EXECUTIVE SUMMARY

Welcome to this edition of "Being better informed", our monthly FS regulatory, accounting and audit bulletin, which aims to keep you up to speed with significant developments and their implications across all the financial services sectors.

In mid-December, EU regulators cleared their desks for the holiday, issuing a raft of technical standards, consultations and guidelines. They are tying up loose ends on CRD IV, EMIR, AIFMD and other reforms coming into force this year.

The EU's banking union proposal gained traction as Eurozone leaders agreed to hand over the prudential supervision of large banks to the ECB from early 2014. The UK government won a major voting concession - the EBA's decisions will need to be supported by majority of Eurozone and non-Eurozone countries. But the political debate on the UK's long-term role in Europe looks likely to continue through 2013.

On OTC derivatives, the EC adopted the first batch of EMIR technical standards setting out most of the operational requirements for firms, CCPs and TRs.

In the US, the CFTC issued a second wave of no-action and interpretation letters. An interim final rule release further delayed some rules due to come into force on 1 January 2013.

Asset managers have a busy year ahead implementing AIFMD. In December, the EC adopted its AIFMD Delegated Regulation, which sets out requirements for fund managers. ESMA published draft AIFMD RTS, setting out the criteria for AIFMs and draft guidelines clarifying some key AIFMD concepts.

Other important asset management developments last month included: ESMA's publication of the official translations of its UCITS guidelines, which kick-starts a two month period for Member States to 'comply or explain'. The EP and Council also agreed on the texts of European Social Entrepreneurship Funds and European Venture Capital Funds regulations, which will come into force with AIFMD in July.

In the UK, the FS Bill 2012 received Royal Assent in December – putting the new regulatory framework on track to launch on 1 April 2013.

After many years of consultation and some disagreement, the UK's revised retail rules under RDR came into force on 31 December 2012. Several rules, such as commission bans, precede EU retail proposals so all eyes should look to the UK's experience as a test case.

Our first 2013 publication wouldn't be complete without gazing into our crystal ball. In this month's feature article we share our perspectives on the regulatory reforms likely to affect you.

We wish you a happy, healthy and prosperous New Year.

Laura Cox
 FS Regulatory Centre of Excellence

2013: A TRANSFORMATIVE YEAR

We expect 2013 to be another remarkable year in the development of financial services regulation. Key post-financial crisis reforms will begin to take hold, intensifying implementation pressure on banks, asset managers and other market participants.

This new regulation is designed to make our markets and financial institutions safer, more transparent, and more closely supervised – this year we should start to see if these solutions are working. Below we consider how key regulatory initiatives coming into force this year will impact firms and our markets.

RRPs: extending the resolution framework

Last year the FSB and other international regulators worked on getting RRPs in place for G-SIBs. In 2013 the resolution efforts will extend to other systemically significant institutions. Regulators will develop a more international approach for G-SIBs and other G-SIFIs: producing institution-specific co-supervisory agreements for international firms, information sharing agreements and frameworks for resolvability assessments.

Investment firms, insurers and financial infrastructure providers such as CCPs, exchanges, payment institutions, and even large investment funds, will come onto the RRP radar. The FSB plans to publish a list of globally significant insurers (G-SIIs) in April 2013, and finalise policy measures 18 months later.

Regulators will extend the RRP framework to domestically significant financial institutions. Canada, Australia, Hong Kong, Singapore and India all plan to require RRPs for both global and domestic firms operating in their jurisdictions.

Regulators' biggest challenge this year may be resolving the balance between global, regional (e.g. the Liikanen EU proposals) and domestic requirements. Groups operating in multiple jurisdictions need certainty and consistency of international rules to manage their businesses effectively.

OTC derivatives: a higher price for safer markets

In 2013 the full force of Dodd-Frank Act Title VII derivatives rules take hold, before EU and other jurisdictions implement their OTC reforms later this year. The new OTC derivative reforms will fundamentally change the US$650trillion global OTC derivatives market's trading, operations and culture. Here is how we see this play out in 2013:

  • Due to tight deadlines, firms will struggle to comply with deadlines for transaction reporting, with some less prepared financial institutions and non-financial firms possibly missing them altogether.
  • Extra-territorial rules will become clearer and firms are likely to reduce or restructure some of their cross-border trading activity. Platform providers may delay developing new trading models until such time as the extra-territorial rules are fully understood.
  • International standards for managing CCP risk will evolve, but will not be fully tested until the next bout of market volatility.
  • The demand for eligible collateral will spike, so collateral optimisation will become more crucial.

From next year onward FMIs will become the dominant force in these markets – designating which trades are cleared and who manages risk in the system.

Shadow banking: more data, please

Policymakers should make significant strides this year to strengthen the oversight and regulation of shadow banking. The FSB proposed many new reforms in securities lending, repos and money market funds in November 2012. These measures will bring many more financial institutions inside the traditional regulatory parameter, substantially increase regulation in some existing regulated sectors, to mitigate potential systemic risks on the financial system and wider-economy.

However, significant challenges remain. Shadow banking reforms must ensure they achieve their primary purpose, and don't impose unnecessary costs on market players.

Data is critical to effective supervision because shadow banking, by its very nature, is ever evolving. Shadow banking supervisors will need to closely monitor data to spot the build-up of risks in the non-regulated banking system. The FSB have also emphasised the importance of international coordination and the need for regulators to regularly share information.

The FSB plans to publish final policy recommendations by September 2013. The EC is also expected to issue legislative proposals on shadow banking in early 2013.

Banking restructuring: policy harmonisation – or not?

In September 2011 the ICB recommended ring-fencing retail banking; increasing loss absorption in ring-fenced banks; and improvements to competition. In October 2012, the Government published a draft bill to bring these recommendations into law. But the draft bill delegates much of the definition, including levels for the de-minimis threshold, to secondary legislation that comes later.

In the wider European context, Ekki Liikanen (Governor of Central Bank of Finland) delivered his recommendations for reforming bank structures in Europe. It echoes the ICB report, calling for trading to be separated from deposit-taking activities, but does not specify how that will be achieved. The Liikanen report proposals are at an early stage than the US and UK measures and it remains to be seen how the EU will take this forward in 2013.

The US Volcker rule, which places limits on banks' proprietary trading abilities, was meant to be finalised by end-2012 but the timetable has slipped to at least Q1 2013. This is due to its complexity and the volume of feedback the SEC received.

These regulators will need to reconcile the restructuring rules they agree this year with RRP requirements, which have similar objectives, and restructuring requirements issued in other jurisdictions. While RRP and restructuring rules will inevitably make groups more local, market infrastructure reforms go the other way, making global markets more interconnected than ever.

Remuneration: finalising CRD IV

If the Council and EP don't reach political agreement on CRD IV by the end of January, it is unlikely that any bonus cap provisions could be in place ahead of the banks' 2013 compensation round. Bonus capping is a major threat to European banks' competitiveness. Any compromise which includes a relaxation of the strict 1:1 bonus to salary ratio will be welcomed by the industry.

But even if the bonus cap is relaxed, these new regulations will still probably have a major impact on compensation structures in the European banking sector.

Moving from regulatory to market transparency

The new FINREP and COREP regimes, Form PF requirements for asset managers, and new derivative transaction reporting requirements under Dodd-Frank and EMIR will give regulators unprecedented views into firm's risks and business operations.

We'll see more proposals to support the wider transparency agenda. Policy makers will move to extend risk disclosure requirements made by the largest financial institutions, in line with the FSB's comments, and new rules for consumer products will lead to greater transparency on pricing and sales incentives.

Firms will be closely watching how consumers, investors and market counterparties react to this information.

Insurance: LTGA decisions, interim Solvency II measures and G-SIIs

Virtually all insurance regulatory developments in Europe are dominated by Solvency II and its progress toward implementation. EIOPA aims to launch its impact assessment of the Solvency II LTG package in January, completing it in March 2013. EIOPA is conducting the LTGA at the request of the EU legislators, in context of the Omnibus II negotiations. The LTGA results should provide legislators with information that will allow them to complete the Omnibus II negotiations and the LTG rules. A report on the LTGA is likely to be published in June 2013.

With delays to the Solvency II implementation date now inevitable, EIOPA issued its opinion on what measures insurers should take during the period between January 2014 and the new implementation date. While EIOPA will likely issue detailed guidelines shortly for national supervisors, EIOPA may require national supervisors to implement certain aspects of Solvency II from 1 January 2014, particularly Pillar 2 and potentially aspects of Pillar 3. Firms may be required to demonstrate an effective risk management framework, system of governance, an ORSA which is both current and forward looking, pre-application of internal models and reporting requirements.

The IAIS will publish by Q2 2013 its conclusions about the data it collected from its October 2012 consultation on policy measures for G-SIIs. This followed the IAIS's earlier consultation proposing a methodology to identify G-SIIs. We expect the IAIS to publish its first list of G-SIIs, but policy measures for (re)insurers designated G-SII will come in until 2014.

Outside of the EU, a number of policy developments are seeking to achieve rules equivalent to Solvency II or simply seek to modernise supervisory regimes. This year could be dominated by EU and US discussions exploring the similarities between the two insurance regimes and a growing mutual recognition of their markets. The US will continue work on the Solvency Modernisation Initiative. This introduces, among other things, rules for the US ORSA as well enhances group company supervisory requirements. A number of insurance regulatory developments are taking place other countries this year as well, in South America, Africa and Asia.

Focus on culture and conduct

Our financial institutions lost ground in 2012 in the fight to regain public trust after the financial crisis. This year, regulators and institutions will be reflecting on failings that came to light last year – fraud in setting LIBOR and other benchmarks, more mis-selling of financial products and failures to comply with basic AML requirements, to name a few. Financial institutions and their investors are paying a huge price for these conduct failings. In 2013, supervisors will expect firms to improve their conduct risk management significantly, but that alone will not be enough.

In many parts of the industry, institutions have cultures that are not in alignment with regulators' and the public's expectations. Recovering from the financial crisis and building trust isn't just about creating new rules and regulations, and no amount of robust new regulation or more intrusive supervision can ever fully counteract a poor culture. Change must come from within. To achieve better outcomes for financial stability and for individual customers, the industry needs to put building stronger culture at the top of its agenda in 2013.

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