Risk and Regulation Round-up: January to May 2016

A quick round-up of key announcements and developments in financial risk and regulation: from 1st January to 26th May 2016 # (most recent first).

The articles in this blog do not constitute advice, but please contact Prism-Clarity for further information, including where to get the best advice.

Key PRA and FCA announcements:
12th May 2016: PRA Liquidity Consultation
9th May 2016: FCA Sandbox
5th April 2016: FCA Business Plan 2016-17
7th March 2016: New Senior Manager Regimes

Key Basel announcements:
25th April 2016 (revised from 6th April): Leverage Ratio
21st April 2016: Interest Rate Risk in the Banking Book
24th March 2016: Credit Risk RWA and IRB
4th March 2016: Operational Risk
14th January 2016: Final FRTB Rules

# Future editions will cover a straight quarter: next June to August 2016

Distorted Window

PRA Liquidity Consultation

12th May 2016

The Bank of England (Prudential Regulatory Authority) issued the first of its two planned Consultation Papers on Pillar 2 Liquidity: comment deadline Friday 12th August 2016

Earlier the PRA had issued a Policy Statement (PS11/15) ‘CRD IV Liquidity’ and Supervisory Statement (SS24/15) ‘The PRA’s approach to supervising liquidity and funding risks’. These papers set out its approach to liquidity supervision under CRR/CRDIV, notably the transition to the Liquidity Coverage Ratio (LCR) as a Pillar 1 standard, which took effect on 1st October 2015. The PRA is now turning its attention to a revised Pillar 2 framework, first outlined as an interim approach in SS24/15. The new CP proposes a statement of policy on the PRA’s approach to three aspects of Pillar 2 liquidity: intraday risk, debt buyback and non-margined derivatives. The CP also outlines the PRA’s Pillar 2 objectives and scope. And it gives an overview of plans to develop the Pillar 2 approach where the PRA is not yet setting out proposals. As such, this CP constitutes the first of two planned CPs on Pillar 2.

In general it is proposed that the level of application for setting requirements under Pillar 2 will be aligned to the Pillar 1 approach. The PRA also invites firms to comment on future disclosure requirements; the planned approach to assessing liquidity risk associated with debt buyback and non-margined derivatives; and the assessment of intraday liquidity risk which will be based on the firm’s maximum net debits, the firm’s stress testing framework, and certain key characteristics such as the degree of its involvement in payment and settlement systems, and the markets it operates in.

Contact Prism-Clarity for further information, including where to get the best advice.

FCA Sandbox

9th May 2016

The Financial Conduct Authority opened up its internal product ‘sandbox’ to external firms as part of its Project Innovate

The FCA opened its internal regulatory ‘sandbox’ – a ‘safe’ product development environment in which businesses can test innovative products, services, business models and delivery mechanisms without any adverse effects on consumers – to external firms. The regulatory sandbox is part of Project Innovate, an initiative kicked off in October 2014, to help the FCA encourage innovation in the interests of consumers and promote competition through disruptive innovation. The sandbox offers a range of options for eligible firms: a tailored authorisation process (restricted authorisation) for new firms in the testing phase; individual guidance for firms testing ideas that do not easily fit into the existing regulatory framework and in some cases waivers or no enforcement action letters.

Contact Prism-Clarity for further information, including where to get the best advice.

FCA Business Plan

5th April 2016

The UK Financial Conduct Authority issued its 2016-17 Business Plan setting out the regulator’s key priorities and concerns for the year ahead

In its new Business Plan the FCA highlights new pension freedoms and responsibilities, firms’ accountability, changing demographics, new legislation and the risks and benefits of technology as just some of the issues facing consumers, firms and markets in financial services during the next twelve months. The Business Plan describes how the FCA plans to use its resources to meet the evolving challenges, and identifies seven key priorities which will be the primary focus of the regulator’s discretionary work over the course of the year ahead: pensions, financial crime and anti-money laundering, wholesale financial markets, advice, innovation and technology, firms’ culture and governance; and treatment of existing customers.

The FCA points out that these priorities do not represent the totality of its planned work, but will be used to drive decisions about thematic projects and market studies, and will also inform the areas the regulator will pay particular attention to in conducting its core activities. The Business Plan also sought to explain how the FCA is developing a sustainable approach to regulation and managing priority risks. This time the Business Plan also incorporates the FCA’s Risk Outlook, which sets out some context within which the FCA operates and the risks the regulator sees in the market.

Contact Prism-Clarity for further information, including where to get the best advice.

New Senior Management Regimes

7th March 2016

The new Senior Managers Regime and Senior Insurance Managers Regime came into force for the banking and insurance sectors respectively

The new regimes replace the former Approved Person Regimes, and hold individuals working at all levels within relevant firms to appropriate standards of conduct, as well as seeking to ensure that senior managers are held to account for misconduct that falls within their area of responsibility. The new regimes emanated from a 2013 report by the Parliamentary Commission for Banking Standards (PCBS) which set out recommendations for legislative and other action to improve professional standards and culture in the UK banking industry. This was followed by legislation in the Banking Reform Act 2013. The launch of the new regime by the PRA and FCA implements the recommendations made by the PCBS.

This topic will be covered in more depth in a future Prism-Clarity blog.

The outgoing CEO of the FCA, Tracey McDermott, commented that the new regime marked the beginning of a new era of increased individual accountability, and that the regime was not designed to re-invent the way that firms organised themselves but more to reflect and ensure clarity about how this operated in practice. She added that the FCA was determined to embed a culture of personal responsibility within the banking sector. Meanwhile Andrew Bailey, currently CEO of the PRA but soon to succeed Tracey McDermott at the FCA, noted that appropriate and robust accountability for senior managers in financial institutions was a crucial part of the effective functioning of the economy. He said that at the heart of the new accountability regime was one very simple principle – you can delegate tasks but you cannot delegate responsibility – this meant that senior managers at banks and insurers needed to know what they were responsible for and could be held accountable for failings in their area. He added that this was a crucial milestone in the regulators’ drive for greater accountability in financial services.

Contact Prism-Clarity for further information, including where to get the best advice.

Wall and Doorframe

Key Basel announcements

March to May 2016

During the period the Basel Committee for Banking Supervision launched a series of key consultations and announcements relating to prudential rules under Basel III and beyond. Deadlines for consultation responses are noted below where applicable, along with brief explanatory comments on each initiative. The general theme is to clarify and resolve rules and standards that had been the subject of earlier consultation (IRBB, FRTB); and to set out some new proposals for implementation of rules in transition under Basel III (Leverage Ratio) or resulting from the Committee’s ongoing review and recalibration of its standardized and modelled capital rule frameworks.

The common theme in these measures is that they are far-reaching, and will have a significant impact both on banks’ capital and liquidity resources and on their implementation programmes. To a greater or lesser degree all five announcements will involve banks in overseeing documentation work programmes, either as part of an application to national regulators for a particular treatment outlined in these proposals or rules; or to demonstrate compliance for internal governance purposes; or both.

Contact Prism-Clarity for support or advice with regard to any of the documentation programmes supporting these changes.

25th April 2016 (revised from 6th April):
Consultation: Revisions to the Basel III Leverage Ratio Framework: comment deadline 6th July 2016

This document proposes revisions to the design and calibration of the Basel III leverage ratio framework. The proposed revisions have been informed by the monitoring process in the parallel run period since 2013, by discussions with market participants and stakeholders, and by the frequently asked questions (FAQ) process since the release of the Basel III Leverage Ratio framework in January 2014.

The four main topics covered are: (i) revisions to the treatment of derivative exposures (based on the revised SA-CCR (standardized counterparty risk capital) calculations; (ii) the treatment of regular-way purchases and sales of financial assets; (iii) revisions to the treatment of provisions; and (iv) additional requirements for G-SIBs. Other proposed revisions include: (v) revisions to the credit conversion factors for off-balance sheet items; (vi) incorporation of responses to frequently asked questions; (vii) treatment of cash pooling transactions; (viii) treatment of traditional securitisations; (ix) Treatment of securities financing transactions (SFTs); and (x) Disclosure requirements.

21st April 2016:
Revised Standards: Interest Rate Risk in the Banking Book (IRRBB)

These standards revise the Committee’s 2004 Principles for the management and supervision of interest rate risk, which set out supervisory expectations for banks’ identification, measurement, monitoring and control of IRRBB as well as its supervision. The main changes in this paper include: guidance on the expectations for a bank’s IRRBB management process in areas such as the development of interest rate shock scenarios, and modelling and behavioural assumptions which banks should consider in measuring IRRBB; and fuller disclosure requirements to promote consistency, transparency and comparability in IRRBB (including quantitative disclosure requirements based on common interest rate shock scenarios).

Other elements in the paper include an updated standardised framework; and a more strict threshold for identifying ‘outlier’ banks, reduced from 20% of total capital to 15% of Tier 1. The new standards, which were published for consultation in June 2015, are targeted for implementation by 2018.

24th March 2016:
Consultation: Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches: comment deadline 24th June 2016

This consultation sets out proposed changes to the Basel framework’s advanced internal ratings-based approach and the foundation internal ratings-based approach (IRB). The IRB allows banks to use internal models as inputs for determining their regulatory capital requirements for credit risk, subject to certain constraints. The proposed changes are part of a regulatory reform programme which the BCBS has committed to complete by end-2016. The consultative document includes a number of complementary measures that aim to: (i) reduce the complexity of the regulatory framework and improve comparability; and (ii) address excessive variability in the capital requirements for credit risk.

Specifically, the Committee proposes to remove the option to use IRB approaches for certain exposure categories, such as loans to financial institutions. This is because the model inputs required to calculate regulatory capital for such exposures cannot be estimated with sufficient reliability. The paper also proposes exposure-level, model-parameter floors to ensure a minimum level of conservatism for portfolios where IRB approaches remain available; and proposes greater specification of parameter estimation practices to reduce variability in risk-weighted assets for IRB portfolios.

The Committee has previously consulted on the design of capital floors based on standardised approaches, and is still considering the design and calibration of these floors; to complement the proposed constraints discussed in this consultation paper. The final design and calibration of the proposals will be informed by both QIS inputs and by the Committee’s wider aim not to significantly increase overall capital requirements.

4th March 2016:
Consultation: Revised Standardised Approach for Operational Risk: comment deadline 3rd June 2016

The BCBS proposed revisions to the standardised approaches for calculating operational risk capital in October 2014. This updated consultation proposes further revisions to the framework, which emerged from the Committee’s broad review of the capital framework. The Committee’s review of banks’ operational risk modelling practices and capital outcomes revealed that the Advanced Measurement Approach’s (AMA) inherent complexity, and the lack of comparability arising from a wide range of internal modelling practices, have increased variability in RWA calculations, and eroded confidence in risk-weighted capital ratios.

The Committee is therefore proposing to remove the AMA from the regulatory framework. The new operational risk capital framework will be based on a single non-model-based method for the estimation of operational risk capital, which is termed the Standardised Measurement Approach (SMA). The SMA builds on the simplicity and comparability of a standardised approach, and embodies the risk sensitivity of an advanced approach.

14th January 2016:
Revised Framework for Market Risk Capital Requirements (FRTB):

The BCBS issued final wording on its proposed new market risk rules, also known as the Fundamental Review of the Trading Book (FRTB). This eagerly awaited paper followed more than three years of intensive consultation, Quantitative Impact Studies, lobbying and analysis since the first BCBS paper in May 2012. The rule is set to fundamentally change the entire regulatory capital framework for Market Risk in the trading book, with tighter boundaries between Trading Book and Banking Book, a major overhaul of both the standardised capital methodology and the Internal Models Approach, and significant capital impacts at both the aggregate level and more particularly for some individual businesses and asset classes deemed not sufficiently capitalised under the present Basel 2.5 capital regime.

This topic will be covered in more depth in future Prism-Clarity blogs.

The timelines for implementation appear a long way off, with parallel running with the current rules regime from 1st January 2019, and full switchover to the new regime from 2020. But the implementation, systems, documentation and regulatory/legal logistical challenges are immense – not to mention the business and capital implications – so most firms with trading books are already well under way with their implementation programmes or, failing that, actively kicking them off now.

Contact Prism-Clarity for further information, including where to get the best advice.

Bridge and Light

Other Resources

Please note: 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 day:
A comprehensive portal of regulatory news and analysis covering the UK and Ireland (and thereby the EU)
Contact: Suzanne Charles ([email protected], 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 ([email protected])

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 protected], 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, a summary of key regulatory stories and developments in different financial market sectors