Risk & Regulation Round-up: September to November 2016

A quarterly round-up of key announcements and developments in UK financial risk and regulation: covering 1st September to 30th November 2016.

Links to underlying source stories or documents are contained in individual articles in this blog.

After covering Brexit in some depth in the last round-up, this time we include only a short section on Brexit, simply noting a few key publications and developments relevant to financial services.

Instead in this edition we focus more on routine technical and policy announcements from the EU/EBA, Basel/FSB and UK national regulators; including an important set of banking reform proposals from the European Commission issued on 23rd November.

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


1. Brexit

Political developments: Sept to Nov 2016

The Prime Minister stated at the Conservative Party conference in September that Article 50 of the Lisbon Treaty would be triggered no later than the end of March 2017.

Subsequently on 3rd November the High Court ruled that Parliament must vote on whether the UK can start the process of leaving the EU, meaning that the government did not have the power to trigger Article 50 – beginning formal exit negotiations with the EU – on its own. The government had argued that the referendum and existing ministerial powers meant MPs did not need to vote prior to the government invoking Article 50, but the High Court rejected this case.

Meanwhile the government is appealing the decision to the Supreme Court, which is expected to hear the case next month.

Official disclosure of passporting data: 20th Sept 2016

Treasury Committee disclosure of correspondence with FCA

The parliamentary Treasury Committee published details of correspondence with the Financial Conduct Authority (FCA) on passporting, which included official data on the number of firms passporting between EEA member states and the UK, in both directions. Nearly 5,500 UK financial services firms hold passports to do business in other EEA member states, while just over 8,000 EEA firms hold passports to operate in the UK.

For more background on passporting see this recent Prism-Clarity blog.

FPC indication of prudential standards after Brexit: 20th Sept 2016

Minutes of Financial Policy Committee meeting

In the minutes of its 20th September meeting, published on 3rd October, the FPC gave an indication of the Bank of England’s likely approach to setting prudential requirements post-Brexit; namely they were likely to remain as as stringent as current standards:

… irrespective of the particular form of the United Kingdom’s future relationship with the EU, and consistent with its statutory responsibility, the FPC would remain committed to the implementation of robust prudential standards in the UK financial system. This would require a level of resilience to be maintained that was at least as great as that currently planned, which itself exceeded that required by international baseline standards.

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


2. EU and EBA announcements

Comprehensive EU banking reform package: 23rd Nov 2016

EU proposals on banking reform, capital and resolution

The European Commission issued a comprehensive set of proposals to further strengthen the resilience of EU banks by amending its key rules relating to capital and resolution.

Namely, the 2013 Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD IV) which set out prudential requirements for banks and investment firms and rules on governance and supervision; and the 2014 Bank Recovery and Resolution Directive (BRRD) and Single Resolution Mechanism Regulation (SRMR), which contain the EU rules on the recovery and resolution of failing institutions and establish the Single Resolution Mechanism.

In effect the proposals represent the final element of implementation of Basel III in the EU. But they also contain important early indications regarding implementation of the Basel Fundamental Review of the Trading Book (FRTB) at EU level: see next section.

The proposals include the following key elements:

  • More risk-sensitive capital requirements, in particular for market risk, counterparty credit risk and exposures to central counterparties (CCPs)
  • Leverage Ratio (LR) requirement, to prevent institutions from taking on excessive leverage
  • Net Stable Funding Ratio (NSFR) requirement, to address excessive reliance on short-term wholesale funding and reduce long-term funding risk
  • Measures enhancing banks’ capacity to lend to Small and Medium-sized Enterprises and fund infrastructure projects

The proposals also include a requirement for global systemically important banks (GSIBs) to hold minimum levels of capital available to bear losses in a resolution (Total Loss-Absorbing Capacity or TLAC); and a harmonised national insolvency ranking of unsecured debt instruments, to facilitate banks’ issuance of loss-absorbing debt instruments.

The BCBS published a detailed fact sheet with Q&A at the same time as the proposals, giving further background and answers to some frequently asked questions.

The package will now go to the European Parliament and Council of Ministers.

FRTB implementation for smaller/less complex banks: 23rd Nov 2016

The EU reform package includes measures to reduce the administrative burden for smaller and less complex banks when implementing the FRTB in the EU, based on a view that the current FRTB rules appeared disproportionate for such banks.

This topic will be covered further in future Prism-Clarity blogs, but for now please see the below extract from the Q&A:

Will banks with small and medium-sized trading book portfolios be subject to the new capital requirements for market risk?

The new Basel standards for market risk capital requirements do not entail proportionality in the application. This might raise some concerns for banks with less sophisticated business models and for those with limited trading activities.

Therefore, implementing the FRTB conclusions for all banks as they currently stand could raise proportionality concerns. For banks with small and medium-sized trading books, the benefits of the new rules in terms of risk sensitivity and accuracy appear outweighed by the operational complexity associated with the implementation and maintenance of the new market risk framework.

As a consequence, this proposal sets out a proportionate approach for market risks capital requirements:
– Banks with small trading books (under EUR 50mm and less than 5% of the institution’s total assets) can still benefit from a derogation, which allows them to apply the treatment of banking book positions to their trading book.
– Banks with medium-sized activities subject to the market risk capital requirements (under EUR 300mm and less than 10% of the institution’s total assets) may use the simplified standardised approach, which corresponds to the existing standardised approach.

In some areas the package included measures to avoid disproportionate capital requirements more broadly, not just for smaller/less complex banks: for example market-making, debt issuance and related hedging, and trades cleared by CCPs.

EBA Final Regulatory Technical Standards on IMA: 22nd Nov 2016

Final Draft RTS on Internal Models Approach: significant share calculation and assessment methodology

The EBA published final draft standards on two IMA-related topics as mandated by the original EU CRR in 2013. Namely the methodology for assessing significance of an application for IMA (market risk capital model) approval; and standards for EU national regulators to apply when assessing such applications. The EBA noted that it had aimed to ensure consistency with the forthcoming FRTB rules while also looking to harmonise the supervisory assessment methodology for IMA approvals across the EU under the current (CRR) rules.

The RTS provide objective criteria for assessing the significance of positions in scope of a model application, with two different methodologies for general and specific risk, both based on the market risk standardised rules.

The remaining sections set out standards for assessing compliance with the IMA requirements in the CRR, both at inception and following any material changes or extensions to the IMA approach. The RTS are structured around the different modelling standards applicable to VaR, stressed VaR (sVaR), Incremental Risk Charge (IRC) and correlation trading models, building on existing guidelines that the EBA issued on sVaR and IRC in 2012.

With regard to FRTB, the EBA acknowledged that the RTS introduce elements that go in the direction of the Basel review but, at the same time, can be implemented within the current legal setting. Examples are the requirements to establish VaR limits, the requirement to backtest models at a higher level of disaggregation than top of house, and the requirement that one-year Probabilities of Default used in the IRC should be greater than zero.

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


3. PRA, FCA and Home Office announcements

PRA: 2016 UK stress testing results: 30th Nov 2016

Bank of England Financial Stability Report: news release

The Bank of England (PRA) released results of the 2016 large UK bank stress tests, alongside publication of its latest Financial Stability Report, following a meeting of the FPC on 23rd November 2016.

The 2016 stress test incorporated a synchronised UK and global recession with associated shocks to financial market prices, and an independent stress of misconduct costs. The test, which is the first conducted under the PRA’s new approach to stress testing, examined the resilience of the system to a more severe stress than in 2014 and 2015. It also judged banks against the PRA’s new hurdle rate framework, which held systemic banks to a higher standard reflecting the phasing-in of capital buffers for GSIBs.

The PRA judged that some capital inadequacies were revealed for three banks (RBS, Barclays and Standard Chartered) but that all three banks now had plans in place to build further resilience. The FPC judged that, as a consequence of the stress test, the UK banking system is in aggregate capitalised to support the real economy in a severe, broad and synchronised stress scenario. The PRA also confirmed that in 2017 the seven participating banks would be subjected to both the annual cyclical scenario and a new biennial exploratory scenario. This was as set out in the PRA’s October 2015 news release which outlined the PRA’s stress testing approach and plans for the period 2016-18.

Furthermore the FPC reaffirmed the UK countercyclical capital buffer (CCB) at 0% and indicated that this was likely to remain until at least June 2017; given the still-challenging outlook for UK financial stability.

PRA: MiFID II implementation, part 2: 25th Nov 2016

Consultation Paper (CP43/16) on part 2 of MiFID II implementation

The PRA published its proposals to implement parts of the Markets in Financial Instruments Directive (MiFID II) and related regulations. This was the second PRA consultation on implementing MiFID II, and followed CP9/16 which covered the MiFID II passporting regime and algorithmic trading. The final rules following CP9/16 are published in Policy Statement PS29/16.

The latest CP includes proposals to enhance governance (via enhanced management and organisational requirements) which will apply to MiFID and non-MiFID business. But in the interests of a coherent approach to corporate governance the regulators have sought to align the MiFID II requirements, so far as possible, to equivalent provisions in the CRR and CRD IV. Comments on the Consultation Paper are due by 27th February 2017.

PRA: Solvency II package: 25th Nov 2016

Consolidation of directors’ letters into a single Policy Statement (PS33/16)

The PRA published a new Policy Statement on Solvency II which, in effect, consolidated the content of a number of ‘directors’ letters’ and feedback statements sent and published by the regulator over the last three years. The supervisory statements in the appendices to PS33/16 set out the PRA’s final expectations on the various Solvency II topics covered by the directors’ letters.

The topics covered include:

  • Internal models – assessment, model change and the role of non-executive directors
  • Longevity risk transfers
  • Own risk and solvency assessment (ORSA)
  • Reinsurance – counterparty credit risk
  • Recognition of deferred tax
  • Transitional measures on risk-free interest rates and technical provisions
  • Treatment of pension scheme risk

FCA: Mission statement: 26th Oct 2016

FCA consultation on mission statement

The Financial Conduct Authority (FCA) launched a long‑awaited consultation on its new mission statement. The FCA aims to provide guidelines explaining how it interprets its objectives and chooses its business plan priorities: the new mission statement will set out a framework to help the regulator prioritise its work and resource allocation. The draft document issued as part of the consultation explains the FCA’s approach and asks some key questions the FCA feels it needs to answer as a conduct regulator. Including on consumer responsibility and vulnerability, change and innovation, how the regulator identifies harm and then decides what action to take to address it, and the interaction between regulation and public policy. Comments are due by 26th January 2017.

FCA: Sandbox update: 7th Nov 2016

FCA announcement of successful sandbox applications

The FCA marked the second anniversary of its Project Innovate by announcing the 24 firms that were successful in their applications to begin testing in the first cohort of the regulatory sandbox. This is part of an initiative kicked off in 2014 to provide innovators with support to navigate the regulatory system and promote competition in the interest of consumers. The sandbox aims to create a safe space in which businesses can test innovative products, services, business models and delivery mechanisms in a live environment, while ensuring that consumers have appropriate protection. Applications for the next round of sandbox testing are now being accepted: deadline 19th January 2017.

Home Office: Financial Crime regime reforms: 13th Oct 2016

UK government response to consultation on April 2016 Action Plan for enhancing AML/CTF regime

The Home Office published proposals to address weaknesses in the framework for addressing money laundering and terrorist financing risks in the UK. An earlier national risk assessment had recommended action in three areas: (i) a more robust law enforcement response, (ii) reform of the supervisory regime, and (iii) increasing the UK’s international reach.

In view of these recommendations, in April 2016 the Home Office launched an extensive Action Plan and consultation process, involving trade bodies, regulators, law enforcement agencies, individuals and statutory organisations. Following the consultation, the government now proposes to reform the UK’s anti-money laundering and counter-financing of terrorism regime in the following ways:

  • Suspicious Activity Reports (SARs) reform
  • Introduction of Unexplained Wealth Orders
  • New information sharing gateway for exchange of data
  • New civil powers on seizure and forfeiture of criminal proceeds

Meanwhile a separate HM Treasury consultation on reform of the AML supervisory regime is still under way.

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


4. Basel and FSB announcements

Coen remarks: 7th Oct 2016

In remarks to the Institute of International Finance (IIF) annual meeting the Secretary General of the BCBS, William Coen, restated his aim of finalising Basel’s post‑crisis reforms by the end of 2016. Coen reiterated that he did not expect the final reforms to increase overall capital requirements. Though he acknowledged there could be outlier banks which could see an increase in capital requirements. Coen also took the opportunity to give updates on some open BCBS policy questions, including the potential for what he called ‘refinements’ to the Basel operational risk proposals.

Technical announcements: Sept to Nov 2016

As in the previous period (Jun to Aug 2016) covered here, the BCBS issued a number of technical consultations and discussion papers relating to different aspects of bank prudential supervision.

IFRS9: The BCBS published a consultative document and a discussion paper on the interaction between the new IFRS9 accounting provisions and the Basel III framework. These papers propose a number of reasons why the introduction of transitional arrangements for moving to Expected Credit Loss (ECL) accounting might be justified, and proposed some transitional options. They also propose possible options for the treatment of provisions in the regulatory capital framework, including retention of the current treatment permanently. Comments are due on both papers by 13th January 2017.

TLAC: The BCBS published its final standard on the capital treatment of investments in other banks’ total loss‑absorbing capacity (TLAC) instruments, which would require banks to deduct TLAC holdings from their Tier 2 capital to limit the potential contagion effect of a bail‑in. The final standard included revisions which the BCBS has conceded to reflect the need for a deep and liquid secondary market for TLAC instruments.

GSIBs: The Financial Standards Board (FSB) published the 2016 list of GSIBs, in consultation with the BCBS and national authorities. The list was based on end-2015 data and the BCBS’s July 2013 assessment methodology. The 30 institutions on the list are the same as those on the 2015 list, though with several changes in ‘bucket’ (category). These changes reflect the combined effects of data quality improvements, changes in underlying activity and supervisory judgment.

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


5. Other Resources

Please note: as in earlier bulletins, the above items represent only a selection of key developments in financial risk and regulation over the period.

However more comprehensive information is available online, including the following resources which Prism-Clarity uses all the time:
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 Regulation round-ups: Nov-16, Oct-16 and Sep-16
The FCA is the primary UK conduct regulator: the above links are to their three latest monthly Regulation round-ups, which summarise key regulatory stories and developments in different financial market sectors