November 2011
Getting to grips with regulatory reform
Key developments this month…
Welcome to the November edition of 'Getting to grips with regulatory reform'. Clearly the agenda is dominated by the Eurozone challenges, but the G20 meeting confirmed that the politicians want to press ahead with a second wave of major regulatory reforms.
We’ve also seen the European Commission issue its much trailed proposals for revisions to the Markets in Financial Instruments Directive (MiFID); we were expecting the Crisis Management Directive but this has been delayed apparently because of market instability.
Firms need to consider seriously the impact of these proposals – together with all the other elements of regulatory reform – on their business models and on their legal entity and operating structures. Each firm must determine whether its existing business activities and structures can accommodate the magnitude of reform or whether a step change will be required if the firm is to emerge with a viable franchise.
Giles Williams and Jon Pain
KPMG’s Financial Services Regulatory Centre of Excellence, EMA region
Insights…
EU Delays Crisis Management…
Tough rules for sovereign debt
G20 Summit: Tightening the regulatory noose on systemically important firms…
Further Solvency II clarity provided by ORSA and EIOPA
ICFR Summit – What does good regulation look like?
MiFID 2 – Another piece of the overall regulatory puzzle…
MiFID commission ban causes a stir…
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On the radar…
ESMA progress on AIFMD
The European Securities and Markets Authority (ESMA) released its latest technical advice on the Alternative Investment Fund Managers Directive (AIFMD). The European supervisor appeared to have taken on board concerns raised during consultation that certain requirements, such as 3rd country equivalence rules, were too stringent. However, further clarity will be required on important issues including depositary liability, delegation to third countries, definition of what qualifies as a letter box entity, leverage reporting and co-operation agreements for third countries. These areas will need to be addressed in the final guidance to be issued by the European Commission next year. Firms will need to understand how these latest rules fit to related frameworks in UCITS and MiFID as there is potential for overlap and duplication in planning for change.
OTC rules short on time
A fundamental disagreement on the scope of rules remains unresolved as the final negotiations on Over-The-Counter (OTC) derivative reforms run out of parliamentary time. Despite last ditch efforts, it appears exchange-traded derivatives will remain out of scope of rules that will require all OTC derivatives to be cleared. Once a final deal is agreed the detailed rule-making by ESMA will begin. Reforms to OTC derivatives are a landmark for EU rule-makers, working on the package of legislation to meet Europe's commitments to the G20.
MEPs tackle MiFID
Following the European Commission's final proposals for MiFID, the European Parliament now begins the process of negotiating detailed amends with an initial exchange of views in December. Given the breadth of proposals there are likely to be considerable areas of contention between different industry participants. Significant concerns are already emerging on the extent to which energy trading will be inside the scope of rules when viewed alongside OTC derivatives proposals. Getting the details right on 3rd country access to the EU is also likely to be challenging.
Dutch regulator issues national requirements for systemically important banks.
Dutch regulator De Nederlandsche Bank (DNB) published its Overview of Financial Stability this month, seeking to promote financial stability in the Netherlands by monitoring and identifying the key risks to the financial system and presenting priorities for policymakers and the financial sector to mitigate these risks where possible. The Netherlands has a large financial sector that fits its open economy, but its size also carries risks. In addition to the biggest threats of the European debt crisis and weak global economic recovery, the structure of the housing market in the Netherlands also makes households and banks vulnerable to shocks. Systemically important banks will need to enhance their resilience. The Dutch Ministry of Finance and DNB demand that systemically important banks prepare for specific requirements, including the build-up of an extra capital buffer (1-3%) and the development of recovery plans. In addition, DNB wants to improve the resolvability of systemically important banks through the drawing up of resolution plans, aimed at salvaging vital functions should they run into unforeseen trouble. Such plans should also limit risks to the taxpayer and contagion effects.
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Other CoE and FS Regulatory Activity…
Wholesale markets - Under the spotlight… Proposed rules over derivatives are game changing. This report explores the key challenges and critical areas of focus for financial institutions. It also looks at how the industry should start to position itself ahead of final rules.
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EU Delays Crisis Management…
Proposals from the European Commission on Crisis Management have been put back until at least the end of November - possibly to avoid further inflaming the current Eurozone crisis. When finalised, the rules should set the framework for a consistent approach to Recovery and Resolution planning across Europe.
We anticipate that the proposals will act as a real challenge in many European countries that have so far made limited progress on resolution planning. Firms will have to provide extensive information to national resolution authorities and after suitable ‘negotiation’ then face the prospect of making changes to their structures and business activities.
Even in countries where pilots or similar have begun, such as the UK and the Netherlands, firms will have to adjust to differences between their evolving national regimes and the Directive, including the scope of application, "bail-in" debt, and pre-funding national resolution funds. Internationally active firms will have a particular interest in cross-border arrangements, both within the EU and globally. Such firms will face challenges in responding to any divergences in requirements, and any lack of cooperation and consistency in their application.
Expected to be in line with the FSB’s resolution guidelines, the EU rules could also introduce a formal framework for bail-in capital, where creditors would see some or all of their investment at risk when resolution is triggered. International proposals for new loss-absorbing capital aren’t expected from the FSB until late 2012.
Please contact Kara Cauter or Clive Briault for more information.
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Tough rules for sovereign debt
Measures put forward by the European Banking Authority (EBA) to strengthen banks' capital position require the 70 banks which were part of the 2011 EU-wide stress test to raise their Core Tier 1 capital ratio to 9 percent, which is stricter than the capital requirements put forward by Basel 3. Furthermore, these banks are also expected to hold additional Core Tier 1 capital temporally against their sovereign debt exposure. It's calculation is linked to total exposure rather than potential losses and is intended to provide reassurance to markets about banks' ability to withstand a range of shocks and still be adequately capitalised. Banks will be required to build up their capital buffers and reach a nine percent Core Tier 1 ratio by 30 June 2012. Banks must submit to their respective national authorities by the end of 2011 (25th December), their plans detailing the actions they intend to take to reach these targets. These plans must be agreed with National Supervisory Authorities and discussed with the EBA. As in the 2011 EU-wide stress test, banks must use CRD 3 to calculate their Core Tier 1 ratio; therefore changes to the trading book and securitisation treatment (so called Basel 2.5) are to be fully incorporated in the requirement.
This will be a considerable challenge for affected banks; the tight timetable being exacerbated by current macro conditions and the scepticism and volatility of the markets. In particular, the levers that would typically be available to banks looking to raise capital in normal times maybe constrained and potentially unavailable:
- Raising capital in markets: Investor sentiment is low and market uncertainty is high.
- Disposal of none core assets: uncertain appetite from potential purchasers. This enhances the risk of timetable slippage.
- Optimisation of Risk Weighted Assets (RWA): adjusting models to refine RWA is an option explored by many, but will be technically very challenging within the timeframe and material changes in numbers will lead to supervisor scrutiny.
- Retained earnings: largely in banks control, however investors may respond negatively withholding bonuses and dividends and banks' actual performance might limit the feasibility of this option.
- Deleveraging: Supervisors indicated this is against their intended aims
Given enhanced limitations in the current market environment, meeting the EBA hurdle is likely to require banks to use a combination of these levers. We urge affected banks to act now to ensure they have clear and executable capital plans in place by end of 2011 and to start executing these without delay. Banks should also consider and plan accordingly for potential deeper funding and liquidity constraints that might result as a consequence of a prolonged Eurozone crisis.
In numerical terms, the EBA has announced that a mammoth 106bn Euros is required to bring capital levels to 9 percent across all affected EU countries. In addition, a further 40bn Euros is required to address the potential sovereign exposure losses. The numbers published by the EBA are included the table below – note these will be updated to reflect banks' sovereign exposures as at 30 Sept 2011 – this is expected to be announced on 18 November 2011.
Breakdown by country of estimated capital target buffers
| Country |
Estimated target capital buffer |
Sovereign capital
buffer* |
| AT (1) |
2,938 |
224 |
| BE (2) |
4,143 |
5,634 |
| CY |
3,587 |
3,085 |
| DE |
5,184 |
7,687 |
| DK |
47 |
35 |
| ES |
26,161 |
6,290 |
| FI |
0 |
3 |
| FR |
8,844 |
3,550 |
| GB |
0 |
0 |
| GR (3) |
30,000 |
/ |
| HU |
0 |
43 |
| IE |
0 |
25 |
| IT |
14,771 |
9,491 |
| LU |
0 |
0 |
| MT |
0 |
0 |
| NL |
0 |
99 |
| NO (4) |
1,312 |
0 |
| PT |
7,804 |
4,432 |
| SE |
1,359 |
4 |
| Sl |
297 |
20 |
| Total |
106,447 |
40,622 |
| amounts are in million Euros |
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It is important to note that these measures form part of the broader European Stability package aimed at addressing the current situation in the EU by restoring stability and confidence in the markets (other key measures being write down of Greek debt and leveraging of the EFSF to 1tr Euros). The EBA has stated that the implementation of bank capitalisation requirements is conditional on the other components of the package being fully clarified, endorsed and implemented across the EU.
Please contact Johanna Day or Giles Williams for more information.
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Further Solvency II clarity provided by ORSA and EIOPA
The European Insurance and Occupational Pensions Authority (EIOPA) released a package of papers in its latest consultation process (7 and 8 November respectively) encouraging insurers to contribute to the final Own Risk and Solvency Assessment (ORSA) requirements and on draft Pillar 3 requirements providing further clarity on some of the more complex areas of Solvency II.
ORSA
The notable feature from the ORSA consultation paper is that EIOPA have recognised that there is no single ORSA approach. EIOPA state that the guidelines focus on “what is to be achieved by the ORSA rather than on how it is to be performed” so are not directive in nature. From the outset, insurance supervisors established their intention to avoid prescriptive requirements on the ORSA to ensure they were not dictating the way that insurers operate, leaving firms to decide how best to address the requirements internally.
A clear message for firms is that there is unlikely to be any further detailed guidance on the ORSA after the finalisation of this paper, so firms should treat this as the last opportunity to raise any key questions still remaining. Firms will need to work through the principles established in this paper and determine how they can be best met for their business. Our analysis of the changes made in the ORSA consultation and the business implications are provided in more detail here.
One significant step in the consultation paper has been to provide further detail on documentation and in particular separate the ORSA reporting requirements from the Pillar 3 reporting which should be a welcome move given the uncertainty raised on ORSA reporting historically.
The paper refers to an ORSA supervisory report which can leverage off the insurers own internal ORSA documentation on the results and conclusions regarding the ORSA. However, in line with the theme of the paper, few details are given on what is required in the ORSA supervisory report as supervisors have consciously resisted providing an example template in favour of insurers developing their own.
Pillar 3
Reporting, as with the ORSA, have been the two missing parts of the Level 3 guidance and moves to finalise these requirements will give some much needed clarity on the final shape of Solvency II. Reporting has also been the Solvency II pillar which thus far has received the least attention by firms.
Some of the main proposals likely to be welcomed by smaller insurers will be the proposal to eliminate quarterly reporting of investments on a security-by-security basis, although it appears that many larger companies will still need to provide this information every quarter.
Insurers still face an enormous level of uncertainty on Solvency II which is delaying their implementation plans. There are a number of key areas still open to change awaiting the finalisation of the level 2 implementing measures and the industry will still have to wait to see EIOPA’s consultation on reporting for financial stability purposes, expected in December to fully gauge likely implications. In addition, the European Parliament is a key stakeholder and has expressed different views on some key areas.
The adoption of Pillar 3 requirements marks an important milestone for the industry across Europe. In essence, the insurance sector is moving closer to having a transparent and consistent reporting method to provide timely and relevant information about the solvency and risk position of insurance companies.
Please contact Rob Curtis for more information.
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ICFR Summit – What does good regulation look like?
KPMG's Financial Services Regulatory Centre of Excellence sponsored the International Centre for Financial Regulation (ICFR) annual summit on 17 and 18 October 2011. The summit was focused on “What does good regulation look like?” and provided a platform for senior market participants, legislators and regulators from around the world to openly discuss the challenges currently facing the industry. A number of key themes emerged from the discussions on what good regulation should look like:
- Trust
- Transparency
- Who regulates the regulators?
- Accountability
- Regulatory Capture
- Effective Enforcement
- International coordination and national diversity
What makes good financial regulation?
The discussion of the impact of recent regulatory changes across banking, securities, and insurance highlights one central component of good regulation: the need to be attentive to the unintended consequences that regulatory change may have on different sectors. It is therefore important that the extensive regulatory changes in the banking industry do not impair the capacity of capital markets to finance global growth, nor excessively constrain the capacity of insurance firms to fulfil their roles as providers of long-term capital. At the same time, despite these sectors falling under the oversight of different regulatory authorities, they remain part of the same ecosystem. Good regulation needs to be alert to the possibility that regulatory innovation in one sector may create new risks and vulnerabilities in others.
It is important for the financial services industry to engage with regulators in this debate on a national, European and global level. Failure to fully engage will mean there will continue to be divergence in policies between jurisdictions, and multiplication of work to comply.
Speaker and discussion summaries are available for members on the ICFR website.
For further discussion on these regulatory issues, visit www.kpmg.com/regulatorychallenges.
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MiFID 2 – Another piece of the overall regulatory puzzle…
The European Commission issued on 21 October its review of the Markets in Financial Instruments Directive (MiFID). MiFID 1, adopted in 2004 and implemented in 2007 in the EU Member States, led to lower transaction costs and more integrated financial markets. Though the review was part of standard EU process to reassess policies after three years, coming when it has in the wake of the financial crisis has shifted the focus from 'review' to full scale extension to reflect market developments as well as the unintended consequences of the original MiFID. The key areas of focus for MiFID 2 are:
- A more robust, efficient market structure – by introducing additional regulated trading platforms which capture significantly more of overall market activity
- Strengthened governance - building on governance enhancements included in multiple recent EU policy proposals to enhance board accountabilities and diversity
- Increased transparency - extending reporting requirements to new trading venues and new asset classes
- Reinforced supervision and tougher sanctions - including an ability to proactively limit or cease trading in certain instruments
- Increased levels of investor protection - through enhanced disclosure and tighter requirements to assess suitability of instruments and protection offered
The regulation ("MiFIR") covers transparency requirements, extensions to supervisory powers and new requirements for trading and access to clearing for derivatives. Investor protection proposals remain in the directive ("MiFID"), which is subject to national implementation, along with authorisation and organisational requirements for trading venues and financial service providers.
MiFID in tandem with a plethora of other reforms
Before 2014 every firm that conducts MiFID related business (including commodities and derivatives) should understand the impact of the far reaching rules in MiFID, MiFIR, the Markets Abuse Directive (MAD), the Markets Abuse Regulation (MAR), the European Markets Infrastructure Regulation (EMIR) and even Dodd-Frank.
More and more reporting
Reporting requirements will increase dramatically. The operational costs of setting up the right technology infrastructures to comply with the additional data and reporting requirements alone are likely to exceed the overall figure mooted by the Commission. Getting the simple initial reporting data right under MiFID 1 proved to be time consuming and expensive; MiFID 2 is even more complex.
Emissions and commodity derivatives under the spotlight
The emissions trading market will be subject to MiFID rules as will commodity derivatives. The objective is to prevent speculation by imposing position limits. The industry is concerned that this could reduce liquidity in the market for commodity derivatives at the expense of all market participants. Supervisors can at any time demand data on positions held in derivatives or emissions allowances, and take action to require that position to be reduced, or pre-emptively set non-discriminatory limits on positions, echoing similar proposals recently agreed in the US.
A blizzard of Governance Rules
Specific requirements, which echo those in CRD 4, set specific guidelines on the shape and accountabilities of the board. This includes the number of directorships held, diversity of the board, and accountabilities for implementation and ongoing compliance with MiFID regulations. In addition, the EBA internal governance guidelines must be implemented by firms by 31 March 2012 indicating that governance is a hot topic among industry bodies in the EU.
Click here to read more.
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MiFID commission ban causes a stir…
MiFID 2 proposals aim to improve investor protection by banning commission for independent advisers. However, the ban on commission only applies to mutual funds and falls short of setting European standards for the entire retail distribution of financial products. Raising the level of investor protection will only be effective if higher standards are applied comprehensively to all competing products as inconsistencies will lead to regulatory arbitrage and an unlevel competitive playing field. This is a concern for the European Fund and Asses Management Association (EFAMA), which called on the Commission to take the MiFID view into account when it publishes reforms on Packaged Retail Investment Products (PRIPs) sales practices early next year. It is argued that MiFID rules should set the benchmark for all PRIPs and all competing products such as life-insurance funds. The Commission is currently working on a review of the Insurance Mediation Directive (IMD), which should be concluded at the beginning of next year. The Commission should aim to ensure that sales practice rules are applied across the board.
Although MiFID 2 proposals ban commission for independent advisers, they say nothing about non-independent advisers, which could lead to confusion for customers. Also, individual countries are setting their own rules, with Denmark and the Netherlands taking a unilateral view on investor protection regulation, and the latter planning a total ban on commission payments to distributors, whether or not sales are advised. The UK Treasury has said that it wanted to make the ban on commission more robust. The UK argues that the ban in MiFID 2 should apply to all advisers as the FSA proposes in the Retail Distribution Review (RDR), which comes into effect in 2013. Levelling the playing field and closing any loop-holes is crucial to ensuring maximum protection for customers.
The MiFID proposals now pass to the European Parliament and the Council for negotiation and adoption, providing lobbying opportunities for financial regulators and trade bodies.
Please contact Heleen Rietdijk or Aoife Tighe for more information.
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