basel iii compliance professionals association

Basel iii Compliance Professionals Association (BiiiCPA)

www.basel-iii-association.com

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Basel iii Compliance Professionals Association (BiiiCPA) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA

Tel: 202-449-9750 Web: www.basel-iii-association.com

Dear Member, Today we will start from the 3 really important papers that have to do with the implementation of the Basel iii framework in the USA.

The three notices of proposed rulemaking (NPRs), taken together, will restructure the Board’s current regulatory capital rules into a harmonized, comprehensive framework, and will revise the capital requirements to make them consistent with the Basel III capital standards established by the Basel Committee on Banking Supervision (BCBS) and certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

The proposals are published in separate NPRs to reflect the distinct objectives of each proposal, to allow interested parties to better understand the various aspects of the overall capital framework, including which aspects of the rule would apply to which banking organizations, and to help interested parties better focus their comments on areas of particular interest.

The problem is we did not learn more about the quantitative liquidity requirements and the capital surcharge for global systemically important banks (these are not part of this rulemaking). I hope we will have more details soon.

http://www.basel-iii-association.com/



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Basel III in the USA



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Basel III in the USA, Board of Governors of the Federal Reserve

3:30 PM, Thursday, June 7, 2012 - Marriner S. Eccles Federal Reserve Board Building, 20th Street entrance between Constitution Avenue and C Streets, N.W., Washington, D.C.

Matters to be Considered:

Discussion Agenda:

1. Proposed interagency rulemakings: strengthening and harmonizing the regulatory capital framework for banking organizations, including proposed rules for implementing Basel III for banking organizations and proposed consolidated capital requirements for savings and loan holding companies.

2. Final interagency rulemaking: market risk capital rule.

Proposed Rulemakings for an Integrated Regulatory Capital Framework, Questions and Answers June 7, 2012

Question 1: What does the package of proposed rulemakings contain and why is it divided into three parts?

The package contains three notices of proposed rulemaking (NPRs) that, taken together, would restructure the Board’s current regulatory capital rules into a harmonized, comprehensive framework, and would revise the capital requirements to make them consistent with the Basel III capital standards established by the Basel Committee on Banking Supervision (BCBS) and certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

The proposals are published in separate NPRs to reflect the distinct objectives of each proposal, to allow interested parties to better understand the various aspects of the overall capital framework, including which aspects of the rule would apply to which banking organizations, and to help interested parties better focus their comments on areas of particular interest.



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The BCBS quantitative liquidity requirements and the BCBS capital surcharge for global systemically important banks are not part of this rulemaking.

First Paper: The Basel III NPR

1. The first NPR, Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action (Basel III NPR), is primarily focused on proposed reforms that would improve the overall quality and quantity of banking organizations’ capital.

The NPR would revise the Board’s risk-based and leverage capital requirements, consistent with the Dodd-Frank Act and with agreements reached by the BCBS in Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems (Basel III).

The proposal includes transition provisions designed to provide sufficient time for banking organizations to meet the new capital standards while supporting lending to the economy.

Second Paper: The Standardized Approach NPR

2. The second NPR, Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements (Standardized Approach NPR), would revise and harmonize the Board’s rules for calculating risk-weighted assets to enhance their risk sensitivity and address weaknesses identified over recent years.

It would incorporate aspects of the BCBS’s Basel II standardized framework in the International Convergence of Capital Measurement and Capital Standards: A Revised Framework (Basel II), Basel III, and alternatives to credit ratings for the treatment of certain exposures, consistent with the Dodd-Frank Act.



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Third Paper: The Advanced Approaches and Market Risk NPR

3. The third NPR, Regulatory Capital Rules: Advanced Approaches Risk-based Capital Rule; Market Risk Capital Rule (Advanced Approaches and Market Risk NPR), would revise the advanced approaches risk-based capital rule (in a manner consistent with the Dodd-Frank Act) and incorporate certain aspects of Basel III that the Board would apply only to advanced approaches banking organizations (generally, the largest, most complex banking organizations).

This NPR would also codify the Board’s market risk capital rule and, in combination with the other components described above, would apply consolidated capital requirements to savings and loan holding companies (SLHCs).

Question 2: Which banking organizations are covered by the proposed rulemakings?

The Basel III NPR and the Standardized Approach NPR would apply to state member banks, bank holding companies domiciled in the United States not subject to the Board’s Small Bank Holding Company Policy Statement (generally, bank holding companies with less than $500 million in consolidated assets), and SLHCs domiciled in the United States.

Consistent with Section 171 of the Dodd- Frank Act, the proposed rulemakings would apply to all SLHCs regardless of asset size.

The Advanced Approaches and Market Risk NPR would generally apply to banking organizations meeting specified thresholds.

In general, the advanced approaches risk based capital rule applies to those banking organizations with consolidated total assets of at least $250 billion or consolidated total on-balance sheet foreign exposures of at least $10 billion (excluding insurance underwriting assets) and their depository institution subsidiaries.



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The market risk capital rule generally applies to those banking organizations with aggregate trading assets and trading liabilities equal to at least 10 percent of quarter-end total assets or $1 billion.

Question 3: How are these proposed rulemakings related to the Dodd-Frank Act?

The NPRs are consistent with statutory requirements in the Dodd-Frank Act.

For example, pursuant to section 171 of the Act, the NPRs would establish minimum riskbased and leverage capital requirements for SLHCs, phase out certain capital instruments over a three-year period, and establish new minimum generally applicable capital requirements.

In addition, pursuant to section 939A of the act, the NPRs remove references to, or requirements of reliance on, credit ratings in the Board’s capital rules and replace them with alternative standards of creditworthiness.

Question 4: What are the main changes to the minimum capital requirements?

The proposal includes a new common equity tier 1 minimum capital requirement of 4.5 percent of risk-weighted assets and a common equity tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets.

The proposal also increases the minimum tier 1 capital requirement from 4 to 6 percent of risk-weighted assets.

The minimum total riskbased capital requirement would remain unchanged at 8 percent.

The proposal introduces a supplementary leverage ratio that incorporates a broader set of exposures in the denominator measure of the ratio for banking organizations subject to the advanced approaches capital rule.

This supplementary leverage ratio is based on the international leverage ratio in Basel III.



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Question 5: What are the main changes related to the definition of capital being proposed?

Capital instruments issued by banking organizations would be subject to a set of strict eligibility criteria that would prohibit, for example, the inclusion in tier 1 capital of instruments that are not perpetual or that permit the accumulation of unpaid dividends or interest.

Trust preferred securities, for example, would be excluded from tier 1 capital, consistent with both Basel III and the Dodd-Frank Act.

Under the Basel III NPR, banking organizations would be subject to generally stricter regulatory capital deductions (the majority of which would be taken from common equity tier 1 capital).

For example, deductions related to mortgage servicing assets, deferred tax assets, and certain investments in the capital of unconsolidated financial institutions would generally be more stringent than those under the current rules.

Question 6: What is the capital conservation buffer and how would it work?

In order to avoid limitations on capital distributions (including dividend payments, discretionary payments on tier 1 instruments, and share buybacks) and certain discretionary bonus payments, under the proposal banking organizations would need to hold a specific amount of common equity tier 1 capital in excess of their minimum risk based capital ratios.

The fully phased-in buffer amount would be equal to 2.5 percent of risk-weighted assets.

Question 7: Will the new capital requirements and capital conservation buffer be imposed immediately or will there be a transition period?



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The Basel III NPR contains transition provisions designed to give ample time to adjust to the new capital requirements, consistent with the agreement in Basel.

The new minimum regulatory capital ratios and changes to the calculation of risk weighted assets would be fully implemented January 1, 2015.

The capital conservation buffer framework would phase-in between 2016 and 2018, with full implementation January 1, 2019.

Question 8: What is common equity tier 1 capital and why are you proposing a new common equity tier 1 requirement?

Common equity tier 1 capital is a new regulatory capital component that is predominantly made up of retained earnings and common stock instruments (that comply with a series of strict eligibility criteria), net of treasury stock, and net of a series of regulatory capital deductions and adjustments.

Common equity tier 1 capital may also include limited amounts of common stock issued by consolidated subsidiaries to third parties (minority interest). Common equity tier 1 capital is the highest quality form of regulatory capital because of its superior ability to absorb losses in times of market and economic stress.

Question 9: What are the main elements of the Standardized Approach NPR?

It would increase the risk sensitivity of the Board’s general risk-based capital requirements for determining risk-weighted assets (that is, the calculation of the denominator of a banking organization’s risk-based capital ratios) by proposing revised methodologies for determining risk-weighted assets for:

- Residential mortgage exposures by applying a more risk-sensitive treatment that would risk-weight an exposure based on certain loan characteristics and its loan-tovalue ratio;



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- Certain commercial real estate credit facilities that finance the acquisition, development, or construction of real property by assigning a higher risk weight;

- Exposures that are more than 90 days past due or on nonaccrual (excluding sovereign and residential mortgage exposures) by assigning a higher risk weight; and

- Exposures to foreign sovereigns, foreign banks, and foreign public sector entities by basing the risk weight for each exposure type on the country risk classification of the sovereign entity.

The NPR would also replace the use of credit ratings for securitization exposures with a formula-based approach.

Additionally, the NPR would provide greater recognition of collateral and guarantees.

However, for most exposures, no changes are being proposed in the NPR.

More specifically, the treatment of exposures to the U.S. government, government-sponsored entities, U.S. states and municipalities, most corporations, and most consumer loans would remain unchanged.

It would introduce disclosure requirements that would apply to banking organizations domiciled in the United States with $50 billion or more in total assets, including disclosures related to regulatory capital.

The changes in the Standardized Approach NPR are proposed to take effect January 1, 2015.

Banking organizations may choose to comply with the proposed requirements prior to that date.

Question 10: What are the primary objectives of the Advanced Approaches and Market Risk NPR?

It would revise the advanced approaches risk-based capital rule in a manner consistent with the Dodd-Frank Act by removing references to



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credit ratings from the securitization framework, requiring an enhanced set of quantitative and qualitative disclosures (especially in regard to definition of capital and securitization exposures), implement a higher counterparty credit risk capital requirement to account for credit valuation adjustments, and propose capital requirements for cleared transactions with central counterparties.

The NPR would incorporate the market risk capital rules into the integrated regulatory capital framework and propose its application to savings and loan holding companies that meet the trading thresholds.

Question 11: How will the Prompt Corrective Action (PCA) framework change as a result of the proposed rulemakings?

Under the proposal, the capital thresholds for the different PCA categories would be updated to reflect the proposed changes to the definition of capital and the regulatory capital minimum ratios.

Likewise, the proposal would augment the PCA capital categories by incorporating a common equity tier 1 capital measure.

In addition, the proposal would include in the PCA framework the proposed supplementary leverage ratio for advanced approaches banking organizations.

Note that the new PCA framework would take effect starting on January 1, 2015, consistent with the full transition of the minimum capital requirements and the Standardized Approach for the calculation of risk weighted assets.



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Basel Committee on Banking Supervision

Report to G20 Leaders on Basel III implementation June 2012

Introduction and summary

At their 2010 summit in Seoul, the G20 Leaders endorsed the Basel III regulatory framework as follows:

“We endorsed the landmark agreement reached by the BCBS on the new bank capital and liquidity framework, which increases the resilience of the global banking system by raising the quality, quantity and international consistency of bank capital and liquidity, constrains the build-up of leverage and maturity mismatches, and introduces capital buffers above the minimum requirements that can be drawn upon in bad times.”

In November 2011, the Leaders, at their summit in Cannes, emphasised the importance of implementing Basel III:

“We are committed to improve banks' resilience to financial and economic shocks. Building on progress made to date, we call on jurisdictions to meet their commitment to implement fully and consistently the Basel II risk-based framework as well as the Basel II additional requirements on market activities and securitisation by end 2011 and the Basel III capital and liquidity standards, while respecting observation periods and review clauses, starting in 2013 and completing full implementation by 1 January 2019.”

This interim report details the progress the members of the Basel Committee on Banking Supervision have made to date in implementing the Basel III regulatory framework (including Basel II and Basel 2.5, which now form integral parts of Basel III).



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The report also describes various implementation issues identified through the comprehensive process the Committee has adopted to monitor members’ implementation of Basel III.

Compared to the status at end-September 2011 and end-March 2012, when the Committee published previous reports, significant progress has been observed.

However, there are jurisdictions which have missed the globally-agreed implementation dates for Basel II and 2.5.

There are also jurisdictions that have not made enough progress to date on Basel III and thus pose concern as to their ability to meet the agreed Basel III implementation date.

As of end-May 2012, 21 of 27 Basel member countries have implemented Basel II, which had been due to come into force from end-2006.

In addition, Indonesia and Russia have implemented Basel II’s Pillar 1 (minimum capital requirements).

Argentina, China, Turkey and the United States are in the process of implementing Basel II.

With regard to Basel 2.5, which was due to be implemented from end 2011, 20 member countries have final rules that are in force.

Argentina, Indonesia, Mexico, Russia, Turkey and the United States have not issued final regulations.

Russia and the United States have issued draft regulations which partially cover Basel 2.5.

Saudi Arabia has issued final regulations but these have not yet come into force.

Among the 29 global systemically important banks (G-SIBs) identified in November 2011, nine are headquartered in jurisdictions that have not yet fully implemented Basel II and/or Basel 2.5.



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Draft Basel III regulations have not yet been issued by seven Basel Committee member jurisdictions: Argentina, Hong Kong SAR, Indonesia, Korea, Russia, Turkey and the United States.

The majority of these jurisdictions believe they can issue final regulations in time to implement by the deadline of 1 January 2013.

However, for others, depending on their domestic rule-making process, meeting the deadline could be a significant challenge.

In addition to monitoring whether its members have issued regulations to implement the Basel III rules, the Basel Committee has established a process to review the content of the new rules.

This second level of review is meant to ensure that the national adaptations of Basel III are consistent with the minimum standards agreed to under Basel III.

The Basel Committee has initiated peer reviews of the domestic regulations of the European Union, Japan and the United States to assess their consistency with the globally agreed standards.

The findings of these reviews are preliminary since the formulation of national standards is still ongoing and the analysis is not yet completed.

Nevertheless, there is a possibility that national implementation will be weaker than the globally-agreed standards in some key areas.

The Basel Committee urges G20 Leaders to call on jurisdictions to meet their commitments made in Cannes to implement Basel III fully and consistently, and within the agreed timetable.

A third level of implementation review conducted by the Basel Committee examines whether there are unjustifiable inconsistencies in risk measurement approaches across banks and jurisdictions and the implications these might have for the calculation of regulatory capital.

This review of banks’ risk-weighting practices includes the use of test portfolio exercises, horizontal reviews of practices across banks and jurisdictions, and joint on-site visits to large, internationally-active banks.



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The Basel Committee firmly believes that full, timely and consistent implementation of Basel III among its members is essential for restoring confidence in the regulatory framework for banks and to help ensure a safe and stable global banking system.

The Committee will provide an updated progress report to G20 Finance Ministers and central bank governors at their meeting in November 2012.

That report will provide

(i) An update on Basel Committee members’ domestic rule-making,

(ii) The final outcome of the regulatory consistency assessment of the European Union, Japan and the United States, and

(iii) Preliminary findings from the Committee’s deeper analysis on banks’ risk measurement approaches and regulatory capital calculations.

This interim report is based on the information that was available to the Basel Committee on 31 May 2012.

Subsequent to this date, further information has become available in both the EU and US but there has been insufficient time to assess whether these latest developments are compliant with the Basel text for this interim report.

Basel standards

In June 2004, a package of reforms known as Basel II introduced more risk-sensitive minimum capital requirements for banks, including an enhanced measurement of credit risk, and capture of operational risk.

Basel II also reinforced the requirements by setting out principles for banks to assess the adequacy of their capital and for supervisors to review such assessments to ensure banks have the necessary capital to support their risks.

It also strengthened market discipline by enhancing transparency in banks’ financial reporting.



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The deadline for implementation of the Basel II framework by member jurisdictions was the end of 2006.

In July 2009, enhancements to the measurement of risks related to securitisation and trading book exposures were agreed in response to early lessons from the 2007/08 crisis.

An implementation deadline of the end of 2011 was set for these reforms, referred to as Basel 2.5.

In December 2010, the Basel Committee published Basel III, a comprehensive set of reforms to raise the resilience of banks. Basel III addresses both firm-specific and broader, systemic risks by:

- Raising the quality of capital, with a focus on common equity, and the quantity to ensure banks are better able to absorb losses;

- Enhancing the coverage of risk, in particular for capital market activities;

- Introducing additional capital buffers for the most systemically important institutions to address the issue of “too big to fail”;

- Introducing an internationally harmonised leverage ratio to serve as a backstop to the risk-based capital measure and to contain the build-up of excessive leverage in the system;

- Stronger standards for supervision (Pillar 2), public disclosures (Pillar 3), and risk management;

- Introducing minimum global liquidity standards to improve banks’ resilience to acute short term stress and to improve longer term funding; and

- Introducing capital buffers which should be built up in good times so that they can be drawn down during periods of stress.

The implementation period starts from 1 January 2013 and includes transitional arrangements until 1 January 2019.



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The transitional arrangements are available to give banks time to meet the higher standards, while still supporting lending to the economy. The liquidity requirements, leverage ratio and systemic surcharges come into force on a phased approach starting from 2015 and will, therefore, be assessed later and are not covered in this report.

Design of the Committee’s Basel III Implementation Review Programme

In January 2012, the Group of Central Bank Governors and Heads of Supervision (GHOS), the Basel Committee’s oversight body, endorsed the comprehensive process proposed by the Committee to monitor members’ implementation of Basel III.

The process consists of the following three levels of review:

- Level 1: ensuring the timely adoption of Basel III;

- Level 2: ensuring regulatory consistency with Basel III; and

- Level 3: ensuring consistency of outcomes (initially focusing on risk-weighted assets).

The Basel Committee has published two “Level 1” progress reports. It has agreed on a detailed “Level 2” assessment process and started reviews of the European Union, Japan and the United States.

Its “Level 3” reviews analyse existing data on risk measured by banks’ models and are designing processes for deeper analysis.

The Basel Committee has worked in close collaboration with the Financial Stability Board (FSB) given the FSB’s role in coordinating the monitoring of implementation of regulatory reforms.

The Committee designed its programme to be consistent with the FSB’s Coordination Framework for Monitoring the Implementation of Financial Reforms (CFIM) agreed by the G20.

The objectives and the process of each of the three levels of review are as follows.



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Level 1: Timely adoption of Basel III

The objective of the “Level 1” assessment is to ensure that Basel III is transformed into domestic regulations according to the agreed international timelines.

It does not include the review of the content or substance of the domestic rules. Each Basel Committee member jurisdiction’s status is reported in a simple table.

Separately, the Financial Stability Institute (FSI) of the Bank for International Settlements is surveying non-Basel Committee member countries.

The outcome of this work will be published by the FSI in the coming months.

Level 2: Regulatory consistency

The objective of the “Level 2” assessments is to ensure compliance of domestic regulations with the international minimum requirements.

Delays or failures to adopt domestic regulations identified by the Level 1 review will feed into the Level 2 assessment.

All Level 2 assessments will be summarised using the following four-grade scale: compliant, largely compliant, materially non-compliant and non-compliant.

The Committee intends to produce an overall assessment, as well as assessments of the main components of Basel III.

All Basel Committee member countries will be assessed over time.

The Committee decided to prioritise its reviews, focusing first on the home jurisdictions of global systemically important banks (G-SIBs).

The first reviews commenced in February 2012 with the European Union, Japan and the United States.



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A summary of the process for the Level 2 reviews is included in appendix 2 of this report.

Level 3: Risk-weighted assets consistency

The objective of the “Level 3” assessments is to ensure that the outcomes of the new rules are consistent in practice across banks and jurisdictions.

It extends the findings of Levels 1 and 2, both of which focus on national rules and regulations, to supervisory implementation at the bank level.

The Committee has established two expert groups, one on the banking book and the other on the trading book.

These groups will identify areas of material inconsistencies in the calculation of risk-weighted assets (RWAs, or the denominator of the Basel capital ratio).

Depending on the outcome, the work may result in policy recommendations to address identified inconsistencies.

Preliminary findings

Level 1

The tables in appendix 1 show member countries’ implementation status as of end-May 2012. The tables use the following number codes:

- “1” for draft regulation not published,

- “2” for draft regulation published,

- “3” for final rule published, and

- “4” for final rule in force.

Summary information about the next steps and the implementation plans being considered by members are also provided for each jurisdiction.

Separate tables are produced for each of Basel II, Basel 2.5 and Basel III.



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For Basel II and 2.5, which should be implemented already according to the agreed timetable, countries that have fully implemented are shown in green; those in the process of implementing are shown in yellow; and those that have not yet issued draft regulations are shown in red.

Compared to the status at end-September 2011 and end-March 2012, when the Committee published previous reports, significant progress has been observed.

However, there are jurisdictions which have missed the globally-agreed implementation dates for Basel II and

2.5. There are also jurisdictions that have not made enough progress to date on Basel III and thus pose concern as to their ability to meet the agreed Basel III implementation date.

Basel II

Three-quarters of member countries have implemented the Basel II requirements.

Of the remaining six countries, Indonesia and Russia have implemented Pillar 1 (minimum capital requirements) but not Pillar 2 (supervisory review process) or Pillar 3 (disclosure and market discipline).

Turkey expects to be fully compliant by July 2012. China has issued final regulations and is currently assessing applications for advanced approaches submitted by large banks.

The United States is in “parallel run” (ie running both Basel I and Basel II calculation for its largest banks), although Basel I rules remain the legal minimum.

Argentina implemented rules on operational risk in April 2012.

Basel 2.5

Again, a majority of Basel Committee member countries (20 out of 27 Basel Committee members) have implemented the requirements, but a



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significant minority are either still in the process of implementation or have not started the process for implementation.

Russia and the United States have issued draft regulations covering the market risk elements of the enhancements.

The US regulations were modified in December 2011 to incorporate restrictions on the use of credit ratings as set forth in the Dodd-Frank regulatory reform legislation.

Other member countries which have not implemented Basel 2.5 are Argentina, Indonesia, Mexico, Saudi Arabia and Turkey.

Basel III

Three countries – India, Japan and Saudi Arabia – have published final regulations necessary for implementing the Basel III package from 1 January 2013.

Full application starts in Japan at the end of March 2013 to match Japanese banks’ fiscal year end.

The European Union has published several rounds of draft directives and regulations (CRD4/CRR) and is expecting to have final rules by the end of June.

The EU level regulations implement most elements of the Basel III package directly.

This means there is no need for national regulations to transpose the regulations into their domestic legislation.

The following seven member jurisdictions have not issued draft regulations: Argentina, Hong Kong SAR, Indonesia, Korea, Russia, Turkey and the United States.

The majority of these countries believe they can finalise regulations in time for the agreed start date of 1 January 2013.



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However, for others, depending on the domestic rule-making process, meeting the deadline could be a significant challenge.

Level 2

The first three Basel III regulatory consistency assessments are currently under way for the European Union, Japan and the United States, which are being conducted in parallel.

In the initial phase of the Level 2 assessment process, the jurisdictions have been asked to complete a detailed self-assessment questionnaire and to provide all components of the regulations that implement Basel III at the domestic level.

After receiving the completed questionnaires, peer review teams of supervisors have reviewed the completed self assessment and drafted an initial list of preliminary findings.

The European Union, Japan and the United States are at different stages of Basel III implementation.

Given these differences, the depth of the preliminary Level 2 findings differs.

The reviews are still work in progress and this interim report is based solely on preliminary findings that are subject to further review as the analysis progresses.

Currently, the peer review teams are in the process of further analysing the preliminary findings based on additional clarifications that were received from the jurisdictions concerned.

The review teams are also working on the assessment of the potential materiality of their findings, using quantitative bank-specific data that was provided by the authorities.

An important element in the second phase of the assessment will be an on-site visit where the teams will discuss their findings with the



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authorities to further narrow down the materiality of the findings to arrive at a final assessment.

The on-site visits are tentatively scheduled in June and July. The final report is expected to be submitted to the Basel Committee in September 2012, and will be published shortly thereafter.

The absence of any item among the topics mentioned above does not necessarily mean that the review team will not add new items to the list of issues for further investigation during the progress towards the final report.

European Union

The review of the European Union (EU) rules related to Basel III has been complicated by the absence of a stable EU text implementing Basel III.

As a pragmatic choice, the review team selected the Third Danish Presidency Compromise proposals for the basis of this interim report.

This choice does not imply any endorsement by the assessment team of these proposals, but simply responds to the need to use the most recent draft such that the text remains stable for the time required to complete the interim review.

At the time this interim report was prepared, the final version of CRD4/CRR – the rules for implementing Basel III in the European Union – were not yet published.

Therefore the number and nature of the findings set out in the Basel Committee’s final report may change substantially from those contained in this interim report to the extent that the final CRD4/CRR rules differ from the Third Danish Compromise proposals.

Besides the changing nature of the EU proposals, the assessment has also been difficult due to the particularities of the EU rule-making process.

This meant that the European Commission (EC) was unable to complete the requested self-assessment questionnaire, beyond mapping the Basel



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framework to the July 2011 EC proposals and providing explanatory notes on the compliance of key areas of the EU regulation with Basel III.

Unlike the other assessments, which have benefited from country self-assessments, the EU review team has not been able to draw on a comprehensive self-assessment from which to begin its assessment process.

Despite these difficulties, the review team conducted a detailed preliminary assessment of the EU framework.

This assessment benefited from face-to-face discussions between the leader of the review team and EC staff as well as with representatives from the European Banking Authority, the European Central Bank, the Danish Presidency, and the nine EU countries which are also BCBS members.


The initial assessment process has identified a large number of features of the current EU Basel III proposals that will require further investigation. Most of these issues will probably prove either consistent with the Basel framework, or immaterial in practice.

There seems to be a small number of issues, however, that are potentially material and will need to be subject to a detailed assessment by the review team.

The EU framework has been developed with the principle of “maximum harmonisation.”

This is designed with the aim of achieving a high level of harmonisation of banking rules and limiting divergence between the approaches taken by individual national authorities.

While not a matter of direct relevance to the assessment in the first instance, the ability for an individual national regulator to comply with Basel III where EU regulation is found to be inconsistent will depend on the degree of “maximum harmonisation” at the EU level.



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In this case, it may work to limit the room an individual regulator has to adopt compliant regulations on its own.

The review team has identified the following specific areas of potential difference. These areas require further review and/or an assessment of their potential materiality before definitive conclusions can be drawn:

Definition of Capital

There are three specific issues that warrant particular attention:

The Basel III rules require banks to deduct significant investments in unconsolidated financial entities, including insurance entities, from the highest quality form of capital (Common Equity Tier 1 – CET1).

The CRD IV/CRR proposals give competent authorities the possibility to permit banks not to deduct insurance holdings under certain conditions.

The review team will need to assess whether the CRD IV/CRR proposals are consistent with the Basel requirements that only permit approaches other than deduction where it can be demonstrated that these are more conservative (ie would produce higher capital requirements) than the deduction approach.

The Basel III rules are explicit that for joint stock companies, only common shares, which comply with a list of substantive criteria, can be included in CET1.

However, the CRD IV/CRR proposals recognise any capital instrument, which satisfies a list of substantive criteria in line with Basel III, as part of CET1 even if they might not be common shares.

The review team will need to evaluate whether this deviation from Basel III has the potential to undermine the quality of capital that banks should have to absorb losses.

Basel III requires that all classes of capital instruments fully absorb losses at the point of non-viability before taxpayers are exposed to loss.

This requirement has been acknowledged in the CRD IV/CRR proposals but not reflected according to the Basel rules.



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Going forward, the review team will closely monitor how this requirement is being reflected in the EU regulations, including within the forthcoming EU resolution and crisis management rules.

Pillar 1: Credit Risk – Internal Ratings-Based (IRB) Approach

Under the Basel rules, a bank electing to use an internal model to calculate its regulatory capital requirements for credit risk (IRB Bank) may only permanently apply the standardised approach for non - significant or immaterial business units or asset classes (referred to as the “partial use exemption”).

The CRD IV/CRR framework allows IRB banks to permanently use the standardised approach for some exposures under certain conditions that might not appear to be related to the immateriality or non-significance described above.

In particular, an IRB Bank in the EU is able to permanently apply a zero risk weight to EU sovereign exposures after receiving the permission of the competent authorities.

The review team will need to further analyse the consistency of the CRD IV/CRR framework with the Basel rules regarding the permanent partial use available to IRB Banks, with special focus on internationally active banks’ sovereign exposures.

Next steps

The review team’s key focus going forward will be to resolve consistency issues, and assess the materiality of any inconsistency.

The latter will be mainly based on bank-specific data.

The nine EU member countries of the Basel Committee have undertaken to assist with securing the data that will be needed for the materiality assessment.

Response from the European Commission

Two preliminary points need to be made. First, from the point of view of banking regulation, the European Union (EU) is a single jurisdiction:



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laws adopted at EU level are agreed by, and apply to, all EU Member States.

Second, the EU has chosen to apply the Basel rules to all its banks (as well to investment firms), not just large, internationally active banks; the law therefore needs to allow national authorities to exercise a certain level of proportionality in applying the rules.

The first point is particularly important with respect to the “maximum harmonisation” principle referred to in the report.

In this context, the assessment fails to provide valid arguments on why the degree of harmonisation pursued in the EU could be considered an issue for any of the specific areas of potential difference mentioned in the report.

The second point is relevant to all the specific issues listed in the report. For example, the possibility for IRB banks to permanently use the standardised approach for certain exposures was never meant to be used for internationally active banks and supervisors were (and will continue to be) expected not to approve it for those banks.

Concerning the specific issues, there are some additional points.

Firstly, the proposed approach on significant investments in insurance reflects the existence of strict and harmonised rules for insurance and financial conglomerates at EU level, takes into account the recently revised Joint Forum's principles for financial conglomerates supervision, provides appropriate incentives for insurance companies' capitalisation and prevents double counting of capital.

The assessment should take these facts into account.

Secondly, the concept of common shares does not exist in a large number of EU Member States, which explains the choice of approach based on the characteristics of capital instruments, rather than their form.

Nevertheless, publicly listed banks are expected to meet their CET1 requirement only with shares meeting the 14 criteria.



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Furthermore, specific monitoring powers have been conferred upon the European Banking Authority in order to identify any misuse of this approach by banks.

Lastly, the European Commission expects to adopt legislation implementing the point-of-non-viability requirement before summer of this year.

Japan

By end March 2012, the Japanese authorities published final rules implementing Basel III with respect to the definition of capital and risk-weighted assets (RWA), while the Basel II and Basel 2.5 regulation had already been transposed into domestic rules previously.

The documents for the Japan Level 2 review include notices, supervisory guidelines, inspection manuals and Qs and As issued by the FSA to spell out the detailed interpretation, all of which are binding.

Where applicable, the Japanese authorities have provided data for 16 internationally active banks, which account for more than 50% of the Japanese banking assets.

Japan has issued final Basel III regulations.

This means that the review of Japan is more detailed than the reviews of the European Union and United States where the assessments are based on drafts.

The review is based on the English translation of the Japanese rules, most of which have been translated into English.

In specific cases, the review team compared the English translation of the documents with the original Japanese text to verify the translation.

A final judgment of the potential discrepancies in the translation will be subject to further analysis.

The Japanese authorities also have provided supplemental information requested by the team.



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Overall, the preliminary analysis of Japan’s Basel II/III framework suggests broad consistency with the majority of the sections of the Basel rules.

The analysis, however, revealed certain differences that will be the focus of further review by the assessment team:

(I) The Basel III capital rules are not fully implemented (additional guidance is under preparation) and deviate in specific areas, while the rules for capital buffers are planned to be published only in 2015, one year ahead of the Basel III schedule for the implementation;

(II) Most Pillar 2 rules are not in place; and

(III) There are a number of issues in certain aspects of risk measurement, both in terms of Pillar 1 and 2, for which the review team will seek further clarification.

Definition of Capital and Capital Buffers

While the Japanese authorities have already finalised the rules concerning the definition of capital and RWA, more detailed guidance to ensure consistency with the Basel III text is not yet established.

This is particularly relevant in the areas concerning the recognition of stock acquisition rights as common equity Tier 1 capital and the deduction of deferred tax assets.

The implementation team has also identified potential deviations in the areas of the recognition criteria for additional Tier 1 instruments as well as with respect to the cut-off date for the grandfathering of state aid instruments, which need to be investigated further in order to understand the potential impact.

For the capital buffers (capital conservation, countercyclical), the domestic rules are not yet in place.

The Japanese authorities plan to issue the rules by 2015, ie, one year ahead of the international schedule for implementation (2016).



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Loss absorbency at the point of non-viability (PON) is partially implemented, such as the resolution scheme in Japan’s deposit insurance law.

The authorities are currently analysing how to organise the linkage between PON requirements and the domestic resolution scheme and plan to finalise the details of the framework by the end of 2012.

Pillar 1 - Minimum Capital Requirement

For securitisation, several areas of deviation have been identified, such as in terms of re-securitisation, for ABCP exposures under the Standardised Approach and specific aspects in terms of the Internal Assessment Approach (IAA) and the Supervisory Formula Approach (SFA).

Other areas of credit risk will also be subject to further analysis.

In terms of counterparty credit risk and cross-product netting, the Internal Model Method (IMM) is not yet implemented.

While in practice no bank has adopted the IMM, implementation into domestic regulation is still desirable.

Concerning market risk, the team has identified areas of non-compliance with respect to the treatment of smaller trading books (<100 billion JPY and no larger than 10% of the bank’s total assets) and the treatment of commodity risk, where Japanese legislation only allows banks to use the simplified approach (for those banks that choose the Standardised Measurement Method, SMM).

In the former case, banks with trading activities slightly below the materiality threshold would benefit from this exception.

While this issue is unlikely to have systemic implications, capital adequacy could be slightly overstated. Banks’ commodity risk is limited, but the ultimate judgement of materiality will be subject to additional analysis.

With regard to operational risk, some of the detailed requirements with regard to the Advanced Measurement Approach (AMA) are not specified in the notice.



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Japan indicates that each of the detailed requirements in the Basel Accord is validated in the process of assessment as necessary.

Pillar 2 – Supervisory Review Process

In terms of Pillar 2, most of the rules are currently not implemented in Japan.

While there is a lack of implementation, the authorities seem to be in a position to impose additional capital charges by the Banking Act.

In practice, however, the FSA does not generally appear to take such an approach.

Rather the FSA examines the appropriateness of banks' comprehensive risk management and, if necessary, the FSA requires banks to take remedial action to mitigate the risks instead of requiring an additional capital charge.

Next steps

The team will follow-up with the Japanese authorities to seek clarification and data with a view towards completing a preliminary final assessment of compliance and materiality in June.

These findings will then be further discussed and assessed during the on-site visit scheduled for early July in order to determine a final assessment and drafting of the final report, to be shared with the authorities in the second half of July.

The final report will be delivered to the Basel Committee in September.

Response from the Japanese authorities

The Japanese authorities appreciate the detailed analysis done by the assessment team to date. In particular, the authorities welcome the acknowledgement of broad consistency with the majority of the sections of the Basel rules.

The FSA is in the process of developing Qs and As and supervisory guidelines which will supplement the notices, and once they are



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published, issues identified as lack of implementation rules in this report will be rectified.

We disagree with the report’s assertion that our rules on the recognition of additional Tier 1 instruments deviate from Basel III.

The cut-off date for the grandfathering of state aid instruments is set on 31 March 2013 instead of 1 January 2013 merely reflecting the fact that the Japan’s fiscal year starts in April and ends in March.

With regard to the credit and securitisation parts of Pillar 1, some additional rules need to be incorporated into our domestic rules, and the FSA intends to develop necessary notices and guidelines in the coming period.

However, the current rules do not result in any material overstatement of capital ratios.

Most of the additional elements needed are only relevant to advanced model methods such as IMM and IAA, which no Japanese bank has adopted yet.

Regarding the market risk exception for banks with small trading book, our impact analysis shows that the impact is very limited and is at most 0.34% of total RWA.

As for commodity risk, banks are allowed to choose between the IMA and simplified SMM, which are both fully compliant with the Basel text. Banks with material commodity exposures use IMA.

In terms of Pillar 2, the overall process and framework is provided in the supervisory guidelines and inspection manuals and forms the basis for on-site and off-site review by the FSA.

There are, however, some specific areas where details are not well documented yet (eg those related to IMM, residual risk and implicit support).

The FSA intends to develop domestic rules on those elements in the near future.



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United States

As noted above, at the time of this interim assessment, the US authorities had not published the final rule to implement the improvements to the Basel II market risk framework (Basel 2.5), nor had they published the proposed regulations to implement Basel III.

[On 7 June, the Federal Reserve’s Board of Governors published final Basel 2.5 and draft Basel III rules. The review team has not had time to assess whether these latest developments are compliant with the Basel text for the interim report, rather these and/or any subsequent texts will form part of the final assessment.]

These are major components of the Basel Committee’s reform programme.

Therefore, the number and nature of findings set out in the final report may change substantially from those contained in this interim report if the United States makes progress in its rulemaking process prior to the finalisation of this report.


The review team has identified a number of overarching issues related to the US implementation of the Basel standards:

Adoption of Basel 2.5 and Basel III regulations

The absence of the final rule on Basel 2.5 and the proposed rule on Basel III represents a potentially significant gap in US implementation and has thus far limited the assessment conducted by the review team to the US adoption of Basel II and to the proposed US rules for Basel 2.5.

Scope of application

US core banks are required to adopt the advanced Basel II standards, while all other banks remain subject to the Basel I standards, unless they elect to be subject to Basel II standards (these are referred to as opt-in banks).



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The Basel Framework is explicitly directed at “internationally active” banks – though this expression has not been defined.

Basel Committee member countries are not required, therefore, to apply the framework to all their banks.

However, the review team intends to assess whether the US definition of core banks inadvertently results in any non-core US bank with substantial international activities not being subject to Basel II standards.

US authorities’ selection of Basel II approaches

The US agencies have implemented the advanced Basel II approaches, but not the less advanced Basel II approaches.

While jurisdictions are not required to implement the less advanced Basel II approaches, the manner in which the US agencies have implemented Basel II implies that US core banks that do not comply – or cease to comply – with the requirements of the advanced approaches are subject to approaches that differ from those contemplated in the Basel II framework for banks that do not qualify for the advanced approaches.

In the United States, the advanced Basel II approaches applicable to core banks are complemented by three other capital requirements, which the US authorities have asserted result in higher minimum capital requirements:

(i) A permanent floor calculated under the agencies’ general risk-based capital rules (which currently implement Basel I);

(ii) The non-risk-weighted US leverage ratio; and

(iii) The Pillar 2 requirements, including those under the Federal Reserve Board’s “capital plan rule”.

However, a core bank that does not satisfy the conditions for the advanced Basel II approaches remains subject to a Basel I-based calculation of risk-weighted assets, thus not being subject to Basel II minimum capital requirements.



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For example, Basel I does not include a charge for operational risk.

The review team intends to discuss with the US authorities the basis for their applying a Basel I-based approach for the calculation of risk-weighted assets to core banks that do not qualify for the advanced approaches rather than the options provided by the simplified, standardised and foundation approaches under Basel II.

Notes

The Level 2 assessment team of the United States is being conducted by a team of experts led by Mr Arthur Yuen (Hong Kong Monetary Authority).

The full review team comprises: Mr Thierry Bayle (Banque de France), Mr Pierpaolo Grippa (Banca d’Italia), Mr Sebastijan Hrovatin (European Commission), Mr Carlos Luna (National Banking and Securities Commission of Mexico) and Mr Naruki Mori (Bank of Japan). The team is supported by Mr Maarten Hendrikx of the Basel Committee Secretariat.

The definition of core banks includes any depository institution (ie bank or savings association) meeting either of the following two criteria:

(i) Consolidated total assets of $250 billion or more; or

(ii) Consolidated total on-balance sheet foreign exposure of $10 billion or more;

or any US-chartered bank holding company (BHC) meeting any of the following three criteria:

(i) Consolidated total assets (excluding assets held by an insurance underwriting subsidiary) of $250 billion or more;

(ii) Consolidated total on-balance sheet foreign exposure of $10 billion or more; or

(iii) Having a subsidiary depository institution that is a core bank or opt-in bank.

Finally, any depository institution that is a subsidiary of a core or opt-in bank is also a core bank.



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Under the “capital plan rule”, based on the Comprehensive Capital Analysis and Review (CCAR) framework using stress tests, bank holding companies with consolidated assets of greater than $50 billion must demonstrate their ability to maintain capital above existing minimum regulatory capital ratios and above a tier 1 common ratio of 5 percent under both expected and stressed conditions over a minimum nine-quarter planning horizon.

Basel II parallel run

At the time this interim report was prepared, none of the core US banks had received permission to exit the transitional parallel run, which would require a bank to base its capital requirements on the advanced Basel II approaches (supplemented by the additional requirements discussed above).

The regulatory capital ratios of the core US banks continue to be based on risk-weighted assets calculated according to the general (Basel I) risk-based capital rules, and there is no rule requiring banks to hold more capital as a consequence of higher risk-weighted assets as calculated under the advanced Basel II approaches.

The review team will assess the consistency of US transitional arrangements with the corresponding Basel II standards and whether this may lead to a situation in which core banks that are not allowed to leave the parallel run over an indeterminate period are effectively subject to lower capital requirements than those provided for by Basel II for banks that do not qualify for the advanced approaches.

Elimination of references to external credit ratings

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) mandates the US agencies to remove references to and requirements of reliance on external credit ratings from regulations and to replace them with appropriate alternatives for evaluating creditworthiness.



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As a first step in this context, in December 2011 the US agencies issued a notice of proposed rulemaking (NPR) that contains alternative methodologies for calculating specific risk capital requirements for debt, securitisation and equity positions under the market risk capital rules.

The review team will engage with the US agencies to assess – both in qualitative and quantitative terms – whether the proposed rulemaking is at least as robust as the corresponding Basel requirements.

In addition to the overarching issues, the review team has identified a number of specific areas of potential difference based on its assessment of the components of Basel II rules and the proposed rules for Basel 2.5.

These areas require further review and/or an assessment of their potential materiality – taking into account that their relevance may be diminished once Basel III is implemented. So far, the main areas identified include:

Definition of capital

The current US capital treatment of insurance subsidiaries of bank holding companies differs from the Basel II full deconsolidation and deduction approach.

This could result in a potential overstatement of capital ratios.

The Basel II treatment is however superseded by Basel III, and the issue may turn out to be irrelevant if the United States alters its treatment to align with Basel III.

Pillar 1 – Minimum capital requirements

The Basel criteria for credit risk mitigation – such as requirements for collateral management, operational procedures, legal certainty and risk management processes – appear absent from the current US regulations, while the scope of eligible collateral and guarantors seems to be larger than those specified by the Basel Framework.



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Differences have also been identified in the definitions and/or treatment of specific asset classes (eg credit card exposures and leasing).

Further, certain overarching principles, such as the IRB approaches’ minimum requirements’ “use test”, appear not to be explicitly enshrined in regulation.

Concerning the treatment of securitisation exposures, the main area of difference relates to the removal of references to external credit ratings and the consistency with the Basel requirements.

Another area relates to the treatment of securitisations containing early amortisation features which appears to deviate from the Basel treatment.

With regard to operational risk, the main area of difference relates to the possibility as permitted in the US rules of using risk mitigants other than insurance to hedge operational risk.

This contrasts with the Basel Framework, which only allows insurance as a risk mitigant.

Concerning market risk, the proposed replacement of external credit ratings with new creditworthiness metrics for specific risk poses an issue of alignment with the Basel standards.

It also raises the question of whether the resulting capital charges would be equally or comparably robust.

Pillar 2 – Supervisory review process

Regarding securitisations, potential significant differences have been identified for the treatment of provision of implicit support and of the recognition of protection against first loss credit enhancements and related supervisory actions.

Next steps

The first stage of the assessment – the qualitative review of the US self-assessment – has progressed according to schedule.



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However, due to the delay in publishing the final Basel 2.5 rule and the proposed Basel III rule, the review team’s completion of the US review within the agreed timelines has become increasingly challenging.

The on-site component of the review, in which the review team will meet face-to-face with the US agencies, is currently scheduled for 25 – 29 June 2012.

Response from the US authorities:

The US agencies welcome the opportunity to respond to the interim report on the US banking agencies’ implementation of the Basel framework.

We wish to comment on three of the overarching issues raised in the report.

First is the scope of application, where a question is raised, does the US application of Basel II standards to “core banks,” as they are called in the report, cover all banks with significant international activities?

The US agencies are confident that it does.

The second issue is the selection of Basel II approaches.

The interim report notes that the United States has implemented the advanced approaches, but has not offered any of the less advanced approaches as options for core banks, as allowed by the Basel framework.

The report goes to suggest that, in this regard, the US implementation may fall short.

The possible implication is that jurisdictions that only adopt the advanced approaches ought to develop their own versions of less advanced approaches that are close to the Basel II options and apply these to non-qualifying internationally active banks.

The US agencies do not see any requirement for this in the Basel framework and, indeed, we would note that using Basel I is specifically permitted.



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The third issue is related and concerns the Basel II parallel run process.

Here, the review team say that they want to look into whether “core” banks not allowed to leave the parallel run ... are effectively subject to lower capital requirements [than the Basel II less advanced approaches].”

This is a fair question.

However, as noted in the report, the US Basel I implementation is complemented by a leverage ratio requirement and the Federal Reserve Board’s capital plan rule, which covers all “core” holding companies.

Unsatisfactory capital plans have severe and specific regulatory consequences.

Moreover, the Board’s 2012 Comprehensive Capital Analysis and Review framework required enough capital to meet the Basel III transition schedule.

Taken together, these and other US requirements such as the prompt corrective action regime are both demanding and effective relative to Basel standards.

The US agencies fully support the efforts of the Basel Committee to monitor progress in implementing the Basel capital framework in different jurisdictions and look forward to working with the US Level 2 review team in the months ahead as they complete their work.



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Level 3

Analysis of risk-weighted assets in the banking book

In December 2011, the Basel Committee approved a work plan to evaluate sources of material differences in risk-weighted assets (RWAs) across banks using the Internal Ratings-Based (IRB) approach for credit risk in the banking book, and assess the extent to which RWA calculations are consistent with relevant Basel standards.

The work, conducted by representatives of 30 regulatory agencies from 23 countries, relies on a combination of top-down analysis of data as reported by banks, bottom-up portfolio benchmarking, observation of the range of practices across banks and supervisors, and on-site work at banks as appropriate.

The work distinguishes between variations in RWAs that are risk-based (those due to differences in underlying risk at the exposure/portfolio level) and those that are practice-based (eg those due to model selection or calibration of model parameters, exercise of judgement, application of national discretion, etc).

Practice-based variations can be further subdivided into differences that are specifically provided for under the Basel Framework (eg IRB rollout, national discretions), and others that arise more from differences in interpretation of standards in the framework or from specific practices such as those related to calibration of risk parameters.

Recommendations to narrow the variation in RWAs are appropriate primarily for practice-based RWA variation.

To date, work has considered and assessed a wide range of existing analyses of RWAs across banks and countries.

Most studies acknowledge that underlying differences in risk are likely to be a key driver in variations in RWA; these include differences in risk arising from differences in business model and portfolio mix.



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However, most studies also conclude that at least some of the variation in RWAs could be attributable to practice-based factors.

For example, several studies from the regulatory community raise model calibration (particularly PD and LGD estimation) and the stage of IRB adoption as potential drivers of RWA variation.

On the other hand, external analysts have focused more on differences in the application of supervisory principles, with regulatory and accounting approaches being frequently cited as reasons for differences in RWA measurement.

Existing studies reveal that, while there are many potential candidates, there is no definitive consensus on the true sources of RWA differences across banks, or on the extent to which differences are due to differences in risks or differences in practices.

Thus, additional work is clearly necessary, and is being pursued.

To extend existing analyses and determine an appropriate focus for regulatory efforts to enhance convergence, the group is undertaking additional high-level analyses of RWA variation using supervisory data from the Basel Committee’s Capital Monitoring Group (CMG).

- The CMG has collected information on Basel II RWA, capital requirements, and risk parameters semi-annually since end-June 2008. The data are extracted from national reporting frameworks of member countries, and submitted to the Basel Committee Secretariat in standardised reporting templates.

- The analytical framework that will be applied to the CMG data combines existing methods with additional approaches being developed as part of this project.



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- The sources and materiality of RWA differences will be assessed across portfolios, across banks, and across countries, with a focus on particular drivers believed to play a material role in RWA dispersion.

- To safeguard data confidentiality, results will be presented in

anonymised or aggregated form.

Conclusions based on top-down analysis of aggregated data as described above are necessarily limited.

Thus, that analysis is being supplemented with bottom-up analysis using test portfolios, in which the risk parameters banks assign to groups of common exposures are compared and analysed.

The portfolio exercise is currently in development.

- Informed by a comprehensive stock-take of similar exercises conducted by the industry and by various regulatory authorities, the initial focus has been narrowed to wholesale credit.

Similar analysis can be extended to other types of credit at a later stage based on the lessons and conclusions of the initial exercise.

- A data collection template has been developed, together with instructions for completion of the template.

- A list of exposures is being developed to be provided to participating banks; banks will be asked to respond with PD and LGD estimates for each exposure.

- The composition of the hypothetical portfolio has not been finalised, but is being designed to ensure maximum overlap across participating banks, and includes large sovereign borrowers, large financial institutions, and large non-financial corporate borrowers.

Output from this work will include various benchmark analyses, including pair-wise rank-ordering analysis, analysis of the distribution of PD and LGD estimates across banks, and assessment of how the impact



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of the observed parameter estimates on RWAs depends on different risk profiles or business strategies.

Quantitative analysis using either aggregated data or hypothetical portfolio results can highlight sources of RWA variation, but will not necessarily pinpoint the reasons for that variation.

Therefore, work is also under way to identify the specific practices that might underlie differences in RWAs.

- In a first phase, an extensive list of potential drivers of RWA differences has been developed, drawing on existing supervisory knowledge and judgement and informed by analysis of existing studies. The list of drivers has been divided into those related to underlying risk or risk profile, and those related to practices.

- The potential significance of the drivers has been assessed based on both magnitude and prevalence; the assessments of significance currently are being refined.

- Further analyses will be conducted to assess the materiality and the

nature of a selected number of drivers.

The work described here – combining top-down data analysis, bottom-up portfolio benchmarking, and supervisory evaluation of the range of practice in specific areas – will extend the preliminary conclusions from prior analyses by identifying selected industry and supervisory practices that appear likely to be causing differences in RWA and capital across institutions and countries that are not reflective of underlying risk.

Specific recommendations for narrowing of the range of practice will be provided to the Basel Committee for consideration and possible action as appropriate.

The analytical framework developed for analysing RWA differences can also serve as an approach for ongoing monitoring of RWA differences.



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Analysis of risk-weighted assets in the trading book

This interim report contains the initial findings of the potential drivers of differences in market risk-related risk-weighted assets (mRWA) using data that is publicly disclosed by banks in financial and regulatory reports.

The scope of these initial findings is therefore limited, since the analysis applies to public data prior to the implementation of Basel 2.5 and is based only on those banks for which sufficient data was available to make meaningful comparisons.

The Committee’s task force is currently working on completing the public data analysis by, among others, evaluating the utility of non-public supervisory data.

In addition, it is performing a test portfolio exercise in which the mRWA calculations of banks are compared on a common set of positions, with the results to be further investigated by means of on-site visits.

A number of banks have volunteered to be included in the test portfolio exercise, which is well under way and the first results are expected in the second half of this year.

The task force will include the findings of this complementary work in a final report that is expected by the end of this year.

Based on public disclosures by a sample of 17 large banks with significant trading activities, the analysis reveals considerable differences in mRWA as a ratio to total trading assets reported in financial disclosures.

Such variation can be justified when it reflects the varying risk profile of trading activities, given the differences in trading strategies and business models among the banks.

In this regard, a preliminary analysis of the public disclosures on a subset of banks in the sample suggests that those banks that trade risky assets,



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such as distressed loans or less liquid equities, exhibit a higher ratio of mRWA to total trading asset.

However, the results are not conclusive, as there remains substantial unexplained variation, and in many instances public disclosures are insufficient to explain the observed variation in mRWA ratios across banks.

One potential policy response is therefore to investigate further improvements in public disclosures for market risk, for instance, by including more information about mRWA and its components and providing more direction to banks regarding Pillar 3 disclosure.

These policy options will be investigated further.

Notes: This graphic presents banks in increasing order of average market risk weighted assets (mRWA) calculated as the ratio of mRWA to Trading Assets, showing the substantial variation, from below 5% to about 45%.



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Trading Assets is defined as the value of all instruments in the trading account, including securities, traded loans, and net derivatives with a positive replacement value.

To put banks on a comparable basis the measurement of total trading assets has been adjusted for the effect of different accounting regimes.

In particular, the data has been adjusted to take into account the different approaches to netting of derivatives.

Source: public information based on banks’ financial and public regulatory reporting.

For bank A data is based on Q4 2010 for all other banks data is from Q2 2011.

The preliminary analysis shows a number of potential reasons for variation in mRWA (the list does not reflect a ranking in order of importance as the analysis does not allow for that at this stage):

- Differences due to variation in the composition of trading assets as evident to some extent in public disclosures.

- Differences in the way that banks apply accounting requirements to their business model in allocating assets between the trading and banking books, for example, the treatment of securities financing transactions and loans.

- Differences in methodology and inputs for market risk models used for regulatory capital calculations.

- Differences in supervisory approaches, with some jurisdictions relying more heavily on the internal models approach and integrated VaR models while others continue to use the standardised approach selectively for some debt and equity positions.



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- Differences in regulatory add-ons and notably the use of VaR multipliers higher than the minimum of 3 to account for model uncertainty.

With regard to the last two points, the analysis indicates that some of the variation in mRWA as a percentage of total trading assets may be related to the degree of reliance on internal models based on Value-at-Risk (VaR).

Banks for which internal models have a more important role in determining mRWA tend to show a lower average ratio of mRWA to total trading assets compared to banks for which models have a lesser role, with standardised approaches more important.

This is in line with expectations as the standardised approach provides for less hedging and diversification benefits and is therefore generally more conservative than the internal models approach.

At the same time, however, there remains substantial unexplained variation, as there is a wide range of mRWA ratios for banks with similar reliance on models and also banks with similar mRWA ratios but varying degrees of reliance on internal models.

This variation will be examined further by means of the test portfolio exercise that is currently under way.

It should be noted that the relationship between the degree of reliance on internal models and the ratio of mRWA as percentage of total RWA may change in the future. Basel 2.5 implementation (from end-2011) is expected to raise the capital charge for banks using internal models approaches for market risk and the fundamental review of the trading book aims to strengthen the relationship between the models-based and standardised approaches by establishing a closer link between the calibration of the two approaches. This may reduce the importance of the degree of reliance on internal



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models as an explanatory factor behind the observed differences among banks.

Notes: The horizontal axis shows mRWA from internal models approach (IMA) as percentage of total mRWA.

The vertical axis shows total mRWA as a percentage of total trading assets.

The sizes of the circles in the figure indicate the size of trading assets (in USD) for each bank.

It should be noted that the ratio of IMA as percentage of total mRWA is an imperfect proxy for degree of reliance on internal models as for some banks a low ratio may still imply a high degree of reliance on internal models, for instance, when the internal model produces a very low mRWA compared to total mRWA.

Source: public information based on banks’ financial and public regulatory reporting. Of the 17 banks in the sample, sufficient disclosure was only available for 14 banks in quarter 4, 2010 and for only 7 banks in quarter 2, 2011.



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The task force has a work programme in place to further analyse the drivers of difference in mRWA across global banks.

This includes:

- Completing the analysis of public data to test, refine, and extend these initial findings;

- Evaluating the utility of internal supervisory data to better understand the drivers of observed differences;

- Identifying key drivers of IRC (Incremental Risk Charge), VaR and stressed VaR based on existing domestic supervisory knowledge of bank’s models (and at a later stage CRM, Comprehensive Risk Measure).

The objectives of this work are to identify the key aspects of model methodology that drive the differences in internal models based approaches and to assess the materiality of these drivers at a high-level.

This work will support the test portfolio exercise and help to focus attention to those areas of the internal models that most likely contribute to differences;

Performing a test portfolio exercise to compare and assess the mRWA calculations by a sample of large, internationally-active banks for a set of hypothetical trading portfolios.

The aim of the exercise is to measure potential mRWA variability due to the implementation of VaR, stressed VaR and IRC models. In addition, banks are being requested to complete questionnaires to specify the workings of their internal models;



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Carrying out selected on-site visits to some participating banks to allow for a deeper investigation of the sources of variability in the calculated mRWA. It should be stressed that the on-site visits will not be model-validation exercises, but are meant to provide further information about the workings of the banks’ internal models and the resulting mRWA numbers from the test portfolio exercise. This exercise will help to identify the major sources of mRWA variability due to modelling choices in large banks. However, as it is a hypothetical portfolio exercise it will not be able to explain mRWA variability due to the differing business strategies of large trading banks.

Further work

The Basel Committee will continue to work to attain the full, timely and consistent implementation among its members.

The Committee will update G20 in November on its work on all of the three levels.

Level 1

The Level 1 reports will continue to be published until all Basel Committee members have fully implemented the requirements.

The next publication of the tables in appendix 1 will reflect the position as at end September 2012.

Level 2

Final reports for the three Level 2 assessments of the European Union, Japan and the United States are expected to be published in September.



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Some follow-up work may be required after September depending on the findings of the reviews.

Additional work will also include the new liquidity requirements, the leverage ratio, and the surcharges for systemically important banks, once the Committee concludes its review on any revision or final adjustments for these elements of the framework.

In line with the three current reviews, the review of liquidity requirements, the leverage ratio and systemic surcharges will take place ahead of the deadline and assess draft regulations where appropriate according to the staggered implementation dates.

A review of Singapore will commence later in 2012, and reviews of China and Switzerland in 2013.

This schedule will mean that all countries which are home of G-SIBs will have been reviewed before the middle of 2013.

Reviews of Australia and Brazil will take place during the second half of 2013.

The Basel Committee is collaborating with the IMF and World Bank to ensure that its schedule is complementary and non-duplicative to the IMF and World Bank’s FSAP review process.

Level 3

The two Level 3 groups assessing the consistency of risk-weighted assets in the banking book and trading book will continue their detailed analyses, including hypothetical portfolio exercises, questionnaires horizontally reviewing practices across banks and jurisdictions and on-site visits to banks.

Preliminary conclusions from the detailed analyses should be available in the fourth quarter of 2012.



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Interesting…

Status of Basel II, Basel 2.5 and Basel III adoption:

Number code:

1 = draft regulation not published; 2 = draft regulation published; 3 = final rule published; 4 = final rule in force.

Country Basel III

Next steps - Implementation plans

Argentina 1 On-going work to draft preliminary documents.

Australia 2 Draft rules for capital requirements issued on 30 March 2012. Draft rules to implement liquidity requirements issued in November 2011 for public consultation until 17 February 2012.

Belgium (2) (Follow EU process - third compromise text published)

Brazil 2 Draft regulation published for public consultation on 17 February 2012.

Canada 2 On 1 February 2011, banks were directed to meet the 7% CET1 standard as of January 2013. Regulations for (i) non-viability contingent capital and (ii) transitioning for non-qualifying instruments published August and October 2011 respectively. Draft regulation for definition of capital and counterparty credit risk issued to banks in March 2012.

China 2 Draft regulation combines BII, B2.5 and BIII. Public consultation ended in 2011. Final rule expected to

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Argentina

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Australia

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Belgium

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Brazil

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Canada

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#China



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come into force in Q3 2012. Will be applied to all banking institutions.

France (2) (Follow EU process - third compromise text published)

Germany (2) (Follow EU process - third compromise text published)

Hong Kong 1, 3 (3) Bill passed by the Legislative Council on 29 February 2012 and published for the purpose of creating rule-making powers for the implementation of Basel III. (1) Industry consultation underway on policy proposals for inclusion in rules. Consultation on draft text of rules scheduled for second half of 2012.

India 2 Draft regulation released for comments on 30 December 2011.

Indonesia 1 Draft regulation to be released for consultation with industry in Q2 2012.

Italy (2) (Follow EU process - third compromise text published)

Japan 3 Draft regulation published on 7 February 2012 - Final rules published on 30 March 2012 - Implementation of final rules (end of March 2013 - In Japan, the fiscal year for banks starts in April and ends in March).

Korea 1 Draft regulation to be published in the first half of 2012.

Luxembourg (2) (Follow EU process - third compromise text published)

Mexico 1 Final rule expected in Q2 2012.

The Netherlands

(2) (Follow EU process - third compromise text published)

Russia 1 Draft regulations under development.

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#France

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Germany

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Hong Kong

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#India

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Indonesia

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Italy

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Japan

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Korea

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Luxembourg

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Mexico

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#The Netherlands

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#The Netherlands

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Russia



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Saudi Arabia 3 Final regulation issued to banks.

Singapore 2 Public consultation on draft ended in February 2012. Final rule is expected to be published in mid-2012.

South Africa 1 Draft amendments to legislation issued on 30 March 2012 for consultation.

Spain (2) (Follow EU process - third compromise text published)

Sweden (2) (Follow EU process - third compromise text published)

Switzerland 2 Public consultation on draft regulation on Basel III has been finished in January 2012. Decision on final rules text expected until mid-2012. Final SIFI regulation (level: Banking Act) adopted by Parliament on 30 September 2011 - Draft SIFI regulation (level: accompanying ordinances) was published in December 2011; decision on final rule text expected before end-2012.

Turkey 1 Draft regulation expected to be published in mid-2012.

United Kingdom

(2) (Follow EU process - third compromise text published)

United States 1 Draft regulation for consultation planned during Q2 2012. Basel 2.5 and Basel III rulemakings in the United States must be coordinated with applicable work on implementation of the Dodd-Frank regulatory reform legislation.

European Union

2 Third compromise text (directive and regulation) published by the Danish Presidency on 28 March 2012.

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Saudi Arabia

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Singapore

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#South Africa

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Spain

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Sweden

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Switzerland

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#Turkey

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#The United Kingdom

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#The United Kingdom

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#The United States

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#European Union

http://www.bis.org/publ/bcbs/b3prog_dom_impl.htm#European Union



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Subject: Liquidity Date: June 8, 2012 Description: Comptroller’s Handbook Revisions and Rescissions

The Office of the Comptroller of the Currency (OCC) recently revised the “Liquidity” booklet of the Comptroller’s Handbook, which replaces a similarly titled booklet issued in February 2001.

This revised booklet provides updated guidance to examiners and bankers on assessing the quantity of liquidity risk exposure and the quality of liquidity risk management.

The major revisions to this booklet include the following:

Narrative more heavily focused on management of liquidity, including

o Emphasis on the importance of maintaining appropriate levels of highly liquid assets, and

o Enhanced discussion regarding the importance of a well-developed planning process for contingency funding.

Additional guidance—particularly for those examiners responsible for examining large and internationally active banks—from the September 2008 “Principles for Sound Liquidity Risk Management and Supervision,” issued by the Basel Committee on Bank Supervision and formally adopted by the OCC and other U.S. banking regulatory agencies.

Addition of eight appendixes providing specific guidance to examiners and bankers on a variety of topics and examples of fundamental liquidity management reports.



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In accordance with the OCC’s supervision-by-risk approach, examiners will generally use the liquidity core examination procedures, which can be found in the 2010 “Community Bank Supervision” booklet and the 2010 “Large Bank Supervision” booklet in the Comptroller’s Handbook. Examiners will supplement the procedures listed in these booklets, as appropriate, with the updated procedures detailed in the “Liquidity” booklet, for additional analysis of liquidity risk. With the issuance of this guidance, the following Office of Thrift Supervision guidance pertaining to liquidity risk is hereby rescinded:

Examination Handbook: Liquidity

o Section 510, “Funds Management” (and related program)

o Section 530, “Liquidity Risk Management” (and related program and appendixes)

o Section 560, “Deposits/Borrowed Funds” (and related program and questionnaire)

Chief Executive Officer Memo #295, “Monitoring and Documenting the Use of Funds from Federal Financial Stability and Guaranty Programs”

The OCC’s “Funds Management” booklet of the Comptroller’s Handbook has also been rescinded, effective immediately. OCC Advisory Letter 2001-5, “Brokered and Rate-Sensitive Deposits,” has been rescinded, while the “Joint Agency Advisory on Brokered and Rate-Sensitive Deposits” has been incorporated into the “Liquidity” booklet as an appendix.



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Liquidity Comptroller’s Handbook June 2012

This booklet provides guidance to examiners and bankers on assessing the quantity of liquidity risk exposure and the quality of liquidity risk management. The sophistication of a bank’s liquidity management process depends on its business activities and appetite for risk, as well as the overall level of liquidity risk. A well-managed bank, regardless of size and complexity, must be able to identify, measure, monitor, and control its exposure to liquidity risk in a timely and comprehensive manner. Liquidity core procedures can be found in the Community Bank Supervision Handbook (January 2010) and in Examiner View (EV). This handbook provides examiners with supplemental procedures for further analyzing the quantity and quality of liquidity risk. Examiners should refer to the Bank Supervision Process Handbook for further guidance on CAMELS Rating System. Additional guidance, particularly for those examiners responsible for examining large and internationally active banks, is provided in the September 2008 “Principles for Sound Liquidity Risk Management and Supervision,“ issued by the Basel Committee on Banking Supervision (BCBS) and formally adopted by the OCC and other U.S. banking regulatory agencies in that same year.

Background

Traditionally, banks have relied on local retail deposits (transaction and



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savings accounts) to support asset growth. Most retail deposit balances are federally insured, stable, and relatively inexpensive. Funding dynamics at community, midsize, and large banks, however, have evolved over time. Technological advances in the delivery of financial products and services, the removal of interstate banking restrictions, and the deregulation of interest rates paid on deposit accounts changed both depositor and banker behavior. Legislative reforms were intended to give depository institutions the tools to compete with other market participants for deposits, but they also increased competition among the banks themselves. The combination of these reforms and technological advances also made it easier for depositors, looking for better returns on their money, to leave their local markets. Consequently, in some cases, retail bank deposit growth did not keep pace with asset growth. Some banks became reliant on alternative deposit, nondeposit, and offbalance-sheet funding sources to cover the shortfall in traditional retail deposit funding. Changes in technology, product innovation, and funding dynamics create new challenges for liquidity managers. Intense competition and declining customer loyalty increase the rate sensitivity of traditional retail deposits. As banking customers are now using deposit accounts more as transaction vehicles than savings vehicles, thereby maintaining lower average excess balances, bankers can no longer rely upon historically inelastic depositor behavior.



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Thus, the reliance on alternative sources of funding from the wholesale and brokered markets exposes banks to more rate and liquidity sensitivity than the reliance on traditional retail deposits did. Moreover, many banks have increased their use of products with embedded optionality on both sides of the balance sheet, which makes it more challenging to manage the corresponding cash flows. Liquidity risk management systems and controls must keep pace with these changes and added complexities. Given these changes in funding dynamics, liquidity management is more complex and requires a more robust risk management process. To effectively identify, measure, monitor, and control liquidity risk exposure, well-managed banks supplement traditional liquidity risk measures like static-balance-sheet ratios with more prospective analyses. Bankers and examiners should have, at a minimum, a sound understanding of a bank’s

projected funding sources and needs under a variety of market

conditions.

net cash flow and liquid asset positions given planned and unplanned

balance sheet changes.

projected borrowing capacity under stable conditions and under adverse scenarios of varying severity and duration.

highly liquid asset and collateral position, including the eligibility and marketability of such assets under a variety of market environments.

vulnerability to rollover risk.

funding requirements for unfunded commitments over various time

horizons.

projected funding costs, as well as earnings and capital positions

under varying rate scenarios and market conditions.



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Definition

Liquidity is a financial institution’s capacity to readily meet its cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on the institution’s ability to efficiently meet both expected and unexpected cash flows and collateral needs without adversely affecting either daily operations or the financial condition of the institution. A bank’s liquidity exists in its assets readily convertible to cash, net operating cash flows, and its ability to acquire funding through deposits, borrowings, and capital injections. By definition, liquidity risk is the risk that an institution’s financial condition or overall safety and soundness is adversely affected by an inability (or perceived inability) to meet its obligations. An institution’s obligations, and the funding sources used to meet them, depend significantly on its business mix, its balance sheet structure, and the cash flow profiles of its on- and off-balance sheet obligations. In managing its cash flows, an institution confronts various situations that can give rise to increased liquidity risk. These include funding mismatches, market constraints on the ability to convert assets into cash or in accessing sources of funds (i.e., market liquidity), and contingent liquidity events. Changes in economic conditions or exposure to credit, market, operational, legal, and reputation risks also can affect an institution’s liquidity risk profile and should be considered in the assessment of liquidity and asset or liability management. In assessing a bank’s liquidity position, examiners should consider a bank’s access to funds as well as its cost of funding.



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Depending on the current interest rate and competitive environments, undue reliance on wholesale or market based funding may increase a bank’s cost structure. The cost of acquiring or renewing such funding is purely market driven, as opposed to rates paid on retail deposits, which may be set at management’s discretion within the parameters of local and national market conditions. Rising or high funding costs, especially in comparison to peer and market rates, is a sign of potential liquidity problems.

Importance of Liquidity Management

Liquidity is the lifeblood of any institution, but it is particularly crucial to highly leveraged entities such as banks. More broadly, the financial crisis beginning in 2008 demonstrated how liquidity problems and risks can be transmitted throughout the entire financial system. For all banks, the immediate and dire repercussions of insufficient liquidity makes liquidity risk management a key element in a bank’s overall risk management structure. The OCC expects all banks to manage liquidity risk with sophistication equal to the risks undertaken and complexity of exposures. Critical elements of a sound liquidity risk management process established by the board include

appropriate corporate governance and active involvement by

management.

appropriate strategies, policies, procedures, and limits used to manage

and control liquidity risk, even in stressed conditions.



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appropriate liquidity risk measurement and monitoring systems.

active management of intraday liquidity and collateral.

maintaining an appropriately diverse mix of existing and potential future funding sources.

adequate levels of highly liquid marketable securities, with no legal,

regulatory, or operational impediments, that can be used to meet liquidity needs in stressful situations.

comprehensive contingency funding plans (CFP) sufficient to address

potential adverse liquidity events and emergency cash flow needs.

adequate internal controls surrounding all aspects of liquidity risk management.

Sources of Liquidity

Structural changes in banks’ deposit bases have prompted banks to take advantage of improved access to wholesale and market-based funding sources. Examples of alternative funding sources include federal funds lines, repurchase agreements (repos), correspondent bank lines, Federal Home Loan Bank (FHLB) advances, Internet deposits, deposit-sharing arrangements, and brokered deposits. Access to these funds providers enables banks to meet funding requirements while still maintaining adequate funding diversification. Funds from the wholesale markets can be accessed at a variety of tenors that provide bankers with greater flexibility to manage their cash flows and liquidity needs.



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On the other hand, too much reliance on wholesale and market-based funding sources elevates a bank’s liquidity risk profile. Bankers who are unfamiliar with wholesale funding markets may become overly complacent during stable economic times. Funding through alternative sources exposes banks to the heightened interest-rate and credit sensitivity of these funds providers. Providers of wholesale funding often require a bank’s more liquid assets as collateral, which may impair the overall liquidity of a bank’s asset base. Further, if that collateral becomes less liquid, or its value becomes uncertain, wholesale funds providers may be unwilling to extend or roll over funding at maturity. A bank’s financial condition as well as market or systemic events unrelated to the institution may adversely affect the cost to a bank to acquire funds or its ability to access the wholesale markets. As a bank’s reliance on wholesale and market-based funding increases, so should the quality of liquidity risk-management processes. These processes should include periodic assessments of a bank’s exposure to changes in market conditions, and a bank should develop corresponding risk control systems to accompany these assessments. Asset sales and securitization are also important sources of bank liquidity. Banks of all sizes have increased the use of asset sales and securitization to access alternative funding sources, manage concentrations, improve financial performance ratios, and more efficiently meet customer needs. Some of these transactions, however, carry explicit recourse provisions within contractual documents, as well as the potential implied recourse



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associated with a bank’s desire to maintain access to future funding by repurchasing or otherwise supporting securitizations that exhibit performance problems. As a result, examiners should be aware of situations in which banks might overestimate the risk transfer of sales and securitization or may underestimate the commitment and resources required to manage this process effectively. Such mistakes may lead to highly visible problems during the life of a transaction that could impair future access to the secondary markets. A bank’s role and level of involvement in asset sales and securitization activities determine the degree of risk to which it is exposed. Off-balance-sheet positions can serve as both a source of liquidity and a potential, sometimes unexpected, drain on liquidity. Banks with a substantial amount of unfunded loan commitments may be required to fund such obligations unexpectedly and on short notice. Other off-balance-sheet commitments, such as legally binding and nonlegally binding support for securitizations, asset-backed commercial paper conduits, and other market based funding vehicles, can affect a bank’s liquidity position. In addition, collateral required for covering adverse mark-to-market changes in derivative hedging and trading activities may reduce the stock of liquid assets. Often, the fulfillment of nonlegally binding off-balance-sheet commitments is necessary to preserve the reputation of the institution, as well as to allow a bank continued access to that segment of the financial markets. On the other hand, off-balance-sheet activities may provide additional sources for liquidity.



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Banks can supplement their liquidity position by maintaining lines of credit with correspondent banks or their respective FHLB. Sound liquidity management includes the analysis of and planning for the operational and contingent sources and uses of funds associated with off-balance-sheet activities.

Relationship of Liquidity Risk to Other Banking Risks

Bankers and examiners must understand and assess how a bank’s exposure to other risks may affect its liquidity. The OCC defines and assesses eight categories of risk. In addition to liquidity, these risk types include credit, interest rate, price, operational, compliance, strategic, and reputation. These categories are not mutually exclusive—any product or service may expose a bank to multiple risks—and a real or perceived problem in any area can erode a bank’s liquidity position or affect its funding costs, thereby increasing its liquidity risk. If a bank does not properly manage these exposures, the risks eventually undermine the institution’s liquidity position. Both the “Community Bank Supervision” and the “Large Bank Supervision” booklets of the Comptroller’s Handbook discuss in detail the OCC’s risk definitions and risk assessment process.

To read more: http://www.occ.treas.gov/publications/publications-by-type/comptrollers-handbook/liquidity.pdf

http://www.occ.treas.gov/publications/publications-by-type/comptrollers-handbook/liquidity.pdf

http://www.occ.treas.gov/publications/publications-by-type/comptrollers-handbook/liquidity.pdf



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12 June 2012

Speech by the Financial Secretary to the Treasury, Mark Hoban MP; the CityUK Debate 2012-2020 and beyond: financial services

Good morning and thank you for inviting me to speak here today. It’s a pleasure to speak with, and alongside, so many leading policy makers and industry leaders, and I’d like to thank CityUK for organising this debate.

At a time of such unprecedented change for the financial system, it is absolutely vital that Governments, regulators and companies continue to work together through these challenging times.

We face the substantial, long term task of strengthening the financial system for the future, learning the lessons from the recent years of financial and economic instability that have affected economies around the world.

It’s only by doing so that we can ensure we build a platform from which the UK can build on its world leading strengths in financial services.

Strengths which include London consistently ranking first in the Global Financial Centres Index.

Ranking as the most attractive destination in Europe for investment according to Ernst & Young.

A financial services sector that originates more cross-border bank lending than any other country, home to Europe’s largest Insurance and asset management industries, and the world’s largest foreign exchange market.



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And a sector that is home to over 250 branches and subsidiaries of foreign banks, channelling more investment into the UK than any other sector.

We are committed to maintaining and strengthening the UK’s role as the leading global financial centre because we know the vital role the sector plays in our economy.

Contributing one in every seven pounds of GDP.

Employing over two million people in financial and related professional services firms across the UK.

And helping UK companies raise almost £450 billion in funding since 2005.

The strength of the UK’s financial sector and our dependence upon it presents us with a challenge which the Chancellor has called the British dilemma.

How can we create a successful but stable financial services sector? How can we preserve the innovation that fuels the sector’s success without putting the wider economy at risk?

Our answer to the British dilemma is to build a strong and proportionate regulatory regime.

Safeguarding the stability of our financial sector as a foundation for sustainable growth, and protecting the competition and innovation that drives its success.

I do not believe that strong and proportionate regulation is a hindrance to the success of financial services in the UK, rather I think it is an essential platform for a successful global financial centre, ensuring that the UK remains an attractive destination for international business, a place where businesses can trade with each other with confidence.

So we are pursuing an ambitious programme of reforms to address the lessons of the financial crisis to safeguard London as a global financial sector.



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Central to this programme is reform of the regulatory architecture – abolishing the failed and discredited tripartite system of supervision.

In its place, a new Prudential Regulatory Authority, an independent subsidiary of the Bank, will take responsibility for micro-prudential regulation.

And a new Financial Policy Committee, sitting within the Bank, will monitor risks across the financial system. Its purpose will be to identify bubbles as they develop, spot dangerous interconnections across the system, and stop excessive levels of leverage before it’s too late.

Together, these bodies will bring judgement and foresight to the task of supervision, rather than mere box ticking.

At the same time it will also take into consideration the impact on economic growth when pursuing financial stability … not neglecting the fact that stability is itself a vital precondition of growth.

The legislation to achieve this critical change in the way British banking operates had its second reading in the House of Lords yesterday and we hope to receive Royal Assent by the end of this year.

And as well as ensuring the UK’s regulatory institutions are fit for purpose, we are addressing the structural problems with the sector itself that caused so much trouble when the crisis hit.

The UK is taking significant steps to improve bank resolvability and address the ‘too big to fail’ issue through the Independent Commission on Banking, reforms that are ambitious in their scope and proportionate in their impact.

We have already committed to implement the Commission’s recommendation to ring fence investment banking practices from retail banking.

Ensuring that when a bank does fail, services that are vital to families, businesses and the whole economy continue without resorting to taxpayer money.



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We have already committed to introduce additional loss absorbency requirements on ring fenced retail banks.

Ensuring that large retail banks hold equity capital of at least 10 per cent, with minimum a loss absorbing capacity for the bigger banks of at least 17 per cent. To ensure that shareholders and bondholders bear the costs of failure, not taxpayers.

And later this week, the Government will publish its White Paper setting out its final proposals for further reforms to the UK banking sector, based on the ICB’s recommendations.

Of course, financial services are an international industry, and regulation has to reflect that reality.

So it is right that much of the debate on regulatory reform is being driven at the international level.

Against the backdrop of continuing instability in Europe, it is critical that we seek regulatory reform that ensures stability, creates opportunities for sustainable growth in the future, and removes the distorting effect of arbitrage.

Abroad, as at home, we need to tackle the issue of ‘too big to fail’ and the perceived implicit guarantee of financial institutions that continues to distort fair and open competition globally. Through the G20, we have agreed that supervisors need to be able to go further to address the risks posed by the largest and most interconnected banks.

This means applying additional loss absorbency requirements to further reduce the risk that these high impact banks fail...

... developing internationally consistent Recovery and Resolution Plans that will require firms to take early action to generate capital and liquidity in stress...



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...and ensuring that supervisors have the tools and powers to intervene early and ensure an orderly resolution where a bank does fail.

The UK is leading the development of these new toolkits. On RRPs, we have already started a pilot project with the six of the largest UK banks, and we expect all banks to develop their own plans by the end of the year.

Reforms to tackle inter connectedness between banks are therefore vital.

We only need to look across the channel to understand the magnitude of the inter connectedness not just between banks, but between banks and public finances and between public finances and monetary union.

The Eurozone crisis needs a response that deals with specific weaknesses in the governance of the single currency. We have, for some time, argued that the “remorseless logic” of monetary union requires closer fiscal integration in the eurozone.

As the Chancellor wrote this weekend, we chose not to join the euro precisely because we would lose national sovereignty and control of our monetary policy.

A banking union is a necessary part of the fiscal and monetary union that the Eurozone is committed to. That is why we will not be taking part in the banking union.

Britain’s place is in the internal market, not the Eurozone block. As the Eurozone integrates, so Europe will have to ensure that it does not do so at the expense of the single market – one of Europe’s greatest achievements.

A Europe that achieved Eurozone stability at the cost of the single market would undermine the benefits that have been achieved through a diverse and ever widening market that promotes competition, offers choice and provides opportunities for growth, investment and jobs

But abroad, as at home, we must also be mindful of the impact that inconsistent, discriminatory and disproportionate regulation can have:



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stifling growth, restricting investment, lowering business returns, imposing higher costs on investors.

That means ensuring that regulation is based on evidence and rigorous analysis.

Ensuring that internationally agreed regulatory standards are implemented fully and consistently at national level.

And ensuring that regulation protects the open and competitive markets that are critical to fostering renewed growth across all our economies and vital to London’s continuing success as a global financial centre.

That is why the UK is taking on a lead role on financial services internationally and in Europe.

Full, consistent and non-discriminatory implementation of these agreements is essential to ensure the stability of the international financial system, but also to protect free and open competition that allows all our sectors to thrive.

And it is not just here that we are safeguarding the Single Market. Through our negotiations on the array of European regulatory reforms, we are securing agreement and supporting the Commission in its duty to uphold single market principles that are vital to support growth.

For example, it is vital that derivatives in any currency can be cleared in any country so on EMIR we have worked hard to ensure a clear recognition of the principle of non-discrimination in the Council.

That is also why we are challenging the ECB’s location policy in the ECJ.

And on MiFID, we continue to make the case against unnecessary barriers to trade within the EU and between the EU and third countries. London thrives not just through trade within Europe’s borders, but also through trade outside those borders.

On the basis of the current proposals, it seems that no third country would meet EU rules, so from the moment that MiFID is passed and until equivalence decisions are taken, it would close the EU market entirely to



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any new third country firm, as well as choking off opportunities for our firms in some of the strongest and fastest growing emerging economies.

So we couldn’t trade with a new Japanese securities house; seek capital from China or invest in Africa.

It’s worth reminding ourselves that EU financial services are a powerful force in the international market, accounting for about a quarter of financial services exports worldwide, and responsible for managing just under half of global bank assets.

At a time when we have to do everything we can to attract investment to support the economic recovery we cannot cut ourselves off from the rest of the world.

Of course this works both ways. We have to resist proposals that seek to raise barriers to UK or European investment in the rest of the world.

Which is why we are concerned, along with many other countries, about the extra-territorial application of the Volcker Rule as currently drafted.

There is a significant risk that the Rule will restrict US banks from trading in non-US sovereign debt, and a risk that non-US banks may be restricted in their ability to transact with US investors.

It is absolutely vital that, as we strengthen the global regulatory framework, we do so in a way that balances stability with the maintenance of global markets, sustaining economic growth.

And it is equally important that we protect UK financial services as we do so – protecting that pole position that I mentioned at the beginning of my speech.

Protecting the Businesses and families that rely on the vast range of services and expertise it provides: foreign exchange and commodity markets; maritime and trade finance; insurance and reinsurance; and many more besides.

And protecting UK financial services’ ability to access markets beyond Europe – when around half of the UK’s financial services trade is with



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countries outside Europe, we must ensure that European regulation does not risk the opportunities we enjoy from key international growth markets at a time when we so vitally need inward investment.

As I said at the outset, London is a leading global financial centre and we are committed to supporting and maintaining the UK’s position as the world’s leading financial services centre.

And we remain committed to attracting the world’s most ambitious and innovative financial services companies to the UK.

I believe that to achieve this it is essential that we reform regulation to remedy the failures of the last decade, safeguarding an innovative and successful financial services sector, without putting the wider economy at risk.

We will continue to work with all of you here today, to ensure that we realise that ambition, embedding proportionate, consistent and non-discriminatory regulation, to promote a competitive, stable and successful financial services sector.

Notes

Mark Hoban was appointed Financial Secretary to the Treasury in May 2010.

Mark was appointed the Shadow Financial Secretary to the Treasury in December 2005. Between November 2003 and December 2005 he was Shadow Minister for Schools. Prior to November 2003, he was an Opposition Whip. Between 2001 and 2003 Mark was a member of the Select Committee on Science and Technology.

Mark was born in 1964. He has an economics degree from the London School of Economics. After graduating he qualified as a Chartered Accountant, and went on to work for PricewaterhouseCoopers between 1985 and 2001. Mark has been the MP for Fareham since June 2001.

http://www.hm-treasury.gov.uk/speech_fst_120612.htm#primaryContentFull



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Overview of Progress in the Implementation of the G20 Recommendations for Strengthening Financial Stability

Report of the Financial Stability Board to G20 Leaders, 19 June 2012

Introduction Since the onset of the global financial crisis, the G20 has established core elements of a new global financial regulatory framework that will make the financial system more resilient and better able to serve the needs of the real economy.

National authorities and international bodies, with the Financial Stability Board (FSB) as a central locus of coordination, have further advanced this financial reform programme, based on clear principles and timetables for implementation.

The FSB coordinates and closely monitors the national implementation of agreed G20 and FSB financial reforms and is responsible for reporting on it to the G20.

The FSB set up in October 2011 a Coordination Framework for Implementation Monitoring (CFIM), in collaboration with international standard-setting bodies (SSBs), to intensify its monitoring and public reporting on implementation, focusing in particular on priority reform areas.

This report details the progress made in global policy development and in implementation of global policy reforms since the G20 Cannes Summit in November 2011.

A central piece of the international policy reforms is stronger minimum standards for bank capital and liquidity through implementation of Basel II, II.5 and III requirements.



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As of end-May 2012:

- 20 of 27 member jurisdictions of the Basel Committee on Banking Supervision (BCBS) had implemented the Basel II.5 rules to strengthen capital charges for banks’ trading books and complex securitisations, which were due to come into force from end-2011. Six member countries have not issued final regulations in this area.

- 20 of 27 BCBS member jurisdictions have issued draft or final Basel III regulations, implementation deadline for which is 1 January 2013. Seven member jurisdictions have yet to do so, but the majority of these believe they can issue final regulations by the implementation deadline.

Another central reform objective is ending “too big to fail” through strengthened resolution regimes and resolution planning for global systemically important banks (G-SIBs):

- Encouraging progress has been made by major jurisdictions, including the US, UK and EU, to put in place or propose legislation to establish effective resolution regimes;

- However, although cross-border crisis management groups (CMGs) have been established for 24 of the 29 G-SIBs, much further work is needed to develop resolution strategies and plans, and the cross-border co-operation agreements needed to ensure the resolvability of these G-SIBs.

With regard to reforms to over-the-counter (OTC) derivatives markets, all jurisdictions and markets need to aggressively push ahead to achieve full implementation of market changes by end-2012 to meet the G20 commitments in as many reform areas as possible:

- Good progress has been made by those jurisdictions with the largest OTC derivatives markets, including the United States (US), European



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Union (EU) and Japan, in advancing national legislation and regulation and practical implementation of reforms to market infrastructures;

- SSBs have also made significant progress in developing the international policies that are key to advancing OTC derivatives reform implementation across jurisdictions.

All jurisdictions now have sufficient information about international standards and policies to put in place the needed domestic legislation and regulation.

With regard to reform of compensation structures at financial institutions:

- Almost all FSB member jurisdictions have now implemented the FSB Principles and Standards for sound compensation practices in regulation or supervisory guidance. Since Cannes, jurisdictions that showed significant gaps have progressed. However, sustained supervisory and regulatory attention will be needed to achieve lasting improvements in financial firms’ compensation structures and practices.

Since the Cannes Summit, the FSB and its members have made good progress in policy development in areas where G20 objectives have been agreed, including developing proposals for public consultation on extending the framework for systemically important financial institutions (SIFIs) to cover global insurers and domestic banks, measures to address the regulation and oversight of shadow banking, and the development of a governance framework for a global Legal Entity Identifier (LEI) system.

An important goal of the monitoring process is to highlight, for corrective action, areas where there are risks that policy objectives will not be met, or where implementation is not meeting the agreed timelines.



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Among these areas:

- Although CMGs have been established, much further work on resolution plans and on cross-border co-operation is needed to improve resolvability. Progress is being made in national legislative reforms to establish more effective resolution regimes. The standards set out in the FSB’s November 2011 Key Attributes of Effective Resolution Regimes provide international standards in this area, and the detailed assessment methodology being developed will provide further guidance.

- Many jurisdictions still need to address weaknesses in their supervisors’ mandates, to ensure sufficient independence to act, appropriate resources, and a full suite of powers to proactively identify and address risks. The Basel Core Principles are being strengthened in this area, with a consultative paper having been issued last December.

The following sections describe in greater detail the progress made by the FSB and its members to promote financial stability and strengthen the resilience of the global financial system, including through surveys conducted by the FSB’s Implementation Monitoring Network (IMN).

2. Building resilient financial institutions 2.1 Implementation of Basel II/II.5/III

The G20 Leaders, at the Cannes Summit, reaffirmed their commitment to improve banks' resilience to financial and economic shocks, and called on jurisdictions to meet their commitment to implement fully and consistently the Basel II/II.5/III requirements.

The Basel III framework seeks to strengthen the resilience of the banking system through prudential measures that will enhance the quality of



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capital; increase the level of capital; promote the build-up of capital buffers to mitigate pro-cyclicality; supplement the risk-based capital requirements with a leverage ratio; and introduce a set of global liquidity standards.

Together with the Basel II and Basel II.5 frameworks, Basel III will improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy.

The BCBS with the endorsement from GHOS, meanwhile launched in January 2012 a comprehensive process to monitor its members’ implementation of Basel II/II.5/III. The process consists of three levels of review:

(i) Level 1: ensuring the timely adoption of Basel II/II.5/III;

(ii) Level 2: ensuring consistency of domestic regulations with Basel II/II.5/III; and (iii) Level 3: ensuring consistency of outcomes (initially, this assessment of implementation at the bank level will focus on risk-weighted assets).

The three-level monitoring framework will promote timely and consistent implementation of Basel II/II.5/III and also provide inputs to the FSB’s reporting to the G20 Leaders on implementation of priority reforms.

On the timely adoption of Basel II/II.5/III (Level 1), the BCBS published in October 2011, April 2012 and June 2012 reports that detailed the progress BCBS members have made in implementing Basel II/II.5/III.

As of end-May 2012, 21 of 27 BCBS member jurisdictions have implemented Basel II, which was due to come into force from end-2006.

In addition, Indonesia and Russia have implemented Basel II’s Pillar 1 (minimum capital requirements).

Argentina, China, Turkey and the US are in the process of implementing Basel II.



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With regard to Basel II.5, as of end-May 2012, 20 BCBS member jurisdictions had implemented those rules, which were due to come into force from end-2011. Argentina, Indonesia, Mexico, Russia, Turkey and the US had not issued final regulations.

The US authorities approved final rules covering the market risk elements of Basel II.5 in early June 2012.

Saudi Arabia has issued final regulations but these have not yet come into force.

Among the 29 G-SIBs identified in November 20114, nine are headquartered in jurisdictions that have not yet fully implemented Basel II or Basel II.5.

Draft Basel III regulations had not been issued by seven BCBS member jurisdictions as of end-May 2012: Argentina, Hong Kong, Indonesia, Korea, Russia, Turkey and the US.

The US authorities however have since then published the draft Basel III rules.

The majority of these countries believe they can issue final regulations by the implementation deadline of 1 January 2013.

However, for the others, depending on their domestic rule-making process, meeting the deadline could pose a significant challenge.

In addition to monitoring the timely adoption of Basel III rules, the BCBS has established a process to review the content of the new national rules for the implementation of Basel III.

This second level of review is meant to ensure that the national adaptations of Basel III are consistent with the minimum Basel III standards.

The BCBS has initiated peer reviews of the domestic regulations of the EU, Japan and the US to assess their consistency with the globally agreed standards.

The findings of these reviews are preliminary since the analysis is not yet completed and the formulation of national standards is still ongoing.



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Nevertheless, there is a possibility that national and regional implementation will be weaker than the globally agreed standards in some key areas.

A third level of review by the BCBS examines whether there are unjustifiable inconsistencies in risk measurement approaches across banks and jurisdictions, and the implications these might have for the calculation of regulatory capital.

This review will initially focus on banks’ risk-weighting practices in the banking and trading books, and includes the use of test portfolio exercises, horizontal reviews of practices across banks and jurisdictions, and joint on-site visits to large, internationally active banks.

The BCBS intends to develop an updated progress report by the time of the G20 Finance Ministers and Central Bank Governors meeting in November 2012 that includes:

(i) An update on its members’ domestic rule-making;

(ii) The final outcome of the regulatory consistency assessment of the EU, Japan and the US; and

(iii) Preliminary findings from its deeper analysis of banks’ risk measurement approaches and regulatory capital calculations.

A review of the consistency of Singapore’s regulations with the international standards (i.e. a Level 2 review) will commence later in 2012, with reviews of China and Switzerland to follow in 2013.

This schedule ensures that all countries that are home to G-SIBs will have been reviewed before the middle of 2013. Reviews of Australia, Brazil and Canada will take place during the second half of 2013.

The BCBS is collaborating with the International Monetary Fund (IMF) and World Bank to ensure that its schedule is complementary and non-duplicative to the Financial Sector Assessment Program (FSAP) review process.



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2.2 Liquidity standards under Basel III

A key component of the Basel III framework is the introduction of global liquidity standards.

During the financial crisis, the banking system experienced severe stress because many banks did not manage their liquidity in a prudent manner.

Basel III’s Liquidity Coverage Ratio (LCR), is designed to promote short-term resilience by ensuring a bank holds adequate highly liquid assets to survive significant stress lasting for one month.

The other standard, the Net Stable Funding Ratio (NSFR), is intended to promote a sustainable maturity structure of assets and liabilities and thereby avoid significant maturity mismatches over longer-term horizons.

To better understand the potential effect of these standards, the Basel Committee on Banking Supervision (BCBS) agreed to put in place rigorous reporting processes to monitor the LCR and NSFR during an observation period that began in 2011.

The BCBS’ oversight body, the Group of Central Bank Governors and Heads of Supervision (GHOS), requested in January 2012 that the LCR rules text be clarified so that the 100% threshold would be a minimum requirement in normal times and banks would be expected to use their pool of liquid assets during the stress period, thereby temporarily falling below the minimum requirement.

The GHOS also asked the BCBS to finalise and publish recommendations by the end of 2012 to address specific concerns regarding the pool of high-quality liquid assets as well as some adjustments to the calibration of net cash outflows so as to reflect the actual experience during the crisis.

The BCBS is working towards finalising the LCR by the end of 2012, with a view to implementing it in January 2015.

The NSFR will be implemented in January 2018.



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2.3 Quantitative impact assessment of Basel III

Apart from monitoring the timely and consistent implementation of Basel II/II.5/III across member jurisdictions, the BCBS is conducting a semi-annual monitoring exercise to assess the impact of Basel III on a representative sample of institutions in each member jurisdiction.

According to the most recent results (as of 30 June 2011), if changes to the definition of capital and risk-weighted assets were applied without considering the transitional arrangements, the average common equity Tier 1 capital ratio (CET1) of Group 1 banks would have been 7.1%, higher than the Basel III minimum requirement of 4.5%.

For the other banks (Group 2 banks), the average CET1 ratio stood at 8.3%.

The BCBS has also estimated that the sum of profits after taxes and prior to distributions during the second half of 2010 and the first half of 2011 would cover about 70% of the capital that the Group 1 banks need to raise over the coming six-year implementation horizon to satisfy the 7% target for CET1 and the surcharge for G-SIBs.

Meanwhile, for the smaller Group 2 banks, the capital shortfall to be met over the same horizon is much less than these banks’ profits.

There is considerable variation across individual banks, so it is difficult to draw firm conclusions from the BCBS estimates.

However, the averages may suggest that a proportion of the industry has the capacity to meet the new capital targets through earnings retention and reduced distributions over the transition period.

On the other hand, the estimated impact of the Basel III liquidity standards by the BCBS seems to suggest the need for banks to further adjust their liquidity positions during the observation period, for example, through lengthening the term of their funding or restructuring business models which are most vulnerable to liquidity risk in periods of stress.

Assuming banks were to make no changes to their liquidity risk profile or funding structure, as of June 2011, the weighted average Liquidity



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Coverage Ratio (LCR) for Group 1 banks would have been 90% while the weighted average LCR for Group 2 banks was 83%.

The weighted average Net Stable Funding Ratio (NSFR) was 94% for both Group 1 and Group 2 banks.

Banks have until 2015 to meet the LCR standard and until 2018 to meet the NSFR standard.

The BCBS is currently investigating the case for modifying a few key aspects of the LCR but will not materially change the framework's underlying approach.

The BCBS will finalise and subsequently publish its recommendations in these areas by the end of 2012.

2.4 Strengthening risk management Risk management functions are the first line of defence in enhancing the resilience of financial institutions.

In this regard, the FSB, SSBs and national authorities are making continuous efforts to strengthen risk management practices through increased supervisory expectations, enhancements of risk disclosures (market discipline), and additional guidance for national authorities and financial institutions.

Across the FSB member jurisdictions, supervisory expectations for risk governance have increased, particularly for SIFIs, as this was an area that exhibited significant weaknesses in many financial institutions during the global financial crisis.

To take stock of changes underway in risk governance practices, the FSB launched a thematic review on risk governance in March 2012.

The peer review will also assess progress in addressing the weaknesses in risk governance identified during the crisis at both national authorities and at firms.

The inclusion of a firm-level survey in the peer review reinforces the message that a firm’s board and senior management are responsible for managing its risk, while supervisors are responsible for assessing whether



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a firm’s risk governance framework and processes are adequate, appropriate and effective for managing the firm’s risk profiles.

The peer review report will be published in the first half of 2013.

In addition, the FSB hosted a roundtable on risk disclosures by financial institutions in December 2011 to encourage the private sector to jointly take forward development of principles and of leading practice disclosures that will be relevant and informative given current market conditions and risks.

Given the importance to market confidence of useful disclosure by financial institutions of their risk exposures and risk management practices, the FSB facilitated the formation of a private-sector Enhanced Disclosure Task Force (EDTF) in May 2012.

The primary objectives of the EDTF are to:

(i) Develop principles for enhanced disclosures, based on current market conditions and risks, including ways to enhance the comparability of disclosures; and

(ii) To identify leading practice risk disclosures.

The recommendations of the EDTF are expected to be reported to the FSB and published in October 2012.

The BCBS issued in May 2012 a consultative document that set out a revised market risk framework and proposed a number of specific measures to improve trading book capital requirements.

These proposals are aimed at fundamentally strengthening capital standards for market risk, an area where weaknesses became apparent during the crisis.

The key elements of the proposals include: a more objective boundary between the trading book and banking book that materially reduces the scope for regulatory arbitrage; and the introduction of the expected shortfall as a risk measure that better captures “tail risk” compared to value-at-risk.



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The BCBS also issued a consultative paper on The Internal Audit Function in Banks in December 2011, which provides guidance to help assess the effectiveness of a bank's internal audit function.

This is a revision of the BCBS’ 2001 document Internal Audit in Banks and Supervisor’s Relationship with Auditors.

The proposed guidance reflects developments in supervisory and banking practices and incorporates lessons drawn from the financial crisis.

To strengthen liquidity risk management practices of collective investment schemes (CIS), the International Organisation of Securities Commissions (IOSCO) published in April 2012 a consultation report entitled Principles of Liquidity Risk Management for Collective Investment Schemes.

These Principles are intended to be used by both the industry and regulators in assessing the quality of regulation and industry practices relating to liquidity risk management for CIS.

The fundamental requirement is to ensure that the degree of liquidity managed by an open-ended CIS enables it to meet redemption obligations and other liabilities.

The consultation report describes how compliance with this requirement can be achieved.

IOSCO also published in January 2012 Principles on Suspensions of Redemptions in Collective Investment Schemes, a report that provides a common approach and standards for use in an exceptional case where CIS face serious liquidity problems.

National authorities have also been making efforts to strengthen the risk management practices of financial institutions in their jurisdictions.

In particular, many jurisdictions are enhancing their liquidity risk management and stress testing practices in line with the Basel III rules and BCBS guidelines, such as:

- In Canada, OSFI’s final Liquidity Guideline (B-6) which is in line with BCBS requirements has been in force since February 2012.



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Financial institutions’ implementation of the B-6 guideline will be reviewed during Q2 2012 through a cross-system benchmarking review/self-assessment. Financial institutions also periodically submit liquidity data related to BCBS liquidity standards.

- In Hong Kong, the supervisory guideline on stress testing has been revised to incorporate the BCBS' guidance and the recommendations from other international organisations to address deficiencies in this area that were revealed by the global financial crisis. The revised guideline was issued on 9 May 2012.14

Ending “Too-Big-To-Fail” The G20 is determined to make sure that no financial institution is “too big to fail” and that taxpayers do not bear the costs of resolution of any institution that does fail (and cannot be put into insolvency for reasons of systemic stability).

To this end, the G20 Leaders endorsed at the Cannes Summit the FSB’s comprehensive policy framework, comprising a new international standard for resolution regimes, more intensive and effective supervision, and requirements for cross-border cooperation and recovery and resolution planning as well as, from 2016, additional loss absorbency for those banks determined as global systemically important financial institutions (G-SIFIs or G-SIBs).

3.1 Improving the capacity to resolve firms in crisis

The FSB Key Attributes of Effective Resolution Regimes for Financial Institutions (“the Key Attributes”) form an international standard that sets out the essential elements that all resolution regimes should have to ensure that national authorities can resolve financial institutions in an orderly manner that does not expose taxpayers to the risk of loss.



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FSB members have committed to an ambitious schedule for bringing their resolution regimes in line with this new standard and for implementing a range of G-SIFI specific requirements, including

(i) The establishment of Crisis Management Groups,

(ii) The elaboration of recovery and resolution plans (RRPs),

(iii) The conduct of resolvability assessments,

(iv) The adoption of institution-specific cross-border cooperation agreements (COAGs); and

(v) The establishment of cooperation arrangements with the relevant jurisdictions that are hosts to systemic operations of a G-SIFI but are not represented on its CMG.

The progress made to date on implementing the G-SIFI framework includes the following key elements:

(i) Effective resolution regimes

A self-assessment by FSB members indicated that national resolution regimes are not fully consistent with the Key Attributes in many FSB member jurisdictions.

However, reforms are underway to align the regimes more closely with the Key Attributes.

For example, the implementation of the Dodd-Frank Act (DFA) in the US, which provides for powers to resolve systemically important financial institutions and requires the preparation of resolution plans, constituted an important step towards implementation of the Key Attributes.

Likewise, the European Commission (EC)’s adoption of proposed EU-wide rules for bank recovery and resolution is critical for advancing consistent reforms across the EU.

FSB members have committed to undergo a first thematic peer review of resolution regimes in the second half of 2012 which should provide a fuller picture of the status of national reform and progress in implementing the FSB standard.



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(ii) Crisis Management Groups (CMGs)

CMGs have been established for 24 G-SIFIs. Where a CMG is not yet established, substantive action is planned. CMG membership includes the prudential supervisor, central bank and, where it is a separate authority, the resolution authority of the home country; in some, the finance ministry of the home or host jurisdiction participates in a restricted manner. The countries represented in the CMGs are generally the same as those in the G-SIFI’s core supervisory college. Senior level engagement has proved critical for advancing cooperation and resolution planning work within CMGs. A few CMGs have discussed detailed resolution strategies and started to develop operational plans to implement them.

(iii) Recovery and resolution plans (RRPs).

Advancing more detailed CMG work on resolution planning, resolvability assessments and cooperation agreements has proved difficult without a clearly articulated resolution strategy – that is, the specification of a high level, strategic approach to how a firm would be resolved. The FSB has therefore given priority to the development - led by home authorities - of high-level resolution strategies by September 2012. Such strategies include “single entry” or “top down” approaches, where a group is resolved through intervention at the level of the holding company; or “multiple-entry resolution” approaches where separate resolution action may be taken at the level of subsidiaries.



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The chosen resolution strategies should provide sufficient direction to CMGs for them to undertake more detailed work on the development of cooperation agreements, RRPs and resolvability assessments. For each G-SIFI, home authorities have committed to lead the development within the CMGs of resolution plans that set out in detail how the resolution strategies could be put into operation by the end 2012.

(iv) Resolvability assessments

Resolvability assessments should help identify any remaining barriers to resolution. They should also inform the development and/or improvement of the resolution plan. Discussions of resolvability assessments of G-SIFIs are at very early stages, due in part to the fact that resolution strategies need first to be developed before their feasibility and credibility can be assessed. CMGs should conduct resolvability assessments in Q1 2013, after the development of basic resolution strategies for all G-SIFIs.

(v) Institution-specific cooperation agreements No institution-specific cooperation agreements consistent with the Key Attributes have as yet been agreed or put in place between the members of a CMG, largely because the development of a resolution strategy is seen as a prerequisite to such an agreement and also because differing terms and conditions for information sharing across jurisdictions complicate cross-border cooperation. The FSB has therefore initiated further work to examine how to address existing obstacles to the exchange of information, and to develop minimum common terms and content for information sharing across jurisdictions.



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These terms and content should be reflected in the cooperation agreements to be put in place for all G-SIFIs in early 2013.

(vi) Coordination with host jurisdictions with systemic G-SIFI operations Effective cooperation should be established with the relevant host authorities that are not included in the CMGs, but that assess the local operations of a G-SIFI as systemically important to the local financial system. The FSB is therefore also proposing to develop further guidance for arrangements and procedures for cooperation and information sharing with such host authorities. The FSB identified several areas where further work is necessary to advance recovery and resolution planning and improve resolvability. The Key Attributes state the need for the effective segregation of client assets and prompt access to segregated client funds in resolution. Further work will be undertaken on these topics, in coordination with IOSCO and the FSB Shadow Banking work stream. To facilitate assessments by the IMF and World Bank of resolution regimes against the Key Attributes, the FSB is developing a draft assessment methodology with the assistance of a drafting team composed of resolution experts from FSB member jurisdictions, EU institutions, IAIS, CPSS and IOSCO, who have the appropriate sectoral expertise, and from the IMF, the World Bank and International Association of Deposit Insurers (IADI), who have particular experience in the development and use of assessment methodologies. Given the status of the Key Attributes as “umbrella” standards for resolution regimes for all types of financial institutions that can



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potentially be systemically-important in failure, the methodology will incorporate sector-specific considerations. The draft methodology will be submitted to all SSBs in the second half of 2012 to help to determine whether the methodology is suitable for assessing resolution regimes for different types of firms, including FMIs, insurers and securities and investment firms. The questionnaire to be used for the FSB’s thematic peer review of resolution regimes will be based on the draft assessment methodology and the findings from that review will be taken into account when the methodology is finalised in 2013.

3.2 Improving the intensity and effectiveness of SIFI supervision

The FSB continued to review progress towards implementation of the 32 recommendations set out in the November 2010 report Intensity and Effectiveness of SIFI Supervision (SIE recommendations) relating to supervisory mandates, powers, resources and practices for making the supervision of financial institutions more effective. The majority of these recommendations have been implemented or are underway. The coming year will see a completion of this work, as well as implementation of additional recommendations set out in the 2011 Progress Report on Implementing the Recommendations on Enhanced Supervision. These include raising supervisory expectations about firms’ abilities to collect and process data to give an accurate picture of their firm-wide risk exposure, promoting strong risk management, and ensuring that supervisors have adequate resources to supervise SIFIs effectively.



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While discussions among FSB members on increasing the intensity of supervision are related to all SIFIs, they are generally focused on institutions that are important for the global system (i.e. G-SIFIs). The FSB’s agenda for improving the intensity and effectiveness of supervision is focused on four main areas: (i) Holding supervisors to higher standards; (ii) Improving supervisory tools and methods; (iii) Enhancing the effectiveness of supervisory colleges; and (iv) Improving firms’ risk data aggregation capabilities. A summary of progress in each of these areas is discussed below.

(i) Holding supervisors to higher standards:

At the core of strengthened supervisory frameworks are the minimum standards set out by the BCBS for sound supervisory practices. The BCBS published in December 2011 a consultative document on the enhanced Core Principles for Effective Banking Supervision (BCBS Core Principles). In developing the revised BCBS Core Principles, close attention was given to addressing many of the significant risk management weaknesses and other vulnerabilities highlighted in the last crisis. Final principles are expected to be published in the fall 2012. National authorities will be assessed as part of the IMF-World Bank FSAPs against the enhanced BCBS Core Principles, thus raising the bar for supervisors.

(ii) Improving supervisory tools and methods:



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Since the beginning of 2012, the FSB has been working to improve its understanding of risk appetite frameworks, resources needed to intensify SIFI supervision, firms’ business models, and supervisory methods used to oversee trading operations. Discussions have revealed that (a) Most G-SIFIs have a risk appetite statement but both firms and supervisors have difficulty determining its suitability; (b) While resources at supervisory authorities have increased since the financial crisis, the pace of increase has not been commensurate with higher regulatory and supervisory demands placed on supervisors, such as supervisory colleges and CMGs; (c) Supervisory approaches to understanding business models vary in part due to resource constraints and lack of expertise; and (d) Supervisors see operational risk as the next big risk which cannot be solved entirely by higher capital. While progress is being made in these areas, more work is needed. The FSB will be developing recommendations on how to ensure supervision of these areas is more intense, more effective and more reliable to promote financial stability.

(iii) Enhancing the effectiveness of supervisory colleges:

As recommended by the SIE report, the BCBS and IAIS are studying how to improve the operations of supervisory colleges in order to ensure a more rigorous and coordinated assessment of the risks facing the G-SIFIs.



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In the second half of 2012, the FSB will also be discussing the means to enhance the effectiveness of supervisory colleges, in particular for G-SIFIs.

(iv) Improving firms’ risk data aggregation capabilities:

The BCBS is acting on the SIE recommendation to develop supervisory expectations for firms’ risk data aggregation capabilities. A paper setting out principles for effective risk data aggregation and risk reporting is under development. The principles will be finalised by the end of the year and G-SIBs are expected to implement these principles by the beginning of 2016, which is the start of the phase-in period for the added loss absorbency requirements for G-SIBs. Supervisors will start discussing implementation with senior management of these firms from early 2013 and ensure that the G-SIBs develop strategies to meet the principles by early 2016.

3.3 Extending the SIFI framework

After the comprehensive framework for addressing the “too-big-to-fail” problem was agreed at the Cannes Summit, the G20 Leaders asked the FSB in consultation with the BCBS, to extend expeditiously the G-SIFI framework to D-SIBs.

The IAIS was asked with the development of an assessment methodology for the identification of global systemically important insurers (G-SIIs) and to continue its work on a common framework for the supervision of internationally active insurance groups (ComFrame).

The G20 Leaders also called on the FSB to prepare methodologies to identify global systemically-important non-bank financial entities (non-bank G-SIFIs) by end-2012 in consultation with IOSCO.



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3.3.1 Domestic systemically important banks

The FSB, in consultation with the BCBS, submitted to the G20 Finance Ministers and Central Bank Governors in April 2012 a progress report on the modalities to extend the G-SIFI framework to D-SIBs.

The G-SIB framework assesses the externalities from a global perspective (i.e., where distress or failure would disrupt the global financial system), making no distinctions about impacts on individual jurisdictions.

The policy framework envisaged for D-SIBs would take the perspective of individual jurisdictions.

That is, it addresses the impact of failure associated with the local presence of a bank - whether a national or an internationally-active bank – in a given jurisdiction.

The D-SIB framework being considered would be based on assessments by local authorities, who are best placed to identify the banks which are systemically-important relative to the domestic economy.

An important aspect of a D-SIB framework relates to its compatibility with the G-SIB framework, to ensure that adequate and consistent incentive structures are in place at the domestic as well as at the international level.

The principles for D-SIBs being considered therefore seek to establish a minimum framework that would ensure compatibility with the G-SIB framework, address the cross border externalities that the failure of a D-SIB may nonetheless pose, and preserve a level playing field within and across jurisdictions.

The principles would include guidelines for national authorities to assess the systemic importance of banks in a domestic context.

The BCBS is developing a set of principles as a common framework for D-SIBs, including on the issues of compatibility with the G-SIB framework, home-host coordination, and the instruments and composition of additional loss absorbency for D-SIBs.



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The FSB and BCBS will submit the outcome of this work to the G20 Finance Ministers and Central Governors meeting in November 2012.

3.3.2 Systemically important insurers

The IAIS has made progress in developing a proposed assessment methodology for identifying G-SIIs.

A consultation paper was issued in May 2012 on the proposed IAIS assessment methodology for identifying G-SIIs.

The paper included some initial thoughts on the policy measures that should apply to G-SIIs and further development of potential policy measures is underway.

Potential measures include enhanced supervision, improved resolvability, structural measures, higher loss absorbency and restrictions on certain activities. A consultation paper on proposed policy measures will be issued in September 2012.

The IAIS will deliver to the G20 in April 2013 a consolidated paper on the assessment methodology and the policy measures.

At that time, the FSB and national authorities, in consultation with the IAIS, will determine the initial cohort of G-SIIs.

Meanwhile, IAIS’ work on developing a common framework for internationally active insurance groups (ComFrame) is progressing and its development phase is expected to be completed in 2013.

3.3.3 Systemically important non-bank financial entities23

In response to the request of the G20 Leaders, the FSB, in consultation with IOSCO, is preparing methodologies for identifying non-bank G-SIFIs whose distress or disorderly failure would cause significant disruption to the wider financial system and economic activity at the global level.

This is in line with the methodologies developed for identifying G-SIBs and also with that of G-SIIs issued for consultation by the IAIS in May.



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In developing the methodologies, the FSB will focus on detailed design issues such as the scope of application, applicability of materiality criteria, modus operandi and data availability.

At the national level, meanwhile, the US Financial Stability Oversight Council (FSOC) published in April 2012 the final rule and the interpretive guidance regarding the process and criteria to be used for designating non-bank financial institutions for consolidated supervision by the Federal Reserve System and enhanced prudential standards as their material financial distress – or the nature, scope, size, scale, concentration, interconnectedness, or mix of its activities – could pose a threat to the US financial stability.

Based on the published rule, the FSOC could make the first of these designations during 2012.

Strengthening the oversight and regulation of shadow banking At the Cannes Summit, the G20 Leaders agreed to strengthen the oversight and regulation of the shadow banking system, and endorsed the FSB’s initial recommendations with a work plan to further develop them in 2012.

At the request of the G20, a progress report on shadow banking was submitted to the G20 Finance Ministers and Central Bank Governors in April 2012.

The “shadow banking system” which can be broadly described as “credit intermediation involving entities and activities outside the regular banking system” has become an integral part of the modern financial system that has an important role in supporting the real economy.

However, the shadow banking system can also pose risks to the financial system, on its own and through its links with the regular banking system.

The FSB issued initial recommendations in its October 2011 report Shadow Banking: Strengthening Oversight and Regulation to address potential risks in the shadow banking system.

It has adopted a two-pronged approach.



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First, the FSB will enhance the monitoring framework through continuing its annual monitoring exercise to assess global trends and risks, with more jurisdictions participating in the exercise.

Second, the FSB will develop recommendations to strengthen the regulation of the shadow banking system, where necessary, to mitigate the potential systemic risks with specific focus on the five areas explained in section 4.2.

An initial integrated set of policy recommendations will be developed by the end of 2012.

A properly structured and regulated shadow banking sector can make the financial system more robust, efficient and diversified; hence, the reforms in this area will seek to mitigate systemic risks while preserving the scope for realising those benefits.

4.1 Strengthening oversight of the shadow banking system

The FSB has set out recommendations for effective monitoring of shadow banking in its October 2011 Report and also committed to conduct annual monitoring exercises to assess global trends and risks in the shadow banking system.

The global monitoring exercise conducted in 2011 covered eleven FSB member jurisdictions and the euro area.

The coverage of the 2012 monitoring exercise will be extended to cover the remaining FSB jurisdictions.

The annual monitoring exercise is expected to facilitate the national authorities’ assessment of shadow banking risks based on the FSB recommendations, and the sharing of experiences among authorities in order to highlight trends in shadow banking that are of relevance to the stability of the global financial system.

In addition to participation in the FSB annual monitoring exercise, a few jurisdictions have also taken steps to enhance the monitoring of shadow banking in their jurisdictions.

For example:



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- In Australia, the Reserve Bank of Australia (RBA) will provide an annual update on the shadow banking system to the Council of Financial Regulators (CFR). This should identify any emerging risks, which may lead to changes to regulatory arrangements if that is warranted.

- In Canada, the Office of the Superintendent of Financial Institutions (OSFI) has initiated work to examine Canadian banks’ interactions with shadow banking entities, in the context of the Canadian marketplace. The Bank of Canada is also expanding the resources devoted to assessing risks and vulnerabilities in the financial system, including the shadow banking system. It is developing a shadow banking monitoring framework in coordination with other federal and provincial authorities, focusing on the channels through which shocks can be propagated through the financial system.

- The European Central Bank (ECB) has proposed the creation of an EU Central Database on Euro Repos as a joint effort by public authorities and the financial industry. This is to address the lack of granular data on the repo market in the euro area, with the aim to allow better monitoring from a financial stability perspective.

- In the US, FSOC provides US regulators with a surveillance mechanism and allows for a flexible approach to address potential risks in the shadow banking system. Under the Dodd-Frank Act (DFA), FSOC has the discretion to subject any non-bank financial company to a detailed review if the company could pose a threat to US financial stability.



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That company would then be subject to heightened prudential standards. The DFA requires that FSOC’s Annual Report address significant financial market and regulatory developments, along with an assessment of developments on the stability of the financial system; potential emerging threats to financial stability; and, recommendations to enhance the integrity, efficiency, competitiveness. As a result of DFA, the SEC expanded its regulatory scope and is now collecting additional information through Form PF on hedge funds and private equity funds that have at least $150m in assets under management to better monitor their activities.

4.2 Strengthening regulation of the shadow banking system

Based on the initial recommendations and work plans set out in the October 2011 Report, five workstreams have been launched to advance the work to develop proposed policy recommendations.

(i) Banks’ interactions with shadow banking entities:

With the objective of mitigating the spill-over effects between the regular banking system and the shadow banking system, the BCBS will propose, where needed, to regulate banks’ interactions with shadow banking entities by July 2012.

It is currently reviewing the consolidation rules for prudential purposes; limits on the size and nature of a bank’s exposures to shadow banking entities; risk-based capital requirements for banks’ exposures to shadow banking entities; and the treatment of reputational risk and implicit support.

(ii) Money market funds (MMFs):



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IOSCO was tasked to develop by the autumn 2012 policy recommendations to reduce the susceptibility of MMFs to “runs”. IOSCO published in April 2012 a consultation report that provides an analysis of the systemic importance of MMFs and their key vulnerabilities, including their susceptibility to runs, and sets out possible policy options to reinforce the soundness of MMFs and to address the identified systemic vulnerabilities. The possible policy options include: a mandatory move from constant to variable net asset value (NAV); enhancement of MMF valuation and pricing framework; enhancement of liquidity risk management; and reduction in the importance of ratings in the MMF industry. These options are not mutually exclusive and some may be considered in combination. IOSCO envisages using the outcomes of the consultation to narrow down the policy options into policy recommendations.

(iii) Other shadow banking entities:

An FSB workstream is developing policy recommendations by September 2012, where appropriate, on the regulation of shadow banking entities other than MMFs to mitigate their systemic risks. The Workstream has completed a categorisation and data collection exercise for a wide range of non-bank financial institutions (or Other Financial Intermediaries (OFIs)). After casting the net wide through this exercise, the Workstream is adopting a two-step prioritisation process to narrow the scope to certain types of entities that may need policy responses. The first step is to develop a list of entity types (filtered list) for closer scrutiny based on national experience (i.e. authorities’ judgements) and size; the second step entails the detailed assessment of the shadow banking risk factors (e.g. maturity transformation, liquidity



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transformation and leverage) with respect to each entity type in the filtered list. The Workstream plans to analyse the filtered entities by looking at their economic functions rather than legal names or forms. In this way, the Workstream aims to develop potential policy recommendations that can be applied across jurisdictions to all entities that have the same economic function, while taking account of the heterogeneity of economic functions carried out by different entities within the same sector.

(iv) Securitisation:

To assess and align the incentives associated with securitisation to prevent it creating excessive leverage in the financial system, IOSCO, in coordination with the BCBS, is examining the (i) Retention requirements and (ii) Measures that are aimed at enhancing transparency and standardisation related to securitisation. As the first phase of its work, the European Commission (EC) and the US Securities and Exchange Commission (SEC) staff have completed a comparison of securitisation rules in the EU and US. Building on this work, IOSCO has conducted an analysis of global regulatory and industry initiatives on risk retention, transparency and standardisation, as well as the identification and assessment of material differences in regulatory/industry approaches and their impact. Draft policy recommendations are set out in a consultation report published in June 2012.29 Based on the comments received on the consultation report, IOSCO will publish the final report in late 2012.



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(v) Securities lending and repos:

An FSB workstream is examining the regulation of secured financing contracts such as repos, and securities lending from a financial stability perspective, by the end of 2012.

The Workstream published in April 2012 its interim report which covers an overview of the securities lending and repo markets; key drivers of the securities lending and repo markets; its location within the shadow banking system; overview of existing regulatory framework; and financial stability issues.

The financial stability issues identified by the Workstream include

(i) Lack of transparency,

(ii) Pro-cyclicality of system leverage and interconnectedness through valuation, haircuts and collateral re-use,

(iii) Other issues associated with re-use of collaterals,

(iv) Potential risks arising from fire-sale of collateral assets,

(v) Potential risks arising from securities lending activities,

(vi) Shadow banking through cash collateral reinvestment, and

(vii) Insufficient rigour in collateral management and valuation.

Based on its mapping of the markets and identification of financial stability issues, the Workstream will develop policy recommendations as necessary by the end of 2012.

In addition to the policy-making work at the FSB-level, some national and regional authorities have embarked on initiatives to address potential risks arising from the shadow banking system in their respective jurisdictions.

For example:

- In Australia, the Australian Securities and Investments Commission (ASIC) will be producing an internal report by 30 June 2012 on MMFs. Any further work in thissector will be informed by the internal report



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and its conclusions regarding whether or not appropriate regulation is in place.

- In the EU, the EC issued in March 2012 a Green Paper on Shadow Banking that draws from the FSB’s October 2011 report. The paper takes stock of current developments and presents on-going reflections on the subject to gather views from the stakeholders, in order to enable the EC to actively respond and contribute to the global debate.

- In the US, authorities have taken many steps to address potential systemic risks to financial stability emanating from the shadow banking system.

In addition to the establishment of FSOC and its authority to designate a non-bank financial firm for prudential supervision, the US has taken policy measures that seek to address risks posed by money market funds, private investment funds, securitisation activities and the tri-party repo market.

For example, the SEC adopted new rules in February 2010 to increase the resilience of MMFs to economic stresses, and reduce the risks of runs by tightening maturity and credit quality standards and imposing new liquidity requirements.

The new rules include provisions to: improve liquidity, credit quality and disclosure, and require periodic stress tests. The DFA imposes new requirements relating to asset-backed securities, including those for risk retention, disclosure, and conflict of interest.

Creating continuous core markets - OTC derivatives reforms In September 2009 in Pittsburgh, the G20 Leaders agreed that all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCPs) by end-2012 at the latest; OTC derivative



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contracts should be reported to trade repositories (TRs); and non-centrally cleared contracts should be subject to higher capital requirements.

The FSB published a report, Implementing OTC Derivatives Markets Reforms, in October 2010 that set out 21 recommendations to address practical issues in implementing the G20 Leaders’ commitments.

The FSB’s OTC Derivatives Working Group has been monitoring the implementation of the OTC derivatives markets reforms, with reports to the FSB every six months.

In October 2011, the FSB published its second progress report on the implementation of OTC derivatives reform, cautioning that, with only just over one year until the end-2012 deadline for implementing the G20 commitments, few FSB members had the legislation or regulations in place to provide the framework for operationalising the commitments.

Since then, as noted in the FSB’s third progress report published in June 2012, encouraging further progress has been made in setting international standards, the advancement of national legislation and regulation by a number of jurisdictions and practical implementation of reforms to market infrastructures and activities.

The report concludes that all jurisdictions and markets need to aggressively push ahead to achieve full implementation of market changes by end-2012 to meet the G20 commitments in as many reform areas as possible. Jurisdictions have sufficient information about international standards and policies to put in place the needed legislation and regulation.

They should do so promptly, and in a form flexible enough to respond to cross-border consistency and other issues that may arise.

Broadly speaking, the jurisdictions currently with the largest markets in OTC derivatives – the EU, Japan and the US – are the most advanced in structuring their legislative and regulatory frameworks.

They expect to have regulatory frameworks in place by end-2012 and practical implementation within their markets is well underway.



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Other jurisdictions are generally less advanced although, as the third progress report indicates, progress has been made by many of them, particularly with respect to central clearing and reporting to TRs.

The development of implementing regulations to require exchange or electronic platform trading, where appropriate, is generally less advanced.

National implementation of capital requirements for exposures to CCPs and margining requirements for non-centrally cleared contracts is awaiting international principles that are currently under development.

One reason for the slower timetables in some jurisdictions has been that authorities had been waiting for the key elements of the regulatory frameworks in the EU, Japan and the US to be finalised before putting their own legislation in place, in an effort to be consistent with these frameworks.

Additionally, some jurisdictions have sought greater certainty about the application of international principles and safeguards to cross-border financial market infrastructure, including CCPs and TRs, so as to make an informed decision about the appropriate form of market infrastructure for their jurisdiction.

Since the October 2011 progress report, SSBs have made significant progress in developing international policies, notably:

- CPSS and IOSCO issued the Principles for FMIs (PFMIs) in April 2012. These principles, which harmonise, strengthen and replace the previously separate sets of principles for different types of FMIs, are an important milestone in the global development of a sound basis for central clearing of all standardised OTC derivatives.

- IOSCO published its Report on Requirements for Mandatory Clearing in February 2012, providing important guidance for jurisdictions on the process for setting the scope of central clearing requirements.

- CPSS and IOSCO published in January 2012 a Report on OTC derivatives data reporting and aggregation requirements,



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recommending that TRs implement measures to provide authorities with effective and practical access.

- IOSCO published its Final Report on International Standards for Derivatives Market Intermediary Regulation in June 2012, which recommends high-level international standards for the regulation of market participants that are in the business of dealing, making a market or intermediating transactions in OTC derivatives.

Additionally, the Committee on the Global Financial System (CGFS) published in November 2011 a report The macrofinancial implications of alternative configurations for access to central counterparties in OTC derivatives markets that analyses the implications for financial stability of the alternative arrangements for access to CCPs (such as through large global or smaller regional or domestic CCPs) and assesses the potential trade-offs involved.

IOSCO published in January 2012 additional analysis of the characteristics of different types of organised trading platforms, following on from its February 2011 report.

International workstreams are also progressing rapidly to develop frameworks for a global LEI (see section 7.1); guidance on resolution of CCPs (see section 3.1); capital adequacy rules for exposures to CCPs; international standards on margin requirements for non-centrally cleared derivatives; and work on regulatory access to data from TRs.

In January 2012, the FSB identified four safeguards for a resilient and efficient environment for central clearing, on which substantial progress should be made by mid-2012 to support national authorities in deciding whether to rely on domestic or global clearing infrastructure to meet the G20 commitment to centrally clear all standardised OTC derivatives.

Substantial progress has now been made, through SSB workstreams and otherwise, to provide these safeguards and thus allow authorities to make their decisions.

The safeguards, and the steps taken to achieve them, are:



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(i) Fair and open access by market participants to CCPs, based on transparent and objective criteria (addressed within the PFMIs);

(ii) Cooperative oversight arrangements between all relevant authorities, both domestically and internationally and on either a bilateral or multilateral basis, that result in robust and consistently applied regulation and oversight of global CCPs (addressed as a minimum standard through the responsibilities for authorities set out in the PFMIs and in practice through individual cooperative agreements in place or in development for CCPs);

(iii) Resolution and recovery regimes that ensure the core functions of CCPs are maintained during times of crisis and that consider the interests of all jurisdictions where the CCP is systemically important (CPSS and IOSCO plan to issue in July a consultation paper on the application of the Key Attributes of Effective Resolution Regimes to CCPs and other FMIs); and

(iv) Appropriate liquidity arrangements for CCPs in the currencies in which they clear (addressed within the PFMIs and through conclusions of the Economic Consultative Committee of the Bank for International Settlements (BIS)).

The FSB, through its OTC Derivatives Working Group, seeks to identify any overlaps, gaps or conflicts in national frameworks or implementation that might compromise the achievement of the G20 commitments, particularly where there may be a risk that such issues will not be satisfactorily resolved through existing bilateral or multilateral channels.

Additionally, the FSB has established the OTC Derivatives Coordination Group, comprising the chairs of the BCBS, CGFS, CPSS, IOSCO and the FSB, to discuss on a regular basis the coordination of international workstreams on OTC derivatives reforms.

The progress achieved to date is contributing to the broader G20 goals of improving transparency, mitigating systemic risk and protecting against market abuse.

This is an important part of FSB’s broader efforts to end “too big to fail” and to support continuouslyopen markets.



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To assist in doing so, the FSB will seek to further improve data and other survey information on the extent to which OTC derivatives are in practice standardised, centrally cleared, traded on organised platforms and reported to TRs.

For the next progress report, the FSB intends to put additional focus on the readiness of infrastructures to provide central clearing, platform trading and reporting of OTC derivatives, the practical ability of industry to meet the requirements and the remaining steps for the industry to take.

At the Cannes Summit, the G20 Leaders requested IOSCO to assess the functioning of credit default swaps (CDS) markets and the role of those markets in price formation of underlying assets.

In response to the G20 request, IOSCO has prepared a report that analyses the CDS markets as a whole, including both corporate and sovereign CDS markets (prioritising sovereign CDS markets) and encompasses:

- An examination of existing research on the functioning of CDS markets, notably information about the trading, pricing and clearing of CDS;

- The nature of the CDS markets, e.g. type or level of volatility and liquidity and the links to the cost of funding; and

- Recent experience with the functioning of the CDS markets, e.g. the effect of a 50% write down on Greek debt triggering or not triggering a default for CDS purposes.

Creating continuous core markets converging accounting standards At the Cannes Summit, G20 Leaders reaffirmed their objective to achieve a single set of high quality global accounting standards and meet the objectives set at the London summit in April 2009, notably as regards the improvement of standards for the valuation of financial instruments.



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They called on the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) to complete their convergence project and requested a progress report at the G20 Finance Ministers and Central Bank Governors meeting in April 2012.

They also looked forward to the completion of proposals to reform the IASB governance framework.

Nearly all FSB member jurisdictions have either adopted IASB standards (International Financial Reporting Standards - IFRS) or have programmes underway to converge with, or consider adoption of, IFRS by end-2012.

The US SEC continues to work toward determining whether to incorporate IFRS into the financial reporting system for US issuers. Foreign private issuers in the US are already allowed to follow IFRS.

As requested by the G20 Leaders, a joint update report from the two standard setters was provided to the FSB and to the G20 Finance Ministers and Central Bank Governors in April 2012.

- While important improvements to their standards on financial instruments’ fair values and off-balance sheet entities were finalised in 2011, the convergence process is taking longer than initially expected in some areas, such as classification, measurement and provisioning. Also, the Boards are not addressing hedge accounting issues jointly. At the Cannes Summit, the FSB encouraged the Boards to redouble their efforts to seek converged standards in these important areas.

- While delays have taken place, the IASB and FASB are making progress on projects to converge their standards on financial instruments, including a joint expected loss impairment (“provisioning”) approach and a more converged approach to classification and measurement.

Consistent with earlier FSB recommendations, it will be important that the IASB and FASB final standard on expected loss impairment result in improved provisioning practices that will incorporate a



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broader range of available credit information than existing provisioning requirements, so as to recognise credit losses in loan portfolios at an earlier stage.

- The IASB and FASB will conduct further public consultations in the second half of 2012, and expect to issue final converged standards in a number of key areas by mid-2013.

The two Boards have extended certain project target completion dates in order to allow sufficient time for extensive outreach and public comment on the large number of planned major Exposure Drafts, and for the Boards to reflect that feedback in high-quality final standards.

The FSB supports the efforts of the IASB and FASB to achieve convergence to a globally accepted set of high-quality accounting standards and urges them to issue final converged standards on key projects by their expected timeframe of mid-2013.

The netting/offsetting of derivative contracts and other financial assets and financial liabilities is another area where the FSB has expressed concerns.

In this case, different approaches result in significant differences in total assets and/or total liabilities in balance sheets of large financial institutions.

After considering the comments of stakeholders the Boards decided to maintain their current different offsetting accounting models but to improve and converge related disclosure requirements.

After the Cannes Summit the Boards issued in December 2011 new requirements for common disclosures about gross and net positions for derivatives and other financial instruments.

This followed the Boards’ issuance of a joint proposal in January 2011 on a converged accounting approach to balance sheet netting.

However, instead of supporting the joint 2011 proposal, commenters from the US generally supported the current FASB netting rules and those



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using IFRS generally supported current IASB rules, with many investors seeking both gross and net information.

Derivatives dealer banks, both inside and outside the US, generally wanted the FASB (net) accounting approach in order to avoid a very significant grossing-up of their balance sheets.

The FSB noted that differences in the offsetting/netting accounting standards would adversely affect the efforts to develop an internationally comparable leverage ratio for capital purposes. However, from a bank supervisory perspective, there may be more convergence for the Basel III leverage ratio purpose than is first apparent. While the IASB and FASB have decided to maintain their different accounting rules for netting/offsetting, the FASB netting approach and the netting approach that will be carried forward to the Basel III leverage ratio are similar in their effect because both recognise netting/offsetting for derivatives based on legally enforceable master netting agreements without requiring the intent or ability to net in the normal course of business. Following a request at the Cannes Summit, reforms were announced in February 2012 by the IFRS Foundation (IFRSF) Trustees and the IFRSF Monitoring Board to improve the governance of the IASB.

These include internal organisational changes as well as reforms that seek to enhance the involvement of key stakeholders, including those from emerging market economies, and improve the technical dialogue of the IASB with market regulators, investors and prudential authorities. The internal changes and reforms are being implemented in a manner that will enhance the IASB’s efficiency and effectiveness.

The IASB provided a report on these governance reforms to the G20 Finance Ministers and Central Bank Governors in April 2012.



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7. Creating continuous core markets – Other market reforms 7.1. Building a common legal entity identifier

At the Cannes Summit, the G20 Leaders supported the creation of a global LEI which uniquely identifies parties to financial transactions, and called on the FSB to take the lead in helping coordinate work among the regulatory community to prepare recommendations for a governance framework for such a global LEI that is consistent with the public interest.

To meet that request, the FSB has prepared a report (LEI Report) containing recommendations to implement a global LEI system.

The global LEI system would contribute to and facilitate many financial stability objectives, including: improved risk management in firms; better assessment of micro and macro-prudential risks; facilitation of orderly resolution; containing market abuse and curbing financial fraud; and enabling higher quality and accuracy of financial data overall.

It would mitigate operational risks within firms by reducing the need for tailored systems to reconcile the identification of entities and to support aggregation of risk positions and financial data, which impose substantial deadweight costs across the economy.

It would also facilitate straight-through-processing.

The LEI Report contains 35 recommendations for the development and implementation of the global LEI system.

These recommendations are guided by a set of “Global LEI System High Level Principles” which set out the objectives that the design of a global LEI system must meet.

The broad goal of the proposals is to put in place a strong global governance framework to protect the public interest, while promoting an open, flexible, and adaptable operational model for the global LEI system.

The proposals draw on input and advice from the FSB LEI Industry Advisory Panel.



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The suggested code and initial reference data are consistent with the standard developed for the LEI by the International Organization for Standardization (ISO) through an industry consensus process (ISO 17442:2012).

A three-tier structure for the global LEI system based on a federated approach is recommended:

- The first element is a Regulatory Oversight Committee (ROC). This will carry the ultimate responsibility for the governance of the global LEI system in the public interest. The ROC will be established by endorsement of a proposed global LEI Regulatory Oversight Committee Charter which will set out the governance framework and arrangements. It will comprise authorities that support the High Level Principles and purposes of the LEI, and will have an Executive Committee to steer the work under guidelines to be set out in the Charter.

- The second component is a Central Operating Unit (COU) which will form the pivotal operational arm of the global LEI system. Key tasks of the COU will be to implement agreed central operational standards that ensure uniqueness of the LEI and that deliver a “logically” centralised database of high quality reference data (such as name and address, and, over time, information on ownership relationships). In legal form, the COU will be a not-for-profit foundation (or equivalent). It will be composed of private industry representatives from the various geographic regions and sectors.

- The third part of the system will be federated Local Operating Units (LOUs).



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The LOUs will be the local implementers of the global system. They will conduct local registration of legal entities and will be responsible for the validation and maintenance of the high quality reference data. Using local systems will facilitate the use of local languages and operational types. LOUs may also build on local infrastructure such as business registries and numbering agencies. LOUs may be operated either by private or public bodies. They will, however, need to adhere to the agreed global standards to ensure that the system delivers high quality and consistent information. In this context, interim local solutions could be subsequently integrated into the proposed global LEI framework.

The FSB’s objective is to have a fully functioning self-standing governance and operational framework for the global LEI system by March 2013.

The timeline and deliverables in moving towards that objective are as follows:

- Submission of the Global LEI ROC Charter to the FSB in October 2012 or the G20 in November 2012 for endorsement;

- Development of the necessary legal framework for the functioning of the ROC and the COU; and

- Development of the legal and technological framework for the proposed global LEI foundation and operational model.

An Implementation Group, comprised of experts from the global regulatory community is being formed to advance this workplan. The



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Implementation Group will work in close coordination with experts from private industry.

7.2 Reducing reliance on credit ratings and improving oversight of credit rating agencies

In February 2012 the FSB conducted a review of its members’ compliance with the FSB Principles for Reducing Reliance on Credit Rating Agency (CRA) Ratings.

The aim of these Principles, issued in October 2010, is to reduce mechanistic reliance on CRA ratings that can amplify procyclicality and contribute to systemic disruption through herding behaviour and selloffs of securities when they are abruptly downgraded (“cliff effects”).

In the period since the FSB Principles were issued, widespread CRA rating downgrades have further underscored the importance of these issues.

The FSB Principles encourage banks, institutional investors and other market participants to develop their own internal risk management capabilities to avoid mechanistic reliance on external credit ratings.

CRA ratings should be an input, but no more than that, to the risk assessment process.

Creating the right incentives for market participants to develop their risk management capabilities includes reducing the use (or “hard wiring”) of CRA ratings in regulatory regimes.

The hard wiring of CRA ratings has been wrongly interpreted as providing them with an official “seal of approval” and has contributed to an undesirable reduction in firms’ own capacity for credit risk assessment and due diligence.

Specifically, the report found that:

- A few jurisdictions have passed, or proposed, wide-ranging legislative or regulatory measures to reduce reliance on CRA ratings, but are facing difficulties in detailed implementation.



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- International standard setters have taken steps to examine the references to CRA ratings in their standards and, in some cases, to discourage undue reliance on CRA ratings within those standards. In a number of cases, study of the issue was either ongoing or was only just getting under way.

- The modest progress described in the report was due in part to the challenge of developing alternative risk assessment capabilities and processes.

These are essential to permit individual firms and official bodies to reduce their reliance on CRAs while maintaining adequate management of credit risk.

When the Principles were written it was recognised that this would take time, and for some market participants the process could take several years. However, the report concluded that the authorities can do more to facilitate this process by identifying the changes in practices that need to be made, sharing experiences and effective practices in developing reforms bearing in mind the need for international consistency, and establishing timetables and milestones for the transition.

The report called for clear milestones to be set out for the transition to a reduced reliance on CRA ratings over the medium term; in many cases those milestones remain to be defined.

Among the steps it recommended are:

- Further actions by national and regional regulators to encourage the appropriate use of CRA ratings as an input, but no more than that, to the risk assessment process.



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- Setting standards that actively promote the use of market participants’ own risk management capabilities rather than reliance on CRA ratings.

- SSBs should promote the sharing of successful practices to strengthen credit risk capabilities.

- Official sector bodies should publicly explain their approach to credit risk assessment in their market and investment operations and the further steps planned to align their practices with the FSB Principles.

- Further comparative analysis of actions to identify hindrances to removing references to CRA ratings in standards, laws and regulations, as well as help re-align national work plans with the FSB Principles.

To encourage further progress on the above issues, the FSB will organise a workshop in September 2012 that will bring together SSBs and national experts to review progress and agree on the next steps.

The output from the workshop will feed into a further progress report for the G20 Finance Ministers and Central Bank Governors meeting in November.

Other than the efforts to reduce mechanistic reliance on CRA ratings, most FSB members have already put in place requirements for the registration of CRAs.

Regulatory action is still in progress in two jurisdictions.

- In Mexico, CRAs have been required to be authorised since 1999. In February 2012, draft regulations were published to enhance the requirements for authorisation, including improvements on structured finance ratings and transparency.

- Saudi Arabia is currently developing its CRA Regulations, which will specify the procedures and conditions for obtaining an authorisation.



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These regulations will be in line with IOSCO’s Code of Conduct Fundamentals for Credit Rating Agencies.

A significant proportion of FSB members have also taken actions to improve CRA practices and procedures, such as the adoption of the IOSCO CRA Code, inclusion in relevant rules/regulations of the requirements for assuring the transparency and quality of the rating process, and providing full disclosure of their ratings track record.

7.3 Enhancing market disclosure and functioning

The financial markets are a potential transmission mechanism for systemic crisis, especially when market participants are faced with significant uncertainty, and engage in panic behaviour. In this regard, IOSCO has taken steps to strengthen market disclosure and enhance investor protection. IOSCO published in February 2012 a consultation report Principles for Ongoing Disclosure for Asset-Backed Securitiesthat provides guidance for securities regulators who are developing or reviewing their regulatory regimes for ongoing disclosure for asset-backed securities (ABS) so as to enhance investor protection. IOSCO issued in March 2012 a consultation report on Principles for the Regulation of Exchange Traded Funds which listed some common principles and guidelines relating to ETFs on investor protection, sound functioning of markets and financial stability.

In response to the G20 Leaders’ request at the Cannes Summit, IOSCO also published in March 2012 a consultation report containing proposals to improve the functioning and oversight of Price Reporting Agencies in the oil markets and has also published its update report to the G20 in June 2012.

In addition, IOSCO published in February 2012 a consultation report on Suitability Requirements with respect to the Distribution of Complex Financial Products, seeking views on common principles relating to



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suitability and disclosure standards for market intermediaries in relation to the distribution of comp

Enhancing compensation practices The 2011 FSB peer review on compensation indicated that good progress had been made in implementing the FSB Principles and Standards on Sound Compensation Practices (“Principles and Standards”, P&S), but that more work was necessary to overcome constraints to full implementation by individual national authorities and to address concerns by firms of an uneven playing field.

In response to the G20 Leaders’ request, the FSB established a Compensation Monitoring Contact Group (CMCG) comprising national experts from member jurisdictions with regulatory or supervisory responsibility on compensation practices.

The CMCG is responsible for monitoring and reporting to the FSB on national implementation of the P&S.

The progress report sent separately to G20 Leaders is the first outcome of this monitoring exercise, which is not as deep as a peer review.

The progress report describes the developments in implementing the P&S since the October 2011 thematic peer review.

Almost all FSB member jurisdictions have now completed the implementation of the P&S in their national regulation or supervisory guidance.

Those jurisdictions that still showed significant gaps at the time of the 2011 peer review (Argentina, India, Indonesia, Russia, and South Africa) have progressed in their implementation efforts.

However, in the case of Indonesia and Russia, the relevant regulation is currently under review and it has not yet been issued.

Moreover, some other jurisdictions (Argentina, Brazil, China, India, and Turkey) have elected not to implement one or more Standards related to the alignment of compensation with risk taking, either because they are



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not deemed applicable or because of domestic constraints (e.g. labour laws).

All jurisdictions that have not fully implemented the P&S will need to continue their efforts to overcome impediments to full implementation in order to ensure an outcome that is fully consistent with the objectives of the P&S. The reasons for not implementing specific Principles or Standards, as well as the nature of the actions taken to address identified impediments, will be reported to the FSB by the relevant jurisdictions and will be described in the next progress report.

In many jurisdictions supervisory attention continues to increase – indeed, a high level of supervisory engagement is reported to contribute to greater attention to compensation issues by firms.

Most authorities report that firms in their jurisdiction have made good progress and generally confirm that especially significant firms do not show major implementation gaps, although some challenges remain where more progress is needed, in particular in the area of alignment of compensation with ex-ante risk taking and with ex-post performance and concerning identification of material risk takers.

Especially in these areas more supervisory cooperation would be beneficial.

The FSB has also established in early 2012 a mechanism for national supervisors from FSB member jurisdictions to bilaterally report, verify and, if necessary, address specific compensation-related complaints by financial institutions that derive from level playing field concerns.

All FSB members have informed the relevant financial institutions operating in their jurisdiction of the main features of the Bilateral Complaint Handling Process (BCHP).

Although it is not possible to estimate a priori the volume of complaints that will be received, the process itself is designed to create the right incentives for implementation of the P&S by firms and to dispel their concerns relating to lack of information or adequate processes to address level playing field issues.



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The findings of the ongoing monitoring confirm that achieving lasting change in behaviour and culture within firms is a long-term challenge requiring a sustained commitment and that additional time is needed for effective and consistent implementation of the P&S to take place.

The FSB will continue to monitor and report on progress so as to generate substantive and relevant information that provides further impetus to aligning compensation practices to prudent risk taking behaviour.

Building and implementing macroprudential frameworks and tools

The G20 Leaders stated at the Cannes Summit that “We are developing macroprudential policy frameworks and tools to limit the build-up of risks in the financial sector, building on the ongoing work of the FSB-BIS-IMF on this subject.”

While a small number of jurisdictions (e.g. UK, US, EU) have established new institutional structures with macroprudential mandates, many others are implementing enhancements within the existing institutional arrangements.

A number of jurisdictions are enhancing their macroprudential frameworks and powers to gather data that are needed for monitoring systemic risk, for example:

- In Switzerland, the Financial Stability Working Group (MoF, SNB, FINMA) published in March 2012 a report on proposals to amendments of regulatory systems. With respect to this, two amendments to the Capital Adequacy Ordinance are planned: the early introduction of a countercyclical capital buffer; and an increase in capital requirements for risky mortgage lending business. Furthermore, a majority of the group has recommended the creation of a right to direct access for the SNB to information on financial market participants which goes beyond its existing entitlement to statistical data.



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- In the US, the DFA created the FSOC to provide comprehensive monitoring of risks to financial stability, promote market discipline, and respond to emerging threats. The FSOC’s assessment of threats to the financial system is a collaborative process, driven by review of the best information available and expertise from FSOC members and their agencies and staff. The FSOC has a number of tools to address threats to financial stability, including its authority to designate non-bank financial companies and financial market utilities for enhanced prudential standards and supervision. The FSOC also has the ability to provide for more stringent regulation of a financial activity by issuing recommendations to financial regulatory agencies to apply new or heightened standards and safeguards. In addition, FSOC members have many tools at their disposal to address vulnerabilities and threats, owing to their involvement in supervision and regulation, consumer and investor protection, and market and infrastructure oversight.

- In the EU, the European Systemic Risk Board (ESRB), the macroprudential authority for the EU, published in January 2012 a set of recommendations addressed to the EU Member States on the macroprudential mandate of national authorities.

Under the recommendation, Member States should designate an authority in national legislation to conduct macroprudential policy, taking due consideration of national institutional frameworks.

Further, the ESRB recommended that EU Member States bestow the macroprudential authority with the powers to conduct macroprudential policy on its own initiative or as a follow-up to recommendations or warnings from the ESRB.



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The national authority should also have full access to all the necessary statistical information and policy instruments.

EU Member States are also called upon to confer on the authority the necessary independence for it to fulfil its tasks, to ensure an adequate level of accountability and to reserve the maximum of transparency.

The EU Member States are required to communicate their intentions with respect to implementation by June 2012 and to take the necessary actions before 1 July 2013.

The BCBS published in May 2012 two working papers arising from its Research Task Force Transmission Channel project that help to build the knowledge base in the area of macroprudential policies.

The first working paper, The policy implications of transmission channels between the financial system and the real economy, analyses the link between the real economy and the financial sector, and channels through which the financial system may transmit instability to the real economy.

The second working paper, Models and tools for macroprudential analysis, focuses on the methodological progress and modelling advancements aimed at improving financial stability monitoring and the identification of systemic risk potential.

The second working paper, in particular, discusses analytical methods used to measure the impact of macro-financial shocks on the real economy; developments in modelling financial sector liquidity risk including the potential for contagion; methods for measuring the potential for systemic risk; and bank behavioural responses to changing central bank and macroprudential policies and macroeconomic conditions.

Strengthening adherence to international financial standards

The FSB, in collaboration with the SSBs, established a framework in October 2011 – the CFIM – for monitoring and reporting on the implementation of the G20 financial reforms.



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The CFIM was subsequently endorsed by the G20 Leaders at the Cannes Summit as a way to “intensify our monitoring of financial regulatory reforms, report on our progress and track our deficiencies”.

The framework highlights priority areas that will undergo more intensive monitoring and detailed reporting via periodic progress reports and peer reviews.

It also outlines a process to facilitate ongoing consultation and collaboration between the FSB and the SSBs by clarifying their respective roles in monitoring national implementation efforts.

This consultation process is important to ensure that the plans for implementation monitoring are consistent with G20 reporting requirements as described in the CFIM.

The FSB has undertaken a number of steps since the adoption of the CFIM in October 2011 to put it in operation.

In priority areas where the policy development work is largely completed, the FSB is working with relevant SSBs to ensure that the scope and approach of implementation monitoring and reporting are sufficiently comprehensive and rigorous to satisfy G20 and FSB information requirements.

This is complemented by the FSB’s IMN, which is tasked with collecting information from national authorities and reporting on the implementation of financial reforms in other areas.

All implementation progress reports for the priority areas and the completed IMN national/regional responses on the progress in other areas are available on the FSB website.

In addition to periodic progress reports, the FSB monitors the implementation and effectiveness of international financial standards and policies via its peer review programme.

Peer reviews are an important institutional mechanism to promote complete and consistent implementation and are a means of fostering a race to the top by FSB member jurisdictions.



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They provide an opportunity for FSB members to engage in dialogue with their peers and to share lessons and experiences.

The FSB completed in December 2011 a review of experience to date with FSB peer reviews.

The review identified lessons and recommended certain refinements to the functioning of the programme in order to further enhance its effectiveness and value-added, which have been incorporated in the Handbook for FSB Peer Reviews.

Since the Cannes Summit, the FSB has completed a thematic peer review on deposit insurance systems (DISs) using the BCBS-IADI Core Principles for Effective Deposit Insurance Systems as a benchmark.

The review confirmed the importance and necessity of an effective DIS and noted that the crisis resulted in greater convergence in practices across jurisdictions and an emerging consensus about appropriate DIS design features.

While the reviewed DISs in FSB member jurisdictions were found to be broadly consistent with thestandard, there remain some areas where there appear to be divergences from (or inconsistencies with) the Core Principles.

In some areas, more precise guidance may be needed to achieve effective compliance or to better reflect leading practices.

The report contains a number of recommendations to address these issues.

The recommendations of past thematic peer reviews are also leading to concrete follow-up activities by relevant parties.

In the case of compensation practices, an ongoing monitoring mechanism has been established by the FSB to follow up on remaining gaps and impediments to full implementation as well as on actions taken in response to the peer review’s recommendations (see section 8).

In the case of risk disclosures, an FSB roundtable with relevant market participants was organised in December 2011 and the Enhanced



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Disclosure Task Force (EDTF) will take forward the work to identify leading practices and develop principles for risk disclosures.

In response to the recommendations from the peer review of residential mortgage underwriting practices, the FSB has issued an international principles-based framework for sound underwriting in this area.

Finally, in the case of the peer review on deposit insurance systems, the IADI is updating its guidance that pre-dates the financial crisis and developing additional guidance in certain areas covered by the Core Principles.

The FSB has also recently completed the country peer reviews of Canada and Switzerland.

Three more peer reviews – thematic reviews of risk governance and resolution regimes as well as the country review of South Africa – will be completed by early 2013.

All completed peer review reports are available on the FSB website.

FSB members’ adherence to international standards is essential to reinforce the credibility of the FSB’s efforts to strengthen adherence by all countries and jurisdictions.

To lead by example, member jurisdictions have agreed to publish information on the commitments they made under the FSB Framework for Strengthening Adherence to International Standards.

In March 2010, the FSB launched an initiative to encourage the adherence of all jurisdictions to regulatory and supervisory standards on international cooperation and information exchange, including by identifying non-cooperative jurisdictions and assisting them to improve their adherence.

The initiative responded to a call by the G20 Leaders at their April 2009 Summit for the FSB to develop a toolbox of measures to promote adherence to prudential standards and cooperation.

The FSB has prioritised about 60 jurisdictions for evaluation, including all 24 FSB member jurisdictions and non-FSB jurisdictions that rank highly in financial importance.



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To recognise the progress that jurisdictions have made toward addressing weaknesses in international cooperation and information exchange, and to incentivise improvements by those jurisdictions not cooperating fully, the FSB published on 2 November 2011 information on the jurisdictions evaluated to date.

Since then, China and Saudi Arabia have demonstrated, through the results of their IMF-World Bank assessments, sufficiently strong adherence to the relevant standards.

The FSB will publish updatedinformation in November 2012 on all jurisdictions that have been evaluated under the initiative.

11. Strengthening FSB governance 11.1 Strengthening FSB’s capacity, resources and governance

To meet the mandate given by the G20 Leaders at the Cannes Summit to strengthen the FSB’s capacity, resources and governance, including its establishment on an enduring organisational footing while preserving its strong and well-functioning links with the BIS, the FSB established a High-Level Working Group on FSB Capacity, Resources and Governance.

The FSB has submitted its recommendations along with a revised FSB Charter to the Los Cabos Summit for G20 Leaders’ endorsement.

The main recommendations of the Working Group include:

(i) Preserving the FSB’s flexible, responsive, member-driven, multi-institutional and multi-disciplinary character, active involvement of senior-level officials from finance ministries, central banks and supervisory authorities, and nexus between the political level and regulatory policy making of the SSBs;

(ii) Pursuing a gradual approach to the institutionalisation of the FSB by establishing it as an association under the Swiss law to provide it a legal personality, with the functional immunities needed for its effective operation as a policy making body while maintaining strong and well-functioning links with the BIS;



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(iii) Strengthening its continuing role in reducing the likelihood of financial crises through vulnerability assessment, effective and forward looking coordination of international standard setting, reviewing regulatory policies within a macroprudential perspective and comprehensive monitoring of members’ implementation of international financial standards and agreed G20 and FSB commitments and recommendations;

(iv) As needed to regulatory gaps that pose risk to financial stability, developing or coordinating development of standards and principles, in collaboration with the relevant SSBs and other stakeholders, as warranted, in areas which do not fall within the functional domain of another international standard-setting body, or on issues that have cross-sectoral implications, in line with the current practice; and

(v) Improving its governance, transparency and accountability arrangements through amendments to its charter, setting up Rules of Procedure and establishing a Standing Committee on Budget and Resources for effective financial governance.

The implementation of the recommendations would commence shortly after the G20’s endorsement.

As part of the ongoing governance reforms, in January 2012, the FSB also reconstituted its Steering Committee to rebalance its composition in terms of institutional and geographic representation.

11.2 Increasing outreach through the FSB regional consultative groups

In response to the G20 Leaders’ call at the Toronto Summit for the FSB to expand and formalise its outreach beyond its membership, the FSB established in 2011 Regional Consultative Groups (RCGs) for the Americas, Asia, the Commonwealth of Independent States, Europe, Middle East & North Africa, and Sub-Saharan Africa.

The RCGs bring together financial sector authorities from FSB member and non-member jurisdictions to exchange views on vulnerabilities



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affecting financial systems and on initiatives to promote financial stability.

Membership in the RCGs includes ministries of finance, central banks and supervisory authorities in 65 FSB non-member jurisdictions and their counterparts in FSB member jurisdictions.

All of the RCGs have met at least once and some have set up working groups to study financial stability issues of interest to their respective region.

RCGs have presented the output of the working groups to the FSB Plenary as a part of the consultative feedback provided by non-FSB members.

12. Other issues 12.1 Addressing data gaps

In the global financial crisis that began in 2007, the lack of timely, accurate and consistent information on large systemically important banks has proved very costly.

The critical initiatives underway to reform and strengthen the financial system all require better data, be it to support more intensive supervision, to identify risk concentrations and the build-up of systemic risk, or to assist authorities in crisis situations.

In this regard, the FSB Data Gaps Project aims to provide a consistent framework to pool and share relevant data on the major bilateral linkages between large international financial institutions, and on their common exposures to and funding dependencies on countries, sectors and financial instruments.

As part of a wider initiative to improve data to support financial stability, the FSB was tasked with improving the availability, quality and consistency of data on major global financial institutions and financial inter-linkages.

To take this forward, the FSB has set up a working group of experts from national authorities and international institutions, with the mandate to



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develop proposals for a new common data template for globally systemic institutions.

The working group is conducting extensive preparatory work, including a thorough examination of legal issues on the sharing of data and a continued consultation with the industry on the common template.

The FSB is taking an incremental approach for the FSB Data Gaps Project with three distinct phases characterised by a progressive increase in the granularity of the data and in the sharing of information.

The FSB has approved the implementation of the initial phase of the project (“Phase 1”) for a start in March 2013.

This phase foresees the creation of a central hub to be hosted by the BIS for the storage and management of data collected and the sharing of this information among relevant supervisory authorities.

Implementation work for Phase 1 is on track, both on the data side, with the planned finalisation of the Phase 1 template very shortly, and on the governance side, where key principles underpinning exchange of information in Phase 1 have been developed.

Regarding the next phases of the project, preparatory work is ongoing on data templates and on the feasibility of wider data sharing.

The FSB will decide on the implementation of Phases 2 and 3 after this preparatory work is completed, as there is no automaticity between Phases 1, 2 and 3.

12.2 Identifying unintended consequences of regulatory reforms on EMDEs

In February 2012, the G20 Finance Ministers and Central Bank Governors asked the FSB to coordinate, with the IMF and World Bank, a study to identify the extent to which the agreed regulatory reforms may have unintended consequences for emerging market and developing economies (EMDEs).



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The intent of the study is not to re-open recent internationally agreed regulatory reforms but to better understand the possible effects of those reforms in the context of broader post-crisis developments on EMDEs.

National authorities from EMDEs that are members of the FSB or of an FSB RCG were surveyed for this purpose, while an FSB Review Group comprising FSB members and co-chairs of RCGs provided guidance on the selection and analysis of the issues included in the study as well as on its main messages.

There is widespread support among EMDEs for the objectives of the agreed reforms.

At the same time, there is a broad range of views regarding the extent to which these reforms are having, or expected to have, an impact on their financial systems.

This heterogeneity in perspectives can be attributed to the early stage of implementation of the reforms and to the diversity of EMDE financial systems, which give rise to different considerations and concerns.

Those respondents that did identify unintended consequences focused on a few key areas: the Basel III capital and liquidity framework; policy measures – including resolution frameworks – for G-SIFIs; and OTC derivatives reforms.

Some respondents also identified other national/regional regulatory reforms – such as higher capital requirements by the European Banking Authority (EBA) for large banks in the EU, and the Volcker Rule in the US – as giving rise to spillovers and/or extraterritorial effects that may lead to unintended consequences.

A number of the concerns raised by EMDEs relate to cross-border effects and perceived home bias in the design or implementation of reforms.

Several of the key concerns have also been raised by advanced economies and are being addressed by relevant international bodies during policy development and implementation.



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The responses reflect some implementation challenges for EMDEs and raise the issue of clearly identifying intended versus unintended consequences.

It is too early to assess fully the materiality and persistence of the effects ofregulatory reforms on EMDEs, and it would be useful to continue to monitor the effects of those reforms as well as to share experiences and implementation lessons.

The findings also highlight the importance of ongoing dialogue and cooperative relationships among national authorities from EMDEs, SSBs and international financial institutions in order to facilitate the mitigation of unintended consequences from the implementation of agreed reforms in EMDEs.

12.3 Enhancing consumer finance protection

The global financial crisis demonstrated the need to strengthen consumer protection policies and frameworks to ensure that the use (or misuse) of individual financial products do not become a source of financial instability.

A significant contributor to that crisis was poorly underwritten residential mortgages, which often represent the largest component of household and consumer debt.

In response, a number of FSB members have encouraged prudent underwriting practices to limit the risks that mortgage markets pose to financial stability and to better safeguard consumers and investors.

The FSB Principles for Sound Residential Mortgage Underwriting Practices released in April 2012 provide a framework for jurisdictions to set minimum acceptable underwriting standards.

After providing sufficient time for implementation, the FSB will conduct a thematic review to assess progress made in implementing the framework. The Principles will assist FSB members in their efforts to improve financial stability and prudential standards.



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They also refer to consumer protection issues that contribute to these objectives, but the Principles are not intended to be a statement of consumer protection standards.

Jurisdictions will want to adopt the consumer protection standards that are appropriate to them, including the Organisation for Economic Cooperation and Development’s (OECD) High-level Principles on Financial Consumer Protection which were endorsed by the G20 Leaders at the Cannes Summit.

The OECD high-level principles are designed to help its member jurisdictions and other interested economies to enhance financial consumer protection.

Several FSB members have already self-assessed their consumer protection frameworks against these high-level principles and found that they are in line with the recommendations (e.g. Australia, Canada, and France).

However, an even larger number of jurisdictions would like additional information to support their efforts toward implementation, particularly on the following principles:

- Disclosure and Transparency (principle 4)

- Responsible Business Conduct of Financial Services Providers and Authorised Agents (principle 6)

- Complaints Handling and Redress (principle 9)

The OECD, in collaboration with the FSB and SSBs, have developed an action plan to identify, within 24 months, a set of relevant approaches to support the effective implementation of the high-level principles. To help advance consumer finance protection efforts, the FSB report on consumer finance protection with a particular focus on credit endorsed by G20 Leaders at the Cannes Summitset out three options, including supporting a global platform for consumer protection authorities to exchange views on experiences as well as lessons learnt from the crisis to



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help strengthen consumer protection policies across the FSB membership and beyond. In this regard, the importance of the Financial Consumer Protection Network (FinCoNet) as a global network of market conduct financial authorities was recognised by the G20 Finance Ministers and Central Bank Governors in April 2012. FinCoNet is currently refining its mandate to enhance its legitimacy as the international organisation of consumer protection authorities. These efforts will help maintain the momentum toward strengthening consumer finance protection frameworks as several jurisdictions are considering significant changes to their frameworks, including strengthening the institutional arrangements for consumer protection authorities (e.g. China), legislative changes (e.g. Korea) as well as enhancements to existing regulatory frameworks (e.g. Switzerland).



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Regulating in a new era of professionalism: what does the FSA want to see from the industry?

14 Jun 2012

Speech by Clive Adamson, Director of Supervision, Conduct Business Unit, FSA to the Marketforce and the IEA’s 15th Annual Conference

Good morning and thank you to Marketforce and the Institute of Economic Affairs for inviting me to speak to you today on ‘Regulating in a new era of professionalism’.

I will begin by giving you a high level view of the changes taking place in UK regulation, how we expect professionalism to play a part in this, and what this means for you.

UK regulatory changes

The events experienced due to Northern Rock meant our focus as

regulators was focused on ensuring the banking system was stable and

prudential regulation appropriate to safeguard the UK’s financial

stability.

The consequence of this, in some cases, was substantially less focus on

how firms treated their customers and greater focus on the firm’s

solvency.

As time moved on, it was recognised that this approach could not

continue in the long term.

During the last few months, the FSA began taking steps to separate

prudential and conduct regulation in preparation for the creation of the

new Financial Conduct Authority and the Prudential Regulatory

Authority, in early 2013, and shaping what these two regulators are going

to look like.



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Internally, the first major milestone was the on April 2011, when we split

into two business units – the Prudential Business Unit and the Conduct

Business Unit.

Our second major milestone was April this year when we split banking

and insurance supervision into the Prudential and Conduct Units, so that

we now essentially operate internally under the FSA umbrella how we will

operate when we are legally formed in 2013.

Today, I will talk to you from the perspective of the FCA, leaving my

colleagues in the PRA to talk from their perspective at other events.

The strategic objective of the FCA is to ‘making markets work well’.

Additionally, it has three operational objectives of ensuring consumer

protection, market integrity and competition is in the interests of

consumers.

Of these, the newest for us in the FCA is the latter.

As a primary statutory objective we will be under the obligation to

consider the role of competition (or lack of it) as a driver of poor outcomes

in markets and work out how address these problems.

What we have learnt from the past is that things go wrong when business

models are not based on a sound foundation of fair treatment of

consumers, and a strong culture that supports this, leading to products

being sold that are not suitable for those buying them.

Our previous supervisory approach was too focused on disclosure at the

point of sale, creating situations where substantial amounts of

information were being provided to consumers who not always

understood what was being presented to them.

This, combined with sales processes that often incentivised staff to sell

products that were profitable to the firm rather than suited to the

consumer, made it almost inevitable that detriment took place.

It is our intention that the FCA will look and feel different from the FSA.



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In brief, we aim to move away from a primarily reactive style to be a

judgement based, confident and pre-emptive regulator that acts to ensure

consumers get a better deal and markets are fair and orderly.

The new supervisory approach will comprise of five main elements:

- To be more forward-looking in assessment of potential problems.

Looking at how we can tackle issues before they start to go wrong.

Increasingly, we will continue to move towards challenging firms

about whether their business models deliver good outcomes for

consumers and, where we disagree with management, have the

confidence in our judgement to require firms to change their business

models.

- Intervene earlier when we see problems.

The point I want to make here is that the FCA will have greater

appetite for earlier intervention, particularly in the product

development lifecycle, than the FSA has had.

To make it clear, it is not our intention to become a product approval

regulator, but we will consider and take action when necessary, when

we feel certain products are too risky for their target audiences or sold

in the wrong way.

- Address the underlying causes of problems that we see, not just the

symptoms.

It would be relatively easy for us to case individual examples of poor

conduct behaviour, but our experience is that these will continue to be

manifested unless the underlying causes of these problems are

satisfactorily dealt with.

As a result, we will be applying a particular focus to identifying and

mitigating the underlying root problems – not just patch up the

symptoms.



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- Secure redress for consumers if failures do occur

For example, what we saw with payment protection insurance.

We are asking those firms that mistreat their customers to take

measures to rectify things.

In practice, this means a combination of appropriate redress for

consumers, changes in their systems and controls and ensuring that

post-sales processes deliver a fair outcome for their consumers.

- Take meaningful action

Against firms that fail to meet our standards, through levels of fines

that have a credible deterrence.

Where we do not see improvements in firms following our actions, we

will consider taking tougher action, including stopping firms taking

on new business.

Let’s take insider dealing as an example – increasingly we are using

our powers to prohibit individuals from the industry and continuing to

focus on senior management responsibility.

How does professionalism fit into this approach?

A key component of the FCA’s approach is to continue implementing the

work that the FSA has already started around professionalism and

provision of advice.

The Retail Distribution Review, which is coming into effect on 31

December this year, is a clear example of action being taken to fulfil one

of the FCA’s operational objectives – consumer protection.

It continues to be our view that consumers should have:

- clarity in the service they receive;

- a transparent and fair charging system for the advice received; and



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- advice from respected and professional advisors.

- This is particularly important in the case of long-term savings, for

example.

The RDR aims to create a resilient, effective, and attractive retail

investment market that consumers can have confidence in and trust at

a time when they need more help and advice than ever with their

retirement and investment planning.

Given that long-term savings are long-term commitments, the quality

of advice and product suitability is key as often it may take years for

signs of detriment to manifest itself.

- The Retail Conduct Risk Outlook document, which we published

some weeks back, also sets out our views on how professionalism

needs to be at the core of advice for long-term savings, including

pensions and retirement planning.

Practically, this means:

- as securing financial wellbeing during retirement is paramount to

most pension investors, the quality of advice and product suitability

for pension and retirement planning become of significant regulatory

concern and interest;

- as retirement planning involves complex decisions, it creates the risk

that poor advice results in lower retirement income and/or purchase

of products with excessive risks; and

- that the impact of detriment is compounded by limited means to

recover from financial loss, especially among vulnerable groups (e.g.

the elderly) that have lower earning opportunity or financial flexibility.

So what do we want to see from the industry?

I want to make it clear that our aim is not to take away the consumers’

responsibility.



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We want them to make decisions for themselves, but ensure that the

decision they make is an informed one.

This is where you, the industry, come in.

Both the RDR and regulatory reform give us all huge opportunities to do

things better.

To give consumers more confidence in the advice they are receiving, it is

important that advisers look at their customers as unique individuals,

consider their personal situations and fully understand their objectives

and potential financial needs.

Questions that you should be asking yourselves are:

- Have you decided if you are going to be independent advisory or

restricted? This is possibly one of the most important decisions you

need to make.

- Is your pricing structure clear? And do you have the systems in place

to ensure your clients fully understand how your advice translates into

costs to them?

- If you are advising on high-risk investments, do the individuals

providing that advice have sufficient understanding of the products

being offered?

- Are you looking at undertaking a wider range of business? If so, have

you identified all the risks associated with these products?

These are just some of the many questions I hope you are asking

yourselves.

For us, advice should be just that, advice – not a sales/product driven

process.

It should be about:

- providing the right product for the right person with the right

information;



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- firms ensuring customer treatment is at the core of their business

model; and

- firms provide common sense, professional and clear advice to their

customers.

Professionalism also means that what you do should be properly

recognised as a profession by setting minimum standards.

This is why it is important that advisers continue to press ahead and

achieve appropriate Level 4 RDR qualification and then obtain a

Statement of Professional Standing.

I can tell you that 93% of advisers believe they are on track to complete

their qualifications on time and 71% of advisers already have appropriate

qualifications.

This is very encouraging news and I want to thank you for the

tremendous work you are doing to get the required qualifications.

Those who are currently appointed representatives should bear in mind

that it is their responsibility to ensure they reach the required standards

and the responsibility of principal firms to ensure their appointed

representatives have the required qualifications.

Conclusions

I hope, however, that I have given you some food for thought.

It is clear that firms have made good progress, but we want to see more of

you getting the appropriate qualification and making the necessary

internal arrangements sooner rather than later.

If you haven’t done so already, you also need to fully consider whether

providing an independent or restricted advice model best suits your client

base; and we want to see you start to test and implement suitable adviser

charging structures now.



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I believe the next few months, as we continue to move towards the

creation of the FCA and the implementation date for RDR, will be

extremely interesting.

We will be increasing our communication around what the FCA will be

and how it will operate as part of a more transparent approach to both

firms and consumers, and welcome opportunities like this to engage with

the regulated community and communicate our views on how we can

ensure that, together, we continue to put customers at the heart of what

we do.

Thank you



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G20 Leaders’ Summit Inaugurated

President Calderón inaugurated the activities of the VII G20 Leaders’ Summit. In his address, he explained that the world is facing various challenges, particularly in the economic and environmental spheres, hence the importance of the G20 Leaders’ Summit, which will seek to discuss and adopt agreements to address the economic situation and to define an agenda for the world’s future. G20 members represent two thirds of the world’s population, conduct over 80 per cent of trade and, together with the European Union, account for over 90 per cent of the world GDP. The president declared that during this Summit, efforts will focus on the definition of an integral action plan with a long-term vision that will promote sustainable human development in member countries as well as a verifiable agenda and follow-up mechanisms. He added that the Leaders’ Summit, which brings together 24 heads of



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state and government and eight leaders of international organizations, provides the possibility of discussing means of achieving a more integrated, stronger European Union that will transcend the current situation and have monetary, banking, fiscal and government mechanisms to prevent further crises. He stressed that the key is to adopt specific, coordinated actions to reinforce global action, job creation and free trade in a framework that will follow up the commitments adopted. The president subsequently declared that part of the solution to the current crisis lies in reinforcing international financial institutions in order for them to efficiently implement solutions to the current crisis and prevent future crises. He declared that with the will of the Group members, the aim is to: • Build consensus to improve the financial capacity of the International Monetary Fund. • Strengthen financial regulations in order to effectively contribute to the aim of stability. • Consolidate efforts to strengthen international financial regulation and supervision organizations. • Bring financial services closer to more people in the world. President Calderón highlighted the importance of finding policies to offset the adverse effects of climate change and the price volatility of food and raw materials, in order to prevent them from impacting on low-income sectors of the population. The president concluded by urging the attendees to cooperate, coordinate and confirm their commitment to working for the future.



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The day’s activities concluded with a dinner for the leaders hosted by the president.

President Felipe Calderón Hinojosa meets with the President of the United States, Barack Obama The President of Mexico, Felipe Calderón, met with Barack Obama, the President of the United States of America, before the start of the day’s activities at the VII Summit of Leaders of the Group of Twenty. At the meeting, the leaders discussed the state and outlook of the international economy, in particular the situation in Europe. They also reviewed the main priority issues on the G20 agenda and emphasized the importance of reaching agreements at the Summit so that global challenges can be met in a context of increased confidence. President Obama reiterated his support for the efforts made by the Mexican G20 Presidency to build a consensus and to encourage all participants to adopt effective measures, praising President Calderón’s leadership in this respect. President Calderón also referred to the importance of strengthening international financial organizations. As North American partners, both presidents agreed on the need to make their respective economies more competitive and identified sustainable growth and job creation as the main priorities; both countries agreed that these issues are inter-related and should be mutually reinforced. In addition, the leaders announced the inclusion of Mexico in the Trans-Pacific Strategic Economic Partnership Agreement negotiations. President Obama warmly welcomed Mexico’s inclusion to the TPP negotiations. President Calderón thanked the United States for its support in this decision. They both agreed that bringing the process to a successful conclusion in the least amount of time would benefit both countries, as it will increase



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competitiveness and create jobs in North America. Reviewing the topics on the bilateral agenda, both leaders reiterated their commitment to secure the principle of shared responsibility as the basis of cooperation in all areas. They discussed the actions taken in matters of security, including the status of the Merida Initiative, and they underlined the importance of having a shared vision in the fight against trans-national organized crime operating on both sides of the common border. President Calderón praised President Obama’s decision to look into the individual cases of young illegal immigrants, who meet specific criteria, to see if their deportation from the United States can be prevented, adding that this action could benefit many Mexican citizens. On this subject, both leaders stressed the need to adopt an integrated approach that recognizes the contributions immigrants make to their communities of origin and destination. As both leaders are approaching the end of their respective presidential terms, they agreed to define the next steps to be taken in the consolidation of bilateral cooperation and strategic relations. President Calderón was accompanied by the Minster of Foreign Affairs, Patricia Espinosa, the Minister of the Interior, Alejandro Poiré, the Minister of Finance and Public Credit, José Antonio Meade, and the Minister of Economy, Bruno Ferrari, as well as by his Chief of Staff, Gerardo Ruíz, the Mexican Ambassador to the United States, Arturo Sarukhan, and the Governor of the Bank of Mexico, Agustín Carstens. President Obama was accompanied by the Secretary of State, Hillary Clinton, the Treasury Secretary, Timothy Geithner, the President’s Chief of Staff, Jack Lew, the National Security Advisor, Tom Donilon, and the U.S. Ambassador to Mexico, Anthony Wayne.



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Press Statement by Mexican President Felipe Calderón on the G20 Leaders’ Summit

Good afternoon, members of the media.

Friends:

I would like to thank you all for your presence here in Los Pinos, the house of all Mexicans.

I have invited you here to talk about the G20 Leaders’ Summit Meeting which, as you know, will be held on 18 and 19 June in Los Cabos, Baja California Sur. It is the most important leaders’ meeting ever held in Mexico.

Since the start of my government, I pledged to promote a responsible, active foreign policy that would trigger national development.

To this end, we have promoted an ambitious international agenda on many issues of global importance that it is worth reviewing.

For example, Mexico assumed a clear leadership of one of the most pressing, important challenges for humanity, namely the challenge of climate change.

That is why we hosted the United Nations Conference on Climate Change, COP16, bringing together leaders and specialists from all over the world, where major commitments were reached to halt environmental deterioration for the benefit of present and future generations.

In commercial matters, we have taken significant steps towards opening up new international markets for all Mexican products. A clear example is the Pacific Alliance, recently signed by Peru, Chile, Colombia and Mexico, which will facilitate access by Mexican products to Latin America and the Asia-Pacific region.

In the political sphere, Mexico promoted the creation of the Community of Latin American and Caribbean States (CELAC) and organized its founding meeting in the Riviera Maya, which constituted a fundamental



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step in strengthening dialogue between our countries in Latin America and the Caribbean. This is the first time there has been a formal organization grouping together Latin American and Caribbean countries in our independent history.

In regard to security, we have acted firmly to strengthen international cooperation mechanisms to combat transnational organized crime. Proof of this is the unanimous support obtained by the Mexican proposal during the last Summit of the Americas to create a hemispheric scheme against transnational organized crime.

This year, Mexico confirmed its decision to assume a leadership role by taking over the G20 Presidency.

In December, we became the first Latin American country and the second emerging country after Korea to occupy this key position.

In its capacity as G20 president, Mexico will host this organization’s Leaders’ Summit. As I mentioned earlier, this will be the most important International Summit Meeting in history.

Why is this event so significant?

Because the G20 is the main forum of international economic coordination, which includes the world’s most important emerging and advanced economies.

Because the G20 members together account for over 80 per cent of the world Gross Domestic Product, nearly 90 per cent if one includes the European Union, which accounts for 80 per cent of global trade and two thirds of the world population.

This distinction undoubtedly reflects Mexico’s position as one of the world’s most solid, important economies.

It reflects the fact that we are a nation with a robust financial system and an export power, committed to free trade.



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It also reflects the fact that the world considers us a responsible country that works on behalf of growth and development. In short, it reflects the fact that Mexico is now a player rather than an observer of global changes.

That is why next week, Mexico will receive the world’s main leaders.

Among those who will honor us with their presence are: from the United States, President Barack Obama; from China, President Hu Jintao; from Japan, Prime Minister Yoshihiko Noda; from Germany, Chancellor Angela Merkel; from France, President François Hollande; from Brazil, President Dilma Rousseff; from the United Kingdom, Primer Minister David Cameron; from Italy, Primer Minister Mario Monti; and from Russia, President Vladimir Putin.

From Canada, Prime Minister Stephen Harper; from India, Prime Minister Manmohan Singh; from Spain, President Mariano Rajoy; from Australia, Prime Minister Julia Guillard; from Korea, President Lee Myung-Bak; from Indonesia, President Susilo Bambang Yudhoyono; from Turkey, Prime Minister Recep Erdogan.

From Argentina, President Cristina Fernández; from South Africa, President Jacob Zuma; from Colombia, Presidente Juan Manuel Santos; from Chile, President Sebastián Piñera; from Ethiopia, Prime Minister Meles Zenawi; from Benín, President Boni Yayi; and from Cambodia President Hun Sen.

This is the highest level and most importance selection of leaders ever to have met in Mexico.

We are convinced that this will be a meeting that will obviously mark the future of Mexico and its presence in the international context. They are all here to discuss the main challenges of the global economy and to define actions that will enable us to recover stability and promote economic growth, as we all wish.

For two days, the world will be focusing on Mexico and the conclusions reached by the G20 under the Mexican Presidency.



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I firmly believe that this Summit Meeting, led by Mexico, is particularly important for the following reasons:

First. Because we know that Mexico is currently experiencing a very delicate economic situation.

One matter of particular concern is, of course, the crisis in the Euro zone which, despite recent efforts, has yet to be resolved and is still a source of concern for the global financial system as a whole.

The crisis in Europe affects the entire world economy, which is why, during the upcoming summit, the Mexican Presidency will strive to ensure that an integral, comprehensive, long-term plan of action is adopted.

In other words, it will not only include measures for coping with and resolving the European crisis which, in the last analysis, is a temporary crisis but will also propose specific public policy measures in key areas, in political, fiscal, financial and monetary areas that will promote long-term global growth and maximize job creation, a common goal of all countries.

In this respect, in Los Cabos, Mexico will have to confirm its commitment to free trade in Los Cabos as a crucial instrument for promoting global growth.

The world will have to resort to trade precisely in order to promote economies and create the jobs and opportunities we all want. It is an extremely useful tool for creating the jobs demanded by societies from all over the world, particularly employment for young people.

In this global agenda and this long-term plan of action, we are also going to promote a proposal for global infrastructure.

This proposal will seek to build practical, pragmatic financial mechanisms that make it possible, for example, to link long-term available resources, such as pension funds, mutualist funds, sovereign funds, insurance funds with long-term assets such as financed infrastructure projects that also provide a great opportunity for growth.



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So the first thing is the long-term agenda.

Second. The gravity of the crisis also urgently requires the strengthening of international financial architecture and the improvement of financial regulation.

We all remember that in the past, Mexico experienced terrible, recurrent financial crises, solving which required requesting resources from international financial organizations such as the International Monetary Fund.

Fortunately, nowadays the stability and solidity of our economy allows us not to be part of the problem, as in the past, but to be part of the solution, to be part of the nations that work intensely to be strengthen these organizations financially, in order for them to be in a condition to help countries that are currently having problems and avert a new crisis that would harm the world economy.

I insist. In the strengthening of international financial institutions, Mexico is now part of the solution to the problem and at this G20 Meeting, under the Mexican Presidency, we will strive to strengthen and establish specific commitments to reinforce these institutions, specifically the International Monetary Fund, to enable it to become a solid, flexible instrument to cope with the economic crisis.

We will work intensely on international financial architecture. Mexico will also work to enable other countries to help strengthen this international financial architecture.

As I mentioned earlier, we will attempt to increase the Monetary Fund resources.

And also, since Mexico is part of the Financial Stability Council, the international mechanism that defines the financial regulation guidelines, Mexico will work to ensure that other countries also adopt financial regulations that will prevent new crises.

In particular, we will work to ensure that the Financial Stability Council is better structured at this G20 Meeting.



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We will attempt to give it a better corporate, regulatory shape and a better framework that will enable the Financial Stability Council to be more effective in performing its functions.

Through our discussions, we will also strive to advance mechanisms to implement international standards and parameters in financial regulation, also known as the Basel Standards.

Third. And very importantly. From the start of the Mexican presidency, we set out to become effective spokespersons for the needs and concerns of developing countries.

That is why, as never before, we have promoted issues that are particularly important for all the world’s economies but particularly for the poorest nations.

For example, Mexico will strive to ensure that world leaders adopt measures to encourage financial inclusion, in order to expand access to a savings account, credit and insurance, to more and more persons throughout the world, to small business owners and also to housewives and workers who in most of the world are excluded from the benefits of banking and financial systems.

Financial inclusion seeks to achieve the following: For everyone to be able to have a bank account and be eligible for credit and have access to the benefits of financing in their own economies.

This expands the options for development, which will be a crucial issue in the Summit.

We will therefore promote measures that will enable countries to have financial systems that are increasingly socially inclusive.

At the same time, the Mexican G20 Presidency will seek options or discuss public policy options to at least attenuate, mitigate and find out more about the adverse phenomena of the enormous volatility of food prices and the impact of the latter on the poorest population, not only in Mexico but also in the rest of the world.



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We want, for example, to promote greater public and private investment, greater investment in technology and scientific research and agriculture in order to boost agricultural productivity to expand the capacities of small farmers in order to produce more food with the same resources.

And at the same time, we are going to analyze how we can analyze and if possible, how financial markets should be regulated in order to prevent the components of the derivatives of financial markets from having an adverse effect on the economy of the poorest people through food prices.

In this respect, Mexico is placing particular emphasis on improving the information on international markets and preventing, as far as possible, financial speculation from having a negative effect on food prices and therefore on people’s well-being as we have seen in recent years.

Fourth. The Mexican G20 Presidency will also make an unprecedented effort to adopt an inclusive approach, which will deal with the concerns of non-member countries of the G20 and various actors in the private sector and civil society.

We have held meetings with countries, such as the recent meeting with Caribbean countries and the remaining Latin American countries not present in the G20.

We have echoed the demands of small island nations and obviously taken note of the concerns of other countries that wish to be heard.

We have therefore arranged meetings with Prime Ministers and Heads of State of many non-G20 nations, who have also conveyed their concerns and proposals to us.

We have also engaged in discussions with business owners from all over the world, with trade unions, young people, young business owners, young leaders and social leaders who have submitted valuable recommendations that are already being included in the Los Cabos agenda.

Fifth. The Mexican G20 Presidency has acted out of the conviction that we cannot allow the urgency of the current situation to distract our



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attention from more important details or the most important problems for humanity, such as the challenge of climate change, which is already dramatically impacting many countries.

This is the case, for example, of the drought in Mexico, where climate change has already severely affecting the living conditions of millions of Mexicans.

In this respect, we have encouraged climate change, specifically green growth, to be included in the discussion agenda of the Group of Twenty Meeting.

We have talked about promoting novel mechanisms to channel private financing into green growth to combat climate change. And we also have a powerful contribution from the private sector.

Within the G20 framework, there will not only be a leaders’ meeting with presidents, heads of state and prime ministers but also a series of events that will significantly contribute to enriching the contents of the agenda of the next Summit.

I would particularly like to mention the Business 20 Meeting, which will be attended by the leaders and decision makers of the world’s most important firms in the food, agriculture, finance, industry and automobile sectors among many others.

The world’s most important business owners will be there, discussing and adding their proposals to enrich the G20 agenda.

In short, within the G20 presidency, Mexico has attempted to promote specific measures for coping with the emergency of the global economy and at the same time, has striven to create a long-term agenda and a plan of action involving a development agenda with a long-term vision.

That is why, at this G20 Meeting, Mexico has and will confirm its responsibility to the world.

Mexico is proposing an ambitious, long-term agenda for the world which we want to be an agenda for the future.



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An agenda for the world’s economic and social development that will go beyond the current circumstances and be preserved and continue in the years and decades to come.

The Mexican government has made every effort and will continue to do so to ensure that the Leaders’ Summit is a success and yields positive results for the development and well-being of our beloved nation and for humanity as a whole.

And I would like to invite Mexicans, particularly South Californians, to prepare to receive our distinguished visitors and to ensure that this event is truly a success for Mexico and a memorable event form Mexicans and of course for the countries involved and for the world which will focus on Los Cabos, Baja California Sur for several days.

I would like to thank you very much for your attention and would be pleased to answer any questions.



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Study on the Potential Unintended Consequences of Regulatory Reforms on Emerging Market and Developing Economies

19 June 2012

The Financial Stability Board (FSB), in collaboration with the International Monetary Fund and the World Bank, published today a study identifying potential unintended consequences of regulatory reforms on emerging market and developing economies (EMDEs).

The study, which was prepared in response to a February 2012 request by G20 Finance Ministers and Central Bank Governors, focuses primarily on internationally agreed regulatory reforms whose implementation may affect EMDEs.

The intent of the study is not to re-open those reforms but to better understand their possible effects on EMDEs in the context of broader post-crisis developments and to facilitate their timely, full and consistent implementation.

Input for this study was received from national authorities in 35 EMDEs that are members of the FSB or an FSB Regional Consultative Group, as well as from the private sector.

There is widespread support among surveyed EMDEs for the objectives of the agreed reforms.

At the same time, there is a range of views about the extent to which these reforms are having, or expected to have, an impact on their financial systems.

This heterogeneity in perspectives reflects the early stage of implementation of these reforms and the diversity of EMDE financial systems, which give rise to different considerations and concerns.



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Most of the responses reflect expectations regarding potential future effects, rather than observed impacts.

While many EMDEs do not expect significant adverse effects from the implementation of the reforms, those that did identify potential unintended consequences focused on certain aspects of the Basel III capital and liquidity frameworks, policy measures for global systemically important financial institutions, and over-the-counter derivatives market reforms.

Some EMDEs also identified specific regional or national regulatory reforms as giving rise to spillovers and/or having extraterritorial effects that may lead to unintended consequences.

The study notes that many of the identified concerns are being addressed by relevant international bodies during policy development and implementation.

Some of the concerns stem from the way that reforms are implemented in other jurisdictions rather than from the design of the reform itself.

The long phase-in periods, the ongoing implementation monitoring and, in certain cases, the flexibility to adjust rules during the calibration process are intended to address these concerns.

The study notes that, while it is too early to be able to assess fully the materiality and persistence of the effects of regulatory reforms on EMDEs, it would be useful to monitor them on an ongoing basis.

The findings also underscore the importance of the ongoing dialogue and cooperation among EMDE national authorities, international financial institutions and standard-setting bodies.

Lawrence Schembri, co-chair of the EMDEs Review Group, said “This study will contribute to a better understanding of the concerns of EMDEs regarding the implementation of the G20 regulatory reforms.

It will thereby not only facilitate the mitigation of potential unintended consequences but also promote the implementation of these reforms in EMDEs.”



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Pascual O’Dogherty, the other co-chair of the EMDEs Review Group, added that “The study recognises the importance of EMDE financial systems and the need for national authorities from those countries to be appropriately consulted and to have their views adequately taken into account by the international community.”



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Scott G. Alvarez, General Counsel

Bank supervision and risk management Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. - June 19, 2012 Chairman Bachus, Ranking Member Frank, and members of the Committee, thank you for the opportunity to testify regarding bank supervision and risk management and the Federal Reserve's response to the trading losses recently announced by JPMorgan Chase & Co. (JPMorgan Chase).

Before discussing JPMorgan Chase's recent trading losses, it may be helpful first to discuss how the Federal Reserve and other supervisors oversee large financial institutions like JPMorgan Chase.

The prudential supervision of the largest, most complex financial firms is a cooperative effort, in which the Federal Reserve acts as the regulator and supervisor of bank holding companies, but with most of the principal business activities of such firms typically conducted through subsidiaries supervised by other functional regulators, such as insured depository institutions, broker-dealers, and insurance companies.

As the consolidated supervisor of holding companies, the Federal Reserve's supervisory program for such firms generally takes a broad view of the activities, risks, and management of those firms on a consolidated basis, with particular focus on financial strength, including the adequacy of capital and liquidity, corporate governance, and risk-management practices and competencies of a firm as a whole.

The Federal Reserve has taken a number of steps in recent years to reorient its supervisory structure and strengthen its supervision of the largest, most complex financial firms.



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Most importantly, we have established the Large Institution Supervision Coordinating Committee (LISCC), which is founded on the principles that large institution supervision should be more centralized; that it should conduct regular, simultaneous, horizontal (cross-firm) supervisory exercises; and that it should be more interdisciplinary than it has been in the past.

Thus, the committee includes senior Federal Reserve staff from the research, legal, and other divisions at the Board and from the markets and payment systems groups at the Federal Reserve Bank of New York, as well as senior bank supervisors from the Board and relevant reserve banks.

Relative to previous practices, this approach to supervision relies more on quantitative methods for evaluating the performance and vulnerabilities of firms.

To date, the LISCC has developed and administered various horizontal supervisory exercises, notably the capital stress tests and related comprehensive capital reviews of the nation's largest bank holding companies, and is now extending its activities to coordinate other supervisory processes more effectively.

JPMorgan Chase's Trading Loss and the Federal Reserve's Response

Last month, JPMorgan Chase announced that it had suffered significant trading losses on credit derivative positions entered into by its Chief Investment Office (CIO).

The CIO is an organizational unit of JPMorgan Chase that carries out, through the firm's subsidiary national bank, a variety of asset-liability management and other activities.

The activities of the CIO are managed and controlled out of JPMorgan Chase's New York headquarters, with a substantial portion of the CIO's activities conducted through the bank's London branch and other overseas branches or offices.



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The trading losses suffered by the CIO arose out of a complex synthetic credit portfolio that the CIO had developed over time, which was primarily composed of both long and short credit default swap positions on a number of different credit assets and indices.

Trading in this synthetic credit portfolio was executed through the London branch of JPMorgan Chase's subsidiary national bank.

JPMorgan Chase has stated that, because of a combination of risk-management failures and execution errors, and the complexity and illiquidity of the positions involved, the CIO's synthetic credit portfolio gave rise to significant trading risks that resulted in the losses.

In response to these significant trading losses, the Federal Reserve--in its capacity as consolidated supervisor of the bank holding company--has been working closely with the Office of the Comptroller of the Currency (OCC), the regulator of the national bank, on a number of fronts.

First, the Federal Reserve is assisting in the oversight of JPMorgan Chase's efforts to manage and de-risk the portfolio in question.

Second, we are working closely with the OCC and Federal Deposit Insurance Corporation (FDIC) to fully assess any risk-management failures, governance weaknesses, or other potential problems that may have given rise to the CIO's losses, and to help ensure that any such shortcomings are promptly and appropriately addressed.

This review includes scrutiny of risk-control practices surrounding the CIO's trading, hedging, and investment activities and strategies; in particular, those activities and strategies that led to the CIO's recent losses.

Third, the Federal Reserve continues to evaluate whether the governance, risk management, and control weaknesses exposed by this incident may be present in other parts of the firm engaged in similar activities. To date, we have found no evidence that they are, but this work is not yet complete.



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The Importance of Capital

The trading losses at JPMorgan Chase have served to remind us of the fundamental importance of capital regulation in our prudential oversight of the largest banking firms.

Although the risk-management failures that led to JPMorgan Chase's recent trading losses are a cause for significant supervisory concern, it is important to note that these losses, though large in absolute dollar terms, are not a threat to the safety and soundness of the firm.

Every dollar of these losses will be borne by JPMorgan Chase's shareholders, and not by depositors or taxpayers, a result that is a function of the substantial amounts of high-quality capital that JPMorgan Chase holds.

While robust bank capital requirements alone cannot ensure the safety and soundness of the largest banking firms, and indeed should be buttressed by other effective regulatory tools, they are central to good financial regulation because they ensure that capital is available to absorb all kinds of losses, unanticipated as well as anticipated.

For precisely this reason, the Federal Reserve and other federal banking regulators continue to take important steps to strengthen bank capital regulation, especially for the largest, most complex firms.

Over the past several weeks, the Federal Reserve, OCC, and FDIC have acted jointly to finalize U.S. implementation of the so-called Basel 2.5 reforms that will materially strengthen the market risk capital requirements of Basel II.

We have also requested public comment on changes to the U.S. regulatory capital rules to implement the Basel III reforms and the capital requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

The proposed changes would improve the quality and quantity of regulatory capital held at our nation's banking organizations. Importantly, many of these regulatory reforms specifically address and



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strengthen the capital requirements applicable to trading activities and positions, including complex derivatives.

The Federal Reserve has also advocated internationally for capital surcharges on the world's largest, most interconnected banking organizations based on their global systemic importance.

Last year, an international agreement was reached on a framework for such surcharges, to be implemented over a 2016–19 transition period.

This initiative is consistent with the Federal Reserve's obligation under section 165 of the Dodd-Frank Act to impose more stringent capital standards on systemically important financial institutions, including the requirement that these additional standards be graduated based on the systemic footprint of the institution.

The recent improvements to the regulatory capital framework have important supervisory complements in the Federal Reserve's development of firm-specific stress testing and capital planning requirements.

These supervisory tools make capital regulation more forward-looking by testing whether firms would have enough capital to remain viable financial intermediaries if they sustained hypothetical losses in asset values and earnings in an adverse macroeconomic scenario.

These tools also help to ensure that a firm's senior management and board of directors have put in place the appropriate processes and procedures to fully understand and manage the capital adequacy of the firm in a variety of economic environments.

In this area, the Federal Reserve recently completed our second annual Comprehensive Capital Analysis and Review (CCAR).

In the CCAR, the Federal Reserve assessed the internal capital planning processes of the 19 largest bank holding companies and evaluated their capital adequacy under a very severe hypothetical stress scenario that included a peak unemployment rate of 13 percent, a 50 percent drop in equity prices, and a further 21 percent decline in housing prices.



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Notwithstanding the stringency of the stress test used in the 2012 CCAR, 15 of the 19 firms showed they would maintain capital above prescribed standards, even assuming that all proposed dividends and other capital actions went forward during the stress period.

Furthermore, the results of the 2012 CCAR process demonstrated that most of the 19 bank holding companies have made considerable progress in their internal capital planning processes.

Crucially, the tier 1 common ratio for these firms, which compares high-quality capital to risk-weighted assets, has doubled during the past three years to a weighted average of 10.9 percent from 5.4 percent in the first quarter of 2009.

Implications for Implementation of the Volcker Rule and Other Regulatory Reforms

The trading losses announced by JPMorgan Chase have also focused attention on the regulation of trading activities by large, complex banking firms.

In particular, there is considerable attention on the Volcker Rule provision of the Dodd-Frank Act banning proprietary trading.

The statute provides an exemption from the general ban on proprietary trading for risk-mitigating hedging activities.

The rulemaking agencies have jointly issued proposed rules to implement the Volcker Rule, and that proposal would implement that statutory exemption by incorporating the terms of the statutory exemption.

Importantly, the agencies' proposal also adds requirements designed to enhance the risk-monitoring and -management of hedging activities and to ensure that these activities are risk-mitigating.

Among the restrictions the agencies proposed to add include a requirement for formal policies and procedures governing hedging activities that includes approved hedging instruments and strategies, a formal governance process, documentation requirements explaining the



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hedging strategy, an internal audit for compliance with these approved hedging strategies, and requirements that incentive compensation paid to traders engaged in hedging not reward proprietary trading.

This multi-faceted approach is intended to limit potential abuse of the hedging exemption and improve risk management of these activities, while not unduly constraining the important risk-management function that is served by a bank entity's hedging activities.

The Federal Reserve has received a significant number of comments on this aspect of the proposed rule, including a number of more recent comments informed by the trading losses that have occurred within JPMorgan Chase's CIO.

We will consider all of these comments carefully as we work with the other rulewriting agencies to finalize the joint agency Volcker Rule proposal.

Thank you for inviting me to appear before you today. I would be pleased to answer any questions you may have.



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Addressing “Too Big To Fail”

The Swiss SIFI Policy

1 Background

Two of the Swiss banks are not only systemically important for the Swiss economy, but may also be considered as institutions of considerable importance for financial stability at global level. Although they have significantly reduced their exposures in the aftermath of the crisis, the size of their balance sheets continues to amount to a multiple of the output of the Swiss economy. Both banks are considered as Globally Systemically Important Financial Institutions (G-SIFIs) and “Too big to Fail”. Hence, the issue of “Too big to fail” (TBTF) is of great relevance for Switzerland. The Swiss Federal Government, the Swiss Financial Market Supervisory Authority FINMA and the Swiss National Bank have therefore decided to move rapidly towards measures strengthening the resilience of the Swiss Systemically Important Financial Institutions (SIFIs), limiting the economic impact of crisis in the financial system and promoting financial stability.



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The starting point of the Swiss initiatives is the work of the commission of experts commissioned by the Swiss Federal Government to develop policy options on how to mitigate risks emerging from TBTF institutions in the Swiss economy. On 4 October 2010, the commission agreed on a proposal for a Swiss SIFI policy framework. What distinguishes the policy proposals is that experts were drawn not only from the relevant authorities and the science community, but also included members from the two Swiss big banks and from the insurance sector. All members of the commission endorsed the results. Currently, FINMA, SNB and the Swiss Federal Department of Finance are working on the practical implementation of these results into Swiss law. The necessary legal changes were sent to Parliament on 20 April 2011. This report describes the Swiss SIFI policy framework based on the proposal of the commission of experts and the dispatch of the Federal Council on strengthening financial sector stability. The Swiss TBTF initiatives are embedded in the global framework, in particular that of the Financial Stability Board and the Basel Committee. A global alignment is paramount given the fact that SIFIs are active at international level and that any substantial regulatory arbitrage may impact financial stability from a domestic and global perspective. However, each country has to consider its own specific situation. Not only is the failure of a big institution a risk for the Swiss economy: the international exposure of the Swiss financial centre and its companies bears a greater responsibility for global financial stability.



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Switzerland has to implement the globally agreed regulations with a “Swiss finish” and to develop and put its initiatives into effect as soon as possible, ahead of those of several peer countries.

2 Defining systemic importance 2.1 Functional perspective

It is broadly agreed that the systemic importance of a financial institution arises out of the financial functions it provides to the general economy.

At the same time, such financial institutions provide a plethora of functions and services which are not systemically important or can be substituted easily and quickly.

The proper classification of functions is of vital importance.

While the set of systemically important functions should not be too narrow to sufficiently protect the economy from the fallout of a banking crisis, an excessively broad definition complicates crisis management and resolution actions, sets false incentives and reduces pressure to come up with market-based solutions in a crisis scenario.

Switzerland aims for a simple, straight-forward yet narrow definition of systemically important functions. According to current discussions, the following functions will presumably fall under this definition:

Payment operations;

Domestic deposits to ensure access to liquidity for payment transactions;

Loans and credit lines to non-financial enterprises;

Domestic mortgages with a maturity of less than 1 year.



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However, the measures proposed are not limited to the systemically important functions as such, but eventually lead to institutional requirements.

When determining capital surcharges, all activities of a SIFI are to be considered, as losses will most probably not be contained in a particular business line, but may impair systemically important functions as well.

Also, when assessing the resolvability of a company, it is not only the systemically important activities which are looked at, but rather all functions the company performs, also from a cross-border perspective.

2.2 Institutional perspective

A company is deemed systemically important if it performs services that are essential to the overall economy and which cannot be substituted by other market participants within a reasonable time frame.

The current Swiss initiatives therefore focus on banks.

To assess the systemic importance of banks, the evaluation framework has been substantiated to include the following criteria:

- Market share in systemically important business activities such as deposits, loans and clearing;

- Value of deposits not covered by the deposit insurance regime;

- Relation between the balance sheet size and the gross domestic product;

- Risk profile of the company.

Evaluating these criteria naturally leads to designating the two big global Swiss banks, the Credit Suisse Group and UBS, as globally and domestically systemically important.

Switzerland has decided to focus its initiatives on these two banks. Once the framework is in place, the initiatives may be extended to include domestic SIFIs.



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Given the fact that such D-SIFIs (Domestic Systemically Important Financial Institutions) operate in an environment and under conditions which are very different from those of a globally active bank, it is unlikely that a framework adequate for G-SIFIs can be directly adopted for D-SIFIs.

However, the rationale – ensuring that D-SIFIs can fail without disrupting systemically important functions and without the need for extraordinary public support – is the same.

Financial infrastructure providers, such as settlement organizations, exchanges and central counterparties, are also systemically important.

However, the risks they handle are quite different from those banks are confronted with.

The policy framework outlined in this paper is therefore not directly appropriate to deal with infrastructure providers.

3 Policy mix SIFIs and the financial system as a whole must be capable of surviving crises, even of larger scale, without public support and taxpayers’ money. The Swiss SIFI policy framework focuses on two major objectives. The first objective, reducing the probability that a TBTF institution fails, is pursued by two key measures:

Capital

Liquidity

The second objective, reducing the potential systemic fallout of a failure of a TBTF institution, is pursued with measures increasing the resolvability of those companies:

Organization, and

Risk diversification.



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The key measures - capital, liquidity, organization and diversification - are not isolated, but constitute an integrated policy mix. Capital and liquidity not only help to prevent crises, but also to set aside resources necessary to implement recovery measures or ultimately enable an orderly resolution of the company. Furthermore, the measures are to take effect at all phases. Capital and liquidity measures, which allow for easier restructuring or resolution by the supervisory authority for a bank in distress, provide incentives for the bank’s management to reduce systemic risk when the company is still a going concern. Organizational measures, which facilitate recovery and limit the impact of failure, need to be designed, prepared and implemented when there is still enough time for diligent action.

Box 1: Pure size limits regarded as ineffective The most appropriate way to tackle the TBTF issue would be to prevent institutions from becoming so big that the consequences of a failure would be too dangerous for the economy. Size limits could be expressed by imposing restrictions on the size of the balance sheet (absolute or relative, e.g. as a fraction of the country’s yearly gross domestic product), on the market share or the level of interconnections with other financial institutions or the economy as a whole. Banks exceeding these limits would be ordered by law to reduce their exposure. While this concept sounds simple, the effectiveness may not be evident.



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From a macroeconomic perspective, the size of a financial system is not only driven by supply. Reducing the exposure of single institutions may not lead to a contraction of the size of the financial system, but rather would cause fragmentation and diversification between many smaller market participants. Such a diversification may help to mitigate risks of isolated issues, but would not be suitable to deal with systemic crises. Business concentrated on a few big companies would migrate to smaller companies, all of them pursuing similar strategies and exposing similar risk behaviour. Crises of a larger scale would cause problems at many of those smaller companies and, at the same time, would render a group of small companies “systemic in a herd”. Strict limitations on the size of business activities have therefore only a limited potential to reduce the systemic risk, but may heavily complicate any crisis management, as such measures would then have to be applied to several companies at the same time. Of course, economies of scale and other efficiency considerations may also favour larger companies. However, such benefits are hard to quantify and did not play a substantial role in our considerations. As a result, we came to the conclusion that imposing hard size restrictions is not an appropriate approach to strengthen the resilience of the financial system.



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4 Capital and liquidity – reducing the probability of failure Higher solvency and liquidity requirements reduce the probability that banks fall below minimum levels of capital and liquidity and therefore reduce the probability of failure. In addition, more solvency and liquidity may significantly facilitate crisis management, resolution or, in a worst case scenario, the liquidation of a company. Finally, as capital and liquidity requirements mostly depend on the volume and risk of a bank’s business activities, they also create incentives to reduce size and risk. Having a lower probability of failure, more flexibility for crisis management and greater incentives for size and risk reduction is especially important for systemically important institutions.



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These companies should therefore be subject to stricter requirements. For some years, large Swiss banks have been subject to a surcharge on top of the regular capital requirements, expressed as a multiple of the Pillar I level. In the wake of the crisis, higher liquidity requirements were quickly imposed. It is now proposed that the existing Pillar II measures are replaced by a system which allows for improved calibration and to better reflect systemic importance. The new system defines surcharges on the Basel baseline requirements (capital quantity), but also prescribes the capital instruments to be used (capital quality). Both dimensions have to be looked at in parallel. While the proposal significantly raises the minimum capital quantity, it also ensures that there is a safety net to enable recovery and resolution and that this safety net cannot be used, or even depleted, for day-to-day business activities. This allows for restructuring a bank without forcing it into liquidation. That way, the whole company, or at least parts of it, may have a realistic future after a crisis, which is paramount to secure the commitment of investors, clients and counterparties.

4.1 Quantity of capital Switzerland proposes that the capitalization of systemically important banks should be defined by three components of capital which complement each other, but have distinct objectives.



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While the baseline requirements are used as going concern capital, the buffer helps to fend off crises. The surcharge serves as a reserve to restructure or resolve the company. The calculation of the components and the capital instruments employed are structured in accordance to these purposes.

4.1.1 Basel III as a baseline requirement

Just as every banking institution, Swiss SIFIs have to fulfil the baseline capital requirements as defined in the Basel framework and its Swiss domestic implementation. The baseline requirement amounts to 8% of the company’s risk weighted assets (RWA). The Basel Committee has proposed substantial amendments to its capital accord (Basel III). Switzerland is committed to implement the Basel III proposals within the internationally agreed time frame. The revised rules will be applicable to all banks in Switzerland regardless of their systemic relevance. Switzerland implemented ahead of time a subset of the rules, mostly centred around trading book rules (“Basel 2.5”). All banks concerned are already required to meet these extended rules since 1 January 2011.

4.1.2 Buffer to increase loss absorbency The last crisis revealed that banks meeting or even exceeding the statutory capital requirements may experience losses at such a scale and



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speed that they may significantly fall below the minimum capital levels within a short period of time. Countermeasures implemented by companies, such as fire sales of liquid assets, accelerated these developments, caused contagion to other financial companies and market segments, and could only be impeded by vast interventions undertaken by governments and central banks. Hence, while capital levels as required by Basel II/III and national regimes were never designed to absorb tail risks of large, internationally active institutions, they were too small to prevent a system-wide contagion. By increasing capital requirements for systemically important financial institutions, contagion could be bounded or at least slowed. Switzerland will therefore implement a capital conservation buffer of 8.5% RWA on top of the Basel III minimum capital requirements for all banks of 4.5% RWA. This buffer will be limited to systemically important financial institutions, as the contagion potential of smaller or mid-size firms is curtailed. However, as part of the supervisory process, we also will require specific buffers for non-SIFI banks if their size, business activities and risk profile mandate capital resources exceeding the Basel baseline rules. In contrast to the countercyclical buffer discussed by the Basel Committee, neither size nor usage of the Swiss capital conservation buffer is directly dependent on the macroeconomic environment. The banks have to schedule when and how they increase their capital in so-called “good times” above the requested threshold. However, a bank will be allowed to make use of the buffer in bad times (e.g. when it faces significant losses).



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As soon as the profit situation improves, the buffer has to be refilled. The size of the buffer has been calibrated considering the experiences of previous crises and model calculations.

4.1.3 Systemic surcharge Banks with a higher systemic importance should maintain a higher solvency. Additional solvency gives the bank’s management, counterparties and regulators alike more time to act, especially to protect the bank’s systemically important functions. Higher systemic importance often comes with a more complex organizational set-up and multifaceted business activities which in turn lead to more difficult and time-consuming crisis management measures. In addition, linking systemic importance with solvency requirements makes systemic importance expensive and provides for incentives to reduce it. As a third major component, a progressive systemic surcharge consisting of two parts is therefore proposed:

Market share-based surcharge taking into account a bank’s share in the Swiss domestic loan and deposit market; and

A size-based surcharge that considers the size of a bank‟s balance sheet.

The relationship between market share, size and the resulting surcharge is linear. Given the current situation of the Swiss big banks, both components of the systemic surcharge will result in ***additional capital requirements amounting to 6% of the risk weighted assets***.



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Total capital will demand 19% of RWAs (i.e. 4.5% RWA minimum capital requirements under Basel III, the capital conservation buffer of 8.5% RWA, as well as the progressive surcharge of 6% RWA based on current calibration).

Box 2: Capital planning enables banks to fulfil upcoming requirements As part of the regular supervisory requirements, FINMA expects companies to perform a prospective capital planning. Part of this process is a systematic gap analysis of the institution’s current capital situation and future capital needs, taking into account regulatory requirements, the strategy and the risk situation of a company, as well as its projected profitability in the economic cycle. FINMA has been closely following the capital planning process and its implementation of the systemically important banks. Even if the proposed TBTF framework has not yet been enacted, FINMA has already requested these banks to aggressively build up capital in order to fulfil upcoming requirements along a front-loaded transition path.

4.2 Quality of capital 4.2.1 Common equity The new Basel III rules include substantial measures to increase the quality of capital on which the Swiss SIFI framework draws. 4.5% of risk-weighted assets of the baseline requirements and 5.5% of the RWA of the buffer have to be held in common equity. This results in at least 10% of risk-weighted assets to be held in common equity.



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4.2.2 Contingent convertible bonds (CoCos) Contingent convertible bonds (CoCos) are debt obligations that convert or become convertible to equity if a specified event occurs. Once converted, CoCos are fully loss absorbing without triggering the company default. The trigger may be discretionary or well defined upon issuance of the bond. The Swiss SIFI framework proposes CoCos which ***automatically trigger if the common equity tier 1 capital ratio (CET1) of a company falls below predefined levels***. Since the thresholds are predefined, pricing models for such instruments can be applied accordingly. In order to be accepted under the Swiss SIFI policy, CoCos have to be structured so that they are eligible as a Basel capital instrument. Depending on the actual trigger point, CoCos have different characteristics. CoCos with low triggers (5% CET1) convert to equity just before a company’s capital situation falls below the minimum requirements. The contribution of low-trigger CoCos to the stability of the company is limited, as the capital ratio may exceed the regulatory minimum even in severe crisis situations. However, if the situation deteriorates rapidly, low-trigger CoCos generate capital necessary to implement crisis management measures, may prevent the bank from being put in receivership and, in a worst case scenario, provide funds for an orderly resolution.



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Since they trigger just before resolution procedures would have to start, it is ensured that the capital is not used for going concern business activities. Because the conversion takes place just before resolution or even before liquidation procedures commence, the risk premium of a low-triggering CoCo is rather small. CoCos with high triggers (7% CET1) convert when the company’s capital situation is deteriorating, but the company is still well above the minimum requirements. High-trigger CoCos further improve the loss absorbing capacity of a company. In this way, high-trigger CoCos contribute to the stabilization of a company before harsher restructuring actions are necessary. The conversion also contributes to systemic stability. CoCo holders may even benefit from a subsequent recovery of the company as they participate in the upside potential of equity. However, it is paramount that the company’s management is rapidly able to regain the trust of its investors. The conversion of CoCos may therefore serve as an important wake up call for the management, the company’s stakeholders and regulators, and also help to strengthen market transparency. Of course, the risk premium of high-trigger CoCos is nearer to that of equity and is expected to be substantially higher than the premium of non-convertible debt instruments. The usage of CoCos eligible under the proposed regime is strictly limited.



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On top of the Basel and Swiss minimum capital requirement of 4.5% CET1, the Swiss additional capital conservation buffer of 8.5% RWA may consist of CoCos to a maximum of 3% RWA. These CoCos must have a high trigger, forcing conversion when the company’s capital ratio undercuts 7% CET1. The progressive surcharge of 6% RWA is planned to include only CoCos. As part of the resolution scheme, those CoCos conceptually convert at a capital ratio of 5% CET1. The characteristics of CoCos are crucial to determine the viability of these instruments. This includes considerations on the issuing price, the event triggering conversion, the conversion ratio as well as the legal set-up of the instrument. Instruments with inappropriate terms have the potential to destabilize institutions and markets in a crisis situation, rather than improving resilience. FINMA has therefore decided to follow the issuance of such instruments closely. In order to become recognized under the capital framework, FINMA has to approve the term sheets of the actual issues. Experience has shown that supervisory guidance on this matter facilitates finding an adequate balance between interests of the issuing bank, investors and supervisory objectives.

4.2.3 Write-off bonds The Swiss policy proposal also includes write-off bonds (bonds with claims waiver).



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These are deemed equivalent to CoCos, provided that their terms lead to equivalent positions of counterparties from an economic point of view which also means that the conditions triggering a write-down would be similar to those causing a conversion of CoCos. Write-down bonds would be recognized under the capital requirements framework to the extent that an actual write-down improves the capital ratio of a company. Consequently, in order to be recognized under the capital requirements regime, the terms of such prescriptions would have to be approved by FINMA. The concept of write-off bonds was primarily introduced to open up the possibility of enhancing capitalization by contingent instruments also for firms that are not stock companies and therefore cannot issue shares. This ensured that all firms can benefit from the introduction of contingent instruments into the capital requirements framework.



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Box 3: Bail-ins At international level, the concept of “bail-ins” has gained significant traction. Under a statutory bail-in regime, certain debt classes would be converted to equity triggered by a discretionary decision of the bank’s supervisor, while the bank is still a going concern. The loss absorbing potential of equity would be effectively extended to debt and subsequently to the whole balance sheet without forcing the bank into bankruptcy. In theory, the concept is elegant: it completely removes the possibility of a TBTF bank failure as it could employ bail-ins to sufficiently generate capital. In practice, however, the concept has several drawbacks. Substantial parts of a bank’s debt would not be available for a bail-in. This especially holds true for big retail banks, which to a large extent refinance themselves by deposits (insured or uninsured). In reality, debt holders would have to know from the beginning that their claims can be bailed in, resulting in an “opt-in” arrangement, such as the issuance of bail-in able bonds. Also, the concept of bail-ins comes with considerable legal challenges, as the inherent discrimination of certain debtor classes may be difficult to uphold. More convergence on international level in regard to key issues such as the definition of triggers, the point of non-viability as well as a common understanding on debt classes available for bail-in would have the potential to significantly enhance the viability of the bail-in concept in an international context.



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Whereas at international level bail-ins seem to trigger only as a “last line of defense”, i.e. just before the bank stops fulfilling the statutory capital requirements and, in normal circumstances, would have to go into liquidation, the Swiss SIFI framework provides for a significant stake of low trigger CoCos at a level of 5% CET1. These instruments will be also activated when there is reasonable concern that the bank is heading towards over-indebtedness, facing serious liquidity problems or does not fulfill its refinancing obligations anymore (equivalent with the point of non-viability). As a result, the probability of a conversion of a bail-in able bond (via administrative write down or debt-to-equity swap) is only slightly higher than that of a normal bond of a bank without any bail-in arrangements. Hence, the risk premium of a bail-in able bond may be rather small. While this outcome may be welcomed by companies and their shareholders, the incentive to reduce the size and risk of a company’s business activities may be too little or non-existent. In addition, because bail-in proceedings are proposed for significant financial institutions only, smaller and mid-size firms may face a competitive disadvantage in favour of big and systemically important companies, effectively amplifying the TBTF issue rather than mitigating it. For all that, Switzerland has decided to include a bail-in mechanism in its Swiss SIFI framework in compliance with the international initiatives (e.g. FSB), but to stay, at the moment, with its definitions of the triggers and point of non-viability. This decision may be reassessed in face of a possible international consensus and the future availability of a cross-border resolution framework.



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4.3 Liquidity The last financial crisis made it very clear that the existing liquidity requirements had substantial deficiencies. The Swiss regime did not take into account the special situation of large, complex and internationally active banking institutions. Today, the situation has changed. In Switzerland, FINMA has tightened the liquidity requirements for big banks, applying stress scenarios modelled on the experiences of the recent crisis. The new requirements are already in force and banks are implementing them. The Swiss implementation is largely based on the Basel consultation paper of December 2009 and goes beyond that proposal in certain areas. Compared to the December 2009 proposition, the current Basel initiatives have been diluted. This will result in the Swiss SIFI liquidity regime significantly extending a future international consensus.

5 Improving resolvability – reducing the impact of failure Although the probability of failure of a SIFI is effectively reduced by the capital measures as described above, failure of a SIFI is still possible. Therefore arrangements should be in place whereby, if prevention fails, a SIFI can exit the market in a controlled manner. Contagion or damages to the financial system and the economy as a whole have to be reduced as much as possible.



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The best measure to reach this would be an internationally harmonized resolution and insolvency regime for SIFIs or banks in general. However, chances of success in the near future are small. Either way, even such a resolution regime would not solve problems arising out of the interconnectedness of SIFIs and would therefore be only one element on the way to reducing the impact of failure.

5.1 Organizational requirements to support recovery and resolution The last crisis has shown that the lack of preparedness of the private sector and authorities alike to dissolve SIFIs in crisis scenarios is a main driver of the TBTF issue. Hence, solutions are needed to manage operational and legal complexity of big banks in “going concern” as well as “gone concern” scenarios. This involves measures to improve recovery and resolution of a SIFI as well as a sound and effective framework for crisis management. The Swiss TBTF proposal is threefold. First, systemically important banks will be required to demonstrate their resolvability not only with regard to systemically important functions, but globally. Second, the proposal does not only focus on the resolution phase but also considers effective recovery arrangements as equally important. It is crucial that companies prepare and implement measures which are able to effectively stabilize banks in a crisis and avoid resolution scenarios to the greatest extent possible.



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Third, supervisory authorities acquire an explicit role in preparing recovery and resolution as well as its implementation. If banks fall short of the supervisory requirements and expectations, FINMA has the power to order the implementation of measures improving resolvability.

5.1.1 Preconditions for effective resolution The effectiveness of resolution procedures is subject to various preconditions which have to be implemented significantly before an actual resolution case has to be solved. First, there must be a viable legal framework for resolution of financial intermediaries in place on national level. Such a regime should not only provide the appropriate tools to authorities, but should also govern responsibilities – ideally by designating a single resolution authority and thereby allowing for swift intervention without national coordination issues. Switzerland already has such a regime in place, not only for SIFIs, but for banks in general. Second, there has to be a better understanding of how national resolution regimes interact in a cross-border crisis scenario. While supervisors and resolution authorities may be able to mitigate such issues by entering into formal or informal agreements, they can only do so within their national frameworks. It is therefore important to understand the interplay of national regimes in a cross-border context and to set up appropriate pre- and in-crisis coordination procedures.



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For its SIFIs, the Swiss authorities have a long-standing tradition of cooperation with key jurisdictions. These arrangements have recently been formalized within crisis management groups and supervisory colleges. However, actual resolvability is ultimately a characteristic of a single company operating under several defined legal frameworks. Hence and finally, firms have to prepare themselves to allow for their effective resolution in both systemic as well as idiosyncratic crisis scenarios with the ultimate objective being to protect systemically important functions. This involves the organization and legal set-up of the company, its governance and control processes, intra-group interdependencies regarding capital and liquidity as well as, ultimately, their position vis-à-vis their counterparties.

5.1.2 Preparing for recovery and resolution The Swiss proposal requires banks to be organized at any time in a way that facilitates resolution in a crisis situation. The ultimate objective is to protect the narrowly defined systemically important functions of a SIFI, not the bank itself. SIFIs are expected to prepare their organizational, operational and structural set-up so that their specific recovery and resolution plan can be executed rapidly and effectively. While the Swiss proposal does not prescribe how to reach these objectives, SIFIs are required to demonstrate their recovery and resolution plans (RRPs) to the regulator in detail.



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The RRP process places the responsibility to define plans for recovery and resolution on the companies.

Current Swiss resolution framework for banks Failures of domestic banks in the 1990s demonstrated the ineffectiveness of general bankruptcy procedures and tools to handle bank insolvency cases and eventually led to the development of a specialized resolution regime for banks. Effective since 2004, the regime has been applied successfully in several cases, including those in a cross-border context. FINMA as the sole bank resolution authority: As a supervisory authority, FINMA has exclusive responsibility for bank bankruptcy and restructuring proceedings. It has a wide range of tools at its disposal to enable it to take preventive measures when the requirements of prudent practice are not complied with, and to rectify existing irregularities. In the event of persistent capital inadequacy or liquidity problems, FINMA can take measures that may lead to restructuring or bankruptcy proceedings. The fact that sole responsibility lies with FINMA ensures continuity and rapid action, as it knows the bank concerned and already has comprehensive information about it. FINMA is also solely responsible for the entire bankruptcy and restructuring proceedings. It appoints and oversees the liquidators or those entrusted with restructuring.



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If necessary, it can also become involved in the liquidation itself. Early intervention: FINMA can step in as soon as a bank is unable to comply with the capital adequacy requirements for an extended period or experiences liquidity problems, or if there are other indications of impending insolvency. No formal evidence of over-indebtedness or inability to meet payment obligations is required before restructuring or liquidation proceedings are initiated. Tailor-made solutions: The individual measures can be tailored to the situation at hand, and can be implemented either individually or jointly in restructuring or bankruptcy proceedings. They do not have to be carried out in a particular order. The initiation of restructuring proceedings does not necessarily require a moratorium. As long as the interests of its creditors are safeguarded, the bank can remain in business. Moreover, the measures do not need to be made public unless they directly affect the rights of third parties. Restructuring as an alternative to liquidation: If there is a realistic prospect of success, FINMA can carry out a restructuring plan. Decisions taken in restructuring that fall within the powers of the annual



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general meeting, such as capital increases, do not require the agreement of the shareholders. The aim of these provisions is to speed up the restructuring proceedings. Only the creditors may reject a restructuring plan, and then only if they represent more than half of the non-privileged claims.

In this case, FINMA will order the bank‟s liquidation (bank bankruptcy). Recognition of foreign insolvency measures: If a foreign authority takes measures concerning a foreign bank or securities dealer with a branch or assets in Switzerland, FINMA is responsible for recognising those measures. Once the claims of those creditors whose claims are protected and privileged under Swiss law have been satisfied, the proceeds of the liquidation of assets located in Switzerland are turned over to the foreign proceedings. Equal treatment of Swiss and foreign creditors: All creditors of the bank and of its foreign branches are entitled to participate in the bank bankruptcy proceedings initiated in Switzerland, and are to be accorded the same privileges. They must, however, allow any sums they have received in foreign proceedings against the bank or its assets to be offset against their entitlement in Switzerland.

5.1.3 Evaluating resolvability FINMA will develop criteria on how to assess the viability of recovery and resolution plans.



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While the details will be defined by a future revision of the Banking Ordinance, FINMA has already come up with a catalogue of criteria to be implemented with a scorecard approach. This will also enable the construction of a “Resolution Effectiveness Test” (RET) as an objective and transparent benchmark. The assessment of a company’s resolvability will drive two supervisory decisions: First, the Swiss framework will define a minimum standard every Swiss SIFI has to fulfil. If a company falls short of these expectations, FINMA will have the power to intervene and order the implementation of measures which will bring the company on par with the minimum requirements. Second, if banks demonstrates that they have significantly increased their resolvability in excess of the minimum requirements, they may be eligible for a capital rebate on the systemic surcharge. Such a rebate would be subject to strict conditions. Banks would have to prove that they have implemented comprehensive and effective measures to facilitate resolvability and to limit the impact of failure for all of their business activities at a domestic and international level. Specifically, limiting the impact on systemically important functions alone would not qualify for a rebate. A SIFI’s RRP may favour systemically important functions and discriminate other SIFI stakeholders in Switzerland and abroad. This is deemed acceptable to protect the overall economy.



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However, the RRP plan is not isolated, but has to be seen within the context of the significantly extended capital requirements. These reduce the probability of failure and, therefore, shrink the potential of discrimination. Also, equal treatment and adequate capitalization in a global perspective, i.e. of all parts of a company even in a resolution scenario, will be considered as an element of the resolution effectiveness assessment.

Box 5: Bank levies and resolution funds deemed ineffective For implementation of the emergency plan in crisis situations, banks can draw on the capital held as a systemic surcharge. Just protecting systemically important functions keeps the capital intensity of a resolution plan reasonably low which in turn allows regulators to require banks to hold the necessary capital on their own in the form of a systemic surcharge. Under this arrangement, system-wide resolution funds are considered neither necessary nor efficient. Having analyzed these ideas, it is believed that in an acceptable time frame funds may never be of a size to cope with systemic crises. Requiring banks to build up capital for contingency measures on their own balance sheet also reduces moral hazard.

5.2 Minimum diversification to reduce concentration risk Having few big banks may lead to risk concentration and a “single point of failure” in the financial system, as smaller and mid-size market participants may become dependent on the services of SIFIs and prone to contagion. Hence, diversification improves financial stability and reduces the TBTF issue.



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Consistent with the new EU-regulation Switzerland will improve the existing regulation of limits on risk concentration between banks by imposing per counterparty limits on interbank exposures whereby the risk weight of exceeding exposures is increased. However, the new risk concentration limits affect all banks and not merely SIFIs. Further measures are to be developed to reduce interconnectedness. Operational interconnectedness has to be considered as well, as many smaller banks have outsourced operations to SIFIs or access the financial infrastructure through them.

Box 6: No restrictions on business activities “Volcker Rule” - like restrictions are not being proposed. Narrowly defined restrictions have the potential to crowd out business activities into other market segments, eventually building up systemically important risks beyond the scope of financial market regulation and supervision. Therefore, having banks conducting such activities in a controlled manner and in observance of appropriate capital requirements is favoured. Companies will be able to continue such operations, provided they are able to fulfil the corresponding capital requirements and that the impact and consequences of such activities are considered in the recovery and resolution planning process.

6 Additional measures 6.1 Leverage ratio



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All capital components (baseline requirement, buffer, systemic surcharge) are defined in reference to risk-weighted assets and are therefore directly dependent on the valuation and risk assessment of the exposure. In order to put a backstop on the expansion of a company’s balance sheet and to mitigate deficiencies in the risk assessment models, a risk-neutral measure should supplement the risk-based capital requirements. Switzerland implemented a leverage ratio as a risk-neutral backstop measure back in 2008. As part of the SIFI policy, the leverage measure will have to be redefined based on the Basel III leverage ratio definition. Independently from challenges resulting from the accounting methodology and the termination of exceptional measures to the national economy, recalibration has to take into account the systemic importance of the banks concerned. The new calibration criteria are supposed to include the size of the bank by imposing progressive requirements.

6.2 Intense supervision and international cooperation Intense supervision of SIFIs is important in all phases of the economic cycle as is international coordination. The Swiss supervisor has implemented a risk-based approach for deciding on the intensity of supervision. By definition, SIFIs belong to the most intensely supervised companies. Given the international exposure of SIFIs, Switzerland will continue to work closely with host supervisors of those countries where Swiss SIFIs have a substantial market position.



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This cooperation has already been formally established within supervisory colleges. In addition to these colleges which deal with day-to-day supervisory issues, crisis management colleges have been created to discuss, improve and assess recovery and resolution preparations of a SIFI in an international scope.

7 Conclusion The Swiss SIFI policy framework describes a diverse policy mix of preventive and curative measures. Increased capital requirements strengthen the solvency of SIFIs and their loss-bearing capacity, while at the same time providing incentives to reduce systemic importance. If prevention fails, capital instruments, which are already available on the bank’s balance sheet, can be used to restructure the company and to protect a narrow set of systemically important functions. Organizational requirements mitigate the current lack of effective resolution frameworks at least to a certain extent. Completed by improved risk concentration limits and liquidity requirements, the Swiss SIFI proposal reduces contagion risk and improves preparation for effective crisis management. Today, however, financial stability is a global issue which cannot be tackled by one country alone, particularly in the case of globally operating banks. It is therefore essential that the international initiatives continue and eventually come up with an effective framework for SIFIs.



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Consultation paper on Draft Implementing Technical Standards on supervisory reporting requirements for liquidity coverage and stable funding 07 June 2012 The European Banking Authority (EBA) launched today a consultation on Draft Implementing Technical Standards (ITS) on supervisory reporting requirements for liquidity coverage and stable funding. These ITS, which will be part of the EU single rulebook, intend to specify the main features (formats, frequencies, IT solutions) of prudential reporting to be applied by financial institutions in Europe. The consultation runs until 27 August 2012. These ITS will become part of the general supervisory reporting framework. In this respect, they are an addition to the draft ITS text proposed in the Consultation Paper on supervisory reporting for institutions (CP50) published on 20 December 2011 and need to be read in conjunction with them.

Main features of the ITS These ITS aim at providing national authorities with harmonized information on their liquid assets, inflows and outflows and their stable



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sources of funding using uniform reporting formats developed by the EBA.

Against this background, this consultation paper puts forward proposals regarding the reporting requirements for both liquidity coverage and stable funding.

The purpose of this monitoring is two-fold:

(i) To inform the economic impact assessment of the liquidity requirements the EBA is asked to perform during the monitoring period, and

(ii) To enable competent authorities to monitor institutions’ compliance with the liquidity requirements once they have been introduced as binding minimum standards.

The scope and level of application of these ITS are in line with the Capital Requirements Regulation (CRR) text.

The latter provides for the liquidity coverage reporting to be done at least monthly and the stable funding reporting at least quarterly.

These ITS have been developed on the basis of the templates for liquidity reporting used by the EBA in compiling the Basel III monitoring exercise as well as on the COREP and FINREP guidelines.

They also build on voluntary reporting exercises conducted predominantly by larger institutions.

Next steps These draft ITS have been developed on the basis of the European Commission’s legislative proposals for the CRR/CRD IV.

Following the end of the consultation period, and to the extent that the final text of the CRR changes before the adoption of the ITS, the EBA will adapt its draft ITS accordingly to reflect any developments.



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The CRR also mandates the EBA to develop additional liquidity monitoring metrics to provide competent authorities with a comprehensive view of institutions’ liquidity risk profiles.

The EBA is currently working on these metrics and will launch a public consultation in due course, depending on the timeline that will be adopted in the CRR.

As stated above, the information collected under these ITS will be used to inform the EBA’s impact assessment on the introduction of the liquidity requirements.

The EBA will disclose the methodology it intends to use for this assessment later this year.

A separate consultation on a data point model containing all the relevant technical specifications necessary for developing an IT reporting format will be published in the second half of 2012.

Based on the CRR proposals and these ITS, institutions are required to comply with the new reporting requirements as of 1 January 2013.

In the current timeline for the implementation of the CRR/CRD IV, the first regular reporting period is expected to be January 2013.

Notes to editors

1. The CRR/CRD IV package (the so-called Capital Requirements Regulation - ‘CRR’- and the so-called Capital Requirements Directive – ‘CRD’) sets out prudential requirements which are expected to be applicable as of 1 January 2013.

The package translates in European law international standards on bank capital agreed at the G20 level (most commonly known as the Basel III agreement).

One of the major achievements will be the creation of a Single Rule Book - a set of rules directly applicable in all EU member states - that will improve both transparency and enforcement in the EU banking sector.



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2. Draft ITS are produced in accordance with Article 15 of EBA regulation which provides for their adoption by means of regulations or decisions.

According to EU law, EU regulations are binding in their entirety and directly applicable in all Member States.

This means that, on the date of their entry into force, they become part of the national law of the Member States and that their implementation into national law is not only unnecessary but also prohibited by EU law, except in so far as this is expressly required by them.

EBA Consultation Paper on Draft Implementing Technical Standards on Supervisory reporting requirements for liquidity coverage and stable funding, London, 07 June 2012 I. Responding to this Consultation EBA invites comments on all matters in this paper Comments are most helpful if they: - respond to the question stated;

- indicate the specific question to which the comments relates;

- contain a clear rationale;

- provide evidence to support the views expressed /rationale proposed; and

- describe any alternative regulatory choices EBA should consider

Please send your comments to the EBA by 27 August 2012



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Publication of responses All contributions received will be published following the close of the consultation, unless you request otherwise. Please indicate clearly and prominently in your submission any part you do not wish to be publically disclosed. A standard confidentiality statement in an e-mail message will not be treated as a request for non-disclosure. A confidential response may be requested from us in accordance with the EBA’s rules on public access to documents. We may consult you if we receive such a request. Any decision we make not to disclose the response is reviewable by the EBA’s Board of Appeal and the European Ombudsman.

II Executive Summary The CRD IV proposals which are expected to be applicable as of 1.1.2013, set out prudential requirements for EEA institutions. The CRR contains, in a number of Articles, specific mandates which require the EBA to develop draft Implementing Technical Standards (henceforth ITS) related to supervisory reporting requirements (Articles 95, 96, 383, 403 and 417 of CRR). These ITS will be part of the single rulebook enhancing regulatory harmonisation in Europe with the particular aim of specifying uniform formats, frequencies and dates of prudential reporting as well as IT solutions to be applied by institutions and, as the case may be, investment firms in Europe.



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The draft ITS are intended to be put forward as one integrated draft Regulation and this consultation paper consequently supplements EBA Consultation Paper CP50 on supervisory reporting for institutions, published on 20 December 20112. The draft ITS text proposed in the present document is an addition to the draft ITS text proposed in that CP and needs to be read in conjunction with it. The rationale behind a single draft Regulation is that it is beneficial that reporting requirements are grouped together in one legal act to facilitate a comprehensive view, improved understanding and compact access to them by legal or natural persons subject to the obligations laid down herein. In the case of monitoring the implementation of new standards, the benefits of standardised data collection and IT solutions will reduce the burden on institutions and allow a more accurate examination of the impact of such standards. This consultation paper puts forward proposals regarding the reporting requirements according to the mandate of the EBA provided in Article 481 of the CRR to monitor and evaluate the liquidity reporting requirements made in accordance with Article 403(1). This CP is not consulting on a number of items not specified in the CRR. Such matters include, but are not limited to, the calibration of the liquidity standards, the definition of liquid assets, the scope of application and frequency of reporting. Please note that the EBA has developed the present draft ITS based on the European Commission’s legislative proposals for the CRR/CRD IV.



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Following the end of the consultation period, and to the extent that the final text of the CRR changes before the adoption of the ITS, the EBA will adapt its draft ITS accordingly to reflect any developments. Following the close of the consultation on dd.mm, the EBA will assess the responses received, along with any relevant changes in the final CRR legislative text.

Main features of this ITS The CRR specifies a new liquidity coverage requirement that would be applicable to all credit institutions no earlier than 1.1.2015, following a delegated act by the EC. Article 481 requires the EBA to, amongst other things, monitor and evaluate the reports submitted in accordance with this ITS and to report to the EC whether a specification of the general liquidity requirement would “have a material detrimental impact on the business and risk profile of Union institutions or on financial markets or the economy and bank lending....”. With regard to a stable funding requirement, the article requires the EBA to submit a report to the EC on whether and how a stable funding requirement would be appropriate, together with a similar assessment on the impact on Union institutions, financial markets and bank lending. The ITS has been developed on the basis of templates for liquidity reporting used by the EBA in compiling its “Report on the Basel III monitoring exercise” which were in turn based on those in the Quantitative Impact Study (QIS) carried out by the Basel Committee on Banking Supervision (BCBS), adapted for the purposes of the requirements put forward by the CRR. The template consequently builds on the experience gained in a number of Member States with voluntary reporting predominantly by larger institutions.



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In addition the EBA has conducted a small number of voluntary reporting exercises for a broader range of institutions to increase familiarity with the liquidity coverage requirement and to improve data quality. The ITS has been developed, as much as possible, on the basis of the COREP and FINREP guidelines, given that these have been implemented already in various Members States and have been proved in practice to improve convergence in the field of supervisory reporting. However, there is a very limited overlap of data requirements with existing data collected, as is commonly the case with liquidity reporting. The scope and level of application of this ITS follows the scope and level of application of the CRR. As mentioned above, the EBA is mandated to follow the legislative text. The reporting frequency will be not less than monthly for the liquidity coverage reporting and not less than quarterly for the reporting of the stable funding as required by the CRR.

Timing of ITS development and application date Based on the EC proposals and this ITS, institutions are required to comply with new reporting requirements according to Titles II and III as of 1 January 2013. From this date onwards competent authorities will have to check

institutions‟ compliance with the afore-mentioned regular reporting requirements and reporting instructions belonging to the reporting templates. The first regular reporting period for the liquidity reporting according to Title II is expected to be January 2013, with the first reporting reference date being end January 2013



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The reporting of the stable funding according to Title III is expected to commence in the quarter of 2013 with the first reporting reference date being end-March 2013 2012.

Q1: Are the proposed dates for first remittance of data, i.e. end of January and end of March 2013, feasible?

The EBA intends to finalise the draft ITS and endorse it for submission to the EC by November 2012. The proposed submission dates assume that a final CRR will be available beforehand. While this is a very short period of time before reporting is legally required, in the case of many large institutions, they will have been reporting on a voluntary basis for an extended period of time, and other institutions can plan on the basis of final legislative text which should be available at a much earlier date. It is important to keep in mind that timelines contained in the CRR might change which may impact the above dates related to the ITS. In any case, EBA will adapt its draft ITS according to the final version of the CRR text before submitting it to the EC for adoption.

III. Background and rationale Draft ITS on Liquidity reporting On July 20th 2011, the EC published legislative proposals on a revision of the CRD which seeks to apply the Basel III framework in the EU. These proposals have recast the contents of the CRD into a revised CRD and a new CRR - which are colloquially referred to as the CRR proposals.



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These are currently being finalised by EU legislators (Council and European Parliament) in the framework of the co-decision procedure. In anticipation of the finalisation of the legislative texts for the CRR, the EBA has developed the draft ITS in accordance with the mandate contained in Article 403.1 (a) of the draft CRR endorsed by the EC in July 2011. This approach, to draft the ITS on the basis of the EC’s endorsed text was deemed a more efficient way forward, as it will allow banks to start evaluating the potential challenges of the new liquidity reporting framework (introduced as a legal requirement for the first time in the CRR proposals) pending finalisation of the co-decision process. In any case, the EBA will adapt its draft ITS according to the final version of the CRR text before submitting them to the EC for adoption. The final ITS on liquidity reporting and reporting on stable funding will be included in the ITS on supervisory reporting requirements for institutions.

The nature of ITS under EU law These draft ITS are produced in accordance with Article 15 of EBA regulation. According to Article 15(4) of EBA regulation, they shall be adopted by means of regulations. According to EU law, EU regulations are binding in their entirety and directly applicable in all Member States. This means that, on the date of their entry into force, they become part of the national law of the Member States and that their implementation into national law is not only unnecessary but also prohibited by EU law, except in so far as this is expressly required by them.



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Shaping these rules in the form of a Regulation would ensure a level-playing field by preventing diverging national requirements and would ease the cross-border provision of services.

Background and regulatory approach followed in the draft ITS

In the context of domestic-based liquidity regimes within the European Union, liquidity risk regulatory and reporting frameworks currently in use in the various Member States are heterogeneous. This led to inefficient outcomes and increased costs for cross-border institutions and national supervisory authorities, especially during the events of the 2007-2008. To tackle such regulatory shortcomings which emerged during the crisis and taking account of the new liquidity regulatory framework proposed by the BCBS in December 20106, the EC’s proposed CRR envisages introducing a liquidity coverage requirement from 1.1.2015 following an observation and a review period. Such a requirement aims to improve short term resilience of the liquidity risk profile of institutions. According to the proposed CRR, the Commission will also consider introducing a stable funding requirement in 2018 following an observation and review period, to address funding problems arising from maturity mismatches. To this aim, institutions are requested to report to national authorities the elements needed to monitor their liquid assets, inflows and outflows and their stable sources of funding according to Title II (Liquidity Reporting), Annex III (Items subject to supplementary reporting of liquid assets) and Title III (Reporting on stable funding) of the CRR, using uniform reporting formats developed by EBA. With that in mind, the present ITS has been developed to provide national authorities with harmonised information on institution’s liquidity risk



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profile, taking into account the nature, scale and complexity of institutions' activities. As the ITS on liquidity reporting will become part of the general supervisory reporting framework requirements, following the introduction of liquidity requirements, formats have been developed with the aim to ensure consistency where allowed by the CRR proposed text. Under the proposed CRR text, EBA is also requested to monitor and evaluate the reports made by institutions and, after consulting the ESRB, to report annually and for the first time by 31 December 2013 to the Commission on the following issues: (a) Whether the general liquidity coverage requirement in Article 401 CRR is likely to have a detrimental impact on the business and risk profile of Union institutions or on financial markets or then economy and bank lending (Article 481(1) CRR);

(b) Appropriate uniform definitions of high and extremely high liquid and credit quality of transferable assets for the purposes of Article 404 CRR. By 31 December 2015, EBA is also requested to report to the Commission whether and how it would be appropriate to ensure that institutions use stable sources of funding, including an assessment of impact on the business and risk profile of Union institutions or on financial markets or the economy and bank lending (Art. 481(3) CRR). Therefore, information included in the ITS on liquidity reporting will also be useful to EBA in reporting on the impact of the general liquidity coverage requirement and the appropriateness of a stable funding requirement. However, this draft ITS will not help the EBA determine whether certain transferable assets are of high or extremely high liquidity and credit quality, as this an assessment independent of whether individual institutions are holding such assets.



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Level of application and frequency of liquidity coverage reporting and the reporting on stable funding The scope and level of application of the ITS follows the scope and level of application of the CRR, i.e. it applies - on a consolidated basis (Article 10(3) CRR): to EU parent credit institutions and investment firms and to credit institutions and investment firms controlled by an EU parent financial holding company or by an EU parent mixed financial holding company; - on an individual basis (Article 5(4)) : to all credit institutions and investment firms that are authorised to provide the investment services listed in points 3 and 6 of section A of Annex I to Directive 2004/39/EC. However, according to Article 7 of the proposed CRR text, competent authorities will be allowed to waive in full or in part the application of Article 401 (Liquidity Coverage Requirement) to a parent institution and to all or some of its subsidiaries, if they fulfil a set a predefined conditions, including if the parent institution complies on a consolidated basis with the obligation set forth in Article 401 and 403 (Article 7(1) (a)). The frequency of the reporting requirements are aligned with those envisaged in the draft CRR text: not less than monthly for the liquidity reporting and not less than quarterly for the reporting on stable funding. Both the frequency and the scope of application of the ITS will be revised to be aligned to final text of the CRR, especially regarding the application of liquidity requirements to investment firms (Article 480(2) of CRR).

IV. Draft Implementing Technical Standards on Supervisory reporting requirements for liquidity coverage reporting and reporting on stable funding



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In between the text of the draft ITS that follows, further explanations on specific aspects of the proposed text are occasionally provided, which either offer examples or provide the rationale behind a provision, and/or set out specific questions for the consultation process. Where this is the case, this explanatory text appears in a framed text box. Structure of the draft ITS CHAPTER 1 Subject matter, Scope and Definitions CHAPTER 2 Reporting reference and remittance dates CHAPTER 3 Format and frequency of reporting on liquidity and on stable funding Section 1 Format and frequency of reporting on liquidity Section 2 Format and frequency of reporting on stable funding CHAPTER 4 IT solutions for the submission of data from institutions to competent authorities CHAPTER 5 Final provisions Annex I Liquidity coverage reporting template Annex II Stable funding reporting template Annex III Instructions liquid assets Annex IV Instructions inflows Annex V Instructions outflows Annex VI Instructions Stable funding



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Draft Commission Implementing Regulation (EU) No XX/2012 of XX Month 2012 laying down implementing technical standards with regard to supervisory reporting of institutions according to the (proposal for a ) European Parliament and Council Regulation (EU) No [xx] of [date] on prudential requirements for credit institutions and investment firms.

CHAPTER 1 Subject matter, Scope and Definitions Article 1 Subject matter and scope 1. This Regulation lays down uniform requirements that all institutions subject to the Regulation of the European Parliament and of the Council on prudential requirements for credit institutions and investment firms (hereinafter “CRR”) must meet relating to the submission of supervisory data to competent authorities for the following areas: a) liquidity reporting requirements as defined in Part III, Title II of Regulation xx/xx ; b) supplementary reporting of liquid assets as defined in Annex III of Regulation xx/xx ; c) stable funding reporting requirements as defined in Part III, Title III of Regulation xx/xx ; d) additional liquidity monitoring metrics as defined in Part III, Title II of Regulation xx/xx ; e) IT solutions as defined in Part III, Title II of Regulation xx/xx . Explanatory text for consultation purposes The draft CRR also requires the EBA to develop a draft ITS to cover additional monitoring metrics by Jan 1, 2013.



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The EBA intends to launch a separate consultation on this matter in autumn 2012. The data point model will be published for consultation in the third quarter of 2012.

2. The liquidity reporting requirements and the supplementary reporting of liquid assets specified in this regulation apply until the delegated act for a liquidity coverage requirement as referred to in Article 444 of Regulation xx/xx has entered in force.

Some supplementary information is asked in the template to increase data coverage.

At certain times the EBA may propose to change, amend or alter the reporting specified in this Regulation in order to inform the report required by Article 481.

This does not prejudge the future calibration of the ratio.

3. The stable funding reporting requirements specified in this regulation apply until a legislative proposal for a stable funding requirement as referred to in Article 481 (3) of Regulation xx/xx would enter in force.

4. The reporting shall be done on an individual basis (Article 5) and on a consolidated basis (Article 10) as defined in Regulation xx/xx.

Individual reporting may only be waived according to the procedures outlined in Articles 7 and 19.

These Articles make clear the respective roles of the EBA and the relevant competent authorities in granting any such waivers.

Article 2 Definitions



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1. For the purpose of this Regulation, the definitions provided by Regulation xx/xx shall apply, in particular those included in Article 4 and 400 of the CRR shall apply.

2. For the purpose of this Regulation, the scope and level of application according to Part 1, Title II of Regulation xx/xx shall apply. Explanatory text for consultation purposes In addition, according to Article 403.2, institutions are required to report items separately if they are indexed to a currency where the institution has significant liquidity risk or such currency is the lawful currency of a jurisdiction where they have a significant branch. For the purposes of harmonising the definition of a currency where an institution has significant liquidity risk the EBA proposes that this should be limited to those currencies which comprise more than 5% of an institution’s liabilities.

Q2: Do respondents agree with this proposal for defining significant currency? The reporting for investment firms should be done following the requirements of Part 1, Title II until the eventual implementation of any legislative proposal referred to in Article 480(2) of CRR.

CHAPTER 2 Reporting reference and remittance dates

Article 3

1. The reporting reference dates shall be:

- Monthly reporting: on the last day of each month;

- Quarterly reporting: 31 March, 30 June, 30 September and 31 December.



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Article 4

Reports shall be submitted by institutions to competent authorities by close of business on the 15th calendar day after the reporting reference date specified in Article 3.

1. If the remittance day is a public holiday, Saturday or Sunday, reporting requirement shall be transmitted on the following working day.

2. The above remittance dates concern the submission of unaudited figures which are figures that have not been assessed by external auditors. Where applicable, audited figures implying changes in already reported data shall be submitted as soon as available.

In addition, any errors in the submitted reports shall be corrected by the reporting institution by submitting the necessary revisions to the relevant competent authority as soon as possible.

Explanatory text for consultation purposes The proposed remittance period is 15 days for the monthly reporting and 15 days for the quarterly reporting.

Q3: Is the proposed remittance period of 15 days feasible? CHAPTER 3 Format and frequency of reporting on liquidity and on stable funding Section 1 Format and frequency of reporting on liquidity coverage requirement Article 5



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1. Information submitted pursuant to the templates set out in Annex I (liquidity coverage reporting template) and according to the instructions in Annex III, IV and V shall be reported on a monthly basis.

2. Institutions shall have the operational capacity to increase the frequency to weekly or even daily in stressed situations at the discretion of the competent authorities. The items listed for reporting in the template include all the necessary items specified in Articles 400 to 415 of the CRR. Certain additional items are included to help institutions and supervisors check data quality and to inform other relevant policy options, such as intra-group treatments.

Q4: Are there additional sub-categories of inflows and outflows that are consistent with the specification of the liquidity coverage requirement in the CRR and would inform policy options that should be included in the template and accordingly reported? With respect to the reporting of liquid assets according to Annex III and Article 404, in the absence of a harmonised definition, institutions are permitted to use internal definitions for the purposes of liquidity reporting. The CRR also permits competent authorities to give guidance institutions shall follow in identifying assets of high and extremely high liquidity and credit quality. It is not practical in the context of a harmonized reporting framework for institutions to have complete freedom to define such assets, both from the point of view of having common IT solutions and data comparability across submissions. Therefore the EBA is using this consultation to ask institutions what additional data on asset class holdings should be collected.



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The most significant amendments to the CRR in respect of liquidity reporting proposed by the co-decision bodies are to include equities, gold and high-quality residential mortgage-backed securities or state-guaranteed bank debt. It should be noted that collecting data on additional assets does increase the complexity of the template given that the inflow and outflow rates on repo and reverse repo transactions are varied according to the liquidity category which each asset belongs to in accordance with Articles 410 and 413. The responses to the following question will be taken into account together with any mandated inclusions or exclusions of assets in the final version of the CRR for the purposes of giving the guidance to institutions permitted in Article 404.

Q5: Fur the purposes of providing guidance as to transferrable securities of high and extremely high credit and liquidity quality, what additional assets, if any, should the ITS collect? Section 2 Format and frequency of reporting on stable funding

Article 5 Format and frequency of reporting on stable funding

1. Information submitted pursuant to the template set out in Annex II (Stable funding reporting requirement) and according to the instructions in Annex VI shall be reported on a quarterly basis. Explanatory text for consultation purposes The scope, definitions, reporting reference and remittance dates as set out in Chapters X and X apply.



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2. The information to be reported are the following: a) information on items providing stable funding according to Article 414(1) of Regulation xx/xx ;

b) information on items requiring stable funding according to Article 415(1) of Regulation xx/xx . Explanatory text for consultation purposes The information gathered will help to compile the report to the Commission on whether and how it would be appropriate to ensure that institutions use stable sources of funding according to the Article 481§3 of the CRR in order to promote more medium and long-term funding of the assets and activities of banking organisations. The amount of stable funding required of a specific institution should be a function of the liquidity characteristics of various types of assets held, off-balance sheet contingent exposures incurred and/or activities pursued by the institution.

Q6: Do respondents agree that the template captures the requirement of the draft CRR on reporting of stable funding?

Where applicable, the information required on stable funding will have to be presented in five buckets (within 3 months, between 3 and 6 months, between 6 and 9 months, between 9 and 12 months and after 12 months).

V. Accompanying documents a. Draft Impact Assessment Introduction Article 403(3)(a) of the CRR requires the EBA to develop draft Implementing Technical Standards (ITS) relating to the reporting on liquidity coverage and stable funding.



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As per Article 15(1) second subparagraph of the EBA Regulation (Regulation (EU) No 1093/2010of the European Parliament and of the Council), any draft technical standards developed by the EBA will have to be accompanied by a separate note on Impact Assessment (IA) which analyses the „the potential related costs and benefits (unless such analyses are disproportionate in relation to the scope and impact of the draft ITS concerned or in relation to the particular urgency of the matter). This IA aims to provide the reader with an overview of findings as regards the problems and options identified and their potential impact. This IA deals with the incremental impact of the EBA’s draft ITS to determine the uniform templates, the instructions on how to use this template, the frequencies and remittance days for reporting. Throughout the project the EBA has closely followed the work of international organisations dealing with related topics, in particular the Basel Committee on Banking Supervision in charge of monitoring Basel III requirements.

Problem definition Article 403(3)(a) CRR mandates the EBA to develop draft implementing technical standards to specify uniform formats with associated instructions, frequencies, dates and delays for reporting of the liquidity coverage and stable funding requirements. These reports will enable authorities to monitor institutions compliance with the two requirements once they have become binding. During the monitoring period, the collected information will inform the economic impact assessment the EBA is mandated to perform under Article 481(1), as well as the report on appropriate uniform definitions of liquid assets according to Article 481(2).



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Article 403 CRR requires institutions to report items for the purpose of monitoring compliance with the liquidity requirements and also stipulates that the reporting frequency shall not be less than monthly for the liquidity coverage requirement and quarterly for reporting on stable funding. On the contrary, the CRR gives discretion for the EBA to propose options on (i) whether to integrate liquidity reporting in the common reporting framework (COREP), (ii) the level of detail for some of the reporting items, (iii) remittance dates and (iv) reporting of significant currencies.

Timing of ITS development and application date Institutions are expected to comply with the new CRR Requirements from January 2013. Sufficient time for implementing ITS requirements is essential to ensure data availability and quality in order for competent authorities to perform their tasks. The CRR applies to institutions regardless of their size, risk profile, etc. The appropriate balance between the required level of detail of the submitted information and the nature, scale and complexity of institutions activities is imperative in the consideration of reporting formats and frequencies.



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Objectives of the technical standards The objective of the draft ITS is to determine uniform templates and instructions on how to use this template, the frequencies and dates of reporting as well as IT solutions for the purposes of liquidity reporting requirements. This draft ITS will assist institutions in fulfilling their reporting requirements under Article 403(1) CRR. Additional liquidity monitoring metrics according to Article 403(3)(b) CRR will be consulted at a later stage. It is important that the relevant data is available for the review of the appropriateness of the liquidity coverage and stable funding requirements in 2015 and 2018, respectively.

Policy proposals Given that the uniform liquidity reporting requirements are being introduced for the first time in the EU, an appropriate reporting template needs to be developed. I. Including the ITS as an Annex to the COREP reporting standard At this stage reporting is for the observation period for the liquidity standards, rather than a final standard. In this light, two alternatives have been considered: (i) Following an approach chosen for the QIS based on a stand-alone Excel template, or

(ii) including liquidity risk reporting in the common reporting framework.

Option I Advantages:



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- Keeping full flexibility for future adaptions after the ratios have been finally calibrated. Disadvantages: -No established reporting infrastructure, -No link to bank identifiers and other data which would be useful for the economic impact assessment to be performed under Article 481 (1). Option 2 Advantages: - Harmonised methodology to collect the data, - the ability to cross-reference to other metrics, - stablished infrastructure to analyse and manipulate the data. Disadvantages: -Any changes to the template as a result of the observation period would need to take place within the COREP timetable. Based on the above reasoning it is concluded that option 2 is more beneficial and hence integration into COREP is proposed.

II. Submission time

The time between reporting date and submission is not specified in CRR. The CP proposes as a baseline that reporting dates should be at month end for LCR and quarter end for NSFR, and that the submission time should be 15 calendar days.



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This would take into consideration that the LCR incorporates a 30 days forward looking stress scenario, i.e. ideally remittance should occur before this period ends. EBA encourages stakeholders to comment on the feasibility of the proposed submission time.

III. Level of detail for certain reporting items for the liquidity coverage requirement

In the absence of an adopted CRR there has been no finalized list of liquid assets to be reported yet. Moreover, according to positions of both the ECOFIN and the European Parliament, the EBA shall collect information on certain assets for the purpose of its economic impact assessment even in cases where they would not meet certain criteria, e.g. central bank eligibility. For the purposes of this consultation, the EBA proposes the following: The template includes those assets that were specifically listed in the Commission proposal. Respondents are explicitly asked to suggest additional asset classes to be included in the reporting for the purpose of the economic impact assessment, and without prejudice to their eligibility after final calibration of the LCR.

IV. Reporting in significant currencies

Article 405(g) CRR on the operational requirements for holdings of liquid assets requires that „the denomination of the liquid assets is consistent with the distribution by currency of liquidity outflows after the deduction of capped inflows.



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Without collecting information on collecting the liquidity coverage requirement by currency, the EBA could not measure the impact of this proposal.

Likely economic impacts It is recognised that the reporting of liquidity requirements will incur operational and compliance costs for institutions and competent authorities. It is not envisaged that these costs would be over and above those incurred if the liquidity reporting requirements were constructed in an alternative manner. In fact, if it was proposed to require reporting outside the scope of COREP, presumably this would increase operational costs in the long-term. The proposal to rely on the COREP reporting framework is aimed at minimising the incremental economic impact of the liquidity reporting requirements for institutions and competent authorities.

b. Overview of questions for public consultation Q1: Are the proposed dates for first remittance of data, i.e. end of January and end of March2013 feasible? Q2: Do respondents agree with this proposal for defining significant currency? Q3: Is the proposed remittance period of 15 days feasible? Q4: Are there additional sub-categories of inflows and outflows that are consistent with the specification of the liquidity coverage requirement in the CRR and would inform policy options that should be reported?



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Q5: Fur the purposes of providing guidance as to transferrable securities of high and extremely high credit and liquidity quality, what additional assets, if any, should the ITS collect? Q6: Do respondents agree that the template captures the requirement of the draft CRR on reporting of stable funding?



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Call for evidence on Transaction Reporting From The British Bankers’ Association (BBA) to the European Securities and Markets Authority (ESMA) To European Securities and Markets Authority 103, Rue de Grenelle 75007 Paris France

1 June 2012

Dear Sir or Madam

Call for evidence on Transaction Reporting

The British Bankers’ Association (BBA) thanks the European Securities and Markets Authority (ESMA) for the opportunity to comment on its call for evidence on what elements ESMA should consider in its work on guidelines on harmonised transaction reporting together with what areas of the OTC derivatives guidelines need to be updated. The BBA is the leading association for UK banking and financial services sector, speaking for over 230 banking members from 60 countries on the full range of the UK and international banking issues. As such our membership has a broad view of transaction reporting obligations and the requirements as applied by the various competent authorities across Europe, and we recognise that divergent



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interpretations of reporting requirements will create difficulties for competent authorities when analysing TREM data for potential market abuse. We would like to preface our detailed responses to the specific questions asked by ESMA by providing some general comments.

General Comments

We welcome that ESMA acknowledges the legislative initiatives on MiFID/R and EMIR and that the work on transaction reporting guidelines will be carried out taking into account the progress of the negotiations. We are fully supportive of the intention to harmonise the approach to transaction reporting across Europe. We would respectfully suggest that ESMA adopt the following three guiding principles when proposing revised transaction reporting guidance:

Simplification

Harmonisation

Standardisation

Simplification

The transaction reporting regime supports a complex array of financial instruments and transaction booking methodologies. We are strongly of the opinion that major drivers of data quality are reporting requirements that are simple, clear and unambiguous. Simplification without question reduces the risk of error in interpretation and application of the reporting requirements.



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The first step must be the introduction of key principles used to assess when and where the execution of a transaction has taken place and by whom and how executions are distinct from the receipt and transmission of orders.

Harmonisation

We firmly believe that data definitions for data fields need to be consistent across jurisdictions and reporting regimes. The time of trade for example is required on both Transaction and Trade reports. To that end a unified approach to trade time reporting is needed. Secondly, consistency between reporting requirements across competent authorities is highly desirable.

Standardisation

We believe, where available, common data standards should be established using where possible existing international data standards.

Questions Q1. What transaction schemes should ESMA consider in its work on harmonised transaction reporting guidelines? Please explain and justify.

We welcome the opportunity to contribute to identifying common transaction reporting schemas which ESMA should consider in its work on guidelines on harmonised transaction reporting. In Annex 1 we have illustrated how the current mandatory fields as stipulated by MiFID allow firms to successfully support the transaction reporting of a wide range of scenarios typically used by BBA members



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with the reports clearly identifying the client and the reporting Firm facilitating the transaction. We have used the scenarios as identified in the call for evidence and have added several examples used for the reporting of Listed Derivative transactions. We have not shown in the examples each and every transaction report that would be made. For example in some cases the client / counterparty might also have an obligation to report and we have not in all cases shown both investment firms reports.

Q2. What updates and clarifications need to be introduced to the OTC derivatives reporting guidelines?

We agree with ESMA that a consistent interpretation of requirements for data fields common across jurisdictions and reporting regimes is essential. It is therefore necessary that ESMA’s harmonised OTC derivatives transaction reporting guidelines must be consistent with the Technical Standards that are being produced as a result of EMIR. Compatibility between the two will allow firms to report once and once only to a Trade Repository as specified in MiFID2 Any divergence of technical standards may mean that firms develop to a set of standards for Transaction Reporting, a set of standards for Repository reporting and a further set of standards when MiFID 2 allows reporting once to fulfil reporting obligations. It is therefore important for ESMA to update reporting guidelines after a detailed gap analysis between the two reporting requirements under EMIR and MiFID has been conducted.



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We are mindful of the complexities of merging a repository reporting regime with a transaction reporting regime and respectfully suggest further research and consultation may be required. The MiFID reportable fields should be a subset of fields required by EMIR. However, as it currently stands, there are differences between what is being asked to be reported. For example the data field for “Derivative Type” is required for transaction reporting but is not required under EMIR. Further, EMIR does not consider all potentially reportable events (for example exercise, termination, novation). EMIR references the Dodd Frank Act and MiFID 2 but there is no reference to CESR guidance of 2010.

We have identified examples of where key data fields in the CESR guidance and EMIR either converge or diverge.

Examples of convergence

The following key data fields appear in both the CESR guidance and EMIR technical standards: - Buy / Sell indicators, Unit Price, Price Notation, Quantity, Venue

identification, Underlying identification, Put / Call indicator, Price Multiplier, Expiration date.

These examples show EMIR referencing MiFID in terms of reference data attributes and their descriptions. However, we believe a more detailed analysis may show gaps.



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Examples of divergence

The following key data fields do not appear in EMIR technical standards for Trade Repositories. - Derivative Instrument type i.e. Complex K, Instrument description

and open question about strike price. - The CESR guidance identifies transactions that are reportable,

however the EMIR technical advice does not reference these transaction types 1

It is evident that the EMIR technical standards do not take into account the CESR guidance. This means that firms have to comply with competing requirements that make the stated aim of reporting once unachievable. It is necessary for ESMA to identify the differences across the CESR guidance, EMIR technical standards and MiFID 2 and then to provide consistency and compatibility of data fields to ensure harmonisation between trade repositories and transaction reporting requirements. It is also apparent from changes to the OTC market, i.e. the increased use of centralised clearing such that bi lateral trades need to be transaction reported for market abuse detection yet the trades are novated to face the clearing house. Further guidance to cater for these circumstances is required. Further we encourage the use of common data standards as follows:

- Standardised reportable events during the lifecycle of a transaction - Standardised Product Classification - Standadised Economic Calculations



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We understand that ISDA have completed an ISDA Taxonomy for products that is awaiting final approval from the CFTC at which point a final ratified version will be published. These standards could be considered for the purposes of transaction reporting. There are also inconsistencies over the use of identifiers, for both products and counterparties between authorities. Guidance should be sought on which identifier should be used for the product underlying OTC Derivatives, when there is no ISIN available. If there is no identifier available, what it the correct course of action - to not report until an ISIN becomes available? The approach that requires the storing - or 'parking' -of unreported trades until such time as an identifier becomes available leads to significant operational support issues. In this situation, updated guidelines on market data identifiers other than ISINs that can be used should be provided.

Q3. What other aspects of transaction reporting should ESMA consider in its work on harmonised guidelines? Please explain and justify.

Use of the Venue ID field:

There is a divergent approach to requirements for this field. In the UK, this field reflects whether exchange rules are applicable to a trade and this is consistent with Exchange requirements for trade reporting.



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This means that the field reflects the legal agreements that are in place between the trading parties and this can change dependent on the nature of the trade. For example, share buy back schemes are typically agreed to be under the rules of the exchange of the primary listing Such as the LSE. As such the client side transaction report includes XLON as the venue even when the stock has been sourced from a different venue or through a house fill. We believe however, for simplicity, the venue of where the trade was executed should be included for market side trades and XOFF for all client side transaction reports.

Adoption of the Legal Entity Identifier code (LEI):

As you will be aware, the LEI is being developed as an additional identifier which may replace the BIC code and this identifier is planned to be an acceptable identifier under EMIR. We would recommend that the use of the LEI is permitted once available as an alternative identifier and the timing of its introduction is before or aligned with the implementation of EMIR.

Branch reporting:

The interim solution provided by CESR as to what is meant by execution and thus whether a reporting obligation arises has been helpful, however, there is still no one clear view of what constitutes “execution” that clarifies what transactions should be reported and to which competent authority. This means that, currently, firms who have established branches may be required to transaction report to multiple Competent Authorities, determined by the varying interpretations of member states of the terms “execute” and “receipt and transmission of orders”.



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Further, each competent authority has its own data standards and reporting requirements. This increases not just the cost, but also the complexity of its reporting processes, and increases operational risk. The move towards harmonisation of transaction reporting standards as envisaged by MiFIR and as referred to in this letter should remove the need to transaction report in different formats to various regulators. In addition, it should result in more efficient information exchange between competent authorities, which will hopefully result in a reduction in the requests from multiple competent authorities for further information on the reports that have been made. As an industry we will be discussing this issue in greater detail and welcome the opportunity to discuss potential solutions with ESMA.

Over-reporting of transactions:

In the absence of a single list of reporting instruments, and we would further encourage the existence of such a list firms must continue to be permitted to report transactions in instruments that are not admitted to trading on an EEA regulated market (i.e. non MiFID instruments).

Central Counterparty:

When trading on exchange the obligation is currently to report the central counterparty. Markets are typically anonymous and therefore the actual counterparty is unknown. Firms should have the option of reporting their preferred CCP under interoperability arrangements.



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This is on the basis that the back office systems need to capture the details of the CCP against which the firm must settle. We continue to favour the use of Counterparty 1 to identify the counterparty as CCP and the Venue field to identify the venue of execution.

Principal crosses:

Within the UK reporting regime Principal crosses are regularly utilised. These allow firms to report both a buy and sell to separate counterparties in the same transaction report where they are executed at the same time and price. Such transactions greatly reduce the volume of transaction reports made and therefore reduces the burden placed on firms in that they have fewer transaction reports to manage. Notwithstanding this, the vast majority of investment firms within the UK utilise the principal cross in several systems. As such should principal crosses not be available going forward this would have very significant cost implications for UK investment firms.

Testing:

We regard to how data is made available by authorities for the purpose of firms' front to back testing of their transaction reporting, we would request ESMA to ensure that this information be provided through an automated service, such as FTP (File Transfer Protocol). At present data is collated in large files, which are then sent by email. Automation would allow for firms' being able to access every day of a months' data, rather than requesting data for specific dates.



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Given automated systems such as FTP are becoming more of a global standard for institutions to run assurance testing programmes on their transaction reporting, we believe this should be considered as part of a EU standardisation / harmonisation drive. We appreciate the opportunity to address and comment on the issues raised by this call for evidence. We look forward to continuing an open dialogue with you on these important issues to achieve harmonised transaction reporting and would welcome a meeting in person to discuss in more detail. Please do not hesitate to contact Sally Springer (+44 20 7216 8841) should any questions arise. Yours faithfully

Sally Springer Senior Policy Director



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1. Investment Firm vs. Investor (Principal) Single Venue

Client A Investment FirmLondon Stock

Exchange

Sell Buy

Transaction Reports

Data Field Name Content of Report

Reporting Firm Investment Firm

Trading Capacity P

Buy/Sell Indicator S

Quantity 1

Counterparty 1 Client A

Counterparty 2 Blank

Venue of execution XOFF



Trading Capacity P

Buy/Sell Indicator B

Quantity 1

Counterparty 1 Clearing House


Venue of execution XLON

The Buy/Sell Indicator is from the perspective of the Investment Firm

Client Side Report Market Side Report

2. Investment Firm vs. Investment Firm (Principal)

Investment Firm B Investment Firm ALondon Stock

Exchange

Sell Buy

Transaction Reports


Reporting Firm Investment Firm A

Trading Capacity P


Quantity 1

Counterparty 1 Investment Firm B





Trading Capacity P


Quantity 1





Counterparty Report Market Side Report



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3a. Investment Firm vs. Investment Firm (Agent)


Exchange

Buy

Transaction Reports



Trading Capacity A


Quantity 1

Counterparty 1 Internal





Trading Capacity A


Quantity 1


Counterparty 2 Internal


Counterparty Side Report Market Side Report

The Buy/Sell Indicator is from the perspective of the Investment Firm B

3b. Investment Firm vs. Investment Firm (Agent)


Exchange

Transaction Reports



Trading Capacity A


Quantity 1




The Buy/Sell Indicator is from the perspective of the Investment Firm B

Buy



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4. Investment Firm matches 2 client orders

Client A Investment Firm Client BSell Buy

Transaction Reports



Trading Capacity P


Quantity 1






Trading Capacity P


Quantity 1

Counterparty 1 Client B




Client Side Report Client Side Report

6. Systematic Internalisers – MiFID Security only

Client A Investment FirmSell

Transaction Reports



Trading Capacity P


Quantity 1



Venue of execution Systematic

Internaliser BIC


Client Side Report



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7. On exchange execution of a client order

Client A Investment FirmLondon Stock

Exchange

Sell Buy

Transaction Reports




Trading Capacity P


Quantity 1






Trading Capacity P


Quantity 1





8. Firm executing a transaction vs. EEA Investment Firm


Exchange

Sell Buy

Transaction Reports



Trading Capacity P


Quantity 1






Trading Capacity P


Quantity 1





Counterparty Report Market Side Report



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9. Two investment firms executing a proprietary transaction

Investment Firm ALondon Stock

ExchangeInvestment Firm B

Sell Sell

Transaction Reports



Trading Capacity P


Quantity 1





Reporting Firm Investment Firm B

Trading Capacity P


Quantity 1




Market Side ReportMarket Side Report


10. Client Order through a chain of Investment Firms

Client A Investment Firm BrokerSell Buy

Transaction Reports



Trading Capacity Principal


Quantity 1

Counterparty 1 Broker



The Buy/Sell Indicator is from the perspective of the Investment Firm or Executing Broker as appropriate

Euronext Paris


Reporting Firm Broker

Trading Capacity Principal Cross


Quantity 1


Counterparty 2 Investment Firm

Venue of execution XPAR

BuySell





Quantity 1




Investment Firm Market side Report Broker Market Side ReportClient Side Report



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11. Execution of client order through a UK branch

Client AUK Branch of

Investment Firm

London Stock

Exchange

Sell Buy

Transaction Reports


Reporting Firm UK Branch

Investment Firm

Trading Capacity P


Quantity 1





Reporting Firm UK Branch

Investment Firm

Trading Capacity P


Quantity 1






12. Investment Firm vs. Investor (Principal) Multiple Venues

Client A Investment Firm

CHI-X

Sell

Buy

Transaction Reports



Trading Capacity P


Quantity 2






Trading Capacity P


Quantity 1



Venue of execution CHIX

BATS EuropeBuy



Trading Capacity P


Quantity 1



Venue of execution BATE


Client Side Report Market Side Reports



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13. Grouping of orders

London Stock

ExchangeInvestment Firm

Client A

Buy

Sell

Transaction Reports



Trading Capacity P


Quantity 1






Trading Capacity P


Quantity 1

Counterparty 1 Client B



Client BSell



Trading Capacity P


Quantity 2





Client Side Reports Market Side Report

14. Direct Electronic Access

London Stock

ExchangeInvestment FirmClient A

Buy

Order via DEA provided by Investment Firm

Transaction Reports


Sell



Trading Capacity P


Quantity 1






Trading Capacity P


Quantity 1







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15. Give up to hedge

London Stock

ExchangeInvestment FirmClient A

BuySell

Transaction Reports


Reporting Firm Swap Broker

Trading Capacity P


Quantity 1



Venue of execution XXXX

Swap BrokerSell



Trading Capacity P


Quantity 1




The Buy/Sell Indicator is from the perspective of the Investment Firm or Swap Broker as appropriate

Swap Broker Report Investment Firm Report

Client A enters into a derivative contract with Swap Broker, Investment Firm executes the underlying security transaction.

Client A’s investment decision is to enter the derivative contract.

16. Smart Order Routing

Client A Investment Firm

CHI-X

Sell

Buy

Transaction Reports



Trading Capacity P


Quantity 2






Trading Capacity P


Quantity 1



Venue of execution CHIX

BATS EuropeBuy



Trading Capacity P


Quantity 1



Venue of execution BATE


Client Side Report Market Side Reports

Smart Order Routing to identify best price



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17. ETD Client Trade (Aii/ISIN)

Client A Investment Firm EuronextSell Buy

Transaction Reports





Quantity 1

Counterparty 1 LCH Clearnet SA


Venue of execution XEUE


LCH Clearnet

18. ETD Client Trade – Order passed for execution

Client A Investment Firm Executing Broker

External Client A buys 1 contract on a principal basis. Investment firm passes the order to an executing

broker for execution. No client details are passed to the Executing Broker

Sell Buy

Transaction Reports





Quantity 1

Counterparty 1 Executing Firm



The Buy/Sell Indicator is from the perspective of the Investment Firm or Executing Broker as appropriate

CCP

Euronext


Reporting Firm Executing Broker



Quantity 1


Counterparty 2 Investment Firm




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19. ETD Client Trade – Order passed for execution

Client A Investment Firm Executing Broker

External Client A buys 1 contract on a principal basis. Investment firm passes the order to an executing

broker for execution. Client details are passed to the Executing Broker

Sell Buy

Transaction Reports

The Buy/Sell Indicator is from the perspective of the Executing Broker

CCP

Euronext


Reporting Firm Executing Broker



Quantity 1




As the client details have been passed to the Executing Broker then

the Investment Firm has no reporting obligation

20. ETD House Trade (Aii/ISIN)

Investment Firm Euronext

Investment Firm A buys 1 contract on a principal basis

Buy

Transaction Reports





Quantity 1





LCH Clearnet



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The Next Phase in Islamic Finance

Ravi Menon Managing Director, Monetary Authority of Singapore

Opening Address at the 3rd Annual World Islamic Banking Conference: Asia Summit, Grant Hyatt Singapore, 5 June 2012

Dr Ahmad Mohamed Ali Al-Madani, President, Islamic Development Bank, Your Excellencies, distinguished guests, ladies and gentlemen, good morning.

And to all our foreign guests, a warm welcome to Singapore.

An Increasingly Difficult Conjuncture

We are meeting here for the 3rd Annual World Islamic Banking Conference Asia Summit, at a time of increasing stress in the global economy and financial system.

The effects of monetary stimulus, which had helped to support the economy and prevent a full-blown financial crisis, are now levelling off in both the Eurozone and the US.

The labour market remains a significant drag on growth in the advanced economies.

Unemployment has hit new highs in the Eurozone while employment and production numbers in the US are showing signs of weakness.



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The story of a two-speed global economy is coming under strain, with demand weakening across emerging Asia.

The moderation in China’s economic growth appears to be somewhat sharper than expected.

India is undergoing an even more pronounced and broad-based slowdown.

But the key risk that has increased in recent months and poses the biggest threat to global economic prospects is the situation in Europe.

- Greece is preparing for a historic election that may well decide its future in the Eurozone.

- Spain is experiencing severe strains in its banking system against a backdrop of a sharp reduction in GDP, high unemployment, and a deteriorating real estate sector.

- Italy and Spain are facing higher sovereign borrowing costs that threaten fiscal sustainability.

To be fair, Eurozone governments have been taking extraordinary measures to help stabilise the situation, reduce fiscal deficits, and restore growth.

But they have reached a turning point where bolder, decisive actions will be needed to reverse the tide.

The next few weeks and months will be critical.

Islamic Finance: Challenges to Overcome

Let me turn now to the subject of our conference.

Islamic finance has shown remarkable resilience during the last five years – perhaps the most challenging economic environment in the post-war era.



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The industry has grown by an estimated 20% annually in the last five years to reach US$1.3 trillion in total assets in 2011.

Islamic banks have grown both in number and in scope.

But the sustained growth of Islamic finance is in no way guaranteed.

For Islamic finance to continue thriving, the industry has to overcome a few key challenges.

But in every challenge, there is also opportunity. Let me highlight three of them this morning.

Islamic Finance in the Era of Deleveraging

The clear and present danger to all financial activity, including Islamic finance, is the risk of contagion from an escalation of the Eurozone crisis.

Islamic finance is closely intertwined with underlying economic activity and will be affected by the impact of slower global growth.

Contagion from the Eurozone has already curtailed economic growth and capital inflows to many emerging economies where Islamic finance has taken root.

Potential spillovers from an escalation of the Eurozone crisis could lower output in the Middle East and North Africa region by about 3¼ percent relative to baseline, the largest spillover effect for any region outside Europe.

But Islamic finance has a window of opportunity in the current climate of deleveraging in the global financial system.

With its strict prohibition on excessive leverage, Islamic finance has been spared the worst of the financial crisis.

Islamic banks are well positioned to reach out to new customers who are in need of financing as many global institutions pull back on their lending due to the need to repair their balance sheets.



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Islamic finance should diversify into growth areas such as trade and infrastructure financing, where demand is still strong, especially in emerging economies.

With a focus on supporting real productive activities, Islamic finance is naturally compatible with trade and infrastructure development.

Tapping these sectors also brings about greater diversification benefits, especially for Islamic institutions which have been hurt by their significant lending exposure to the real estate sector.

Islamic Finance and Global Regulatory Reforms

A second factor that Islamic finance will have to contend with is the ongoing global regulatory reforms.

The scale and scope of these reforms are probably unmatched in recent history.

Islamic financial institutions will have to devote considerable resources to meet the new international standards.

But there are certain inherent characteristics of Islamic finance that will stand it in good stead in the emerging regulatory environment.

Take for example, banking, where the emphasis of regulatory reform is on more capital and more liquidity.

Islamic banks have consistently held higher levels of capitalisation vis-à-vis conventional banks, by some 2.5 percentage points on aggregate, according to research from the World Bank.

Islamic banks also start off with a higher level of liquid assets compared to their conventional counterparts.

Islamic finance is also well placed to meet the increased “return-to-basics” investor demand.

Following the global financial crisis, investors have become more averse to the unknown risks embedded in complex financial instruments.



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Islamic finance, with its stronger emphasis on transparency, price certainty and risk-sharing, can benefit from this renewed demand for more basic investments, from Muslim and non-Muslim investors alike.

Integrating Islamic Finance with Global Finance

The third, and perhaps most important, challenge that Islamic finance must overcome is its present fragmented state.

Islamic finance currently suffers from low economies of scale.

The overall size of Islamic assets is still less than 1% of the global financial system.

Being smaller and relatively young, Islamic finance currently offers fewer product choices for consumers and less comprehensive risk management options for institutions.

Cross-border investment flows are also constrained by differing interpretations of permissible transactions under Shariah principles.

The isolated pools of Islamic liquidity in each market restrict opportunities for more efficient allocation of capital across consumers, industries, and jurisdictions.

Islamic finance must become more integrated with the global financial system.

The industry must expand beyond its traditional markets to include a wider range of financial institutions, investors and consumers.

This means Islamic finance must strike roots in the key international financial centres of the world.

These centres can contribute to Islamic finance in several ways.

First, market liquidity.



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The broad and deep investor pools in international financial centres offer an opportunity to channel non-traditional sources of funds into Islamic finance.

In Singapore, for instance, several local and foreign issuers have successfully tapped the capital markets using Islamic instruments.

The demand comes from not just Singapore but a diverse group of international investors across Asia and Europe.

Many of them are conventional investors, attracted by the credit quality and yields.

Second, capabilities in global financial markets.

Islamic finance should leverage on the capabilities and strengths offered by conventional financial markets in international centres, to augment the range of Shariah-compliant products.

Take for example the market for Real Estate Investment Trusts, or REITs. Singapore has grown over the past decade to become the largest REIT market in Asia outside of Japan.

Building on this strength, players in Singapore have established the world’s largest Shariah-compliant REIT, which draws in conventional and Islamic investors around the world.

Third, opportunities for interaction and collaboration.

As Islamic finance gains prominence, conventional financial institutions increasingly want to be involved to tap these opportunities.

Financial centres like Singapore serve as intersecting nodes where Islamic financial institutions collaborate with their conventional partners to jointly grow the industry.

By applying the same regulatory framework to both conventional and Islamic financial institutions, Singapore aims to encourage financial institutions here to grow their suite of products and services for the Islamic finance industry.



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Conclusion

Let me conclude. Islamic finance has come a long way.

As it embarks on its next phase of growth, the industry must overcome the challenges posed by slower growth and global deleveraging, and build scale and reach critical mass.

This requires financial institutions, regulators, and international standard setting agencies to work closely together. Forums like these are ideal platforms. I wish you fruitful discussions. Thank you.



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Governor Daniel K. Tarullo

Dodd-Frank Act Implementation Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C. June 6, 2012

Chairman Johnson, Ranking Member Shelby, and other members of the committee, thank you for the opportunity to testify on the Federal Reserve's implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).

As we approach the second anniversary of the Dodd-Frank Act, implementation of the financial reforms enacted by the Congress remains a formidable task.

At the Federal Reserve, staff teams with a wide range of expertise continue to contribute to Dodd-Frank Act projects, many as part of joint rule-making efforts with other federal agencies.

We have been working to put final Dodd-Frank Act rules in place and to negotiate and implement international reforms compatible with various Dodd-Frank Act provisions; these include enhanced capital requirements for systemically important banks, liquidity requirements, resolution mechanisms, and margining requirements for over-the-counter derivatives.

As we continue rule implementation and the related international initiatives, we are trying to provide as much clarity as possible to financial markets and the public about the post-crisis financial regulatory landscape, and are also taking the time to consider comments and alternatives carefully.

In addition, the Federal Reserve continues to work cooperatively with other supervisors to ensure that prudential supervision is conducted in a manner that supports these important reforms.

As a final introductory point, it bears noting that both the Dodd-Frank Act reforms and the international regulatory reforms share an important



260

feature--a strong focus on the largest, most complex, and most interconnected financial firms and the systemic risks posed by those firms.

This effort reflects the provenance of both the Dodd-Frank Act and international reform initiatives, which were motivated largely by the failure or near failure of a number of major financial firms and the significant public policy problems created by the market perception that such firms are "too big to fail."

As the Federal Reserve implements reforms, we have maintained this core focus on the largest firms by proposing rules that try to mitigate the systemic risks posed by those firms and minimize the burden on smaller entities, particularly community banks.

Similarly, we seek to implement reforms in a manner that is faithful to statutory requirements and that maximizes financial stability and other economic benefits at the least cost to credit availability and economic growth.

This morning I will briefly describe the Federal Reserve's progress on several important Dodd-Frank Act rules and recent reforms to the international bank regulatory framework.

I will also describe briefly the Federal Reserve's role in supervising and examining the largest financial firms in cooperation with other federal and state supervisors.

Enhanced Capital Standards

While robust bank capital requirements alone cannot ensure the safety and soundness of our financial system, they are central to good financial regulation precisely because capital is available to absorb all kinds of potential losses--unanticipated as well as anticipated.

Indeed, the best way to safeguard against taxpayer-funded bailouts in the future is for our large financial institutions to have capital buffers commensurate with their own risk profiles and the damage that would be done to the financial system if such institutions were to fail.



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Recent events serve to remind us that the presence of substantial amounts of high-quality capital is the best way to ensure that significant losses at individual firms are borne by their shareholders, and not by depositors or taxpayers.

Ensuring the capital adequacy of financial firms requires both improvement of the traditional, firm-based approach to capital regulation and the creation of a more systemic, or macroprudential, component of capital regulation.

With respect to improving the traditional approach to capital regulation, the Federal Reserve's work has principally involved the development of stronger regulatory capital standards in cooperation with other supervisors in the Basel Committee on Banking Supervision.

This work includes the so-called Basel 2.5 reforms that strengthened the market-risk capital requirements of Basel II.

This work also includes the Basel III reforms, which improve the quality of regulatory capital, increase the quantity of required minimum regulatory capital, require banks to maintain a capital conservation buffer and, for the first time internationally, introduce a minimum leverage ratio.

The Federal Reserve and other U.S. banking agencies are moving to finalize regulations to implement Basel 2.5 in the United States and soon will be proposing regulations to implement Basel III.

These significant changes to the international regulatory capital framework have been supplemented by an important element of the Dodd-Frank Act known as the "Collins Amendment."

The Collins Amendment provides a safeguard against declines in minimum capital requirements in the Basel II capital regime based on bank internal modeling.

The Federal Reserve and other U.S. banking agencies issued final rules to implement this provision in June 2011.



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Capital Surcharges for Systemically Important Financial Firms

The recent financial crisis also made clear that the existing international regulatory capital framework was not sufficiently responsive to macroprudential concerns, such as the threat to financial stability posed by systemically important financial institutions.

Accordingly, in Basel Committee deliberations, the Federal Reserve advocated for capital surcharges on the world's largest, most interconnected banking organizations based on their global systemic importance.

Last year, an international agreement was reached on a framework for such surcharges, to be implemented during the same 2016-2019 transition period for the capital conservation buffers in Basel III.

This initiative is consistent with the Federal Reserve's obligation under section 165 of the Dodd-Frank Act to impose more stringent capital standards on systemically important financial institutions, including the requirement that these additional standards be graduated based on the systemic footprint of the institution.

Both the Dodd-Frank Act provision and the Basel framework are motivated by the fact that the failure of a systemically important firm would have dramatically greater negative consequences on the financial system and the economy than the failure of other firms.

Stricter capital requirements on systemically important firms should also help offset any funding advantage these firms derive from any remaining perceived status as too-big-to-fail and provide an incentive for such firms to reduce their systemic footprint.

The Federal Reserve's aim has been to fashion the enhanced capital requirements of section 165 and work toward an associated international framework in a simultaneous and congruent manner.



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Stress Testing and Capital Planning

Recent improvements to the regulatory capital framework have important supervisory complements in the Federal Reserve's development of firm-specific stress testing and capital planning requirements.

These supervisory tools serve two related functions.

First, they make capital regulation more forward-looking by testing whether firms would have enough capital to remain viable financial intermediaries if they sustained hypothetical losses in asset values and earnings in an adverse macroeconomic scenario.

Second, they contribute to the macroprudential dimension of supervision by enabling simultaneous examination of the risks faced by all large financial institutions in a hypothetical adverse economic scenario.

The Dodd-Frank Act creates two forms of stress-testing requirements.

These requirements mirror the Supervisory Capital Assessment Program model, a 2009 effort led by the Federal Reserve that helped restore confidence in the viability of the banking system during the financial crisis.

First, the act mandates that the Federal Reserve conduct annual stress tests on all bank holding companies with $50 billion or more in assets to determine whether they have the capital needed to absorb losses in hypothetical baseline, adverse, and severely adverse economic conditions.

Second, the act requires both these companies and certain other regulated financial firms with assets between $10 billion and $50 billion to conduct internal stress tests.

The Federal Reserve must publish a summary of results of the supervisory stress tests and issue regulations requiring firms to publish a summary of the company-run stress tests.



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Regular and rigorous stress testing provides regulators with knowledge that can be applied to both microprudential and macroprudential supervision efforts.

Disclosure of the general methodology and firm-specific results of our stress testing has additional regulatory benefits.

First, the release of certain details about assumptions, methods, and conclusions exposes the supervisory approach to greater external scrutiny and discussion.

Such discussions will almost surely help us improve our assumptions and methodology over time.

Second, because bank portfolios are difficult to value without a great deal of detailed information, the stress test results should be very useful to investors in and counterparties of the largest banking firms.

Further, I believe the demands of supervisors for well-specified data and projections from firms have improved risk management at these firms.

The stress testing that the Federal Reserve has instituted during the past few years has become an important part of our horizontal, interdisciplinary approach to supervising the largest bank holding companies.

Firm-specific capital planning has also become an important supervisory tool.

In November 2011, the Federal Reserve issued a new regulation requiring large banking organizations to submit an annual capital plan.

This tool serves multiple purposes.

First, it provides a regular, structured, and comparative way to promote and assess the capacity of large bank holding companies to understand and manage their capital positions.

Second, it provides supervisors with an opportunity to evaluate any capital distribution plans against the backdrop of the firm's overall capital



265

position, a matter of considerable importance given the significant distributions that some firms made in 2007 even as the financial crisis gathered momentum.

Third, at least for the next few years, it will provide a regular assessment of whether large bank holding companies will readily meet the Basel 2.5 and Basel III capital requirements as they take effect in the United States.

A stress test is a critical part of the annual capital plan review.

But, as these three different purposes indicate, the capital plan review is about more than using a stress test to determine whether a firm's capital distribution plans are consistent with remaining a viable financial intermediary in adverse economic conditions.

As indicated during our capital plan reviews in both 2011 and 2012, the Federal Reserve may object to a capital plan because of significant deficiencies in a firm's capital planning process, as well as because one or more relevant capital ratios would fall below required levels under the assumptions of stress and planned capital distributions.

Likewise, the stress test is relevant not only for its role in the capital planning process.

As noted earlier, it also serves other important purposes, not least of which is increased transparency of both bank holding company balance sheets and the supervisory process of the Federal Reserve.

Enhanced Liquidity Standards

As with capital, the financial crisis also brought attention to defects in the liquidity risk-management practices of large financial firms.

As seen during the crisis, a financial firm--particularly one with significant amounts of short-term funding--can become illiquid before it becomes insolvent, as creditors run in the face of uncertainty about the firm's viability.



266

While higher levels and quality of capital can mitigate some of this risk, it was widely agreed that quantitative liquidity requirements should be developed.

The Basel Committee generated two liquidity standards: one, a Liquidity Coverage Ratio (LCR) with a 30-day time horizon; the other, a Net Stable Funding Ratio (NSFR) with a one-year time horizon.

However, insofar as this was the first-ever effort to specify such requirements, the Governors and Heads of Supervision of the countries represented on the Basel Committee determined that implementation of both frameworks should be delayed while they are subject to further examination and possible revision.

As is the case with enhanced capital standards for the largest banking firms, the Basel Committee's liquidity initiatives are consistent with the Federal Reserve's obligation under section 165 of the Dodd-Frank Act to impose more stringent liquidity standards on the largest bank holding companies as well as other systemically important nonbank financial firms.

The LCR has been actively reconsidered within the Basel Committee over the last year or so. As this work proceeds, four types of changes appear particularly ripe for consideration.

First, the LCR's definition of high-quality liquid assets should be broadened.

In this regard, we support efforts to move away from the current credit risk-based approach and toward a quantitative liquidity-based approach.

Second, some of the assumptions embedded in the LCR about run rates of liabilities and the liquidity of assets might be grounded more firmly in actual experience during the crisis, as the LCR may overstate in particular the liquidity risks of commercial banking activities.

Third, additional consideration needs to be given to the liquidity risks inherent in trading activities that rely upon large amounts of short-term wholesale funding.



267

Fourth, the LCR could be better adapted to ensure usability of the high-quality liquid asset buffer in appropriate circumstances: for example, by making credibly clear that ordinary minimum liquidity levels need not be maintained in the midst of a crisis.

As currently constituted, the LCR may have the unintended effect of exacerbating a period of stress by forcing liquidity hoarding.

The Basel Committee will likely suggest a set of changes to the LCR later this year, with a goal of introducing the LCR in 2015.

Work on the NSFR is on a considerably slower track; the current plan is for implementation in 2018.

Enhanced Prudential Standards for the Largest Financial Firms

Sections 165 and 166 of the Dodd-Frank Act require the Federal Reserve to establish a broad set of enhanced prudential standards, both for bank holding companies with total consolidated assets of $50 billion or more and for nonbank financial companies designated by the Financial Stability Oversight Council (Council).

In addition to enhanced risk-based capital and liquidity requirements and stress testing, the required standards also include single-counterparty credit limits, an early remediation regime, and risk-management and resolution-planning requirements.

Sections 165 and 166 also require that these prudential standards become more stringent as the systemic footprint of a firm increases.

In December, the Federal Reserve issued a package of proposed rules to implement sections 165 and 166 of the Dodd-Frank Act.

The Federal Reserve's proposed rules would apply the same set of enhanced prudential standards to covered companies that are bank holding companies and to covered companies that are nonbank financial companies designated by the Council.



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As we made clear in the proposal, however, the Federal Reserve expects to tailor the application of the enhanced standards to different companies individually or by category, taking into consideration each company's capital structure, riskiness, complexity, financial activities, size, and any other risk-related factors that the Federal Reserve deems appropriate.

The comment period for our enhanced prudential standards proposal closed on April 30. Nearly 100 comment letters were received.

The Federal Reserve is currently reviewing those comments carefully as we work to develop final rules.

The Volcker Rule

Section 619 of the Dodd-Frank Act, commonly known as the "Volcker Rule," generally prohibits banking entities from engaging in proprietary trading or acquiring an ownership interest in, sponsoring, or having certain relationships with a hedge fund or private equity fund.

In October, the Federal Reserve joined the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the Securities and Exchange Commission in seeking public comment on a proposal to implement the Volcker Rule.

The Commodities Futures Trading Commission issued its substantially similar proposal for comment shortly thereafter.

Because of the importance and complexity of the issues raised by the statutory provisions that make up the Volcker Rule, the Federal Reserve and other agencies provided the public with a 120-day opportunity to submit comments.

The comment period is now closed, and nearly 19,000 public comments were received.

The agencies are now working together to review and consider these comments and put final implementing rules in place as soon as practicable.



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In April, after consultation with the other agencies, the Federal Reserve issued guidance on a Volcker Rule conformance period that was intended to help limit any confusion about when banking entities will need to comply with the final rules once issued.

The Federal Reserve's statement clarified that a banking entity has the full two-year period provided by the statute (i.e., until July 21, 2014), unless that period is extended by the Board, to fully conform its activities and investments to the requirements of the Volcker Rule, including any final implementing rules adopted by the agencies.

Prudential Supervision of Large Financial Firms

In the wake of the Dodd-Frank Act, the prudential supervision of the largest, most complex financial firms remains a cooperative effort.

As before, the law mandates that a variety of federal and state supervisors execute particular supervisory and examination responsibilities for certain parts of a firm.

This allocation of supervisory oversight among different agencies reflects, among other factors, the historical development of various types of financial intermediaries in the United States and a series of legislative decisions about regulatory and supervisory structure.

As the regulator and supervisor of bank holding companies, the Federal Reserve's role in this statutory arrangement is typically that of consolidated regulator and supervisor of the parent holding company.

Accordingly, our supervisory program for such firms generally takes a broad view of the activities, risks, and management of the consolidated firm, with a particular focus on the capital adequacy, governance, and risk-management practices and competencies of the firm as a whole.

Many of the principal business activities of the largest financial firms are conducted through the functionally regulated subsidiaries of those firms, such as insured depository institutions, broker-dealers, and insurance companies.



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As required by section 5 of the Bank Holding Company Act, the Federal Reserve generally relies to the fullest extent possible on the examination and supervision of those subsidiaries by the functional regulators.

Together, the Federal Reserve and other functional regulators work to discharge the supervisory and examination responsibility given to each agency for particular parts of a large financial firm in a way that maximizes the expertise and resources of each agency and best ensures the safety and soundness of the consolidated firm and each of its constituent parts.

Just as the financial crisis revealed the need for change in the prudential standards applicable to financial firms and activities, so too did it make clear that important changes in supervisory practices were needed to improve both the microprudential and macroprudential oversight of banks and bank holding companies.

To that end, even before passage of the Dodd-Frank Act, the Federal Reserve began to reorient its supervisory structure and strengthen its supervision of the largest, most complex financial firms.

The most important change has been creation of the Large Institution Supervision Coordinating Committee (LISCC).

The LISCC is founded on several principles: that large institution supervision should be more centralized; that it should conduct regular, simultaneous, horizontal (cross-firm) supervisory exercises; and that it should be more interdisciplinary than it has been in the past.

Thus, the LISCC includes senior Federal Reserve staff from research, legal and other divisions at the Board, from the markets and payments systems groups at the Federal Reserve Bank of New York, and senior bank supervisors from the Board and relevant reserve banks.

Relative to previous practices, this approach to supervision relies more on quantitative methods for evaluating the performance and vulnerabilities of firms.



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To date, the LISCC has developed and administered various horizontal supervisory exercises, notably the capital stress tests and the related comprehensive capital reviews of the nation's largest bank holding companies, and is now extending its activities to coordinate other supervisory processes more effectively.

It also has focused its attention on potential implications for financial stability in the United States from stresses arising in Europe.

Review of JPMorgan Chase & Co. Trading Loss

In response to the significant trading losses that were recently announced by JPMorgan Chase & Co. (JPMorgan) as a result of trading operations at the London branch of its national bank, the Federal Reserve--in its capacity as consolidated supervisor of the bank holding company--is working with the OCC, the regulator of the national bank, to review the firm's response and remedial actions.

In particular, the Federal Reserve has been assisting in the oversight of JPMorgan's efforts to manage and de-risk the portfolio in question.

As this process proceeds, we anticipate also working with the OCC and FDIC to identify the changes in risk measurement, management and governance that will be necessary to improve risk-control practices surrounding the firm's trading activities and to address trading strategies that led to these losses.

In addition, the Federal Reserve has been looking at other parts of the holding company to determine if governance, risk management and control weaknesses--similar to those exposed by this incident--are present elsewhere.

While we have, to date, found no evidence that they are, this review is not yet complete.



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Conclusion

The recent financial crisis disrupted the financial system and the broader economy on a scale and scope not seen since the 1930s.

Some of the world's largest financial firms collapsed or required government assistance to stay afloat, sending shock waves through the highly interconnected global financial system.

Asset prices fell sharply, flows of credit to American families and businesses slowed dramatically, and millions of people lost their jobs.

Extraordinary actions by governments around the world helped to provide stability, but more than four years after the onset of the crisis, the recovery is far from complete.

It is critical that we complete the implementation of capital and other prudential measures to prevent another crisis and protect taxpayers from having again to recapitalize financial firms.

Thank you very much for your attention. I would be pleased to answer any questions you may have.



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Mortgage financing: FINMA recognises new minimum standards

Press release

The Swiss Financial Market Supervisory Authority FINMA has approved the new minimum re-quirements for mortgage financing drawn up by the Swiss Bankers Association (SBA) as a minimum regulatory standard.

The new self-regulatory regime, which enters into force from 1 July 2012, for the first time lays down minimum requirements concerning down-payments by borrowers and introduces compulsory amortisation.

The recognition comes in the context of the measures presented today by the Federal Council concerning the implementation of Basel III, “too big to fail” and reduction of the risks in the mortgage market, which FINMA expressly welcomes.

FINMA has for a long time been pointing out the risks that could build up as a result of rapid growth in mortgages for residential property.

There is no sign of a weakening in the strong demand for mortgage financing, not least due to the exceptionally low level of interest rates.

In the course of its supervisory activities and direct inspections, FINMA has also noted that many banks are stretching their own lending criteria to the limit, as regards both financial sustainability for the borrower and the loan-to-value ratio applied to the property, and are also making increased use of exceptions to policy.

This is creating a new segment of borrowers who would not be able to acquire residential property under different market conditions.



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In particular, there is a risk that rising interest rates would leave such borrowers unable to service their loans, ultimately raising the possibility of defaults and falling property prices.

When a real-estate bubble bursts, the implications for a country’s financial stability can be extremely serious.

Guidelines on minimum down-payments and amortisation

The SBA guidelines set out basic requirements concerning minimum down-payments by borrowers and contain clear rules on amortisation that must be taken into account during financial sustainability analyses.

Given that this is a self-regulatory regime imposed by the banks themselves, FINMA ex-pects it to be widely accepted by them and implemented swiftly and conscientiously.

Minimum down-payments from own funds:

In future, borrowers will be required to supply at least 10 per cent of the lending value of the property from their own funds, which may not be obtained by pledging or early withdrawal of Pillar 2 assets.

This means that the purchase of a property by a mort-gagor using a down-payment derived exclusively from pension fund assets will not meet the minimum standards.

The new guidelines require borrowers to be on a sounder financial footing.

Equally, they reduce the danger that they will put at risk their retirement capital and, with it, their pensions.

Amortisation:

Under the new rules, mortgages must in all cases be paid down to two thirds of the lending value within a maximum of 20 years.

Waiving amortisation in the expectation of rising property prices would not, therefore, meet the minimum standards.



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The amortisation rules require the debt burden to be steadily reduced, which will have a positive effect on long-term financial sustainability.

Revised Capital Adequacy Ordinance contains reference to the new minimum standards

In the event that a mortgage granted after 1 July breaches these new minimum standards, banks will be required to significantly increase the capital involved to cover it.

This is stipulated in the Federal Council’s revised Capital Adequacy Ordinance, which also contains a further instrument for reducing mortgage risks.

If a bank grants a mortgage amounting to more than 80 per cent of the lending value, it will be required to back it with a higher level of capital.

This measure comes into force on 1 January 2013.

As a further measure, from 1 July 2012 the Federal Council will have at its disposal a new capital buffer for all banks that can be selectively and temporarily activated for specific sectors, such as the mortgage business. Although the amortisation requirement has a direct impact on financial sustainability calculations, there are still no binding minimum standards in this central area of residential property financing.

However, a realistic assessment of the medium-term financial situation is invariably in the interest of borrowers too, as it ensures that their property remains affordable for them even if interest rates rise or their own income falls.

FINMA views the measures as positive steps

The package of measures for the mortgage sector presented by the Federal Council today, and the binding SBA guidelines issued in this context, are steps towards counteracting the increasing risks in the mortgage market.



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FINMA welcomes these measures and their rapid implementation.

In the medium term, the measures will improve the quality of the banks’ mortgage portfolios or, alternatively, lead to higher capital requirements geared to the risks involved.

However, the guidelines will have no direct effect on existing loan agreements and the risks associated with them.



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May 30, 2012

The Federal Reserve Board on Wednesday announced the approval of a final rule outlining the procedures for securities holding companies (SHCs) to elect to be supervised by the Federal Reserve.

An SHC is a nonbank company that owns at least one registered broker or dealer.

The Dodd-Frank Wall Street Reform and Consumer Protection Act eliminated the previous supervision framework that applied to SHCs under the Securities and Exchange Commission and permitted SHCs to be supervised by the Federal Reserve.

An SHC may seek supervision by the Federal Reserve to meet requirements by a regulator in another country that the firm be subject to comprehensive, consolidated supervision in the United States in order to operate in the country.



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The final rule specifies the information that an SHC will need to provide to the Board as part of registration for supervision, including information related to organizational structure, capital, and financial condition.

Under the final rule, an SHC's registration becomes effective no later than 45 days from the date the Board receives all required information.

The final rule provides that upon an effective registration, an SHC would be supervised and regulated as if it were a bank holding company.

However, consistent with the Dodd-Frank Act, the restrictions on nonbanking activities in the Bank Holding Company Act would not apply to a supervised SHC.

FEDERAL RESERVE SYSTEM

12 CFR Part 241 Regulation OO; Docket No. R-1430 RIN 7100 –AD 81

Supervised Securities Holding Company Registration AGENCY: Board of Governors of the Federal Reserve System (“Board”). ACTION: Final Rule SUMMARY: The Board is adopting this final rule to implement section 618 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act” or “Act”), which permits nonbank companies that own at least one registered securities broker or dealer, and that are required by a foreign regulator or provision of foreign law to be subject to comprehensive consolidated supervision, to register with the Board and subject themselves to supervision by the Board. The final rule outlines the requirements that a securities holding company must satisfy to make an effective election, including filing the appropriate form with the responsible Reserve Bank, providing all additional required information, and satisfying the statutory waiting



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period of 45 days or such shorter period the Board determines appropriate. DATES: The rule is effective [30 days after date of publication in the Federal Register].

Important parts SUPPLEMENTARY INFORMATION: I. Background Section 618 of the Dodd-Frank Act permits a company that owns at least one registered securities broker or dealer (a “nonbank securities company”), and that is required by a foreign regulator or provision of foreign law to be subject to comprehensive consolidated supervision, to register with the Board as a securities holding company and become subject to supervision and regulation by the Board. A securities holding company that registers with the Board under section 618 is subject to the full examination, supervision, and enforcement regime applicable to a registered bank holding company, including capital requirements set by the Board (although the statute allows the Board to modify its capital rules to account for differences in activities and structure of securities holding companies and bank holding companies). The primary difference in regulatory frameworks between securities holding companies and bank holding companies is that the restrictions on nonbanking activities that apply to bank holding companies do not apply to securities holding companies. Under section 618 of the Act, a securities holding company that elects to be subject to supervision by the Board must submit a registration form that includes all such information and documents the Board, by regulation, deems necessary or appropriate.



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The statute also specifies that registration as a supervised securities holding company becomes effective 45 days after the date the Board receives all required information, or within such shorter period as the Board, by rule or order, may determine. Section 618 makes a registered securities holding company subject to all of the provisions of the Bank Holding Company Act of 1956 (12 U.S.C. 1841 et seq.) (“BHC Act”) in the same manner as a bank holding company, other than the restrictions on nonbanking activities contained in section 4 of the BHC Act. Consistent with the Dodd-Frank Act, the Board anticipates applying the same supervisory program, including examination procedures, reporting requirements, supervisory guidance, and capital standards, to supervised securities holding companies that the Board currently applies to bank holding companies. However, the Board may, based on experience gained during the supervision of supervised securities holding companies, modify these requirements as appropriate and consistent with section 618.

II. Notice of Proposed Rulemaking: Summary of Comments.

On September 2, 2011, the Board invited public comment on a proposed rule implementing the registration requirements and procedures for securities holding companies pursuant to section 618 of the Act. The Board received three comments, none of which addressed any substantive aspect of the proposed rule. One commenter expressed the view that firms should not elect to be supervised by the Federal Reserve because of a “lack of leadership at the FED Districts.”



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Another commenter included the phrase “supervised securities holding companies registration” in the subject line of the comment letter but provided no comment. The third commenter mistakenly believed that section 618 of the Dodd-Frank Act and the Board’s proposed Regulation OO apply to foreign companies that own national banks in the United States. This commenter argued that such foreign companies should be subject to supervision by the Board as supervised securities holding companies if they wish to operate in the United States by owning national banks. The Board is finalizing the rule with only technical modifications.

III. Description of Final Rule.

The final rule permits securities holding companies to elect to become supervised securities holding companies by registering with the Board. The final rule outlines the requirements that a securities holding company must satisfy to make an effective registration, including filing the appropriate form with the responsible Reserve Bank, providing all additional information requested by the Board, and satisfying the statutory waiting period of 45 days or such shorter period the Board determines appropriate. Section 241.1 of the final rule outlines the authority under which the Board is issuing the rule. Section 241.2 of the final rule changes the proposed definition of the term “securities holding company” in order to more closely reflect the statutory language. The revised definition contains additional language, which makes clear that to become a securities holding company, a company must, among



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other things, be “required by a foreign regulator or a provision of foreign law to be subject to comprehensive consolidated supervision.” Under the Dodd-Frank Act and final rule, a company that is currently subject to comprehensive consolidated supervision by a foreign regulator, a nonbank financial company supervised by the Board, a bank holding company, a savings and loan holding company, an insured bank, a savings association, or a foreign banking organization with U.S. banking operations would not qualify for registration as a supervised securities holding company. Under the final rule, terms such as “affiliate,” “bank,” “bank holding company,” “control,” and “subsidiary” are defined to have the same meaning as in section 225.2 of the Board’s Regulation Y. Section 241.3 of the final rule requires a securities holding company that elects to register to become a supervised securities holding company to file the proper form with the responsible Reserve Bank. The Board is creating a new form for this purpose. The form, which is similar to the Board’s current form Application for a Foreign Organization to Acquire a U.S. Bank or Bank Holding Company (FR Y-3F; OMB No. 7100-0119), used by a company registering to become a bank holding company, includes a number of questions relating to the organizational structure of the securities holding company, its capital structure, and its financial condition. Specifically, the form requires a securities holding company electing to be supervised to submit: 1. An organization chart for the securities holding company showing all subsidiaries. 2. The name, asset size, general activities, place of incorporation, and ownership share held by the securities holding company for each of the



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securities holding company’s direct and indirect subsidiaries that comprise 1 percent or more of the securities holding company’s worldwide consolidated assets. 3. A list of all persons (natural as well as legal) in the upstream chain of ownership of the securities holding company who, directly or indirectly, own 5 percent or more of the voting shares of the securities holding company. In addition, the Board would request information concerning any voting agreements or other mechanisms that exist among shareholders for the exercise of control over the securities holding company. 4. For the senior officers and directors with decision-making authority for the securities holding company, the biographical information requested in the Interagency Biographical and Financial Report FR 2081c (the Financial Report need not be provided). 5. Copies of the most recent quarterly and annual reports prepared for shareholders, if any, for the securities holding company and certain subsidiaries. 6. Income statements, balance sheets, and audited GAAP statements, as well as any other financial statements submitted to the securities holding company’s current consolidated supervisor, if any, each on a parent-only and consolidated basis, showing separately each principal source of revenue and expense, through the end of the most recent fiscal quarter and for the past two (2) fiscal years. 7. A description of the methods used by the securities holding company to monitor and control its operations, including those of its domestic and foreign subsidiaries and offices (e.g., through internal reports and internal audits).



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8. A description of the bank regulatory system that exists in the home country of any of the securities holding company’s foreign bank subsidiaries. The description also should include a discussion of each of the following: a. The scope and frequency of on-site examinations by the home country supervisor; b. Off-site monitoring by the home country supervisor; c. The role of external auditors; d. Transactions with affiliates; e. Other applicable prudential requirements; f. Remedial authority of the home country supervisor; g. Prior approval requirements; and, h. Any applicable regulatory capital framework. 9. A description of any other regulatory capital framework to which the securities holding company is subject. The final rule further provides that the Board may at any time request additional information that it believes is necessary to complete the registration. Under the rule, the registration is considered filed when all information required by the Board is received. Section 241.3 of the final rule also states that a registration filed by a securities holding company becomes effective and supervision by the



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Board begins on the 45th calendar day after the date that a complete filing is received. Under the final rule, the Board also reserves the right to shorten the 45-day waiting period and begin consolidated supervision at such earlier date as the Board specifies to the securities holding company in writing. The final rule provides that, upon an effective registration, a supervised securities holding company would be supervised and regulated as if it were a bank holding company, and that the nonbanking restrictions contained in section 4 of the BHC Act will not apply to a supervised securities holding company. This treatment will generally mean that supervised securities holding companies will, among other things, be required to submit the same reports and be subject to the same examination procedures, supervisory guidance, and capital standards that currently apply to bank holding companies. The final rule provides the Board with flexibility to adjust these requirements as appropriate to ensure that securities holding companies operate in a manner that is consistent with safety and soundness and that addresses the risks they pose to financial stability.

IV. Administrative Law Matters A. Paperwork Reduction Act Analysis

In accordance with the requirements of the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et seq.) (“PRA”), the Board may not conduct or sponsor, and the respondent is not required to respond to, an information collection unless it displays a currently valid Office of Management and Budget (OMB) control number. The OMB control numbers for the existing information collections are provided below.



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The OMB control number will be assigned for the new information collection related to registrations described below. The Board reviewed the final rule under the authority delegated to the Board by OMB.

Title of Existing Information Collections:

The Annual Report of Bank Holding Companies (FR Y-6),

The Report of Foreign Banking Organizations (FR Y-7),

The Consolidated Financial Statements for Bank Holding Companies (FR Y-9C),

The Parent Company Only Financial Statements for Large Bank Holding Companies (FRY-9LP),

The Parent Company Only Financial Statements for Small Bank Holding Companies (FRY-9SP),

The Financial Statements for Employee Stock Ownership Plan Bank Holding Companies (FR Y-9ES),

The Supplement to the Consolidated Financial Statements for Bank Holding Companies (FR Y-9CS),

The Financial Statements of U.S. Nonbank Subsidiaries of U.S. Bank Holding Companies (FR Y-11 and FR Y-11S),

The Financial Statements of Foreign Subsidiaries of U.S. Banking Organizations (FR2314 and FR 2314S),

The Bank Holding Company Report of Insured Depository

Institutions’ Section 23A Transactions with Affiliates (FR Y-8),

The Consolidated Bank Holding Company Report of Equity Investments in Nonfinancial Companies (FR Y-12) and the Annual Report of Merchant Banking Investments Held for an Extended Period (FR Y-12A), and

The Capital and Asset Report of Foreign Banking Organizations (FR Y-7Q), and the Financial Statements of U.S. Nonbank



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Subsidiaries Held by Foreign Banking Organizations (FR Y-7N and FR Y-7NS).

Frequency of Response: Annually, semi-annually, quarterly, event-generated.

Affected Public: Nonbank companies.



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Introduction Last year, the UK financial services industry faced regulatory change on a sweeping scale. At the national level the last UK government introduced the Financial Services Act 2010, which resulted in a number of changes to our objectives, powers and duties, in particular giving us a new financial stability objective and additional enforcement powers. In June 2010, the current UK coalition government announced that the FSA will be split up. The prudential supervision of banks and insurers will be moved to a new operationally independent subsidiary of the Bank of England: the Prudential Regulation Authority (PRA). The FSA will be renamed the Financial Conduct Authority (FCA) and will focus on consumer protection and markets oversight. The government also established a new committee of the Bank of England with responsibility for delivering financial stability: the Financial Policy Committee (FPC).



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The European Union (EU), meanwhile, created three pan-European agencies to address the risk of regulatory arbitrage and improve the quality of national supervision of banks, securities markets and the insurance industry. The EU also created a new advisory body, the European Systemic Risk Board (ESRB), to identify systemic risks and make recommendations for mitigating them. Europe’s new regulatory architecture became operational in January 2011 and will fundamentally change the way in which national supervisory authorities operate. A significant majority of regulatory requirements will be determined solely at the EU level and national supervisors will play a key role in negotiating and agreeing these, but their role as decision makers will centre on their function as supervisors of firms and markets.

The Financial Services Act 2010 The Financial Services Act 2010 (the Act), which received royal assent on 8 April 2010, resulted in a number of changes:

Consumer protection The Act removed the FSA’s public awareness objective and required us to set up an independent body to take forward consumer education work. The Act also provides for more funding to be made available for consumer education work. The Act gave us additional powers for the FSA to require consumer redress. This allows us to make sure that consumers receive redress in cases involving large-scale consumer mis-selling or other failures.



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Financial stability The Act gave us a new financial stability objective to contribute to protecting and enhancing UK financial stability. We are required to cooperate appropriately with the Treasury, the Bank of England and other relevant bodies in pursuing this objective. The Act requires us to have and keep under review a financial stability strategy. It enables us to gather information from entities, including unregulated entities for financial stability purposes. It also requires us to consider the impact that international events and circumstances could have on financial stability in the UK.

Enhanced powers The Act extends the scope of our key regulatory powers to make rules and to alter authorised firms’ regulatory permissions, so we may use the powers in pursuit of any of our regulatory objectives, including the new financial stability objective. We have new rule-making powers for: • Remuneration: we now have the power to specify that remuneration agreements in breach of our rules are void; • Recovery and resolution plans; • Short selling; and • Consumer redress schemes.



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We have new enforcement powers to: • restrict or suspend the carrying on of regulated activities for up to 12 months; • suspend or impose restrictions on an approved person for up to two years; • impose a financial penalty at the same time as cancelling a firm’s permission; • penalise any person who performs a controlled function4 without approval; and • issue a warning notice against an individual three years from the time we first became aware of the misconduct (increased from two years).

Financial Services Compensation Scheme (FSCS) The Act contains provisions that will enable the FSCS to act as a single point of contact and to pay redress to consumers where redress is due to them under other schemes, such as schemes established outside the UK.

UK regulatory reform Over the past nine months, the FSA has begun the process of aligning the organisation to ensure it is ready to cut over to the new regulatory structure. As a result, we incurred approximately £1m of direct costs last financial year: • Programme management support £0.33m; • Regulatory design £0.10m;



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• IT design £0.33m; and • Other (e.g. HR and other central functions) £0.24m. Shortly after the end of our financial year in April 2011, we replaced our Risk and Supervision business units with two new ones: the Conduct Business Unit, which broadly aligns with the regulatory activities to be undertaken by the FCA, other than enforcement; and the Prudential Business Unit, which broadly aligns with the regulatory activities of the PRA, other than enforcement. Central services will continue for the lifetime of the FSA to be structured on an unitary basis. We are confident that our programme remains on track and further progress will be made during 2011/12.

A new European supervisory structure European Supervisory Authorities (ESAs) and the European Systemic Risk Board (ESRB) The creation of ESRB and the three new ESAs marks a significant change to the way in which financial services regulation will be developed and delivered across Europe. The ESRB will undertake macro-prudential analysis at EU level to identify risks to EU financial stability and will make recommendations to address these risks.

European Supervisory Authorities (ESAs) The ESAs became operational in January 2011. They are: • The European Banking Authority (EBA); • The European Insurance and Occupational Pensions Authority (EIOPA); and



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• The European Securities and Markets Authority (ESMA). They replace: • The Committee of European Banking Supervisors (CEBS); • The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS); and • The Committee of European Securities Regulators (CESR).

The ESAs are responsible for developing a large proportion of the rules that apply to the financial services sector in the UK. These will be issued as EU regulations, so will be directly applicable across the EU. As well as developing binding rules, the ESAs have powers to: • impose a temporary ban on financial activities; • investigate alleged breaches of EU rules; • take binding decisions in emergencies; • arbitrate in disputes between national supervisors; • play a coordinating role within colleges of supervisors; • undertake peer review; • directly supervise credit rating agencies (ESMA only); and • require information to be passed to them that is necessary for discharging their responsibilities.



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In 2010/11, we devoted significant resource during the negotiation of the ESA legislation to ensure that the ESA package as a whole secured the key objectives of: • protecting the single market; • addressing the risks arising from regulatory arbitrage; • raising standards of supervision among national supervisors; while • retaining responsibility for day-to-day supervision at the national level. Once the ESA legislative package was agreed in the Autumn of 2010, our focus shifted to preparing for the new European order. During 2010/11, we: • influenced the ESAs regulatory framework and operating model; • adapted our operating model to work effectively with the ESAs; • enhanced our secondments strategy and identified training requirements; and • developed systems to handle ESA data requests.

Financial stability Introduction During 2010/11 the FSA’s mandate was significantly extended. From April 2010, we were given a new statutory objective, which made more explicit the responsibilities for promoting financial stability that we had been exercising under the ‘market confidence’ objective mandated under FSMA.



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At the same time, our supervisory approach continued to progress toward intensive supervision and proactive challenge, laying the groundwork for the preventative interaction framework that will guide the PRA. We continued to embed the organisational and cultural change needed to implement intensive supervision, moving our regulatory approach from retrospective intervention to proactive challenge. Our supervisors made judgements on firms’ business models; intervening early if they anticipated any risks that might arise from firms’ business strategies and approaches to funding and capital. This approach has demanded quality staff, industry knowledge and the will to challenge the industry robustly where potential threats were identified. We contributed significantly to the development of a robust policy reform programme, driven by the initiatives and issues identified in The Turner Review and the wider policy agenda mandated by the EU. And the FSA continued to play a leading role in influencing regulatory reform on the global stage, while ensuring that the UK arrangements on, for example, key issues of capital and liquidity were consistent with the direction of international standards. This section describes the work we accomplished in these areas, under these headings: • The Financial Services Act – our new financial stability objective; • FSA supervision – a major intensification of approach; • Progress on reforming the international and European regulatory framework – policy and practice; and • Specific measures to strengthen firms’ resilience.



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We also include the principal metrics we use to assess our supervisory effectiveness in relation to our financial stability objective and to gauge financial stability generally. These are:

Supervisory effectiveness

Chart 1: Supervisory issues closed Chart 2: Firm feedback on the quality of FSA supervisory risk assessments

Measures of financial stability Chart 3: Cost of credit Chart 4: FSA firm cancellations Chart 5: Major UK banks – CDS spreads, five-year senior debt



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A central tool in supervision is identifying the risk mitigation actions firms must take. Looking at the quantity identified and speed which with these are closed gives a perspective on the intensity and effectiveness of our supervision. The number of issues closed in Q4 2010/11 is 439 (from 303 in Q3 2010/11); this represents 17% (12% in Q3 2010/11) of the population of open issues. This shows an absolute and proportional increase in the number of issues closed than previously reported. The proportion of high-risk issues closed was slightly higher than other issues at 18%, reflecting us prioritising issues with the most risk.



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Also, about 40% of the issues (recorded and closed) were in respect of high-impact firms, reflecting the enhanced focus of our risk assessment and mitigation work on these firms.

From our regulated firms’ perspective, the quality of our risk assessment in the last six months has reduced slightly from 5.2 down to 4.9, with the most significant reductions in our Major Retail Groups Division and Retail Division. Risk mitigation is scored more positively at 5.3, but again this represents a fall against the 5.6 recorded for the six months to June. However, scores remain positive in the context of a 1-7 scoring system, where 4 is neutral. The deterioration may have been driven by the amount and pace of regulatory change, which has continued to put pressure on both sides of the firm-supervisory relationship.



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The current cost of interbank borrowing (measured by the Libor-OIS spread) – in a context and relative to the extremes of 2008 – is not excessive. However, spreads have recently entered a slightly more volatile period, driven by movement in the OIS swap rate. In part, this reflects uncertainty about the short-term outlook for the bank rate, amid persistent above target inflation and variable information about the performance of the economy.



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This chart shows the number of authorised firms this year that have cancelled their authorisation with the FSA. Not all cancellations are necessarily failures and not all failures are regulatory failures. Nevertheless, this chart gives some indication of the level of distress in the system. During 2010/11, there was a significant reduction in the cancellation rate among significant impact firms.



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UK banks’ credit default swaps (CDS) spreads are a measure of how investors perceive the default risk posed by these firms. UK banks’ CDS spreads rose in November, as the Irish sovereign crisis pushed up CDS spreads for Eurozone sovereigns. Spreads for some of the banks fell back after the EU and IMF bailout was announced. HSBC and Standard Chartered have seen swap rates rise in early 2011 due to concerns in the aftermath of the Japanese earthquake. Nevertheless, using absolute CDS as an indicator, they remain the banks with the lowest perceived credit risk, driven in part by their strength in emerging market economies.



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Solvency II As we said in our Business Plan for 2010/11, Solvency II is a fundamental change of the prudential regime for the European insurance industry. It aims to establish a revised set of EU-wide risk management standards and capital requirements that will replace and harmonise the current arrangements. Policy in this area continues to be developed in Europe. There have been delays to the timeline that have affected our own consultation and shortened the window for implementation. As a result, we are looking for ways to manage this uncertainty. At the same time, we have continued to contribute to the development of the Directive, such as through our involvement in the work of European Insurance and Occupational Pensions Authority (EIOPA). We continue to lead some of the working groups, and Hector Sants was appointed to the EIOPA Management Board in January 2011.

Our work with the UK industry We have maintained close contact with the UK insurance industry on both policy and implementation issues. We continued in 2010 to engage with firms to understand how the developing requirements affect them and inform our contributions to EIOPA. We also had ongoing discussions with firms about how prepared they are for the new regime.



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The fifth quantitative impact study (QIS5) helped us increase our dialogue with firms on both fronts. We gave briefings and ran workshops to educate firms about the importance of taking part in QIS5. We encouraged firms of all sizes and types to participate in the exercise to provide a robust evidence base to inform the ongoing development of the Solvency II landscape. During the exercise, we answered over 600 queries, and the UK report to EIOPA was compiled with submissions from 267 solo firms and 35 groups, representing over 70% of the market. We also had discussions with firms about the practical implications for them and we will continue to do so in the run up to implementation. We have continued to make progress with the internal model approval process (IMAP). We published an update in April 2010 setting out the pre-application process for firms, and the findings of the thematic review in February 2011. At the end of March 2011, started the next phase of IMAP as we endeavour to give as many firms as possible a decision on their model for day one. We further detailed our approach at our Solvency II Conference in April 2011 – more information about this is available on the dedicated Solvency II pages of the FSA website. As stated above, we had started to prepare our consultations; however, the publication of the Omnibus II proposals to amend the Solvency II Directive to bring it in line with the new European regulatory structure and allow for transitional provisions has meant that our consultation timetable has been affected.



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Our consultation process will relate to the transposition of the level 1 text of the Directive and consequential changes to the Handbook. We expect to publish the first Consultation Paper later this year. We will review the European policy timelines regularly, and publish our own consultation timeline on our website in due course. Internally, we developed and delivered technical training for supervisors and other specialists working on Solvency II. At the end of March, we had trained over 450 people. To deliver Solvency II we have increased our resources significantly, with recruitment ongoing to provide the skills and processes to support and deliver the implementation of the Directive. Most recently, we shared our current thinking on the policy issues and implementation approach, with approximately 550 people from the UK insurance industry at our Solvency II Conference on 18 April 2011. • We outlined our two-tier approach to the way we would allocate resources to firms in the pre-application phase of IMAP. • We discussed the main policy uncertainties, which we also set out in the accompanying conference document Delivering Solvency II, April 2011. • We outlined the key dates, including our assumptions that full implementation will be on 1 January 2013, and that we would be open to receive applications on the provisions of the Directive that require our approval. • We underlined the importance of the UK industry’s continued involvement in developing the approach to implementation in Europe and the UK.



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We will do this through a number of different fora, including the existing Insurance Standing Group and its sub-groups, which has over 100 people registered to receive information. We will also create new ones as needed. We published an overall update on Solvency II in June 2010 on all pillars of the Directive to inform and motivate firms to take action as needed. We have tailored our information for smaller insurers through our events and our website, including things for firms to consider when creating their implementation plans. We also gave briefings to market analysts and ratings agencies (February 2011), and to non-executive directors of insurance and reinsurance firms (January and April 2011) as part of our educational programme. 2011/12 is critical in our preparations for implementing Solvency II, in Europe and the UK. We are confident that our implementation approach will help us deliver our Solvency II programme and carry out our obligations fully.



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30 May 2012

Meeting of the Financial Stability Board in Hong Kong on 29-30 May At its meeting in Hong Kong, the Financial Stability Board (FSB) discussed vulnerabilities currently affecting the global financial system and the progress in authorities’ ongoing work to strengthen global financial regulation.

Vulnerabilities in the financial system After a period of calm in financial markets earlier this year, tensions have increased more recently and risk aversion has returned to elevated levels. In the euro area, the adverse feedback loop between sovereign debt strains, weak economic growth and fragile banking systems has intensified. There has been a pull-back in cross-border financial activity. Against this background, risks of adverse spillovers to global financial markets and economies have increased. The FSB supports the work of European and national authorities to lower short-term risks and foster lasting confidence and stability, including completing the repair and restructuring of some banks as required. In addition, authorities agreed to work together to minimise the downside risks from the ongoing process of bank deleveraging. All FSB members remain committed to strong cooperation to support



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market functioning. Central banks, supervisors and treasuries are maintaining close dialogue and cooperation during this period of heightened uncertainty.

Addressing systemically important financial institutions (SIFIs) The FSB reviewed the ongoing work to develop further the SIFI framework, including extending it to domestic systemically important banks and establishing a process to ensure consistent implementation of the policy measures, in particular for resolvability, that apply to global SIFIs (G-SIFIs). The FSB endorsed the International Association of Insurance Supervisors (IAIS) consultation paper that sets out a proposed methodology for assessing the global systemic importance of insurance companies. The paper will be published ahead of the Los Cabos G20 Summit. The FSB evaluated progress in implementing its Key Attributes of Effective Resolution Regimes for Financial Institutions. Authorities are in the process of putting in place recovery and resolution plans, resolvability assessments and institution-specific cross-border cooperation agreements for G-SIFIs, and home authorities of G-SIFIs will prioritise the development of high-level resolution strategies to guide these processes. FSB members reaffirmed the need for further work to establish international guidance on common terms for information sharing and on the handling of client assets in resolution. FSB members will begin in July the first of an iterative series of peer reviews on the implementation of the Key Attributes. The FSB also welcomed progress of its Data Gaps Initiative, which will



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collect and share among authorities information on the common exposures and financial interlinkages of global systemically important banks. It supported operational preparations in close interaction with the banks to implement the initial phase of the project from March 2013.

Over-the-counter (OTC) derivatives The FSB reviewed the steps being taken to implement OTC derivatives reforms, on which it will shortly issue its third progress report. Members noted that encouraging progress has been made in setting international standards, in advancing legislation and regulation by a number of jurisdictions and in practical implementation of reforms to market infrastructure and activities. They recognised, however, that the current momentum must be maintained as much work remains to be done to complete the reforms by the end-2012 deadline agreed by the G20. The FSB noted in particular the substantial progress that has been made in the four safeguards for a resilient and efficient global framework for central clearing. In addition, the Committee for Payment and Settlement Systems and the International Organization of Securities Commissions published in April the Principles for Financial Market Infrastructures. These actions will ensure the robustness of financial market infrastructures and allow national authorities to decide on the appropriate form of CCPs to meet the G20 commitment to centrally clear all standardised OTC derivatives by the end of 2012. In the coming weeks, standard setters will issue consultation papers on margining requirements for bilaterally-cleared derivatives transactions



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and on resolution of central counterparties (CCPs) and other financial market infrastructures.

Shadow banking Members reviewed the ongoing workstreams to strengthen the oversight and regulation of shadow banking. Members looked forward to policy recommendations by IOSCO by the autumn on potential measures that would mitigate the susceptibility of money market funds to runs and other systemic risks. The FSB will publish by end-2012 an initial integrated set of policy recommendations to strengthen regulation of shadow banking. The FSB also launched its second annual monitoring exercise of the global shadow banking system, which includes all FSB member jurisdictions. The FSB will report its findings to the G20 Finance Ministers and Central Bank Governors in November.

Legal entity identifier (LEI) The FSB approved recommendations to support the establishment of a global LEI system that will provide a unique global identifier for parties to financial transactions, as requested at the Cannes Summit. The recommendations will be submitted to the Los Cabos Summit. The proposals set out a governance framework to protect the public interest, while promoting active coordination between the global regulatory community and the private sector in the implementation of the system.



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The proposals for the initial reference data and LEI code are in line with the ISO 17442:2012 standard published today. The recommended implementation plan targets launch of the global LEI system on a self-standing basis by March 2013.

FSB capacity, resources and governance FSB members welcomed the draft report of the High-Level Group that it set up in response to a call by the G20 Leaders at the Cannes Summit to strengthen the FSB’s capacity, resources and governance. They agreed to submit, for endorsement at the G20 Los Cabos Summit, the recommendations set out in the report to place the FSB on an enduring organisational footing with institutional standing, legal personality and greater financial autonomy, while maintaining the existing strong links with the Bank for International Settlements.

Implementation monitoring and adherence to standards As the global financial reform process has progressed, the focus of the FSB and its members is increasingly turning from global policy development to timely and consistent implementation. The FSB reviewed progress in the implementation of G20 reforms under its Coordination Framework for Implementation Monitoring, on which it will report to the Los Cabos Summit. In addition to the progress report on OTC derivatives market reforms, members approved progress reports in two other priority areas: Basel III and compensation practices. These reports will be published around the time of the Los Cabos Summit.



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Basel III. The interim report prepared by the Basel Committee on Banking Supervision (BCBS) will describe the progress made and issues identified in implementing the Basel III framework (including Basel II and II.5). The BCBS, in coordination with the FSB, will continue to closely monitor and promote the full, consistent and timely implementation of Basel III.

Compensation practices. The report will describe the progress made by FSB member jurisdictions and firms in implementing the FSB Principles and Standards for Sound Compensation Practices since the FSB’s October 2011 thematic peer review. The FSB will continue its ongoing monitoring of actions taken and identification of remaining gaps and impediments to full implementation. The Bilateral Complaint Handling Process launched in April will be an important input to this process. Members agreed to publish on the FSB’s website summary information on their actions to meet their commitments to undergo and publish the results of assessments under the IMF/World Bank Financial Sector Assessment Programme and FSB peer reviews under the FSB Framework for Strengthening Adherence to International Standards.

Study on the effects of agreed regulatory reforms on emerging market and developing economies (EMDEs) The FSB reviewed a study, which has been prepared in coordination with the IMF and the World Bank, identifying the extent to which agreed regulatory reforms may have unintended consequences for EMDEs. The study will be submitted to the Los Cabos Summit.



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Regional consultative groups In 2011 the FSB established six regional consultative groups (RCGs) to expand upon and formalise its outreach. The six RCGs include 112 institutions from 65 jurisdictions beyond the FSB’s membership. Members heard reports from the co-chairs of each of the RCGs on their meetings in the first half of 2012.

Notes to editors The FSB has been established to coordinate at the international level the work of national financial authorities and international standard setting bodies and to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. The FSB is chaired by Mark Carney, Governor of the Bank of Canada. Its Secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements.



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Chairman Ben S. Bernanke

Economic Outlook and Policy Before the Joint Economic Committee, U.S. Congress, Washington, D.C. June 7, 2012

Chairman Casey, Vice Chairman Brady, and other members of the Committee, I appreciate this opportunity to discuss the economic outlook and economic policy.

Economic growth has continued at a moderate rate so far this year.

Real gross domestic product (GDP) rose at an annual rate of about 2 percent in the first quarter after increasing at a 3 percent pace in the fourth quarter of 2011.

Growth last quarter was supported by further gains in private domestic demand, which more than offset a drag from a decline in government spending.

Labor market conditions improved in the latter part of 2011 and earlier this year.

The unemployment rate has fallen about 1 percentage point since last August; and payroll employment increased 225,000 per month, on average, during the first three months of this year, up from about 150,000 jobs added per month in 2011.

In April and May, however, the reported pace of job gains slowed to an average of 75,000 per month, and the unemployment rate ticked up to 8.2 percent.

This apparent slowing in the labor market may have been exaggerated by issues related to seasonal adjustment and the unusually warm weather this past winter.

But it may also be the case that the larger gains seen late last year and early this year were associated with some catch-up in hiring on the part of



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employers who had pared their workforces aggressively during and just after the recession.

If so, the deceleration in employment in recent months may indicate that this catch-up has largely been completed, and, consequently, that more-rapid gains in economic activity will be required to achieve significant further improvement in labor market conditions.

Economic growth appears poised to continue at a moderate pace over coming quarters, supported in part by accommodative monetary policy. In particular, increases in household spending have been relatively well sustained.

Income growth has remained quite modest, but the recent declines in energy prices should provide some offsetting lift to real purchasing power.

While the most recent readings have been mixed, consumer sentiment is nonetheless up noticeably from its levels late last year.

And, despite economic difficulties in Europe, the demand for U.S. exports has held up well.

The U.S. business sector is profitable and has become more competitive in international markets.

However, some of the factors that have restrained the recovery persist. Notably, households and businesses still appear quite cautious about the economy.

For example, according to surveys, households continue to rate their income prospects as relatively poor and do not expect economic conditions to improve significantly.

Similarly, concerns about developments in Europe, U.S. fiscal policy, and the strength and sustainability of the recovery have left some firms hesitant to expand capacity.

The depressed housing market has also been an important drag on the recovery.



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Despite historically low mortgage rates and high levels of affordability, many prospective homebuyers cannot obtain mortgages, as lending standards have tightened and the creditworthiness of many potential borrowers has been impaired.

At the same time, a large stock of vacant houses continues to limit incentives for the construction of new homes, and a substantial backlog of foreclosures will likely add further to the supply of vacant homes.

However, a few encouraging signs in housing have appeared recently, including some pickup in sales and construction, improvements in homebuilder sentiment, and the apparent stabilization of home prices in some areas.

Banking and financial conditions in the United States have improved significantly since the depths of the crisis.

Notably, recent stress tests conducted by the Federal Reserve of the balance sheets of the 19 largest U.S. bank holding companies showed that those firms have added about $300 billion to their capital since 2009; the tests also showed that, even in an extremely adverse hypothetical economic scenario, most of those firms would remain able to provide credit to U.S. households and businesses.

Lending terms and standards have generally become less restrictive in recent quarters, although some borrowers, such as small businesses and (as already noted) potential homebuyers with less-than-perfect credit, still report difficulties in obtaining loans.

Concerns about sovereign debt and the health of banks in a number of euro-area countries continue to create strains in global financial markets.

The crisis in Europe has affected the U.S. economy by acting as a drag on our exports, weighing on business and consumer confidence, and pressuring U.S. financial markets and institutions.

European policymakers have taken a number of actions to address the crisis, but more will likely be needed to stabilize euro-area banks, calm market fears about sovereign finances, achieve a workable fiscal



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framework for the euro area, and lay the foundations for long-term economic growth.

U.S. banks have greatly improved their financial strength in recent years, as I noted earlier.

Nevertheless, the situation in Europe poses significant risks to the U.S. financial system and economy and must be monitored closely.

As always, the Federal Reserve remains prepared to take action as needed to protect the U.S. financial system and economy in the event that financial stresses escalate.

Another factor likely to weigh on the U.S. recovery is the drag being exerted by fiscal policy.

Reflecting ongoing budgetary pressures, real spending by state and local governments has continued to decline.

Real federal government spending has also declined, on net, since the third quarter of last year, and the future course of federal fiscal policies remains quite uncertain, as I will discuss shortly.

With regard to inflation, large increases in energy prices earlier this year caused the price index for personal consumption expenditures to rise at an annual rate of about 3 percent over the first three months of this year.

However, oil prices and retail gasoline prices have since retraced those earlier increases.

In any case, increases in the prices of oil or other commodities are unlikely to result in persistent increases in overall inflation so long as household and business expectations of future price changes remain stable.

Longer-term inflation expectations have, indeed, been quite well anchored, according to surveys of households and economic forecasters and as derived from financial market information.



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For example, the five-year-forward measure of inflation compensation derived from yields on nominal and inflation-protected Treasury securities suggests that inflation expectations among investors have changed little, on net, since last fall and are lower than a year ago.

Meanwhile, the substantial resource slack in U.S. labor and product markets should continue to restrain inflationary pressures.

Given these conditions, inflation is expected to remain at or slightly below the 2 percent rate that the Federal Open Market Committee (FOMC) judges consistent with our statutory mandate to foster maximum employment and stable prices.

With unemployment still quite high and the outlook for inflation subdued, and in the presence of significant downside risks to the outlook posed by strains in global financial markets, the FOMC has continued to maintain a highly accommodative stance of monetary policy.

The target range for the federal funds rate remains at 0 to 1/4 percent, and the Committee has indicated in its recent statements that it anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate at least through late 2014.

In addition, the Federal Reserve has been conducting a program, announced last September, to lengthen the average maturity of its securities holdings by purchasing $400 billion of longer-term Treasury securities and selling an equal amount of shorter-term Treasury securities.

The Committee also continues to reinvest principal received from its holdings of agency debt and agency mortgage-backed securities (MBS) in agency MBS and to roll over its maturing Treasury holdings at auction.

These policies have supported the economic recovery by putting downward pressure on longer-term interest rates, including mortgage rates, and by making broader financial conditions more accommodative.



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The Committee reviews the size and composition of its securities holdings regularly and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.

The economy's performance over the medium and longer term also will depend importantly on the course of fiscal policy.

Fiscal policymakers confront daunting challenges. As they do so, they should keep three objectives in mind.

First, to promote economic growth and stability, the federal budget must be put on a sustainable long-run path.

The federal budget deficit, which averaged about 9 percent of GDP during the past three fiscal years, is likely to narrow in coming years as the economic recovery leads to higher tax revenues and lower income support payments.

Nevertheless, the Congressional Budget Office (CBO) projects that, if current policies continue, the budget deficit would be close to 5 percent of GDP in 2017 when the economy is expected to be near full employment.

Moreover, under current policies and reasonable economic assumptions, the CBO projects that the structural budget gap and the ratio of federal debt to GDP will trend upward thereafter, in large part reflecting rapidly escalating health expenditures and the aging of the population.

This dynamic is clearly unsustainable.

At best, rapidly rising levels of debt will lead to reduced rates of capital formation, slower economic growth, and increased foreign indebtedness.

At worst, they will provoke a fiscal crisis that could have severe consequences for the economy.

To avoid such outcomes, fiscal policy must be placed on a sustainable path that eventually results in a stable or declining ratio of federal debt to GDP.



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Even as fiscal policymakers address the urgent issue of fiscal sustainability, a second objective should be to avoid unnecessarily impeding the current economic recovery.

Indeed, a severe tightening of fiscal policy at the beginning of next year that is built into current law--the so-called fiscal cliff--would, if allowed to occur, pose a significant threat to the recovery.

Moreover, uncertainty about the resolution of these fiscal issues could itself undermine business and household confidence.

Fortunately, avoiding the fiscal cliff and achieving long-term fiscal sustainability are fully compatible and mutually reinforcing objectives.

Preventing a sudden and severe contraction in fiscal policy will support the transition back to full employment, which should aid long-term fiscal sustainability.

At the same time, a credible fiscal plan to put the federal budget on a longer-run sustainable path could help keep longer-term interest rates low and improve household and business confidence, thereby supporting improved economic performance today.

A third objective for fiscal policy is to promote a stronger economy in the medium and long term through the careful design of tax policies and spending programs.

To the fullest extent possible, federal tax and spending policies should increase incentives to work and save, encourage investments in workforce skills, stimulate private capital formation, promote research and development, and provide necessary public infrastructure.

Although we cannot expect our economy to grow its way out of federal budget imbalances without significant adjustment in fiscal policies, a more productive economy will ease the tradeoffs faced by fiscal policymakers.

Thank you. I would be glad to take your questions.



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