive, with more to follow by the end of 2016. [These are not detailed here.]
Meanwhile the FCA published a major new consultation paper (CP16/19) on the changes to the FCA’s Handbook which are necessary to implement MiFID2. This followed on from CP15/43, published in December 2015, where the FCA gave background on the introduction of MiFID2 and its key objectives. The first CP had mainly covered issues relating to new rules governing the secondary trading of financial instruments. The new CP covered a range of issues including position limits and reporting for commodity derivatives, systems and controls requirements for firms providing MiFID investment services, fees and client asset protections. The new consultation period closes on 28th October 2016.
EBA: EU-wide Stress Tests: 29th July 2016
The EBA published details of its 2016 EU-wide stress tests covering more than 50 banks from 15 EU and EEA countries. These represented around 70% of total banking assets across the EU. The intention of the stress test was to provide supervisors, banks and other market participants with a common analytical framework to assess the resilience of large EU banks to adverse economic developments.
In short, these results showed an improvement in the capital position of the EU banking sector. The starting point Common Equity Tier 1 capital ratio was 13.2% for the stress test sample (at end-2015). This was two points higher than 2014 and four points higher than 2011. Meanwhile the hypothetical stress scenario results in an average stressed impact of 380 bps on this ratio, to 9.4% at the end of 2018; driven mainly by credit risk losses. The EBA pointed out that this stress test does not contain a pass-fail threshold, but regulators use it instead to support ongoing supervisory review and Pillar 2 capital guidance.
June to August 2016
During the period there were no major Basel announcements, compared to the previous period (January to May 2016) reviewed in the last edition of this round-up.
Nevertheless there were a number of technical announcements from the BCBS during the period. Notably, these included Frequently Asked Questions on Net Stable Funding Ratio implementation; a proposed new regulatory framework on securitisation including revised capital treatment; and results from monitoring of five Basel Committee member countries’ implementation of the Committee’s frameworks for global and domestic systemically important banks (G-SIBs and D-SIBs).
In addition there was a joint response to the BCBS consultation on its proposed revisions to the Basel III leverage ratio framework, published in April 2016 and mentioned in the last edition. The joint submission was made by the International Swaps and Derivatives Association (ISDA), the Global Financial Markets Association (GFMA), the Institute of International Finance (IIF), Japan Financial Markets Council (JFMC) and The Clearing House (TCH).
Please note: as in earlier bulletins, the above items represent only a selection of key developments in financial risk and regulation over the period.
More comprehensive information is available online, including the following resources which Prism-Clarity uses every week:
A comprehensive portal of regulatory news and analysis covering the UK and Ireland (and thereby the EU)
Contact: Suzanne Charles (email@example.com, tel +442076656639)
An independent information source and online community for OTC derivatives professionals globally, providing industry trend analysis, peer commentary and educational resources via articles, podcasts, videos and interactive webinars and webcasts: 15,000 members globally
Contact: Julia Schieffer (firstname.lastname@example.org)
Deloitte FS Risk & Regulation Monthly
A comprehensive monthly round-up of key developments in Financial Services Risk and Regulation, from the widely-respected Deloitte EMEA Centre for Regulatory Strategy
Contact: David Strachan (email@example.com, tel +442073034791)
Bank of England Prudential Regulation Authority (PRA)
The primary UK prudential regulator: this link contains a valuable source of recent prudential publications and notices
Financial Conduct Authority (FCA)
The primary UK conduct regulator: this link is to their Monthly Regulatory Round-up portal, a summary of key regulatory stories and developments in different financial market sectors