REGULATION

Capital and liquidity

Basel Committee examines Basel III implementation

The Basel Committee published its Report to G20 Finance Ministers and Central Bank Governors on Basel III implementation on 31 October 2012. The report finds that, generally, there has been significant progress since the publication of the previous report in June 2012.

The Basel Committee found:

  • eight of the 27 Basel Committee members had now issued final regulations on Basel III standards
  • 17 members have published draft regulations
  • two are in the process of drafting regulations.

The Basel Committee has undertaken assessments on draft regulations in the EU and US, and these jurisdictions now have the opportunity to address gaps as they finalise their rules. But both jurisdictions must apply significant efforts to ensure that they are ready for 1 January 2013 Basel III implementation date.

ECB's Praet discusses bank deleveraging poses concerns

Peter Praet, member of the Executive Board of the ECB, gave a speech on 'Deleveraging and the role of central banks' at Bocconi University in Milan on 26 October 2012.

Since 2008, banks have been forced to restructure their balance sheets to reduce their debts and, clearly, when the deleveraging process becomes abrupt and disorderly, it can pose a serious threat to the financial system. Praet highlights the challenges that central banks face in managing this deleveraging process, focusing on the special circumstances of the euro area and the benefits of an integrated financial market union.

The ways in which banks choose to deleverage - from disposal of assets to recapitalisation - do not necessarily foster economic welfare. When a bank increases its capital this dilutes existing shareholder capital. Under normal market conditions, central banks can provide liquidity to the banking sector while controlling the ultimate interest rate impact on the real economy. During financial and banking crises, central banks' intervention can help to stabilise the situation but their monetary policy cannot resolve structural problems.

Praet reviewed the ECB's measures during the crisis, including the ECB's recent enhanced credit support programme which took the form of a three-year refinancing operation. He explained how those measures have helped to prevent abrupt deleveraging and mitigate the disparity between stable and less stable central banks within the euro area.

On banking union, Praet wants the institutional architecture to be based on principles that prevent excessive risk-taking and cross-border fragmentation of the banking sector. The latest policy measures to achieve this include the EC's proposal on a single supervisory mechanism under the ECB, and its recent proposals for a bank recovery and resolution directive and deposit guarantee schemes.

EBA Banking Stakeholder Group advise on dangers of regulating liquidity

The EBA's Banking Stakeholder Group (the Stakeholder Group) published a position paper on New Bank Liquidity Rules: Dangers Ahead on 3 October 2012. The paper focuses on the potential impact of the Liquidity Coverage Ratio (LCR) under CRD IV.

The Stakeholder Group estimated that EU banks will need an additional €1.15 trillion worth of liquid assets to comply with the LCR rules, expected to come into force in 2015. Since the crisis, this shortfall has widened as banks have focused on replenishing their capital base rather than building-up their liquidity buffers. The Stakeholder Group believes banks may direct funding towards LCR-eligible assets, rather than providing loans to the SME sector. They worry that the LCR will 'crowd out' productive investments and 'sterilise' €1.15 trillion of liquidity from the real EU economy.

This trend is already evident. More than US$850 million worth of large EU banks' deposits are sitting in central bank coffers and thus playing 'no role in financing the real economy'. The Stakeholder Group calls on the EBA to consider ways to expand the range of assets eligible for liquidity buffers. For example, allowing banks to use corporate bonds and asset-backed securities as liquid assets, would enable capital markets to support lending activities that banks are not providing under the new regime.

The Stakeholder Group believes that the impact of LCR and other new banking regulations are not yet fully understood, but further research will help to inform the debate and help the EBA design technical standards. New standards should not just bolster the stability of financial markets but also help to support the important credit intermediation role that banks play.

EBA assesses SME proposals for CRD IV

The EBA published a detailed Assessment of SME proposals for CRD IV/CRR on 22 October 2012. Back in July 2011, the EC asked the EBA to analyse the current risk weights (RWs) and thresholds under CRR for small and medium sized enterprises (SMEs).

The EBA's report recommends that the proposed RWs and thresholds for SMEs should not be relaxed to stimulate a growth in credit for the 20 million SMEs in the EU. The EBA argue that chipping away at CRD IV/CRR is not optimal as it will "endanger" future financial stability. The current regulatory framework already incorporates a discount factor for RWs vis-à-vis SMEs (75% RW for exposures below €1 million). Loans in the Corporate exposure class have an RW according to the rating of the borrower (from 20% to 150% depending on the rating--but usually 100% for most unsecured corporate loans).

SME loans do not appear to be less risky than other corporate loans so there is no justification for allowing banks to treat those loans more favourably than currently proposed. However, the EBA does recognise that lending conditions are deteriorating for SMEs and some temporary measures may be needed in the medium term. The EBA can see some sense in neutralising the affects of the conservation buffer, which comes into effect in 2016, for SMEs. It believes that structural reform to make SMEs less reliant on bank loans would work better. Promoting venture capital, private equity and the use of consistent ratings across SMEs, would open up new, more stable funding lines to help get the engine of the EU economy working again.

Fed begins bank stress tests

The Federal Reserve's final rules with stress testing requirements for both banks and non-bank financial companies under Dodd-Frank were published in the Federal Register on 9 October 2012.

The Federal Reserve will start stress tests for 19 US bank holding companies; with bank run stress tests to follow later this autumn. The test results will be published in March 2013. The Federal Reserve will release scenarios and historical data which will be used in this year's stress tests in November 2012.

Other companies that fall within the scope of the final rules are required to comply with the stress testing rules from October 2013.

Consumer protection

ESMA's Maijoor speaks on restoring investors' trust

Steven Maijoor, ESMA Chairman, spoke on Restoring investors' trust in Europe's markets at a BBA conference on 17 October 2012. He outlined the causes of investors' distrust and considered regulatory initiatives to address the problem.

Maijoor believes the root cause of investor distrust is a combination of general economic circumstances: the financial crisis, the sovereign debt crisis, longer-term consumer concerns over poor service, low returns, hidden costs and high-profile retail scandals resulting in large compensation payments.

He said that stricter investor protection rules, such as bans on inducements and limits on remuneration for advice or sales, won't restore confidence. Maijoor acknowledged concerns that a ban on inducements could lead to competitive distortions and impact some firms' business models, stressing that firms must have time to adjust.

ESMA is engaging in more dialogue with firms, and Maijoor believes that the UK financial sector's participation is crucial to ESMA's work, especially for the single rulebook. He encouraged firms to look beyond the Eurozone and non-Eurozone Member State divide over the Banking Union to ESMA's pan-European work.

Maijoor's focus on the benefits of the single rulebook and his concerns about the growing sense of UK disenfranchisement suggest that some policy makers are aware of the increasing tension between politics and economics in Europe's financial markets.

Corporate governance

EDTF issues first report on banks' risk disclosures

The Enhanced Disclosure Task Force (EDTF), formed by the FSB in May 2012, published 'Enhancing the Risk Disclosures of Banks' on 29 October 2012.

The EDTF identified the risk disclosure principles applicable to all banks: clarity, completeness, relevance, consistency, comparability and timeliness. It makes 32 specific recommendations covering, inter alia:

  • risk governance and risk management strategies/business model
  • capital adequacy and risk weighted assets
  • liquidity and funding
  • market risk, credit risk and other risks.

The report includes best practice examples on risk disclosures and bank reporting.

The EDTF wants banks to start implementing its recommendations proactively to help restore investors' confidence in their risk disclosure in 2012-2013, although some recommendations that require regulators to make new policy will take longer to implement.

PwC publishes 'Corporate governance - towards best-practice reporting'

Our guide, which we developed with the London Stock Exchange, will help listed companies understand how they can use governance reporting to build the confidence of investors and other stakeholders – and therefore company value.

CRAs

EU publishes rules granting CRAs enforcement rights

A delegated regulation containing rules of procedure on fines imposed by ESMA on CRAs (No 946/2012) was published in the Official Journal on 16 October 2012 and came into force on 19 October 2012. The regulation supplements CRA1 and grants CRAs new rights during enforcement and sets out a clear process for ESMA to following for CRA investigation and enforcement:

  • rights for CRAs to comment during enforcement investigations and enforcement stages
  • rights for CRAs access their ESMA files
  • limitation periods for imposing and enforcing penalties.

CRAs now have clear rights to review an Investigating Officer's findings prior to submission to the ESMA Board of Supervisors, and to comment during the investigation and any resulting enforcement.

The regulation also establishes fixed procedures and time periods for the imposition of penalties and enforcement actions. ESMA may impose fines within three years for any infringement for which the minimum amount of the fine is 50,000 Euros or less, and five years for imposing penalties on all the other infringements. ESMA has a five year state of limitations period during which it may bring an enforcement action.

Supervision of CRAs is ESMA's first direct supervisory duty and expands its role from policy maker to supervisor. The CRA supervisory procedures will likely create a precedent for its future supervisory duties, in particular its supervision of TRs starting in 2013.

Dodd-Frank Act

SEC upgrades CCP standards

The SEC adopted Rule 17Ad-22 under the Securities Exchange Act of 1934, establishing standards on risk management and operations for registered clearing agencies that provide CCP services. The rule, adopted on 22 October 2012, sets out new requirements for CCPs:

  • risk management standards for credit exposures, margin requirements and financial resources
  • membership standards, e.g. providing fair and reasonable terms for participants
  • record keeping
  • financial disclosure and
  • other standards for clearance and settlement processes.

The new rule comes into effect 60 days after its publication in the Federal Register.

SEC proposes capital, margin, and segregation requirements

The SEC adopted proposed rules on capital and margin requirements for security based swap dealers and major security based swap participants (SBSPs) and segregation requirements for SBSPs on 17 October 2012. The SEC is also proposing to increase the minimum net capital requirements for broker-dealers using the alternative internal model-based method for computing net capital.

The proposed rules require security based swap dealers and SBSPs to hold a minimum of $20 million in net capital, in addition to eight percent of the total collected margin. The SEC is seeking to revise net capital rules for large brokerages that rely on internal modeling to comply with net capital rules by increasing the fixed minimum requirement from $500 million to $1 billion.

But the proposals exempt firms designated as "end-users," such as some asset managers, from margin requirements when use swaps to hedge risk.

The proposals also set out a client money/assets regime for security based swap dealers. Dealers would be responsible for maintaining customers' fully paid and excess margin securities, in addition to maintaining an account with reserve cash that equals the net cash owed to the customers.

The consultation period will close 60 days after its publication in the Federal Register.

CFTC Dodd-Frank Title VII regime comes into force

On 12 October, 2012, the regulation of swaps under the Dodd-Frank Act by the CFTC commenced. This first compliance date set the compliance dates for other Dodd-Frank Act Title VII rules which will be phased in during the coming months. To address market requests for guidance, on 11 and 12 October CFTC issued 16 no-action letter and staff interpretation letters addressing:

  • Swap entity definitions
  • Extraterritoriality
  • Foreign exchange
  • Agricultural and exempt commodities
  • Commodity pool regulations
  • Introducing brokers, commodity pool operators, commodity trading advisors, floor brokers and floor traders
  • Energy-related transactions
  • Swap data reporting
  • Eligible contract participants.

To further assist firms, the CFTC published five frequently asked question (FAQ) documents. Of particular interest to prospective swap dealers are the two no-action letters concerning the handling of potentially exempt FX swaps and forward and the definition of 'U.S. person' for the purpose of the de minimus test.

See our FS Regulatory Brief for more details.

Q & A documents:

No-action letters and interpretations:

CFTC conforms its regulations to Title VII rules

Final Rule Amending existing CFTC Regulations to Incorporate Swaps was approved by the CFTC on 16 October, 2012. The CFTC has amended certain of its regulatory definitions and record keeping rules for swap transactions to make them equivalent to its rules for futures transactions. The final rule was published in the Federal Register 2 November 2012 and will become effective on 2 January 2013.

Financial crime

ENISA reports on EU-wide cyberattack exercise

The EU's European Network and Information Security Agency (ENISA), the EC and Member States conducted the biggest ever EU-wide cyberattack exercise ('Cyber Europe 2012'), on 4 October 2012. The EC and ENISA issued press releases to report on the event on the same day (IP/12/1062 and Cyber Europe 2012: first results).

The exercise tested how participating countries and the private sector would cooperate in the event of a large-scale attack. Participants included hundreds of experts from major financial institutions, telecom and internet service providers and national governments across the EU. The exercise used a self-contained system to simulate the characteristics and performance of a real-life critical information infrastructure but did not involve any real infrastructures.

ENISA announced that Cyber Europe 2012 was, overall, a success and that it would publish a report on the exercise before end of the year. The EC and the European External Action Service also plan to present a strategy on cyber security before the end of 2012 which will include a legislative proposal to improve network and information security standards across Europe.

EU High Representative speaks on cyber security

Catherine Ashton, High Representative of the Union for Foreign Affairs and Security Policy and Vice-President of the EC, spoke at the Conference on Cyberspace in Budapest on 4 October 2012. Ashton discussed the significant global impact of the internet in recent years. Global growth presents opportunities for the economy (as well as opportunities for enhancing social and democratic reforms) and challenges.

Ashton believes that the EU should stand united in its protection of fundamental rights: freedom of speech, freedom of expression, freedom of association and the right of access to information. The EU must promote trust and confidence by agreeing pan-European norms of behaviour in cyberspace and enhancing international communication on cyber crisis issues. In doing so, the EU should apply the principles of existing international laws, e.g. the International Covenant on Civil and Political Rights, the Geneva Conventions to resolve conflicts, and the Budapest Convention on cybercrime.

Finally, Ashton mentioned the EU's development of its Cyber Security Strategy, which will help to harmonise the way that Member States deal with cyber issues. She also emphasised that preserving the benefits of cyberspace and working for a safe, secure and free internet are responsibilities shared by the private sector, civil society, governments, international organisations and individuals.

FATF corruption experts meet

The FATF held an Experts Meeting on corruption, in collaboration with the G20 Anti-Corruption Working Group, on 13 October 2012, focusing on:

  • asset tracing and financial investigations
  • provisional measures on the freezing and seizing of assets
  • confiscation
  • international cooperation in asset recovery.

Experts shared their experiences on how to exploit the synergies between anti-money laundering (AML), counter terrorist financing (CTF) and anti-corruption (AC) measures.

FATF concluded that AML/CTF and AC efforts have not always been brought together effectively and that regulators and firms can further leverage their efforts to improve that through policy, legislative, operational and enforcement measure.

Market infrastructure

FSB reports progress on OTC clearing

The FSB published its fourth progress report on OTC Derivatives Market Reforms on 31 October 2012. The report departs from earlier policy focussed reports to analyse the readiness of market infrastructures. It also includes an update on the progress of international standards and national implementation efforts.

The FSB's key messages were that:

  • The market infrastructure is in place and can be scaled to meet the increasing numbers of products and participants subject to clearing, reporting and execution requirements.
  • International policy work setting the global clearing standards is substantially completed and national implementation is proceeding. All jurisdictions should, without delay, implement their regulatory approach to central clearing.
  • Regulatory uncertainty remains the most significant impediment to further progress and the comprehensive use of market infrastructure.

The FSB noted that central clearing levels seems to have reached a plateau since 2010, with clearing rates of approximately 40% for interest rate derivatives and 12% for credit derivatives. CCPs believe this is due to regulatory uncertainty and that volumes will increase when regulators have finalised rules on the scope of products and participants subject to mandatory clearing.

Transaction reporting figures were more encouraging - over 90% of interest rate and credit derivative contracts are reported to TRs. But reporting formats have not been standardised between jurisdictions which hampers regulators' ability to aggregate counterparty exposure information. Legal impediments, such as confidentiality, will also hinder aggregation.

Organised trading platforms are available in each of the primary derivatives asset classes (interest rate, credit, equity, FX, commodities) but market providers are unable to further develop platforms until regulators finalise the scope of clearing, trading and reporting requirements. Platform providers are also concerned about the extra-territoriality of many national OTC reform rules.

The FSB plans to publish its fifth progress report in spring 2013 which will focus on the readiness of market participants.

IOSCO commodity derivatives market principles gain traction

At the G20 summit in Cannes in November 2011, the G20 representatives endorsed the IOSCO Principles for the regulation and supervision of commodity markets. On 29 October 2012, IOSCO published its Review of Implementation of Commodity Market Principles which the G20 requested at the Los Cabos summit last June.

The 21 Principles address contract design, trading surveillance, disorderly markets, enforcement, information sharing, and price discovery. A majority of members are already broadly compliant with the principles. Some members did fail to comply with the principles but generally where local commodity markets were limited or non-existent. Some EU respondents noted that current gaps in the application of the principles would be addressed by MiFID II and the revised MAD so EU Member States would be compliant when they come into force.

ECB clarifies SEPA migration requirements

On 25 October 2012, the ECB released 'SEPA (Single Euro Payments Area) migration key facts', with key information on Regulation No 260/2012, known as the 'SEPA migration end-date regulation' or 'SEPA regulation' which came into force on 31 March 2012. The regulation harmonises the initiation and processing of euro payments across the 30 EEA countries, as well as Switzerland and Monaco. The factsheet summarises SEPA regulation's key requirements and implementation dates. Member States in the euro area have until 1 February 2014 to implement the SEPA regulation, and non-euro countries have until 31 October 2016

Operating rules and standards

EU brings short selling regime into force

The SSR came into force on 1 November 2012. Firms now have to notify their competent authority of net short positions in securities where they exceed a specified threshold. The relevant competent authorities have to identify shares which have their principal trading venues located in a third country.

ESMA published the threshold levels for net short positions in sovereign debt on 11 October 2012, and the list of shares exempt from the notification and disclosure requirements and the restriction on uncovered short sale on 4 October 2012. ESMA also updated its Q&A on the Implementation of the Regulation on 10 October 2012.

The sovereign debt threshold notice provides thresholds for approximately 60 sovereign issuers, the total amount of outstanding debt they have issued, the required threshold amounts for each issuer and their respective competent authorities.

ESMA will update the threshold document quarterly. ESMA uses a duration adjusted valuation approach, explained in the updated Q&A document. The Q&A also includes additional guidance on reporting issues for group and fund management activities.

The list of exempted shares includes over 10,000 shares with ISIN code, name, effective exemption date and country code. ESMA will update the list bi-annually at the end of March. However, national competent authorities can update the list on an ad-hoc basis. Any revision will be effective the day after its publication.

Other regulatory

ESMA publishes 2013 work programme

ESMA published its 2013 work programme on 1 October 2012.

On securities markets, ESMA's programme for the coming year focuses primarily on MiFID II/MiFIR and MAD II/MAR reforms. Its other key deliverables include preparations for the new credit rating agency regulation (CRA3), revising the Transparency Directive (2004/109/EC), and the technical standards relating to central securities depositories.

For asset management, it first intends to finalise the regime for AIFMD (following the release of the Level 2 measures by the EC), and to develop technical standards relating to the venture capital and social entrepreneurship fund regimes which also come into effect on 22 July 2013. Later in the year, ESMA will advise the EC on UCITS V and develop related technical standards, assuming that the EP, Council and EC complete the Level 1 legislative negotiations in the first half of 2013.

In addition, ESMA will work on creating a European single rule book for European securities and markets regulators through providing guidelines on existing legislation. It will also conduct peer reviews in 2013 to ascertain how Member States have implemented EU legislation - to identify areas where further convergence is required and publish summarise of best practices.

ESMA will also continue to improve its direct supervision capabilities for CRAs, and will assume direct supervision responsibilities for TRs registered under EMIR, probably from Q2 2013. It will also assume a coordinating role for all CCP supervisory colleges to be established under EMIR.

EU publish US, Australian and Canadian CRA equivalence

The EU published CRA2 equivalence decisions on the US and Australia in the Official Journal on 9 October 2012, and decision on Canada's equivalence on 12 October 2012. The decisions come into force 20 days following publication.

To pass the EU's CRA2 equivalence test, a third country's CRA regime must:

  • subject CRAs to appropriate supervision
  • require all CRAs to be registered or authorised
  • prevent interference from supervisors or other authorities in respect of the content of the credit rating or methodologies used
  • agree a co-operation agreement with ESMA or EU national supervisors.

Brazil, Hong Kong and Singapore are likely to be declared equivalent soon pending the EC's final assessment on these regimes. Meanwhile, EU banks and other financial institutions can use credit ratings issued by CRAs established in these countries.

ESMA is finalising assessments for other countries, such as Argentina and Mexico, and working on the necessary co-operation agreements with national regulators. EU firms may not use credit ratings issued by CRAs in these countries for regulatory purposes until their national regimes are deemed equivalent.

Pensions

EIOPA launches QIS for occupational pensions

EIOPA launched its first IORP QIS on 16 October. The study assesses occupational pensions in nine EU countries and closes on 17 December 2012. The study will test the holistic balance sheet (HBS) approach under proposed changes to the IORP methodology. The QIS will target entities that run defined benefit pension schemes but excludes entities which operate only defined contribution schemes.

Marc Hommel, PwC partner for global pensions, encourages firms to participate in the process: EIOPA plans to publish results in spring 2013.

Prospectus Directive

ESMA consults on mineral company requirements in prospectus rules

ESMA published a consultation Further amendments to ESMA's Recommendations for the consistent implementation of the Prospectus Regulation regarding mineral companies on 1 October 2012. The consultation seeks views on the information that mineral companies should disclose in their prospectuses. ESMA proposes to amend its recommendations of:

  • definition of a mineral company
  • materiality concept within the meaning of "material mineral projects"
  • endorsement procedures of the NAEN Code
  • thresholds and risk factors
  • competent Person's Report regime.

The consultation closes on 21 December 2012. ESMA intends to publish the final guidelines during Q2 2013.

Regulatory reform

IOSCO Board gets started

The IOSCO Board, a new governing and standard-setting body for IOSCO with representatives from 32 securities regulators, held its first meeting on 3-4 October 2012. Its remit is to give the IOSCO a more "efficient and inclusive structure".

The Board:

  • approved recommendations on the regulation of MMFs and oil price reporting agencies
  • reported on summarising the status of securitisation regulation reforms
  • agreed next steps regarding IOSCO's report on the CDS market
  • noted that the recently constituted Board Level Task Force on Financial Market Benchmarks of the IOSCO had held its first meeting. The task force plans to develop recommendations on safeguards against abusive practices in benchmark setting by the first quarter of 2013.

The Board considered a new initiative on reviewing the impact of national regulatory requirements on securities market cross-border activity. The Board also discussed possible work to improve retail investor protection rules and standards.

FSB reviews progress on G20 agenda

Following its Tokyo meeting on 10-11 October 2012, the FSB published a summary of its meeting discussions on current global market conditions and the progress and status of reports to be delivered for the November G20 meeting in Australia.

The FSB noted that recent policy announcements have lead to increased investor confidence and access to financing markets. Peripheral Eurozone markets are strengthening, but recovery is fragile and policy makers must continue to act prudently and swiftly to aid recovery. The FSB found recent fragmentation trends, particularly international firms withdrawing from the Eurozone, reflected a reasonable retrenchment after overextension during the past decade. Authorities and the FSB are committed to strengthening the financial system without discouraging global integration.

The FSB touched on a number of areas that it will report on at the G20 meeting:

  • SIFIs regulation: the FSB endorsed the Basel Committee's framework for dealing with D-SIBs and the IAIS consultation on policy proposals for G-SIIs. The FSB also intends to publish a consultation paper with guidance on RRPs in October 2012. It expects the ongoing FSB peer review of members' existing regimes and planned changes to bring them into line with the FSB's key attributes of effective resolution regimes to be finalised in early 2013.
  • Shadow banking: the FSB will consult on an initial integrated set of policy recommendations to strengthen regulation of shadow banking activities after the November G20 meeting.
  • OTC derivatives reform: the FSB issued its fourth progress report on implementation of the G20 commitments to OTC derivatives reforms on 31 October. The FSB will report to the G20 meeting on members' decisions on national approaches to central clearing.
  • Disclosure and accounting: the private-sector Enhanced Disclosure Task Force (EDTF) updated the FSB on its work to complete recommendations for bank risk disclosure standards. The FSB discussed progress on achieving convergence on IASB and FASB standards to agree the classification and measurement of financial instruments. However, the FSB noted that standards on the impairment of loans had yet to be developed.
  • LIBOR and other financial benchmarks: the FSB agreed to coordinate the information and lessons from the benchmark reviews undertaken by the FSA, IOSCO, the EC and BIS and to set best practices and principles for standards which emerge.
  • LEI: the FSB supports the draft Charter for the LEI Regulatory Oversight Committee which will be submitted to the G20 for endorsement. The FSB continues to collaborate with the Private Sector Preparatory Group to establish the global LEI foundation, which will operate the proposed Central Operating Unit and operational elements in the global LEI system.
  • CRA regulation: the FSB discussed progress on implementing its principles for reducing reliance on CRA ratings.
  • Basel II implementation: the FSB reviewed the Basel Committee implementation report findings and calls on member jurisdictions to implement Basel II in a timely way and consistent with internationally agreed standards.

The FSB also reviewed the steps it had taken following its June 2012 recommendations to strengthen its capacity, resources and governance and will report its findings to the G20.

IMF's Lagarde bemoans patchy progress on reforms

Christine Lagarde, IMF Managing Director, spoke about Global Financial Sector Reform: An Unfinished Agenda on 26 October 2012. Lagarde believes that we have seen regulatory reform progress since the crisis, noting that success with Basel III capital and liquidity standards for banks and large investment firms, OTC derivative reforms and recovery and resolution frameworks are evidence that we are moving in the "right direction".

But many countries have not yet delivered on these reforms and sources of systemic weaknesses exposed during the crisis are still present. Financial systems are still overly complex and interconnected. Banking assets are still highly concentrated with strong domestic bank interlinkages, some banks continue to rely excessively on wholesale funding, and many banks are still too-important-to-fail.

Lagarde posits two reasons for the slow progress of reforms. She believes that the financial systems are still under distress and "crisis-fighting efforts are inadvertently impeding reforms". In many EU countries, it might take banks decades to re-build their damaged balance sheets. However, reforms such as Basel III provide "generous implementation timetables" to allow the economy to recover so there is no excuse for delaying the implementation of this critical regulation.

Lagarde said that there are vested interests are working against regulatory reform, slowing down progress, and that this "pushback is intensifying". Lagarde is troubled by banks that say the new regulations will be "too burdensome" and are mounting significant lobbying efforts against them.

Policy makers should not be surprised that banks are seeking to dilute some regulatory requirements. Banking reform proposals seek to fundamentally change the banking industry and will affect its structure, culture and profitability.

RRPs

EC publish non-bank RRP proposals

The EC published a Consultation on recovery and resolution framework for non-bank financial institutions on 5 October 2012. This consultation discusses how the failure of non-bank financial institutions such as CCPs, central securities depositaries and systemic insurance companies can threaten financial stability.

The EC discusses what arrangements can be put in place, at minimal taxpayer cost, to prevent the firms failing. It focuses on recovery and resolution issues, rather than changes to prudential or market conduct rules.

The EC identifies which non-bank failures are likely to be relevant to financial stability. A non-bank entity's systemic relevance depends on their businesses:

  • are extensive
  • are inter-connected with other institutions and markets
  • could be replaced by products and services that other institutions provide.

The EC considers which aspects of insurance business are interconnected with the financial system and/or with the real economy, and whether that business could be replaced readily. Non-banks can fail in various ways, such as a serious insolvency problem, a major technical failure or a combination of the two.

Finally, the EC asks if other types of institutions fail could that result in mass disruption to the financial system and the economy, and what recovery and resolution tools could be introduced to address such risks. It identifies other types of non-bank institutions including investment funds and certain trading venues, which have not been previously included in RRP regulatory proposals but could introduce systemic risk.

The consultation closes on 28 December 2012. This consultation represents an important opportunity for all non-banks to help shape appropriate RRP requirements that are appropriate for their industries and reflect how their businesses differ from banks.

Shadow banking

IOSCO finalises recommendations for MMFs

IOSCO published its Policy Recommendations for Money Market Funds on 9 October 2012, setting out final rules following its consultation in April 2012. The recommendations set international standards for MMF regulation and management practices, setting out 15 key principles for valuation, liquidity management, use of ratings, disclosure to investors and use of repos.

Compared to previous MMF international policy measures which focused mainly on fund assets, these recommendations address vulnerabilities arising from fund liabilities, as well as valuation and requirements to maintain a constant net asset value (CNAV). In particular, the recommendations seek to address the risk of runs on MMFs and to remove the 'first mover advantage' for shareholders who redeem their shares from stable NAV funds at first suggestion of difficulties, leaving losses to be borne by residual shareholders.

As the size, features and systemic relevance of MMFs differs significantly between countries, IOSCO acknowledges that the implementation may vary between countries. It plans to review implementation within two years, to consider possible amendments to the recommendations.

Single supervisory mechanism

Council considers Banking Union proposals

Proposals to create a banking union and its requirements for a SSM in the Eurozone continue to gain support as to help address the fragility of the single currency.

The Council published the conclusions of its meeting on 18 and 19 October 2012 where it considered banking union amongst other things. The Council sees the the EC's legislative proposal to create the SSM as a priority and wants to agree on it by 1 January 2013. In parallel, it advocates the quick adoption of provisions harmonising national recovery and resolution and deposit guarantee schemes, and to push ahead with the single rulebook.

The ministers discussed the treatment of Member States that will remain outside SSM. The Council calls for the equitable treatment and representation of euro and non-euro area member states participating in the single supervisory mechanism, to ensure a level playing field.

But non-eurozone Member States are still concerned about their status vis-à-vis the SSM.

ACCOUNTING

IASB

IFRS - Revenue recognition project

This IASB and the FASB joint project IFRS - Revenue Recognition aims to clarify the principles for recognising revenue from contracts with customers. The rules apply to all contracts with customers except leases, financial instruments and insurance contracts. The boards' timeline indicates that they will issue a final standard in the first half of 2013, with an effective date no earlier than 2015. The boards will continue to re-deliberate over the next several months and intend to publish guidance on some of the more significant changes.

The boards met in September and October 2012 to continue re-deliberating their revenue recognition and reached tentative decisions on:

  • constraint for recognising variable consideration
  • certain issues related to collectability
  • time value of money
  • distributor and reseller arrangement
  • contract modifications
  • measuring progress toward satisfying a performance obligation.

See our Straight Away 94 and Straight Away 95 publications for summaries of these meetings. The boards will analyse further the constraint on recognising revenue from variable consideration and the presentation of impairment losses on receivables. Findings will be discussed at a future meeting. Other key issues which the boards plan to re-deliberate include licences, allocation of transaction price, disclosures and transition. Our practical guide summarises the boards' re-deliberations, their tentative decisions and implications.

IASB amends IFRS 10 to exempt 'investment entities' from consolidation

Many funds and similar entities will be exempt from consolidating most of their subsidiaries under the IASB's Amendments to IFRS 10, 'Consolidated financial statements'. Instead, entities will measure subsidiaries at fair value, through profit or loss. The amendments published by the IASB on 31 October 2012 exempt entities that meet an 'investment entity' definition and which display certain characteristics. The IASB also amended IFRS 12 to introduce new disclosures for investment companies. See Straight Away 97 for more details.

There are no 'roll-up' provisions in these amendments. This means that if a parent entity (e.g. an insurer) is not an investment entity, it will need to consolidate all of its subsidiaries, including those entities that are held via subsidiaries that are themselves investment entities.

PwC publications

  • Practical guide to IFRSs 10 and 12: Questions and answers.– The IASB issued IFRS 10, Consolidated Financial Statements, and IFRS 12, Disclosure of Interests in Other Entities in May 2011. Some of the detailed guidance is new and may change the scope of consolidation for some parent companies. Our publication sets out our views on some of the most common implementation issues.
  • Practical guide to IFRS: Classification of joint arrangements.– The classification of joint activities under IAS 31 seldom created any controversy or even much in the way of discussion. But IFRS 11 has changed all that, and there will be instances which will require you to undertake significant analysis and exercise judgement. Our guide takes through the key aspects of classifying a joint arrangement under IFRS 11.
  • IFRS pocket guide 2012. Our guide summarises the recognition and measurement requirements of IFRS documents issued up to August 2012. This quick-reference guide is intended for a variety of audiences, including finance directors, financial controllers and other members of the finance team, as well as broader management, actuaries, lawyers, merchant bankers and analysts.
  • IFRS news.– IFRS news is our monthly newsletter highlighting developments at the IASB. The October 2012 edition addresses the following issues:
    • IASB and FASB make progress with revenue discussions
    • Leases - viewpoint on project's progress
    • IFRS quiz: deferred tax.
  • IFRS disclosure checklist.– Our checklist is designed to facilitate the collection and review of disclosures for each component of the IFRS financial statements. It has been updated to outline the disclosures required for December 2012 year ends. It also contains an appendix (Appendix H) which provides the disclosures required of entities that early-adopt IFRSs effective for annual periods beginning after 1 January 2012.
  • IASB Foundation staff responds to SEC work plan.– Our publication considers the IFRS Foundation (the parent organisation of the IASB and the IFRS IC) response to the SEC's IFRS 'work plan'. The IFRS Foundation draws different conclusions in several areas from those reached in the SEC work plan. The IFRS Foundation also sets out information that it indicate might not have been fully considered or given appropriate weight by the SEC staff.
  • IFRS and US GAAP: similarities and differences.– The update to this publication includes:
    • revised introduction reflecting the current status, likely next steps, and what companies should be doing now
    • more current analysis of the differences between IFRS and US GAAP – including an assessment of the impact embodied within the differences
    • details on incorporating authoritative standards and interpretive guidance issued as at 1 September 2012.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.