BANK OF THE FUTURE A CHANGING VISTA Developments in banking regulation in selected jurisdictions A report for the British Bankers Association December 2010
Contact us UK Michael Raffan T +44 20 7832 7102 E michael.raffan@freshfields.com Guy Morton T +44 20 7832 7135 E guy.morton@freshfields.com Mark Kalderon T +44 20 7832 7106 E mark.kalderon@freshfields.com David Rouch T +44 20 7832 7520 E david.rouch@freshfields.com James Smethurst T +44 20 7832 7478 E james.smethurst@freshfields.com Andrew Marsh T +44 20 7716 4526 E andrew.marsh@freshfields.com Germany Alexander Glos T +49 69 27 30 82 64 E alexander.glos@freshfields.com France Philippe Goutay T +33 1 44 56 44 89 E philippe.goutay@freshfields.com
Introduction This report looks at key aspects of the current and proposed regulatory regime for banks in a number of significant jurisdictions: Australia, Canada, France, Germany and the US. In particular, it compares them with the position in the UK and with international agreements. The focus is on prudential regulation and structural issues. Competition issues are not covered. It has been prepared at the request of the British Bankers Association. The surveyed countries have been chosen for the following reasons: Australia and Canada, because they are perceived to have survived the crisis well; France and Germany, because of their importance in the EU; the US, because of its global importance. Other important jurisdictions (for example, China and Japan) have not been covered because of their substantial differences from the UK regime. The report takes the form of two tables summarising the position on a number of key issues. The first presents the position in the UK and the surveyed jurisdictions alongside global and EU standards. The second considers the position in each of the surveyed jurisdictions in more detail. We gratefully acknowledge the assistance of the Australian Bankers Association and the Canadian Bankers Association in helping us to understand the regulatory regimes in their countries. We have aimed to take into account information that was in the public domain on 10 December 2010.
Banking regulation overview Global/EU agreement Outstanding issues UK position Other surveyed jurisdictions Capital Present: Basel II/Capital Requirements Directive (CRD). Differences in interpretation and approach in some areas. Basel II/CRD fully implemented. Large banks are currently subject to higher ratio than Basel II/CRD minima and the permitted constituents of capital are more restrictive in some respects. Canada also currently requires banks to have higher capital ratios than Basel II minima. Future: Basel III now agreed. Equivalent amendments to CRD (CRD4) not yet agreed. Definition and role of capital that is not core tier one still needs to be finalised (contingent capital/ bail-ins). Basel III/CRD4 likely to be implemented in full. Keen to retain supervisory discretion to set higher. Basel III likely to be followed closely in Australia and Canada. Unclear how far US will follow Basel III. France and Germany likely to follow CRD4. Liquidity Present: no current global or EU quantitative standards. N/a. New regime already in place. Qualitative aspects already in force. Quantitative aspects are being phased in these are more stringent than Basel III in some respects. No other jurisdiction yet has quantitative standards equivalent to Basel III. Future: Basel III contains quantitative standards. Equivalent amendments to CRD not yet agreed. Implementation of Basel III liquidity rules is subject to a prior observation period and possible review. Unclear how far US will follow Basel III. France and Germany likely to follow CRD4. Canada expected to follow Basel III. Issues in Australia re shortage of government bonds. Macro prudential regulation Present: very little global or EU harmonisation at present. N/a. Canada has for some time had a gross leverage ratio limit, and loan-to-value (LTV) restrictions for residential mortgages. The US has also had a gross leverage ratio limit for some time. Future: gross leverage ratio to be introduced under Basel III/CRD4. Basel Committee on Banking Supervision (BCBS) and EC working on proposals for countercyclical capital buffers and capital retention buffers. Details of leverage ratio still to be published. Standards on countercyclical capital buffers and capital retention buffers not yet agreed. The UK has been in the forefront of arguing for counter-cyclical and capital retention buffers in international fora. Likely to follow Basel III/CRD4 and related buffer in full.
Global/EU agreement Outstanding issues UK position Other surveyed jurisdictions Too big to fail the regulation of systemically important banks Present: no global or EU standards. N/a. Authorities already have broad set of resolution tools under the special resolution regime. Large banks already producing recovery and resolution plans. US authorities already have wide range of resolution tools, which extend to holding companies also. Dodd Frank also deals with this issue: size restrictions, Volcker rule and derivatives push-out rule. German authorities are obtaining new powers of intervention. Future: Financial Stability Board (FSB) recommendations now endorsed. EC initiative under way for an EU crisis management framework formal proposal expected spring 2011. Work being done to quantify extra loss absorption capacity to be required of systemically important financial institutions and possible means by which that can be supplied (eg contingent capital/bail-ins). Cross border issues Strengthened arrangements for colleges of supervisors (and crisis management groups) for systemically important financial groups have been agreed at global level. It remains to be seen how these new structures will operate in practice. Compliant with global and EU standards. Broadly compliant with global and (in the case of France and Germany) EU standards. Within the EU, supervisory college arrangements are being strengthened under CRD2 and the new European Banking Authority will have stronger powers to promote harmonisation of regulation and co-operation and co-ordination in supervision.
Banking regulation in the surveyed jurisdictions Micro-prudential regulation Capital UK FRANCE GERMANY AUSTRALIA CANADA US Has Basel II been fully implemented? Basel II is reflected in the Capital Requirements Directive (CRD), which is fully implemented in the UK. CRD2 will be implemented in the UK from 31 December 2010 and is more stringent than Basel II in some respects. Basel II is reflected in the CRD, which is fully implemented in France. CRD2 will be implemented in France from 31 December 2010 and is more stringent than Basel II in some respects. Basel II is reflected in the CRD, which is fully implemented in Germany. CRD2 will be implemented in Germany from 31 December 2010 and is more stringent than Basel II in some respects. Yes. Yes. To a limited extent. Large, internationally active banks having at least $250bn in assets or at least $10bn in foreign exposure are subject to risk-based capital based on the Basel II internal ratings-based (IRB) approach. Other banks may opt in. Definition of capital Consistent with Basel II and CRD, but will continue to be super-equivalent in some respects eg permitted constituents of core tier one, limitations on hybrid capital that can be raised through specialpurpose vehicles and stricter rules on deductions from capital. II and CRD. Broadly consistent with Basel II and CRD. II. II. Interim guidance introduced in 2010 on eligibility of capital instruments pending finalisation of Basel III. Broadly consistent with Basel II. Certain hybrid securities being phased out of eligibility as tier one capital. Financial Stability Oversight Council (FSOC) to study feasibility of large interconnected bank holding companies being required to hold a minimum amount of contingent capital.
UK FRANCE GERMANY AUSTRALIA CANADA US Capital ratio II/CRD. In practice the UK operates guidelines implying a minimum 4 per cent core tier one ratio and 6-7 per cent tier one ratio (after applying stress tests). II/CRD. II/CRD. Minima consistent with Basel II, but supervisor has discretion to specify higher ratios for particular banks. All Canadian banks are required to maintain target ratios higher than Basel II minima: 7 per cent tier one; total 10 per cent. Consistent with Basel II. Capital being reviewed under Dodd Frank, but no specific proposals issued yet. Risk weightings II/CRD. Measures already introduced to minimise pro-cyclical impact of point in time -based risk models. The UK will be super-equivalent in restricting the availability of 0 per cent weighting for intra-group exposures under CRD2. II/CRD. II/CRD. II, but risk weights for residential mortgage lending in the standardised approach more granular than required under Basel II. Valuation provisions recently tightened. II. Broadly consistent with Basel II. Use of supervisory discretion in setting individual capital under pillar two Consistent with Basel II/CRD capital applied in practice exceed CRD minima (see above). II/CRD. II/CRD (but see below). II. II capital applied in practice exceed Basel II minima (see above). II.
UK FRANCE GERMANY AUSTRALIA CANADA US Basel III capital Basel III likely to be reflected in CRD changes (CRD4), which are likely to be implemented in full in the UK. UK superequivalence likely in some areas (eg permitted constituents of core tier one). II/CRD. Implementation of Basel III dependent on EU-level (CRD4). Due to the German three-pillar bank structure there is still a debate about silent contribution to capital as supervisory accepted tier one capital. Basel III likely to be followed closely. Basel III likely to be followed closely. Official support expressed for Basel III unclear how closely it will be followed. Capital conservation buffer Nothing specific at present. Recently agreed Basel standards likely to form part of CRD4 and to be implemented in full in the UK. The UK has been in the forefront of arguing for this buffer in international fora. Nothing specific at present. The Federal Financial Supervisory Authority (BaFin) now has discretionary power to impose capital above Basel II/CRD minima to create additional capital buffer for periods of economic downturn. Power may be exercised for individual institutions. Nothing specific at present. No explicit capital buffer. In 2008 the regulator was promoting increased conservatism in capital management this recently relaxed. Nothing specific at present.
UK FRANCE GERMANY AUSTRALIA CANADA US Liquidity Near-term liquid asset buffer New UK liquidity regime introduced in 2009. Qualitative aspects came into force in December 2009, including more frequent and granular reporting and enhanced for systems and controls. Quantitative being phased in (including for liquid asset buffer for near-term needs). Definition of liquid assets narrower than Basel III/CRD4 proposals. Likely to follow CRD4. The German Liquidity Regulation provides for concrete liquidity. A recent BaFin circular stipulates the minimum for liquidity management, reflecting CRD. Australian Prudential Regulation Authority (APRA) reviews and agrees with each bank the adequacy and appropriateness of the bank s liquidity management strategy. Insufficient quantity of high-quality liquid assets to meet Basel III alternatives under discussion with Basel Committee on Banking Supervision (BCBS). A stock of liquid assets must be maintained, but less specific than Basel III. Expected to follow Basel III. Dodd Frank does not contain any specific on liquidity no proposals have yet been released. Longer-term funding profile New UK liquidity regime referred to above includes quantitative for longer-term funding profile, which are being phased in. Likely to follow Basel III/CRD4. The Liquidity Regulation deals with a liquidity recording framework covering a total period of up to 12 months divided into four maturity bands. Expected to follow Basel III. No direct equivalent at present to the Basel III net stable funding ratio. Expected to follow Basel III. Dodd Frank does not contain any specific on liquidity no proposals have yet been released.
UK FRANCE GERMANY AUSTRALIA CANADA US Use of supervisory discretion in setting individual liquidity Exercisable in context of individual liquidity adequacy assessment under the new liquidity regime. II/CRD. BaFin is required to define on a case-bycase basis the content and form of reporting if a bank chooses to use an internal liquidity risk management procedure. Banks liquidity management strategies must be agreed with the regulator and reflect the bank s size and the nature of its operations. Cash flow are established bilaterally between the regulator and each bank. Regulator will have discretion to differentiate between banks based on various risk factors. Securitisation Skin in the game (ie risk retention) and other No skin in the game requirement at present. CRD2 requirement for 5 per cent retention is being introduced from 31 December 2010. No skin in the game requirement at present. CRD2 requirement for 5 per cent retention is being introduced from 31 December 2010. CRD2 for 5 per cent retention will come widely into force on 31 December 2010. However, according to the current law, after a two-year transition period a 10 per cent retention requirement will apply. No skin in the game requirement at present. Discussions continuing to determine whether and to what extent this may be appropriate. Regulator issued updated guidance in 2008 on securitisation expected practices (increased risk assessment, reduced reliance on external ratings, more capital for complex securitisation exposures such as resecuritisations). While there are no current regulatory for skin in the game, Canadian banks do typically retain a significant first loss position. Minimum 5 per cent retention requirement will apply (other than for certain residential mortgage securitisations) under rules to be made under Dodd Frank.
Macro-prudential regulation UK FRANCE GERMANY AUSTRALIA CANADA US Counter-cyclical Nothing specific at present. Recently agreed Basel standards for a counter-cyclical capital buffer likely to form part of CRD4 and to be implemented in full in the UK. The UK has been in the forefront of arguing for this buffer in international fora. Measures already introduced to minimise pro-cyclical impact of point in time -based risk models. See above under Capital conservation buffer. Capital rules to be made under Dodd Frank are required to be counter-cyclical. No specific counter-cyclical buffer requirement. Variable risk weights raising capital against specific types of lending The Autorité de contrôle prudentiel (ACP) has power to change the risk weighting of any type of asset or off-balance sheet item. developments specifically on point. But new BaFin discretionary power referred to above. The regulator has power to vary the risk weights applicable to different types of asset.
UK FRANCE GERMANY AUSTRALIA CANADA US Leverage limits as backstop to risk-weighted capital None at present. Likely to implement Basel III/ CRD4 in full. The UK has been in the forefront of arguing for a gross leverage ratio in international fora. None at present. Likely to follow Basel III/ CRD4. A leverage ratio reporting obligation (but not a limit) has now been imposed. Likely to follow Basel III/CRD4. None at present. Likely to implement Basel III. Leverage ratio limit has existed for many years: total assets (including specified off-balance sheet items) should not exceed 20 times adjusted net tier one and adjusted tier two capital, although the multiple can be exceeded with the regulator s prior approval to an amount no greater than 23 times. However, the regulator may prescribe a lower multiple. Bank holding companies are currently subject to a maximum tier one capital-to-total-assets ratio of 3 per cent if certain conditions are met; otherwise 4 per cent. Higher ratios can be required if particular risk factors are present. New may be imposed under Dodd Frank. Under Dodd Frank a debt-to-equity limit of 15:1 may be imposed if the FSOC determines that a large bank poses a grave threat to US financial stability.
UK FRANCE GERMANY AUSTRALIA CANADA US Collateral and loan-tovalue (LTV) limits developments, except that the idea of LTV or loan-to-income (LTI) limits for residential mortgages has recently been rejected by the regulator. Nothing specific, but more granular risk-weighting for residential mortgage lending already imposes higher capital for higher LTV ratios. Loans and mortgages are subject to LTV limits. There is a hard LTV limit of 80 per cent for residential mortgages (subject to exceptions), with mortgage insurance required for mortgages above this level. No proposals yet made, but the regulator is required to set margin for swaps and higher margin for uncleared swaps. Quantitative credit controls and reserve Macroprudential oversight New architecture being implemented under which a financial policy committee within the Bank of England will be responsible for macro-prudential regulation and a new Prudential Regulatory Authority will be responsible for prudential regulation of banks. A new Council for Financial Regulation and Systemic Risk has been set up to advise the government on systemic risk. Proposals have been announced to concentrate banking supervision in the Bundesbank (currently shared with BaFin), but debate ongoing. Australia already has the twin peaks model of regulation, with separate conduct of business and prudential regulators. The Reserve Bank of Australia is responsible for systemic risk. FSOC now established to identify threats to US financial stability, promote market discipline and respond to emerging risks.
UK FRANCE GERMANY AUSTRALIA CANADA US Too big to fail the regulation of systemically important banks Are systemically important financial institutions (SIFIs) to be clearly identified as such ex ante? Financial Stability Board (FSB) principles likely to be followed. FSB principles likely to be followed. The German Restructuring Act, coming widely into force on 31 December 2010, provides for a definition of systemically important bank, which is very general; there are no current plans for a specific list to be drawn up. Future position unclear regulator has opposed concept of prior identification of SIFIs. More stringent prudential rules are to apply to large interconnected bank holding companies (LIBHCs) that have total consolidated assets of $50bn or more. Capital surcharge for systemically important institutions FSB principles likely to be followed. FSB principles likely to be followed. New BaFin discretionary power referred to above at least in theory could be used in this context. FSB principles likely to be followed. Future position unclear regulator has opposed idea of capital surcharge for SIFIs, but is expected to follow Basel III rules. The regulator is required to impose more stringent capital on LIBHCs that have total consolidated assets of more than $50bn. Recovery and resolution plans (RRPs) The large banks have already taken part in a pilot exercise, producing RRPs. Rules are to be made making these mandatory in future. The Restructuring Act does not oblige banks to draw up RRPs prior to a restructuring situation. APRA has wideranging powers to revoke a banking licence, require a bank to undertake specific actions, appoint an investigator, take control of its business when its ability to repay deposits could be threatened and appoint an administrator or manager. No current requirement to draw up RRPs. Recent recovery exercises (including living wills ) with the regulator may result in further guidance in this area. The regulator is directed to make rules requiring LIBHCs with consolidated assets of $50bn or more to provide RRPs on a periodic basis.
UK FRANCE GERMANY AUSTRALIA CANADA US Size restrictions None at present. Being considered by Independent Commission on Banking. None. None. None. (There is a longstanding prohibition on mergers between the four major trading banks.) None. Dodd Frank prohibits mergers or acquisitions if merged group s consolidated liabilities would exceed 10 per cent of liabilities of all financial companies. Prohibition contingent on study to be conducted by FSOC. Prudential restrictions on permissible activities None at present. Being considered by Independent Commission on Banking. The Volcker Rule in general prohibits banks from engaging in proprietary trading or acquiring or retaining any ownership interest in, or sponsoring, a hedge fund or private equity fund. The regulators must also impose additional capital and limitations on proprietary trading and fund sponsorship, which is permitted if appropriate for prudential reasons. The derivatives pushout rule prohibits federal assistance to a swaps entity, effectively requiring banks to spin off such business to an affiliate.
UK FRANCE GERMANY AUSTRALIA CANADA US Resolution tools available to the authorities Wide range of tools has been available under the special resolution regime since 2008. Under the Restructuring Act it would be possible under regulatory law to order the transfer of assets and liabilities from a systemically important bank whose existence is endangered to another bank by way of spin-off. The regulator may appoint an administrator to take control of a bank s business. But the authorities do not have powers comparable to the UK special resolution regime. The authorities have power (subject to government approval) to take control of a bank and to vest its shares in the Canada Deposit Insurance Corporation for the purpose of a restructuring. These powers have recently been extended to enable a bridge bank option to be implemented. The authorities have had a wide range of powers available for some time to resolve banks. Dodd Frank extends these powers to enable them to be exercised against bank holding companies as well. Bail-ins Being actively considered. The Restructuring Act provides for measures including the conversion of receivables into shares. Such debt-equity swap is possible in the re-organisation proceeding, but only with the consent of the affected creditors. No specific bail-in provisions. Levies (to fund resolution funds or otherwise) A bank levy is to be imposed at the rate of 0.05 per cent of global balance sheet in 2011, rising to 0.075 per cent in 2012. A tax on high-risk activities of large banks is expected to be imposed in 2011. The Restructuring Act would require banks to pay a levy to finance a restructuring fund. No bank levies anticipated. No bank levies anticipated. The authorities may charge risk-based assessments on LIBHCs with consolidated assets of $50bn or more to ensure that the funds used in the exercise of their orderly liquidation authority are repaid within five years.
Cross-border issues UK FRANCE GERMANY AUSTRALIA CANADA US Incoming foreign banks subsidiarisation required? For non-eea banks the regulator will sometimes require subsidiarisation. (Foreign banks may establish Canadian subsidiaries or branches and are no longer restricted as to asset size.) Outgoing national banks restrictions or other group structure? International structures and co-operation General Are there any other significant features?
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