Welcome to the latest Prism-Clarity round-up of key announcements and developments in UK financial risk and regulation.
It won’t have escaped your attention that, far from being a quarterly update, it’s been over a year since my last one. The demands of a corporate contracting role since last November have affected my ability to provide more timely updates. Still, here we are, and will aim to resume doing this update on a more regular basis in future.
As a result of the long gap, my reporting in this note is even more selective and summarised than usual. So I include the usual curated links to underlying source stories or documents for the reader who wants more detail.
And to help readers pick up any stories I don’t cover in detail, I also include selected links to publications and announcements from individual regulators’ websites.
*** Note: The articles in this blog do not constitute advice, but please contact me here for further information, including where to get the best advice. ***
Brexit is (probably) almost upon us and more than three years’ worth of preparations in the financial sector will soon come to fruition. Rather than filling this entire update with a detailed account of the technical preparations and likely ramifications, I take a more focused approach, supplemented with some links to some of the huge body of literature on Brexit produced by law firms, consultants, academics, banks and regulators over the last year.
The Withdrawal Act
For financial risk and regulation an important technicality to enable business and operational continuity on the day after Brexit is the European Union (Withdrawal) Act 2018. In effect this act converts EU law (including financial regulations) to UK law, and retains existing UK domestic law required to maintain a functional legal framework.
The Act also gives UK ministers and delegated authorities (such as the Bank of England) power to amend the law going forward. The current position is that the Bank is consulting on a number of final amendments to the legal instruments required to effect the changes in law on 1st November 2019.
Transitional powers and permissions
The Bank of England’s consultation paper contains details on its intended use of the temporary transitional powers post-Brexit. It sets out PRA proposals on both its own Rulebook and the EU Binding Technical Standards (BTS) which will be retained (‘onshored’ in the technical language) in UK law post-Brexit. The CP also sets out infrastructure-related proposals from the Bank in its role as a competent authority under the EU central securities depository rules.
Just as important, the CP gives guidance for firms seeking to apply for PRA authorisation in the future. It sets out how the Bank will be applying permissions under both the so-called temporary permissions regime (TPR) and the new financial services contracts regime (FSCR). [The FSCR was introduced in February 2019 to enable firms who do not enter the temporary permissions regime to wind down their UK business in an orderly fashion if the UK leaves the EU without a deal.]
What of equivalence?
The idea of the EU applying an ‘equivalence’ framework – to help compensate for the loss of EU passporting rights for financial firms after Brexit – is still alive but looking rather ill, in intensive care even. Yes, one recent Reuters story indicated that some UK financial sectors still see equivalence as a viable approach. But another story raised doubts over whether anything remotely resembling equivalence is still feasible after the events of the last year.
The UK government’s 2018 White Paper on the Future Relationship Between the United Kingdom and the European Union – though ancient history from the point of view of the current path towards a no-deal Brexit – included some interesting proposals on an expanded equivalence regime. The idea was (i) that equivalence would extend to a range of cross-border financial services not covered by the current regime. Furthermore (ii) the EU wouldn’t necessarily have the sole final word on equivalence, and would not be able to withdraw the equivalence determination unilaterally. Instead the UK envisaged a system of joint governance and safeguards to prevent UK firms’ access to the EU financial services market being withdrawn at short notice.
It is safe to say, if the second Reuters story above is true, that an expanded equivalence regime of any kind simply will not happen. Accepting this, to overcome the loss of their EU passport, most cross-border service firms have gone down the more expensive route of establishing double-hubs. One hub in London to take advantage of the fact that – for now – London remains a major global centre for banking, insurance, trading and capital markets. And one hub in continental Europe to act as a central hub for European cross-border activity post-Brexit.
European supervisory perspective
We sometimes forget amid the ongoing Brexit debates in the UK that there is another side to the story, namely the perspective of the continental Europeans who we are leaving behind. In April the EBA put out a thoughtful report on the risks and asset price volatility that it expected to arise from a no-deal Brexit.
Earlier, in a low key publication in March, the EBA announced the basis of future co-operation between EU and UK supervisors in the event of no-deal. This takes the form of a template for a memorandum of understanding (MoU) outlining provisions of supervisory cooperation and information exchange. This template serves as the basis for the bilateral MoUs that are being negotiated and signed by the relevant EU competent authorities and the UK authorities.
These MoUs will only take effect in the event of a no-deal scenario materialising, and will aim to ensure that – irrespective of the outcome of any discussions on equivalence per the Reuters stories reported above – there are no breakdowns in the supervision of cross-border financial institutions in a no-deal scenario.
Links to other Brexit material
There is a lot of material out there on Brexit – perhaps an overwhelming amount. I am just going to point you towards three authoritative, balanced (i.e. non political!) resources I find useful to help me keep on top of things.
The joint ESRC/King’s College website UKandEU.ac.uk is a tremendous resource on UK/EU relations in general and Brexit in particular. By its own account it provides an authoritative, non-partisan and impartial reference point for those looking for information, insights and analysis about UK-EU relations leaving aside the politics surrounding the debate.
For a clear-headed, independent viewpoint on the likely Brexit political path, and outcomes for the economy and markets over the next few weeks (written as at 7th August 2019), see this beautifully written and researched article by Karen Ward of J.P. Morgan Asset Management.
For an independent, practical, broadly-based analysis of Brexit implications on business and law, see this portal overseen by the Institute of Chartered Accountants in England and Wales (ICAEW). This page contains a list of externally produced resources which offer practical advice on the impact of the decision to leave the EU and opportunities for future business.
2. Basel and FSB announcements
Over the space of any given year there are many communications from central banks, no less from the central bank of central banks, the Bank for International Settlements in Basel. The same applies to the Financial Stability Board (FSB), which monitors and makes recommendations about the global financial system. The FSB routinely produces a lot of content, most of which is worth paying attention to given its position as the overarching global financial sector policy making body.
Still, against the background of a whole year’s comms, my initial approach to summarising this vast pool of content is to draw your attention to the press release sections on both the BIS and FSB websites: the BIS covering just the last 12 months, the FSB further back.
BCBS consolidated standards
One of the most useful BIS publications over the last year was something that was primarily organisational and technical rather than a new ruleset: namely, a consolidation of Basel Committee on Banking Supervision standards introduced over the years. Given the scale and complexity of Basel rulesets over a long period, this was a welcome and perhaps overdue effort to bring all the BCBS regulatory and supervisory standards together in one place.
Final market risk capital rules (formerly known as FRTB)
In January the BIS published its planned Basel III work programme alongside the final, final version of the new rules on market risk capital; these changes have been in development now for several years under the aegis of the Fundamental Review of the Trading Book (FRTB).
The original ‘final’ FRTB rules were published in January 2016, and would have given rise to a total increase in market risk capital across the industry of around 40%. The Basel Committee proposed changes in a March 2018 consultation, supported by the results of a major quantitative impact study as of December 2017. The new ‘final, final’ rules in effect implement those revised March 2018 standards, resulting in an estimated increase in capital of just 22% compared to the original 40%. The rules will come into effect in January 2022.
What’s in the new market risk rules?
As in the January 2016 framework, the core features of the new standard include a clearly defined boundary between the trading book and the banking book; an internal models approach (IMA) that uses expected shortfall models and sets out separate capital requirements for risk factors that are deemed non-modellable; and a standardised approach that is risk-sensitive, and designed and calibrated to serve as a credible fallback to the IMA.
Revisions to the January 2016 framework include the following key changes:
- a simplified standardised approach for banks that have small or non-complex trading portfolios;
- clearer description of the scope of what is and is not subject to market risk capital requirements;
- new standardised approach treatments of foreign exchange risk and index instruments;
- new standardised approach risk weights for general interest rate risk, FX and some credit spread exposures;
- revisions to the assessment process to determine whether a bank’s internal risk management models appropriately reflect the risks of individual trading desks; and
- new requirements for identifying risk factors eligible for IMA.
Amid the raft of communications published by the FSB over the last year, perhaps the most useful for our purposes, given the length of time we are reviewing, is the summary letter sent by the FSB Chair to the G20 summarising the FSB’s activities over the period to April 2019.
The FSB said it would continue addressing new and emerging vulnerabilities in the financial system, scanning the horizon to identify and assess emerging risks. While the core of the financial system is considerably more resilient than it was a decade ago, the FSB said potential vulnerabilities in the financial system persist, and in some cases have built up further. It noted that loosening lending standards, elevated asset values, and high corporate and public debt call for particular vigilance.
Other topics of concern included (i) finalising and operationalising post-crisis reforms; (ii) evaluating the effects of those reforms, for example on small and medium-sized enterprises, and the effect of too-big-to-fail reforms in the banking sector; (iii) market fragmentation; and (iv) improving communication and transparency with its external stakeholders, to increase understanding of the FSB’s work and obtain greater input from the people affected by it.
3. European supervisory announcements
As with the central banks, one approach to assessing what has happened over a long period in European financial supervision is to look at the press releases. Here are the European Banking Authority’s releases going back quite far in time. I count just the 127 since the beginning of August 2018.
Another approach is to take a functional view and look at relevant websites from a subject matter perspective. The EU has a really excellent portal on financial supervision and risk management which contains five big topics of interest under the heading of European financial supervision.
As with other regulatory entities, we can’t do much more than scratch the surface of such a large body of material. Still, below are a few of the entries that caught my eye from a quick review of these sources.
EU action to strengthen supervisory architecture
The European Commission continued its strenuous efforts to bring about a stronger and more integrated European supervisory architecture, notably in the areas of anti-money laundering and counter terrorist financing.
Back in September the Commission announced its intention to strengthen the EBA’s mandate and concentrate supervisory powers in the authority, including on anti-money laundering.
Then in March it was announced that political agreement had been reached by the European Parliament and member states on the core elements of reform of European financial supervision. The Commission noted that this agreement was an important step to achieve the Capital Markets Union’s objective to ensure stronger, safer and more integrated financial markets to the benefit of European consumers, investors and businesses.
The path to further integration continues apace across the channel, certainly in the areas of regulation and supervision, even as the UK falls out of the union.
EBA report on crypto assets
Crypto assets and currency – and the regulatory treatment of them – is one of the topics we follow closely on Prism-Clarity and in January the EBA produced a useful report on crypto assets which looked at various angles of the rapid evolution of the crypto asset market. The EBA examined (1) the application of current EU banking, payments, e-money and anti-money laundering laws to crypto assets; (2) the activities of crypto asset custodian wallet providers and crypto asset trading platforms; and (3) the activities of traditional banks, investment firms, payment institutions and electronic money institutions’ in crypto assets; as well as (4) associated regulatory and supervisory issues.
Two main recommendations came out of the report: (i) that the European Commission should carry out further analysis to determine the appropriate EU-level response; and (ii) that the EBA will in 2019 enhance its own monitoring of financial institutions’ crypto-asset activities and disclosure practices to consumers.
EBA annual report
The EBA’s annual report published in May contained the usual wealth of information on the supervisor’s activities over the last year; including on the single EU rulebook, and an increased monitoring role on key parts of the prudential framework (capital, liquidity, securitisation and models) with the aim of strengthening supervisory convergence.
Other important EBA work in the year under review was undertaken on payments, notably on the delivery of technical standards and guidelines under PSD2; on non performing loans, transparency and disclosure, and financial innovation. Plus of course Brexit: the EBA noted that throughout 2018 it had been making strong efforts to ensure good preparedness at all levels for the consequences of the UK’s withdrawal, taking into account all possible outcomes, including the worst-case scenario.
Another key topic of concern in 2018, prompted by the EU’s initiative mentioned above, was improving the effectiveness of anti-money laundering and counter-terrorist financing. The EBA noted that it had been working closely with ESMA and EIOPA to develop a framework aimed at supervision across the EU, and at strengthening cooperation and information exchange between national supervisory authorities, both domestically and across borders. To this end, two technical standards and three guidelines came into force during 2018, representing an important first step on the road towards a more consistent and effective European AML/CFT regime.
Please contact Prism-Clarity if you need specific information on any European activities or publications not covered in this bulletin.
4. Bank of England/PRA announcements
Financial Stability Report
A good place to start after a little while away is the Bank’s Financial Stability Report (FSR), most recently published in July. This highlights in very clear summary messages the things that the Bank is most concerned about and how banks and markets are responding to those concerns.
Obviously Brexit features highly in this latest assessment, including banks’ own resilience to the potential shocks of a no-deal exit. But macroeconomic concerns also feature, notably around trade. The Bank also makes special mention of its plans to test firms’ planning on the risks from climate change, and the transition to a carbon-neutral economy.
The Bank, perhaps surprisingly, believes that most risks to UK financial stability from disruption to cross-border financial services in a no-deal Brexit have been mitigated. But it also adds a word of caution: financial stability is not the same as market stability, and – like the EBA – the Bank believes that a no-deal exit could easily result in increased market volatility and big changes in asset prices.
Other topics included in the latest FSR were financial innovation, in the wake of the well-received Huw van Steenis paper on The Future of Finance published in June; the transition away from Libor; and the market vulnerabilities that open-ended investment funds pose, on which the Bank will be embarking on a joint study with the FCA.
Bank of England speeches
Over the space of a year a modern central bank will not be short of words. In the period covered by this review I calculate that Bank senior officials have published well over 80 speeches on a huge variety of topics. Choosing from among them is not straightforward. But what is notable if you scan down the list is a general departure from the dry, macroeconomic focus of yesteryear. Diversity and inclusion, innovation and artificial intelligence, education and access, all feature prominently alongside the usual suspects: prices, markets and jobs.
Three speeches caught my eye as reflecting the preoccupations of readers of this note. I emphasise this is just a selection from a very good bunch. Readers with time are urged to check back on the list in the above link.
First, Ben Broadbent in a speech in July focused on financial education and the Bank of England, at a conference aimed at helping young people learn about money. Broadbent admitted that his topic was partly driven by self-interest, as the Bank needs a strong supply of good economists coming in as new recruits. More importantly, though, the effectiveness of policy relies on public understanding: the deeper that understanding can go, rooted in better economics education, the more effective the policy.
Broadbent drew attention to two initiatives aimed at improving the engagement of secondary school students with economics and money: a series of ambassadorial visits from senior Bank staff; and an online content package, labelled ‘EconoME’, to help non-specialist teachers of students aged between 11-16 years deliver quality financial education.
Second, David Rule back in May talked about model use and the growing importance of model risk management, particularly in the context of insurance but actually more broadly applicable to the financial sector. Not surprisingly the main focus was capital and pricing models, but Rule also focused on what he called ‘model drift’, where a well functioning model gradually and imperceptibly ceases to effectively represent the risks it purports to cover.
He also focused on management’s responsibility to understand the models it is using, where a model is expected to work well, and under what circumstances it is likely to break down. Are the assumptions and judgements used in the model reasonable, and what factors will cause them to change? Quoting FCA Chief Andrew Bailey, Rule reiterated that the challenge with financial models is ‘to reduce complexity to simplicity’, so Board members can gain a good understanding of these issues.
Finally Sarah Breeden in April made a thoughtful and ground-breaking speech on climate change and its implications for financial markets, perhaps the first time a senior global regulator had set out its expectations in this key area. Breeden described how the financial risks from climate change are far-reaching, foreseeable and require action today. We need a new map to avoid the impending storm, and so far it does not exist.
Despite this she put out some ideas on opportunities, as well as risks. The investment needs to finance this transition are significant – an estimated $90 trillion (around 5x current US GDP) by 2030. This presents a substantial opportunity for the financial sector to develop new products and services to bring green finance into the mainstream. Breeden said that to support that goal new standards and classifications might be needed, to identify which economic activities might best contribute to the transition to a low-carbon economy.
Operational resilience update
Operational resilience (including resilience to cyber attacks) remains a big current priority for both regulators and industry practitioners. The last edition of this note highlighted the July 2018 release of PRA Discussion Paper 1/18, jointly published with the FCA (DP 18/04 in FCA notation). This paper subsequently attracted a lot of attention in terms of downloads and responses, and intensive work has continued in both the regulatory and industry spheres in 2019.
In May Nick Strange from the Bank gave a speech to the Operational Risk Europe conference which highlighted the regulators’ current resilience plans. These include cyber stress tests and a range of collaboration initiatives, both within the UK and internationally, to oversee and test financial sector resilience.
Then in July the industry body City UK launched its joint report ‘Operational resilience in financial services: time to act’. Marking the report launch with a key update on progress over the last year, the Bank’s Lyndon Nelson drew attention to two changes in mindset which he believed the regulators’ discussion paper had helped bring about.
First, the assumption that operational disruption would occur (and the need to plan accordingly). Second the heightened degree of collaboration across numerous organisations which is important for good operational resilience. Nelson gave the example of the formation of the Financial Sector Cyber Collaboration Centre, which promises to bring a step-change to industry collaboration, and therefore defensive capabilities, on cyber risks.
Other PRA announcements and publications
The Bank/PRA website page What’s New summarises PRA rules currently out for consultation and due for implementation. The picture below is what it looks like.
Alternatively, as always, a good source to catch up on PRA technical publications is the regulator’s monthly prudential regulatory digest. The last three editions of this are linked in the ‘Other Resources’ section at the foot of this blog.
5. FCA announcements
Just as stated in this note a year ago, the FCA remains as preoccupied with Brexit. Still time waits for no regulator, and the conduct watchdog has many other preoccupations, from crypto assets to pensions, As usual this section deals with some of the FCA’s other (non Brexit) work programmes as set out in various publications and announcements. See this link for a guide to currently open FCA consultations and recent policy/guidance papers.
Annual report and business plan
In July the FCA published its 2018/19 annual report and accounts, alongside its other usual mandated reports on diversity, anti money laundering, competition and enforcement. CEO Andrew Bailey chose to highlight four themes in particular. (1) The regulator’s work with claims management companies to bring them under FCA regulation for the first time. (2) Reducing harm to the 3 million+ UK consumers who use high-cost credit, many of them among the most vulnerable in society. (3) Adjustments to the responsible lending rules, to protect consumers inadvertently suffering harm from the current drafting of the rules. And (4) maintaining integrity in wholesale markets. In the year under review, the FCA opened 484 preliminary market abuse investigations and started a programme of visits to improve monitoring in fixed income, commodity and derivative markets.
Meanwhile the FCA’s 2019-20 business plan, published earlier in the year in April, took the forward-looking view, focusing on eight cross-sectoral priorities. Not surprisingly EU withdrawal and international engagement were top of the list, and there were few surprises in the rest of the list either. Firms’ culture and governance; operational resilience (alongside the PRA); financial crime and anti money laundering; fair treatment of customers; and innovation, data and data ethics. Two longer term priorities rounded off the list: demographic change and the future of regulation.
Reports on high cost credit and defined benefit pensions
This summer the FCA published two reports on different areas of treating customers fairly in key consumer markets. In July they published a set of actions and recommendations to improve the availability and awareness of alternatives to high-cost credit. The regulator also provided an update on its thinking since publishing a key consultation paper on the topic in November 2018. The FCA noted that it is now implementing wide-ranging reforms of several key high-cost markets: rent-to-own, catalogue credit and store cards, buy now pay later offers, home-collected credit and overdrafts. The regulator also acknowledged that not all consumers have access to mainstream credit, and that lower-cost and non-credit options may exist as an alternative for those people.
Earlier, in July, the FCA highlighted results from its multi-firm review of the defined benefit (DB) transfers market. This is another sensitive area for the FCA given its perception that the advice being given in this sector is still not good enough. The FCA’s view is that too many recommendations to transfer are being made (and accepted). And in some cases recommendations from advisers not to transfer are being actively ignored by the DB pension holder. The regulator said its ambition is for pension transfer advice to reach the same standard as the wider financial advice market, where it finds advice is suitable in around 90% of cases. At the moment, the FCA admitted, the disparity between the quality of advice on DB transfers and that on investments is a significant concern.
6. Other resources
The above items represent only a small selection of developments in financial risk and regulation over quite a long period. More comprehensive information is available online, including the following resources which Prism-Clarity always finds useful.
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 produced by the Deloitte EMEA Centre for Regulatory Strategy
Contact: David Strachan ([email protected])
The Prudential Regulation Authority, a division of the Bank of England, is the primary UK prudential regulator: the links below are to its three latest monthly regulatory digests, which summarise key prudential developments in different financial market sectors:
June 2019 May 2019 April 2019
The Financial Conduct Authority is the primary UK conduct regulator and publishes monthly Regulation Round-ups, which summarise key conduct developments in different financial market sectors. You need to sign up here to receive these, as the FCA no longer publishes them on the FCA website. For illustration, the link below is to the last version available on the website: