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metric CHASE COOPERThe new UK regulatory framework —the mists are clearing Nick Gibson, Chase Coopers Director of Compliance Solutions,US’s PCAOB to inspect summarises the recent clarification received from the UK Treasuryoverseas auditors Department and comments on its impact on regulated firms. In the UK we are in the midst of a low‐key but far‐reaching regulatory revolution, driven by the The PCAOB, created by the Sarbanes–Oxley Act (Sarbox) to oversee auditors of Sarbox‐ coalition government, in response to the perceived past failings of the participants in the effected companies, has said that in 2011 it existing system (and in particular the Financial Services Authority ‐ FSA).will inspect audit firms in 31 countries, On 17th February HM Treasury issued its 138 page blueprint for including the UK, despite initial reluctance from many overseas the revised UK regulatory system. This follows the first HMT auditors citing sovereignty and legal consultation document, issued in July (for which comments closed concerns. in October) and contains a number of significant changes. Further In 2010 the EU declared the PCAOB an comments are invited on the new paper by the closing date in mid‐“equivalent regulator” and the Dodd‐Frank Act allowed the PCAOB to share April.information with overseas bodies. The Professional Oversight Board, the UK’s Whilst the most noticeable headline change is the change of name “super‐regulator” of accountancy and from the Consumer Protection & IN THIS ISSUE OF metricaudit supervisory bodies, has agreed to Nick Gibson, Chase Cooper Markets Authority (CPMA) to the more G20 sets targetsshare information. digestible Financial Conduct Authority ‐ about which more below ‐ London trader jailedDame Barbara Mills, Chair of the POB said there are a number of more fundamental changes or clarifications New EBA Head appointed“The agreement will improve our respective access to information, for example relating from the original, some of which are, to our eyes, potentially quite Managing Liquidity Riskto US audit firms registered in the UK, and disturbing.UK firms registered in the US”. StructureAll foreign companies with any share listing in the USA need to comply with Sarbox The structure remains almost entirely as originally planned, with a Financial Policy Committee requirements and their audit firms must be (FPC) within the Bank of England running macro‐prudential supervision, to identify and reduce registered with the PCAOB in order to carry systemic risks arising within the financial system. The FPC will not be an institutional supervisor, out compliant audits. Over 900 audit firms from over 85 countries have registered with and will have no powers over individual firms.the PCAOB and are subject to inspections in the same manner as US firms. The two new supervisory bodies will be the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA), whilst the Bank of This is the new format for our newsletter, Chase Cooper metric. We will be publishing this monthly towards the end of the month and distributing it by email. England will have direct responsibility for 1 In view of the recent announcements on the UK’s regulatory changes we have made supervising systemically‐important this a 6 page issue with a major article summarising and commenting on these infrastructure, such as payment systems, changes. We would enjoy receiving any comments on our new format at settlement systems under the firstname.lastname@example.org. continued on page 2
Uncertificated Securities Regulations 2001, and recognised clearing setting balance sheet leverage ratios,houses under FSMA. requiring the publication of specific information by classes of firms The PRA has a single strategic objective: "contributing to the promotion during times of stress,of the stability of the UK financial system". The PRA mandate makes it setting higher collateral requirements where lending growth in solely responsible for the prudential regulation of all banks, building specific classes of lending appears unsustainable.societies, credit unions and insurers. The PRA may also designate The FPC will also be able to direct the PRA and FCA to gather and investment firms that deal as principal, to bring them under its provide information supervision, where PRA believes specific firms may pose systemic risks to Whilst PRA and the FCA are metric from authorised the UKs financial stability, or to other de facto PRA‐regulated firms “equal in status”, there are firms needed by the within the firms group. significant issues where it Bank of England in In addition to insurance providers, the role in relation to insurance also order to meet its appears that the PRA hasmakes it the prudential regulator for Lloyds of London; comfort is given, financial stability primacy.in relation to insurance business generally, that a prudential lighter touch objective at any time, may be appropriate by comparison with banks. but particularly during times of stress. The Bank of England, FPC and PRA Both the PRA and FCA will in any event be under statutory duties to will be collectively responsible under provide or share detailed information with the FPC on a routine basis to the same roof for designing the UK inform its own decision making. In return, the FPC will provide advice and response to the next emergent expertise to both regulators on systemic financial stability and current financial crisis, and executing the and developing risks thereto. The PRA and the FCA are clearly described special resolution regime where as "equal in status". This is, in some respects, true. There are, however, necessary. significant operational issues where it appears that PRA has primacy over the FCA. The second supervisory body, the HECTOR SANTS, current Chief Financial Conduct Authority, will The PRAs relevant powers include: Executive of the FSA and Chief Executive designate of the PRA regulate the conduct of all Where FCA wishes to take action against an authorised firm by authorised financial services firms, and will be prudential regulator for all imposing requirements or cancelling its permissions, it is the PRA that firms not regulated by the PRA. The FCA will be by far the larger of the has the expertise to judge whether this might cause the firm to fail in two bodies, but will have a clearly subsidiary role. a disorderly way and/or cause financial instability within the system. Leaving reporting lines to one side, a natural hierarchy of influence has When consultation between the two regulators about the proposed emerged in the governments deliberations. The FPC, as the macro‐ action takes place, the government expects that the FCA will prudential regulator, sits at the top of the influence tree, and is being 2 take the PRAs advice in relation to the risk of disorderly failure.given powers in respect of both supervisors. In the event that the PRA and FCA are unable to agree on a The FPCs powers in respect of the PRA and FCA include: course of action, the legislation will grant PRA the power of veto over the FCAs proposed course where the PRA considers that it would risk The ability to make "recommendations" to the PRA and FCA, under financial instability or the disorderly failure of the firm concerned. the comply or explain principle, where either body, if not adopting the recommendation, will be required to explain publicly why it chose The PRA power of veto also extends to the making of rules by FCA, not to, and and even FCAs granting of individual firm modifications or waivers, where PRA believes there may be a negative impact on financial The ability to direct the PRA and FCA to adopt and apply specific stability or the prospect of a disorderly failure. macro‐economic tools in specific ways, which could include (amongst Lead responsibility for approving particular Controlled Functions for others): jointly‐regulated firms will be split between the two regulators. setting levels for counter‐cyclical capital buffers/dynamic Subject to consultation between them, the PRA will have the final say provisioning, in approving Significant Influence Functions which impact on setting variable risk weights focused on specific sectors or asset prudential soundness, such as that of the Chief Executive Officer: the classes, FCA will have similar powers in respect of functions which impact continued on page 3
more on its own statutory responsibilities, such as client assets or This is clearly a very direct response to the governments fury over FSA anti‐money laundering. being unable to publish its report into RBS due to its interpretation of the current confidentiality provisions in FSMA. Financial Policy Committee The Financial Policy Committee remains broadly as envisioned in the first In a material change from earlier proposals, significant regulatory document, with the statutory objective of "..the identification of, decisions in respect of particular firms will no longer be taken solely by a monitoring of, and PRA Executive Committee, or one with a majority of executive staff. The government has fortunately recognised the obvious incongruity that this metricPRA reports will contain taking of action to would contradict the principles of good corporate governance that PRA confidential information remove or reduce, itself should be enforcing on firms. It now proposes to give the PRA where publication is in the systemic risks with a flexibility to create its own decision‐making structures, involving non‐national interest. view to protecting and enhancing the resilience executives "as appropriate" in this context. of the UK financial system…" . Operationally, the PRA will be obliged to take a judgment‐led supervisory The particular systemic risks within that objective are: approach to the firms it regulates, and will take a more principles‐based approach in creating regulation, requiring PRA‐supervised firms to systemic risks attributable to structural features of financial markets comply with the spirit, as well as the letter, of its prudential rules. or to the distribution of risk within the financial sector, and On the back of this approach, PRA unsustainable levels of leverage, debt or credit growth will have its own enforcement powers. The obvious challenges In response to concerns raised during consultation, the objective has of effective enforcement in metric been extended to reflect that the FPC should not take actions under this response to breaches in a objective that would be, in their own view "…likely to have a significant judgment‐led, principles‐based adverse effect on the capacity of the financial sector to contribute to the regime are recognised. growth of the UK economy in the medium or long term…". A particularly interesting The 12 members of the interim FPC have also been announced, notably statement in the document is including a former Vice Chairman of the US Federal Reserve and a former that, "The Government is Director General of the Confederation for British Industry. This interim Sir Richard Lambert, new member considering whether appeals of the FPC and until recently, FPC started to operate experimentally in February and is waiting for the Director General of the CBI from judgement‐based (Photo courtesy of the CBI) legislation to catch up before it takes full powers. supervisory decisions should be Prudential Regulation Authority heard by the Upper Tribunal on limited grounds (those which could be raised on a judicial review) rather than the full merits review The PRA will be "operationally independent" from the Bank of England, with its own Board, but accountable to the Court of Directors of the Bank currently provided for in relation to FSA supervisory decisions 3 which engage the statutory notice procedure." of England for administrative matters, which include budget, remuneration, and performance against objectives. This constitutes an Simply put, if implemented, this appears to mean that PRAs decisions interesting definition of independence, particularly as the Chairman of would only be able to be challenged if it could be demonstrated that in the PRA will be the Governor of the Bank of England. reaching a judgment‐led decision, PRA had acted illegally, acted irrationally or unreasonably, or created a procedural impropriety. Clearly However, operational independence will apparently be preserved by the this would make PRA decisions even more difficult, and even more PRA Board having a majority of non‐executive directors. It will also be expensive, to overturn than under the existing FSA regime. subject to audit by the National Audit Office, and accountable to Parliament and Ministers, with a new measure that where there is a The PRA will also have powers, transferred from FSA, to require significant regulatory failure, the PRA must then make a formal report to information for financial stability purposes from unregulated persons as HM Treasury containing an analysis of the causes of the failure, and well as from those it directly supervises. lessons to be learned. HM Treasury will in turn lay the report before Financial Conduct Authority Parliament, and it will be made public. Whereas there was a lot of the political rhetoric on the role of the ex‐ This provision is unambiguous in stating that such reports will contain CPMA as a consumer champion fighting for the downtrodden, there is confidential information where its publication is in the national interest. significant back‐tracking on this both in Parliament and in the current continued on page 4
proposals ‐ part of which is reflected in the change of name. To a large action is subsequently dropped, a large part of the reputational extent this is designed to answer questions about a future lack of damage to the firm or person will already have been done.impartiality in its dealings with firms. In an apparent turnaround, the FCA will be retaining its powers of The proposal therefore includes a very early and clear statement in the prosecution for market abuse offences, rather than transferring them description of the FCAs role as "...protecting and enhancing the to the proposed new Economic Crime Agency.confidence of all consumers of financial services ‐ from retail customers choosing a current account to a hedge fund engaging in multi‐million The UK Listing Authority will also remain within the FCA, rather than pound derivatives trades." as was previously being considered, transferred to the Financial Reporting Council.The FCA has ‐ like the PRA ‐ been given a single strategic objective, to protect and enhance confidence in the UK financial system. Its operating It is proposed that The FCA will be able to metricmodel will be, as envisaged, materially different from FSAs current the FCA will also have approach, with a much greater focus on financial products, and rather a significant role in publish Warning Noticesless focus on firms themselves: applying general signalling the start of formal competition law in enforcement proceedings There is recognition that detriment in retail financial services is more financial services, but likely to arise from a sector or product than from the conduct of an the details are subject to subsequent publication. individual firm. Because of this, much of FCAs focus will be on issues‐ based, rather than firm‐based supervision ‐ a continuance and Current measures strengthening of theme‐based supervision, where the FCA will be As noted above, the "interim FPC" was appointed in February and will expected to publish more observations of good and bad business start to meet with an initial focus on identifying the right macro‐ practice. prudential tools to be used when it assumes full powers. The "vast majority" of FCA firms will interact with the regulator FSA itself is constructing a shadow organisation to mirror and trial the through a contact centre, and only a small number of firms will have a operations of the proposed PRA and FCA. In practical terms this means dedicated FCA supervisor. that FSA staff are being allocated to one or other organisation, as described in Hector Sants "Dear CEO letter" of 7th February (which still All firms will, however, be subject to periodic review of their referred to CPMA rather than FCA). The new FSA internal organisation, governance, culture and controls ‐ so ARROW will remain in some split between the Prudential Business Unit and the Consumer & Markets form. Business Unit will start operating on 4th April. The FCA will be granted powers to ban products in development, or In a spin‐off bonus for firms, the focus on the new organisation will mean those already in the market, where there is a significant prospect of a reduction in routine supervisory activity; on which affected firms are to be informed. 4 consumer detriment, and where setting conditions on the product or the sales process has proven ineffective. Sants himself has been confirmed as the first head of the PRA, and Martin Wheatley, current Chief Executive of the Hong Kong There is, happily, no intention to involve the FCA in the pre‐approval Securities & Futures Commission and former Deputy Chief Executive of of financial products. the London Stock Exchange, is CEO‐designate for the FCA. He will join There is a proposed power to enable the FCA to direct a firm to FSA to run the new CMBU in September this year. withdraw a financial promotion, and to make public the fact that it Next steps has done so to warn consumers. The draft bill creating the new structure and both dealing with the new As an enhancement to the current FSA credible deterrence policy, the powers and transferring the existing ones is intended to be published by the government is proposing that the FCA will be able to publish Warning early summer, and enacted within 12 months. The government is determined Notices, which signal the start of formal enforcement proceedings that the new regulatory structure will be up and running by the end of 2012. (rather than their end). This is a sweeping change. Effectively the The closing date for responses to the current paper is 14th April 2011, and charges against a firm or individual, and the summary supporting consultation responses will feed into both the governments White Paper on evidence, will be published without the accused having had the reform and the draft Parliamentary Bill. We will continue to update you as opportunity for its defence to be heard. Whilst there is then an things develop further. m obligation to publish a Notice of Discontinuance if the enforcement
G20 sets targets European Parliament confirms EBA head At this month’s Paris meeting, the G20 Finance Ministers and Earlier this month the European Central Bank Governors have agreed the next steps to combat the Parliament confirmed Andrea Enria current crisis. They will agree, by April, on quantitative indicators as the first Chairperson of the that will be used to assess public debt and deficits, private savings European Banking Authority (EBA), rate and debts, and trade balances and investment flows. By the new regulatory body October they want the IMF to established at the start of this year have developed a plan for and which takes over all existing strengthening the IMS and for and ongoing tasks and them to report on progress in responsibilities from the previous April. Committee of European Banking Andrea Enria, first Chairperson of Supervisors (CEBS). the European Banking Authority Commodity price volatility was also a target and the IMF and This confirmation followed a meeting of the Economic and the International Energy Monetary Affairs Committee (ECON). Forum are being asked to In his opening statement, Enria emphasised the need for the EBA to coordinate strategies on oil, move towards a more integrated regulatory and supervisory Christine Lagarde gas and coal price volatility. France’s Finance and Economics Minister framework in the Union and to work as a “hub and spoke” (Photo courtesy World Economic Forum) October is also scheduled as European system of supervision heavily backed by national the date by which the G20 expect to propose and agree the supervisors. When describing the way forward, he said “the first handling of globally systemically important financial institutions (G‐ priority should be the success of the European stress test exercise. SIFIs) and a framework is expected to ensure stability through European banks are still operating in a fragile market environment capital surcharges, contingent capital, bail‐in instruments and and we need to make sure that they are able to withstand a further systemic levies. This framework is expected to be on top of the severe shock and that those that aren’t strong enough are subject requirements of Basel III. The G20 also expect proposals by the to appropriate supervisory actions.” middle of this year on regulation and oversight of the shadow Enria starts his role of Chairperson on March 1st. Previously, he banking system with an emphasis on the risks of arbitrage as well was Head of the Supervisory Regulations and Policies Department as those associated with new technological trading platforms. m at the Banca d’Italia. m London trader jailed for £14M fraud A case brought by the City of London Polices Economic Crime Chase Cooper Directorate has resulted in a City trader being jailed for eight years. Strategic Compliance Terry Freeman of GFX Capital assured 350 investors of high returns Breakfast Briefing by investing in foreign exchange markets. Investors were also Held on 16th February, Chase Cooper’s fourth Strategic 5 assured that stop loss checks had been put on their accounts. They Compliance Breakfast Briefing was held as a complimentary were also given false trading statements which showed that their service to current and new clients. accounts were healthy when, in fact, Freeman was using their funds to pay off other investors. It also turned out that Freeman Nick Gibson, Director of Compliance Solutions at Chase Cooper, had falsely stated he had previously worked at Morgan Stanley covered a wide‐ranging agenda, looking in some detail at the when the truth was that he had a string of convictions going back troublesome practical implications for UK businesses of the new to 1979 but that he had changed his name in 2000 to avoid being European regulatory system and of the ongoing MiFID2 review, set identified as such. against the backdrop of the current political and economic situation in the UK and worldwide, and the existing focus of FSA Freeman pleaded guilty in Southwark Crown Court to six charges and proposed changes within UK regulation. The event was including fraudulent trading and trading whilst bankrupt. Although attended by 15 senior delegates from brokers, corporate banks, the deception was uncovered when Freeman could not hide the private banks and the insurance sector. losses made following the Lehman collapse, much of the investors’ funds had been spent on holiday homes, entertaining in executive The next Breakfast Briefing, which is open to senior compliance, boxes and on gifts for his family. The court heard that threats from business and risk staff working in FSA authorised firms, will be held overseas investors had resulted in Freeman handing himself into at Chase Cooper’s offices on 16th March 2011 with registration the police. m from 8.30 a.m. You can register your interest online here. m
Regulatory ASYMmetricALNEWS The back page, sometimes critical view from the EditorFSA HANDBOOK RULE CHANGES Who will manage liquidity risk? Who has overall responsibility for this?The rule changes to the FSA Handbook Liquidity risk, its management, measurement and standards, are now firmly part of the new resulting from the Consultative Paper 10/3 and Basel III requirements. A standard, part of the many documents that currently make up Basel Policy Statement 10/15 on Effective Corporate III, "International Framework for Liquidity Risk Measurement, Standards and Monitoring", was Governance come into released last December. The objectives are to manage both the short‐term effect on the 1st of May. resilience of a banks liquidity risk profile and to pressure the banks to look These new rules, based for more stable sources of longer‐term funding. on the 2009 Walker Review, are to improve To achieve these, two measurements have been introduced: the Liquidity corporate governance in Coverage Ratio (LCR) for the short‐term objective, and the Net Stable financial firms. Included Funding Ratio (NSFR) with a time horizon of one year to provide a in the requirements is "sustainable maturity structure of assets and liabilities". The timetables the setting‐up of a Board for both of these are relatively benign: January 1st 2015 for the LCR, and level risk committee three years later for the NSFR. However that does not mean that risk predominantly made up managers can sit back and wait as these are dates for achieving of non‐executive compliance with the required ratios and it will take time to implement directors and with direct contact with the new funding disciplines. Liquidity management will require daily checking on the ratios and regulators. assurance that stocks held are not encumbered or otherwise compromised in ways not MiFID REGULATION reflected in the risk management calculations.Consultation has just ended on the The question then arises as to where the responsibility for the management of stocks and the categorisation and regulation used in EUs associated liquidity risk should sit in an organisation. What is the level of involvement of the MiFID (Markets in Financial Instruments banks existing risk management framework and where does overall responsibility lie?Directive) for trading venues. There is On page 7 of the abovementioned standard, the BIS comes down marginally in favour of the particular market concern on the impact the banks treasurer. It says "The stock should be under the control of the specific function or proposed changes could have on broker functions charged with managing the liquidity risk of the bank (typically the treasurer)" and crossing networks (BCNs) with their having to suggests that, as part of its ongoing stock management, the bank should periodically test the identify all their trades in post‐trade data submissions and to provide public end of day liquidity of stocks via repos or outright sales of portions of the assets. But this means that information on daily activity. This would there are two separate operations managing the liquidity risk within an organisation, one run effectively transform them into MTFs by the treasurer and one run by the chief risk officer. (Multilateral Trading Facilities) with open Liquidity is only one of the risks associated with a banks assets. There is also the price and memberships and price disclosure. return on the assets (market risk) and their probability of default (credit risk). And there is the operational risk embedded in the process of testing, and eventually liquidating, the AUDITORS/SUPERVISORS CONSULTATION The FSA and the Bank of England have positions. All these facets need to be managed and reported together and banks need to avoid creating any silos, or even conflicts, in their control of risk. 6published, for consultation, a code of practice on how external auditors and supervisors will At a Basel III conference, late last year, attended mainly by delegates from the risk work together. This is particularly targeted at management community, an informal show of hands on the question "who manages risk high impact firms and obliges their auditors to management" came down firmly in favour of the treasury department. There was no question work closely with the regulatory supervisors. that these risk managers did not want this extra responsibility ‐ or maybe there were a lot of Responses to the consultation should be in by treasurers in the audience?March 25th. But whilst there is never any single measurement of risk in an organisation, there should be a SOLVENCY II UNLIKELY FOR IORPs single point of reporting the risks ‐ from the chief risk officer supported by the risk committee, According to the European Federation for to the Board risk committee and via them to the Board. Having parallel reporting lines will be Retirement Provision it is unlikely that the EU counter‐productive. will apply Solvency II to institutions for Would it be possible that the liquidity risk manager, sitting within treasury, then also reports to occupational retirement provision (IORPs). An the chief risk officer, along with the heads of operational, credit and market risk? There is a internal EC report said that changes to possible precedence for this in the ALM. But, like ALM, treasury is a well established part of a pensions would result in substantial costs to banks operations and it is unlikely that the department will appreciate the imposition of member states, raise government debt levels branched reporting lines. It would be interesting to and increase budget deficits. The report did, metric is published by understand how banks are planning to handle liquidity risk Chase Cooper.however, call for enhanced control regulations management processes and responsibilities. m web: www.chasecooper.comon pensions. email: email@example.com