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22752089 v1
Regulatory reform –
understanding the impact
Paul Edmondson
Simon Morris
2nd June and 17th June (London) 9th June (Edinburgh)
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Outline
Introduction to the reform agenda and CMS roadmap
FSA – a different type of regulation?
Learning the lessons – specific post crisis reforms
Beyond the banking sector
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CMS reporting – the seminar series
First seminar in the series
– Grasping the big picture
Later seminars
– By sector and
– In detail
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CMS reporting – the roadmap
The report
– Making sense of the deluge from UK,EU and international
– Key issues summaries
– Key impacts - which sectors/firms and how
– Timeline – key dates
– ‘More detail’ (than we can provide today)
– ‘Policy options’
On-line – www.law-now.com/financial-services
– Will be kept update
– Hyperlinked –
– Referenced external materials
– Our law now reports and tools
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No magic or silver bullets
The regulatory system failed
– But can be fixed
– Each ‘magic bullet’ has been oversold
So we keep - FSA, FSMA, the EU legislation, FSF, Basel, Solvency II etc etc
Many diverse reforms to recalibrate the system
– Overall a sea change
– But using the same infrastructure for firm supervision
IMPACT
A lot of lobbying to be done!
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How reform will be delivered?International consensus –
– Global standards but no global regulator
EU measures –
– new priorities (systemic)
– More effective European authorities
– A more standard rulebook and regulatory system
Domestic –
– White Paper awaited - FSA fights to keep its supervisory role (financial regulation of banks) from the Bank of England
IMPACT:
more policy/rule making at EU level
UK authorities less independent
FSA continues to supervise firms –
– Cross-border regulation coordinated via colleges of supervisors
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FSA – a different type of
regulation?
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Macro-prudential regulation - oversight
of the financial system
New focus on systemic risk –
– the missing piece of the jigsaw
– fell between the stools
Function to include* –
– System review/early warning
– Set parameters for micro/firm prudential rules
– Inputs into stress testing and SREP and capital
– Lots of big issues (many raised by Turner) for the
macro-economists (and the new European Systemic
Risk Council) to ponder
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New focus on systemic risk and macro-
prudential regulation/oversight
The policy question - who is responsible and what are their powers?
– See the chart
– FSA/Bank of England turf war
– New FSA systemic risk department
IMPACT
Increased burden on firms (helping systemic
analysis)
More regulatory intervention/less free market
Uncertainty for several years
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Rethinking regulation – from ‘light touch’
to ‘intrusive’
Denying accepted thinking
Managing the managers
Bulking up capital
Challenging the models
Managing insolvency
And sharpening supervision
FSA v Rest of World
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New style for rule making and firm
supervisionIntensive Supervision – US/Spanish style bank inspectors?
– Supervisory challenge in previous no-go areas
– Competence of senior appointments and non-execs
– Accounting decisions
– Business models, sustainability and strategy
– Product regulation
– Wholesale market operation
IMPACT
Firms will find FSA supervision more challenging
Broader internal team -
– with enhanced capabilities
– for ARROW etc
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Enforcement
FSA gets tough
Credible deterrence
EU ideas – the 1 billion Euro fine!
IMPACT
More enforcement against individuals including–
– Senior management and executive directors
– Non-executive directors?
– Higher fines
– More criminal arrests and prosecutions
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Management and governance
Walker review on governance – getting bank boards to mitigate risk
– Extension –lessons applicable to non-bank sectors
– Board level
– Governance
– Remuneration
– Risk management
– Committees – audit, REMCO, nomination, risk
IMPACT
Watch this space
Much ‘hotter’ for directors of large banks/major institutions
Increased emphasis on ‘internal policing’ and duties towards depositors/insureds
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Non-executive directors
Watch out!
– Another scapegoat?
Walker
The independent role –
– Time
– Resources
– Competence
Towards a supervisory board?
IMPACT
Much hotter for non-executives
More independent with greater policing role
More time, resource and expertise
Greater exposure
Conflicting relationships with FSA (their internal spies?), executive and shareholders?
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Regulating remuneration
Turner is less hysterical than the media and TSC
– But a political ‘must have’
FSF Principles and EU Recommendation
– All financial institutions – not just banks
FSA running ahead with its draft rules and code
– ?Scope – big banks or all sectors?
– Broad requirements
– Formal remuneration policy to promote effective risk
management
– Limits,deferral and risk adjusted basis for bonus
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Regulating remuneration
Part of*
– ARROW
– ICAS – capital add-ons and CRD amendment
– SREP
CMS remuneration checklist from specific seminar (in the
pack)
IMPACT
New area of regulation to deal with
Transition plan required
Much bigger role for REMCOs
Combined team required - HR, risk, compliance,legal
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Learning the lessons –
specific post crisis reforms
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The new role of the state in financial
servicesToo big to fail?
– Now recognised by regulators (as well credit rating agencies!)
– Implicit state guarantee – provider of capital and liquidity of last resort?
The search for a regulatory response
– Additional requirements – financial (higher capital/liquidity) - and risk based restrictions?
IMPACT
Larger banks/institutions to face
– Heavier supervision
– Heavier involvement in systemic planning
– Need to lobby against requirements
Other firms may lobby for higher requirements
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Competition policy post crisis?
Will there be a competition response
– Competing for deposits –
– market share issues
– State ownership
– Implicit guarantee
– The current OFT consultation on their financial services strategy
– State aid is currently an EU issue – e.g. restructuring terms for APS clearance
IMPACT
(Conflicting) lobbying from both sides of the industry
Short term uncertainty
Post crisis – new competition investigations to gauge competition and use competition powers?
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Group supervision –
international
Lessons from Lehman and AIG for ‘Global in life;national in death’
Conflict between
– Operational, management/matrix reporting and financial structure (central liquidity/cash management etc) and
– Legal/local entities
– Made local supervision ineffective
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Group supervision
Can groups demonstrate that their structures enable effective supervision at the local level (without breaking-up into local subsidiaries with separate operations, management and finances)?
Branching –
– One EU wide deposit insurance scheme or roll back the single market principles with greater powers for EU host regulators
– Non-EU – more ready to require local subsidiary?
IMPACT
Review all aspects of group structure to demonstrate ‘survivability’ of local operations
Greater emphasis legal entity structure, solo/local regulation and intra-group exposures
Potential loss of management, operational and financial efficiency
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Group supervision
Regulating unauthorised holding companies
– Extension of approved persons regime for directors
and SIFs
Extended reach to unregulated entities connected with
the group –
– Off-balance sheet entities
– SIVs
– And the shadow land
IMPACT
Unauthorised holding companies brought into regulation
Much greater scrutiny of off balance sheet entities
Achieving off balance sheet status may not be enough
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Regulation in the unauthorised ‘shadows’
Unauthorised entities beyond the perimeter of regulation
– Bank like activities e.g. US money market funds not breaking the buck
– Systemically important entities
Indirect monitoring/supervision
– Via connected financial group or
– Via commercial contact e.g. prime broker
Ability to
– Apply restrictions or
– Bring into direct regulation (but uncertain how to legislate for this)
IMPACT
More onerous
– reporting of hedge fund funding etc
– Indirect regulation of connected entities
Bank like regulation for guaranteed products
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Financial regulation*
Higher liquidity requirements*
– Individual liquidity adequacy requirements
– Non-EU banks
More capital*
More equity*
Counter-cyclical reserves (Spanish style)*
Penalising the trading book*
IMPACT
More risk adverse financial regulation with higher requirements
Smoothing of bank profits
Speculative prop trading on bank balance sheet less attractive
– Boost for external hedge funds?
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Financial regulation*
More realistic accounts*
More stress testing – the what if game*
Tougher rules for securitisation*
Credit ratings – reforming the system*
IMPACT
Battle over accounting standards
Securitisation/originate and distribute to continue
but with greater due diligence and retentions
More challenge to ratings
More time ‘playing what if’ with FSA
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Planning for failure
Rescues and administration* – the new tools
– Banking Act – SRR etc to protect retail deposits
– Investment banking (current HMT consultation on the Lehman lessons)
FSCS – trying to make it work*
Planning your own funeral –
– Reverse stress testing
– Manuals for regulators and administrators
– The single customer view requirements
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Planning for failure
IMPACT
FSCS pre-funding will come but no policy yet on
– who pays for what on what basis or national/EU
Recent rescues –
– Building societies paying interest cost of FSCS loans
– unresolved issues on capital (insurers and others on the
hook)
Heavy burden on firms in helping regulator plan for disaster
– Potential for huge costs
– ?dubious benefits driven by traumatised authorities
– Need to lobby
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Improving market infrastructure*
Reducing the risks in OTC derivative markets*
– Central counterparties
– Exchange trading
IMPACT
After compression – operational changes for CCP
trading
Increased reporting/disclosure re OTC
Uncertainty whilst policy is thought through
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Beyond the banking sector
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Regulatory reform spreads beyond the
banking sector
Specific sector issues – e.g. hedge funds
The lessons to be learnt relevant to other sectors
Changing the institutions and the regulatory system
– FSA
– EU
IMPACT
Non-banks ignore at their peril
Need to engage and lobby
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A boost for the mutual model?
Sector feels hard done by –
– FSCS liabilities
– Credit downgrade
– Regulatory overload
Some support for the mutual model but narrow
banking tarnished by toxic exposures
IMPACT
Difficult world for the smaller societies
Possible encouragement for new mutuals
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Tightening insurance regulation
Financial regulation and risk management
– Solvency II level one agreed for October 2012*
– Group support abandoned*
– ‘Lessons to be learnt’ from crisis (equivalent to Basel revamp)
– Internal model approval process
– Capital quality
IMPACT
Group structures less efficient without group support
Internal Solvency II project needs to be on track – in-house counsel and compliance/risk need to be plugged in
Watch out for tightening at level 2
Internal model benefits at risk
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Tightening insurance regulation*
List of earlier issues which are relevant to insurance –
– The spill-over from banking reform
– Walker – governance/board risk management under Solvency II but
– Non-executives ?
– Board remuneration?
– Macro-prudential
– Too big to fail
– FSA supervisory and enforcement
– Groups
– FSCS – exposures to banking rescues - back to a dedicated scheme?
– EU institutions and
– branching
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Tightening insurance regulation
IMPACT
Uncertain but broad and significant
Need to lobby against inappropriate read across
from the banking sector
– Need stronger industry engagement than on
previous regulatory changes
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Increased fund regulation – direct and
indirect
Proposed EU directive on fund managers*
– All non-UCITS managers above size threshold (includes hedge and private equity but not limited to alternative sector)
– Trade sanctions re tax and regulatory standards in non-European fund centres
– European
– Authorisation
– Rules (including re liquidity of funds)
– Passport
IMPACT
Private equity concerned
Fund domicile threat needs monitoring
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Increased fund regulation – direct and
indirect
Already mentioned –
– Shadow lands* –
– Via regulated group
– Via prime broker
– Extending direct regulation
– Avoiding bank like activities
IMPACT
Limited immediate impact - few funds
– large enough to be systemically important
– Offer guarantee
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Tightening up retail regulation*
A better way to regulate consumer finance?
– Mortgages and product regulation? (LTI/LTV limits?)
Changing the way investments products are sold*
– RDR/RDIP
– Proposed EU packaged products legislation
IMPACT
Uncertain – EU/FSA still struggling to find a
coherent policy
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Next steps
Feedback forms and later re roadmap
Seminar follow up –
– The roadmap report
– Monitoring via www.law-now.com/financial-services
What we can do for you –
– Training – board, non-execs, legal etc
– Impact analysis
– Lobbying and consultation responses
– Strategy
– Reviews –
– Group/legal structure
– Capital
– Risk management
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