Regulatory reform banks and broker-dealers. Simon Morris, Ash Saluja, Paul Edmondson and Jean Price Mitre House 11 th November

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2 Regulatory reform banks and broker-dealers Simon Morris, Ash Saluja, Paul Edmondson and Jean Price Mitre House 11 th November

3 Outline Tougher supervision and enforcement (Simon) The new regulatory order the new authorities, their roles and macro-prudential regulation (Ash) Prudential regulation systemically significant firms and living wills, financial regulation update, risk management and governance (Paul) CoB -Tougher consumer protection mortgage market reform, cards and consumer finance (Jean)

4 Intrusive supervision and tough enforcement - banks and brokerdealers Simon Morris Partner CMS Cameron McKenna LLP

5 The new supervisory regime Intensive supervision/regulation More intrusive, challenging and systemic Increase in front line supervision Increase in specialist resources Shift in style and focus proactive rather reactive Expect challenge in new areas, previously out of FSA scope Competence of senior management and NEDs Accounting decisions Business model sustainability and strategy Products Firm failure and systemic/fscs impacts

6 And also More frequent meetings More frequent MI Closer engagement on projects Pushing the high-impact/non-relationship managed perimeter More interviews - when Approval ( Dear CEO on SIF approval process 172 interviews so far) ARROW All the time Probing Your competence, understanding and judgements Grasp of lessons from reverse stress tests

7 Five key messages to convey 1. I know my role 2. I know the strategy 3. I know the risks 4. I understand our governance 5. I understand the new order

8 The new enforcement regime Credible deterrence More high profile criminal action Fines (recent FSA consultation) More intelligent approach Higher (by a factor of 300% or more) 50/100 million possible? Conservatives say FSA enforcement has been very weak? new prosecutor to replace SFO BUT THE KEY POINT IS..

9 New emphasis on enforcement and fines against individuals personally An investigation will now normally include relevant individuals Chairman Chief executive More investigation and enforcement against senior management and NEDs personally even where not involved in front line breach and acted honestly FSA now making judgements on managements judgements

10 The new regulatory order for banks and broker-dealers Ash Saluja Partner, CMS Cameron McKenna LLP

11 The new order the different roles and objectives Macro-prudential (new/missing role) Regulating the system as whole In support of financial stability Firm regulation (micro-prudential) and supervision Covering individual firm requirements But also includes implementation of systemic requirements, so all gets mixed up

12 The new order the authorities developing the rules International European National

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14 Regulation at the international level International - G20 lead (High level) policy driven Bank of International Settlements (BIS) hosted Financial Stability Board (FSB) beefed up and expanded 3 standing committees Basel Accords/Committee on Bank Supervision (BCBS) thinking again about its Basel II regime International Association of Deposit Insurers IMF, IOSCO, IASB etc

15 Regulation at the EU level the policy agenda EU regulatory regime needs to be More joined up (groups and home/host) More systemic, More consistent technical standards and supervision Enforced (getting tough with the national supervisors) European Systemic Risk Board - talking shop for central bankers?

16 European System of Financial Supervision (ESFS) Supervision to remain with domestic authorities European Banking Authority (EBA) and European Securities and Markets Authority (ESMA) but still a forum of regulators (acting by qualified/simple majority) More powerful authority to Set detailed technical standards ( e.g. conditions to permit IRB approach) Ensure common supervisory standards Promote colleges and resolve disputes between home/host/group supervisors (tie-breaker powers and appeals controversial in UK)

17 Domestic reform - Labour Financial Services and Business Bill a rag bag following HMT white paper and BIS/BERR consumer consultations Keep FSA as combined financial/prudential and Conduct of Business regulator for all sectors Keep existing tripartite (BoE, FSA and HMT) Macro-prudential role (e.g. systemic issues and living wills) FSA Lobbying internationally Moving ahead of and beyond international consensus in some areas - bank liquidity, living wills and remuneration Big issues debated (yet again) in FS 09/3 and DP 09/4

18 Domestic reform - the Conservatives Scrap FSA, the single regulator model and the tripartite system Bank of England Gets the entire macro-prudential role And main role in financial regulation of firms banks and broker-dealers New Consumer Protection Agency (CPA) takes on Conduct of Business/consumer protection Lots of issues being considered continental style Markets and Securities Authority (UKLA and market conduct -?plus Takeover Panel and Financial Reporting Council?)?RIE and MTF supervision?

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20 The new macro-prudential order key drivers Systemic impacts (e.g. of Lehmans collapse, money market fund withdrawals or a central counterparty failure) Rescue costs to save the system (e.g. Citi) Exposures and risks for The broader system e.g. Consumer confidence (Northern Rock, B&B) Wholesale markets (AIG) Real economy (RBS) Taxpayer (all of the above) Indirect exposures via deposit guarantee and FSCS

21 The new macro-prudential order options Still early days but lots to ponder Various international work underway Everyone has a view! Watch BoE dynamic stability and flexible risk weightings Tobin tax and macro-economic levers taking the punch bowl away The plumbing and wiring market infrastructure Regulating systemically significant firms Resolution and recovery

22 The new macro-prudential order protecting retail deposits Hard structural restrictions for retail banks Conservatives are keen but depends on international consensus? Or equivalent result by capital penalties Glass-Steagall indirectly? Lord Turner s preferred approach? The demise of the universal bank model and the funding of wholesale business with retail deposits? Barclays retail bank split announced last week?

23 Market infrastructure reform policy International G20 summits (April/September 2009) Standardized OTC derivative contracts to be traded on exchange or e-platform (organised trading venues) and cleared through Central Counterparty (CCP) by end 2012 European Commission consultation (July-October 2009) Increase standardization for OTC derivatives Use central data repository Strengthen use of CCPs Increase use of organised trading venues International (especially US)/European approach to be co-ordinated before proposals become concrete at National level

24 Market infrastructure reform implications Scope unclear but most standardised OTC derivatives to avoid regulatory arbitrage Reduction of risk CCP prevents domino effect of counterparty collapse through multilateral (rather than bilateral) netting CCP requires margin (initial and variation) and takes guarantee funds from clearing members CCPs (implicitly) will not be allowed to fail Exceptions non-standard OTC derivatives, may be cleared bilaterally but potentially subject to Increased margin requirements (initial and variation) Higher capital charges and greater transparency on positions for regulated firms

25 Regulating groups and cross border businesses Bringing unauthorised holding companies into direct regulation Intra-group relationships work Groups level regulation versus local survivability Higher capital for group level or A constellation of local ring fenced banks EU passport UK still wants more host state powers Better cross-border supervision - colleges of supervisors EU and international (G20 says 30 now in operation) and the ESFS

26 Winding down banks and broker-dealers paying for resolution International work on deposit insurance/ collective and individual resolution funds Revised EU deposit guarantee legislation Should there be one EU wide scheme? Move to pre-funded schemes Avoid post-event levy with interim government funding With risk based premium (BoE view) Avoid cross subsidisation

27 Reforming the prudential regulation of banks and brokerdealers Paul Edmondson Partner CMS Cameron McKenna LLP

28 Macro-prudential impacts Regulating systemically significant banks and broker-dealers - Authorities must ensure that groups providing economically critical functions are capable of being supervised and resolved Banks should not be too big or complex Simpler, more transparent legal structures that are capable of being supervised and resolved

29 Defining systemically significant firms A few (based on impact of failure in good times) or Lots (based on impact of failure in bad times eg all Irish banks or a herd ) What criteria? Size? Infrastructure providers Or a graduated response? regulatory standards calibrated to firms contribution to systemic risk Even small deposit takers being treated as systemically significant First international work delivered to G20 St Andrews meeting DP09/4 also considers

30 Principles emerging for banks and broker-dealers.firms must Be capable of being supervised effectively Understand what would cause them to fail have reduced that risk by reverse engineering Have resources available for recovery (as a going concern) But also be capable of resolution (a gone concern winddown) without tax payer support Unacceptable consequences for the system or consumers And have detailed systems in operation to ensure this

31 In light of their Legal and corporate structure Intra-group relationships Current FSA/international thematic Size, international structure and complexity etc Business mix Recovery facilities available Resolution insurance coverage (currently only limited FSCS capacity)

32 Living wills FSA s requirements for recovery and resolution plans Recovery as a going concern (plan 1) Eg contingent capital/liquidity De-risk and contagion control plan Resolution/wind down (plan 2) Detailed plan for use of different SRR tools Demonstrate ability to unplug from the system without systemic impact protect consumers from available resolution insurance Produce data

33 Living wills - scope FSA intends to apply to All UK banks and building societies And other systemically important firms (insurers and broker-dealers etc) FSB/international Top 25 banks and broker-dealers Already working on plans International dimension different perspectives at group level and home/host state

34 Preparing for the new order and living wills do you have? An intelligible and reliable mapping of Group corporate structure legal entity and regulatory status (FSA worried directors do not understand) Contractual, operational and branding overlay Intra-group relationships finance, security, guarantees, collateral, cross default, capital/liquidity/cash management Structured relationships (tax or capital driven) Group Treasury arrangements Client asset and stock lending Analysis of how this legal structure plays out under stress (for plan 1) and SRR/failure/insolvency (for plan 2).

35 Living wills potential impact on firms Huge cost in Set up Maintaining plans/data/contingency arrangements (for ever) Provides FSA with over-arching mechanism to deal with many of the themes from financial crisis reform? Not just areas where detailed requirements are being imposed (such as reverse stress testing and single customer view) Huge power to FSA to unpick, restructure and restrain your business? Plans must be negotiated with regulator Reverse engineering/stress testing Onus on firm - not FSA or its rules Fate hangs on subjective value judgements by FSA

36 Financial regulation of banks and brokerdealers Detail and timing of reforms in the RegZone Complex mix of international/basel and EU legislation Quick fixes (wave 1) and fundamental reform (wave 2) Liquidity Capital Higher requirements Common equity Internal models Higher for systemically important banks and brokerdealers (macro-prudential add-ons) Accounting

37 Walker and governance Big bank focus but extended to BAOFI including broker-dealers but muddled on read-across Draft proposals focus on developing the Combined Code for listed companies Comply or explain may not be enough for HMG/FSA Non-listed groups outside scope? FSA to respond/consult on its rules Remuneration and shareholder engagement debate

38 Walker on risk for banks and brokerdealers Separate board risk committee NED chair NED majority Independent enterprise risk management function Independent Chief Risk Officer Risk report

39 Non-executives at banks and brokerdealers FSA New APER guidance on NED role Original ideas more radical than Walker? Walker proposes.

40 Non-executives at banks and brokerdealers the Walker consultation No liability cap (Walker considered a cap) More time but not full time (non-exec chairman at least 2/3rds of his time) Better understanding of business model, risks and legal structure More challenge of executives and more independent but not dual level boards More training and expertise/qualifications More support/resources for independent role Greater overall responsibility for risk management and remuneration

41 Remuneration - update More internal/external transparency - Walker recommends public disclosure of high end non-board remuneration (above board median) Even FSA admit remuneration is not the cause or cure but huge political focus FSA s new Remuneration rule and code currently only applies to 26 banks and broker-dealers FSA to announce decision on broader application And review next year FSA and Conservatives against direct regulation of quantum

42 Tougher consumer protection banks and broker-dealers in retail markets Jean Price Head of retail banking CMS Cameron McKenna LLP

43 Current issues - FSA Retail Investments Retail Distribution Review Banking: Conduct of Business Payment Services Regulations Mortgage Market Review

44 Current Issues other OFT Consultation Guidance on Irresponsible Lending Consumer Credit Directive Consultation of Store and Credit Cards The Lending Code

45 What are the current targets? Mortgages Credit and store cards Secured and unsecured lending

46 What are the key themes? Suitability Affordability ability of borrower to repay Customers in financial difficulty Arrears handling

47 How are the regulators intending to protect consumers? Transparency Better qualified and more accountable advisers Banning products Greater responsibility on lenders More rules Increased scope for FSA Wider Implications More enforcement action Class actions as another route to redress

48 Current consultations Mortgage Market Review - Discussion paper closes 20 January 2010 Review of Regulations of Credit and Store Cards: Consultation closes 19 January 2010

49 What else is on the horizon? OFT Possible removal as key regulator for certain products Conservatives will move to new CPA Europe Integration of EU Mortgage Credit Markets Responsible lending and borrowing PRIPS Single Euro Payments Area

50 How we can help Living wills legal and regulatory input Scoping the legal mapping All areas Governance and systems benchmarking Training Board briefing Strategic impacts Lobbying And

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52 Regulatory change - keeping track of What is proposed by international forum, EU, labour government, the Conservatives, FSA, BoE etc etc Stream of publications 100s of pages a day, mostly with heavy political spin/twist Difficult to gauge what the readacross/impact/timing will be for the insurance market Only bite sized chunks today but all the detail is in the RegZone..

53 RegZone and the roadmap On-line free to view without passwords! Up to date Roadmap report 40 areas of regulatory change Overview, status/timing and impact More detailed chronology with hyperlinks Charts and visuals Other tools by topic ( Handling a regulatory crisis tool), by type of publication (Articles and press quotes), by sector (insurance specific section coming soon )

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