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Regualtion update

The longest journey- Update on financial services regulation 

Our Regulatory Centers of Excellence around the world discuss the impending regulatory issues financial services firms face as they seek the best strategies and business models to maximize value.


The big political issue in the European Union (EU) recently has been banking union. Finally, in October, EU leaders agreed to set up a single regulator within the European Central Bank (ECB) to supervise of all the eurozone’s 6,000 banks. A legislative framework is set to be in place by 1 January 2013, with the supervisory body starting work some time later in the year. Eurozone leaders have also re-affirmed that operation of the ‘Single Supervisory Mechanism’, as it is known, would allow the new eurozone debt rescue fund, the European Stability Mechanism, to recapitalize banks directly without adding to national debt burdens. The aim is to ultimately have a common bank recapitalization policy and fund, a single resolution mechanism and, eventually, a single deposit insurance scheme.

Despite this apparent progress, concerns – and potential legal complications – remain. For example, the details of bank supervision have been left for finance ministers to work out, leaving room for time-consuming arguments with non-Euro members of the EU about  the extent to which giving more powers to the ECB would weaken those of national regulators. Moreover, the precise details of how banks could be recapitalized directly and how to deal with legacy assets have yet to be agreed.

The EU’s liikanen report on banking reform, meanwhile, has echoed many of the proposals made last year by the UK’s Vickers Commission. The report recommends that European banks be forced to split ‘risky’ businesses out into a separate legal vehicle. Banks would also be required to create a new class of ‘bail-in’ debt that could be used to support their operations in the event of losses. The Commission is seeking comments on  the recommendations before coming up with concrete proposals by summer 2013.

In other areas, progress seems equally slow. It seems unlikely that the Capital Requirements Directive IV rule (CRD IV), which will implement Basel III rules in Europe, will come into force as scheduled on 1 January 2013. There is doubt that the European Securities and Markets Authority (ESMA) can meet its year-end deadline for delivering and gaining approval of proposals to toughen supervision of the derivatives market.

And little progress seems to have been made on shadow banking and recovery and resolution plans (RRPs). Indeed, the European Parliament will not consider proposals for RRPs until its plenary session, due to take place in mid-June 2013.

In the insurance sector, negotiations on Omnibus II – Solvency II’s enabling legislation – have stagnated, leading the European Parliament’s vote to be pushed back for a third time to March 2013. Solvency II is due to be implemented on 1 January 2014, but 2015 is now more likely.

All these delays are increasing uncertainty in Europe about when – or even whether – all these reform proposals will be consolidated, aligned and implemented. Further, there is growing concern that the whole regulatory exercise has become too complicated, especially given the sensitivity of the national political and economic interests involved.

For now, banks and insurance companies will have to carry on formulating strategy and conducting operations in the context of continuing regulatory uncertainty.


Since the passage of the Dodd-Frank Act in July 2010, the focus of the financial services industry and the regulatory agencies in the US has been on drafting over 240 implementing regulations covering everything from consumer protection to the clearing and settlement of derivatives.

In the US, as in Europe, the rulemaking process has been slower than expected. Therefore, uncertainties remain over the timing and precise detail of many proposed regulations. But the greater emphasis is on meeting not just the letter of the law, but also the spirit, together with a more systemic approach and shift from micro-- prudential supervision to macro-- prudential supervision , meanings that there are many areas where financial services firms can take action in the short term. For example, firms know they will be expected to deliver stronger governance and oversight and, in particular, to integrate business strategy more closely with risk management and capital planning. Firms also need to take steps to ensure they have the tools to conduct comprehensive capital analysis as a reflection of their risk exposure.

US regulatory agencies do not have infinite resources. As the regulatory requirements ratchet up, these bodies will demand more and more from the internal controls and Internal self-assessments of financial services firms, which they will study in depth. Operational Operational Risk and Enterprise Risk Management are a particularly important focus for regulatory agencies and they will be scrutinizing the approaches and completeness of self- assessments, not least to ensure that the most effective advanced methodologies are being applied when and where applicable. The visibility and significance of internal audit will continue to rise dramatically as the regulators expect specific criteria around coverage, substance and frequency to be met, as well as findings to be tracked, escalated appropriately and closed out. Similarly, requirements around the volume, accuracy and scope of reporting – both internally to the board and externally to the regulators – is rising significantly, not just to capture individual risks but also systemic, interconnected risks, as exemplified by the new Banking Organization Systemic Risk Report – FR Y-15.

The result of the 6 November US election does not change the direction or objectives of the regulatory changes underway in the US. Financial services firms will have to continue to make the transition to the new environment. The trick will be to approach the required changes strategically rather than tactically, with the aim of achieving not just compliance, but better management and competitive advantage.


Basel reforms continue to be high on the agenda for Asian regulators. The recent progress report on Basel III implementation shows that there is a growing gulf between jurisdictions that made an early head start and those that are only slowly coming on board. At this point, however, we expect that nearly all the Asian member countries of the Basel Committee, at least, will meet theinitial start date.

Publication of this progress report has highlighted the level of scrutiny to which each Basel member country is subject, making departure from the core elements practically impossible. Because local market realities can vary significantly from the assumptions made under Basel rules, this lack of flexibility poses challenges in Asia and has the potential to disadvantage Asian banks and, ultimately, economies. For example, the rules may directly or indirectly affect small and medium size enterprise funding, trade, finance and infrastructure finance in markets that are largely dependent on bank funding, with few alternative sources of money.

Several Asian member countries of the Basel Committee – including some that have up to now been proactive in implementation – have not yet published requirements relating to the implementation of certain elements, such as liquidity reforms. This may be due to these challenges, at least in part, although it may also be because some details in relation to the definition of high quality liquid assets and run-off rates are expected to be relaxed and amendments to the liquidity coverage ratio are still under discussion. Another topical issue for Asian banks is how country regulators will approach systemic risk, now that the final domestic systemically important financial institutions (D-SIFIs) regime paper has been published. We expect many regimes will include both the domestic banks and the local operations of foreign banks, if they are large and systemic. It is possible that the regulators will add certain requirements for these entities in three areas: capital (or loss absorbency); additional supervision and reporting; and recovery and resolution planning.

The Asian-based foreign banks are perhaps facing the most operationally complex challenges at the moment, with global and local regulation often moving at distinctly different speeds and with different priorities. Many are quite proactive in their approach and are considering various options for their operating structure in the region in response to the structuring/ring- fencing proposals coming out of the US, UK and EU. Many Asian regulators are as yet undeclared on the issue of ring-fencing certain activities. However, one that has taken a relatively clear stance is the Hong Kong Monetary Authority, which has declared itself a continuing advocate of the universal banking model. It is, however, carefully weighing up the possible impact of the Volcker, Vickers and liikanen proposals on the operations of foreign banks in Hong Kong, as well as possible trickle-down effects on more local banks.

Any segregation of wholesale and retail activities in Europe and the US would clearly affect the format of bank operations in overseas markets. Many Asian jurisdictions host a significant number of foreign banking operations, including some that hold a substantial share of local retail deposits. The regulators are carefully considering how to protect their local depositors and many are now demanding – explicitly or implicitly – that foreign bank branches become locally incorporated.

On the insurance side, many Asian supervisors are still playing catch-up in the implementation of the insurance core principles (ICPs), promulgated by the International Association of Insurance Supervisors (IAIS). Interestingly, Indonesia has recently signed up to IAIS membership. The wide range of themes covered by the ICPs, from the supervisory review process, solvency and enterprise risk management, to group supervision and consumer protection, means there is no shortage of work to be done.

This holds true even in the more advanced jurisdictions such as Japan, which has recently received the results of its Financial Sector Assessment Program. The report measured the gaps between the current regime and the ICPs. The results will no doubt provide much food for thought to other supervisors around the region as they clarify and enhance their regimes to meet the higher standards of supervision being expected.

With growth stagnant in the traditional economic engines of Europe and North America, Asia is in the spotlight as one of the bright spots for financial services. Country regulators in the region are very conscious of any factors – including the cumulative effect of regulation – that may slow economic growth. They are also now increasingly vocal on the global stage, as recently illustrated by several Asia-Pacific securities regulators publicly raising concerns regarding global derivatives market reform which, in their view, would exacerbate systemic risk and inhibit trading. It is possible that this is the beginning of a trend, with Asian regulators increasingly speaking out.

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