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Article list                                                                    THE FOLLOWING WRITERS
                                                                                CONTRIBUTED TO THIS
p3     Introduction                           p40 Middle East                   SPECIAL REPORT:
p5     United States: Litigation and          p41 Asia: Asean nations           London
       Stability Council to be regulatory
                                              p43 Non-Asean nations             • Martin Coyle
       battlegrounds in 2013
                                                                                • Alex Davidson
                                              p46 Australia and New Zealand
p9     Regulatory outlook for money                                             • Peter Elstob
       market funds                           p49 Risk managers in ascendancy   • Susannah Hammond
                                                  post-prop trading failures    • Joanne Wallen
p11    Q&A: Volcker rule, money market
                                                                                • Jane Walshe
       fund debates to highlight 2013         p50 Model risk management
                                                                                • Rachel Wolcott
                                                  in banking
p12 Capital structure is main Basel III
    issue for U.S. banks                                                        Hong Kong

p15 Enforcement crackdown tightens                                              • Ajay Shamdasani
    with new tools, practices                                                   • Trond Vagen
                                                                                • Yixiang Zeng
p18 Advisers face tough SEC
    enforcement, exams                                                          New York

p20 New Year to see emergence of                                                • Stuart Gittleman
    new anti-money laundering rules                                             • Jason Wallace
    and review of old ones                                                      • Brett Wolf
                                                                                • Bora Yagiz
p22 Firms, countries gear up for U.S.
    FATCA tax-reporting law                                                     Singapore
p23 Investor confidence a big goal on                                           • Patricia Lee
    Canadian agenda
p24 EU structural reform of banks
                                                                                • Wietske Jarvis-Blees
p28 EU reaches deal on banking                                                  • Nathan Lynch
    union, details to follow
p30 UK: Legislative overhaul inches
                                                                                • Daniel Seleanu
    closer to completion
p32 Threshold conditions                                                        Washington
                                                                                • Emmanuel Olaoye
p33 Expectations on managers in the
    brave new regulatory world
p35 Libor: A brave new benchmark?
p37 Retail financial services
                                                                                • Randall Mikkelsen
p38 Anti-money laundering
p39 Financial crime
                                                                                • Alexander Robson


2013 will see the maturing of a number
of significant regulatory reform
programs stimulated by the global
financial crisis, which began six years
ago. The changes follow extensive
international debate and consultation.
All firms, but particularly those that
operate across borders, are likely
to see an increase in their level of
compliance spending in order to keep
abreast of the changes and to ensure
that they are adequately prepared to
meet shifting regulatory expectations.
Every jurisdiction is affected by the
large-scale structural changes taking
place across the globe, including the
new regulatory bodies coming into
                                                                                                           REUTERS/Brendan McDermid
effect on April 1 in the UK and the
imminent creation of a euro zone           shown in its pressure on regulators          What unites all the initiatives is the
banking regulator. Some initiatives        to come up with new rules for money          international political desire to curb
are local, many more are global and        market mutual funds. Look for a              free market excess and risk taking, to
require a good deal of internal analysis   thorough review and possible overhaul        make banks and financial institutions
and translation on the part of firms,      of the U.S. anti-money laundering            stronger and less likely to destabilize
including Basel III, over-the-counter      system, and for examiners from the           markets and economies when they
derivative markets requirements and        Securities and Exchange Commission           fail. The aims may be laudable but the
the developing approach to model           to cast a sharp eye on newly-registered      impact that the myriad plans might
risk management.                           private fund advisers.                       have on the fragile global economic
In the United States, regulatory           Other countries will watch nervously to      recovery remains to be seen. The
momentum has gained force following        make sure the United States completes        plans are also likely to have an impact
the convincing reelection of President     its delayed implementation of Basel III’s    on the size and number of firms
Barack Obama. This ensures the Dodd-       bank capital standards, and to see the       which may wish to enter the financial
Frank overhaul will remain enshrined       final details of the far-reaching FATCA      services industry.
in law. That means more industry           tax-reporting regulations. At a global
challenges to its provisions, including    level, the growing power and reach of
the Volcker rule, may end up on court      the Financial Stability Board will have
dockets. Obama’s administration is         a strong bearing on the direction of
likely to take a more activist stance      travel of financial regulation, notably in
toward the rulemaking process, as          its upcoming paper on risk governance.

                                                                                          The oversight council gives the Treasury
                                                                                          new tools to impose a rule after it is
                                                                                          blocked in the primary regulator’s
                                                                                          process. After the election, the FSOC
                                                                                          used its powers to bypass SEC gridlock
                                                                                          and industry opposition, by proposing
                                                                                          in its own right money market fund
                                                                                          reforms that the Treasury had sought.
                                                                                          The council claims that this action is
                                                                                          necessary to limit systemic risks from a
                                                                                          rapid sale of funds by investors.

                                                                                          FSOC POWERS
                                                                                          By acting on money market funds,
                                                                                          the FSOC asserted an activist role in
                                                                                          administration regulatory policy. The
                                                                     REUTERS/Bob Strong   council, created under Dodd-Frank,
                                                                                          has 10 voting members comprising
With President Barack Obama winning         of regulators.
                                                                                          heads of the federal regulators, and
re-election on a platform that included     Obama will also appoint leaders at            is chaired by the Treasury secretary.
regulation, expect the new inter-           several agencies expected to have             As part of its systemic risk role, it can
governmental council of financial           vacancies. Elisse Walter was designated       direct regulators to take specific action
regulators to seek a more active role,      Securities and Exchange Commission            or designate large non-banks, such
and legal skirmishes as the financial       (SEC) chairman, after Mary Schapiro’s         as money market mutual funds, for
industry tries to block rules of the        post-election resignation. There were         stricter supervision. When Treasury
Dodd-Frank Act that Obama signed            signs Walter’s tenure may be short, and       Secretary Tim Geithner leaves the
in 2010. The administration will press      several SEC division heads have also          administration as expected early in
regulators to finish implementing           announced their departures, but the           the year, his replacement will wield
Dodd-Frank.                                 appointment of a longtime associate           these regulatory powers via the
With the U.S. Treasury Department           of Schapiro’s indicates continuity at the     FSOC chairmanship.
at the chair of the Financial Stability     agency for the time being.
                                                                                          The FSOC was established to constrain
Oversight Council (FSOC), the agency        With little chance of Dodd-Frank              systemic risk. However, its broad
will actively use its new systemic          revision from Congress or regulators,         oversight role can be used to resolve
oversight powers to push for rules,         industry will likely try to block rules       disagreements between regulators. It
especially where the primary regulator      by seeking lawsuits and delays. After         can also step in where a regulator fails
has not done so, or if there are            the election, the Commodity Futures           to issue rules that the council believes
disagreements between agencies.             Trading Commission (CFTC) voted               are necessary. While the council cannot
New legislation to revise Dodd-Frank        to appeal a recent court rejection of         overturn a court decision blocking a
is unlikely in a divided Congress, with a   its rule imposing position limits. A          rule or impose a rule on its own, its
Democratic majority in the Senate and       chief strategy of the lawsuits, refined       opinion may pressure the regulator to
Republicans in control of the House         by attorney Eugene Scalia, son of             fight lawsuits against rules, or to re-
of Representatives. As Democrats            Supreme Court Justice Antonin Scalia,         issue a rule in a modified form.
will resist reopening debate on Dodd-       is to claim a rule is invalid because
                                                                                          Geithner urged the FSOC to issue
Frank, the only issues with a chance of     the regulator misinterpreted the
                                                                                          money market fund recommendations,
passage will be targeted amendments         law or failed to follow the required
                                                                                          and to provide a final version to the
to resolve problem areas, rather than       rulemaking process.
                                                                                          SEC. That regulator, down to four
complex matters such as merging
                                                                                                               REUTERS/Tony Gentile

commissioners after Schapiro left,           LAWSUITS AND COST BENEFIT                 “Our appeal should send a message
would then be required to adopt these        Ryan also urged regulators “to ensure     that the largest speculators on the
recommendations as its own, or explain       proper economic impact analyses are       planet can’t litigate regulators to
why it was not doing so.                     undertaken for each rule.” Many major     death,” CFTC Commissioner Bart
                                             rules remain unresolved, and “even        Chilton said. “We will fight back. Your
The SEC failed to act on money
                                             rules that have been issued do not        deep pockets can’t protect you from
market fund reform after canceling
                                             always stand up in court,” Ryan said      what the law clearly states.” he said.
an August meeting intended to issue
                                             in October. He cited a federal court’s    In case the CFTC’s appeal was to fail,
rule proposals supported by Schapiro.
                                             rejection of the CFTC’s position-limits   Chilton also supports proposing and
Three of the five commissioners stated
                                             rule, in a lawsuit brought by SIFMA       finalizing a second position-limits
they would vote against issuance,
                                             and the International Swaps and           rule that responds to issues raised by
amid pressure from the fund industry.
                                             Derivatives Association.                  the court.
Schapiro then passed the fund
issue over to the Treasury and the           Court successes challenging rules have    Schapiro said in September that the
stability council.                           encouraged more industry lawsuits         SEC would not seek a re-hearing of
                                             against other Dodd-Frank provisions       a D.C. federal court ruling against
“FSOC should take a much stronger
                                             on cost-benefit grounds. The federal      the “proxy access” proposal, which
leadership role in ensuring coordination
                                             court for the District of Colombia is     would have enabled shareholders to
between regulators on a number
                                             an attractive location for suits to be    nominate directors. In the case brought
of rulemakings,” Tim Ryan, chief
                                             filed due to its record of judgments,     by the U.S. Chamber of Commerce,
executive of the Securities Industry and
                                             which included striking down an SEC       the court judged the rule violated the
Financial Markets Association (SIFMA),
                                             shareholder-rights proxy rule in 2011.    Administrative Procedures Act, as it
told the International Financial Law
                                             Cases are pending against several         did not consider efficiency or impact on
Review (IFLR). Ryan cited as examples
                                             other CFTC and SEC rules.                 capital formation.
a lack of coordination by CFTC and
SEC on derivatives rules, and the five       But the CFTC is appealing the             “The SEC (and, lately, the CFTC) often
different agencies with various versions     judgment on position limits, and some     does a poor job with the hard work of
of the pending Volcker rule to limit risky   commissioners have vowed to put up a      the rule-making process,” Scalia said
trading by banks.                            tough fight.                              in a Wall Street Journal opinion piece
in October. “An agency must listen            Republican U.S. Rep Jeb Hensarling          whether by an SRO or by the SEC,
carefully to what the public says about       takes over in 2013 as the new House         should be the product of a careful and
a proposed regulation, reconsider its         Financial       Services     Committee      balanced assessment of the potential
approach in light of that public input,       Chairman, replacing Spencer Bachus.         consequences that could arise,” SEC
and then cogently explain (not merely         In November, both representatives           Commissioner Daniel Gallagher said at
assert) why it made the regulatory            wrote to agency heads saying they           SIFMA’s Market Structure Conference
choices it did in crafting the final rule.”   are troubled that the five regulators       in October.
                                              responsible for the Volcker rule are
Some challenges have been thwarted.                                                       The process should require regulators
                                              unable to agree on a single text. This
A D.C. federal court judge in December                                                    to identify the scope and nature
                                              was a particular concern, they claimed,
ruled against the Investment Company                                                      of an underlying problem, and the
                                              as the costs of Volcker rule on the U.S.
Institute (ICI) and the Chamber of                                                        likelihood that the proposed rule will
                                              system will likely outweigh the benefits.
Commerce in their challenge to another                                                    mitigate or remedy it, Gallagher said.
CFTC rule. This rule would require            They requested that the agencies            This includes evaluating how the rule
advisers to registered investment             conduct a thorough cost-benefit             change could affect firms, including
companies already regulated by the SEC        analysis of the Volcker rule and its        the expected costs and benefits.
to also be supervised by the CFTC as          likely impact. This should assess the       Finally, the regulators should justify
“commodity pool operators.” The judge,        effects on investors, borrowers, capital    their recommended rule or course
held that the CFTC had adequately             markets, the financial system, and U.S.     of action, as compared with the
assessed costs and benefits. Just before      economy. They suggested compliance          main alternatives.
year-end, the ICI and Chamber appealed        should be delayed until two years after
                                                                                          “Cost-benefit analysis isn’t easy, it isn’t
the court ruling, claiming that the           the rule is finalized.
                                                                                          quick, and it isn’t cheap,” Gallagher
judgment fell short of the established
                                              Industry also opposes CFTC rules on         said. “If self-regulation is to remain
D.C. Circuit precedent for agencies to
                                              over-the-counter derivatives, citing high   viable, however, it is necessary.” He
measure such costs.
                                              costs and a lack of coordination. The       questioned whether the SROs have the
VOLCKER RULE, OTC DERIVATIVES                 rules apply both to U.S. swap dealers       resources and will to do cost benefit
AND BASEL III                                 and to overseas firms that deal with        analyses to support their rulemakings.
SIFMA, the American Bankers                   U.S. persons. The House scheduled
                                                                                          But SRO rules only need to be
Association and the Financial Services        a hearing in December to assess the
                                                                                          consistent with the law, said Financial
Roundtable wrote to bank regulators           economic and market implication of
                                                                                          Industry Regulatory Authority (FINRA)
to recommend they withdraw their              the rules, at which CFTC Chairman
                                                                                          chief Rick Ketchum. He said the
proposed rules implementing the               Gary Gensler has been asked to testify.
                                                                                          SEC, whose approval is required on
international Basel III capital standards.    “Congress should raise the bar              FINRA rules, should defer to the self-
They said the rules should not be             by providing specific minimum               regulatory bodies.
proposed until regulators conduct a           requirements that CFTC must satisfy
study showing that the risk weights in                                                    Ketchum conceded that FINRA has to
                                              when conducting a cost-benefit
Basel are accurate, and that the rules                                                    rethink how it revises and reviews rules,
                                              analysis,” said CFTC Commissioner
take account of the economic cost of                                                      which it does now through an informal
                                              Scott O’Malia in November. He is also
the higher capital required.                                                              process that has depended on industry
                                              seeking to revise the swap dealer
                                                                                          comment letters and input from board
The groups opposed Basel III rules for        registration rule because, he said, CFTC
                                                                                          members. “We have an obligation
smaller banks, and called for an extended     “failed to follow the statute” and the
                                                                                          to reach out at an earlier stage in the
compliance period for community banks,        expansive nature of the cross-border
                                                                                          process to be more transparent about
on the grounds that they “face significant    guidance, which O’Malia stated was a
                                                                                          the rulemaking we are thinking about.
difficulties in meeting the proposed          “misreading of the statute.”
                                                                                          This should have regard to the costs,
new capital requirements.” The Senate                                                     any alternatives to the rule and why
and House in November held oversight          SELF-REGULATORY ORGANIZATIONS
                                              ALSO FACE COST-BENEFIT PRESSURE             the alternatives are not satisfactory,”
hearings on the rules, and bank regulators                                                Ketchum said.
                                              Self-regulatory organizations (SROs)
have delayed their implementation
                                              are also being pressed to apply the         The Municipal Securities Rulemaking
beyond the internationally scheduled
                                              same standards as federal regulators        Board (MSRB), which writes rules for
January 1, 2013 date due to the high level
                                              and to do better cost-benefit analyses      municipal bonds, is also developing a
of comments.
                                              of their rules. “Any rulemaking,
cost-benefit-analysis model to assess         the National Securities Markets              has finalized a rule,” Sommers said.
new rules.                                    Improvement Act of 1996, which               “These after-the-fact clarifications may
                                              imposes heightened responsibilities          require market participants to integrate
“We are re-examining rules to ensure
                                              when determining if a rule is consistent     completely new processes into their
they accomplish what they are intended
                                              with the public interest. The act requires   businesses, all done outside of the
to, and are consistent where possible
                                              the SEC to consider not only the             rulemaking process and free from a
with FINRA,” said MSRB chairman Jay
                                              protection of investors but also to assess   cost-benefit analysis.”
Goldstone in October. Consistency with
                                              whether a rule will “promote efficiency,
FINRA rules would reduce duplicate                                                         Staff guidance limits public comment
                                              competition, and capital formation.”
compliance costs for firms subject to                                                      on the specific method of compliance or
rules of both regulators. An MSRB             Republican lawmakers have introduced         the costs it involves, “which in my view
consultation paper was issued in late         bills that would require regulators          violates the Administrative Procedure
December that invited firms to submit         to conduct more formal cost-benefit          Act,” Sommers said. “Unfortunately, we
comments on any parts of their rules.         analyses of all proposed rules. The          (or Congress, through reauthorization)
                                              Senate Homeland Security Committee           will most likely be re-writing many
LEVEL OF ANALYSIS REQUIRED                    has also proposed the Independent            of our Dodd-Frank rules over the
“The real message of the proxy-rule           Agency Regulatory Analysis Act,              next couple of years because they
judgment is for regulators to be more         which would require agencies to do           do not reflect input we received from
transparent when making rules, to             formal cost-benefit analyses of major        the market.”
show their work and what they have            rules. Analysis would then be sent for
done,” said Craig Lewis, director of SEC                                                   While cost benefit analysis is often
                                              review to the White House Office of
Division of Risk, Strategy, and Financial                                                  used to slow-down rulemaking that
                                              Management and Budget (OMB). That
Innovation (RiskFin). Lewis asked firms                                                    industry does not like, it can work the
                                              would give the White House greater
to submit better comment letters to                                                        other way. The SEC recently cited cost-
                                              authority over the regulatory agencies,
rules that clearly specify the expected                                                    benefit deliberations as justification for
                                              and the agencies are fighting back.
cost of a provision, rather than merely                                                    delaying rules that industry supports.
stating it will impose a ‘heavy burden’.      The bill “would interfere with our
                                                                                           House Republicans criticized Schapiro
                                              ability to promulgate rules critical to
The SEC has issued guidance on the                                                         for delaying implementation of rules
                                              our missions in a timely manner and
four stages that it now uses in its                                                        required by the 2012 Jumpstart Our
                                              would likely result in unnecessary and
economic analysis of new rules.                                                            Business Startups (JOBS) Act that
                                              unwarranted litigation in connection
                                                                                           would allow broader advertising for
The first stage is to identify the need for   with our rules,” said the heads of six
                                                                                           private placements. After critical
regulatory action. This will define the       regulators, including the Federal
                                                                                           comments from a consumer body, SEC
goals of a rulemaking and examine the         Reserve and SEC.
                                                                                           issued a proposed rule for comment,
avenues available to achieve it. A law        “I have spoken in the past of my             rather than an interim final rule
such as Dodd-Frank is a mandate that          frustration with the thoroughness of         that would have been immediately
represents that Congress has identified       our cost-benefit analysis,” said CFTC        effective. The SEC said the risk of a
the need for the SEC to act. If there is      Commissioner Jill Sommers in October.        lawsuit overturning the rule for lack
no law, the identification stage should       Instead of the analysis required by the      of comment was a reason to delay
evaluate why the regulation is needed,        Commodity Exchange Act, Sommers              implementing it.
and how significant the need is, which        said CFTC merely raised questions            Nick Paraskeva is the principal of Reg-Room
can be a subjective matter.                   and asked commenters to quantify             LLC (, which provides
The second is to set a baseline for           their costs. This was compounded by          regulatory information and consultancy.
measuring the rule. The third is to look      many no-action letters and guidance          He publishes the Regulatory Risk Report,
at alternative regulatory approaches.         issued just before the swap dealer rules     and delivers exclusive analysis through
                                              took effect.                                 Thomson Reuters. He can be contacted at
These only need to be the reasonable
                                                                                           (212) 217-0403 and
alternatives, not every possible one.         “We have a new issue with compliance
The fourth is the evaluation of benefits      costs and the prescriptive nature
and costs, of both the rule and any           of our rules, which involves staff
alternatives considered.                      interpreting an even more precise
Regulators     are   also    subject    to    manner for compliance after the CFTC

                                                                                     such as more stringent investment
                                                                                     diversification requirements, increased
                                                                                     minimum liquidity levels and tougher
                                                                                     disclosure requirements.
                                                                                     Lobbyists for the U.S. fund industry are
                                                                                     furious at the FSOC recommendations.
                                                                                     Low interest rates and earlier capital
                                                                                     requirements have already put U.S.
                                                                                     funds under pressure. Lobbyists
                                                                                     and some analysts argue that more
                                                                                     regulatory requirements and the
                                                                                     introduction of capital buffers will pile
                                                                                     expenses onto funds and force them
                                                                                     to shut. It is unlikely, however, that this
                                                                                     multi-trillion dollar sector of the fund
                                                                                     industry will close up overnight.
                                                                                     The November FSOC report was open
                                                                                     for a 60-day comment period. Section
                                                                                     120 of the Dodd-Frank Wall Street
                                                                                     Reform and Consumer Protection Act
Money market funds (MMFs) came             GEITHNER SENDS FUND ISSUE TO              2010 gives the FSOC the authority to
                                           OVERSIGHT COUNCIL                         provide for more stringent regulation
under regulators’ microscopes in
                                           Having failed to pass further             of financial activity that it deems
2012 as first the U.S. and then the
                                           fund reform at the Securities and         systemically risky. That means it can
International Organization of Securities
                                           Exchange Commission (SEC), U.S.           issue recommendations to a primary
Commissions       (IOSCO)      published
                                           Treasury Secretary Timothy Geithner       financial regulatory agency such as
recommendations for making these
                                           empowered the Financial Stability         the SEC “to apply new or heightened
funds less vulnerable to mass
                                           Oversight Council (FSOC) to come          standards or safeguards.”
withdrawals, or “run risk” in times of
                                           up with its own recommendations
extreme market volatility. Officials in                                              That is precisely what the FSOC is
                                           for tightening up MMF regulation. In
Washington and Madrid said reforms in                                                likely to do absent SEC action. Once
                                           November, the FSOC published the
2010 that forced the funds to increase                                               the comment period is over, it would
                                           recommendations, which by and large
liquidity, decrease average maturities,                                              recommend that the SEC proceed with
                                           are similar to those put before the SEC
enhance transparency and improve                                                     money market funds reform. If the SEC
                                           last summer.
credit quality were insufficient.                                                    does not implement the recommended
                                           The FSOC proposed three alternative       standards with 90 days, it must write
Originally, money market funds came
                                           recommendations: (1) that MMFs float      to the FSOC to explain why. This case is
to regulators’ attention in 2008 when,
                                           their net asset values and go to a        the first instance where the FSOC has
post-Lehman Brothers, some funds’
                                           variable net asset value (VNAV); or (2)   used its new Dodd-Frank powers to
share price dropped below one dollar,
                                           funds could maintain their constant       try to force through regulatory change.
known as “breaking the buck.” The
                                           net asset value (CNAV) but put into       The industry, the FSOC and the SEC are
drop prompted investors to redeem
                                           place a 1 percent capital buffer and      moving into uncharted legal territory,
more than $300 billion from the funds
                                           a 3 percent minimum value at risk;        making it difficult to predict how it will
and resulted in the closure of the
                                           or (3) CNAV funds could put in place      play out.
commercial paper markets to even the
                                           a risk-based net asset value buffer
highest-quality issuers.
                                           of 3 percent and other measures,

                                                                                              FINANCIAL STABILITY BOARD AND
                                                                                              SHADOW BANKING
                                                                                              The Group of 20’s Financial Stability
                                                                                              Board (FSB) is likely to have the final say
                                                                                              on regulation of both U.S. and European
                                                                                              money market funds. The FSB, as part
                                                                                              of its recommendations on shadow
                                                                                              banking, specifically seeks to “reduce
                                                                                              the susceptibility” of MMFs to runs.
                                                                                              The FSB’s new rules for money-funds
                                                                                              and other shadow banking activities
                                                                                              should be published by September
                                                                                              2013. For the biggest constant NAV
                                                                                              funds the FSB recommendations could
                                                                                              lead to them being labeled as non-
                                                                                              bank systemically important financial
                                                                                              institutions and being regulated in a
                                                                          REUTERS/Jason Lee
                                                                                              similar way to banks.
                                                                                              The IOSCO report said the organization
IOSCO RECOMMENDATIONS                        IOSCO has also said it will revisit the
                                                                                              and the FSB were working on a
Prior to the appearance of the FSOC’s        topic of money-fund regulation in two
                                                                                              methodology for non-bank SIFIs, and
recommendations, in October IOSCO            years to determine whether further
                                                                                              the project “may also have implications
published its own. Its report “Policy        rules and guidance are needed. Part of
                                                                                              for the regulation and supervision of
Recommendations for Money Market             that future work will certainly pertain
                                                                                              money market funds.”
Funds” outlines 15 recommendations           to MMFs’ role within the shadow
covering       valuation,     liquidity      banking system. In its report, IOSCO             Similarly, the FSOC considers non-
management, use of ratings, disclosure       clearly states that it considers the             bank financial firms as systemically
to investors and use of repo.                funds to be part of the shadow banking           important if they hold consolidated
                                             system, “on the basis that they perform          assets of $50 billion, making them a
The recommendations for valuation
                                             maturity and liquidity transformation            potential candidate for designation.
were the cornerstone of the report.
                                             and are important sources of short-              According to data from Standard &
The report asserts that constant NAV
                                             term funding, particularly for banks.” It        Poor’s, that means that potentially
funds are more prone to run risk than
                                             looks likely that, from IOSCO’s point of         seven of the 10 largest U.S. money
variable NAV funds, which use mark-
                                             view, even if MMFs avoid being labeled           market funds could be classified
to-market accounting to value some of
                                             as systemically important financial              as SIFIs. MMFs with less than $50
their assets. Regulators have said the
                                             institutions (SIFIs), which is a possibility,    billion in assets may also attract
net asset value of these funds varies
                                             they will come under the new shadow-             more regulation.
slightly, thus reflecting a more accurate
valuation of the fund. Market analysts       banking regulations. Ultimately, that
have said the IOSCO report gives U.S.        means MMFs could be regulated in a
and EU supervisors a green light to          similar way to banks.
regulate money market funds in the           For European MMFs the most likely
way they see fit. MMFs have never had        regulatory outcome is a move to
to think about regulation such as this.      partial variable NAV funds, according
                                             to analysts.

With President Barack Obama
seeking to capitalize on the political
momentum of his reelection win and
new lawmakers joining influential
Congressional     committees       that
oversee the financial services industry,
2013 could bring changes for financial
institutions and the compliance
officers tasked with keeping up with
new regulations.
Compliance Complete recently sat
down with Wayne State University
law professor Peter Henning to
discuss potential regulatory initiatives
that will be coming out of the next
Congress. Henning is a former official
at the SEC’s enforcement division
                                                                                                                 REUTERS/Darren Staples
and the Justice Department’s fraud
section. As a senior attorney at the         SO WILL IT BE MORE DIFFICULT                 reform). In terms of sheer size that’s
SEC, he worked on cases involving            TO COMPLETE THE REGULATIONS
                                             IMPLEMENTING THE VOLCKER RULE?               got to be the most important area that
insider trading, market manipulation,                                                     Congress will have to address. They’ve
                                             Yes. The Volcker rule is going to get tied
and accounting irregularities. At the                                                     basically been playing defense for the
                                             up. Even if the agencies can come out
Justice Department, he was involved in                                                    last four years.
                                             with regulations, it is then going to be
investigating and prosecuting cases of
                                             tied up in court challenges. Then you’re
bank fraud.                                                                               DO YOU SEE HAMP (HOME AFFORDABLE
                                             going to have Capitol Hill. Whether          MODIFICATION PROGRAM) BEING
A longtime observer of regulations           the Republicans can get anything             WOUND DOWN OR WILL THE
coming out of Washington, Henning                                                         GOVERNMENT TRY TO FIX ITS
                                             through the Senate is another issue.         DEFICIENCIES?
touched on a range of topics, from           I wonder whether we’re going to see          That’s a good question. I would have
the Volcker rule and the derivatives         much of anything aside from carping or       said two years ago they would wind
rules to money market reform and the         complaining.                                 it down. But when you see Fannie
regulation of too-big-to-fail banks. The
                                             I don’t think we’ll see any major            and Freddie and all the different
questions and Henning’s answers have
                                             initiatives to write new rules. Not in       moving parts: The Federal Housing
been edited for length and clarity.
                                             the financial sector, unless there is        Administration (FHA), the different
WHAT DO YOU SEE AS THE BIG                   a blowup (such as a scandal in the           mortgage loan programs, and the tax
REGULATORY ISSUES IN THE                     financial industry).                         area (mortgage interest deduction).
NEW CONGRESS?                                                                             That is a lot of moving pieces. They’re
There is enormous pressure over the          An interesting area in the second
                                                                                          going to have to take that on at some
Volcker rule. Getting rid of it or cutting   Obama term is the issue of what
                                                                                          point. You can’t just let Fannie and
it way back. We have an administration       they are going to do with Fannie and
                                                                                          Freddie limp.
that wants to regulate in some areas.        Freddie. Will Congress be able to
In contrast, if Republicans do not like it   do anything on mortgage markets?             WHAT ABOUT THE VOLCKER RULE?
or they do not want regulations in other     They’re good at suing banks, but now         The Volcker rule is going to get mired
areas like the JOBS Act the Republicans      are they going to do anything positive?      down and eventually get watered
in the House start to beat drums             It will be interesting to see. That to me    down. We will get a little bit of the
about it.                                    is probably the most likely area (for        Volcker rule but certainly not the way

Paul Volcker envisioned it. I suspect
most of its effect has already been felt.
                                             DO YOU THINK WALTER WILL BE ABLE
                                             TO PERSUADE THE REPUBLICAN
                                             COMMISSIONERS AT THE SEC TO BACK
The banks are winding down their prop
trading and things like that. I don’t
                                             MONEY MARKET REFORM?
                                             I think they’ll be able to work out some
                                                                                        STRUCTURE IS
think it will have the kind of impact
that reform of the mortgage market
                                             compromise with a new chairman, and
                                             I think there is a chance she’ll become
                                                                                        MAIN BASEL III
will have.                                   the (long-term) chairman. A lot of times
                                             inertia takes over in D.C.
                                                                                        ISSUE FOR
I think that the real pain of the Volcker
rule has come and gone. Now they’re
                                             IF THE SEC IS UNABLE TO GAIN ANY
                                                                                        U.S. BANKS
just going to try and figure out how we      TRACTION WITH MONEY MARKET
deal with it. I don’t think we’ll see any    REFORM, DO YOU SEE THE FINANCIAL           The first set of phase-in periods for the
                                             STABILITY OVERSIGHT COUNCIL
major initiatives in that area. Whenever     TAKING UP THE BATON?                       Basel III rules on bank capital standards
it does become a final rule, the venue       That raises an interesting question.       is due to kick in for U.S. institutions
shifts over to the courts, and maybe         This is an agency of agencies. There       during 2013. U.S. regulators — the
you go to Capitol Hill and you get some      are all sorts of administrative law        Federal Reserve Bank, the Federal
tinkering with it.                           constitutional issues lurking there.       Deposit Insurance Corporation, and
                                             What is their authority? Can they cram     the Office of the Comptroller of the
COMMITTEES INTRODUCING ANY                   a rule down another agency’s throat?       Currency — in November pushed the
NEW LEGISLATION?                             It will be interesting to see how active   original deadline of January 1, 2013
In the mortgage market maybe; I think        they are. Essentially they’re supposed     further into the year for three proposed
a lot will revolve around whatever the       to be a back-stop for the agency. It       Basel-related       regulations,     after
tax deal is. Once we get past the fiscal     will be interesting to see how that        meeting banking industry resistance.
cliff stuff then I think a lot of it will    plays out.                                 The delay, which sparked some
be focused on deals with the fallout                                                    questions over the U.S. commitment to
of that.                                     LET’S TALK A BIT ABOUT THE                 Basel III, is nonetheless perceived to be
                                             COMMODITY FUTURES TRADING
                                             COMMISSION (CFTC). THE AGENCY HAS          only temporary. “The U.S. authorities
WHAT AREAS DO YOU SEE AS THE                 BEEN VERY BUSY WITH THE DODD-              expect it to happen during the
SEC’S TOP PRIORITIES?                        FRANK SWAP RULES. WHAT ARE THE             course of 2013,” the German finance
If we ever get anything out about            BIG ISSUES TO KEEP AN EYE ON?
                                                                                        ministry said.
money market reforms, that is an             They’ve altered the swaps market so
important area for the SEC to look           they’re going to have to come up with      While an alternative date was still
at. Because everyone uses them as            some rules. They basically have to put     being awaited at year end, the industry
bank accounts and they don’t have            together a brand-new market with           believes it will be set for some time
any FDIC (Federal Deposit Insurance          real transparency.                         in the first half of 2013. The head of
Corp.) insurance.                                                                       the Group of 20’s Financial Stability
                                             Again they can get the daylights sued
                                                                                        Board, Mark Carney, said U.S. stress
You have the basic investment                out of them, too — particularly the
                                                                                        testing of its 19 biggest banks reflects
company rules, but these are not bank        challenges by (attorney) Eugene Scalia
                                                                                        Basel III standards and “an accelerated
accounts and everybody seems to treat        over economic analysis. (The legal
                                                                                        implementation” of the rules.
them as one. The government stepped          challenges are) a backdoor way to try
in to back them in 2008 at no charge.        to slow rulemaking. People will take       There will be a number of milestones
That’s a pretty nice deal whereas            advantage of it if they don’t like the     for banks in 2013 regarding Basel III
the bank gets whacked with FDIC              rule. The legal challenges will slow the   implementation, but the focus will fall
insurance charges.                           CFTC and SEC down on the front end         on their capital structure, as much in
                                             to where they become gun shy about         quality as on quantity.
It will be interesting to see the
                                             these lawsuits, and they (draft rules)     The quality will be improved with a
regulatory initiative, not only from the
                                             much more slowly.                          shift in emphasis to a stronger Tier
SEC but Congress, to see if they will do
anything with that. Now that (former                                                    1 capital base through an increase
SEC Chairman Mary) Schapiro’s gone                                                      in the common-equity Tier 1 (CET1)
maybe (new Chairman) Elisse Walter                                                      component, and with significantly less
can come up with a compromise.                                                          reliance on Tier 2 capital. Banks will

be required to bring their level of Tier      capital well above both the existing and      capital adds the Basel III leverage
1 capital from 4 percent to 4.5 percent       the proposed regulatory minimums.             ratio as a requirement, which includes
of risk-weighted assets, 3.5 percent of       The agency estimated the costs                off-balance sheet instruments in its
which will have to be in CET1.                associated with the Basel-related rules       calculation, while keeping the current
                                              to be about $145 million in the first         U.S. leverage ratio.
This new and highest form of capital
                                              year of implementation. The agencies’
created under Basel III includes only                                                       Separately from these rules, the so-
                                              rules proposed in June fall closely in
the strictest types of capital, such as                                                     called “Collins amendment” to Dodd-
                                              line with the Basel standards, but with
retained earnings, the common stock                                                         Frank has outlined a more conservative
                                              a few differences that are stricter than
issued by a bank, and accumulated                                                           approach for capital treatment than
                                              Basel III.
other comprehensive income to fully                                                         the Basel III requirements. It stipulated
absorb losses. It excludes any capital        The standardized approach rule aimed          that banking organizations operating
instrument that carries a contractual         at harmonizing standards among U.S.           under the advanced approaches must
obligation for repayment. Under the           regulators, for instance, provides a          calculate their risk-based capital ratios
new capital regime, non-cumulative            more granular approach for weighting          under Basel I along with the advanced
perpetual preferred shares, considered        risk than the current two weights, with       approach, and then choose the lower
to be a strong form of capital, will now      ten different buckets of risk-weightings      of the two Tier 1 risk-based minimums
qualify as additional Tier 1 capital, while   ranging from 35 percent to 200 percent        as floor for regulatory purposes.
the cumulative preferred shares will          for residential mortgage loans. The
move to Tier 2.                               approach takes into account duration,         REGULATORY ARBITRAGE
                                              amortization, performance of the loan         All of these differences reduce
Large U.S. banks, keen to show                                                              the opportunity to exploit regulatory
                                              and its underwriting characteristics.
investors that they are sound and                                                           arbitrage.
gain a competitive edge over their            The same provision, in line with the
peers, have already met these capital         Dodd-Frank regulatory overhaul, also          “It (arbitrage) can manifest itself only
requirements, according to Federal            rules out references to credit ratings        through the inherent discretion left
Reserve stress testing through the            agencies. Securitization exposures,           to national regulators in determining
Supervisory     Capital   Assessment          for instance, would follow a formulaic        what instruments qualify for CET1, and
Program and the Comprehensive                 approach to determining the exposure’s        the criteria used for the stress tests,”
Capital Analysis and Review.                  risk weight based on the underlying           said Dwight Smith, a partner with
                                              assets and the exposure’s relative            Morrison Foerster law firm.
Assessments by the Office of the
                                              position in the securitization’s structure.   For example, the European Union’s
Comptroller of Currency indicate that
many community banks also hold                Similarly, a proposed rule on general         Capital Requirements Directive IV

                                                                                                                       REUTERS/Jason Lee

— the EU equivalent of the Basel III
rules — gives EU banks more latitude
to include certain capital instruments
in CET1 that may differ from common
stock, such as minority interests in
Tier 1 capital and holdings in other
financial institutions.
Other capital buffers, such as the
capital conservation buffer requiring
all banks to hold 2.5 percent of CET1
and the countercyclical capital buffer
that may require large internationally
active banks with assets in excess of
$250 billion to retain up to 2.5 percent
of additional CET1, are not to start
                                                                                                                     REUTERS/Tim Chong
until 2016.
The former is intended to allow banks        Similarly, Basel III liquidity ratios will    and weigh in factors such as size,
to have a supplementary cushion of           not phase in until 2015, although banks       interconnectedness, complexity, and
capital, bringing their total CET1 to 7      will begin reporting relevant data for        cross-jurisdictional activity.
percent, a level below which the banks’      the liquidity-coverage ratio in 2013.
                                                                                           The Basel Committee will, once again,
discretionary earnings distribution          This ratio, which will have a slight tweak
                                                                                           place certain banks into five different
would be limited. The latter is intended     by the Basel Committee in the first part
                                                                                           categories based on their respective
to rein in banks’ excessive lending and      of the year, is intended to measure
                                                                                           systemic importance, and will assign
a possible deterioration in underwriting     the short-term resilience of a bank’s
                                                                                           different levels of capital surcharge
standards      during      periods     of    liquidity risk profile through comparing
                                                                                           ranging from 1 to 3.5 percent of
economic expansion.                          its highly liquid unencumbered assets
                                                                                           common equity as percentage of
                                             with its net cash outflows for a month
“Banks generally are well positioned to                                                    risk-weighted assets. The surcharges
                                             under a stressed scenario.
meet the 7 percent CET1 requirement                                                        related to globally significant status
and in fact generally exceed it,” said       UPDATED “TOO BIG TO FAIL” LIST                will apply to those on the November
Stefan Walter, a principal at Ernst          There are other milestones, however,          2014 list, with phase-in to begin only in
& Young, and a former Secretary              that the U.S banks will have to be            November 2016.
General of the Basel Committee on            mindful of in 2013. Big U.S. banks,           Prior lists, however, will indicate
Banking Supervision. “Some will have         especially those that feature on              which banks may have to begin their
to achieve further capital retention to      Basel’s annual list of systemically           preparations in raising the extra capital.
meet the additional SIFI surcharge           important “too big to fail” institutions
requirements,” he added.                                                                   The Basel Committee’s principles
                                             that appeared in November 2012 —
                                                                                           on information technology and data
Except for trust-preferred securities        Citigroup, JPMorgan Chase, Bank of
                                                                                           architecture will not enter into force
that will be phased out of the Tier 1 for    America, Bank of NY Mellon, Goldman
                                                                                           until 2014 for G-SIBs and even later
bank holding companies with assets           Sachs, Morgan Stanley, State Street
                                                                                           for others. U.S. banks will nonetheless
of $50 billion, in line with the Collins     and Wells Fargo — will also be closely
                                                                                           start drafting their self-assessments.
amendment, no capital deduction              watching for the list’s updated version
                                                                                           These assessments will demonstrate
phase-out will occur in 2013. A number       that is expected to come out in
                                                                                           improvements the banks intend to
of staggered phase-out periods for           November 2013.
                                                                                           make in their risk-data aggregation
other types of capital deductions,           The criteria used for Basel’s G-SIB (global   capabilities, risk reporting practices,
such as deferred tax assets, mortgage        systemically important banks) list closely    and governance. There will also be
servicing rights, minority interests, and    mirror those used by the U.S. Financial       some key datasets that will include
investments in financial institutions are    Stability Oversight Council for the U.S.      yield curves, foreign exchange, equities
scheduled to begin in January 2014.          Treasury’s designation of systemically        and commodities, as well as credit
                                             important financial institutions (SIFI),      risk indicators such as counterparty

exposure, positions, trades and
collateral, and aggregation data by           ENFORCEMENT CRACKDOWN
clients, geography, and industry.
There will be more disclosure rules
                                              TIGHTENS WITH NEW TOOLS,
put into effect on June 30, 2013 for the      PRACTICES
U.S. banks operating under the earlier
Basel II advanced approach. These will        The overseers of the U.S. financial           Federal prosecutors are also using
give a breakdown of their regulatory          industry, having turned up the                evidence-gathering techniques, such
capital      composition,     including       enforcement heat since the financial          as wiretaps, recordings by informers
the main features of regulatory               crisis, are showing no signs of letting up.   and “flipping” participants to turn
capital instruments they issued,                                                            against their coconspirators, that
the non-regulatory ratios involving           “We’ve now brought more enforcement
                                                                                            until recently were only used against
components of regulatory capital, and         actions in each of the last two years
                                                                                            traditional criminal organizations.
a comprehensive explanation of how            than ever before, including some of the
these ratios are calculated. These will       most complex cases we’ve ever seen,”          TAPED CONVERSATIONS
be supplemented by a transitional             Mary Schapiro said in November before         For example, former hedge fund owner
template detailing phasing-in of              she stepped down as chairman of the           Raj Rajaratnam was convicted of insider
deductions and adjustments.                   Securities and Exchange Commission.           trading after a Manhattan federal jury
                                              “It is not simply numbers, but the            heard taped telephone conversations
Finally, community banks in 2013
                                              increasing complexity and diversity           in which illegal tips were discussed. He
will find out whether they will receive
                                              of the cases we file that shows how           has asked an appeals court to review
relief from some of the Basel III
                                              successful we’ve been,” said Robert           whether the wiretap order was properly
requirements, particularly in the area
                                              Khuzami, director of the SEC Division         granted. The use of wiretaps will likely
of risk weight calculation for residential
                                              of Enforcement.                               continue whatever the court’s ruling,
and commercial mortgages. They also
                                                                                            although federal agents may have to
hope to be exempt from including              The monitors — federal and state
                                                                                            be more careful in seeking court orders
unrealized losses on available-for-           regulators, enforcement agencies, and
                                                                                            for doing so.
sale debt securities for the purposes         industry authorities — are expanding
of regulatory capital deduction               their definitions of misconduct. They are     Prosecutors and enforcement officials
calculations. Lacking the same level of       looking at potential violations globally      have said that whether a suspect’s
access to capital markets as their larger     as well as in the U.S., and domestic and      collar is white or blue is less important
peers, community banks may have a             foreign agencies are more frequently          than whether their conduct was part
more difficult time compensating for          sharing what they find.                       of an organized criminal enterprise.
these deductions.                                                                           Whether the ring sells drugs or market
                                              “Even if we cannot pursue you criminally
                                                                                            secrets, the chief value of each lower-
“The main challenge for the community         in the U.S. — because we lack criminal
                                                                                            level participant is their information
banks will be, however, to operationally      jurisdiction, for example — corrupt
                                                                                            about the next person up the chain, all
bring their Basel I infrastructures in line   leaders should not be permitted to
                                                                                            the way to the kingpin.
with the Basel III requirements,” said        use the U.S. as a safe haven for the
Peter Went, a vice-president with Global      proceeds of their corrupt activities,”        For example, prosecutors have agreed
Association of Risk Professionals.            said U.S. Assistant Attorney General          not to press criminal charges against a
                                              Lanny Breuer.                                 medical expert suspected of providing
2013 will be a critical year for the
                                                                                            market-moving tips to a former
Basel III process, especially as the          As a consequence of the crackdown,
                                                                                            portfolio manager at the SAC Capital
first wave of capital rules comes into        firms and exchanges must produce
                                                                                            hedge fund group in exchange for
effect. Uncertainty around the precise        and keep more detailed data, and
                                                                                            that expert’s cooperation in an insider
timelines with finalization of proposed       provide it to the monitors, which are
                                                                                            trading probe that threatens to snare
rules and synchronization among               using advanced technology to mine
                                                                                            the fund’s owner, Steven A. Cohen.
various jurisdictions will be resolved, as    for evidence of potential manipulation,
will the applicability of certain rules to    misuse of nonpublic information, and          Cohen is seen as a lightning rod for
small size U.S. banks.                        other violations.                             prosecutors’ interest because several
                                                                                            of his former employees have been

convicted of insider trading at other          while the others are trying to negotiate    issuance and sales, insurance,
funds after leaving his firm. Neither          a global settlement.                        commercial and consumer banking,
Cohen nor his firm has been charged,                                                       lending and property sales, some or all
                                               These risks came together when a new
and he has denied that he or SAC have                                                      of which may monitor a firm depending
                                               regulator, the New York Department of
done anything improper.                                                                    on its size and business lines.
                                               Financial Services, charged Standard
Market monitors have another tool:             Chartered, another UK-based bank,           These agencies generally work
taking a violator’s money. SAC’s               over alleged financial transactions with    separately but they have achieved
suspected profits and avoided                  counterparties in sanctioned nations.       headline-grabbing, big-dollar results
losses totaled $276 million from               Standard Chartered has agreed to            from working together. Starting in
the deal under investigation, which            pay $667 million to resolve probes          2008 the SEC, FINRA and state
would generally lead to a regulatory           by multiple U.S. regulators, including      securities regulators returned tens
settlement of about twice as much.             the Manhattan District Attorney’s           of billions of dollars to investors in
But if the owner or another “control           office, which has long played a key         auction rate securities after liquidity for
person” is implicated in the trading,          role in combating international money       the seemingly safe products froze once
that person could be barred from the           laundering and terrorist financing.         their sponsors stopped supporting
industry, leaving the fund without its
                                               Another UK bank, HSBC, agreed               them. And a federal and multi-state
head, and the penalties could double
                                               in December to pay $1.9 billion,            task force this year obtained some
to over $1.1 billion. Even for a $14 billion
                                               restructure its financial-crime oversight   $25 billion in homeowner relief as
fund this is a lot of money.
                                               and accept an independent monitor to        part of an investigation into mortgage
But $1.1 billion may not be a lot              resolve charges of enabling financial       servicing practices.
compared with what it may cost to              transactions with drug cartels and
resolve investigations by multiple             sanctioned nations.                         EXAM PRIORITIES
international agencies into the alleged                                                    The list of examination and enforcement
manipulation of global lending rates by        MORE OVERSIGHT OF TRANSACTIONS              priorities grows each year. Perennials
over a dozen banks. UK bank Barclays           Global political tensions are leading to    include fraud, insider trading, custody
was the first to reach a settlement in         more oversight of financial transactions    of client and customer assets, misusing
the Libor probe and has agreed to pay          with sanctioned nations. The stated         confidential information and money
$450 million, while Swiss bank UBS             U.S. goal is to bring North Korea, Iran     laundering controls. New priorities
has reached a $1.5 billion settlement.         and other states, including some of         include compliance by private funds
Another UK bank, RBS, is also said to          the “Arab Spring” governments, to
                                                                                           with new registration and reporting
be nearing a deal.                             the negotiating table, and to limit their
                                                                                           requirements, and enhanced suitability
                                               ability to develop non-conventional
Morgan Stanley has estimated that                                                          and       know-your-customer         rules.
                                               weapons or to finance terrorism. It will
global banks could pay a combined                                                          Looming are potential rules for the swaps
                                               be hard for even small firms to stay off
total of $14 billion in regulatory and                                                     industry, a fiduciary duty for broker-
                                               the regulatory radar.
legal expenses to resolve continuing                                                       dealers, securities-offering reforms
probes in multiple countries, and more         For all but the smallest firm, and even     and the Volcker rule, which would limit
top bank executives could join Barclays’       then depending on its business, the         riskier and proprietary trading by banks
former head in losing their jobs.              SEC and the CFTC respectively police        with insured deposits.
                                               investment advisers and funds, and
The rate-rigging probe began with                                                          Market participants are also feeling
                                               securities issuance, sales and trading,
the Commodity Futures Trading                                                              the weight of other, more targeted
                                               and commodity and futures trading.
Commission (CFTC), the U.S. futures                                                        regulators. The Federal Energy
                                               Much of the daily oversight, including
regulator, fining Barclays, because                                                        Regulatory Commission has fined
                                               licensing and disciplining firms and
the lending rates affect products                                                          banks over deceptive or manipulative
                                               their trading, sales and some of their
overseen by the CFTC. This highlights                                                      trading    practices;   the     Justice
                                               operations and accounting staff, is
two other risks for international                                                          Department antitrust division has
                                               conducted for the SEC by the Financial
financial institutions: first, that cross-     Industry Regulatory Authority (FINRA)       charged banks with rigging bids
border transactions can leave banks            and by the National Futures Association     for investments by state and local
open to regulatory actions from                for the CFTC.                               governments; and the Department of
foreign regulators, and secondly, one
                                               In addition, each state has a regulator     Labor oversees job-related retirement
participant in a multi-agency probe
                                               for advisers and brokers, securities        planning and advising.
may lose patience and file charges

                                                                                                               REUTERS/Toby Melville

Federal and state prosecutors, often       lower sanctions and deferred- and          agreement is to show that the
working with functional regulators,        non-prosecution agreements.                business will not only comply with the
add another layer of oversight and                                                    agreement but also with all applicable
                                           The Justice Department antitrust
generally use prison terms, fines and                                                 laws and rules because it has a strong
                                           division has a leniency program for
court-ordered restitution as preferred                                                compliance program, including training
                                           entities that voluntarily come forward
sanctions. A key federal priority is the                                              for employees and supervisors.
                                           before an investigation into the type
Foreign Corrupt Practices Act, which
                                           of conduct begins, admit and rectify       “We know the difference between a
bans the bribing of foreign officials,
                                           their violations, and provide credible     make-believe compliance program and
requires enhanced record-keeping
                                           assurances of future compliance. Two       a real one,” Breuer said.
practices and has generated fines
                                           years ago the division waived a fine
exceeding $1 billion against companies                                                WHISTLEBLOWERS
                                           against Bank of America over rigging
with global operations. Other countries,                                              Firms that wait too long after
                                           bids for investments by states and
particularly the UK, have similarly                                                   being apprised of serious potential
                                           cities after the bank paid restitution,
stepped up the fight against corruption,                                              violations before initiating a thorough
                                           admitted wrongdoing, conducted a
and national regulators are increasingly                                              investigation and implementing a
                                           thorough internal investigation, and
working together in this effort.                                                      remediation program may find it is
                                           reformed its business practices.
                                                                                      too late to obtain much relief from
COOPERATION TERMS                          In the past, deferred- and non-            regulatory enforcement.
Prosecutors may be better able than        prosecution agreements generally
regulators to obtain evidence and          required the entity to have and pay        Firms also will need to consider the
to trade leniency for testimony, but       for an outside court-approved monitor      increased effectiveness of federal
regulators are increasingly including      for the first year or two. A trend for     whistleblower programs. The SEC has
cooperation terms as part of their         letting an entity instead monitor itself   said its program to protect and reward
settlement negotiations, giving them       began in 2011. But as shown with the       certain whistleblowers, which began in
continued leverage in cases.               requirement for an outside monitor         2011, is exceeding expectations. A firm
                                           in the HSBC settlement, regulators         that only self-reports a matter after the
Federal prosecutors and regulators
                                           are not always willing to accept           regulator has begun its investigation
such as the Justice Department and
                                           self-monitoring.                           will get less cooperation credit, but may
the SEC have policies for crediting
                                                                                      still receive credit for its remediation
cooperation,    remediation     and        The key to obtaining cooperation credit    and compliance efforts.
improved business practices through        or a deferred- or non-prosecution


                                                                                                                REUTERS/Yuriko Nakao

A new population of advisers under           advisers hold for the SEC, with over       increased with more staff, accounting
SEC supervision, coupled with                11,000 registered advisers managing        for the rise of adviser enforcement
numerous high-profile investment             more than $40 trillion in assets. Both     actions over the last few years,
adviser enforcement and examination          documents highlight plans to add 40        Bowden told compliance professionals
initiatives, are keeping enforcement         staff members to oversee investment        in November.
activities by the commission at              management, which would bring the
                                                                                        The asset management unit was
record levels. The SEC filed a record        total to 220.
                                                                                        a product of Khuzami’s restructuring
147 enforcement actions against              However, the SEC’s National Exam           and now has approximately 90
investment advisers and investment           Program examined only 8 percent            enforcement attorneys.
companies in 2012, one more than             of investment advisers in fiscal 2012.
2011’s record. The agency obtained           The figure was less than the target        PRIVATE ADVISERS A HIGH PRIORITY
more than $3 billion in penalties and        of 9 percent of advisers, although         Investment advisers last year were a
disgorgements for harmed investors           it represented 21 percent of the           focus of SEC-sponsored compliance
in 2012, an 11 percent increase over the     regulatory assets under management         outreach programs, risk alerts, SEC
year before.                                 for the industry.                          speeches and conferences attended
The tough enforcement comes                                                             by high-ranking SEC officials. Private
                                             The high enforcement numbers coming        advisers in particular are a high priority
after a recent reorganization of the         from relatively few exams might indicate
SEC’s Division of Enforcement. The                                                      for the SEC in 2013.
                                             examiners themselves are being
most significant since the division          unusually determined. But the rate         A high-profile SEC compliance exams
was established in the early 1970s,          at which issues have been uncovered        effort is its “Presence Exams Initiative,”
Khuzami, the division’s director,            by exam teams and referred to              in which the OCIE conducts focused,
hired industry experts and created           enforcement staff has stayed relatively    risk-based examinations of investment
specialized enforcement units focused        consistent at about 10 percent, said       advisers to private funds that recently
on high-priority misconduct, while           Andrew Bowden, deputy director for the     registered with the SEC. The initiative
flattening the management structure          Office of Compliance Inspections and       was officially rolled out in an October
and revamping the way the division           Examinations (OCIE).                       letter to advisory firm chief executives.
handles tips and complaints.
                                             Instead, the percentage of referred        The initiative has three primary phases
The SEC’s latest financial report            cases accepted by the enforcement          that will be spread over the next two
and its budget report to Congress            division’s asset management unit has       years: engagement, examination
reinforce the position that investment                                                  and reporting.
The examination phase is arguably             functions, and leaders of business          performance seems abnormally
the most anticipated for the newly            lines to discuss enterprise risk, and       high, and inconsistent with
registered firms. The SEC has identified      in particular, how a firm governs           their investment strategies or
marketing, portfolio valuation and            and manages financial, legal,               benchmarks. It will target them for
management, conflicts of interest,            compliance, operational, and                greater scrutiny.
and custody as focus areas for                reputational risks.                        - Fee initiative. The initiative will
the examiners.                               - Conflicts of interest and risk-             look into the investment advisory
                                               governance frameworks that firms            contract renewal process and fee
Last year brought two significant              may have in place to identify and           arrangements in the fund industry,
National Exam Risk Alerts from OCIE            address conflicts.                          among others.
as well. The first, highly anticipated by
                                             - Social media use and the compliance       - Operation ADV. The asset
the industry, looked at the use of social
                                               controls associated with it.                management unit is analyzing
media for advisers. That alert was the                                                     adviser Form ADVs for
first of its kind from the SEC and it saw    - Compliance with “pay-to-play” rules.
                                                                                           misrepresentation in the disclosure
its staff take positions on matters such     - Inherent risks at firms dually              document and its supplements.
as what constitutes a prohibited client        registered as investment advisers           The SEC is scrutinizing the
testimonial in social media outlets.           and broker-dealers.                         documents of high-risk investment
It also set forth considerations,            - Governance and supervision of               advisers to determine who
including usage guidelines, content            firms’ information technology               is inflating their educational
standards,         monitoring,    content      systems in areas such as                    achievements, business affiliations,
approval, and training.                        operational capability, business            and assets under management.
                                               continuity planning, market access,       - Private equity initiative. This initiative
The second was a risk alert concerning         and information security controls.          would be in line with the presence
rules of the Municipal Securities
                                             - Ensuring firms employ written               exams conducted by OCIE. It will
Rulemaking Board (MSRB) that restrict
                                               policies and procedures that                also look at the use of side pockets
the political activities of issuers.                                                       and hard-to-value assets.
                                               can prevent violations, and
The alert noted that SEC examiners             the performance of an annual
observed practices that raised concerns                                                  - Enforcement involvement in
                                               compliance review.                          examination process. This is a
about firms’ compliance with their
                                             - Code of ethics, which the SEC will          somewhat new initiative but one
obligations under MSRB Rule G-37,
                                               want to ensure is tailored to the firm      that was highlighted by Chad Earnst,
which clamped down on so-called                and includes all relevant personnel.        assistant director of the SEC’s
“pay to play” practices. The concerns                                                      asset-management unit, who told a
include: compliance with the rule’s ban      - Repeat exam deficiencies.
                                                                                           recent professional conference that
on doing business with a municipal          It can be assumed that the priorities          enforcement staff may be present
issuer within two years of a political      for the “presence exam initiative”             during upcoming inspections.
contribution to officials of the issuer     would also be applied to the entire
                                                                                        It is a safe bet that the SEC’s
by any of the firm’s municipal finance      adviser population. Those not already
                                                                                        enforcement will continue its record-
professionals; recordkeeping violations;    mentioned        include:    marketing,
                                                                                        breaking pace with investment advisers,
failure to file accurate and complete       portfolio valuation and custody.
                                                                                        fueled by the new population of private
required forms with regulators                                                          advisers and new, more defined OCIE
regarding political contributions; and      ENFORCEMENT DIVISION PRIORITIES
                                            There is some overlap in priorities of      and enforcement initiatives. The SEC
inadequate supervision.                                                                 has committed to communicating
                                            the enforcement division and OCIE,
OCIE has also stated its priorities over    reflecting increased cooperation. The       guidance and highlighting problem
the year. Besides its focus on newly        initiatives include:                        areas, especially for the newly
registered private advisers, other                                                      registered advisers.
priorities include:                          - Aberrational performance initiative.
                                               The initiative is intended to fight
 - A focus on fraud prevention,                fraud at hedge funds and other
   including client-asset verification;        private pooled investment vehicles.
 - Meeting with independent board              The SEC is using proprietary
   members, senior management,                 risk analytics to evaluate fund
   internal audit, key risk and control        returns and focus on funds whose

After a year of high-profile anti-money       directorship of FinCEN in September.           Once the rule is finalized financial
laundering enforcement cases in the           She was chosen for the role in part            institutions will be granted time to
United States, 2013 will be busy with         because of the intimate knowledge she          come into compliance, Sorcher said.
the development of stricter rules.            had developed of CDD and beneficial            Although he has no way of knowing
The U.S. Treasury Department is               ownership issues while running                 how tight the deadline will be, he
expected to propose or finalize several       the Justice Department’s money                 said the grace period for past anti-
new anti-money laundering rules. A            laundering section.                            laundering rules has generally been
comprehensive review of the overall                                                          between six months and nine months.
                                              “This is clearly a top priority for the new
U.S. anti-money laundering framework                                                         Some comments submitted by the
                                              director,” said Rob Rowe, a lawyer with
that has been put into place over the                                                        private sector have requested one to
                                              the American Bankers Association’s
past four decades is also in the works,                                                      two years to prepare once the final rule
                                              Center for Regulatory Compliance.
setting the stage for a broader overhaul.                                                    is issued, he said.
                                              Financial institutions have expressed
The most significant of the new rules
                                              concern about the costs associated             AML RULES FOR INVESTMENT
will require financial institutions to know                                                  ADVISERS
                                              with gathering beneficial-ownership
the true, or “beneficial,” ownership of                                                      FinCEN is also working on a long-
                                              information and bringing existing
the legal entities with which they do                                                        awaited rule aimed at extending
                                              accounts up to standard. Furthermore,
business. The government will also                                                           anti-money laundering obligations
                                              they have questioned whether it makes
propose requiring investment advisers                                                        to investment advisers, an effort it
                                              sense at all for them to try to collect the
to enact anti-money laundering                                                               has taken on in consultation with the
                                              information since their only option is to
programs and report suspicious activity.                                                     Securities and Exchange Commission
                                              ask clients to complete questionnaires.
“The customer due-diligence rule is           This pales in authority compared with          (SEC). It is a “safe bet” the bureau will
certainly the most significant of the         the subpoena powers available to law           issue a proposed rule during 2013, a
impending rules and there has been            enforcement authorities.                       Treasury official with knowledge of the
a lot of dialogue and comments made                                                          matter said.
                                              It is widely expected that Treasury
to Treasury at public hearings over                                                          The rule for investment advisers is
                                              will issue a proposed rule in early
the past several months,” said Alan                                                          expected to require them to implement
                                              2013. While officials have not publicly
Sorcher, the leader of the Anti-Money                                                        anti-money laundering compliance
                                              set a date for the proposal, Betty
Laundering Strategic Leadership                                                              programs and report suspicious
                                              Santangelo, a partner with New York
Group for Deloitte Financial Advisory                                                        activity, obligations broker-dealers
                                              law firm Schulte Roth & Zabel, said her
Services LLP.                                                                                have had for a decade, sources said.
                                              firm expects that it may be released
The Treasury Department and its               in January.                                    In 2008, FinCEN withdrew rules that
anti-money      laundering     bureau,                                                       it had proposed in 2002 and 2003
                                              Once a proposal is released, there will
the Financial Crimes Enforcement                                                             for investment advisers, hedge fund
                                              be another round of comments, said
Network (FinCEN), began soliciting                                                           managers, and commodity trading
                                              Sorcher, a former senior advisor at
private-sector feedback on customer                                                          advisers. The new proposal is only
                                              FinCEN. “That will be a crucial period
due diligence (CDD) and beneficial                                                           aimed at investment advisers, and it
                                              when the comments come in and
ownership matters early last year by                                                         is unclear whether FinCEN plans to
                                              Treasury and FinCEN absorb those and
issuing an advance notice of proposed                                                        pursue rules for the other entities.
                                              understand them and decide whether
rulemaking. Since then they have held
                                              to accommodate them or not.”
public meetings across the country to                                                        WIRE TRANSFER REPORTING RULE
gather concerns and views on how to           Since FinCEN and Treasury have                 A rule that will require banks to report
best implement a rule.                        repeatedly stated that the beneficial          all cross-border electronic transmittals
                                              ownership rule is “an important                of funds to FinCEN is under review
Jennifer Shasky Calvery, a former
                                              priority,” a final rule is likely by the end   and should be complete by mid-2013,
federal prosecutor, was assigned the
                                              of 2013, Sorcher said.                         the Treasury official said. The rule’s

                                                                                                             REUTERS/Scott Audette

aim is to help law enforcers ferret out     slog to get a response for a query due    Sorcher called the effort “significant”
laundrymen, terrorism financiers and        to the volume of data that will have      and said it could ultimately lead to
tax evaders.                                to be processed for each and every        guidance that interprets certain rules
                                            request,” Rowe predicted.                 in a way that is beneficial to financial
However, the official said: “Even if a
final rule moves forward, we can’t          A rule forcing Fannie Mae, Freddie Mac
implement it until we have the systems      and the Federal Home Loan Banks to        “I don’t think that it will be a fast
in place to collect and utilize the data,   have anti-money laundering programs       process where we can expect to see in
so there’s no impending impact [on          and report suspicious activity, and one   a short amount of time some real quick
financial institutions] at this time.”      that obliges the reporting of certain     deliverables, but I do think in the long
                                            prepaid access devices at U.S. borders,   run we will see some benefits from
FinCEN is currently undergoing an
                                            are also under review and should be       this,” he said.
upgrade of its IT systems. It has not
                                            finalized during 2013, the Treasury
said when it expects to be ready for                                                  The anti-money laundering framework
                                            official said.
the massive volume of data it will have                                               review will be “a critical issue in 2013
to handle once banks begin reporting        AML FRAMEWORK REVIEW                      and beyond,” Rowe said.
all wires.                                  The      Treasury   Department       in   “Since the Bank Secrecy Act was
The cross-border wire transfer              November said it had launched an          adopted in 1970, there haven’t been any
reporting rule poses “a number              anti-money laundering task force          real changes to the entire program,”
of significant challenges,” in part         along with federal regulators and law     he said.
because “the number of data fields for      enforcement agencies. The goal was to
                                                                                      During 2012 the Justice Department
international wires is extensive and the    review the patchwork net of anti-money
                                                                                      and regulators made it clear that
volume processed through US banks           laundering rules and seek to correct
                                                                                      anti-money laundering and sanctions
on a daily basis is huge,” Rowe said.       “gaps, redundancies or inefficiencies,”
                                                                                      compliance had better be a priority for
                                            said David Cohen, Treasury Under
“The initial premise for the rule was the                                             financial institutions. During a flurry
                                            Secretary for terrorism and financial
wire reporting systems in Australia and                                               of activity in December, Standard
Canada, but they have far fewer banks                                                 Chartered Plc agreed to pay $327
and process far less volume,” he said.      The effort is expected to take at least   million to resolve allegations that it
                                            a year and the private sector will have   violated U.S. sanctions and HSBC
Even when FinCEN has systems in place
                                            the opportunity to offer input through    reached a $1.92 billion settlement over
to hold the flood of data, providing
                                            a separate Bank Secrecy Act Advisory      anti-money laundering and sanctions
useful access to law enforcement will
                                            Group task force being organized by       compliance lapses, the highest ever
likely be a challenge. “It will be a slow
                                            FinCEN.                                   fine on a bank.
The U.S. Foreign Account Tax                 that can hurt firms’ internal process for    Germany, Italy, Spain, Switzerland, and
Compliance Act (FATCA) will pose             achieving FATCA compliance.                  Japan have pending agreements.
significant compliance challenges for
                                             Additionally, the U.S. Treasury              By becoming FATCA partners, foreign
non-U.S. financial institutions through
                                             Department has also delayed the              jurisdictions receive special exemptions
2013. Recent deadline extensions by
                                             issuance of FATCA’s final rules until        for certain institutions and financial
the U.S. Treasury Department have
                                             later in 2013.                               products, such as pension funds and
given foreign firms more time to
                                                                                          registered accounts, which would
implement their compliance programs,         “The longer we go into 2013 without
                                                                                          otherwise be subject to FATCA’s
but they have also sown uncertainty.         certainty about final rules … the less
                                                                                          onerous customer due diligence and
                                             likely it is that firms can actually start
                                                                                          reporting requirements. If foreign
HARMONIZED DEADLINES AND                     implementing them by 2014,” said
DELAYED RULES                                                                             jurisdictions fail to reach a bilateral
                                             Andrea Taylor, a director and tax law
In October 2012, the Internal Revenue                                                     agreement, then their financial
                                             expert at the Investment Industry
Service extended most of FATCA’s                                                          institutions will be subject to a higher
                                             Association of Canada. While firms
key dates to harmonize deadlines                                                          compliance burden and increased risk
                                             can look to FATCA drafts for guidance,
across all jurisdictions, regardless of                                                   of penalties due to non-compliance.
                                             their specific procedure and system
whether they have signed bilateral           requirements will remain unclear until       Since the agreements differ from one
intergovernmental agreements (IGAs)          the final rules are released, she added.     jurisdiction to another, however, foreign
that could streamline reporting                                                           firms will have to manage variations in
requirements. The extension will             Other experts have suggested that the
                                                                                          FATCA requirements across multiple
help large financial groups with             delay offers foreign institutions more
                                                                                          jurisdictions, which will be their
complex geographical footprints to           time to review potentially hundreds
                                                                                          principal challenge throughout 2013.
coordinate compliance procedures             of thousands of accounts, which will
                                                                                          For example, institutions operating in
across multiple jurisdictions, since all     help them understand what additional
                                                                                          the UK (with a Model 1 agreement),
entities will now be working toward the      screening might be required once the
                                                                                          Switzerland (Model 2), and non-IGA
same milestones.                             final rules are adopted.
                                                                                          jurisdictions must manage a FATCA
U.S. financial institutions, participating   INTERGOVERNMENTAL AGREEMENTS                 compliance program that includes
foreign financial institutions (FFIs)        To facilitate international FATCA            three sets of rules, as well as specific
and reporting financial institutions         compliance, the U.S. is pursuing             variations for each IGA territory.
must implement FATCA-compliant               intergovernmental agreements that            To stay ahead of developments,
new account procedures by January            ease the compliance burden for partner       compliance officers should seek
1, 2014. They must also review pre-          country financial institutions.              guidance from their governments on
existing, high-value individual accounts                                                  whether a FATCA agreement with the
                                             The IGAs come in two principal flavors.
and other pre-existing accounts by                                                        U.S. is pending and, if so, what form it is
                                             Model 1 agreements allow foreign
December 31, 2014, and December                                                           likely to take. If the answer is uncertain,
                                             banks to report FATCA-related tax
31, 2015, respectively. Additionally, the                                                 industry experts have advised firms
                                             information to their home tax agencies,
IRS delayed by two years, to January                                                      to use the available time to continue
                                             which then transmit that data to
1, 2017, the date by which firms must                                                     implementing their FATCA compliance
                                             the IRS. The newly published Model
start withholding U.S. taxes from their                                                   programs. This will ensure that firms
                                             2 agreement allows FFIs to report
clients’ investment gains.                                                                will at least be able to meet the Act’s
                                             directly to the U.S. tax authority.
Experts have noted that extending the                                                     basic requirements, including detailed
                                             As of November 2012, the Treasury
deadline for new-account due diligence                                                    entity-level      analysis,    relationship
                                             was negotiating IGAs with more than
will give firms more time to implement                                                    mapping,        data      analysis,    and
                                             50 countries. So far, only the United
compliance programs. On the other                                                         system enhancements.
                                             Kingdom, Denmark, and Mexico
hand, the delays contribute uncertainty
                                             have finalized FATCA pacts. France,
and a “start-stop” pattern of activity
                                                                                       propose broad new regulations to
                                                                                       govern high-frequency trading and
                                                                                       other issues related to secondary
                                                                                       equity markets. IIROC and the CSA are
                                                                                       expected to release the results of an
                                                                                       extensive research study that examined
                                                                                       the nature, dynamics, and effects
                                                                                       of fast trading in Canada. Securities
                                                                                       regulators will be under pressure to
                                                                                       react to the research, which will also
                                                                                       draw conclusions about the merits of
                                                                                       high-frequency trading.

                                                                                       EXTRATERRITORIAL COMPLIANCE
                                                                                       ISSUES: FATCA AND DODD-FRANK
                                                                                       Like other jurisdictions, Canada will
                                                                                       face challenges from the U.S. Foreign
                                                                                       Account Tax Compliance Act (FATCA)
                                                                                       and the Dodd-Frank Act.
                                                                                       Canadian      authorities   are     still
                                                                                       negotiating a FATCA intergovernmental
                                                                                       agreement (IGA) with the United States,
                                                                                       which is expected to be completed
                                                                                       in 2013. The investment industry is
                                                                                       pursuing enhanced exemptions and
                                                              REUTERS/Kim Kyung-Hoon
                                                                                       safe harbors, especially for registered
Restoring investor confidence through    for dealers and advisers. The move            accounts, to limit the compliance
retail reforms in capital markets will   is a possible precursor to new rules,         burden on Canadian firms.
keep Canadian regulators busy in         and the industry is still debating its        Canada is also seeking assurances
2013. Throughout 2012, Canadian          position on how such a duty should be         that its existing anti-money laundering
securities regulators passed new rules   structured, said Ian Russell, president       procedures will be accepted as the
targeting client disclosure, conflicts   of the Investment Industry Association        compliance standard for U.S. tax
of interest, and enhanced suitability    of Canada (IIAC).                             reporting. Additionally, the IIAC wants
requirements, which all take effect                                                    the agreement to include terms
                                         Market data providers in Canada
in 2013. Additionally, the Canadian                                                    allowing FATCA investigations by the
                                         may also face regulatory pressure in
Securities Administrators (CSA), which                                                 U.S. Treasury Department to be run by
                                         2013, with the CSA recently proposing
harmonizes regulatory standards for                                                    the Canada Revenue Agency.
                                         several measures to limit data costs.
the provincial securities commissions,
                                         Those options include capping the             Negotiations on Canada’s FATCA
is likely to propose new portfolio-
                                         price of core data, capping fees charged      agreement are taking a relatively long
performance reporting requirements
                                         by marketplaces or information                time because Canada has traditionally
in early 2013.
                                         processors, and mandating a public            had a much more comprehensive and
The Ontario Securities Commission        data utility that would operate on a          complex relationship with the U.S.
(OSC), which presides over Canada’s      cost-recovery basis.                          Internal Revenue Service (IRS) than it
largest and most active capital                                                        did with counterparts in the European
                                         The Investment Industry Regulatory
markets, has begun consultations on                                                    Union, Russell said.
                                         Organization of Canada (IIROC) will
the introduction of a fiduciary duty
Canada also hopes to reach an
agreement with the U.S. Financial
                                             “There has been a lot of work that’s
                                             already been done, both on the              EU STRUCTURAL
Industry Regulatory Authority (FINRA)
regarding the registration of employees
                                             structure and on the legislation, but
                                             it has to fit together in this [Canadian
at Canadian parent firms that act as
agents for U.S. affiliates in the clearing
                                             context] where day-to-day provincial
                                             regulation is paramount,” Russell said.
                                                                                         OF BANKS
and settlement of Canadian-listed
                                             OTC DERIVATIVES                             LIIKANEN REPORT ON EU BANKING
securities purchased by U.S. investors.                                                  STRUCTURAL REFORM: VICKERS HELP
                                             Like other Group of 20 member               OR HINDRANCE?
For two decades, U.S. broker dealers         countries, Canada will be moving            The future structure, shape and
were able to sell Canadian securities        forward with reforms to standardize         supervision of banks in Europe have
to U.S. clients through their Canadian       trading in over-the-counter (OTC)           been under intense scrutiny, with
affiliates. The U.S. Dodd-Frank              derivatives. This will result in            three different but potentially equally
regulatory overhaul, however, placed         requirements for OTC derivatives to         significant reports being published,
restrictions on American firms dealing       be traded on exchanges or electronic        all of which are aimed at banking
with entities that are not registered in     trading platforms, cleared through          reform. Banking union proposals are
the United States. To circumvent the         central clearing counterparties (CCPs),     being fast-tracked to bring all euro
registration of Canadian employees,          and reported to a repository. The           zone banks under the direct oversight
FINRA authorized a carve-out based           framework will also cover financial         of the European Central Bank;
on the recognition of Canadian               requirements and business conduct.          the UK government accepted the
regulatory standards. That agreement
                                             During 2012, the CSA issued seven           Vickers report from the Independent
requires approval from the SEC, which
                                             consultation papers on OTC derivatives      Commission on Banking (ICB) to ring-
is expected shortly.
                                             reform, many of which are likely to yield   fence retail operations in banks; and,
NATIONAL SECURITIES REGULATOR                rule-making proposals in 2013. They         last but not least, the Liikanen report
Efforts to establish a national securities   covered concepts such as exemptions,        was published in October 2012.
regulator will continue in 2013, and         clearing and settlement, margin capital     The high-level expert group (HLEG),
will likely begin to show results. In        requirements, segregated clearing,          chaired by Erkki Liikanen, has reported
December 2011, the Supreme Court             trading platforms and repositories,         on reforming the structure of the
of Canada ruled that, under the              and rules of conduct for dealing with       EU banking sector. The HLEG was
Constitution, provinces held authority       counterparties. In early 2013, the CSA      convened in February 2012 by Michel
over the day-to-day regulation of            plans to propose new rules governing        Barnier, EU internal market and
securities trading. To establish national    the oversight of trade repositories,        services commissioner, and was asked
authority, therefore, provinces would        disclosure of derivative trades, and        to assess whether additional reforms
have to delegate their authority to a        derivative registration.                    directly targeted at the structure
common regulatory body. Such a body                                                      of individual banks would further
                                             The main rule-making priorities —
would, in turn, be accountable not only                                                  reduce the probability and impact of
                                             trading, clearing, and transparency
to the federal government, but also to                                                   failure, ensure the continuation of vital
                                             — relate to systemic stability and the
the provinces.                                                                           economic functions upon failure, and
                                             integrity of participant institutions.
This is further complicated by the fact      “The idea is to take OTC derivatives out    better protect vulnerable retail clients.
that the federal government already has      of the dark,” Russell said. He added        The HLEG considered the regulatory
some jurisdiction over capital markets,      that the new regime will make it much       and legal reforms already under way
in areas including systemic risk.            more difficult and expensive to create      in Europe and consulted with a range
                                             customized, “dark” derivative products.     of stakeholders. While there was not
Intensive closed-door negotiations
were taking place to construct a model       Due to its G20 obligations, Canada’s        unanimous agreement on the details of
that accommodates these jurisdictional       new OTC framework will mirror those         all the proposals, the HLEG did agree
issues, Russell said. Some aspects           being adopted in the U.S. and EU. Many      that structural reforms are needed in
of the project were well under way,          of the G20 deadlines arrive in 2013 and     the EU banking sector to ensure the
including the drafting of a federal          2014, and Canadian regulators are           creation of a stable and efficient banking
securities act.                              striving to implement the new regime        system serving the needs of citizens, the
                                             on time.                                    economy, and the internal market.

                                                                                                               REUTERS/Vincent Kessler

The HLEG’s proposals are a set of            European Commission’s June 2012 Bank        is also suggested that the Commission
five measures that augment and               Recovery and Resolution Directive. The      should review whether the results
complement the suite of regulatory           resolution authority envisaged in the       would be sufficient to cover the risks
reforms already enacted or proposed          new crisis management infrastructure        of all types of European banks. The
by the EU, the Basel Committee on            would be empowered to request wider         treatment of real estate lending within
Banking Supervision (BCBS) and               separation than considered mandatory        the capital requirements framework
national governments.                        above if this is deemed necessary to        should also be reconsidered, and
                                             ensure resolvability and operational        maximum loan-to-value (and/or loan-
MAIN HLEG PROPOSALS                          continuity of critical functions.           to-income) ratios included in the
The main proposal is that proprietary                                                    instruments available for micro- and
trading and other significant trading        The HLEG “strongly supports” the
                                                                                         macro-prudential supervision.
activities should be assigned to a           use of designated bail-in instruments.
separate legal entity if the activities to   Banks should build up a sufficiently        Last, but not least, the HLEG considers
be separated amount to a significant         large layer of bail-inable debt that        that it is necessary to augment existing
share of a bank’s business. The aim          should be clearly defined, so that its      corporate governance reforms with a
would be to ensure that trading              position within the hierarchy of debt       series of specific measures.
activities beyond the threshold are          commitments in a bank’s balance
                                                                                         The HLEG has made it clear that
carried out on a standalone basis and        sheet is clear and investors understand
                                                                                         it   considers      strengthening    the
separate from the deposit-taking part        the eventual treatment in case of
                                                                                         governance and control of banks to
of a bank. As a consequence, deposits,       resolution. Such debt should be held
                                                                                         be critical. It has even gone so far as
and the explicit and implicit guarantee      outside the banking system. The debt
                                                                                         to say that “governance and control
they carry, would no longer directly         (or an equivalent amount of equity)
                                                                                         is more important for banks than for
support risky trading activities. The        would increase overall loss absorptive
                                                                                         non-banks,” citing banks’ systemic
long-standing universal banking model        capacity,       decrease      risk-taking
                                                                                         importance, ability quickly to expand
in Europe would remain untouched as          incentives, and improve transparency
                                                                                         and collapse, higher leverage, dispersed
the separated activities could still be      and pricing of risk.
                                                                                         ownership, predominantly institutional
carried out in the same banking group.       The     recommendations         propose     investor base with no strategic/long-
Hence, banks’ ability to provide a wide      the application of more effective           term involvement, and the presence of
range of financial services to their         risk weights in the determination of        (underpriced) safety nets.
customers would be maintained.               minimum capital standards and more
                                             consistent treatment of risk in internal    ADDITIONAL RECOMMENDATIONS
Banks will need to draw up and maintain
                                             models. Following the conclusion of         Senior managers in banks and other
effective and realistic recovery and
                                             the BCBS’s review of the trading book, it   financial services firms should be
resolution plans, as proposed in the
                                                                                           report to risk and audit committees
                                                                                           in parallel to the chief executive.
                                                                                          • Incentive schemes — One essential
                                                                                            step to rebuild trust between the
                                                                                            public and bankers is to reform
                                                                                            banks’ remuneration schemes, so
                                                                                            they are proportionate to long-
                                                                                            term sustainable performance.
                                                                                            Building on the existing CRD III
                                                                                            requirement that 50 percent of
                                                                                            variable remuneration must be
                                                                                            in the form of the bank’s shares
                                                                                            or other instruments and subject
                                                                                            to appropriate retention policies,
                                                                                            a share of variable remuneration
                                                                                            should be in the form of bail-in
                                                                                            bonds. Moreover, the impact of
                                                                                            further restrictions (for example,
                                                                                            to 50 percent) on the level of
                                                                                            variable income to fixed income
                                                                                            ought to be assessed. A regulatory
                                                                                            approach to remuneration should
                                                                                            be considered that could stipulate
                                                                                            more absolute levels to overall
                                                                                            compensation (e.g., that the
                                                                                            overall amount paid out in bonuses
                                                                                            cannot exceed paid-out dividends).
                                                                                            Board and shareholder approvals
                                                                                            of remuneration schemes should
                                                                                            be appropriately framed by a
                                                                                            regulatory approach.
                                                                                          • Risk disclosure — To enhance
                                                                      REUTERS/Bobby Yip
                                                                                            market discipline and win back
all too well aware of the increased            • Risk management — To improve               investor confidence, public
level of regulatory focus on corporate           the standing and authority of the          disclosure requirements for
governance. Building on the corporate            risk management function within            banks should be enhanced and
governance reforms currently under               all banks, so as to strengthen             made more effective to improve
                                                 the control mechanism within               the quality, comparability and
consideration at the European level
                                                 the group and to establish a risk          transparency of risk disclosures.
and in addition to the reform proposals
                                                 culture at all levels of financial         Risk disclosure should include all
outlined above, the HLEG has proposed:                                                      relevant information and, notably,
                                                 institutions, legislators and
 • Governance and control                        supervisors should fully implement         detailed financial reporting
   mechanisms — Attention should                 the Capital Requirements Directive         for each legal entity and main
   be paid to the governance and                 (CRD) III and CRD IV proposals.            business lines. Indications should
   control mechanisms of all banks.              In addition, while the CRD                 be provided about which activities
   More attention needs to be given              often remains principles-based,            are profitable and which are loss
   to the ability of management and              level 2 rules must spell out the           making, and be presented in
   boards to run and monitor large               requirements on individual banks           easily understandable, accessible,
   and complex banks. Specifically, fit          in much greater detail to avoid            meaningful, and fully comparable
   and proper tests should be applied            circumventions. For example, there         formats, taking into account
   when evaluating the suitability of            should be a clear requirement for          continuing international work on
   management and board candidates.              risk and control senior managers to        these matters.

 • Sanctioning — To ensure effective           capital standards for banks, especially     Barnier welcomed the Liikanen report,
   enforcement, supervisors across             for those with systemic importance,         and said: “This report will feed our
   Europe must have effective                  and national jurisdictions wishing to go    reflections on the need for further
   sanctioning powers to enforce               further should indeed be free to do so.”    action. I will now consider the next steps,
   risk management responsibilities,                                                       in which the Commission will look at
   including sanctions against the             The Liikanen report may offer some
                                                                                           the impact of these recommendations
   executives concerned, such as               support to the UK position by proposing
                                                                                           both on growth and on the safety and
   lifetime professional bans and claw-        the application of more-effective
                                                                                           integrity of financial services. We need
   backs on deferred compensation.             risk weights in the determination of
                                                                                           to look at these questions also in the
Senior managers need to appreciate             minimum capital standards and more
                                                                                           light of the financial reforms that I
the implications of the differing              consistent treatment of risk in internal
                                                                                           have already put on the table of the
geographies of the three European              models. That said, if for whatever
                                                                                           European Parliament and the Council.”
banking reform reports. The Vickers            reason the UK is unable to change
                                               the CRD IV approach, and higher             Senior managers in UK banks and
report covers UK banks, the banking
                                               capital together with lower leverage        building societies need once again
union    and    single   supervisory
                                               is not permitted to be mandated for         to consider their own in-house
mechanism proposals cover the euro
                                               UK ring-fenced banks, then to achieve       expert resources for assessing and
zone, and Liikanen is EU-wide. Not
                                               the same level of safety more stringent     responding to the continuing sweep
only do the geographies overlap and
                                               separation measures (such as legal          of regulatory change. Assuming that
intersect but the recommendations
                                               separation) may need to be considered.      much of what the Liikanen report has
themselves, while all nominally
                                                                                           recommended is adopted, then it will
aimed at making banks safer, are not           The Liikanen report applies to all banks
                                                                                           require EU-level legislation, most likely
the same.                                      regardless of business model, including
                                                                                           in the form of a directive for, at least,
                                               mutual and cooperative banks, and so
For UK banks the most important                                                            the separate legal entity requirement,
                                               will catch UK building societies which
contrasts are between Liikanen and                                                         followed by consultation on more
                                               had been carved out of the bank ring-
Vickers. The headline difference is that                                                   detailed rules and regulations prior
                                               fencing proposals but were subject to
Liikanen concludes that retail banking                                                     to implementation, all of which will
                                               their own consultation by HM Treasury
operations should, above certain                                                           need expert analysis. Firms that are
                                               on the future of building societies. HM
limits, sit in a separate legal entity.                                                    unable to undertake their own critical
                                               Treasury has proposed a level playing
Vickers, however, concluded (and the                                                       assessment of the detailed practical
                                               field by seeking to apply the same
UK government agreed) that the ring-                                                       implications of the proposals will be at
                                               restrictions to building societies as it
fencing of deposit taking activities was                                                   a distinct disadvantage to those that
                                               will be applying to ring-fenced banks.
the way forward.                                                                           have such resources in-house.
                                               To maintain the distinctiveness and
Other than the ring-fence versus
                                               to reflect the lower-risk nature of the
“separate legal entity within a group”
                                               sector, this will be done by carving the
difference, at a high level there are
                                               entire building societies sector out of
many similarities between the two
                                               the ring-fencing legislation and then
sets of reform proposals. For instance
                                               bringing building societies legislation
the loss absorbency proposals set out
                                               into line with ring-fencing restrictions
by the ICB are designed expressly to
                                               through appropriate amendments to
prevent future disorderly bank failures.
                                               the Building Societies Act 1986. HM
The ICB concluded that while Basel             Treasury has stated that this would
III’s minimum standards approach is a          be the simplest way to ensure that
start point, it is not nearly sufficient for   building societies did not have to face
the future financial stability of the UK’s     the unnecessary burden of complying
banks. The ICB is even more critical of        with two different sets of legislative
the proposed European CRD IV, stating          requirements operating in substantially
that “maximum harmonization is not             the same area. On a similar level playing
the right approach to capital standards        field basis it has also been suggested
for banks. Rather, the international           that no de minimis exemption should
community should focus on stronger             be introduced for building societies.
In the small hours of December 13,           commanding qualified majority, could         Instruments Directive implemented in
the finance ministers of all 27 member       always force its decisions through           2007, ‘MAD/R’, a legislative package
states of the European Union agreed          the 27-member European Banking               to update the 2003 Market Abuse
the blueprint of a single banking            Authority (EBA). Bowing to UK demands        Directive (and bring it into line with
supervisory mechanism (SSM) for the          couched as “saving the single market”,       MiFID II), and the latest iteration of the
17 members of the euro zone. Months          the euro zone finance ministers              Capital Requirements Directive (CRD),
of discussions — some public, many           agreed that a plurality, at least, of        CRD IV, to implement into European
behind closed doors — culminating in         non-euro zone countries must sign off        law the Basel III capital accord. But
over 14 hours of political negotiations      all EBA decisions. Smaller euro zone         partly because European bureaucrats,
at ministerial level, finally delivered      countries had meanwhile voiced their         as well as national politicians and
the outlines of a plan to include            own concerns about being too easily          officials, have been so busy grappling
direct prudential supervision by the         outvoted within the SSM, and here too        with the travails of the euro zone, these
European Central Bank (ECB) of up to         the ministers struck a compromise, in        ‘dossiers’, to use the EU jargon, have
200 of the euro zone’s largest banks,        the shape of an agreement to combine         at times appeared to take a temporary
from March 2014. Under the plan, still       qualified (i.e. weighted by country size)    back seat.
subject to ratification by the European      and simple majorities when reaching
                                                                                          In its drive to break down as many
and national parliaments, national           SSM decisions.
                                                                                          national boundaries in banking and
regulators in each euro zone state
                                             The SSM is only the first step in the        financial services as it can, the European
would continue to supervise smaller
                                             extremely ambitious project of full          Commission has taken to issuing new
banks, but the ECB would oversee the
                                             banking union. To achieve full banking       draft legislation in the form of European
whole mechanism, and reserves the
                                             union — initially probably confined to       Regulations, rather than European
right to intervene in any bank or group
                                             the euro zone but with a number of           Directives alone. This is because, while
of banks that the European Stability
                                             non-euro countries joining later — it        directives only become law when they
Mechanism         (ESM)     unanimously
                                             will be necessary to agree coordinated,      have been transposed into national
judged to pose immediate risks to
                                             harmonized, and eventually unified           legislation in each member state, with
financial stability.
                                             bank      resolution       arrangements,     all the room for national variations
Depending on whether the European            including — a very long-term goal,           that that allows, regulations apply
Commission or certain national               this — a single resolution fund for all      directly, becoming national law at their
officials are providing the spin, the        banks in the banking union. Then there       implementation date, thereby (at least
result appears to be either a single         will need to be equally coordinated,         in theory) ensuring total harmonization
structure, albeit with some ‘hub-and-        harmonized, and eventually unified           across the EU. The EBA and its sister
spokes’ characteristics, or effectively a    deposit guarantee insurance — again          bodies, the European Securities and
two-tier regime.                             with the long-term aim of a single           Markets Authority (ESMA) and the
                                             deposit guarantee fund. As things            European Insurance and Occupational
Of the 10 non-euro zone countries, one,
                                             stand, there is no guarantee that the        Pensions Authority (EIOPA), then
the United Kingdom, has effectively
                                             full extent of either of these aspirations   cement this harmonization by
opted out of ever joining the SSM,
                                             will be achieved.                            issuing what is essentially secondary
while two others, Sweden and the
                                                                                          legislation, in the form of detailed,
Czech Republic, have indicated               Not surprisingly, banking union has
                                                                                          directly applicable, and legally binding
they are unlikely to join in the             tended to dominate the EU headlines
                                                                                          European standards.
foreseeable future.                          in recent months, largely because
                                             of its importance in trying to resolve       This move from directives to
The political agreement reached on
                                             the deep crisis of the euro zone itself.     regulations has been evident in all
December 13 also addressed the
                                             Other EU initiatives have continued,         three areas mentioned above. MiFID
concerns of the UK and other ‘outs’ that
                                             including ‘MiFID II’, an extensive re-       is to be replaced with the Markets
the SSM would give birth to a euro zone
                                             writing of the Markets in Financial          in Financial Instruments Regulation
bloc that, by dint of its 17 members’

                                                                                          the timetable for MAR, and the two
                                                                                          markets regulations may now not be
                                                                                          adopted until late spring.
                                                                                          In August last year EMIR came into
                                                                                          force. This regulation sets out both
                                                                                          clearing obligations for derivative
                                                                                          trades eligible for central clearing and
                                                                                          reporting of a wider set of trades to
                                                                                          trade repositories. Collateralization
                                                                                          of ineligible trades will be considered
                                                                                          later. On February 8 or soon after, the
                                                                                          Commission will publish the regulatory
                                                                                          technical standards (RTS) for EMIR in
                                                                                          the Official Journal, making March 1 the
                                                                                          earliest possible date for entry into force
                                                                                          of the standards, a form of secondary
                                                                                          legislation. Within six months, central
                                                                                          counterparties must have applied for
                                                                                          authorization under EMIR. It will be
                                                                                          2015 before all the obligations will be
                                                                                          in force.
                                                                                          The week before Christmas saw
                                                                                          publication of the final implementing
                                                                                          text of the Alternative Investment
                                                                   REUTERS/Kevin Coombs   Fund Managers Directive (AIFMD),
                                                                                          which brings hedge funds and
(MiFIR) as well as a new directive.         of jurisprudential differences, while a       private equity funds into the scope of
MiFIR sets out requirements that            brand new Market Abuse Regulation             European supervision and sets up a
need to be harmonized to avoid              (MAR) will in due course completely           “third-country” authorization regime
regulatory arbitrage, on such issues        harmonize civil market abuse regimes          for non-EU funds operating in the EU.
as trade reporting to both regulators       throughout the EU. MAR will also bring        As a directive rather than a directly-
and the market, moving derivatives          the scope of this Europe-wide regime,         applicable regulation, the AIFMD must
trading onto organized venues, and          as well as definitions of instruments,        now be transposed into the domestic
breaking      down     anti-competitive     trading venues and so on, into line with      laws of all 27 member states.
barriers in trading and clearing. The       MiFID II.
directive includes investor protection                                                    With AIFMD on the European statute
                                            Disagreements among member states             book, ESMA is consulting until
rules, rules for authorizing trading
                                            on some of these details in the new           February 1 on guidelines aimed at
venues, data providers and others by
                                            MiFID — for example, whether over-            clarifying exactly which types of funds
national regulators, and the sanctions
                                            the-counter (OTC) trading should be           it covers, as well as on draft RTS setting
framework for infringements of local
                                            formally defined, and whether or not          out EU-wide criteria for different types
market rules. Both the regulation and
                                            to create a new trading venue category,       of AIFMs. A number of fund managers
directive contain extensive provisions
                                            the Organized Trading Facility (OTF),         may have to comply with the directive
for ‘implementing measures’ that the
                                            to capture OTC trading strategies that        as early as July this year, although many
commission would craft, as well as a
                                            might escape the existing Multilateral        existing EU-based AIFMs will have until
long to-do list for ESMA.
                                            Trading Facility (MTF) and Systematic         July 2014 to apply for authorization
There will also be a fresh Market           Internalizer (SI) categories — have           under the directive.
Abuse Directive, but it will mostly cover   delayed MiFID II’s progress through
criminal sanctions, which necessarily       the complex European legislative
vary among member states because            process. This, in turn, has affected

The legislative process to reform           and prudential behavior respectively        what is going to keep our system safe,
the structure of the UK’s financial         (although the FCA will be responsible       competitive and prosperous.”
regulatory framework took most of           for both conduct and prudential
                                                                                        From a prudential perspective, this
last year, during which the Financial       regulation of a large number of firms,
                                                                                        means that the PRA will not attempt to
Services Bill, the main draft of the        such as fund managers, that do not
                                                                                        run a zero-failure regime of the 2000
proposed        changes,      underwent     take deposits). The FPC is a “macro-
                                                                                        or so “dual-regulated” firms it will
important changes. Andrew Tyrie, the        prudential” regulator, with the job of
                                                                                        supervise (the FCA will regulate the
member of parliament who chairs             guarding the UK’s financial stability.
                                                                                        remaining 24,400 or so firms both for
the House of Commons’ influential
                                            From the middle of 2011 until the end       conduct and prudentially). Rather, its
Treasury Committee, which holds both
                                            of last year, a series of consultations,    focus will be on regulating individual
government and regulators to account
                                            amendments in both houses of                firms’ soundness and safety in the
in the financial services area, described
                                            parliament, and pre-legislative scrutiny    interests of systemic stability. As the
the bill as “the most complicated, and
                                            by a joint committee of both chambers,      government puts it: “This objective
one of the most important, pieces of
                                            has resulted in a number of changes to      gives the PRA a clear mandate to
financial legislation for decades.”
                                            the bill; for example, to meet concerns     intervene to ensure that firms address
The Conservative-Liberal Democrat           that the new structure will concentrate     possible solvency and systemic risks
coalition government first published        excessive power in the central bank         for the benefit of all interested parties
the bill, which amends the laws             and its governor. The Chancellor of the     — customers, the financial system,
underpinning the previous system —          Exchequer will now have powers to           and the economy as a whole — while
the Financial Services and Markets          direct the BoE when serious financial       ensuring that firms are also prepared
Act 2000 (FSMA) and the Banking Act         crises put taxpayers’ money at “material    for their own orderly failure, should
2009 — in late January last year, and       risk”, and the FPC will have to follow a    they run into difficulty.”
it received Royal Asset (became law)        government-set remit. The governor’s
                                                                                        The government’s original intention
on December 19, 2012. April 1 will mark     term will be a single eight-year term,
                                                                                        was to include in the bill a potentially
the “legal cutover” from the Financial      rather than two five-year terms. (The
                                                                                        fundamental review of the regulators’
Services Authority to two new bodies,       next governor, Mark Carney, has however
                                                                                        “Threshold Conditions” (TCs) —
the Prudential Regulation Authority         negotiated a single five-year term for
                                                                                        requirements firms must meet to
(PRA) and the Financial Conduct             himself.) The FCA, PRA and FPC must
                                                                                        become and remain authorized
Authority (FCA), as well as the formal      all report regularly on their engagement
                                                                                        (see following article for details).
advent of the third component of the        with stakeholders and their coordination
                                                                                        Responding, however, to legislators’
new structure, the Financial Policy         with European and global regulators.
                                                                                        concern that a radical overhaul of these
Committee (FPC), which has been
                                            Alongside the fundamental shift from        requirements could be disruptive,
operating on an interim basis since
                                            a unitary to a “twin-peaks” regulatory      there will now be a separate detailed
February 2011.
                                            structure, the government is keen           consultation of threshold conditions,
The FCA will be a stand-alone regulator,    to stress a cultural move; from a           which secondary legislation divides
like the FSA, and accountable to            reactive, compliance-led, “box-ticking”     between the two regulators. The main
government and parliament. The PRA          approach to a proactive, forward-           result is that there will now be four
will be an “operationally independent       looking and “judgment-led” style of         different sets of TCs: PRA-specific
subsidiary” of the Bank of England          supervision. As the chancellor, George      TCs for banks and dual-regulated
(BoE), while the FPC, like its sister       Osborne, told the pre-legislative           investment firms; PRA-specific TCs
body, the Monetary Policy Committee,        scrutiny committee: “If I was to point to   for insurance firms; FCA-specific TCs
is a committee of the central bank. As      one principle behind the entire change      for PRA-authorized (dual-regulated)
their names suggest, the FCA and PRA        we are making, it is that we would wish     firms; TCs for FCA-only authorized and
will regulate and supervise financial       to emphasize more than was the case         regulated firms.
institutions’       conduct-of-business     in the past the role of judgment in

The government has also taken the             secondly, to the need for consumers to       The draft bill is being scrutinized by a
opportunity to introduce some brand-          receive advice and information “that is      specially established parliamentary
new TCs. Examples include a “business         accurate, timely and fit for purpose.”       joint committee, the Parliamentary
to be conducted in a prudent manner”                                                       Commission on Banking Standards
                                              Another important new “have
TC for PRA-authorized firms, references                                                    (PCBS), which Andrew Tyrie MP also
                                              regard” for the FCA relates to senior
in both FCA and PRA TCs to the probity                                                     chairs. The PCBS was extremely
                                              managements’ responsibility for their
of the authorized firm’s management,                                                       busy in the latter part of last year,
                                              firms’ regulatory compliance. The pre-
and for FCA-only regulated firms, an                                                       often taking evidence three or more
                                              legislative committee had pushed for
assessment of authorized persons’                                                          times a week. It is possible that yet
                                              firms to be made directly responsible,
“vulnerability to being used for the                                                       another piece of legislation, a banking
                                              but the government decided that
purposes of financial crime.”                                                              standards bill, will also emerge from
                                              that would be “legally complex and
                                                                                           this increasingly complex and even
The FCA’s objectives have also                potentially cumbersome, giving rise to
                                                                                           potentially entangled process.
undergone revision in the light of pre-       the potential for litigation and dispute.”
legislative scrutiny and consultation,                                                     Speaking in the final Commons debate
                                              An       important      new     “product
with the regulator’s strategic objective                                                   on the Financial Services Bill just
                                              intervention” power for the FCA has
now being to ensure that markets                                                           before Christmas, Tyrie expressed the
                                              made it through to law, despite some
function well, rather than merely to                                                       frustration that a number of those
                                              concerns that there should have been
foster consumer confidence in markets.                                                     close to regulatory reform feel about
                                              better safeguards against its misuse.
“Promoting effective competition                                                           what they see as an over-hasty process
                                              When it comes into existence, the
in markets for financial services” is                                                      that could result in a far from perfect
                                              conduct regulator will be required
another reframed objective for the                                                         new framework.
                                              to make a policy statement on the
FCA. The overall effect is to make
                                              temporary product intervention rules         “We are now legislating in a huge rush
the conduct regulator’s competition
                                              that it will make, and the circumstances     to get this on the statute book by the end
mandate far stronger and more explicit.
                                              in which it would use them. Rejecting        of the year in order to meet an entirely
As the government said: “The revised          any further crimping of the regulator’s      arbitrary deadline,” Tyrie complained
objectives will encourage the FCA to          powers in this area, the government said     to his fellow legislators. “The deadline
actively promote effective competition,       it believed the safeguards it originally     has been rendered all the more absurd
and provide a mandate for the FCA             set out “strike the right balance in         by the fact that we will be back here
to take the initiative to use its powers      terms of giving the FCA sufficient           next year anyway, amending it as part
to tackle competition problems more           flexibility to act while providing the       of the banking [reform] bill, which is
swiftly and effectively than the FSA did      right framework to ensure the power          required to give effect to the Vickers
previously, for example by promoting          is used in an appropriate and targeted       commission’s recommendations, parts
switching, removing barriers to               way that is transparent to both firms        of which have to be done by amending
entry or addressing asymmetries               and consumers.”                              FSMA and cannot be done in any other
of information.”                                                                           way. I am not making some recondite
                                              A number of other political and
                                                                                           point about parliamentary procedure; I
Following on from this recognition of         regulatory processes have been
                                                                                           am making a point about how to make
information asymmetries between               going on that will feed into the
                                                                                           the bill effective. It is a point that is
providers and consumers of financial          evolving structure. The government
                                                                                           being made to me right now by senior
services, the government has also             accepted the recommendations of the
                                                                                           regulators, who would very much
recalibrated the three-way balance            Independent Commission on Banking,
                                                                                           prefer that we just take a little bit more
of responsibilities among firms’              chaired by John Vickers, a leading
                                                                                           time to get the legislation right.”
managements,           consumers       and    economist who headed the Office of
regulators in relation to consumer            Fair Trading from 2000-2005. The
protection. Again taking account of           result was the Banking Reform Bill
feedback during consultation and pre-         published in October 2012, which
legislative scrutiny, the bill now requires   contains the “Vickers proposals” for
the FCA to “have regard” to, first, the       a “ring-fence” between wholesale
general principle that providers should       investment and commercial and retail
be expected to give “an appropriate           banking.
level of care” to consumers and,

An important part of the UK’s new             TC makes this an explicit requirement,         The new suitability TC applies to all firms
regulatory structure will be the              thus emphasizing its significance to           and enshrines in law the requirement for
redrafted Threshold Conditions (TCs).         the regulator. For firms only regulated        firms to consider how their actions affect
These are the legal conditions firms          by the FCA, the regulator will consider        consumers, and indeed the integrity of
must meet to become and to remain,            their financial as well as their non-          the system as a whole.
authorized, and are at the heart of           financial resources. For dual-regulated
                                                                                             Both the PRA and the FCA will assess
the regulatory regime. Firms will be          firms, the FCA TC only requires firms to
                                                                                             the probity, skills and experience
familiar with the existing TCs, but           have adequate non-financial resources
                                                                                             of those who manage firms’ affairs
should note that the new TCs, which           because all matters financial will be
                                                                                             when deciding on compliance with
are expected to take effect on April 1,       dealt with by the Prudential Regulation
                                                                                             the suitability TC. The PRA and the
2013, have very little in common with         Authority (PRA).
                                                                                             FCA will consider matters through
them, and are much more detailed and
                                              For     dual-regulated     firms,     the      the prism of their own objectives so
prescriptive. Dual-regulated firms will
                                              “appropriate resources” TC has become          that, although they may be assessing
have two sets of TCs to comply with.
                                              “business to be conducted in a prudent         the same people in the case of dual-
The existing condition of “adequate           manner”, which will be assessed                regulated firms, the two regulators
resources” takes the new form of              by the PRA. This condition is highly           may be looking at different things.
“appropriate” resources and requires          prescriptive, and states that firms must
                                                                                             The business model TC is an FCA TC,
analysis of quality as well as quantity       have assets that are appropriate given
                                                                                             applicable to all firms. It is completely
of resource. The Financial Conduct            their liabilities, which they must be
                                                                                             new and has no parallel in the current
Authority (FCA), which will also come         able to value appropriately, as well as
                                                                                             TCs. Firms will need to satisfy the
into being in the spring of 2013, will look   adequate liquidity to meet liabilities.
                                                                                             regulator that their business model is
at adequacy of resource in the light of
                                              The PRA will consider continuity of            in the interests of consumers and the
risks to the continuity of firms’ services
                                              services, assessing the effect that the        integrity of the system, and compatible
and will also consider the skills and
                                              carrying on of the business (and its           with affairs being conducted in a sound
expertise of firms’ management teams.
                                              potential failure) might be expected to        and prudent manner. Firms will have to
The Financial Services Authority (FSA)        have on the stability of the UK financial      carefully explain their business model
has always looked at skills of managers       system. This introduces the concept of         and the rationale behind it to satisfy
and human resources generally under           “resolvability” into the TCs.                  this condition.
the existing TC, but the newly drafted
                                                                                             The “close links” TC has been
                                                                                             redrafted as “effective supervision”.
                                                                                             Each regulator will assess whether a
                                                                                             firm can be effectively supervised by
                                                                                             looking at close links (as is currently
                                                                                             the case), group membership, product
                                                                                             complexity, the organization of the
                                                                                             business, and its nature, scale and
                                                                                             complexity. Firms should prepare
                                                                                             themselves for the possibility of the
                                                                                             FCA/PRA engaging more directly with
                                                                                             their head office (if this is outside the
                                                                                             UK) than has hitherto been the case.
                                                                                             These TCs mark a seismic shift in the
                                                                                             regulatory landscape. Firms need to
                                                                                             plan for how they will satisfy them now.
                                                                    REUTERS/Stefan Wermuth


                                                                                                            REUTERS/Ueslei Marcelino

Regulatory expectations on senior           failure in the overarching management      FOCUS ON FIRMS’ CULTURES
managers will continue to intensify         and governance arrangements in place.      The regulatory expectations are not
in 2013. Senior managers are not                                                       limited to corporate governance,
                                            As an example the UK’s Prudential
expected to be risk experts themselves                                                 and the PRA states that it intends
                                            Regulation Authority (PRA) has
but they are expected to be well                                                       to focus on firms’ cultures and
                                            already made its expectations of
versed and up-to-date on all the main                                                  whether they are consistent with
                                            senior managers very clear. The PRA’s
regulatory issues in their firm and the                                                the prudent management of those
                                            proposed approach delineates the
wider marketplace. Post-financial crisis,                                              firms. Specifically the PRA will expect
                                            expected role of senior managers in
regulators worldwide are sharpening                                                    senior managers to take responsibility
                                            managing their firms prudently and
their focus on the role and activities of                                              for “establishing, embedding and
                                            states “this goes beyond complying
senior managers and are intensifying                                                   maintaining the culture.” The PRA
                                            with the letter of the PRA’s detailed
the supervision applied to individuals                                                 is not alone in its increased focus on
                                            requirements … and it will often mean
as well as their firms. Although senior                                                senior managers and all approved
                                            firms acting more prudently than they
managers are not expected to be                                                        persons in all financial services firms
                                            might otherwise choose.” The PRA also
risk experts they are expected to set                                                  need to understand, both personally
                                            reiterated the board’s responsibility
the “tone from the top” in terms of                                                    and corporately, the implications of
                                            for ensuring that senior managers are
culture and corporate governance.                                                      changing regulatory regimes.
                                            held to account as part of the corporate
Effective corporate governance is a core                                               There are several important themes
                                            governance of the business and that
competency for all firms and regulators                                                for senior managers, no matter which
                                            board responsibility is individual as
will increasingly seek to hold senior                                                  jurisdiction or business sector their
                                            well as collective.
managers to account personally for any                                                 firm operates in. First and foremost

is the need for senior managers to           when assessing and responding to the         As an insurance regulator, the FCA will
be fully engaged with all corporate          continuing sweep of regulatory change.       seek a balance between listening and
governance arrangements and in               Firms with in-house experts will be          intervention, and will be focused more
particular to consider how evidence of       able to highlight the issues, brief senior   on culture than the FSA, and less on
operation of effective governance can        managers, respond to and, where              controls and compliance. In wholesale
be provided. The minutes of meetings         necessary, lobby regulators, as well         insurance, the FCA seeks to improve
should, for instance, document the           as being able to give them valuable          transparency and efficiency but not to
arguments made, reasons for decisions        insight about the practical implications     introduce retail redress. The authority
being taken and capture all challenges       of the changes. All of which will help to    is to increase the proportionate focus
made and risks discussed. Simply             demonstrate that the firm concerned          on general insurance, and will engage
stating that, say, the board agreed a        has an embedded risk culture driven          extensively with Europe, moving away
course of action without evidencing          and supported by senior managers.            from the FSA’s focus on the failure
the debate, including the consideration                                                   probability to focus more on the
of the risks involved, will no longer be     INSURANCE                                    reduction of the impact of such failure.
good enough. Inherent in corporate           The PRA, as prudential regulator of          The FCA will give special attention to two
governance is a continuing assessment        insurers, is to work closely with the Bank   types of risks in Lloyd’s and insurance
of the ability of senior managers to run     of England, including the Financial          markets: delegated underwriting and
the business adequately. This is not         Policy Committee (FPC), which can            affinity schemes, where underwriting
just a question of complexity, size and      make recommendations and direct the          controls can be slack, and susceptible to
geography but also the availability and      PRA on the supervision of insurers. The      financial crime.
mix of skills within the ranks of senior     PRA will work closely with the Financial
                                             Conduct Authority (FCA), the conduct         The transition to the new regulatory
management and the board.
                                             regulator of insurers, and coordinate        regime is happening as the industry is
VISIBLE, CONSISTENT SUPPORT                  further on with-profits policies. The        also burdened with the expense and
Senior managers need to ensure the           PRA marks out insurance in its objective     uncertainty of Solvency II delays. At the
risk, compliance, legal and internal         of policyholder protection, required         time of writing, the FSA has added its
audit functions are all appropriately        because insurance contracts can lock in      voice to the industry’s calls for a credible
resourced and are able to act with the       policyholders. The PRA will reflect, but     timetable. When it comes, the regulator
visible support of senior managers           also aim to influence, the work of the       may reconsider its own scheduling, but,
at a suitably high level of authority.       European Insurance and Occupational          as things stand, it is working with firms
Visible, consistent support from senior      Pensions Authority (EIOPA) in setting        engaged in internal models towards
managers for all risk functions is a         prudential policy for insurers, and will     agreed revised “landing slots”, at a
means of setting the appropriate             support the International Association        date of firms’ choosing up to December
risk-aware culture within a firm as          of Insurance Supervisors’ (IAIS) work.       31, 2015.
well as the required “tone from the
                                             The PRA’s remit is narrower than
top”. As part of the overall approach
                                             the FSA’s, enabling it to make new
to corporate governance and risk
                                             use of senior staff for decisions
management senior managers will be
                                             and judgments about insurers. The
expected to set the firm’s risk appetite
                                             industry, as represented by the
and then oversee its deployment into
                                             Association of British Insurers (ABI) and
risk-taking in the business.
                                             others, is as yet, however, unconvinced
One of the best means of embedding           about the planned level of insurance
effective risk management is for             expertise at the PRA. As an innovation,
senior managers to ensure that the           the PRA, in its decision making, will
risk and control functions are aligned       engage with insurers’ boards, which
in terms of approach, standing and           must understand how the regulator
reporting. An additional benefit for         sees the risks within their business and
firms that have well-resourced in-           engage fully with their firms’ recovery
house compliance functions is that           and resolution plans.
they will have a distinct advantage                                                                      REUTERS/Andrew Caballero-Reynolds

The autumn of 2012 saw the                   persons regime, to provide the            submissions; (b) systems and
publication of the UK’s response to the      assurance of credible independent         controls for submitting firms;
London interbank offered rate (Libor)        supervision, oversight and                (c) transaction record keeping
attempted manipulation scandal.              enforcement, both civil and criminal.     responsibilities for submitting banks;
Martin Wheatley, managing director          • The British Bankers’ Association         and (d) a requirement for regular
of the UK Financial Services Authority        (BBA, the current Libor                  external audit of submitting firms.
(FSA), and chief executive designate          administrator) should transfer         • The BBA should cease the
of the Financial Conduct Authority            responsibility for Libor to a new        compilation and publication of
(FCA), put his name to the HM Treasury        administrator, which will be             Libor for those currencies and
publication setting out wholesale             responsible for compiling and            tenors for which there is insufficient
                                              distributing the rate, as well           trade data to corroborate
reform for the benchmark-setting
                                              as providing credible internal           submissions, immediately engaging
process. The final report of the Wheatley
                                              governance and oversight. This           in consultation with users and
Review was a landmark publication             should be achieved through               submitters to plan and implement
which concluded that while Libor is           a tender process run by an               a phased removal of these rates.
broken “it is not beyond repair.” The         independent committee convened         • The BBA should publish individual
core recommendation is to reform Libor        by the regulatory authorities. In        Libor submissions after three
rather than replace it. Senior managers       response to the Wheatley Review,         months to reduce the potential
need to be aware of the issues and            the BBA has broadly agreed with          for submitters to attempt
proposals arising from the Wheatley           the recommendations made and             manipulation, and to reduce
Review. The high-level 10-point plan          has proposed a phased approach           any potential interpretation
may read like an aspirational shopping        to the streamlining of Libor tenors      of submissions as a signal of
list but it sets the stage for the            (i.e., borrowing periods) and            creditworthiness.
regulatory future of benchmarks in the        currencies during the early months
                                              of 2013.                               • Banks, including those not currently
UK and will provide the template for                                                   submitting to Libor, should be
international discussions.                  • The new administrator should             encouraged to participate as widely
                                              fulfill specific obligations as part     as possible in the Libor compilation
It may be tempting for senior managers        of its governance and oversight
in non-Libor contributing banks to think                                               process, including, if necessary,
                                              of the rate, having due regard           through new powers of regulatory
that the scandal has nothing to do with       to transparency and fair and             compulsion.
them. They could not be more wrong.           non-discriminatory access to the
At its heart the Libor scandal was yet        benchmark. These obligations will      • Market participants using Libor
another failure of corporate governance       include surveillance and scrutiny        should be encouraged to consider
                                              of submissions, publication              and evaluate their use of Libor,
and that, along with culture, is the crux
                                              of a statistical digest of rate          including a consideration of whether
of future regulatory focus. All senior
                                              submissions, and periodic reviews        Libor is the most appropriate
managers need to ensure that effective                                                 benchmark for the transactions
corporate governance is embedded as           addressing the issue of whether
                                              Libor continues to meet market           that they undertake, and whether
a core competency within their firm.                                                   standard contracts contain
                                              needs effectively and credibly.
                                                                                       adequate contingency provisions
WHEATLEY REVIEW: BOTH LONG-                 • Submitting banks should                  should Libor not be produced.
TERM AND IMMEDIATE CHANGES                    immediately comply with the
The Wheatley Review proposals                 submission guidelines presented        The UK authorities should work closely
cover both long-term and immediate            in the report, making explicit and     with the European and international
changes for regulation, governance            clear use of transaction data to       community and contribute fully to
and technical amendments to Libor:            corroborate their submissions.         the debate on the long-term future of
                                            • The new administrator should,          Libor and other global benchmarks,
 • The authorities should
   introduce statutory regulation of          as a priority, introduce a code of     establishing and promoting clear
   administration of, and submission          conduct for submitters that defines:   principles   for    effective  global
   to, Libor, including an approved           (a) guidelines for the explicit use    benchmarks. The details of the
                                              of transaction data to determine       proposals are even more sharply
aimed at getting UK firms to focus on        all to aid credible submissions and          benchmark should be transparent
the governance, systems and controls         has now paid the price. Other banks          and consistent, as this will aid the
around contributions to and the setting      will follow.”                                detection of inaccuracies or attempted
of Libor. Specific recommendations are                                                    manipulation. There may be cases
                                             It is not just the UK that has focused on
made that:                                                                                where transparency needs to be
                                             benchmarks. In July 2012, the European
 • the submission and administration                                                      balanced against other concerns, such
                                             Commission published an amended
   of Libor should become regulated                                                       as intellectual property, confidentiality
                                             proposal for a regulation on insider
   by the FSA (and then by the FCA);                                                      or the potential facilitation of
                                             dealing and market manipulation that
                                                                                          manipulation. Benchmarks should have
 • key individuals in these processes        updated both the proposed Market
   should be FSA-approved persons;                                                        clear rules that are publicly available
                                             Abuse Regulation and the Markets
   and                                                                                    and which govern administration.
                                             in Financial Instruments Regulation.
 • the UK government should amend            The amendment specifically seeks to          Fair and non-discriminatory access
   the Financial Services Bill to enable     include benchmarks, such as Libor,           — Benchmarks that are systemically
   the FSA to prosecute manipulation         by extending the definition of market        relevant should be available to all
   or attempted manipulation of Libor.       abuse to include transmitting false or       market participants on a fair and non-
For senior managers the expectation          misleading information, providing false      discriminatory basis with reasonable
is that they should not just be aware of     or misleading inputs, or any action          commercial terms.
the proposed regulatory changes but          that manipulates the calculation of
                                                                                          Subject to credible oversight —
already be taking action to ensure they      a benchmark.
                                                                                          The degree of, and balance between,
can consistently provide evidence of any     The net is cast deliberately wide. The       governance and oversight and formal
governance arrangements around Libor         provision will apply to transactions,        regulation will depend on the type of
contributions within their firm. Ideally     orders to trade, and other behavior          benchmark and how it is derived. For
there should be a board member who           relating to benchmarks, where any            example, the process surrounding a
is tasked with direct oversight of any       transmission of information, input,          benchmark that is based primarily
remedial action required to bring the        calculation, or behavior is used to          on data from transactions in the
Libor processes fully within the scope       affect, does affect or is likely to affect   underlying market could look very
of the firm’s corporate governance           the calculation of the benchmark.            different from one that is based
and risk management processes.               A “benchmark” is defined for these           on a survey of market participants.
Specifically, senior managers need to        purposes as being any commercial             Notwithstanding, however, the precise
ensure their firm’s risk and compliance      index or published figure calculated         design of a benchmark, a credible
functions have the necessary skill sets      by the application of a formula to the       governance and regulation structure
and resources available to assess in         value of one or more underlying assets       should have sufficient independence
detail all future regulatory proposals       or prices, including estimated prices,       and powers to ensure that attempted
and in the immediate term include            interest rates or other values, or surveys   manipulation of the benchmark does
all Libor processes in the appropriate       by reference to which the amount             not occur.
monitoring plans and reporting packs.        payable under a financial instrument
                                             is determined.                               CONTINUING INTERNATIONAL DEBATE
STAND UP AND TAKE RESPONSIBILITY                                                          The reform of international and
If senior managers needed any further        The Wheatley Review will help to             domestic benchmarks is far from over.
indication that the regulators are           delineate the template for the wider         Wheatley himself will be involved in the
taking Libor seriously then the speech       international debate by setting out          continuing international debate as he
that Wheatley made to accompany              principles that ought to cover aspects       is co-chairing, alongside Gary Gensler,
the publication of the review repeated       of the rate methodology, governance          chairman of the U.S. Commodity
the warning about banks other than           and regulation, with the objective that      Futures Trading Commission (CFTC),
Barclays being involved. Wheatley            benchmarks should be:                        the International Organization of
stated that banks need to “stand up          Representative — The inputs to the           Securities Commissions’ (IOSCO) task
and take responsibility for the quality      benchmark should be a fair reflection        force on financial market benchmarks.
of the submissions they make to Libor.”      of the market that underlies it.             The mandate for the group includes
Even more pertinently, he said: “One                                                      identifying benchmark-related issues
bank we know of made no effort at            Transparent — The methodology
                                                                                          across securities and derivatives, and
                                             used to turn the inputs into a
other financial sectors, as well as
defining the types of benchmarks that          RETAIL FINANCIAL SERVICES
are relevant to financial markets. Policy
issues to be considered include:
                                               2013 will be a year of profound             Just as all of this change gets under
 • exercising appropriate regulatory           change for the UK’s retail financial        way, the new UK regulatory structure
   oversight of the process of                 services. December 31, 2012 saw the         will be coming into force. Banks,
   benchmarking;                               last vestiges of commission paid by         insurers and some large securities
 • having in place effective processes         product providers to financial advisers     firms will find themselves answerable
   and procedures for benchmark                for selling their products. The much-       to two regulators while all firms will
   calculation, and constructing               anticipated Retail Distribution Review      face a promised radical shake-up in the
   credible governance structures, to          (RDR) came into force on January 1,         regulation of conduct. The Financial
   address conflicts of interest in the        bringing with it “adviser charging” in      Conduct Authority (FCA) has promised
   benchmark setting process;
                                               the form of a fee paid by the client for    to take a proactive, interventionist
 • ensuring transparency and                   financial advice. It was also the date by   approach. Firms will expect to see
   openness in the benchmarking                which all advisers wishing to continue      the regulator looking at their business
   process, and                                giving advice had to have achieved a        models and at early product designs
 • the development of global policy            QCF Level 4 qualification (equivalent to    and challenging them on what the
   guidance and principles, including          the first year of an honors degree).        outcomes will be for consumers. The
   those related to effective self-                                                        FCA has promised less negotiation and
   regulation that would take into             A small and much-debated percentage
                                                                                           more stringent intervention.
   account the Wheatley Review                 of advisers will have chosen the end of
   as well as other initiatives,               2012 to retire, change careers or switch    Elsewhere, retail banks will be
   including those from the European           to non-advisory functions rather than       preparing for a major shake-up
   Commission and the Bank                     comply with RDR. Others will spend          as they begin to implement the
   for International Settlements               the early months of 2013 coming             Independent Commission on Banking
   (BIS) so as to avoid overlaps or            to terms with what RDR means in             (ICB) recommendations, which will see
   inconsistencies.                            practice for their business. For a start,   them separate from their investment
IOSCO has stated that the new task             cash flow will be significantly affected    banking and securities businesses
force intends to produce a consultation        in the early days of the RDR as those       within their group and lock themselves
report towards the end of 2012 or in           advisers used to receiving commission       away inside a ring-fence. According to
early 2013.                                    upfront for a sale adjust to building up    Deloitte, although the implementation
                                               a new revenue stream based on fees          timetable stretches to 2019, the ICB
Additional disclosure: Thomson Reuters
is currently the calculating agent acting      from clients.                               has urged banks and the government
under contract to the BBA. Thomson Reuters                                                 to initiate the ring-fence as soon as
is committed to actively participating with    RETAIL DISTRIBUTION REVIEW                  possible. Deloitte reckons the market
the financial industry in the transformation                                               will also price in expectations well
                                               Many in the industry have voiced
of Libor with Martin Wheatley and others                                                   ahead of the deadline. It said it was
for the good of the financial markets and      concern that clients will not be
                                                                                           possible to construct and position the
the public as a whole. Thomson Reuters         prepared to pay for advice once its cost
                                                                                           ring-fence as a vehicle or legal entity
is also committed to supporting the            becomes transparent. Some industry
                                                                                           well before knowing precisely which
continuing calculation and distribution of     specialists predict that it will be late
Libor while regulators and governments
                                                                                           of the permitted activities it would
                                               in 2013 before the full impact of the
conduct the reviews, and will implement the                                                contain. Retail banks are therefore likely
                                               RDR changes is known. Whatever the
improvements that were recommended.                                                        to become embroiled in planning and
                                               longer-term consequences of RDR for
                                                                                           strategy to prepare for the separation.
                                               the UK market, all eyes will also be
                                               fixed on Europe, where initiatives such
                                               as packaged retail investment products
                                               (PRIPS) could yet again change the
                                               way retail investment products are sold
                                               throughout Europe.

                                                                                             under the scope of the rules. One issue
                                                                                             for MLROs to watch out for is potential
                                                                                             changes that could see firms forced to
                                                                                             implement group-wide AML policies.
                                                                                             While most cross-border organizations
                                                                                             already have high-level AML policies
                                                                                             there is often a disparity between local
                                                                                             regulatory requirements. These issues
                                                                                             will need to be ironed out.

                                                                                             FATF EFFECTIVENESS TEST
                                                                                             MLROs will need to look closely
                                                                                             at the work of the FATF over the
                                                                                             coming year, as it beds down changes
                                                                       REUTERS/Jo Yong hak   introduced in 2012. Countries will
                                                                                             be tested on the “effectiveness” of
The fallout from the big ticket U.S.          The increasingly political nature of
                                                                                             their AML regimes and not just their
investigations into money laundering at       regulatory enforcements, as shown by
                                                                                             compliance with technical standards.
global banks Standard Chartered and           the Libor and U.S. money laundering
                                                                                             It will be interesting to see how this
HSBC is likely to dominate the thinking       probes, is likely to continue.
                                                                                             approach filters through regulators
of money laundering reporting officers
                                              On the regulatory side European focus          and ultimately to firms. In the UK three
(MLROs) for at least the early part
                                              will center on proposals to introduce          institutions face enforcement action in
of 2013.
                                              a fourth Money Laundering Directive.           2013 over AML failings connected with
The massive fines coupled with                In its review of the existing legislative      the Financial Services Authority’s (FSA)
damaging reputational loss should             framework the European Commission              investigation into banks’ handling of
focus MLROs’ minds and motivate               concluded that the current directive           high-risk customers. Two have been hit
them to ensure that appropriate               had no fundamental shortcomings but            already.
systems and controls are resolutely           that changes were needed to bring it
                                                                                             The new Financial Conduct Authority
in place at banks and other firms.            into line with evolving criminal threats.
                                                                                             (FCA) has said that it plans to continue
Although the focus has so far been            The Commission was due to publish
                                                                                             the development of the FSA’s “Core
largely U.S.-centered, an increasingly        its proposals at the end of 2012 but
                                                                                             Financial Crime Program”, which will
joined-up global regulatory approach          an impact assessment was rejected by
                                                                                             focus on AML and financial crime issues
means those outside the jurisdiction          its internal review board. This minor
                                                                                             at the UK’s highest-impact banks.
need to be on the ball. The fallout and       setback means that the proposals are
                                                                                             From the middle of 2013 this scrutiny
the lessons learned from the scandals         unlikely to be set out before February
                                                                                             will be extended to include anti-bribery
will be tough.                                2013.
                                                                                             and corruption risks. Systems and
Despite the enormous size of the              It is not thought that the Commission          controls issues are likely to be the focus
penalties, observers believe that UK          will stray too far from the changes            as the UK’s fledgling bribery legislation
MLROs can use the U.S. cases to               introduced by the Financial Action             beds down.
their advantage. There is a school of         Task Force (FATF), the global standard
                                                                                             The regulator is also planning to
thought that the sheer terror brought         setter, in 2012. This means that the
                                                                                             “deep dive” firms’ defenses against
about by these huge settlements               focus is likely to be on the adoption of
                                                                                             trade-based money laundering, given
could lead to a boost for hard-pressed        a more risk-based approach to anti-
                                                                                             concerns it has over industry practices.
compliance departments.                       money laundering (AML).
                                                                                             Inevitably these concerns, which will be
At the very least, MLROs can use the          The directive is also likely to be             published in the summer, will lead to
penalties to alert senior management          extended to cover the gambling sector,         enforcement action.
to the perils of getting it wrong.            while tax crimes will probably come
Following a largely positive 2012,        regulator’s Operation Tabernula case,        TOUGHER SENTENCING
notwithstanding one notable exception,    its most complex investigation to date,      Aside      from       the     continuing
the UK Financial Services Authority’s     is likely to reach the courts. The FSA       investigations, the upwards trend in
(FSA) criminal crackdown on insider       has charged five men, including Martyn       sentencing for insider trading is likely to
trading looks set to continue in 2013.    Dodgson, a former managing director          develop as the regulator takes on more
The regulator secured 10 convictions      at Deutsche Bank, with various insider       serious cases. The highest sentence
in 2012, a record, and so far has five    dealing offences. A number of other          imposed so far has been four years,
more cases set for 2013. In January,      individuals remain under investigation       with the average jail term just under 30
Richard Joseph faces a criminal trial     in this wide-ranging insider dealing         months. These figures show that that
over insider dealing allegations, which   probe. The case will be a stern test of      the courts can and are taking tough
he denies. More significantly the         the regulator’s criminal powers.             action against financial crime, and this
                                                                                       trend should continue.
                                                                                       As the FSA case load in this sphere
                                                                                       grows it is thought that the number
                                                                                       of guilty pleas entered by defendants
                                                                                       will increase as well. Until 2010 the
                                                                                       FSA had secured no guilty pleas. In
                                                                                       2011 there were three; in 2012 four. An
                                                                                       increasing realization that conviction
                                                                                       remains a possibility when a case
                                                                                       reaches the court should see this
                                                                                       trend continue.
                                                                                       This year will also see the UK move
                                                                                       a step closer to the U.S. model of
                                                                                       deferred prosecution agreements,
                                                                                       which will allow companies to settle
                                                                                       fraud investigations by paying fines.
                                                                                       The Serious Fraud Office (SFO) and
                                                                                       the Crown Prosecution Service will be
                                                                                       allowed to use the tool to encourage
                                                                                       firms to “self-cleanse” by reporting
                                                                                       issues. The embattled SFO has already
                                                                                       tried this approach but ran into judicial
                                                                                       difficulties when judges were unhappy
                                                                                       at being “presented” with settled cases.
                                                                                       This tool, which will be introduced
                                                                                       as part of the Crime and Courts Bill,
                                                                                       possibly in 2014, would put the power
                                                                                       on a more formal footing.

                                                              REUTERS/Kim Kyung-Hoon

                                                                                           The Central Bank of Bahrain (CBB) will
                                                                                           continue to encourage and facilitate
                                                                                           mergers between smaller Islamic
                                                                                           financial institutions to make the
                                                                                           country’s banks more competitive
                                                                                           globally. The CBB’s governor recently
                                                                                           noted that larger, more lucrative deals
                                                                                           were frequently beyond the reach of
                                                                                           Islamic banks, a situation he said could
                                                                                           only be resolved by the creation of
                                                                                           larger entities.
                                                                                           In December 2012, after a year-long
                                                                                           delay, Oman issued regulations
                                                                                           permitting the sale of Sharia’h-
                                                                                           compliant banking services through
                                                                        REUTERS/Aly Song
                                                                                           licensed Islamic banks or Islamic
Gulf regulators have been adjusting to      range of supervisory and compliance            windows at existing institutions. Despite
the post-financial crisis world and 2013    issues and a growing emphasis on               being welcomed by the industry, banks
will be busy for them again. In Qatar,      enforcement. It will also focus on anti-       are lobbying the Central Bank of Oman
the Emir has given a long-awaited           money laundering and counter-terrorist         (CBO) to relax certain provisions, such
green light to regulatory reform, which     financing in the coming months, in line        as liquidity management rules, which
investors hope will help to simplify the    with its international obligations to the      they say will harm profits. Additionally,
slow and complex process of doing           Financial Action Task Force.                   many institutions in Oman are still
business in the Gulf Arab state. The                                                       in the process of obtaining product
                                            The United Arab Emirates has delayed
reform was first mooted five years                                                         expertise and organizing boards of
                                            the long-awaited amendment of its
ago but there is no timetable for its                                                      Islamic scholars to oversee compliance.
                                            insolvency regime until at least the
completion. The law provides for an
                                            end of 2013. The reform initiative,            The CBO has also come under fire for
umbrella body to regulate banks,
                                            which began in 2009, is intended to            allowing Oman’s two licensed Islamic
financial services and insurance
                                            facilitate the orderly restructuring of        banks, Bank Nizwa and Alizz Islamic
companies, and the country’s bourse,
                                            businesses, instead of resorting to            Bank, to raise funds through initial
as well as banking, financial, and
                                            bankruptcy and liquidation. The new            public offerings (IPOs) before the new
insurance companies licensed by the
                                            law is still in the consultation phase,        rules were in place and before the banks
Qatar Financial Center. This body will be
                                            and the federal government has not yet         were operational. Bank Nizwa and
placed under the authority of the Qatar
                                            prepared a draft. Sources involved in the      Alizz Islamic Bank went public in June
Central Bank. Currently banks and
                                            consultation noted, however, that the          and October 2012, respectively. As of
financial services companies in Qatar
                                            proposed legislation was unlikely to ease      December 2012, however, neither bank
are regulated by the central bank, while
                                            the seizure of assets by foreign creditors,    had begun operations. Currently, the
the country’s bourse is regulated by the
                                            including assets that were explicitly          CBO is considering whether to exempt
Qatar Financial Markets Authority.
                                            pledged as collateral. The sources also        Bank Nizwa from foreign exposure
Dubai will review remuneration              noted that government entities would be        restrictions that require Omani Islamic
incentives as part of a broader range       exempt from the revised insolvency law,        firms to keep their money onshore.
of conduct of business issues and will      as would firms operating in financial free
carry out some 125 on-site inspection       zones, which have their own insolvency
visits in 2013. The regulator, which        laws, such as the Dubai International
concentrated on licensing in its early      Financial Centre.
days, is now focusing on a traditional

The ASEAN (Association of Southeast        another country. Mutual recognition         The rules and regulations that
Asian Nations) banking integration         of investment products is another goal      previously came under Bapepam-LK,
will continue to be a dominating           that market players would like to see       the Indonesian capital market and
theme in Southeast Asia’s financial        achieved as part of the ASEAN banking       financial institution supervisory agency
services sector as the region’s leaders    integration initiative.                     and OJK’s predecessor, will remain
work towards achieving the ASEAN                                                       unchanged. One of OJK’s main tasks,
Economic Community (AEC) 2020                                                          however, is to review the various acts
vision. Several working groups have                                                    regulating the different sectors in the
been formed to lead the various                                                        financial services industry and develop
initiatives that fall under the ASEAN                                                  a more synchronized regulation that will
banking integration theme and efforts                                                  allow it to supervise Indonesia’s financial
by these working groups are expected                                                   industry in a more holistic manner. While
to continue unabated in 2013.                                                          Bank Indonesia has ceded its power to
                                                                                       regulate Indonesian banks to OJK, its
One of the main aims of the ASEAN
                                                                                       remit on economic and monetary policy
banking integration initiative is the
                                                                                       matters remains unchanged.
harmonization of the financial rules
and regulations of all the ASEAN                                                       MALAYSIA
jurisdictions, and mutual recognition of                                               2012 was a relatively quiet year for
regulations will be an important aspect                                                the Securities Commission Malaysia
of this. The differences between the                                                   following a busy 2011 that saw the
level of sophistication and economic                                                   implementation of a number of new
development of the financial sectors                                                   regulations, amendments to the
and the banking regulations among                                   REUTERS/Aly Song
                                                                                       Capital Markets and Services Act and,
the ASEAN countries will need to           INDONESIA                                   most notably, the launch of the Capital
be acknowledged and overcome               Indonesia’s regulatory environment is       Markets Masterplan II and the five-year
before there can be agreement on           undergoing a major transformation in        Corporate Governance Blueprint.
which regulations should be mutually       response to changes in the domestic
recognized. From a political point of                                                  Malaysia is one of few jurisdictions
                                           banking sector and global regulatory
view it would be almost impossible                                                     in Southeast Asia that has been
                                           developments. Domestically, work is
for any ASEAN countries to give up                                                     quick to respond to global regulatory
                                           in progress as the country prepares for
regulatory sovereignty, which has been                                                 developments. In line with that effort,
                                           Otoritas Jasa Keuangan (OJK), the newly
widely regarded as the main obstacle                                                   the Bank Negara Malaysia is expected
                                           established financial sector regulator,
to achieving mutual recognition                                                        to continue with its efforts to prepare
                                           to become fully operational in 2014.
of regulations.                                                                        the country’s banks for Basel III’s new
                                           OJK will be the only bank regulator
                                                                                       capital and liquidity requirements.
Market players in ASEAN’s financial        in Southeast Asia that is not a central
                                                                                       The Malaysian central bank has said
services sector have singled out           bank. A new law has mandated OJK
                                                                                       that the banks are well poised to
trading licenses and investment            to regulate and supervise all financial
                                                                                       meet the higher capital and liquidity
banking products as two key areas that     institutions operating in Indonesia,
                                                                                       requirements required under Basel III.
they would like ASEAN regulators to        and to provide oversight of the entire
mutually recognize. The goal of ASEAN      financial system. Modeled closely on        Bank Negara Malaysia said in 2012
banking integration, they suggest,         the UK’s Financial Services Authority       that over-the-counter (OTC) derivatives
should eventually be the mutual            (FSA), OJK has been empowered to set        regulation was not a main focus
recognition of trading licenses among      regulations, oversee licensing, impose      because of the small volume of OTC
members of the ASEAN countries so          sanctions, and conduct inspections. It      derivatives trades in the country. 2013,
that traders from one jurisdiction can     will also focus on consumer protection      however, could see several regulatory
easily trade in another without having     as mandated by the OJK law.                 developments as Malaysia is expected
to apply for the trading license in                                                    to start building the infrastructure
for trade repositories to prepare for        the quality of Pillar 3 disclosures        for insurers. The MAS is expected to
mandatory reporting as part of the           regarding the capital that banks use to    respond to all these initiatives this year.
G20 commitments. Malaysia amended            meet their regulatory requirements.
the Capital Markets and Services Act                                                    THAILAND
                                             This year could also see Singapore         The Bank of Thailand will continue
in 2011 to facilitate the establishment
                                             conclude talks with the U.S.               to focus on ensuring the stability of
of trade repositories, and it has set
                                             Department of the Treasury on the          the domestic financial system amid
October 2013 as the deadline for the
                                             signing of the intergovernmental           global economic uncertainties. It
repositories to become operational.
                                             agreement (IGA) for complying with         has adopted two major supervisory
Where local regulations are concerned,       the FATCA provisions.                      tools to do so. It will ensure that Thai
the Securities Commission Malaysia                                                      banks: meet Basel III’s new capital and
                                             Domestically, one major regulatory
is consulting the public on a new                                                       liquidity requirements; and continue
                                             development will be amendments to
set of guidelines on the suitability                                                    to conserve provisions for absorbing
                                             the Securities and Futures Act (SFA)
of investment products. This is in                                                      expected losses, and losses that will be
                                             and the Financial Advisers Act (FAA),
response to the mis-selling of Lehman                                                   incurred in the near future.
                                             as public consultation on both closed
Brothers minibonds to pensioners
                                             on January 4, 2013. The proposed           Like Malaysia, the Bank of Thailand
during the 2008 financial crisis. The
                                             amendments to the SFA are significant      has also spent much of 2012 ensuring
Securities Commission Malaysia is
                                             and extensive. They included proposed      that the banks it governs are Basel III-
also hiring regulators to supervise the
                                             amendments to three regulations            compliant. This effort will continue in
private retirement schemes following
                                             under the SFA: licensing and conduct       2013 as the Basel III deadlines loom.
their launch in December 2011.
                                             of business regulations; the offers of     According to Krirk Vanikkul, deputy
SINGAPORE                                    investments — shares and debentures        governor of the Bank of Thailand, the
2012 was yet another busy year for the       regulations; and the composition of        central bank’s existing requirements
Monetary Authority of Singapore (MAS)        offences regulations. The proposed         are already in line with international
as it worked towards keeping pace with       amendments to the FAA cover two            standards, such as those set by the
global regulatory developments, in           areas: expanding the application of the    BCBS. As at the end of the third
particular Basel III, the OTC derivatives    prescribed duties of chief executives      quarter of 2012, the capital adequacy
reform and the U.S. Foreign Account          and directors of financial advisers        ratio of the Thai banking system is 16
Tax Compliance Act (FATCA). This year        license holders, and empowering the        percent, with tier 1 capital of Thai banks
the MAS is expected to implement             MAS to offer compensation for offenses     averaging 12 percent.
a number of new regulations and              that are punishable by a fine only and/
                                             or imprisonment under the FAA.             Locally, the Bank of Thailand will to
respond to a range of proposed
                                                                                        continue to require Thai banks to
regulations following the close of           Other significant developments this        increase their provisioning. Given global
public consultations.                        year include the impending enactment       economic uncertainty, the Thai central
Where      global   regulations     are      of a new Financial Holding Companies       bank sees increasing provisioning as
concerned, the MAS has revised Notice        Act, which will introduce a new            an important strategy and an essential
637 to implement the Basel III capital       regulatory framework for financial         buffer to help Thai banks withstand
reforms for bank exposures to central        holding companies. and the outcome of      future external shocks.
counterparties issued by the Basel           the independent review of rates setting
Committee on Banking Supervision             processes, which banks in Singapore
(BCBS). The revised regulation will          had been told to undertake following
take effect from July 1, 2013, while         the Libor-fixing scandal involving
other revisions that seek to enhance         Barclays last year.
the clarity of the MAS’ capital rules        The MAS also conducted extensive
were implemented on January 1,               reviews of the insurance sector in 2012.
2013. The MAS will respond to the            These reviews included amendments to
proposed amendments to implement             the Insurance Bill, legislative changes
composition of capital disclosure            to requirements for key executives
requirements as required by the BCBS.        and directors for insurers, and a study
The aim of the regulation is to improve      of the risk-based capital 2 framework

China’s financial markets will continue
to open up in 2013 and further market
liberalization reforms are also likely
to be carried out under the new
leadership elected in the country’s 18th
National Party Congress. Both Guo
Shuqing, head of the China Securities
Regulatory Commission (CSRC), and
Li Keqiang, the new premier, are both
seen as reformists.
The CSRC is expected to continue to
crack down on illegal market conduct
and insider trading in 2013. China
remains a developing, albeit huge,
economy and the economic growth
experienced during the past 20 years
has given insider dealing an opportunity
to flourish. Following his appointment in
                                                                                                                   REUTERS/Yuriko Nakao
late 2011 Guo has attempted to address
this by introducing stricter enforcement    China’s hedge funds sector should             Potential areas of concern in 2013 could
of insider dealing offences, but much       also see growth in 2013 following the         be the huge and loosely regulated
remains to be done. The regulator has,      launch of a pilot Qualified Domestic          shadow banking sector in China, as
however, maintained a zero tolerance        Limited Partner (QDLP) scheme,                well as an unexpected increase in non-
attitude towards insider dealing, and       which allows foreign hedge funds              performing loans if there is a prolonged
is expected to continue to strengthen       to operate in the domestic Chinese            economic downturn. The real estate
its enforcement and supervision             market. The Renminbi Qualified                sector is heavily exposed to the shadow
procedures. The CSRC will also increase     Foreign Institutional Investor (RQFII)        banking sector, while the country’s
cooperation with overseas regulators        scheme, which allows trades made in           banks have begun to offer various
on enforcement issues, even if some         renminbi offshore, is also expected to        wealth management products linked
other areas of cooperation, such as on      be expanded in 2013, after a recent           to real estate construction projects.
the accounting records of U.S.-listed       increase in investment quotas was             There are concerns that a slump in
Chinese companies, remain contentious.      approved by the CSRC.                         the economy would hit the ability of
Comments made by Guo at the                                                               property developers, among others, to
                                            On Basel III, China has said it is on track
November 2012 Party Congress                                                              repay banks and other lenders in the
                                            to begin implementation in 2013 and is
suggest that the country plans to                                                         shadow banking sector, thus affecting
                                            expecting both foreign and domestic
expand the foreign currency quotas                                                        stability and banks’ balance sheets.
                                            banks in China to comply with localized
provided under the Qualified Foreign        Basel II and Basel III rules. China, which    Following the November 2012
Institutional Investor (QFII) scheme,       had previously not signed up to Basel         publication of the Financial Stability
which allows foreign investors to           II, has undertaken to implement both          Board’s study on the shadow banking
trade A-shares on mainland stock            Basel regulations fully over a four-          sector, the practice is expected to remain
exchanges. In addition, the regulator       year period to 2016, a full two years         a hot topic in China well beyond 2013.
is expected to streamline investment        ahead of the rest of the world. The
                                                                                          The China Insurance Regulatory
approval procedures and improve             China Banking Regulatory Commission
                                                                                          Commission (CIRC) is expected to
financial infrastructure and regulations    (CBRC) has said, however, that banks in
                                                                                          continue to tackle the mis-selling of
to facilitate further QFII investment in    China will have no difficulties achieving
                                                                                          insurance products to retail investors.
the years to come.                          the capital adequacy ratios required.
The insurance sector will remain topical      hold U.S. government debt, of which            published false accounting information
as the country’s insurance companies          there is plenty, and thereby meet              in its prospectus, something which
were allowed a greater choice of              the requirements.                              was not caught by the IPO sponsor.
investment venues in late 2012 to boost                                                      Under the new regime, an IPO sponsor
                                              Another issue with the two Basel III
returns, although this could potentially                                                     found to have knowingly or recklessly
                                              liquidity ratios is that the LCR is meant
also spell higher risks.                                                                     neglected their duties when drafting
                                              to allow a bank to withstand a one-
                                                                                             a listing prospectus could face both
HONG KONG                                     month stress period, such as a run
                                                                                             civil and criminal penalties, the SFC
Hong Kong’s regulatory agenda in              on deposits. It has been argued both
                                                                                             has warned.
2013 will continue to be dominated            locally and in other parts of the region
by two main themes: the introduction          that this one-month period is less             The SFC is expected to have a busy
of globally agreed reforms, such as           relevant in Hong Kong, where bank              year, with a study on dark pools,
Basel III and OTC derivatives clearing,       runs have long-rooted traditions and           market structure and internal broker
and local reforms aimed at increasing         have brought banks to their knees in           crossing systems in focus following
transparency and accountability in            less than a week.                              a consultation by the regulator on
the market.                                                                                  electronic trading in 2012. In addition,
                                              On the mandatory clearing and
                                                                                             the SFC is expected to streamline rules
Hong Kong is well positioned to begin         reporting of OTC derivatives trades,
                                                                                             for the listing of overseas companies
the six-year implementation process           another G20-coordinated requirement,
                                                                                             from jurisdictions other than mainland
for Basel III in 2013, with the territory’s   Hong Kong has been in the forefront of
                                                                                             China on the stock exchange.
banks holding an average capital              implementation globally. The territory
adequacy ratio of 16 percent, according       has prepared a limited reporting and           On the retail side, Ashley Alder, SFC
to the Hong Kong Monetary Authority           clearing regime, which will initially          chief executive, has recently suggested
(HKMA), which regulates local banks.          apply only to interest rate swaps and          that the regulator plans to look at its
A number of Basel III-related problems        non-deliverable foreign exchange               professional investor rules and how
loom on the horizon, however, and             forwards. The HKMA and the Securities          the point-of-sale element of the sales
the way in which the Basel III regime         and Futures Commission (SFC) have              process fits in with them. Alder has also
handles the issue of liquidity may pose       finished their consultations on the new        said that the SFC may consider looking
particular problems in Hong Kong. The         rules, and a bill on its implementation        more closely at the responsibilities of
type of high-quality liquid assets banks      is likely to be presented to the territory’s   structured product issuers, and at the
should hold to meet the net stable            legislature in mid-2013, making Hong           design of such products.
funding ratio (NSFR) and the liquidity        Kong one of the first jurisdictions
                                                                                             The Office of the Commissioner
coverage ratio (LCR) under Basel III is in    globally to enact such a regime.
                                                                                             of Insurance is expected to have a
short supply in Hong Kong, something          Domestically, the focus will also be           busy final year before its planned
which might lead to competition for the       on the SFC’s implementation of a new           transformation into an independent
“right” kind of assets.                       regulatory regime for sponsors of initial      authority in 2014.
Some have argued that the kind                public offerings (IPOs) in October. The
                                              SFC first touted this regime in mid-2012,      INDIA
of assets approved under the two
                                              suggesting that standards were not             Foreign direct investment (FDI) in retail
ratios, such as local government debt,
                                              high enough among underwriters and             has taken center stage in the winter
reflect the Basel III doctrine’s origins
                                              sponsors of IPOs in the territory, which       session of the Indian parliament. Once
in the West, where such products
                                              has in recent years ranked among the           this issue has been resolved, parliament
are more abundant. Alas, in cash-
                                              world’s top IPO hot spots. In particular,      is expected to consider a number
rich Hong Kong there are hardly any
                                              the SFC accused sponsors of carrying           of amendments to Indian financial
government bonds to go around, and
                                              out shoddy work on due diligence and           laws and regulations, which could
as a consequence the HKMA has had
                                              accounting issues in the lead-up to            result in a new framework of financial
to consider allowing a broader set of
                                              listing on the Stock Exchange of Hong          regulation in 2013. These changes
assets to satisfy the high-quality liquid
                                              Kong. A case to note would be that of          include enhancing the FDI limit in the
assets (HQLA) requirements. Due
                                              Hontex, the Chinese sportswear maker,          insurance sector to 49 percent with
to the territory’s currency peg to the
                                              which was suspended and eventually             the passage of the Insurance Laws
U.S. dollar, it is likely that the HKMA
                                              de-listed from the stock exchange              (Amendment) Bill and introducing FDI
will allow banks in the territory to
                                              when the SFC found that it had                 in the pension sector on a par with the
insurance sector under the Pension            derivatives clearing and on Basel III        election as parties seek to bring down
Fund Regulatory and Development               implementation. Although struggling          government spending. The regulator
Authority Bill. Company law is set to         with a stagnating economy and the            has warned that there is an acute need
be revamped with the promulgation             huge task and cost of cleaning up after      for a boost in the budget of the JFSA’s
of the Companies Bill 2011, which             the March 2011 tsunami, the country          supervisory and surveillance unit, the
introduces more stringent standards           has not let this affect its efforts to       Securities and Exchange Surveillance
of corporate governance and oversight,        stay up-to-speed with international          Commission, given the ever-increasing
and express guidelines for corporate          regulatory developments. Japan has           sophistication of frauds.
social responsibility.                        joined a growing international chorus
                                              criticizing the U.S. for its unilateral      SOUTH KOREA
Changes to banking regulation law                                                          South Korea’s Financial Services
                                              approach to handling the clearing
are also proposed while the role of                                                        Commission (FSC) has stated that it will
                                              of OTC derivatives, and has warned
the Forward Markets Commission                                                             tighten regulations on market-related
                                              that this may lead to marginalization
(FMC) is expected to be strengthened.                                                      financial products, such as money
                                              of Asian markets and a higher risk of
Amendments to the Competition Act                                                          market funds, in mid-2013. The cap on
                                              regulatory arbitrage.
2002 are on the anvil to fine-tune certain                                                 duration, maturity and credit ratings
details and clarify the jurisdiction of the   On the domestic front, a number of           for such instruments is expected to
Competition Commission of India (CCI)         issues still linger, and will remain         be tightened and shortened to lessen
in sectors with other regulators, such as     near the top of the agenda for 2013.         liquidity risks from possible redemption
insurance and banking. Major changes          Among these are insider dealing and          demands. The duration of such
to tax law are also likely with the           corporate governance, as witnessed           products will be shortened from the
finalization of General Anti-Avoidance        during 2012 in cases involving blue-         current 90 days to 60 days. “Duration
Rules (GAAR) and greater clarity on           chip companies such as Nomura and            ceiling is relatively long compared with
the Direct Taxes Code and Goods and           Olympus, respectively. As a result,          advanced nations. The ceiling will be
Services Tax, which restructures the          investor protection has come to the          shortened to, for example, 60 days
direct and indirect tax regime in India.      fore as a priority for Japan’s Financial     from the current 90 days,” Kim Yong-
                                              Services Agency (JFSA). The regulator        beom, director general of the FSC’s
The impact of changes to FDI in retail
                                              is strengthening anti-insider dealing        capital market bureau, told reporters in
is also likely to be felt, with 51 percent
                                              rules and their associated monetary          late 2012.
foreign investment permitted in multi-
                                              penalties, as well as other measures
brand retail and 100 percent foreign                                                       The FSC said that legislation to tighten
                                              aimed at preventing market abuse.
investment permitted in single-brand                                                       the regulation of money market
retail. The effect of the conditions          A 2012 scandal that involved an adviser      financial products would become
attached to such investment will              deceiving a pension fund has led to a        effective in July 2013. Domestic money
also become apparent. Reports also            call for the oversight of investment         market funds will have to maintain a
suggest that the government may               advisers to be strengthened. Proposed        certain percentage of liquid assets,
relax the valuation norms for FDI to          measures being reviewed include more         i.e., 30 percent of assets that mature in
increase foreign investment and clarify       thorough checks on such advisers by          seven days and 10 percent of assets with
its position on “options”, which is a         third parties, such as trust banks, as       a one-day maturity, to manage liquidity
contentious area.                             well as tougher penalties and oversight      risk in times of market upheaval.
                                              of investment managers.                      Regulation for money market trusts
Increased capital market activity
is expected as the government’s               Among other recent initiatives there has     and money market wraps will also be
disinvestment program picks up to             been a change in the law to introduce        raised to the level of those for money
bridge the fiscal deficit and companies       alternative dispute resolution systems       market funds. Such wraps and trusts
approach the market to meet the               as part of the overall investor protection   will be mandated to have a certain
minimum public shareholding norm of           picture. The regulator has also recently     level of the credit rating and be subject
25 percent by August 2013.                    introduced a system to strengthen the        to maturity ceilings for assets maturing
                                              oversight of credit rating agencies, and     within three months.
JAPAN                                         is reviewing its procedures for issuing      The Covered Bond Act is also
Japan will enter 2013 as one of               fines in enforcement cases.                  expected in 2013. It was submitted
the few countries that has hit the
                                              Funding remains an issue and this            for parliamentary approval in late
international timelines on OTC
                                              will continue after the December 2012        2011 and was followed by a Ministry
of Government legislation review. In
future, if financial institutions in South   AUSTRALIA AND NEW ZEALAND
Korea are to issue covered bonds,
they will have to meet both eligibility      RETAIL FINANCIAL ADVICE:                      are expected to retain a place in the
                                             THE FOFA REFORMS                              financial advisory market, it is the
and       institutional     requirements.
This includes institutions such as           Australian financial advisers are             large, vertically-integrated businesses
the Housing Finance Corporation,             preparing for unprecedented change            that own the entire value chain, from
Korea Finance Corporation, and               this year with the introduction               the advisory functions through to the
other equivalent institutions that are       of the Future of Financial Advice             licensees, platforms and investment
designated by presidential decree.           (FoFA) reforms on July 1, 2013. The           managers, which will have the
The eligibility requirement is that          controversial reforms aim to trigger a        strongest competitive advantage. This
institutions must have equity capital of     shift to the “fee for service” model and      process has been borne out by industry
more than 100 billion won and a Bank         improve the quality of financial advice       consolidation in recent months, and
for International Settlements (BIS) ratio    that is given to consumers. Among the         the trend is expected to continue
of more than 10 percent to be capable        main reforms that FoFA will introduce         during 2013.
of ensuring proper funding, operation        are a best-interest duty that will force
                                             financial advisers to put their clients’      A critical change with FoFA will be the
and risk management.                                                                       new pre-emptive powers for ASIC. FoFA
                                             interests first, a ban on conflicted
                                             remuneration and a requirement for            will give the regulator the capacity to
TAIWAN                                                                                     act at an earlier stage if it has concerns
                                             clients to opt-in to financial advice every
Taiwan’s     Financial       Supervisory                                                   about individuals or a licensee. ASIC
                                             two years unless the adviser in question
Commission (FSC) is expected to                                                            will be able to ban a person who is
                                             adheres to an Australian Securities
tackle issues related to corporate                                                         “not of good fame and character or
                                             and Investments Commission (ASIC)
governance in 2013. The FSC has                                                            not adequately trained or competent
                                             approved code of conduct.
already announced a set of measures                                                        to provide financial services”: in
upon which it will focus in 2013 to          While most market participants agree          essence, a fitness and propriety test.
improve the jurisdiction’s corporate         with the intent of the legislation, the       This represents a fundamental shift in
governance. These include increasing         reforms have met strong opposition,           the regulatory approach to licensing
the transparency of its enforcement          in particular from groups such as             in Australia.
actions and the possibility of setting up    stockbrokers, who argue they were not
audit committees for listed companies.       the source of the problems identified         MARKET SUPERVISION: CURTAILING
                                             in the Ripoll Report. Some have raised        THE ALGORITHMS
Elsewhere, the island’s exchange-                                                          ASIC will continue its regulatory reform
                                             concerns that FoFA may trigger a
traded fund (ETF) market has seen its                                                      work in the area of market supervision
                                             wave of consolidation in the financial
profile raised in recent years thanks                                                      during 2013, most notably by putting
                                             advice sector and reduce the overall
to the Taiwan Stock Exchange’s (TSE)                                                       new controls in place to curtail
                                             availability of advice.
support and promotion. Schive Chi,                                                         algorithmic trading and dark pools.
chairman of TSE, has suggested that          The reforms will have huge
                                                                                           The market regulator, which took
overseas ETFs and local ETF products         implications for the business models
                                                                                           over from the Australian Securities
that track overseas indices in the           employed by providers of financial
                                                                                           Exchange (ASX) in 2010, has made
market might be introduced to the            advice in Australia. Businesses that
                                                                                           market supervision a priority amid
jurisdiction in 2013.                        have traditionally relied on hidden
                                                                                           concerns within the financial services
                                             fees, such as volume-based platform
The regulator is also expected to                                                          sector about the growth of high-
                                             fees and trailing commissions, will
continue its fight against insider trading                                                 frequency trading (HFT) and market
                                             be unable to accept those payments
and market manipulation in 2013.                                                           fragmentation. The regulator now
                                             in future. Instead, they will need to
                                                                                           estimates that 30 percent of all trades
                                             persuade their clients to pay for advice
                                                                                           in ASX-listed securities take place in
                                             as an upfront charge. Given that just
                                                                                           unlit venues, while 25 percent of ASX
                                             one in five Australians seeks financial
                                                                                           activity is attributable to HFT. This
                                             advice, this is likely to require a huge
                                                                                           figure has surged to 50 percent of
                                             cultural shift.
                                                                                           all trading activity on the alternative
                                             While high-quality boutique advisers          Chi-X market.

                                                                                                                    REUTERS/Tyrone Siu

In late 2012, ASIC released a set of         stiff opposition from HFT operators,        with dark pools licensed in a different
draft Market Integrity Rules that            which are concerned that it could add       category to public exchanges and
proposed to give the regulator much          latency to their trading algorithms. The    markets, each of which would have its
greater control over algorithmic             pre-trade filters will sit between the      own set of regulatory obligations.
trading. The draft rules have set a clear    client server and the exchange server
trajectory for ASIC’s moves in this area     and make an automated decision on           CENTRAL CLEARING OF OTC
                                                                                         DERIVATIVES: THE INTERNATIONAL
over the next 12 months. Some of the         whether to allow the trade to proceed       AGENDA
more controversial controls include          to the market. Despite the industry’s       The end of 2012 saw the passing
mandatory pre-trade filters and a            concerns, ASIC has indicated that it        of the G20’s deadline to clear all
requirement for market participants          has every intention of proceeding with      standardized over-the-counter (OTC)
to have direct control over their            these reforms in 2013.                      derivative contracts centrally through
clients’ orders.                                                                         central counterparties. Australia’s
                                             In the area of dark pools and market
The proposals are expected to                fragmentation, the government has           major banks are all in a position to
encounter stiff resistance throughout        backed ASIC’s calls for new powers          comply with the requirement. While a
2013 on a number of fronts. One of           to regulate and structure the market.       local central clearing platform is yet
the main concerns is the fact that           Its main priority is to allow ASIC to       to be established, and the banks are
HFT clients closely guard their trading      respond quickly to market changes.          yet to sign up as clearing members
strategies and are unwilling to share this   The government intends to do this           to foreign central clearing platforms
information with market participants.        by passing laws in 2013 that will give      (CCPs), they have each set up client-
At a broader level, however, market          ASIC the ability to vary the license        clearing arrangements with members
participants have supported moves            conditions for different classes of         of offshore CCPs to clear trades on
to require brokers to gain a better          market operators.                           their behalf.
understanding of their clients, their                                                    While that provides a temporary
                                             The government has indicated that
investment goals, and how they intend                                                    solution to compliance with global
                                             the new laws will also enable ASIC to
to achieve those goals.                                                                  initiatives to reduce systemic risk in the
                                             respond to new market types that may
The plans to force brokers to install        emerge in the future. This may involve      OTC derivatives market, in Australia
pre-trade filters have also triggered        the creation of multiple license classes,   the Council of Financial Regulators

is taking more of a “wait and see”            be phased in over two years with the         The government instead created a
approach. The Council includes                requirement commencing by the end            lengthy transition period to the new
representatives from the prudential           of 2013 for major financial institutions     regime to give reporting entities
and securities regulators, the central        following the establishment of a             enough time to get their compliance
bank and the Treasury.                        licensed trade repository.                   processes, systems, and controls
                                                                                           in place.
In December, the Corporations                 Looking ahead, the Council has
Legislation Amendment (Derivative             announced that it will engage further        The AML/CFT legislation will capture
Transactions) Act 2012 became                 with stakeholders to explore their           a range of business sectors, including
law, creating a mechanism by                  concerns about the impediments to            securities market participants, banks,
which mandatory trade reporting,              central clearing. These include the          life insurers, non-bank deposit takers,
central clearing and trade execution          operational and design elements; the         casinos, non-deposit-taking lenders,
obligations can be imposed for                development of mutually acceptable           money changers and trust and company
specified classes of products or              client clearing agreements; how best to      service providers. The supervisory
participants. To date, however, no            manage systemic risks in other markets       responsibilities will be split between
such products or participants have            that do not support central clearing;        the Financial Markets Authority, the
been prescribed. While the regulators         and whether any further regulatory           Reserve Bank of New Zealand and the
have said that they support the idea of       intervention may be warranted to             Department of Internal Affairs.
central clearing for Australian dollar-       improve the efficiency, integrity,
                                                                                           During the development of the AML/
denominated interest rate derivatives,        and stability of the Australian OTC
                                                                                           CFT legislation the government
they would prefer to see a practitioner-      derivatives market and the broader
                                                                                           decided to include financial institutions
led solution. As such, they are not at this   financial system.
                                                                                           and casinos in the first phase of reform
stage planning to impose a mandatory
                                              ANTI-MONEY LAUNDERING:                       and consider designated non-financial
clearing obligation, although this may
                                              NEW ZEALAND                                  businesses and professions in a second
change if the industry does not take the
                                              In January 2012, the clock began             phase, rather like Australia’s proposed
initiative in 2013.
                                              ticking on the final six-month deadline      “tranche two” concept. Pawnbrokers,
As far as trade reporting is concerned,       for the introduction of New Zealand’s        auctioneers and internet-based auction
the regulators are taking a stricter          long-awaited anti-money laundering           sites have obtained special exemptions
stance, recommending that the                 and counter financing of terrorism           from phase one.
Australian government should consider         (AML/CFT) regime. The new regime             One of the key elements of the AML/
the introduction of a mandatory               represents a fundamental shift for           CFT Act will be the requirement to have
trade reporting obligation for a broad        reporting entities in New Zealand. For       in place an appropriate transaction
range of OTC derivatives and market           the first time these entities will have to   monitoring system. Although the
participants. The idea behind this,           put in place a compliance plan, screen       legislation does not state what form
and one that is largely supported by          their customers, monitor transactions        that system should take, experience in
the market, is that the reporting of          and train their employees in AML/            other markets has shown that larger
trades would increase transparency            CFT awareness. The new regime will           reporting entities will inevitably adopt
in the traditionally opaque market,           also overhaul the existing suspicious        some form of automated solution.
which would enhance the efficiency,           transaction reporting obligations and
integrity and stability of the Australian     hand new powers to the country’s             The FIU is planning to move to web-
financial system. A consultation paper        three AML supervisors and the Police         based XML reporting this year and
published in December has proposed            Financial Intelligence Unit (FIU).           will require all suspicious transaction
that a broad-ranging determination                                                         reports (STRs) to be submitted online
                                              The deadline for compliance with the         by June 30. The only exception will be
should be made in the first quarter of
                                              full set of requirements under the Anti-     for reports that are submitted “under
2013 that will require the reporting of
                                              Money Laundering and Countering              urgency”. These reports, which involve
all five derivative classes — comprising
                                              Financing of Terrorism Act 2009              potentially high-risk activity, can be
interest rate, foreign exchange
                                              will be June 30, 2013. New Zealand           lodged in whatever format is fastest for
(FX), credit, equity and commodity
                                              has chosen not to follow Australia’s         the reporting entity.
derivatives — to a licensed trade
                                              lead with the so-called “policy
repository where one is available.
                                              principles” enforcement-free period.
This trade reporting obligation would

There have been calls for financial
services firms to improve dramatically
their risk management capabilities
since 2008, when the world learned
how sorely lacking they were. Since
then there has been plenty of
discussion about risk and even claims
that risk management’s importance
has been elevated. Risk managers,
say commentators, garner much
more respect than before and senior
managers are more likely to listen to
their concerns. That is partially true.
What has been learned in 2012 is that                                                                              REUTERS/Yuriko Nakao

risk management is slowly gaining
                                              which set out specific guidelines           have been low-balling their potential
more importance in financial services.
                                              for integrated data taxonomies and          losses and therefore are holding
It is also clear that not all firms are
                                              architectures across the banks. “A          insufficient capital against them. The
created equal when it comes to
                                              bank should be able to capture and          Financial Policy Committee (FPC), the
managing risk. Some large firms are
                                              aggregate all material risk data across     new stability regulator, also suspects
just beginning to study their risk on a
                                              the banking group. Data should be           that banks’ risk-weighted models are
more granular level, such as liquidity
                                              available by business line, legal entity,   too optimistic.
risk. Moreover, JPMorgan’s costly
                                              asset type, industry, region and other
London Whale debacle demonstrated                                                         Large banks use their own internal
                                              groupings,” it said.
that even firms thought to be good                                                        models to measure risk and sometimes
at managing risk can have Moby                A big challenge for 2013 will be for        these models do not tell the whole
Dick-sized gaps in their systems and          firms, using the BIS principles, to         story. Take the recent reports that
controls. The JPMorgan losses also            improve their effectiveness in risk data    Deutsche Bank was able to game its
showed what risk management is not,           gathering and reporting. Currently,         internal models to hide $12 billion in
for example, proprietary trading: that is     firms struggle with maintenance or          losses back in 2008. Regulators are
risk-taking.                                  upgrades to rickety legacy systems to       onto that kind of behavior. They want
                                              get to a point where they can produce       to make sure firms’ risk models are not
Soon, firms may well have little choice
                                              the risk information regulators are now     making them look stronger than they
about whether they are going to invest
                                              demanding. Many firms have difficulty       really are.
in risk management. The Basel III
                                              in producing complete and accurate
Capital Accords have gone a long way                                                      This issue of gaming internal risk
                                              regulatory reporting program data
toward regulating for risk management                                                     models has become more pronounced
                                              in the time envisaged. In short, firms
practices. To be Basel III-compliant                                                      in recent months. Banks in the U.S. and
                                              simply do not possess the technology
banks will have to step up their risk                                                     Europe have accused their competitors
                                              or the operating model that will allow
management practices and be able to                                                       of rigging risk models to create a rosier
                                              them to deliver what regulators want.
report their findings to the regulators.                                                  picture of the riskiness of the assets they
                                              GREATER SCRUTINY OF RISK MODELS             hold so that they will be able to meet
                                              Scrutiny of banks’ risk models will         more stringent capital requirements.
In September, the Bank for                                                                Regulators on both sides of the Atlantic
                                              increase in 2013. The UK Financial
International     Settlements        (BIS)                                                are wise to banks’ latest ploy, however,
                                              Services Authority (FSA) has already
published its principles for effective risk                                               and are taking measures to prevent
                                              started to go through the books of large
data aggregation and risk reporting,                                                      them from fiddling their internal
                                              UK banks looking for signs that they

models. For example, the European
Banking Authority (EBA) has put a           MODEL RISK MANAGEMENT
lower limit on how low risk weightings
can go when calculating the 9 percent
                                            IN BANKING
capital requirement.
                                            In the recent publication “Prudential       used to calculate regulatory capital
Risks attached to the use of models
                                            Regulation Authority Approach to            requirements to be “appropriately
by banks and insurers are well
                                            Banking Supervision”, the FSA states        conservative”.
recognized within the global regulatory
                                            that while quantitative models can
community. The Basel Committee on                                                       Boards and senior managers must
                                            play an important role in supporting
Banking Supervision (BCBS) has done                                                     understand the data upon which they
                                            firms’ risk management, the regulator
work on the use of models through                                                       base their decisions. Boards that use
                                            will expect firms to be prudent in their
the measures contained in Basel II                                                      output from models to direct parts
                                            use of such models, given the inherent
and III. In the insurance world, Pillar                                                 of their business must be able to
                                            difficulties with risk measurement.
II of Solvency II deals specifically with                                               understand the model, its input and
                                            Senior management and the board
capital evaluation based on internal                                                    output, as well as its limitations.
                                            should, therefore, understand the
assessment of risk and control models,                                                  Compliance staff need to ensure that
                                            extent of reliance on models for
with supervisory review. A particularly                                                 the board and senior managers in their
                                            managing risk, as well as the limitations
stark example of the dangers of using                                                   firms understand the key tenets of any
                                            that arise from the structure and
ineffective models occurred in summer                                                   models they are using, so that they are
                                            complexity of models, the data used as
2012 when JPMorgan had to admit to                                                      able to question and test findings, and
                                            inputs, and underpinning assumptions.
a $2 billion mark-to-market trading                                                     make informed decisions based on the
                                            Models, and their output, should be
loss that had been masked following                                                     information they have received, both
                                            subject to effective, continuing, and
the implementation of a new value-at-                                                   for their own benefit and the benefit of
                                            independent validation to ensure they
risk model. Following the loss, the firm                                                the regulator.
                                            are performing as anticipated.
reverted to its previous model.
                                            The Prudential Regulation Authority         OBJECTIVE CHALLENGE OF MODELS
The U.S. Treasury, through the Office
                                            (PRA), which is due to come into            Model risk needs to be managed and
of the Comptroller of the Currency
                                            being in the UK in the spring of 2013,      mitigated through internal control
(OCC), issued its supervisory guidance
                                            will expect senior managers to have a       mechanisms, using an effective model
on model risk management in April
                                            clear understanding of the risks that       valuation process that has evaluated
2011. This guidance explicitly requires
                                            are not adequately captured by the          conceptual soundness, continuous
banks to ensure that their models are
                                            models used, and the alternative risk       monitoring and outcomes analysis. The
subject to “effective challenge”. The
                                            management processes in place to            U.S. OCC has also stated that a central
UK and Europe has yet to follow suit
                                            ensure that such risks are properly         principle for managing model risk is
with specific, targeted guidance in
                                            measured and incorporated into firms’       the need for “effective challenge” of
this area. But the issue of model risk
                                            overall risk management frameworks.         models: critical analysis by objective,
management is high on the agenda.
                                            The PRA is generally skeptical that         informed parties that can identify
                                            modeling alone can provide an               model limitations and assumptions,
                                            appropriate basis upon which to             and produce appropriate change.
                                            calculate capital requirements for          The PRA documents on banking
                                            the purposes of Pillar I. In any event      and insurance supervision also make
                                            firms will need to have their models        reference to “effective, continuing and
                                            approved by the regulator prior to use.     independent validation” of models.
                                            The PRA has said that models, due to        While the PRA papers do not elaborate
                                            their complex natures that make them        on what “effective challenge” might
                                            time-consuming to review, can hide          look like, the OCC guidance is helpful,
                                            bias and mask the inherent riskiness        and says that effective challenge
                                            of activities. For these reasons, the       depends on a combination of
                                            PRA will, in particular, expect models      incentives, competence, and influence.

                                                                                                                REUTERS/Russell Boyce

Whether such challenge can come              when one considers that the new           NEED TO GUARD AGAINST OVER-
from an internal source, such as model       regulators will be engaging in a much     RELIANCE ON MODELS
experts in the compliance and risk, or       greater degree of peer-group analysis     The PRA paper on banking supervision
internal audit, function, depends on the     than has previously been the case. Cost   makes it clear that the regulator will not
skills of staff in these areas. Some firms   and complexity are factors militating     allow firms to use models to quantify
may prefer to subject their models           against the use of external parties.      risk where there is sufficient data to
to external challenge by engaging                                                      input, in relation to that particular asset
                                             Each firm’s solution to the need          class, or where past experience shows
consultants to conduct the work.
                                             to ensure effective challenge and         that the use of models in that area is
A benefit of engaging external parties       independent validation to its models      inadequate, either in whole or in part.
is that they are arguably more likely        will depend on its nature, scale,         Models have an important part to play
than firms themselves to be aware of         and complexity, and the reliance it       in the measurement and management
prevailing trends and issues around          places on the models it uses. What is     of risk but only as a constituent in a
particular models across the industry        clear is that where the challenge to a    wider risk management framework that
sector in which their clients operate.       model only comes from the designer        includes effective qualitative analysis.
They can perform some peer-group             or owner of that model, the conflict
analysis in the context of models, which     of interest inherent in this makes the
could benefit the client, especially         challenge inadequate.

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