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        International Association of Risk and Compliance
                     Professionals (IARCP)
    1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
      Tel: 202-449-9750 www.risk-compliance-association.com




 Top 10 risk and compliance management related news stories
   and world events that (for better or for worse) shaped the
                week's agenda, and what is next

Dear Member,

This was a difficult week. We had significant
amendments to the Basel iii liquidity rules.
And we needed 206 pages for this weekly
newsletter… Sorry, important things
happen.

1. The LCR will be introduced as planned on 1 January 2015, but the
minimum requirement will begin at 60%, rising in equal annual steps of
10 percentage points to reach 100% on 1 January 2019.




This graduated approach is designed to ensure that the LCR can be
introduced without disruption to the orderly strengthening of banking
systems or the ongoing financing of economic activity.

2. During periods of stress it would be entirely appropriate for banks to
use their stock of high quality liquid assets (HQLA), thereby falling
below the minimum.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
Page |2


3. Banks will be able to count a much wider variety of liquid assets
towards their buffers, including some equities and high-quality
mortgage-backed securities.

4. European and American banking stocks surged because they will incur
much reduced costs due to the implementation of the relaxed rules.

5. Banks in many other counties will have no benefit, as supervisors have
already asked for strict liquidity rules, and they are not willing to take it
back.

6. On the negative side, the main objective of Basel iii is to restore
investor confidence. The Basel Committee has developed the new
framework as a response to the crisis, and has explained (time and time
again, every month since November 2010) the need for these strict rules.

Although it is true that Basel iii is an overreaction to the market crisis, it is
way too late now to “ease” the rules and make (clever) investors happy
the same time.

This is simply a red flag for many investors, leading to the conclusion that
banks could not comply with the rules.

I agree with the Liquidity Coverage ratio (LCR) Basel iii amendment, but
I cannot agree with the way it was presented.

Welcome to the Top 10 list.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
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Basel III - Group of Governors and Heads of
Supervision endorses revised liquidity
standard for banks
The Group of Governors and Heads of Supervision
(GHOS), the oversight body of the Basel Committee
on Banking Supervision, met today to consider the
Basel Committee's amendments to the Liquidity
Coverage Ratio (LCR) as a minimum standard.

It unanimously endorsed them.




Commissioner Michel Barnier

The impact of the latest Basel
Committee liquidity developments for
Capital Requirements (CRD 4) in the
EU

In the light of the Group of Governors and Heads of Supervision meeting
and the Basel Committee on Banking Supervision press release dated 6
January 2013




Basel III: The Liquidity
Coverage Ratio and liquidity risk monitoring
tools, January 2013


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Summary Responses
To the Commissions’
Green Paper on Shadow
Banking
The European Commission's consultation on shadow banking attracted
high interest from stakeholders.

The comments provided cover a broad range of issues and responded to
all the questions raised by the European Commission Green Paper.

The Commission received in total 140 contributions, of which 24 from
Public Authorities; 47 from registered organisations; and, 64 from
individual organisations.




European Union: Financial Sector
Assessment, Preliminary Conclusions
by the IMF Staff

A Financial Sector Assessment Program (FSAP) team led by the
Monetary and Capital Markets Department of the International Monetary
Fund (IMF) visited the European Union (EU) during November
27–December 13, 2012, to conduct a first-ever overall EU-wide assessment
of the soundness and stability of the EU’s financial sector (EU FSAP).




European Cybercrime
Centre (EC3) opens on 11
January
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As from 11 January the new European Cybercrime Centre (EC3) will be
up and running to help protect European citizens and businesses from
cyber-crime.
EU Commissioner for Home Affairs Cecilia Malmström will participate
in the official opening of the Centre established at the European Police
Office, Europol in the Hague (the Netherlands).




Sebastian von Dahlen and Goetz von Peter

Natural catastrophes and global reinsurance –
exploring the linkages

Natural disasters resulting in significant losses have
become more frequent in recent decades,
with 2011 being the costliest year in history.

This feature explores how risk is transferred within and beyond the global
insurance sector and assesses the financial linkages that arise in the
process.




Morten Bech, Todd Keister

On the liquidity coverage ratio and monetary
policy implementation

Basel III introduces the first global framework for bank
liquidity regulation.

As monetary policy typically involves targeting the interest rate
on interbank loans of the most liquid asset – central

      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
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bank reserves – it is important to
understand how this new
requirement will impact the
efficacy of current operational
frameworks.




EIOPA – Risk Dashboard




Sovereign risk – a world without
risk-free assets

Panel comments by Mr Patrick Honohan,
Governor of the Central Bank of Ireland, at
the BIS Conference on “Sovereign risk – a
world without risk-free assets”, Basel, 8
January 2013.

What’s new about sovereign risk since the
crisis began?

Conceptually, not so much, I would suggest – and nothing that cannot be
fully explained within standard models of finance.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
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Basel III - Group of Governors and Heads
of Supervision endorses revised liquidity
standard for banks
6 January 2013

The Group of Governors and Heads of
Supervision (GHOS), the oversight body of the
Basel Committee on Banking Supervision, met
today to consider the Basel Committee's
amendments to the Liquidity Coverage Ratio (LCR) as a minimum
standard.

It unanimously endorsed them.

Today's agreement is a clear commitment to ensure that banks hold
sufficient liquid assets to prevent central banks becoming the "lender of
first resort".

The GHOS also endorsed a new Charter for the Committee, and
discussed the Committee's medium-term work agenda.

The GHOS reaffirmed the LCR as an essential component of the Basel
III reforms.

It endorsed a package of amendments to the formulation of the LCR
announced in 2010.

The package has four elements:

1. Revisions to the definition of high quality liquid assets (HQLA) and net
cash outflows

2. A timetable for phase-in of the standard


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3. A reaffirmation of the usability of the stock of liquid assets in periods of
stress, including during the transition period

4. An agreement for the Basel Committee to conduct further work on the
interaction between the LCR and the provision of central bank facilities.

A summary description of the agreed LCR is in Annex 1.

The changes to the definition of the LCR, developed and agreed by the
Basel Committee over the past two years, include an expansion in the
range of assets eligible as HQLA and some refinements to the assumed
inflow and outflow rates to better reflect actual experience in times of
stress.

These changes are set out in Annex 2.

The GHOS agreed that the LCR should be subject to phase-in
arrangements which align with those that apply to the Basel III capital
adequacy requirements.

Specifically, the LCR will be introduced as planned on 1 January 2015, but
the minimum requirement will begin at 60%, rising in equal annual steps
of 10 percentage points to reach 100% on 1 January 2019.

This graduated approach is designed to ensure that the LCR can be
introduced without disruption to the orderly strengthening of banking
systems or the ongoing financing of economic activity.

The GHOS agreed that, during periods of stress it would be entirely
appropriate for banks to use their stock of HQLA, thereby falling below
the minimum.

Moreover, it is the responsibility of bank supervisors to give guidance on
usability according to circumstances.

The GHOS also agreed today that, since deposits with central banks are
the most - indeed, in some cases, the only - reliable form of liquidity, the

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interaction between the LCR and the provision of central bank facilities is
critically important.

The Committee will therefore continue to work on this issue over the next
year.

GHOS members endorsed two other areas of further analysis.

First, the Committee will continue to develop disclosure requirements for
bank liquidity and funding profiles.

Second, the Committee will continue to explore the use of market-based
indicators of liquidity to supplement the existing measures based on asset
classes and credit ratings.

The GHOS discussed and endorsed the Basel Committee's medium-term
work agenda.

Following the successful agreement of the LCR, the Committee will now
press ahead with the review of the Net Stable Funding Ratio.

This is a crucial component in the new framework, extending the scope of
international agreement to the structure of banks' debt liabilities.

This will be a priority for the Basel Committee over the next two years.

Over the next few years, the Basel Committee will also:

1. Complete the overhaul of the policy framework currently under way

2. Continue to strengthen the peer review programme established in 2012
to monitor the implementation of reforms in individual jurisdictions

3. Monitor the impact of, and industry response to, recent and proposed
regulatory reforms.

During 2012 the Committee has been examining the comparability of
model-based internal risk weightings and considering the appropriate
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balance between the simplicity, comparability and risk sensitivity of the
regulatory framework.

The GHOS encouraged continuation of this work in 2013 as a matter of
priority.

Furthermore, the GHOS supported the Committee's intention to promote
effective macro- and microprudential supervision.

The GHOS also endorsed a new Charter for the Basel Committee.

The new Charter sets out the Committee's objectives and key operating
modalities, and is designed to improve understanding of the Committee's
activities and decision-making processes.

Finally, the GHOS reiterated the importance of full, timely and consistent
implementation of Basel III standards.

Mervyn King, Chairman of the GHOS and Governor of the Bank of
England, said,

"The Liquidity Coverage Ratio is a key component of the Basel III
framework.

The agreement reached today is a very significant achievement.

For the first time in regulatory history, we have a truly global minimum
standard for bank liquidity.

Importantly, introducing a phased timetable for the introduction of the
LCR, and reaffirming that a bank's stock of liquid assets are usable in
times of stress, will ensure that the new liquidity standard will in no way
hinder the ability of the global banking system to finance a recovery."

Stefan Ingves, Chairman of the Basel Committee and Governor of the
Sveriges Riksbank, noted:


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"The amendments to the LCR are designed to ensure that it provides a
sound minimum standard for bank liquidity - a standard that reflects
actual experience during times of stress.

The completion of this work will allow the Basel Committee to turn its
attention to refining the other component of the new global liquidity
standards, the Net Stable Funding Ratio, which remains subject to an
observation period ahead of its implementation in 2018."

Annex 1

Summary description of the LCR

To promote short-term resilience of a bank’s liquidity risk profile, the
Basel Committee developed the Liquidity Coverage Ratio (LCR).

This standard aims to ensure that a bank has an adequate stock of
unencumbered high quality liquid assets (HQLA) which consists of cash
or assets that can be converted into cash at little or no loss of value in
private markets to meet its liquidity needs for a 30 calendar day liquidity
stress scenario.

The LCR has two components:

(a) The value of the stock of HQLA

(b) Total net cash outflows

and is expressed as:




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High Quality Liquid Assets

The numerator of the LCR is the stock of HQLA.

Under the standard, banks must hold a stock of unencumbered HQLA to
cover the total net cash outflows over a 30-day period under the
prescribed stress scenario.

In order to qualify as HQLA, assets should be liquid in markets during a
time of stress and, in most cases, be eligible for use in central bank
operations.

Certain types of assets within HQLA are subject to a range of haircuts.

HQLA are comprised of Level 1 and Level 2 assets.

Level 1 assets generally include cash, central bank reserves, and certain
marketable securities backed by sovereigns and central banks, among
others.

These assets are typically of the highest quality and the most liquid, and
there is no limit on the extent to which a bank can hold these assets to
meet the LCR.

Level 2 assets are comprised of Level 2A and Level 2B assets and include
certain marketable government securities as well as corporate debt
securities, residential mortgage backed securities and equities that meet
certain conditions.

Level 2 assets (comprising Level 2A and Level 2B assets) are typically of
slightly lesser quality and may not in aggregate account for more than
40% of a bank’s stock of HQLA.

Level 2B assets may not account for more than 15% of a bank’s total stock
of HQLA.



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Total net cash outflows

The denominator of the LCR is the total net cash outflows.

It is defined as total expected cash outflows, minus total expected cash
inflows, in the specified stress scenario for the subsequent 30 calendar
days.

Total expected cash outflows are calculated by multiplying the
outstanding balances of various categories or types of liabilities and
off-balance sheet commitments by the rates at which they are expected to
run off or be drawn down.

Total expected cash inflows are calculated by multiplying the outstanding
balances of various categories of contractual receivables by the rates at
which they are expected to flow in.

Total cash inflows are subject to an aggregate cap of 75% of total
expected cash outflows, thereby ensuring a minimum level of HQLA
holdings at all times.

Liquidity Coverage Ratio

The standard requires that, absent a situation of financial stress, the value
of the ratio be no lower than 100% (ie the stock of HQLA should at least
equal total net cash outflows).

Banks are expected to meet this requirement continuously and hold a
stock of unencumbered HQLA as a defence against the potential onset of
liquidity stress.

During a period of financial stress, however, banks may use their stock of
HQLA, thereby falling below 100%.

Important - The 100% threshold is the minimum requirement absent a
period of financial stress, and after the phase-in arrangements are
complete.

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References to 100% may be adjusted for any phase-in arrangements in
force at a particular time.

Annex 2
Complete set of agreed changes to the Liquidity Coverage Ratio

HIGH QUALITY LIQUID ASSETS (HQLA)

Expand the definition of HQLA subject to a higher haircut and limit

- Corporate debt securities rated A+ to BBB– with a 50% haircut

- Certain unencumbered equities subject to a 50% haircut

- Certain residential mortgage-backed securities rated AA or higher with a
25% haircut

Aggregate of additional assets, after haircuts, subject to a 15% limit of the
HQLA

Rating requirement on qualifying Level 2 assets

- Use of local rating scales and inclusion of qualifying commercial paper

Usability of the liquidity pool

- Incorporate language related to the expectation that banks will use their
pool of HQLA during periods of stress

Operational requirements

- Refine and clarify the operational requirements for HQLA

Operation of the cap on Level 2 HQLA

- Revise and improve the operation of the cap


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Alternative liquid asset (ALA) framework

- Develop the alternative treatments and include a fourth option for
sharia-compliant banks

Central bank reserves

- Clarify language to confirm that supervisors have national discretion to
include or exclude required central bank reserves (as well as overnight
and certain term deposits) as HQLA as they consider appropriate

INFLOWS AND OUTFLOWS

Insured deposits

- Reduce outflow on certain fully insured retail deposits from 5% to 3%

- Reduce outflow on fully insured non-operational deposits from
non-financial corporates, sovereigns, central banks and public sector
entities (PSEs) from 40% to 20%

Non-financial corporate deposits

- Reduce the outflow rate for “non-operational” deposits provided by
non-financial corporates, sovereigns, central banks and PSEs from 75% to
40%

Committed liquidity facilities to non-financial corporates

- Clarify the definition of liquidity facilities and reduce the drawdown rate
on the unused portion of committed liquidity facilities to non-financial
corporates, sovereigns, central banks and PSEs from 100% to 30%

Committed but unfunded inter-financial liquidity and credit facilities

- Distinguish between interbank and inter-financial credit and liquidity
facilities and reduce the outflow rate on the former from 100% to 40%
Derivatives
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- Additional derivatives risks included in the LCR with a 100% outflow
(relates to collateral substitution, and excess collateral that the bank is
contractually obligated to return/provide if required by a counterparty)

- Introduce a standardised approach for liquidity risk related to market
value changes in derivatives positions

- Assume net outflow of 0% for derivatives (and commitments) that are
contractually secured/collateralised by HQLA

Trade finance

- Include guidance to indicate that a low outflow rate (0–5%) is expected
to apply

Equivalence of central bank operations

- Reduce the outflow rate on maturing secured funding transactions with
central banks from 25% to 0%

Client servicing brokerage

- Clarify the treatment of activities related to client servicing brokerage
(which generally lead to an increase in net outflows)

OTHER

Rules text clarifications

- Clearer guidance on the usability of HQLA, and the appropriate
supervisory response, has been developed to ensure that the stock of
liquid assets is available to be used when needed

- A number of clarifications to the rules text to promote consistent
application and reduce arbitrage opportunities (eg operational deposits
from wholesale clients, derivatives cash flows, open maturity loans). Also
incorporation of previously agreed FAQ

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Internationally agreed phase-in of the LCR

- The minimum LCR in 2015 would be 60% and increase by 10 percentage
points per year to reach 100% in 2019




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Basel Committee on Banking Supervision (BCBS) Charter
January 2013

I. Purpose and role
1. Mandate
The BCBS is the primary global standard-setter for the prudential
regulation of banks and provides a forum for cooperation on banking
supervisory matters.

Its mandate is to strengthen the regulation, supervision and practices of
banks worldwide with the purpose of enhancing financial stability.
2. Activities
The BCBS seeks to achieve its mandate through the following activities:

(a) Exchanging information on developments in the banking sector and
financial markets, to help identify current or emerging risks for the global
financial system;

(b) Sharing supervisory issues, approaches and techniques to promote
common understanding and to improve cross-border cooperation;

(c) Establishing and promoting global standards for the regulation and
supervision of banks as well as guidelines and sound practices;

(d) Addressing regulatory and supervisory gaps that pose risks to
financial stability;

(e) Monitoring the implementation of BCBS standards in member
countriesand beyond with the purpose of ensuring their timely, consistent
and effective implementation and contributing to a "level playing field"
among internationally-active banks;

(f) Consulting with central banks and bank supervisory authorities which
are not members of the BCBS to benefit from their input into the BCBS
policy formulation process and to promote the implementation of BCBS

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standards, guidelines and sound practices beyond BCBS member
countries; and

(g) Coordinating and cooperating with other financial sector standard
setters and international bodies, particularly those involved in promoting
financial stability.
3. Legal status
The BCBS does not possess any formal supranational authority. Its
decisions do not have legal force.

Rather, the BCBS relies on its members' commitments, as described in
Section 5, to achieve its mandate.
II. Membership

4. BCBS members
BCBS members include organisations with direct banking supervisory
authority and central banks.

After consulting the Committee, the BCBS Chairman may invite other
organisations to become BCBS observers.

BCBS membership and observer status will be reviewed periodically.

In accepting new members, due regard will be given to the importance of
their national banking sectors to international financial stability.

The Committee will make recommendations to its oversight body, the
Group of Governors and Heads of Supervision, for changes in BCBS
membership.

The Secretariat will publish the list of BCBS members and observers on
its website.
5. BCBS members' responsibilities
BCBS members are committed to:
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(a) Work together to achieve the mandate of the BCBS;

(b) Promote financial stability;

(c) Continuously enhance their quality of banking regulation and
supervision;

(d) Actively contribute to the development of BCBS standards, guidelines
and sound practices;

(e) Implement and apply BCBS standards in their domestic jurisdictions
2 within the pre-defined timeframe established by the Committee;

(f) Undergo and participate in BCBS reviews to assess the consistency
and effectiveness of domestic rules and supervisory practices in relation
to BCBS standards; and

(g) Promote the interests of global financial stability and not solely
national interests, while participating in BCBS work and
decision-making.
III. Oversight

6. The Group of Governors and Heads of Supervision (GHOS)
The GHOS is the oversight body of the BCBS.

The BCBS reports to the GHOS and seeks its endorsement for major
decisions.

In addition, the BCBS looks to the GHOS to:

(a) Approve the BCBS Charter and any amendments to this document;

(b) Provide general direction for the BCBS work programme

(c) Appoint the BCBS Chairman from among its members.


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If the BCBS Chairman ceases to be a GHOS member before the end of
his/her term, the GHOS will appoint a new Chairman.

Until a new Chairman has been appointed, the Secretary General assumes
the Chairman's functions.
IV. Organisation

7. Structure
The internal organisational structure of the BCBS comprises:

(a) The Committee

(b) Groups, working groups and task forces

(c) The Chairman

(d) The Secretariat
8. The Committee
The Committee is the ultimate decision-making body of the BCBS with
responsibility for ensuring that its mandate is achieved.
8.1 Responsibilities
The Committee is responsible for:

(a) Developing, guiding and monitoring the BCBS work programme
within the general direction provided by GHOS;

(b) Establishing and promoting BCBS standards, guidelines and sound
practices;

(c) Establishing and disbanding groups, working groups and task forces;
approving and modifying their mandates; and monitoring their progress;

(e) Recommending to the GHOS amendments to the BCBS Charter; and


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(f) Deciding on the organisational regulations governing its activities.
8.2 Number of Committee meetings
The Committee generally meets four times every year.

However, the Chairman can decide to hold additional meetings as
necessary.
8.3 Representation at Committee meetings
The Chairman presides over Committee meetings.

All BCBS members and observers are entitled to appoint one
representative to attend Committee meetings.

BCBS representatives should be senior officials of their organisations and
should have the authority to commit their institutions.

Representation at Committee meetings is expected to be, for example, at
the level of head of banking supervision, head of banking
policy/regulation, central bank deputy governor, head of financial
stability department or equivalent.
8.4 Decisions
Decisions by the Committee are taken by consensus among its members.
8.5 Communication of decisions
Committee decisions of public interest shall be communicated through
the BCBS website.

The Committee shall issue, when appropriate, press statements to
communicate its decisions.
9. Groups, working groups and task forces
The BCBS's work is largely organised around groups, working groups
and task forces.



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The Secretariat will make publicly available the list of BCBS groups and
working groups.
9.1 Groups
BCBS groups report directly to the Committee.

They are composed of senior staff from BCBS members that guide or
undertake themselves major areas of Committee work. BCBS groups
form part of the permanent internal structure of the BCBS and thus
operate without a specific deliverable or end date.
9.2 Working groups
Working groups consist of experts from BCBS members that support the
technical work of BCBS groups.
9.3 Task forces
Task forces are created to undertake specific tasks for a limited time.

These are generally composed of technical experts from BCBS member
institutions.

However, when these groupings are created by the Committee, they
consist of BCBS representatives and deal with specific issues that require
prompt attention of the Committee. In such cases, they are called
high-level task forces.
10. Chairman
The Chairman directs the work of the Committee in accordance with the
BCBS mandate.
10.1 Appointment
The Chairman is appointed by the GHOS for a term of three years that
can be renewed once.
10.2 Responsibilities
The Chairman's main responsibilities are to:


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(a) Convene and chair Committee meetings.

If the Chairman is unable to attend a Committee meeting, he or she can
designate the Secretary General to chair the meeting on his/her behalf;

(b) Monitor the progress of the BCBS work programme and provide
operational guidance between meetings to carry forward the decisions
and directions of the Committee;

(c) Report to the GHOS when appropriate; and

(d) Represent the BCBS externally and be the principal spokesperson for
the BCBS.
11. The Secretariat
The Secretariat is provided by the Bank for International Settlements
(BIS) and supports the work of the Committee, the Chairman and the
groups around which the Committee organises its work.

The Secretariat is staffed mainly by professional staff, mostly on
temporary secondment from BCBS members.
11.1 Responsibilities
The Secretariat's main responsibilities are to:

(a) Provide support and assistance to the Committee, the Chairman,
groups, working groups and task forces;

(b) Ensure timely and effective information flow to all BCBS members;

(c) Facilitate coordination across groups, working groups and task forces;

(d) Facilitate a close contact between BCBS members and non-member
authorities;

(e) Support the cooperation between the BCBS and other institutions;


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(f) Maintain the BCBS records, administer the BCBS website and deal
with correspondence of the BCBS; and

(g) Carry out all other functions that are assigned by the Committee and
the Chairman.
11.2 Secretary General
The Secretary General reports to the Chairman and directs the work of the
Secretariat.

The Secretary General manages the financial, material and human
resources allocated to the Secretariat.

He/she also assists the Chairman in representing the Committee
externally.

The Secretary General is selected by the Chairman on recommendation of
a selection panel comprising BCBS and/or GHOS members and a senior
representative of the BIS.

The term of appointment is typically three years with the potential to be
extended.
11.3 Deputy Secretaries General
Deputy Secretaries General report to and assist the Secretary General in
discharging his/her duties.

Deputy Secretaries General substitute for the Secretary General in case of
absence, incapacity or as requested by the Secretary General.

Deputy Secretaries General are selected by the Secretary General in
conjunction with the Chairman.
11.4 Location of the Secretariat
The Secretariat is located at the BIS in Basel.



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V. BCBS standards, guidelines and sound practices

12. Standards
The BCBS sets standards for the prudential regulation and supervision of
banks.

The BCBS expects full implementation of its standards by BCBS
members and their internationally active banks.

However, BCBS standards constitute minimum requirements and BCBS
members may decide to go beyond them.

The Committee expects standards to be incorporated into local legal
frameworks through each jurisdiction's rule-making process within the
pre-defined timeframe established by the Committee.

If deviation from literal transposition into local legal frameworks is
unavoidable, members should seek the greatest possible equivalence of
standards and their outcome.
13. Guidelines
Guidelines elaborate the standards in areas where they are considered
desirable for the prudential regulation and supervision of banks, in
particular international active banks.

They generally supplement BCBS standards by providing additional
guidance for the purpose of their implementation.
14. Sound practices
Sound practices generally describe actual observed practices, with the
goal of promoting common understanding and improving supervisory or
banking practices.

BCBS members are encouraged to compare these practices with those
applied by themselves and their supervised institutions to identify
potential areas for improvement.

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VI. Consultation with non-member authorities

15. Consultation with non-member authorities
Consistent with the activities described under section 2, the BCBS is
committed to consulting widely on its activities with non-member
authorities through the following structures and mechanisms:
15.1 The Basel Consultative Group (BCG)
The BCG provides a forum for deepening the Committee's engagement
with supervisors around the world on banking supervisory issues.

It facilitates broad supervisory dialogue with non-member authorities on
new Committee initiatives early in the process by gathering senior
representatives from various countries, international institutions and
regional groups of banking supervisors that are not members of the
Committee.
15.2 The International Conferences of Banking Supervisors (ICBS)
The biennial ICBS provides a venue for supervisors around the world to
discuss issues of common interest.
15.3 Participation in BCBS groups, working groups and task forces
By participating as observers in BCBS bodies, non-member authorities
contribute to the Committee's policy development work.
15.4 The Financial Stability Institute (FSI)
The FSI is a joint initiative of the BCBS and the BIS to assist supervisors
around the world in implementing sound prudential standards.

The BCBS supports FSI activities, including in particular the BCBS-FSI
High Level Meetings.

These are targeted at senior policymakers within central banks and
supervisory authorities and provide a series of regional fora for
distributing information on BCBS standards, keeping participants
updated on Committee work, sharing supervisory practices and concerns,
and establishing and maintaining strong contacts.
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15.5 Regional groups of banking supervisors
The BCBS supports the work and activities of regional groups of banking
supervisors worldwide.

Secretariat staff may participate in meetings of such groups to exchange
ideas and seek feedback on BCBS work.
VII. Relationship with other international financial bodies

16. International cooperation
The BCBS cooperates with other international financial standard setters
and public sector bodies with the purpose of achieving an enhanced
coordination of policy development and implementation.

In carrying out their responsibilities to support this cooperation, the
Chairman and the Secretariat will pay particular attention to the need to
comply with the BCBS's due process and governance arrangements.

Together with other international financial standard setters, the BCBS
sponsors the Joint Forum, where issues of common concern to the
standard setters can be addressed and recommendations for coordinated
action can be developed.

The BCBS is a member of the Financial Stability Board (FSB) and
participates in the FSB's work to develop, coordinate and promote the
implementation of effective regulatory, supervisory and other financial
sector policies.
VIII. Public consultation process

17. Public consultation process of draft BCBS standards, guidelines
and sound practices
In principle, the BCBS seeks input from all relevant stakeholders on
policy proposals.



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The consultation process will include issuing a public invitation to
interested parties to provide comments in writing to the Secretariat on
policy proposals issued by the Committee, within a specified timeframe.

The consultation period shall normally last 90 calendar days, but could
exceptionally be shorter or longer.

As a general rule, responses to public invitations for comments shall be
published on the BCBS website, unless confidential treatment is
requested by respondents.

This process is compulsory for BCBS standards.




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Commissioner Michel Barnier

The impact of the latest Basel
Committee liquidity developments for
Capital Requirements (CRD 4) in the EU

In the light of the Group of Governors and Heads of Supervision meeting
and the Basel Committee on Banking Supervision press release dated 6
January 2013
"I welcome the unanimous agreement reached by the Basel Committee
on the revised liquidity coverage ratio and the gradual approach for its
phasing-in by clearly defined dates.
This is significant progress which addresses issues already raised by the
European Commission.
We now need to make full use of the observation period, and learn from
the reports that the European Banking Authority will prepare on the
results of the observation period, before formally implementing in 2015
the liquidity coverage ratio under EU law in line with the Basel
standards.
The treatment of liquidity is fundamental, both for the stability of banks
as well as for their role in supporting wider economic recovery.
I now call upon the Parliament and the Council to successfully conclude
the CRD 4 trilogue negotiations in the coming weeks."

Context
The Basel Committee on Banking Supervision (BCBS) has agreed a
package of LCR (liquidity coverage ratio) revisions unanimously as well
as its 2013 work plan.
The LCR revisions include an expansion of eligible assets, a less severe
calibration for certain cash flows and a phasing-in arrangement from
January 2015 to 2019.

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The current Commission approach to liquidity in the CRD4 negotiations,
namely first a reporting period followed by comprehensive European
Banking Authority (EBA) Reports and subsequently a delegated act by
the Commission to define the detailed ratio remains fully valid.

Background information
The Commission's approach to liquidity in CRD 4 still remains valid in
the light of the latest Basel Committee approval of the revision of a
number of parameters and calibrations on liquidity (GHOS meeting of 6
January).
In the Basel Committee, the European Central Bank, the European
Commission and various countries including from the EU had argued for
such a revision.
At the level of the Basel Committee, the final package of LCR revisions
will now be subject to an observation period with a Quantitative Impact
Study (QIS) that will take place in 2013 together with some other
important work that still needs to be completed in the coming year.
The EU needs to take full benefit of this observation period and learn
from it, as this is the first time in history that regulators are defining
globally harmonized, quantitative liquidity standards.
The EBA will make reports on the results of the observation period for
EU banks before the end of 2013.
Based on the evaluation of this work, the Commission will propose
defining the detailed LCR through a delegated act (i.e. legislation
adopted by the Commission provided no objections are raised by the EP
and the Council).
Nevertheless, important work still remains to be completed at the global
and European levels.
This includes the determination of alternative, market-based indicators
for the definition of High Quality Liquid Assets (HQLA); the treatment
of Central Bank facilities which could impact upon the definition of
HQLA and related cash flows; and the treatment of market valuation
changes on derivative cash flows.


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In this light, the best course continues to be rapid adoption of the CRD 4
package while leaving the necessary flexibility to implement the final
detailed LCR standard through a delegated act, taking into account the
on-going work by Basel and the comprehensive EBA reports.
Subject to this approach, the texts on the table now of the European
Parliament and Council should be adopted shortly, hopefully in the
coming weeks.




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Basel III: The Liquidity
Coverage Ratio and liquidity risk
monitoring tools, January 2013

Introduction
1. This document presents one of the Basel
Committee’s key reforms to develop a more
resilient banking sector: the Liquidity
Coverage Ratio (LCR).

The objective of the LCR is to promote the
short-term resilience of the liquidity risk profile of banks.

It does this by ensuring that banks have an adequate stock of
unencumbered high-quality liquid assets (HQLA) that can be converted
easily and immediately in private markets into cash to meet their liquidity
needs for a 30 calendar day liquidity stress scenario.

The LCR will improve the banking sector’s ability to absorb shocks
arising from financial and economic stress, whatever the source, thus
reducing the risk of spillover from the financial sector to the real
economy.

This document sets out the LCR standard and timelines for its
implementation.

2. During the early “liquidity phase” of the financial crisis that began in
2007, many banks – despite adequate capital levels – still experienced
difficulties because they did not manage their liquidity in a prudent
manner.

The crisis drove home the importance of liquidity to the proper
functioning of financial markets and the banking sector.


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Prior to the crisis, asset markets were buoyant and funding was readily
available at low cost.

The rapid reversal in market conditions illustrated how quickly liquidity
can evaporate, and that illiquidity can last for an extended period of time.

The banking system came under severe stress, which necessitated central
bank action to support both the functioning of money markets and, in
some cases, individual institutions.

3. The difficulties experienced by some banks were due to lapses in basic
principles of liquidity risk management.

In response, as the foundation of its liquidity framework, the
Committee in 2008 published Principles for Sound Liquidity Risk
Management and Supervision (“Sound Principles”).

The Sound Principles provide detailed guidance on the risk management
and supervision of funding liquidity risk and should help promote better
risk management in this critical area, but only if there is full
implementation by banks and supervisors.

As such, the Committee will continue to monitor the implementation by
supervisors to ensure that banks adhere to these fundamental principles.

4. To complement these principles, the Committee has further
strengthened its liquidity framework by developing two minimum
standards for funding liquidity.

These standards have been developed to achieve two separate but
complementary objectives.

The first objective is to promote short-term resilience of a bank’s liquidity
risk profile by ensuring that it has sufficient HQLA to survive a
significant stress scenario lasting for one month.

The Committee developed the LCR to achieve this objective.

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The second objective is to promote resilience over a longer time horizon
by creating additional incentives for banks to fund their activities with
more stable sources of funding on an ongoing basis.

The Net Stable Funding Ratio (NSFR), which is not covered by this
document, supplements the LCR and has a time horizon of one year.

It has been developed to provide a sustainable maturity structure of assets
and liabilities.

5. These two standards are comprised mainly of specific parameters
which are internationally “harmonised” with prescribed values.

Certain parameters, however, contain elements of national discretion to
reflect jurisdiction-specific conditions.

In these cases, the parameters should be transparent and clearly outlined
in the regulations of each jurisdiction to provide clarity both within the
jurisdiction and internationally.

6. It should be stressed that the LCR standard establishes a minimum
level of liquidity for internationally active banks.

Banks are expected to meet this standard as well as adhere to the Sound
Principles.

Consistent with the Committee’s capital adequacy standards, national
authorities may require higher minimum levels of liquidity.

In particular, supervisors should be mindful that the assumptions within
the LCR may not capture all market conditions or all periods of stress.

Supervisors are therefore free to require additional levels of liquidity to be
held, if they deem the LCR does not adequately reflect the liquidity risks
that their banks face.

7. Given that the LCR is, on its own, insufficient to measure all
dimensions of a bank’s liquidity profile, the Committee has also
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developed a set of monitoring tools to further strengthen and promote
global consistency in liquidity risk supervision.

These tools are supplementary to the LCR and are to be used for ongoing
monitoring of the liquidity risk exposures of banks, and in
communicating these exposures among home and host supervisors.

8. The Committee is introducing phase-in arrangements to implement
the LCR to help ensure that the banking sector can meet the standard
through reasonable measures, while still supporting lending to the
economy.

9. The Committee remains firmly of the view that the LCR is an essential
component of the set of reforms introduced by Basel III and, when
implemented, will help deliver a more robust and resilient banking
system.

However, the Committee has also been mindful of the implications of the
standard for financial markets, credit extension and economic growth,
and of introducing the LCR at a time of ongoing strains in some banking
systems.

It has therefore decided to provide for a phased introduction of the LCR,
in a manner similar to that of the Basel III capital adequacy requirements.

10. Specifically, the LCR will be introduced as planned on 1 January 2015,
but the minimum requirement will be set at 60% and rise in equal annual
steps to reach 100% on 1 January 2019.

This graduated approach, coupled with the revisions made to the 2010
publication of the liquidity standards, are designed to ensure that the
LCR can be introduced without material disruption to the orderly
strengthening of banking systems or the ongoing financing of economic
activity.




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11. The Committee also reaffirms its view that, during periods of stress, it
would be entirely appropriate for banks to use their stock of HQLA,
thereby falling below the minimum.

Supervisors will subsequently assess this situation and will give guidance
on usability according to circumstances.

Furthermore, individual countries that are receiving financial support for
macroeconomic and structural reform purposes may choose a different
implementation schedule for their national banking systems, consistent
with the design of their broader economic restructuring programme.

12. The Committee is currently reviewing the NSFR, which continues to
be subject to an observation period and remains subject to review to
address any unintended consequences.

It remains the Committee’s intention that the NSFR, including any
revisions, will become a minimum standard by 1 January 2018.

13. This document is organised as follows:

- Part 1 defines the LCR for internationally active banks and deals with
  application issues.

- Part 2 presents a set of monitoring tools to be used by banks and
  supervisors in their monitoring of liquidity risks.

Part 1: The Liquidity Coverage Ratio
14. The Committee has developed the LCR to promote the short-term
resilience of the liquidity risk profile of banks by ensuring that they have
sufficient HQLA to survive a significant stress scenario lasting 30
calendar days.

15. The LCR should be a key component of the supervisory approach to
liquidity risk, but must be supplemented by detailed supervisory
assessments of other aspects of the bank’s liquidity risk management

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framework in line with the Sound Principles, the use of the monitoring
tools included in Part 2, and, in due course, the NSFR.

In addition, supervisors may require an individual bank to adopt more
stringent standards or parameters to reflect its liquidity risk profile and
the supervisor’s assessment of its compliance with the Sound Principles.

I. Objective of the LCR and use of HQLA

16. This standard aims to ensure that a bank has an adequate stock of
unencumbered HQLA that consists of cash or assets that can be
converted into cash at little or no loss of value in private markets, to meet
its liquidity needs for a 30 calendar day liquidity stress scenario.

At a minimum, the stock of unencumbered HQLA should enable the
bank to survive until Day 30 of the stress scenario, by which time it is
assumed that appropriate corrective actions can be taken by management
and supervisors, or that the bank can be resolved in an orderly way.

Furthermore, it gives the central bank additional time to take appropriate
measures, should they be regarded as necessary.

As noted in the Sound Principles, given the uncertain timing of outflows
and inflows, banks are also expected to be aware of any potential
mismatches within the 30-day period and ensure that sufficient HQLA
are available to meet any cash flow gaps throughout the period.

17. The LCR builds on traditional liquidity “coverage ratio”
methodologies used internally by banks to assess exposure to contingent
liquidity events.

The total net cash outflows for the scenario are to be calculated for 30
calendar days into the future.

The standard requires that, absent a situation of financial stress, the value
of the ratio be no lower than 100% (ie the stock of HQLA should at least
equal total net cash outflows) on an ongoing basis because the stock of
unencumbered HQLA is intended to serve as a defence against the
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potential onset of liquidity stress.

During a period of financial stress, however, banks may use their stock of
HQLA, thereby falling below 100%, as maintaining the LCR at 100%
under such circumstances could produce undue negative effects on the
bank and other market participants.

Supervisors will subsequently assess this situation and will adjust their
response flexibly according to the circumstances.

18. In particular, supervisory decisions regarding a bank’s use of its
HQLA should be guided by consideration of the core objective and
definition of the LCR.

Supervisors should exercise judgement in their assessment and account
not only for prevailing macrofinancial conditions, but also consider
forward-looking assessments of macroeconomic and financial conditions.

In determining a response, supervisors should be aware that some actions
could be procyclical if applied in circumstances of market-wide stress.

Supervisors should seek to take these considerations into account on a
consistent basis across jurisdictions.

(a) Supervisors should assess conditions at an early stage, and take
actions if deemed necessary, to address potential liquidity risk.

(b) Supervisors should allow for differentiated responses to a reported
LCR below 100%.

Any potential supervisory response should be proportionate with the
drivers, magnitude, duration and frequency of the reported shortfall.

(c) Supervisors should assess a number of firm- and market-specific
factors in determining the appropriate response as well as other
considerations related to both domestic and global frameworks and
conditions.

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Potential considerations include, but are not limited to:

(i) The reason(s) that the LCR fell below 100%.

This includes use of the stock of HQLA, an inability to roll over funding
or large unexpected draws on contingent obligations.

In addition, the reasons may relate to overall credit, funding and market
conditions, including liquidity in credit, asset and funding markets,
affecting individual banks or all institutions, regardless of their own
condition;

(ii) The extent to which the reported decline in the LCR is due to a
firm-specific or market-wide shock;

(iii) A bank’s overall health and risk profile, including activities, positions
with respect to other supervisory requirements, internal risk systems,
controls and other management processes, among others;

(iv) The magnitude, duration and frequency of the reported decline of
HQLA;

(v) The potential for contagion to the financial system and additional
restricted flow of credit or reduced market liquidity due to actions to
maintain an LCR of 100%;

(vi) The availability of other sources of contingent funding such as central
bank funding, or other actions by prudential authorities.

(d) Supervisors should have a range of tools at their disposal to address a
reported LCR below 100%.

Banks may use their stock of HQLA in both idiosyncratic and systemic
stress events, although the supervisory response may differ between the
two.

(i) At a minimum, a bank should present an assessment of its liquidity
position, including the factors that contributed to its LCR falling below
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100%, the measures that have been and will be taken and the expectations
on the potential length of the situation.

Enhanced reporting to supervisors should be commensurate with the
duration of the shortfall.

(ii) If appropriate, supervisors could also require actions by a bank to
reduce its exposure to liquidity risk, strengthen its overall liquidity risk
management, or improve its contingency funding plan.

(iii) However, in a situation of sufficiently severe system-wide stress,
effects on the entire financial system should be considered.

Potential measures to restore liquidity levels should be discussed, and
should be executed over a period of time considered appropriate to
prevent additional stress on the bank and on the financial system as a
whole.

(e) Supervisors’ responses should be consistent with the overall approach
to the prudential framework.

II. Definition of the LCR

19. The scenario for this standard entails a combined idiosyncratic and
market-wide shock that would result in:

(a) The run-off of a proportion of retail deposits;

(b) A partial loss of unsecured wholesale funding capacity;

(c) A partial loss of secured, short-term financing with certain collateral
and counterparties;

(d) Additional contractual outflows that would arise from a downgrade in
the bank’s public credit rating by up to and including three notches,
including collateral posting requirements;


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(e) Increases in market volatilities that impact the quality of collateral or
potential future exposure of derivative positions and thus require larger
collateral haircuts or additional collateral, or lead to other liquidity needs;

(f) Unscheduled draws on committed but unused credit and liquidity
facilities that the bank has provided to its clients; and

(g) The potential need for the bank to buy back debt or honour
non-contractual obligations in the interest of mitigating reputational risk.

20. In summary, the stress scenario specified incorporates many of the
shocks experienced during the crisis that started in 2007 into one
significant stress scenario for which a bank would need sufficient
liquidity on hand to survive for up to 30 calendar days.

21. This stress test should be viewed as a minimum supervisory
requirement for banks.

Banks are expected to conduct their own stress tests to assess the level of
liquidity they should hold beyond this minimum, and construct their own
scenarios that could cause difficulties for their specific business activities.

Such internal stress tests should incorporate longer time horizons than
the one mandated by this standard.

Banks are expected to share the results of these additional stress tests
with supervisors.

22. The LCR has two components:

(a) Value of the stock of HQLA in stressed conditions; and

(b) Total net cash outflows, calculated according to the scenario
parameters outlined below.




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A. Stock of HQLA

23. The numerator of the LCR is the “stock of HQLA”.

Under the standard, banks must hold a stock of unencumbered HQLA to
cover the total net cash outflows (as defined below) over a 30-day period
under the prescribed stress scenario.

In order to qualify as “HQLA”, assets should be liquid in markets during
a time of stress and, ideally, be central bank eligible.

The following sets out the characteristics that such assets should
generally possess and the operational requirements that they should
satisfy.
1. Characteristics of HQLA

24. Assets are considered to be HQLA if they can be easily and
immediately converted into cash at little or no loss of value.

The liquidity of an asset depends on the underlying stress scenario, the
volume to be monetised and the timeframe considered.

Nevertheless, there are certain assets that are more likely to generate
funds without incurring large discounts in sale or repurchase agreement
(repo) markets due to fire-sales even in times of stress.

This section outlines the factors that influence whether or not the market
for an asset can be relied upon to raise liquidity when considered in the
context of possible stresses.

These factors should assist supervisors in determining which assets,
despite meeting the criteria from paragraphs 49 to 54, are not sufficiently
liquid in private markets to be included in the stock of HQLA.




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(i) Fundamental characteristics

- Low risk: assets that are less risky tend to have higher liquidity.

   High credit standing of the issuer and a low degree of subordination
   increase an asset’s liquidity.

   Low duration, low legal risk, low inflation risk and denomination in a
   convertible currency with low foreign exchange risk all enhance an
   asset’s liquidity.

- Ease and certainty of valuation: an asset’s liquidity increases if market
  participants are more likely to agree on its valuation.

   Assets with more standardised, homogenous and simple structures
   tend to be more fungible, promoting liquidity.

   The pricing formula of a high-quality liquid asset must be easy to
   calculate and not depend on strong assumptions.

   The inputs into the pricing formula must also be publicly available.

   In practice, this should rule out the inclusion of most structured or
   exotic products.

- Low correlation with risky assets: the stock of HQLA should not be
  subject to wrong-way (highly correlated) risk.

   For example, assets issued by financial institutions are more likely to
   be illiquid in times of liquidity stress in the banking sector.

- Listed on a developed and recognised exchange: being listed
  increases an asset’s transparency.

(ii) Market-related characteristics
- Active and sizable market: the asset should have active outright sale
  or repo markets at all times.
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   This means that:

- There should be historical evidence of market breadth and market
  depth.

   This could be demonstrated by low bid-ask spreads, high trading
   volumes, and a large and diverse number of market participants.

   Diversity of market participants reduces market concentration and
   increases the reliability of the liquidity in the market.

- There should be robust market infrastructure in place.

- The presence of multiple committed market makers increases
  liquidity as quotes will most likely be available for buying or selling
  HQLA.

- Low volatility: Assets whose prices remain relatively stable and are
  less prone to sharp price declines over time will have a lower
  probability of triggering forced sales to meet liquidity requirements.

   Volatility of traded prices and spreads are simple proxy measures of
   market volatility.

   There should be historical evidence of relative stability of market
   terms (eg prices and haircuts) and volumes during stressed periods.

- Flight to quality: historically, the market has shown tendencies to
  move into these types of assets in a systemic crisis.

   The correlation between proxies of market liquidity and banking
   system stress is one simple measure that could be used.

25. As outlined by these characteristics, the test of whether liquid assets
are of “high quality” is that, by way of sale or repo, their liquidity -
generating capacity is assumed to remain intact even in periods of severe
idiosyncratic and market stress.

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Lower quality assets typically fail to meet that test.

An attempt by a bank to raise liquidity from lower quality assets under
conditions of severe market stress would entail acceptance of a large
fire-sale discount or haircut to compensate for high market risk.

That may not only erode the market’s confidence in the bank, but would
also generate mark-to-market losses for banks holding similar
instruments and add to the pressure on their liquidity position, thus
encouraging further fire sales and declines in prices and market liquidity.

In these circumstances, private market liquidity for such instruments is
likely to disappear quickly.

26. HQLA (except Level 2B assets as defined below) should ideally be
eligible at central banks for intraday liquidity needs and overnight
liquidity facilities.

In the past, central banks have provided a further backstop to the supply
of banking system liquidity under conditions of severe stress.

Central bank eligibility should thus provide additional confidence that
banks are holding assets that could be used in events of severe stress
without damaging the broader financial system.

That in turn would raise confidence in the safety and soundness of
liquidity risk management in the banking system.

27. It should be noted however, that central bank eligibility does not by
itself constitute the basis for the categorisation of an asset as HQLA.

2. Operational requirements

28. All assets in the stock of HQLA are subject to the following
operational requirements.

The purpose of the operational requirements is to recognise that not all
assets outlined in paragraphs 49-54 that meet the asset class,
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risk-weighting and credit-rating criteria should be eligible for the stock as
there are other operational restrictions on the availability of HQLA that
can prevent timely monetisation during a stress period.

29. These operational requirements are designed to ensure that the stock
of HQLA is managed in such a way that the bank can, and is able to
demonstrate that it can, immediately use the stock of assets as a source of
contingent funds that is available for the bank to convert into cash
through outright sale or repo, to fill funding gaps between cash inflows
and outflows at any time during the 30-day stress period, with no
restriction on the use of the liquidity generated.

30. A bank should periodically monetise a representative proportion of the
assets in the stock through repo or outright sale, in order to test its access
to the market, the effectiveness of its processes for monetisation, the
availability of the assets, and to minimise the risk of negative signalling
during a period of actual stress.

31. All assets in the stock should be unencumbered.

“Unencumbered” means free of legal, regulatory, contractual or other
restrictions on the ability of the bank to liquidate, sell, transfer, or assign
the asset.

An asset in the stock should not be pledged (either explicitly or
implicitly) to secure, collateralise or credit-enhance any transaction, nor
be designated to cover operational costs (such as rents and salaries).

Assets received in reverse repo and securities financing transactions that
are held at the bank, have not been rehypothecated, and are legally and
contractually available for the bank's use can be considered as part of the
stock of HQLA.

In addition, assets which qualify for the stock of HQLA that have been
pre-positioned or deposited with, or pledged to, the central bank or a
public sector entity (PSE) but have not been used to generate liquidity
may be included in the stock.

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P a g e | 48


32. A bank should exclude from the stock those assets that, although
meeting the definition of “unencumbered” specified in paragraph 31, the
bank would not have the operational capability to monetise to meet
outflows during the stress period.

Operational capability to monetise assets requires having procedures and
appropriate systems in place, including providing the function identified
in paragraph 33 with access to all necessary information to execute
monetisation of any asset at any time.

Monetisation of the asset must be executable, from an operational
perspective, in the standard settlement period for the asset class in the
relevant jurisdiction.

33. The stock should be under the control of the function charged with
managing the liquidity of the bank (eg the treasurer), meaning the
function has the continuous authority, and legal and operational
capability, to monetise any asset in the stock.

Control must be evidenced either by maintaining assets in a separate pool
managed by the function with the sole intent for use as a source of
contingent funds, or by demonstrating that the function can monetise the
asset at any point in the 30-day stress period and that the proceeds of
doing so are available to the function throughout the 30-day stress period
without directly conflicting with a stated business or risk management
strategy.

For example, an asset should not be included in the stock if the sale of
that asset, without replacement throughout the 30-day period, would
remove a hedge that would create an open risk position in excess of
internal limits.

34. A bank is permitted to hedge the market risk associated with
ownership of the stock of HQLA and still include the assets in the stock.

If it chooses to hedge the market risk, the bank should take into account
(in the market value applied to each asset) the cash outflow that would

      _____________________________________________________________
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P a g e | 49


arise if the hedge were to be closed out early (in the event of the asset
being sold).

35. In accordance with Principle 9 of the Sound Principles a bank “should
monitor the legal entity and physical location where collateral is held and
how it may be mobilised in a timely manner”.

Specifically, it should have a policy in place that identifies legal entities,
geographical locations, currencies and specific custodial or bank
accounts where HQLA are held.

In addition, the bank should determine whether any such assets should
be excluded for operational reasons and therefore, have the ability to
determine the composition of its stock on a daily basis.

36. As noted in paragraphs 171 and 172, qualifying HQLA that are held to
meet statutory liquidity requirements at the legal entity or sub -
consolidated level (where applicable) may only be included in the stock at
the consolidated level to the extent that the related risks (as measured by
the legal entity’s or sub-consolidated group’s net cash outflows in the
LCR) are also reflected in the consolidated LCR.

Any surplus of HQLA held at the legal entity can only be included in the
consolidated stock if those assets would also be freely available to the
consolidated (parent) entity in times of stress.

37. In assessing whether assets are freely transferable for regulatory
purposes, banks should be aware that assets may not be freely available to
the consolidated entity due to regulatory, legal, tax, accounting or other
impediments.

Assets held in legal entities without market access should only be
included to the extent that they can be freely transferred to other entities
that could monetise the assets.

38. In certain jurisdictions, large, deep and active repo markets do not
exist for eligible asset classes, and therefore such assets are likely to be
monetised through outright sale.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
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P a g e | 50


In these circumstances, a bank should exclude from the stock of HQLA
those assets where there are impediments to sale, such as large fire-sale
discounts which would cause it to breach minimum solvency
equirements, or requirements to hold such assets, including, but not
limited to, statutory minimum inventory requirements for market
making.

39. Banks should not include in the stock of HQLA any assets, or liquidity
generated from assets, they have received under right of rehypothecation,
if the beneficial owner has the contractual right to withdraw those assets
during the 30-day stress period.

40. Assets received as collateral for derivatives transactions that are not
segregated and are legally able to be rehypothecated may be included in
the stock of HQLA provided that the bank records an appropriate outflow
for the associated risks as set out in paragraph 116.

41. As stated in Principle 8 of the Sound Principles, a bank should actively
manage its intraday liquidity positions and risks to meet payment and
settlement obligations on a timely basis under both normal and stressed
conditions and thus contribute to the smooth functioning of payment and
settlement systems.

Banks and regulators should be aware that the LCR stress scenario does
not cover expected or unexpected intraday liquidity needs.

42. While the LCR is expected to be met and reported in a single currency,
banks are expected to be able to meet their liquidity needs in each
currency and maintain HQLA consistent with the distribution of their
liquidity needs by currency.

The bank should be able to use the stock to generate liquidity in the
currency and jurisdiction in which the net cash outflows arise.

As such, the LCR by currency is expected to be monitored and reported to
allow the bank and its supervisor to track any potential currency
mismatch issues that could arise, as outlined in Part 2.

      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 51


In managing foreign exchange liquidity risk, the bank should take
into account the risk that its ability to swap currencies and access the
relevant foreign exchange markets may erode rapidly under stressed
conditions.

It should be aware that sudden, adverse exchange rate movements could
sharply widen existing mismatched positions and alter the effectiveness
of any foreign exchange hedges in place.

43. In order to mitigate cliff effects that could arise, if an eligible liquid
asset became ineligible (eg due to rating downgrade), a bank is permitted
to keep such assets in its stock of liquid assets for an additional 30
calendar days.

This would allow the bank additional time to adjust its stock as needed or
replace the asset.

3. Diversification of the stock of HQLA

44. The stock of HQLA should be well diversified within the asset classes
themselves (except for sovereign debt of the bank’s home jurisdiction or
from the jurisdiction in which the bank operates; central bank reserves;
central bank debt securities; and cash).

Although some asset classes are more likely to remain liquid irrespective
of circumstances, ex-ante it is not possible to know with certainty which
specific assets within each asset class might be subject to shocks ex-post.

Banks should therefore have policies and limits in place in order to
avoid concentration with respect to asset types, issue and issuer types,
and currency (consistent with the distribution of net cash outflows by
currency) within asset classes.

4. Definition of HQLA

45. The stock of HQLA should comprise assets with the characteristics
outlined in paragraphs 24-27.

      _____________________________________________________________
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P a g e | 52



This section describes the type of assets that meet these characteristics
and can therefore be included in the stock.

46. There are two categories of assets that can be included in the stock.
Assets to be included in each category are those that the bank is holding
on the first day of the stress period, irrespective of their residual maturity.

“Level 1” assets can be included without limit, while “Level 2” assets can
only comprise up to 40% of the stock.

47. Supervisors may also choose to include within Level 2 an additional
class of assets (Level 2B assets - see paragraph 53 below).

If included, these assets should comprise no more than 15% of the total
stock of HQLA.

They must also be included within the overall 40% cap on Level 2 assets.

48. The 40% cap on Level 2 assets and the 15% cap on Level 2B assets
should be determined after the application of required haircuts, and after
taking into account the unwind of short-term securities financing
transactions and collateral swap transactions maturing within 30 calendar
days that involve the exchange of HQLA.

In this context, short term transactions are transactions with a maturity
date up to and including 30 calendar days.

The details of the calculation methodology are provided in Annex 1.

(i) Level 1 assets

49. Level 1 assets can comprise an unlimited share of the pool and are not
subject to a haircut under the LCR.

However, national supervisors may wish to require haircuts for Level 1
securities based on, among other things, their duration, credit and
liquidity risk, and typical repo haircuts.
      _____________________________________________________________
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P a g e | 53


50. Level 1 assets are limited to:

(a) Coins and banknotes;

(b) Central bank reserves (including required reserves), to the extent that
the central bank policies allow them to be drawn down in times of stress;

(c) Marketable securities representing claims on or guaranteed by
sovereigns, central banks, PSEs, the Bank for International Settlements,
the International Monetary Fund, the European Central Bank and
European Community, or multilateral development banks, and satisfying
all of the following conditions:

- assigned a 0% risk-weight under the Basel II Standardised Approach
  for credit risk;

- traded in large, deep and active repo or cash markets characterised by
  a low level of concentration;

- have a proven record as a reliable source of liquidity in the markets
  (repo or sale) even during stressed market conditions; and

- not an obligation of a financial institution or any of its affiliated
  entities.

(d) where the sovereign has a non-0% risk weight, sovereign or central
bank debt securities issued in domestic currencies by the sovereign or
central bank in the country in which the liquidity risk is being taken or in
the bank’s home country; and

(e) where the sovereign has a non-0% risk weight, domestic sovereign or
central bank debt securities issued in foreign currencies are eligible up to
the amount of the bank’s stressed net cash outflows in that specific
foreign currency stemming from the bank’s operations in the jurisdiction
where the bank’s liquidity risk is being taken.



      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 54


(ii) Level 2 assets

51. Level 2 assets (comprising Level 2A assets and any Level 2B assets
permitted by the supervisor) can be included in the stock of HQLA,
subject to the requirement that they comprise no more than 40% of the
overall stock after haircuts have been applied.

52. A 15% haircut is applied to the current market value of each Level 2A
asset held in the stock of HQLA.

Level 2A assets are limited to the following:

(a) Marketable securities representing claims on or guaranteed by
sovereigns, central banks, PSEs or multilateral development banks that
satisfy all of the following conditions:

- assigned a 20% risk weight under the Basel II Standardised Approach
  for credit risk;

- traded in large, deep and active repo or cash markets characterised by
  a low level of concentration;

- have a proven record as a reliable source of liquidity in the markets
  (repo or sale) even during stressed market conditions (ie maximum
  decline of price not exceeding 10% or increase in haircut not
  exceeding 10 percentage points over a 30-day period during a relevant
  period of significant liquidity stress); and

- not an obligation of a financial institution or any of its affiliated
  entities.

(b) Corporate debt securities (including commercial paper) and covered
bonds that satisfy all of the following conditions:

- in the case of corporate debt securities: not issued by a financial
  institution or any of its affiliated entities;


      _____________________________________________________________
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                      www.risk-compliance-association.com
P a g e | 55


- in the case of covered bonds: not issued by the bank itself or any of its
  affiliated entities;

- either

   (i) have a long-term credit rating from a recognised external credit
   assessment institution (ECAI) of at least AA-21 or in the absence of a
   long term rating, a short-term rating equivalent in quality to the
   long-term rating; or

   (ii) do not have a credit assessment by a recognised ECAI but are
   internally rated as having a probability of default (PD) corresponding
   to a credit rating of at least AA-;

- traded in large, deep and active repo or cash markets characterised by
  a low level of concentration; and

- have a proven record as a reliable source of liquidity in the markets
  (repo or sale) even during stressed market conditions: ie maximum
  decline of price or increase in haircut over a 30-day period during a
  relevant period of significant liquidity stress not exceeding 10%.

(iii) Level 2B assets

53. Certain additional assets (Level 2B assets) may be included in Level 2
at the discretion of national authorities.

In choosing to include these assets in Level 2 for the purpose of the LCR,
supervisors are expected to ensure that such assets fully comply with the
qualifying criteria.

Supervisors are also expected to ensure that banks have appropriate
systems and measures to monitor and control the potential risks (eg
credit and market risks) that banks could be exposed to in holding these
assets.

54. A larger haircut is applied to the current market value of each Level 2B
asset held in the stock of HQLA.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
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P a g e | 56


Level 2B assets are limited to the following:

(a) Residential mortgage backed securities (RMBS) that satisfy all of the
following conditions may be included in Level 2B, subject to a 25%
haircut:

- not issued by, and the underlying assets have not been originated by
  the bank itself or any of its affiliated entities;

- have a long-term credit rating from a recognised ECAI of AA or
  higher, or in the absence of a long term rating, a short-term rating
  equivalent in quality to the long-term rating;

- traded in large, deep and active repo or cash markets characterised by
  a low level of concentration;

- have a proven record as a reliable source of liquidity in the markets
  (repo or sale) even during stressed market conditions, ie a maximum
  decline of price not exceeding 20% or increase in haircut over a 30-day
  period not exceeding 20 percentage points during a relevant period of
  significant liquidity stress;

- the underlying asset pool is restricted to residential mortgages and
  cannot contain structured products;

- the underlying mortgages are “full recourse’’ loans (ie in the case of
  foreclosure the mortgage owner remains liable for any shortfall in
  sales proceeds from the property) and have a maximum loan-to-value
  ratio (LTV) of 80% on average at issuance; and

- the securitisations are subject to “risk retention” regulations which
  require issuers to retain an interest in the assets they securitise.

(b) Corporate debt securities (including commercial paper) that satisfy all
of the following conditions may be included in Level 2B, subject to a 50%
haircut:

- not issued by a financial institution or any of its affiliated entities;
      _____________________________________________________________
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P a g e | 57


- either

- (i) have a long-term credit rating from a recognised ECAI between A+
  and BBB- or in the absence of a long term rating, a short-term rating
  equivalent in quality to the long-term rating; or

- (ii) do not have a credit assessment by a recognised ECAI and are
  internally rated as having a PD corresponding to a credit rating of
  between A+ and BBB-;

- traded in large, deep and active repo or cash markets characterised by
  a low level of concentration; and

- have a proven record as a reliable source of liquidity in the markets
  (repo or sale) even during stressed market conditions, ie a maximum
  decline of price not exceeding 20% or increase in haircut over a 30-day
  period not exceeding 20 percentage points during a relevant period of
  significant liquidity stress.

(c) Common equity shares that satisfy all of the following conditions may
be included in Level 2B, subject to a 50% haircut:

- not issued by a financial institution or any of its affiliated entities;

- exchange traded and centrally cleared;

- a constituent of the major stock index in the home jurisdiction or
  where the liquidity risk is taken, as decided by the supervisor in the
  jurisdiction where the index is located;

- denominated in the domestic currency of a bank’s home jurisdiction
  or in the currency of the jurisdiction where a bank’s liquidity risk is
  taken;

- traded in large, deep and active repo or cash markets characterised by
  a low level of concentration; and


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 58


- have a proven record as a reliable source of liquidity in the markets
  (repo or sale) even during stressed market conditions, ie a maximum
  decline of share price not exceeding 40% or increase in haircut not
  exceeding 40 percentage points over a 30-day period during a relevant
  period of significant liquidity.

(iv) Treatment for jurisdictions with insufficient HQLA

(a) Assessment of eligibility for alternative liquidity approaches
(ALA)

55. Some jurisdictions may have an insufficient supply of Level 1 assets
(or both Level 1 and Level 2 assets) in their domestic currency to meet the
aggregate demand of banks with significant exposures in this currency.

To address this situation, the Committee has developed alternative
treatments for holdings in the stock of HQLA, which are expected to
apply to a limited number of currencies and jurisdictions.

Eligibility for such alternative treatment will be judged on the basis of the
qualifying criteria set out in Annex 2 and will be determined through an
independent peer review process overseen by the Committee.

The purpose of this process is to ensure that the alternative treatments are
only used when there is a true shortfall in HQLA in the domestic currency
relative to the needs in that currency.

56. To qualify for the alternative treatment, a jurisdiction should be able
to demonstrate that:

- there is an insufficient supply of HQLA in its domestic currency,
  taking into account all relevant factors affecting the supply of, and
  demand for, such HQLA;

- the insufficiency is caused by long-term structural constraints that
  cannot be resolved within the medium term;


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 59


- it has the capacity, through any mechanism or control in place, to
  limit or mitigate the risk that the alternative treatment cannot work as
  expected; and

- it is committed to observing the obligations relating to supervisory
  monitoring, disclosure, and periodic self-assessment and
  independent peer review of its eligibility for alternative treatment.

All of the above criteria have to be met to qualify for the alternative
treatment.

57. Irrespective of whether a jurisdiction seeking ALA treatment will
adopt the phase-in arrangement set out in paragraph 10 for implementing
the LCR, the eligibility for that jurisdiction to adopt ALA treatment will
be based on a fully implemented LCR standard (ie 100% requirement).

(b) Potential options for alternative treatment

58. Option 1 – Contractual committed liquidity facilities from the relevant
central bank, with a fee:

For currencies that do not have sufficient HQLA, as determined by
reference to the qualifying principles and criteria, Option 1 would allow
banks to access contractual committed liquidity facilities provided by the
relevant central bank (ie relevant given the currency in question) for a fee.

These facilities should not be confused with regular central bank
standing arrangements.

In particular, these facilities are contractual arrangements between the
central bank and the commercial bank with a maturity date which, at a
minimum, falls outside the 30-day LCR window.

Further, the contract must be irrevocable prior to maturity and involve no
ex-post credit decision by the central bank.

Such facilities are only permissible if there is also a fee for the facility
which is charged regardless of the amount, if any, drawn down against
      _____________________________________________________________
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P a g e | 60


that facility and the fee is set so that banks which claim the facility line to
meet the LCR, and banks which do not, have similar financial incentives
to reduce their exposure to liquidity risk.

That is, the fee should be set so that the net yield on the assets used to
secure the facility should not be higher than the net yield on a
representative portfolio of Level 1 and Level 2 assets, after adjusting for
any material differences in credit risk.

A jurisdiction seeking to adopt Option 1 should justify in the independent
peer review that the fee is suitably set in a manner as prescribed in this
paragraph.

59. Option 2 – Foreign currency HQLA to cover domestic currency
liquidity needs:

For currencies that do not have sufficient HQLA, as determined by
reference to the qualifying principles and criteria, Option 2 would allow
supervisors to permit banks that evidence a shortfall of HQLA in the
domestic currency (which would match the currency of the underlying
risks) to hold HQLA in a currency that does not match the currency of the
associated liquidity risk, provided that the resulting currency mismatch
positions are justifiable and controlled within limits agreed by their
supervisors.

Supervisors should restrict such positions within levels consistent with
the bank’s foreign exchange risk management capacity and needs, and
ensure that such positions relate to currencies that are freely and reliably
convertible, are effectively managed by the bank, and would not pose
undue risk to its financial strength.

In managing those positions, the bank should take into account the
risks that its ability to swap currencies, and its access to the relevant
foreign exchange markets, may erode rapidly under stressed conditions.

It should also take into account that sudden, adverse exchange rate
movements could sharply widen existing mismatch positions and alter
the effectiveness of any foreign exchange hedges in place.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
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Monday January 14 2013 Top 10 Risk Compliance News Events

  • 1. Page |1 International Association of Risk and Compliance Professionals (IARCP) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's agenda, and what is next Dear Member, This was a difficult week. We had significant amendments to the Basel iii liquidity rules. And we needed 206 pages for this weekly newsletter… Sorry, important things happen. 1. The LCR will be introduced as planned on 1 January 2015, but the minimum requirement will begin at 60%, rising in equal annual steps of 10 percentage points to reach 100% on 1 January 2019. This graduated approach is designed to ensure that the LCR can be introduced without disruption to the orderly strengthening of banking systems or the ongoing financing of economic activity. 2. During periods of stress it would be entirely appropriate for banks to use their stock of high quality liquid assets (HQLA), thereby falling below the minimum. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 2. Page |2 3. Banks will be able to count a much wider variety of liquid assets towards their buffers, including some equities and high-quality mortgage-backed securities. 4. European and American banking stocks surged because they will incur much reduced costs due to the implementation of the relaxed rules. 5. Banks in many other counties will have no benefit, as supervisors have already asked for strict liquidity rules, and they are not willing to take it back. 6. On the negative side, the main objective of Basel iii is to restore investor confidence. The Basel Committee has developed the new framework as a response to the crisis, and has explained (time and time again, every month since November 2010) the need for these strict rules. Although it is true that Basel iii is an overreaction to the market crisis, it is way too late now to “ease” the rules and make (clever) investors happy the same time. This is simply a red flag for many investors, leading to the conclusion that banks could not comply with the rules. I agree with the Liquidity Coverage ratio (LCR) Basel iii amendment, but I cannot agree with the way it was presented. Welcome to the Top 10 list. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 3. Page |3 Basel III - Group of Governors and Heads of Supervision endorses revised liquidity standard for banks The Group of Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision, met today to consider the Basel Committee's amendments to the Liquidity Coverage Ratio (LCR) as a minimum standard. It unanimously endorsed them. Commissioner Michel Barnier The impact of the latest Basel Committee liquidity developments for Capital Requirements (CRD 4) in the EU In the light of the Group of Governors and Heads of Supervision meeting and the Basel Committee on Banking Supervision press release dated 6 January 2013 Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools, January 2013 _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 4. Page |4 Summary Responses To the Commissions’ Green Paper on Shadow Banking The European Commission's consultation on shadow banking attracted high interest from stakeholders. The comments provided cover a broad range of issues and responded to all the questions raised by the European Commission Green Paper. The Commission received in total 140 contributions, of which 24 from Public Authorities; 47 from registered organisations; and, 64 from individual organisations. European Union: Financial Sector Assessment, Preliminary Conclusions by the IMF Staff A Financial Sector Assessment Program (FSAP) team led by the Monetary and Capital Markets Department of the International Monetary Fund (IMF) visited the European Union (EU) during November 27–December 13, 2012, to conduct a first-ever overall EU-wide assessment of the soundness and stability of the EU’s financial sector (EU FSAP). European Cybercrime Centre (EC3) opens on 11 January _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 5. Page |5 As from 11 January the new European Cybercrime Centre (EC3) will be up and running to help protect European citizens and businesses from cyber-crime. EU Commissioner for Home Affairs Cecilia Malmström will participate in the official opening of the Centre established at the European Police Office, Europol in the Hague (the Netherlands). Sebastian von Dahlen and Goetz von Peter Natural catastrophes and global reinsurance – exploring the linkages Natural disasters resulting in significant losses have become more frequent in recent decades, with 2011 being the costliest year in history. This feature explores how risk is transferred within and beyond the global insurance sector and assesses the financial linkages that arise in the process. Morten Bech, Todd Keister On the liquidity coverage ratio and monetary policy implementation Basel III introduces the first global framework for bank liquidity regulation. As monetary policy typically involves targeting the interest rate on interbank loans of the most liquid asset – central _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 6. Page |6 bank reserves – it is important to understand how this new requirement will impact the efficacy of current operational frameworks. EIOPA – Risk Dashboard Sovereign risk – a world without risk-free assets Panel comments by Mr Patrick Honohan, Governor of the Central Bank of Ireland, at the BIS Conference on “Sovereign risk – a world without risk-free assets”, Basel, 8 January 2013. What’s new about sovereign risk since the crisis began? Conceptually, not so much, I would suggest – and nothing that cannot be fully explained within standard models of finance. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 7. Page |7 Basel III - Group of Governors and Heads of Supervision endorses revised liquidity standard for banks 6 January 2013 The Group of Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision, met today to consider the Basel Committee's amendments to the Liquidity Coverage Ratio (LCR) as a minimum standard. It unanimously endorsed them. Today's agreement is a clear commitment to ensure that banks hold sufficient liquid assets to prevent central banks becoming the "lender of first resort". The GHOS also endorsed a new Charter for the Committee, and discussed the Committee's medium-term work agenda. The GHOS reaffirmed the LCR as an essential component of the Basel III reforms. It endorsed a package of amendments to the formulation of the LCR announced in 2010. The package has four elements: 1. Revisions to the definition of high quality liquid assets (HQLA) and net cash outflows 2. A timetable for phase-in of the standard _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 8. Page |8 3. A reaffirmation of the usability of the stock of liquid assets in periods of stress, including during the transition period 4. An agreement for the Basel Committee to conduct further work on the interaction between the LCR and the provision of central bank facilities. A summary description of the agreed LCR is in Annex 1. The changes to the definition of the LCR, developed and agreed by the Basel Committee over the past two years, include an expansion in the range of assets eligible as HQLA and some refinements to the assumed inflow and outflow rates to better reflect actual experience in times of stress. These changes are set out in Annex 2. The GHOS agreed that the LCR should be subject to phase-in arrangements which align with those that apply to the Basel III capital adequacy requirements. Specifically, the LCR will be introduced as planned on 1 January 2015, but the minimum requirement will begin at 60%, rising in equal annual steps of 10 percentage points to reach 100% on 1 January 2019. This graduated approach is designed to ensure that the LCR can be introduced without disruption to the orderly strengthening of banking systems or the ongoing financing of economic activity. The GHOS agreed that, during periods of stress it would be entirely appropriate for banks to use their stock of HQLA, thereby falling below the minimum. Moreover, it is the responsibility of bank supervisors to give guidance on usability according to circumstances. The GHOS also agreed today that, since deposits with central banks are the most - indeed, in some cases, the only - reliable form of liquidity, the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 9. Page |9 interaction between the LCR and the provision of central bank facilities is critically important. The Committee will therefore continue to work on this issue over the next year. GHOS members endorsed two other areas of further analysis. First, the Committee will continue to develop disclosure requirements for bank liquidity and funding profiles. Second, the Committee will continue to explore the use of market-based indicators of liquidity to supplement the existing measures based on asset classes and credit ratings. The GHOS discussed and endorsed the Basel Committee's medium-term work agenda. Following the successful agreement of the LCR, the Committee will now press ahead with the review of the Net Stable Funding Ratio. This is a crucial component in the new framework, extending the scope of international agreement to the structure of banks' debt liabilities. This will be a priority for the Basel Committee over the next two years. Over the next few years, the Basel Committee will also: 1. Complete the overhaul of the policy framework currently under way 2. Continue to strengthen the peer review programme established in 2012 to monitor the implementation of reforms in individual jurisdictions 3. Monitor the impact of, and industry response to, recent and proposed regulatory reforms. During 2012 the Committee has been examining the comparability of model-based internal risk weightings and considering the appropriate _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 10. P a g e | 10 balance between the simplicity, comparability and risk sensitivity of the regulatory framework. The GHOS encouraged continuation of this work in 2013 as a matter of priority. Furthermore, the GHOS supported the Committee's intention to promote effective macro- and microprudential supervision. The GHOS also endorsed a new Charter for the Basel Committee. The new Charter sets out the Committee's objectives and key operating modalities, and is designed to improve understanding of the Committee's activities and decision-making processes. Finally, the GHOS reiterated the importance of full, timely and consistent implementation of Basel III standards. Mervyn King, Chairman of the GHOS and Governor of the Bank of England, said, "The Liquidity Coverage Ratio is a key component of the Basel III framework. The agreement reached today is a very significant achievement. For the first time in regulatory history, we have a truly global minimum standard for bank liquidity. Importantly, introducing a phased timetable for the introduction of the LCR, and reaffirming that a bank's stock of liquid assets are usable in times of stress, will ensure that the new liquidity standard will in no way hinder the ability of the global banking system to finance a recovery." Stefan Ingves, Chairman of the Basel Committee and Governor of the Sveriges Riksbank, noted: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 11. P a g e | 11 "The amendments to the LCR are designed to ensure that it provides a sound minimum standard for bank liquidity - a standard that reflects actual experience during times of stress. The completion of this work will allow the Basel Committee to turn its attention to refining the other component of the new global liquidity standards, the Net Stable Funding Ratio, which remains subject to an observation period ahead of its implementation in 2018." Annex 1 Summary description of the LCR To promote short-term resilience of a bank’s liquidity risk profile, the Basel Committee developed the Liquidity Coverage Ratio (LCR). This standard aims to ensure that a bank has an adequate stock of unencumbered high quality liquid assets (HQLA) which consists of cash or assets that can be converted into cash at little or no loss of value in private markets to meet its liquidity needs for a 30 calendar day liquidity stress scenario. The LCR has two components: (a) The value of the stock of HQLA (b) Total net cash outflows and is expressed as: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 12. P a g e | 12 High Quality Liquid Assets The numerator of the LCR is the stock of HQLA. Under the standard, banks must hold a stock of unencumbered HQLA to cover the total net cash outflows over a 30-day period under the prescribed stress scenario. In order to qualify as HQLA, assets should be liquid in markets during a time of stress and, in most cases, be eligible for use in central bank operations. Certain types of assets within HQLA are subject to a range of haircuts. HQLA are comprised of Level 1 and Level 2 assets. Level 1 assets generally include cash, central bank reserves, and certain marketable securities backed by sovereigns and central banks, among others. These assets are typically of the highest quality and the most liquid, and there is no limit on the extent to which a bank can hold these assets to meet the LCR. Level 2 assets are comprised of Level 2A and Level 2B assets and include certain marketable government securities as well as corporate debt securities, residential mortgage backed securities and equities that meet certain conditions. Level 2 assets (comprising Level 2A and Level 2B assets) are typically of slightly lesser quality and may not in aggregate account for more than 40% of a bank’s stock of HQLA. Level 2B assets may not account for more than 15% of a bank’s total stock of HQLA. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 13. P a g e | 13 Total net cash outflows The denominator of the LCR is the total net cash outflows. It is defined as total expected cash outflows, minus total expected cash inflows, in the specified stress scenario for the subsequent 30 calendar days. Total expected cash outflows are calculated by multiplying the outstanding balances of various categories or types of liabilities and off-balance sheet commitments by the rates at which they are expected to run off or be drawn down. Total expected cash inflows are calculated by multiplying the outstanding balances of various categories of contractual receivables by the rates at which they are expected to flow in. Total cash inflows are subject to an aggregate cap of 75% of total expected cash outflows, thereby ensuring a minimum level of HQLA holdings at all times. Liquidity Coverage Ratio The standard requires that, absent a situation of financial stress, the value of the ratio be no lower than 100% (ie the stock of HQLA should at least equal total net cash outflows). Banks are expected to meet this requirement continuously and hold a stock of unencumbered HQLA as a defence against the potential onset of liquidity stress. During a period of financial stress, however, banks may use their stock of HQLA, thereby falling below 100%. Important - The 100% threshold is the minimum requirement absent a period of financial stress, and after the phase-in arrangements are complete. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 14. P a g e | 14 References to 100% may be adjusted for any phase-in arrangements in force at a particular time. Annex 2 Complete set of agreed changes to the Liquidity Coverage Ratio HIGH QUALITY LIQUID ASSETS (HQLA) Expand the definition of HQLA subject to a higher haircut and limit - Corporate debt securities rated A+ to BBB– with a 50% haircut - Certain unencumbered equities subject to a 50% haircut - Certain residential mortgage-backed securities rated AA or higher with a 25% haircut Aggregate of additional assets, after haircuts, subject to a 15% limit of the HQLA Rating requirement on qualifying Level 2 assets - Use of local rating scales and inclusion of qualifying commercial paper Usability of the liquidity pool - Incorporate language related to the expectation that banks will use their pool of HQLA during periods of stress Operational requirements - Refine and clarify the operational requirements for HQLA Operation of the cap on Level 2 HQLA - Revise and improve the operation of the cap _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 15. P a g e | 15 Alternative liquid asset (ALA) framework - Develop the alternative treatments and include a fourth option for sharia-compliant banks Central bank reserves - Clarify language to confirm that supervisors have national discretion to include or exclude required central bank reserves (as well as overnight and certain term deposits) as HQLA as they consider appropriate INFLOWS AND OUTFLOWS Insured deposits - Reduce outflow on certain fully insured retail deposits from 5% to 3% - Reduce outflow on fully insured non-operational deposits from non-financial corporates, sovereigns, central banks and public sector entities (PSEs) from 40% to 20% Non-financial corporate deposits - Reduce the outflow rate for “non-operational” deposits provided by non-financial corporates, sovereigns, central banks and PSEs from 75% to 40% Committed liquidity facilities to non-financial corporates - Clarify the definition of liquidity facilities and reduce the drawdown rate on the unused portion of committed liquidity facilities to non-financial corporates, sovereigns, central banks and PSEs from 100% to 30% Committed but unfunded inter-financial liquidity and credit facilities - Distinguish between interbank and inter-financial credit and liquidity facilities and reduce the outflow rate on the former from 100% to 40% Derivatives _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 16. P a g e | 16 - Additional derivatives risks included in the LCR with a 100% outflow (relates to collateral substitution, and excess collateral that the bank is contractually obligated to return/provide if required by a counterparty) - Introduce a standardised approach for liquidity risk related to market value changes in derivatives positions - Assume net outflow of 0% for derivatives (and commitments) that are contractually secured/collateralised by HQLA Trade finance - Include guidance to indicate that a low outflow rate (0–5%) is expected to apply Equivalence of central bank operations - Reduce the outflow rate on maturing secured funding transactions with central banks from 25% to 0% Client servicing brokerage - Clarify the treatment of activities related to client servicing brokerage (which generally lead to an increase in net outflows) OTHER Rules text clarifications - Clearer guidance on the usability of HQLA, and the appropriate supervisory response, has been developed to ensure that the stock of liquid assets is available to be used when needed - A number of clarifications to the rules text to promote consistent application and reduce arbitrage opportunities (eg operational deposits from wholesale clients, derivatives cash flows, open maturity loans). Also incorporation of previously agreed FAQ _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 17. P a g e | 17 Internationally agreed phase-in of the LCR - The minimum LCR in 2015 would be 60% and increase by 10 percentage points per year to reach 100% in 2019 _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 18. P a g e | 18 Basel Committee on Banking Supervision (BCBS) Charter January 2013 I. Purpose and role 1. Mandate The BCBS is the primary global standard-setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Its mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability. 2. Activities The BCBS seeks to achieve its mandate through the following activities: (a) Exchanging information on developments in the banking sector and financial markets, to help identify current or emerging risks for the global financial system; (b) Sharing supervisory issues, approaches and techniques to promote common understanding and to improve cross-border cooperation; (c) Establishing and promoting global standards for the regulation and supervision of banks as well as guidelines and sound practices; (d) Addressing regulatory and supervisory gaps that pose risks to financial stability; (e) Monitoring the implementation of BCBS standards in member countriesand beyond with the purpose of ensuring their timely, consistent and effective implementation and contributing to a "level playing field" among internationally-active banks; (f) Consulting with central banks and bank supervisory authorities which are not members of the BCBS to benefit from their input into the BCBS policy formulation process and to promote the implementation of BCBS _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 19. P a g e | 19 standards, guidelines and sound practices beyond BCBS member countries; and (g) Coordinating and cooperating with other financial sector standard setters and international bodies, particularly those involved in promoting financial stability. 3. Legal status The BCBS does not possess any formal supranational authority. Its decisions do not have legal force. Rather, the BCBS relies on its members' commitments, as described in Section 5, to achieve its mandate. II. Membership 4. BCBS members BCBS members include organisations with direct banking supervisory authority and central banks. After consulting the Committee, the BCBS Chairman may invite other organisations to become BCBS observers. BCBS membership and observer status will be reviewed periodically. In accepting new members, due regard will be given to the importance of their national banking sectors to international financial stability. The Committee will make recommendations to its oversight body, the Group of Governors and Heads of Supervision, for changes in BCBS membership. The Secretariat will publish the list of BCBS members and observers on its website. 5. BCBS members' responsibilities BCBS members are committed to: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 20. P a g e | 20 (a) Work together to achieve the mandate of the BCBS; (b) Promote financial stability; (c) Continuously enhance their quality of banking regulation and supervision; (d) Actively contribute to the development of BCBS standards, guidelines and sound practices; (e) Implement and apply BCBS standards in their domestic jurisdictions 2 within the pre-defined timeframe established by the Committee; (f) Undergo and participate in BCBS reviews to assess the consistency and effectiveness of domestic rules and supervisory practices in relation to BCBS standards; and (g) Promote the interests of global financial stability and not solely national interests, while participating in BCBS work and decision-making. III. Oversight 6. The Group of Governors and Heads of Supervision (GHOS) The GHOS is the oversight body of the BCBS. The BCBS reports to the GHOS and seeks its endorsement for major decisions. In addition, the BCBS looks to the GHOS to: (a) Approve the BCBS Charter and any amendments to this document; (b) Provide general direction for the BCBS work programme (c) Appoint the BCBS Chairman from among its members. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 21. P a g e | 21 If the BCBS Chairman ceases to be a GHOS member before the end of his/her term, the GHOS will appoint a new Chairman. Until a new Chairman has been appointed, the Secretary General assumes the Chairman's functions. IV. Organisation 7. Structure The internal organisational structure of the BCBS comprises: (a) The Committee (b) Groups, working groups and task forces (c) The Chairman (d) The Secretariat 8. The Committee The Committee is the ultimate decision-making body of the BCBS with responsibility for ensuring that its mandate is achieved. 8.1 Responsibilities The Committee is responsible for: (a) Developing, guiding and monitoring the BCBS work programme within the general direction provided by GHOS; (b) Establishing and promoting BCBS standards, guidelines and sound practices; (c) Establishing and disbanding groups, working groups and task forces; approving and modifying their mandates; and monitoring their progress; (e) Recommending to the GHOS amendments to the BCBS Charter; and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 22. P a g e | 22 (f) Deciding on the organisational regulations governing its activities. 8.2 Number of Committee meetings The Committee generally meets four times every year. However, the Chairman can decide to hold additional meetings as necessary. 8.3 Representation at Committee meetings The Chairman presides over Committee meetings. All BCBS members and observers are entitled to appoint one representative to attend Committee meetings. BCBS representatives should be senior officials of their organisations and should have the authority to commit their institutions. Representation at Committee meetings is expected to be, for example, at the level of head of banking supervision, head of banking policy/regulation, central bank deputy governor, head of financial stability department or equivalent. 8.4 Decisions Decisions by the Committee are taken by consensus among its members. 8.5 Communication of decisions Committee decisions of public interest shall be communicated through the BCBS website. The Committee shall issue, when appropriate, press statements to communicate its decisions. 9. Groups, working groups and task forces The BCBS's work is largely organised around groups, working groups and task forces. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 23. P a g e | 23 The Secretariat will make publicly available the list of BCBS groups and working groups. 9.1 Groups BCBS groups report directly to the Committee. They are composed of senior staff from BCBS members that guide or undertake themselves major areas of Committee work. BCBS groups form part of the permanent internal structure of the BCBS and thus operate without a specific deliverable or end date. 9.2 Working groups Working groups consist of experts from BCBS members that support the technical work of BCBS groups. 9.3 Task forces Task forces are created to undertake specific tasks for a limited time. These are generally composed of technical experts from BCBS member institutions. However, when these groupings are created by the Committee, they consist of BCBS representatives and deal with specific issues that require prompt attention of the Committee. In such cases, they are called high-level task forces. 10. Chairman The Chairman directs the work of the Committee in accordance with the BCBS mandate. 10.1 Appointment The Chairman is appointed by the GHOS for a term of three years that can be renewed once. 10.2 Responsibilities The Chairman's main responsibilities are to: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 24. P a g e | 24 (a) Convene and chair Committee meetings. If the Chairman is unable to attend a Committee meeting, he or she can designate the Secretary General to chair the meeting on his/her behalf; (b) Monitor the progress of the BCBS work programme and provide operational guidance between meetings to carry forward the decisions and directions of the Committee; (c) Report to the GHOS when appropriate; and (d) Represent the BCBS externally and be the principal spokesperson for the BCBS. 11. The Secretariat The Secretariat is provided by the Bank for International Settlements (BIS) and supports the work of the Committee, the Chairman and the groups around which the Committee organises its work. The Secretariat is staffed mainly by professional staff, mostly on temporary secondment from BCBS members. 11.1 Responsibilities The Secretariat's main responsibilities are to: (a) Provide support and assistance to the Committee, the Chairman, groups, working groups and task forces; (b) Ensure timely and effective information flow to all BCBS members; (c) Facilitate coordination across groups, working groups and task forces; (d) Facilitate a close contact between BCBS members and non-member authorities; (e) Support the cooperation between the BCBS and other institutions; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 25. P a g e | 25 (f) Maintain the BCBS records, administer the BCBS website and deal with correspondence of the BCBS; and (g) Carry out all other functions that are assigned by the Committee and the Chairman. 11.2 Secretary General The Secretary General reports to the Chairman and directs the work of the Secretariat. The Secretary General manages the financial, material and human resources allocated to the Secretariat. He/she also assists the Chairman in representing the Committee externally. The Secretary General is selected by the Chairman on recommendation of a selection panel comprising BCBS and/or GHOS members and a senior representative of the BIS. The term of appointment is typically three years with the potential to be extended. 11.3 Deputy Secretaries General Deputy Secretaries General report to and assist the Secretary General in discharging his/her duties. Deputy Secretaries General substitute for the Secretary General in case of absence, incapacity or as requested by the Secretary General. Deputy Secretaries General are selected by the Secretary General in conjunction with the Chairman. 11.4 Location of the Secretariat The Secretariat is located at the BIS in Basel. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 26. P a g e | 26 V. BCBS standards, guidelines and sound practices 12. Standards The BCBS sets standards for the prudential regulation and supervision of banks. The BCBS expects full implementation of its standards by BCBS members and their internationally active banks. However, BCBS standards constitute minimum requirements and BCBS members may decide to go beyond them. The Committee expects standards to be incorporated into local legal frameworks through each jurisdiction's rule-making process within the pre-defined timeframe established by the Committee. If deviation from literal transposition into local legal frameworks is unavoidable, members should seek the greatest possible equivalence of standards and their outcome. 13. Guidelines Guidelines elaborate the standards in areas where they are considered desirable for the prudential regulation and supervision of banks, in particular international active banks. They generally supplement BCBS standards by providing additional guidance for the purpose of their implementation. 14. Sound practices Sound practices generally describe actual observed practices, with the goal of promoting common understanding and improving supervisory or banking practices. BCBS members are encouraged to compare these practices with those applied by themselves and their supervised institutions to identify potential areas for improvement. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 27. P a g e | 27 VI. Consultation with non-member authorities 15. Consultation with non-member authorities Consistent with the activities described under section 2, the BCBS is committed to consulting widely on its activities with non-member authorities through the following structures and mechanisms: 15.1 The Basel Consultative Group (BCG) The BCG provides a forum for deepening the Committee's engagement with supervisors around the world on banking supervisory issues. It facilitates broad supervisory dialogue with non-member authorities on new Committee initiatives early in the process by gathering senior representatives from various countries, international institutions and regional groups of banking supervisors that are not members of the Committee. 15.2 The International Conferences of Banking Supervisors (ICBS) The biennial ICBS provides a venue for supervisors around the world to discuss issues of common interest. 15.3 Participation in BCBS groups, working groups and task forces By participating as observers in BCBS bodies, non-member authorities contribute to the Committee's policy development work. 15.4 The Financial Stability Institute (FSI) The FSI is a joint initiative of the BCBS and the BIS to assist supervisors around the world in implementing sound prudential standards. The BCBS supports FSI activities, including in particular the BCBS-FSI High Level Meetings. These are targeted at senior policymakers within central banks and supervisory authorities and provide a series of regional fora for distributing information on BCBS standards, keeping participants updated on Committee work, sharing supervisory practices and concerns, and establishing and maintaining strong contacts. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 28. P a g e | 28 15.5 Regional groups of banking supervisors The BCBS supports the work and activities of regional groups of banking supervisors worldwide. Secretariat staff may participate in meetings of such groups to exchange ideas and seek feedback on BCBS work. VII. Relationship with other international financial bodies 16. International cooperation The BCBS cooperates with other international financial standard setters and public sector bodies with the purpose of achieving an enhanced coordination of policy development and implementation. In carrying out their responsibilities to support this cooperation, the Chairman and the Secretariat will pay particular attention to the need to comply with the BCBS's due process and governance arrangements. Together with other international financial standard setters, the BCBS sponsors the Joint Forum, where issues of common concern to the standard setters can be addressed and recommendations for coordinated action can be developed. The BCBS is a member of the Financial Stability Board (FSB) and participates in the FSB's work to develop, coordinate and promote the implementation of effective regulatory, supervisory and other financial sector policies. VIII. Public consultation process 17. Public consultation process of draft BCBS standards, guidelines and sound practices In principle, the BCBS seeks input from all relevant stakeholders on policy proposals. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 29. P a g e | 29 The consultation process will include issuing a public invitation to interested parties to provide comments in writing to the Secretariat on policy proposals issued by the Committee, within a specified timeframe. The consultation period shall normally last 90 calendar days, but could exceptionally be shorter or longer. As a general rule, responses to public invitations for comments shall be published on the BCBS website, unless confidential treatment is requested by respondents. This process is compulsory for BCBS standards. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 30. P a g e | 30 Commissioner Michel Barnier The impact of the latest Basel Committee liquidity developments for Capital Requirements (CRD 4) in the EU In the light of the Group of Governors and Heads of Supervision meeting and the Basel Committee on Banking Supervision press release dated 6 January 2013 "I welcome the unanimous agreement reached by the Basel Committee on the revised liquidity coverage ratio and the gradual approach for its phasing-in by clearly defined dates. This is significant progress which addresses issues already raised by the European Commission. We now need to make full use of the observation period, and learn from the reports that the European Banking Authority will prepare on the results of the observation period, before formally implementing in 2015 the liquidity coverage ratio under EU law in line with the Basel standards. The treatment of liquidity is fundamental, both for the stability of banks as well as for their role in supporting wider economic recovery. I now call upon the Parliament and the Council to successfully conclude the CRD 4 trilogue negotiations in the coming weeks." Context The Basel Committee on Banking Supervision (BCBS) has agreed a package of LCR (liquidity coverage ratio) revisions unanimously as well as its 2013 work plan. The LCR revisions include an expansion of eligible assets, a less severe calibration for certain cash flows and a phasing-in arrangement from January 2015 to 2019. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 31. P a g e | 31 The current Commission approach to liquidity in the CRD4 negotiations, namely first a reporting period followed by comprehensive European Banking Authority (EBA) Reports and subsequently a delegated act by the Commission to define the detailed ratio remains fully valid. Background information The Commission's approach to liquidity in CRD 4 still remains valid in the light of the latest Basel Committee approval of the revision of a number of parameters and calibrations on liquidity (GHOS meeting of 6 January). In the Basel Committee, the European Central Bank, the European Commission and various countries including from the EU had argued for such a revision. At the level of the Basel Committee, the final package of LCR revisions will now be subject to an observation period with a Quantitative Impact Study (QIS) that will take place in 2013 together with some other important work that still needs to be completed in the coming year. The EU needs to take full benefit of this observation period and learn from it, as this is the first time in history that regulators are defining globally harmonized, quantitative liquidity standards. The EBA will make reports on the results of the observation period for EU banks before the end of 2013. Based on the evaluation of this work, the Commission will propose defining the detailed LCR through a delegated act (i.e. legislation adopted by the Commission provided no objections are raised by the EP and the Council). Nevertheless, important work still remains to be completed at the global and European levels. This includes the determination of alternative, market-based indicators for the definition of High Quality Liquid Assets (HQLA); the treatment of Central Bank facilities which could impact upon the definition of HQLA and related cash flows; and the treatment of market valuation changes on derivative cash flows. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 32. P a g e | 32 In this light, the best course continues to be rapid adoption of the CRD 4 package while leaving the necessary flexibility to implement the final detailed LCR standard through a delegated act, taking into account the on-going work by Basel and the comprehensive EBA reports. Subject to this approach, the texts on the table now of the European Parliament and Council should be adopted shortly, hopefully in the coming weeks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 33. P a g e | 33 Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools, January 2013 Introduction 1. This document presents one of the Basel Committee’s key reforms to develop a more resilient banking sector: the Liquidity Coverage Ratio (LCR). The objective of the LCR is to promote the short-term resilience of the liquidity risk profile of banks. It does this by ensuring that banks have an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted easily and immediately in private markets into cash to meet their liquidity needs for a 30 calendar day liquidity stress scenario. The LCR will improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy. This document sets out the LCR standard and timelines for its implementation. 2. During the early “liquidity phase” of the financial crisis that began in 2007, many banks – despite adequate capital levels – still experienced difficulties because they did not manage their liquidity in a prudent manner. The crisis drove home the importance of liquidity to the proper functioning of financial markets and the banking sector. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 34. P a g e | 34 Prior to the crisis, asset markets were buoyant and funding was readily available at low cost. The rapid reversal in market conditions illustrated how quickly liquidity can evaporate, and that illiquidity can last for an extended period of time. The banking system came under severe stress, which necessitated central bank action to support both the functioning of money markets and, in some cases, individual institutions. 3. The difficulties experienced by some banks were due to lapses in basic principles of liquidity risk management. In response, as the foundation of its liquidity framework, the Committee in 2008 published Principles for Sound Liquidity Risk Management and Supervision (“Sound Principles”). The Sound Principles provide detailed guidance on the risk management and supervision of funding liquidity risk and should help promote better risk management in this critical area, but only if there is full implementation by banks and supervisors. As such, the Committee will continue to monitor the implementation by supervisors to ensure that banks adhere to these fundamental principles. 4. To complement these principles, the Committee has further strengthened its liquidity framework by developing two minimum standards for funding liquidity. These standards have been developed to achieve two separate but complementary objectives. The first objective is to promote short-term resilience of a bank’s liquidity risk profile by ensuring that it has sufficient HQLA to survive a significant stress scenario lasting for one month. The Committee developed the LCR to achieve this objective. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 35. P a g e | 35 The second objective is to promote resilience over a longer time horizon by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing basis. The Net Stable Funding Ratio (NSFR), which is not covered by this document, supplements the LCR and has a time horizon of one year. It has been developed to provide a sustainable maturity structure of assets and liabilities. 5. These two standards are comprised mainly of specific parameters which are internationally “harmonised” with prescribed values. Certain parameters, however, contain elements of national discretion to reflect jurisdiction-specific conditions. In these cases, the parameters should be transparent and clearly outlined in the regulations of each jurisdiction to provide clarity both within the jurisdiction and internationally. 6. It should be stressed that the LCR standard establishes a minimum level of liquidity for internationally active banks. Banks are expected to meet this standard as well as adhere to the Sound Principles. Consistent with the Committee’s capital adequacy standards, national authorities may require higher minimum levels of liquidity. In particular, supervisors should be mindful that the assumptions within the LCR may not capture all market conditions or all periods of stress. Supervisors are therefore free to require additional levels of liquidity to be held, if they deem the LCR does not adequately reflect the liquidity risks that their banks face. 7. Given that the LCR is, on its own, insufficient to measure all dimensions of a bank’s liquidity profile, the Committee has also _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 36. P a g e | 36 developed a set of monitoring tools to further strengthen and promote global consistency in liquidity risk supervision. These tools are supplementary to the LCR and are to be used for ongoing monitoring of the liquidity risk exposures of banks, and in communicating these exposures among home and host supervisors. 8. The Committee is introducing phase-in arrangements to implement the LCR to help ensure that the banking sector can meet the standard through reasonable measures, while still supporting lending to the economy. 9. The Committee remains firmly of the view that the LCR is an essential component of the set of reforms introduced by Basel III and, when implemented, will help deliver a more robust and resilient banking system. However, the Committee has also been mindful of the implications of the standard for financial markets, credit extension and economic growth, and of introducing the LCR at a time of ongoing strains in some banking systems. It has therefore decided to provide for a phased introduction of the LCR, in a manner similar to that of the Basel III capital adequacy requirements. 10. Specifically, the LCR will be introduced as planned on 1 January 2015, but the minimum requirement will be set at 60% and rise in equal annual steps to reach 100% on 1 January 2019. This graduated approach, coupled with the revisions made to the 2010 publication of the liquidity standards, are designed to ensure that the LCR can be introduced without material disruption to the orderly strengthening of banking systems or the ongoing financing of economic activity. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 37. P a g e | 37 11. The Committee also reaffirms its view that, during periods of stress, it would be entirely appropriate for banks to use their stock of HQLA, thereby falling below the minimum. Supervisors will subsequently assess this situation and will give guidance on usability according to circumstances. Furthermore, individual countries that are receiving financial support for macroeconomic and structural reform purposes may choose a different implementation schedule for their national banking systems, consistent with the design of their broader economic restructuring programme. 12. The Committee is currently reviewing the NSFR, which continues to be subject to an observation period and remains subject to review to address any unintended consequences. It remains the Committee’s intention that the NSFR, including any revisions, will become a minimum standard by 1 January 2018. 13. This document is organised as follows: - Part 1 defines the LCR for internationally active banks and deals with application issues. - Part 2 presents a set of monitoring tools to be used by banks and supervisors in their monitoring of liquidity risks. Part 1: The Liquidity Coverage Ratio 14. The Committee has developed the LCR to promote the short-term resilience of the liquidity risk profile of banks by ensuring that they have sufficient HQLA to survive a significant stress scenario lasting 30 calendar days. 15. The LCR should be a key component of the supervisory approach to liquidity risk, but must be supplemented by detailed supervisory assessments of other aspects of the bank’s liquidity risk management _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 38. P a g e | 38 framework in line with the Sound Principles, the use of the monitoring tools included in Part 2, and, in due course, the NSFR. In addition, supervisors may require an individual bank to adopt more stringent standards or parameters to reflect its liquidity risk profile and the supervisor’s assessment of its compliance with the Sound Principles. I. Objective of the LCR and use of HQLA 16. This standard aims to ensure that a bank has an adequate stock of unencumbered HQLA that consists of cash or assets that can be converted into cash at little or no loss of value in private markets, to meet its liquidity needs for a 30 calendar day liquidity stress scenario. At a minimum, the stock of unencumbered HQLA should enable the bank to survive until Day 30 of the stress scenario, by which time it is assumed that appropriate corrective actions can be taken by management and supervisors, or that the bank can be resolved in an orderly way. Furthermore, it gives the central bank additional time to take appropriate measures, should they be regarded as necessary. As noted in the Sound Principles, given the uncertain timing of outflows and inflows, banks are also expected to be aware of any potential mismatches within the 30-day period and ensure that sufficient HQLA are available to meet any cash flow gaps throughout the period. 17. The LCR builds on traditional liquidity “coverage ratio” methodologies used internally by banks to assess exposure to contingent liquidity events. The total net cash outflows for the scenario are to be calculated for 30 calendar days into the future. The standard requires that, absent a situation of financial stress, the value of the ratio be no lower than 100% (ie the stock of HQLA should at least equal total net cash outflows) on an ongoing basis because the stock of unencumbered HQLA is intended to serve as a defence against the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 39. P a g e | 39 potential onset of liquidity stress. During a period of financial stress, however, banks may use their stock of HQLA, thereby falling below 100%, as maintaining the LCR at 100% under such circumstances could produce undue negative effects on the bank and other market participants. Supervisors will subsequently assess this situation and will adjust their response flexibly according to the circumstances. 18. In particular, supervisory decisions regarding a bank’s use of its HQLA should be guided by consideration of the core objective and definition of the LCR. Supervisors should exercise judgement in their assessment and account not only for prevailing macrofinancial conditions, but also consider forward-looking assessments of macroeconomic and financial conditions. In determining a response, supervisors should be aware that some actions could be procyclical if applied in circumstances of market-wide stress. Supervisors should seek to take these considerations into account on a consistent basis across jurisdictions. (a) Supervisors should assess conditions at an early stage, and take actions if deemed necessary, to address potential liquidity risk. (b) Supervisors should allow for differentiated responses to a reported LCR below 100%. Any potential supervisory response should be proportionate with the drivers, magnitude, duration and frequency of the reported shortfall. (c) Supervisors should assess a number of firm- and market-specific factors in determining the appropriate response as well as other considerations related to both domestic and global frameworks and conditions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 40. P a g e | 40 Potential considerations include, but are not limited to: (i) The reason(s) that the LCR fell below 100%. This includes use of the stock of HQLA, an inability to roll over funding or large unexpected draws on contingent obligations. In addition, the reasons may relate to overall credit, funding and market conditions, including liquidity in credit, asset and funding markets, affecting individual banks or all institutions, regardless of their own condition; (ii) The extent to which the reported decline in the LCR is due to a firm-specific or market-wide shock; (iii) A bank’s overall health and risk profile, including activities, positions with respect to other supervisory requirements, internal risk systems, controls and other management processes, among others; (iv) The magnitude, duration and frequency of the reported decline of HQLA; (v) The potential for contagion to the financial system and additional restricted flow of credit or reduced market liquidity due to actions to maintain an LCR of 100%; (vi) The availability of other sources of contingent funding such as central bank funding, or other actions by prudential authorities. (d) Supervisors should have a range of tools at their disposal to address a reported LCR below 100%. Banks may use their stock of HQLA in both idiosyncratic and systemic stress events, although the supervisory response may differ between the two. (i) At a minimum, a bank should present an assessment of its liquidity position, including the factors that contributed to its LCR falling below _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 41. P a g e | 41 100%, the measures that have been and will be taken and the expectations on the potential length of the situation. Enhanced reporting to supervisors should be commensurate with the duration of the shortfall. (ii) If appropriate, supervisors could also require actions by a bank to reduce its exposure to liquidity risk, strengthen its overall liquidity risk management, or improve its contingency funding plan. (iii) However, in a situation of sufficiently severe system-wide stress, effects on the entire financial system should be considered. Potential measures to restore liquidity levels should be discussed, and should be executed over a period of time considered appropriate to prevent additional stress on the bank and on the financial system as a whole. (e) Supervisors’ responses should be consistent with the overall approach to the prudential framework. II. Definition of the LCR 19. The scenario for this standard entails a combined idiosyncratic and market-wide shock that would result in: (a) The run-off of a proportion of retail deposits; (b) A partial loss of unsecured wholesale funding capacity; (c) A partial loss of secured, short-term financing with certain collateral and counterparties; (d) Additional contractual outflows that would arise from a downgrade in the bank’s public credit rating by up to and including three notches, including collateral posting requirements; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 42. P a g e | 42 (e) Increases in market volatilities that impact the quality of collateral or potential future exposure of derivative positions and thus require larger collateral haircuts or additional collateral, or lead to other liquidity needs; (f) Unscheduled draws on committed but unused credit and liquidity facilities that the bank has provided to its clients; and (g) The potential need for the bank to buy back debt or honour non-contractual obligations in the interest of mitigating reputational risk. 20. In summary, the stress scenario specified incorporates many of the shocks experienced during the crisis that started in 2007 into one significant stress scenario for which a bank would need sufficient liquidity on hand to survive for up to 30 calendar days. 21. This stress test should be viewed as a minimum supervisory requirement for banks. Banks are expected to conduct their own stress tests to assess the level of liquidity they should hold beyond this minimum, and construct their own scenarios that could cause difficulties for their specific business activities. Such internal stress tests should incorporate longer time horizons than the one mandated by this standard. Banks are expected to share the results of these additional stress tests with supervisors. 22. The LCR has two components: (a) Value of the stock of HQLA in stressed conditions; and (b) Total net cash outflows, calculated according to the scenario parameters outlined below. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 43. P a g e | 43 A. Stock of HQLA 23. The numerator of the LCR is the “stock of HQLA”. Under the standard, banks must hold a stock of unencumbered HQLA to cover the total net cash outflows (as defined below) over a 30-day period under the prescribed stress scenario. In order to qualify as “HQLA”, assets should be liquid in markets during a time of stress and, ideally, be central bank eligible. The following sets out the characteristics that such assets should generally possess and the operational requirements that they should satisfy. 1. Characteristics of HQLA 24. Assets are considered to be HQLA if they can be easily and immediately converted into cash at little or no loss of value. The liquidity of an asset depends on the underlying stress scenario, the volume to be monetised and the timeframe considered. Nevertheless, there are certain assets that are more likely to generate funds without incurring large discounts in sale or repurchase agreement (repo) markets due to fire-sales even in times of stress. This section outlines the factors that influence whether or not the market for an asset can be relied upon to raise liquidity when considered in the context of possible stresses. These factors should assist supervisors in determining which assets, despite meeting the criteria from paragraphs 49 to 54, are not sufficiently liquid in private markets to be included in the stock of HQLA. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 44. P a g e | 44 (i) Fundamental characteristics - Low risk: assets that are less risky tend to have higher liquidity. High credit standing of the issuer and a low degree of subordination increase an asset’s liquidity. Low duration, low legal risk, low inflation risk and denomination in a convertible currency with low foreign exchange risk all enhance an asset’s liquidity. - Ease and certainty of valuation: an asset’s liquidity increases if market participants are more likely to agree on its valuation. Assets with more standardised, homogenous and simple structures tend to be more fungible, promoting liquidity. The pricing formula of a high-quality liquid asset must be easy to calculate and not depend on strong assumptions. The inputs into the pricing formula must also be publicly available. In practice, this should rule out the inclusion of most structured or exotic products. - Low correlation with risky assets: the stock of HQLA should not be subject to wrong-way (highly correlated) risk. For example, assets issued by financial institutions are more likely to be illiquid in times of liquidity stress in the banking sector. - Listed on a developed and recognised exchange: being listed increases an asset’s transparency. (ii) Market-related characteristics - Active and sizable market: the asset should have active outright sale or repo markets at all times. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 45. P a g e | 45 This means that: - There should be historical evidence of market breadth and market depth. This could be demonstrated by low bid-ask spreads, high trading volumes, and a large and diverse number of market participants. Diversity of market participants reduces market concentration and increases the reliability of the liquidity in the market. - There should be robust market infrastructure in place. - The presence of multiple committed market makers increases liquidity as quotes will most likely be available for buying or selling HQLA. - Low volatility: Assets whose prices remain relatively stable and are less prone to sharp price declines over time will have a lower probability of triggering forced sales to meet liquidity requirements. Volatility of traded prices and spreads are simple proxy measures of market volatility. There should be historical evidence of relative stability of market terms (eg prices and haircuts) and volumes during stressed periods. - Flight to quality: historically, the market has shown tendencies to move into these types of assets in a systemic crisis. The correlation between proxies of market liquidity and banking system stress is one simple measure that could be used. 25. As outlined by these characteristics, the test of whether liquid assets are of “high quality” is that, by way of sale or repo, their liquidity - generating capacity is assumed to remain intact even in periods of severe idiosyncratic and market stress. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 46. P a g e | 46 Lower quality assets typically fail to meet that test. An attempt by a bank to raise liquidity from lower quality assets under conditions of severe market stress would entail acceptance of a large fire-sale discount or haircut to compensate for high market risk. That may not only erode the market’s confidence in the bank, but would also generate mark-to-market losses for banks holding similar instruments and add to the pressure on their liquidity position, thus encouraging further fire sales and declines in prices and market liquidity. In these circumstances, private market liquidity for such instruments is likely to disappear quickly. 26. HQLA (except Level 2B assets as defined below) should ideally be eligible at central banks for intraday liquidity needs and overnight liquidity facilities. In the past, central banks have provided a further backstop to the supply of banking system liquidity under conditions of severe stress. Central bank eligibility should thus provide additional confidence that banks are holding assets that could be used in events of severe stress without damaging the broader financial system. That in turn would raise confidence in the safety and soundness of liquidity risk management in the banking system. 27. It should be noted however, that central bank eligibility does not by itself constitute the basis for the categorisation of an asset as HQLA. 2. Operational requirements 28. All assets in the stock of HQLA are subject to the following operational requirements. The purpose of the operational requirements is to recognise that not all assets outlined in paragraphs 49-54 that meet the asset class, _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 47. P a g e | 47 risk-weighting and credit-rating criteria should be eligible for the stock as there are other operational restrictions on the availability of HQLA that can prevent timely monetisation during a stress period. 29. These operational requirements are designed to ensure that the stock of HQLA is managed in such a way that the bank can, and is able to demonstrate that it can, immediately use the stock of assets as a source of contingent funds that is available for the bank to convert into cash through outright sale or repo, to fill funding gaps between cash inflows and outflows at any time during the 30-day stress period, with no restriction on the use of the liquidity generated. 30. A bank should periodically monetise a representative proportion of the assets in the stock through repo or outright sale, in order to test its access to the market, the effectiveness of its processes for monetisation, the availability of the assets, and to minimise the risk of negative signalling during a period of actual stress. 31. All assets in the stock should be unencumbered. “Unencumbered” means free of legal, regulatory, contractual or other restrictions on the ability of the bank to liquidate, sell, transfer, or assign the asset. An asset in the stock should not be pledged (either explicitly or implicitly) to secure, collateralise or credit-enhance any transaction, nor be designated to cover operational costs (such as rents and salaries). Assets received in reverse repo and securities financing transactions that are held at the bank, have not been rehypothecated, and are legally and contractually available for the bank's use can be considered as part of the stock of HQLA. In addition, assets which qualify for the stock of HQLA that have been pre-positioned or deposited with, or pledged to, the central bank or a public sector entity (PSE) but have not been used to generate liquidity may be included in the stock. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 48. P a g e | 48 32. A bank should exclude from the stock those assets that, although meeting the definition of “unencumbered” specified in paragraph 31, the bank would not have the operational capability to monetise to meet outflows during the stress period. Operational capability to monetise assets requires having procedures and appropriate systems in place, including providing the function identified in paragraph 33 with access to all necessary information to execute monetisation of any asset at any time. Monetisation of the asset must be executable, from an operational perspective, in the standard settlement period for the asset class in the relevant jurisdiction. 33. The stock should be under the control of the function charged with managing the liquidity of the bank (eg the treasurer), meaning the function has the continuous authority, and legal and operational capability, to monetise any asset in the stock. Control must be evidenced either by maintaining assets in a separate pool managed by the function with the sole intent for use as a source of contingent funds, or by demonstrating that the function can monetise the asset at any point in the 30-day stress period and that the proceeds of doing so are available to the function throughout the 30-day stress period without directly conflicting with a stated business or risk management strategy. For example, an asset should not be included in the stock if the sale of that asset, without replacement throughout the 30-day period, would remove a hedge that would create an open risk position in excess of internal limits. 34. A bank is permitted to hedge the market risk associated with ownership of the stock of HQLA and still include the assets in the stock. If it chooses to hedge the market risk, the bank should take into account (in the market value applied to each asset) the cash outflow that would _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 49. P a g e | 49 arise if the hedge were to be closed out early (in the event of the asset being sold). 35. In accordance with Principle 9 of the Sound Principles a bank “should monitor the legal entity and physical location where collateral is held and how it may be mobilised in a timely manner”. Specifically, it should have a policy in place that identifies legal entities, geographical locations, currencies and specific custodial or bank accounts where HQLA are held. In addition, the bank should determine whether any such assets should be excluded for operational reasons and therefore, have the ability to determine the composition of its stock on a daily basis. 36. As noted in paragraphs 171 and 172, qualifying HQLA that are held to meet statutory liquidity requirements at the legal entity or sub - consolidated level (where applicable) may only be included in the stock at the consolidated level to the extent that the related risks (as measured by the legal entity’s or sub-consolidated group’s net cash outflows in the LCR) are also reflected in the consolidated LCR. Any surplus of HQLA held at the legal entity can only be included in the consolidated stock if those assets would also be freely available to the consolidated (parent) entity in times of stress. 37. In assessing whether assets are freely transferable for regulatory purposes, banks should be aware that assets may not be freely available to the consolidated entity due to regulatory, legal, tax, accounting or other impediments. Assets held in legal entities without market access should only be included to the extent that they can be freely transferred to other entities that could monetise the assets. 38. In certain jurisdictions, large, deep and active repo markets do not exist for eligible asset classes, and therefore such assets are likely to be monetised through outright sale. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 50. P a g e | 50 In these circumstances, a bank should exclude from the stock of HQLA those assets where there are impediments to sale, such as large fire-sale discounts which would cause it to breach minimum solvency equirements, or requirements to hold such assets, including, but not limited to, statutory minimum inventory requirements for market making. 39. Banks should not include in the stock of HQLA any assets, or liquidity generated from assets, they have received under right of rehypothecation, if the beneficial owner has the contractual right to withdraw those assets during the 30-day stress period. 40. Assets received as collateral for derivatives transactions that are not segregated and are legally able to be rehypothecated may be included in the stock of HQLA provided that the bank records an appropriate outflow for the associated risks as set out in paragraph 116. 41. As stated in Principle 8 of the Sound Principles, a bank should actively manage its intraday liquidity positions and risks to meet payment and settlement obligations on a timely basis under both normal and stressed conditions and thus contribute to the smooth functioning of payment and settlement systems. Banks and regulators should be aware that the LCR stress scenario does not cover expected or unexpected intraday liquidity needs. 42. While the LCR is expected to be met and reported in a single currency, banks are expected to be able to meet their liquidity needs in each currency and maintain HQLA consistent with the distribution of their liquidity needs by currency. The bank should be able to use the stock to generate liquidity in the currency and jurisdiction in which the net cash outflows arise. As such, the LCR by currency is expected to be monitored and reported to allow the bank and its supervisor to track any potential currency mismatch issues that could arise, as outlined in Part 2. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 51. P a g e | 51 In managing foreign exchange liquidity risk, the bank should take into account the risk that its ability to swap currencies and access the relevant foreign exchange markets may erode rapidly under stressed conditions. It should be aware that sudden, adverse exchange rate movements could sharply widen existing mismatched positions and alter the effectiveness of any foreign exchange hedges in place. 43. In order to mitigate cliff effects that could arise, if an eligible liquid asset became ineligible (eg due to rating downgrade), a bank is permitted to keep such assets in its stock of liquid assets for an additional 30 calendar days. This would allow the bank additional time to adjust its stock as needed or replace the asset. 3. Diversification of the stock of HQLA 44. The stock of HQLA should be well diversified within the asset classes themselves (except for sovereign debt of the bank’s home jurisdiction or from the jurisdiction in which the bank operates; central bank reserves; central bank debt securities; and cash). Although some asset classes are more likely to remain liquid irrespective of circumstances, ex-ante it is not possible to know with certainty which specific assets within each asset class might be subject to shocks ex-post. Banks should therefore have policies and limits in place in order to avoid concentration with respect to asset types, issue and issuer types, and currency (consistent with the distribution of net cash outflows by currency) within asset classes. 4. Definition of HQLA 45. The stock of HQLA should comprise assets with the characteristics outlined in paragraphs 24-27. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 52. P a g e | 52 This section describes the type of assets that meet these characteristics and can therefore be included in the stock. 46. There are two categories of assets that can be included in the stock. Assets to be included in each category are those that the bank is holding on the first day of the stress period, irrespective of their residual maturity. “Level 1” assets can be included without limit, while “Level 2” assets can only comprise up to 40% of the stock. 47. Supervisors may also choose to include within Level 2 an additional class of assets (Level 2B assets - see paragraph 53 below). If included, these assets should comprise no more than 15% of the total stock of HQLA. They must also be included within the overall 40% cap on Level 2 assets. 48. The 40% cap on Level 2 assets and the 15% cap on Level 2B assets should be determined after the application of required haircuts, and after taking into account the unwind of short-term securities financing transactions and collateral swap transactions maturing within 30 calendar days that involve the exchange of HQLA. In this context, short term transactions are transactions with a maturity date up to and including 30 calendar days. The details of the calculation methodology are provided in Annex 1. (i) Level 1 assets 49. Level 1 assets can comprise an unlimited share of the pool and are not subject to a haircut under the LCR. However, national supervisors may wish to require haircuts for Level 1 securities based on, among other things, their duration, credit and liquidity risk, and typical repo haircuts. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 53. P a g e | 53 50. Level 1 assets are limited to: (a) Coins and banknotes; (b) Central bank reserves (including required reserves), to the extent that the central bank policies allow them to be drawn down in times of stress; (c) Marketable securities representing claims on or guaranteed by sovereigns, central banks, PSEs, the Bank for International Settlements, the International Monetary Fund, the European Central Bank and European Community, or multilateral development banks, and satisfying all of the following conditions: - assigned a 0% risk-weight under the Basel II Standardised Approach for credit risk; - traded in large, deep and active repo or cash markets characterised by a low level of concentration; - have a proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions; and - not an obligation of a financial institution or any of its affiliated entities. (d) where the sovereign has a non-0% risk weight, sovereign or central bank debt securities issued in domestic currencies by the sovereign or central bank in the country in which the liquidity risk is being taken or in the bank’s home country; and (e) where the sovereign has a non-0% risk weight, domestic sovereign or central bank debt securities issued in foreign currencies are eligible up to the amount of the bank’s stressed net cash outflows in that specific foreign currency stemming from the bank’s operations in the jurisdiction where the bank’s liquidity risk is being taken. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 54. P a g e | 54 (ii) Level 2 assets 51. Level 2 assets (comprising Level 2A assets and any Level 2B assets permitted by the supervisor) can be included in the stock of HQLA, subject to the requirement that they comprise no more than 40% of the overall stock after haircuts have been applied. 52. A 15% haircut is applied to the current market value of each Level 2A asset held in the stock of HQLA. Level 2A assets are limited to the following: (a) Marketable securities representing claims on or guaranteed by sovereigns, central banks, PSEs or multilateral development banks that satisfy all of the following conditions: - assigned a 20% risk weight under the Basel II Standardised Approach for credit risk; - traded in large, deep and active repo or cash markets characterised by a low level of concentration; - have a proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions (ie maximum decline of price not exceeding 10% or increase in haircut not exceeding 10 percentage points over a 30-day period during a relevant period of significant liquidity stress); and - not an obligation of a financial institution or any of its affiliated entities. (b) Corporate debt securities (including commercial paper) and covered bonds that satisfy all of the following conditions: - in the case of corporate debt securities: not issued by a financial institution or any of its affiliated entities; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 55. P a g e | 55 - in the case of covered bonds: not issued by the bank itself or any of its affiliated entities; - either (i) have a long-term credit rating from a recognised external credit assessment institution (ECAI) of at least AA-21 or in the absence of a long term rating, a short-term rating equivalent in quality to the long-term rating; or (ii) do not have a credit assessment by a recognised ECAI but are internally rated as having a probability of default (PD) corresponding to a credit rating of at least AA-; - traded in large, deep and active repo or cash markets characterised by a low level of concentration; and - have a proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions: ie maximum decline of price or increase in haircut over a 30-day period during a relevant period of significant liquidity stress not exceeding 10%. (iii) Level 2B assets 53. Certain additional assets (Level 2B assets) may be included in Level 2 at the discretion of national authorities. In choosing to include these assets in Level 2 for the purpose of the LCR, supervisors are expected to ensure that such assets fully comply with the qualifying criteria. Supervisors are also expected to ensure that banks have appropriate systems and measures to monitor and control the potential risks (eg credit and market risks) that banks could be exposed to in holding these assets. 54. A larger haircut is applied to the current market value of each Level 2B asset held in the stock of HQLA. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 56. P a g e | 56 Level 2B assets are limited to the following: (a) Residential mortgage backed securities (RMBS) that satisfy all of the following conditions may be included in Level 2B, subject to a 25% haircut: - not issued by, and the underlying assets have not been originated by the bank itself or any of its affiliated entities; - have a long-term credit rating from a recognised ECAI of AA or higher, or in the absence of a long term rating, a short-term rating equivalent in quality to the long-term rating; - traded in large, deep and active repo or cash markets characterised by a low level of concentration; - have a proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions, ie a maximum decline of price not exceeding 20% or increase in haircut over a 30-day period not exceeding 20 percentage points during a relevant period of significant liquidity stress; - the underlying asset pool is restricted to residential mortgages and cannot contain structured products; - the underlying mortgages are “full recourse’’ loans (ie in the case of foreclosure the mortgage owner remains liable for any shortfall in sales proceeds from the property) and have a maximum loan-to-value ratio (LTV) of 80% on average at issuance; and - the securitisations are subject to “risk retention” regulations which require issuers to retain an interest in the assets they securitise. (b) Corporate debt securities (including commercial paper) that satisfy all of the following conditions may be included in Level 2B, subject to a 50% haircut: - not issued by a financial institution or any of its affiliated entities; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 57. P a g e | 57 - either - (i) have a long-term credit rating from a recognised ECAI between A+ and BBB- or in the absence of a long term rating, a short-term rating equivalent in quality to the long-term rating; or - (ii) do not have a credit assessment by a recognised ECAI and are internally rated as having a PD corresponding to a credit rating of between A+ and BBB-; - traded in large, deep and active repo or cash markets characterised by a low level of concentration; and - have a proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions, ie a maximum decline of price not exceeding 20% or increase in haircut over a 30-day period not exceeding 20 percentage points during a relevant period of significant liquidity stress. (c) Common equity shares that satisfy all of the following conditions may be included in Level 2B, subject to a 50% haircut: - not issued by a financial institution or any of its affiliated entities; - exchange traded and centrally cleared; - a constituent of the major stock index in the home jurisdiction or where the liquidity risk is taken, as decided by the supervisor in the jurisdiction where the index is located; - denominated in the domestic currency of a bank’s home jurisdiction or in the currency of the jurisdiction where a bank’s liquidity risk is taken; - traded in large, deep and active repo or cash markets characterised by a low level of concentration; and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 58. P a g e | 58 - have a proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions, ie a maximum decline of share price not exceeding 40% or increase in haircut not exceeding 40 percentage points over a 30-day period during a relevant period of significant liquidity. (iv) Treatment for jurisdictions with insufficient HQLA (a) Assessment of eligibility for alternative liquidity approaches (ALA) 55. Some jurisdictions may have an insufficient supply of Level 1 assets (or both Level 1 and Level 2 assets) in their domestic currency to meet the aggregate demand of banks with significant exposures in this currency. To address this situation, the Committee has developed alternative treatments for holdings in the stock of HQLA, which are expected to apply to a limited number of currencies and jurisdictions. Eligibility for such alternative treatment will be judged on the basis of the qualifying criteria set out in Annex 2 and will be determined through an independent peer review process overseen by the Committee. The purpose of this process is to ensure that the alternative treatments are only used when there is a true shortfall in HQLA in the domestic currency relative to the needs in that currency. 56. To qualify for the alternative treatment, a jurisdiction should be able to demonstrate that: - there is an insufficient supply of HQLA in its domestic currency, taking into account all relevant factors affecting the supply of, and demand for, such HQLA; - the insufficiency is caused by long-term structural constraints that cannot be resolved within the medium term; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 59. P a g e | 59 - it has the capacity, through any mechanism or control in place, to limit or mitigate the risk that the alternative treatment cannot work as expected; and - it is committed to observing the obligations relating to supervisory monitoring, disclosure, and periodic self-assessment and independent peer review of its eligibility for alternative treatment. All of the above criteria have to be met to qualify for the alternative treatment. 57. Irrespective of whether a jurisdiction seeking ALA treatment will adopt the phase-in arrangement set out in paragraph 10 for implementing the LCR, the eligibility for that jurisdiction to adopt ALA treatment will be based on a fully implemented LCR standard (ie 100% requirement). (b) Potential options for alternative treatment 58. Option 1 – Contractual committed liquidity facilities from the relevant central bank, with a fee: For currencies that do not have sufficient HQLA, as determined by reference to the qualifying principles and criteria, Option 1 would allow banks to access contractual committed liquidity facilities provided by the relevant central bank (ie relevant given the currency in question) for a fee. These facilities should not be confused with regular central bank standing arrangements. In particular, these facilities are contractual arrangements between the central bank and the commercial bank with a maturity date which, at a minimum, falls outside the 30-day LCR window. Further, the contract must be irrevocable prior to maturity and involve no ex-post credit decision by the central bank. Such facilities are only permissible if there is also a fee for the facility which is charged regardless of the amount, if any, drawn down against _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 60. P a g e | 60 that facility and the fee is set so that banks which claim the facility line to meet the LCR, and banks which do not, have similar financial incentives to reduce their exposure to liquidity risk. That is, the fee should be set so that the net yield on the assets used to secure the facility should not be higher than the net yield on a representative portfolio of Level 1 and Level 2 assets, after adjusting for any material differences in credit risk. A jurisdiction seeking to adopt Option 1 should justify in the independent peer review that the fee is suitably set in a manner as prescribed in this paragraph. 59. Option 2 – Foreign currency HQLA to cover domestic currency liquidity needs: For currencies that do not have sufficient HQLA, as determined by reference to the qualifying principles and criteria, Option 2 would allow supervisors to permit banks that evidence a shortfall of HQLA in the domestic currency (which would match the currency of the underlying risks) to hold HQLA in a currency that does not match the currency of the associated liquidity risk, provided that the resulting currency mismatch positions are justifiable and controlled within limits agreed by their supervisors. Supervisors should restrict such positions within levels consistent with the bank’s foreign exchange risk management capacity and needs, and ensure that such positions relate to currencies that are freely and reliably convertible, are effectively managed by the bank, and would not pose undue risk to its financial strength. In managing those positions, the bank should take into account the risks that its ability to swap currencies, and its access to the relevant foreign exchange markets, may erode rapidly under stressed conditions. It should also take into account that sudden, adverse exchange rate movements could sharply widen existing mismatch positions and alter the effectiveness of any foreign exchange hedges in place. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com