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Regulatory reform –

understanding the impact

Paul Edmondson

Simon Morris

2nd June and 17th June (London) 9th June (Edinburgh)

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Outline

Introduction to the reform agenda and CMS roadmap

FSA – a different type of regulation?

Learning the lessons – specific post crisis reforms

Beyond the banking sector

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CMS reporting – the seminar series

First seminar in the series

– Grasping the big picture

Later seminars

– By sector and

– In detail

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CMS reporting – the roadmap

The report

– Making sense of the deluge from UK,EU and international

– Key issues summaries

– Key impacts - which sectors/firms and how

– Timeline – key dates

– ‘More detail’ (than we can provide today)

– ‘Policy options’

On-line – www.law-now.com/financial-services

– Will be kept update

– Hyperlinked –

– Referenced external materials

– Our law now reports and tools

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No magic or silver bullets

The regulatory system failed

– But can be fixed

– Each ‘magic bullet’ has been oversold

So we keep - FSA, FSMA, the EU legislation, FSF, Basel, Solvency II etc etc

Many diverse reforms to recalibrate the system

– Overall a sea change

– But using the same infrastructure for firm supervision

IMPACT

A lot of lobbying to be done!

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How reform will be delivered?International consensus –

– Global standards but no global regulator

EU measures –

– new priorities (systemic)

– More effective European authorities

– A more standard rulebook and regulatory system

Domestic –

– White Paper awaited - FSA fights to keep its supervisory role (financial regulation of banks) from the Bank of England

IMPACT:

more policy/rule making at EU level

UK authorities less independent

FSA continues to supervise firms –

– Cross-border regulation coordinated via colleges of supervisors

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FSA – a different type of

regulation?

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Macro-prudential regulation - oversight

of the financial system

New focus on systemic risk –

– the missing piece of the jigsaw

– fell between the stools

Function to include* –

– System review/early warning

– Set parameters for micro/firm prudential rules

– Inputs into stress testing and SREP and capital

– Lots of big issues (many raised by Turner) for the

macro-economists (and the new European Systemic

Risk Council) to ponder

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New focus on systemic risk and macro-

prudential regulation/oversight

The policy question - who is responsible and what are their powers?

– See the chart

– FSA/Bank of England turf war

– New FSA systemic risk department

IMPACT

Increased burden on firms (helping systemic

analysis)

More regulatory intervention/less free market

Uncertainty for several years

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Rethinking regulation – from ‘light touch’

to ‘intrusive’

Denying accepted thinking

Managing the managers

Bulking up capital

Challenging the models

Managing insolvency

And sharpening supervision

FSA v Rest of World

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New style for rule making and firm

supervisionIntensive Supervision – US/Spanish style bank inspectors?

– Supervisory challenge in previous no-go areas

– Competence of senior appointments and non-execs

– Accounting decisions

– Business models, sustainability and strategy

– Product regulation

– Wholesale market operation

IMPACT

Firms will find FSA supervision more challenging

Broader internal team -

– with enhanced capabilities

– for ARROW etc

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Enforcement

FSA gets tough

Credible deterrence

EU ideas – the 1 billion Euro fine!

IMPACT

More enforcement against individuals including–

– Senior management and executive directors

– Non-executive directors?

– Higher fines

– More criminal arrests and prosecutions

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Management and governance

Walker review on governance – getting bank boards to mitigate risk

– Extension –lessons applicable to non-bank sectors

– Board level

– Governance

– Remuneration

– Risk management

– Committees – audit, REMCO, nomination, risk

IMPACT

Watch this space

Much ‘hotter’ for directors of large banks/major institutions

Increased emphasis on ‘internal policing’ and duties towards depositors/insureds

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Non-executive directors

Watch out!

– Another scapegoat?

Walker

The independent role –

– Time

– Resources

– Competence

Towards a supervisory board?

IMPACT

Much hotter for non-executives

More independent with greater policing role

More time, resource and expertise

Greater exposure

Conflicting relationships with FSA (their internal spies?), executive and shareholders?

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Regulating remuneration

Turner is less hysterical than the media and TSC

– But a political ‘must have’

FSF Principles and EU Recommendation

– All financial institutions – not just banks

FSA running ahead with its draft rules and code

– ?Scope – big banks or all sectors?

– Broad requirements

– Formal remuneration policy to promote effective risk

management

– Limits,deferral and risk adjusted basis for bonus

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Regulating remuneration

Part of*

– ARROW

– ICAS – capital add-ons and CRD amendment

– SREP

CMS remuneration checklist from specific seminar (in the

pack)

IMPACT

New area of regulation to deal with

Transition plan required

Much bigger role for REMCOs

Combined team required - HR, risk, compliance,legal

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Learning the lessons –

specific post crisis reforms

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The new role of the state in financial

servicesToo big to fail?

– Now recognised by regulators (as well credit rating agencies!)

– Implicit state guarantee – provider of capital and liquidity of last resort?

The search for a regulatory response

– Additional requirements – financial (higher capital/liquidity) - and risk based restrictions?

IMPACT

Larger banks/institutions to face

– Heavier supervision

– Heavier involvement in systemic planning

– Need to lobby against requirements

Other firms may lobby for higher requirements

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Competition policy post crisis?

Will there be a competition response

– Competing for deposits –

– market share issues

– State ownership

– Implicit guarantee

– The current OFT consultation on their financial services strategy

– State aid is currently an EU issue – e.g. restructuring terms for APS clearance

IMPACT

(Conflicting) lobbying from both sides of the industry

Short term uncertainty

Post crisis – new competition investigations to gauge competition and use competition powers?

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Group supervision –

international

Lessons from Lehman and AIG for ‘Global in life;national in death’

Conflict between

– Operational, management/matrix reporting and financial structure (central liquidity/cash management etc) and

– Legal/local entities

– Made local supervision ineffective

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Group supervision

Can groups demonstrate that their structures enable effective supervision at the local level (without breaking-up into local subsidiaries with separate operations, management and finances)?

Branching –

– One EU wide deposit insurance scheme or roll back the single market principles with greater powers for EU host regulators

– Non-EU – more ready to require local subsidiary?

IMPACT

Review all aspects of group structure to demonstrate ‘survivability’ of local operations

Greater emphasis legal entity structure, solo/local regulation and intra-group exposures

Potential loss of management, operational and financial efficiency

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Group supervision

Regulating unauthorised holding companies

– Extension of approved persons regime for directors

and SIFs

Extended reach to unregulated entities connected with

the group –

– Off-balance sheet entities

– SIVs

– And the shadow land

IMPACT

Unauthorised holding companies brought into regulation

Much greater scrutiny of off balance sheet entities

Achieving off balance sheet status may not be enough

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Regulation in the unauthorised ‘shadows’

Unauthorised entities beyond the perimeter of regulation

– Bank like activities e.g. US money market funds not breaking the buck

– Systemically important entities

Indirect monitoring/supervision

– Via connected financial group or

– Via commercial contact e.g. prime broker

Ability to

– Apply restrictions or

– Bring into direct regulation (but uncertain how to legislate for this)

IMPACT

More onerous

– reporting of hedge fund funding etc

– Indirect regulation of connected entities

Bank like regulation for guaranteed products

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Financial regulation*

Higher liquidity requirements*

– Individual liquidity adequacy requirements

– Non-EU banks

More capital*

More equity*

Counter-cyclical reserves (Spanish style)*

Penalising the trading book*

IMPACT

More risk adverse financial regulation with higher requirements

Smoothing of bank profits

Speculative prop trading on bank balance sheet less attractive

– Boost for external hedge funds?

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Financial regulation*

More realistic accounts*

More stress testing – the what if game*

Tougher rules for securitisation*

Credit ratings – reforming the system*

IMPACT

Battle over accounting standards

Securitisation/originate and distribute to continue

but with greater due diligence and retentions

More challenge to ratings

More time ‘playing what if’ with FSA

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Planning for failure

Rescues and administration* – the new tools

– Banking Act – SRR etc to protect retail deposits

– Investment banking (current HMT consultation on the Lehman lessons)

FSCS – trying to make it work*

Planning your own funeral –

– Reverse stress testing

– Manuals for regulators and administrators

– The single customer view requirements

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Planning for failure

IMPACT

FSCS pre-funding will come but no policy yet on

– who pays for what on what basis or national/EU

Recent rescues –

– Building societies paying interest cost of FSCS loans

– unresolved issues on capital (insurers and others on the

hook)

Heavy burden on firms in helping regulator plan for disaster

– Potential for huge costs

– ?dubious benefits driven by traumatised authorities

– Need to lobby

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Improving market infrastructure*

Reducing the risks in OTC derivative markets*

– Central counterparties

– Exchange trading

IMPACT

After compression – operational changes for CCP

trading

Increased reporting/disclosure re OTC

Uncertainty whilst policy is thought through

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Beyond the banking sector

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Regulatory reform spreads beyond the

banking sector

Specific sector issues – e.g. hedge funds

The lessons to be learnt relevant to other sectors

Changing the institutions and the regulatory system

– FSA

– EU

IMPACT

Non-banks ignore at their peril

Need to engage and lobby

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A boost for the mutual model?

Sector feels hard done by –

– FSCS liabilities

– Credit downgrade

– Regulatory overload

Some support for the mutual model but narrow

banking tarnished by toxic exposures

IMPACT

Difficult world for the smaller societies

Possible encouragement for new mutuals

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Tightening insurance regulation

Financial regulation and risk management

– Solvency II level one agreed for October 2012*

– Group support abandoned*

– ‘Lessons to be learnt’ from crisis (equivalent to Basel revamp)

– Internal model approval process

– Capital quality

IMPACT

Group structures less efficient without group support

Internal Solvency II project needs to be on track – in-house counsel and compliance/risk need to be plugged in

Watch out for tightening at level 2

Internal model benefits at risk

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Tightening insurance regulation*

List of earlier issues which are relevant to insurance –

– The spill-over from banking reform

– Walker – governance/board risk management under Solvency II but

– Non-executives ?

– Board remuneration?

– Macro-prudential

– Too big to fail

– FSA supervisory and enforcement

– Groups

– FSCS – exposures to banking rescues - back to a dedicated scheme?

– EU institutions and

– branching

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Tightening insurance regulation

IMPACT

Uncertain but broad and significant

Need to lobby against inappropriate read across

from the banking sector

– Need stronger industry engagement than on

previous regulatory changes

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Increased fund regulation – direct and

indirect

Proposed EU directive on fund managers*

– All non-UCITS managers above size threshold (includes hedge and private equity but not limited to alternative sector)

– Trade sanctions re tax and regulatory standards in non-European fund centres

– European

– Authorisation

– Rules (including re liquidity of funds)

– Passport

IMPACT

Private equity concerned

Fund domicile threat needs monitoring

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Increased fund regulation – direct and

indirect

Already mentioned –

– Shadow lands* –

– Via regulated group

– Via prime broker

– Extending direct regulation

– Avoiding bank like activities

IMPACT

Limited immediate impact - few funds

– large enough to be systemically important

– Offer guarantee

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Tightening up retail regulation*

A better way to regulate consumer finance?

– Mortgages and product regulation? (LTI/LTV limits?)

Changing the way investments products are sold*

– RDR/RDIP

– Proposed EU packaged products legislation

IMPACT

Uncertain – EU/FSA still struggling to find a

coherent policy

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Next steps

Feedback forms and later re roadmap

Seminar follow up –

– The roadmap report

– Monitoring via www.law-now.com/financial-services

What we can do for you –

– Training – board, non-execs, legal etc

– Impact analysis

– Lobbying and consultation responses

– Strategy

– Reviews –

– Group/legal structure

– Capital

– Risk management