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  1. P age |1 InternationalAssociationofRiskandCompliance Professionals(IARCP) 1200GStreetNWSuite800Washington, DC20005-6705USATel:202-449-9750www.risk-compliance-association.com Top10riskandcompliancemanagementrelatednewsstoriesandworldeventsthat(forbetterorforworse)shapedthe week'sagenda,andwhatisnext DearMember, NowyoucanpurchasethepresentationsoftheCertifiedRiskandComplianceManagementProfessional(CRCMP)programat$97(instead of$297,thecostofthefullprogram).Tolearnmore: www.risk-compliance-association.com/Distance_Learning_and_Certification_CRCMP_Presentations.htm Whosaid…? “Icanannouncethatyourhighstreetbankwillhavedifferentbossesfromitsinvestmentbank. Yourhighstreetbankwillmanageitsownrisks,butnottherisksoftheinvestmentbank. Andtheinvestmentbankwon’tbeabletouseyoursavingstofundtheirinherentlyriskyinvestments. Mymessagetothebanksisclear:ifabankfloutstherules,theregulatorandtheTreasurywillhavethepowertobreakitupaltogether–fullseparation,notjustaringfence.” TheChancelloroftheExchequer,RtHonGeorgeOsborneMP,ontheReformofBankingsaidthat. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  2. P age |2 Justbeforethat,hesaid: “ThankyouforwelcomingmetoJPMorganhereinBournemouth. Whenyouthinkaboutwheretogiveaspeechoncultureandethicsand thefutureofBritishbanking,theofficesofoneoftheworld’slargestAmericaninvestmentbanksmayseemlikeanoddchoiceofvenue.” Readmoreatnumber9ofourlist. Whosaid…? “Ican'trememberatimewhenIhaveseenmoreregulatoryproposalsdraftedthatdifferentiatebetweenbanksbasedonsizeorcomplexity” ItisGovernorElizabethA.Duke,speakingaboutthefutureofcommunitybankingattheSoutheasternBankManagementandDirectorsConference,UniversityofGeorgia,TerryCollegeofBusiness,Duluth,Georgia. Shecontinued: “Infact,mostoftheregulationsrequiredbytheDodd-FrankWallStreetReformandConsumerProtectionAct(theDodd-FrankAct)aredirectedprimarilyatlarger,systemicallyimportantbanks,andmanyoftheAct'sprovisionsspecificallyexemptcommunitybanks. Forexample,bankswithlessthan$10billionintotalassetswereexemptedfromanumberofthedebitinterchangerestrictions,andearlystudiesindicatethatthoseexemptionsareworking. Inaddition,formalstresstestingwasrequiredonlyforbankswithtotalassetsof$10billionormore. Inimplementingtheserequirementsforthelargerbanks,thebankregulatoryagenciesspecificallyindicatedthatcapitalstresstestingwouldnotberequiredforcommunitybanks. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  3. P age |3 Thisdoesnotmeanthatcommunitybanksareexemptedfromprudentriskmanagement,butratherthatsmallerbanksshouldthinkaboutthenegativeshocksthatcouldaffecttheirbusinessinthefutureandtailortheirrisk-managementprocedurestotherisksandcomplexitiesoftheirindividualbusinessmodels.” Readmoreatnumber2below. WelcometotheTop10list. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  4. P age |4 Regulatoryconsistencyassessmentprogramme(RCAP)-Analysisofrisk-weightedassetsformarketrisk TheBaselCommitteeonBankingSupervisionhaspublisheditsreportontheregulatoryconsistencyofrisk-weightedassetsformarketrisk. Thisanalysisofrisk-weightedassetsinthetradingbookispartofthewiderRegulatoryConsistencyAssessmentProgramme(RCAP)initiatedbytheCommitteein2012;asimilaranalysisiscurrentlyunderwayforthebankingbook. GovernorElizabethA.Duke AttheSoutheasternBankManagementandDirectorsConference,UniversityofGeorgia,TerryCollegeof Business,Duluth,Georgia TheFutureofCommunityBanking SpeechbyPatrickSpens,HeadofMarketMonitoring,theFSA,attheFuturesOptionsAssociationComplianceForum InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  5. P age |5 QuestionsandAnswers ImplementationoftheRegulation onshortsellingandcertainaspectsofcreditdefaultswaps Regulation(EU)No236/2012oftheEuropeanParliamentandoftheCouncilof14March2012onshortsellingandcertainaspectsofcreditdefaultswaps(“Regulation”)hasalreadyenteredintoforceandwillbefullyapplicableon1November2012. ItissupplementedbydelegatedregulationsadoptedbytheEuropeanCommissionspecifyingcertaintechnicalelementsoftheRegulation,toensureitsconsistentapplicationandtofacilitateitsenforcement. FromthePublicResponsestothe2012NovemberConsultativeDocuments StrengtheningOversightandRegulationofShadowBanking TheFSBpublishedinNovember2012itsConsultativeDocumentsonStrengtheningOversightandRegulationofShadowBanking,whichprovidedaninitialintegratedsetofpolicyrecommendationstostrengthenoversightandregulationofshadowbanking. DeutscheBankresponsetoconsultation InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  6. P age |6 J.P.MorganAssetManagement-ResponsetotheFSBConsultativeDocuments StrengtheningOversightand RegulationofShadowBanking [TheFSBpublishedinNovember2012its ConsultativeDocumentsonStrengtheningOversightandRegulationofShadowBanking,whichprovidedaninitialintegratedsetofpolicyrecommendationstostrengthenoversightandregulationofshadowbanking] PCAOBEntersIntoCooperativeAgreement withFrenchAuditRegulator ThePublicCompanyAccountingOversightBoardtodayannouncedthatithasenteredintoacooperativeagreementwiththeFrenchHighCouncilforStatutoryAuditors(H3C)relatingtotheoversightofauditfirmssubjecttotheregulatoryjurisdictionsofbothregulators. SolvencyII–earlyuseofSolvencyIIworktomeetICASrequirements Theintentionto***allowfirmstousetheirSolvencyIIworktomeet,asfaraspossible,thecurrentregulatoryrequirements***undertheIndividualCapitalAdequacyStandards(ICAS). InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  7. P age |7 SpeechbytheChancelloroftheExchequer,RtHonGeorgeOsborneMP,ontheReformofBanking “WhenyouthinkaboutwheretogiveaspeechoncultureandethicsandthefutureofBritishbanking,theofficesofoneoftheworld’slargestAmericaninvestmentbanksmayseemlikeanoddchoiceofvenue. Butit’sadeliberateone.” Designflawsoftheeuro IntroductoryremarksbyMr.PatrickHonohan,GovernoroftheCentralBankofIreland,forthe TKWhitakerLecture“Designflawsoftheeuro”by MrHaroldJames,PrincetonUniversity,Dublin InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  8. P age |8 Regulatoryconsistencyassessmentprogramme(RCAP)-Analysisofrisk-weightedassetsformarketrisk TheBaselCommitteeonBankingSupervisionhaspublisheditsreportontheregulatoryconsistencyofrisk-weightedassetsformarketrisk. Thisanalysisofrisk-weightedassetsinthetradingbookispartofthewiderRegulatoryConsistencyAssessmentProgramme(RCAP)initiatedbytheCommitteein2012;a similaranalysisiscurrentlyunderwayforthebankingbook. TheprogrammeaimstoensureconsistentimplementationoftheBaselframework,whichwillhelpstrengthentheresilienceoftheglobalbankingsystem,maintainmarketconfidenceinregulatoryratiosand providealevelplayingfieldforbanksoperatinginternationally. Thereportbringstogethertwopiecesofanalysis. Thefirstisbasedonanexaminationofpubliclyavailablebankdataforaselectionoflargebanks. Italsocontainstheresultsofahypotheticaltestportfolioexercise,inwhich15internationallyactivebanksparticipated. TheBaselCommitteeplanstoconductafurtherhypotheticaltestportfolioexerciselaterthisyear. Thiswillincludeother,morecomplex,hypotheticaltestportfolios,withtheaimofhelpingtheCommitteetodeepenitsanalysisofthevariationinriskmeasurementoftradingbooksacrossbanks. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  9. P age |9 • Introduction • ConsistentimplementationoftheBaselframeworkisfundamentaltoraisingtheresilienceoftheglobalbankingsystem,maintainingmarketconfidenceinregulatoryratiosandprovidingalevelplayingfieldforinternationallyoperatingbanks. • Againstthisbackground,theBaselCommitteehasinitiatedtheRegulatoryConsistencyAssessmentProgramme(RCAP). • Theassessmentprogrammeisconductedonthreelevels: • Level1:ensuringthetimelyadoptionofBaselIII; • Level2:ensuringregulatoryconsistencywithBaselIII;and • Level3:ensuringconsistencyofrisk-weightedasset(RWA)outcomes.ThisreportpresentsthepreliminaryresultsoftheCommittee’sanalysisof • RWAoutcomesforbanks’tradingbookassets(Level3);asimilaranalysisisunderwayforthebankingbook. • Atthesametime,theCommitteeiscurrentlyworkingonafundamentalreviewofthemarketriskframework. • Oneoftheobjectivesofthefundamentalreviewistodeliveraregulatoryframeworkthatcanbeimplementedconsistentlybysupervisorsandwhichachievescomparablelevelsofcapitalacrossjurisdictions. • ThefindingsinthisreportwillfeedintothefundamentalreviewandwillinformtheCommitteeaboutpossibledirectionsforfurtherpolicywork. • Recently,anumberofprivatesectorstudiesusingpubliclyavailabledatahavecometomixedconclusionsonthevariabilityofriskweightingfortradingassets:someindicatethatvariabilityreflectsgenuinedifferencesinbusinessmodelsandiscommensuratetoactualexposuretorisk,whileotherssuggestthatvariabilityisdrivenbyotherfactors,suchasdifferentmodellingapproaches. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  10. P age |10 Inordertobetterunderstandthepotentialdriversofthevariabilityinthemeasurementanddisclosureofmarketrisk–measuredbyRWAsbasedonthemarketriskframework(mRWAs)–theCommitteeundertook Ananalysisofpubliclyavailabledataoflargegloballyactivebankswithsignificanttradingoperationsand Ahypotheticaltestportfolioexercisetoexaminewhatmethodologychoicesarethegreatestpotentialdriversbehindthevariabilityofinternalmarketriskmodeloutcomes. Importantly,theobjectiveofthisworkwasnottojudgethecorrectnessofthemodellingchoicesmadebybanksortoassessthecomplianceofsupervisoryapproachestakenindifferentjurisdictions. Rather,theobjectivewastoobtainapreliminaryestimateofthepotentialforvariationinmRWAsacrossbanksandtohighlightaspectsoftheBaselstandardsthatcontributetothisvariation. Thereviewofpublicdisclosuresfocusedonasampleof16globalbankswithsignificanttradingactivity. TheobservationperiodincludesthemostrecentchangesrelatedtoBasel2.5,whichhadtakeneffectinsomejurisdictionsbutnotall. DespitetheasynchronousadoptionofBasel2.5,valuewasfoundincomparingmRWAsacrosspre-andpost-Basel2.5jurisdictionsbecausemanyoftheissuescarryovertothenewregime,forexampleregardingthecontributiontomRWAsfrominternalmodelsandstandardisedapproaches. Forsomebanks,thedisclosuresrequiredunderBaselII(Pillar3)factoredintotheanalysisandprovidedachancetoevaluatetheutilityofsuchdisclosuresforthistypeofproject. ThefocusofthehypotheticaltestportfolioexercisewastodiscoverthedesignelementsofinternalmodelsthathavethegreatestpotentialimpactonthelevelofvariabilityinmRWAs. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  11. P age |11 Hypotheticaltestportfoliosovercomethelimitationsencounteredwhenattemptingtousepublicandsupervisorydataonrealportfoliostoinvestigatepotentialsourcesofvariationbecausetheycontrolfordifferencesinportfoliocomposition. However,theyshowonlypotentialandnotrealisedvariationinoutcome.Moreover,inthiscase,theexercisefocusedonaseriesofsimplelongand shortpositions,designedtorevealtheimpactofmodeldesignfeatures. Toshedlightontheeffectofdifferentsourcesofvariationonmorerealisticportfolios,theCommitteeplanstoconductafurtherhypotheticaltestportfolioexerciselaterthisyear. Thiswillincludeother,morecomplex,hypotheticaltestportfolios,withtheaimofhelpingtheCommitteetodeepenitsanalysisofthevariationinriskmeasurementoftradingbooksacrossbanks. Executivesummary Keyfindingsoftheanalysis TheanalysisofpublicreportsonmRWAs,andthehypotheticaltestportfolioexercise,providedaclearpictureofsubstantialvariationinmRWAsacrossbanks. Basedonpublicreports,theanalysisshowsconsiderablevariationinaveragepublishedmRWAsfortradingassetsandprovidessomeindicationthatdifferencesinthecompositionandsizeoftradingpositionsarecorrelatedwithbanks’averagemRWAs. However,thequalityofdisclosureswasfoundtobeinsufficienttoallowinvestorsandotherinterestedpartiestoassesshowmuchofthevariationreflectsdifferinglevelsofactualriskandhowmuchisaresultofotherfactors. Thehypotheticaltestportfolioexerciseindicatedthat,usingahypotheticaldiversifiedportfolioconsistingprimarilyofsimplelongand InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  12. P age |12 • shortpositions,therecanbeasubstantialdifferencebetweenthebankreportingthelowestmRWAsandthebankreportingthehighest. • Thisoutcomeisattributedtoarangeoffactors: • Asizeableportionofthevariationisduetosupervisorydecisions • appliedeithertoallbanksinajurisdiction,ortoindividualbanks. • Anexampleoftheformerwouldbepolicydecisionstorestrictmodelling options(egtodisallowanydiversificationbenefitbetweentypesofrisk). • Anexampleofthelatterwouldbetheapplicationofsupervisorymultipliers:aroundone-quarterofthetotalvariationinthehypotheticaldiversifiedportfoliocouldbeattributedtothissinglefactor. • ThesesupervisoryactionstypicallyresultinhighercapitalrequirementsthanwouldotherwisebethecasebutcanalsoincreasethevariationinmRWAbetweenbanks,particularlyacrossjurisdictions. • Thesesupervisoryactions,particularlyatanindividualbanklevel,areoftennotdisclosed. • Anotherimportantsourceofvariationisduetomodellingchoicesmadebybanks. • Theexercisefoundthatasmallnumberofkeymodellingchoicesarethemaindriversoftheremainingmodel-drivenvariability. • ItisimportantpointingoutthattheBaselstandardsdeliberatelyallowbanksandsupervisorssomeflexibilityinmeasuringrisksinorderto accommodatefordifferencesinriskappetiteandlocalpractices,butwiththegoalofalsoprovidinggreateraccuracy. • SomevariationinmRWAshouldthereforebeexpected. • Inaddition,fromafinancialstabilityperspective,itisdesirabletohavesomediversityinriskmanagementpracticessoastoavoidthatallbanksactinasimilarway,whichpotentiallycouldcreateadditionalinstability. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  13. P age |13 Atthesametime,excessivevariationinriskmeasurementisundesirable.Thisstudydidnotseektodeterminewhattheoptimallevelofvariation shouldbe,butthepreliminaryfindingshighlightpotentialpolicyoptions thatcanbeconsiderediftheCommitteewishedtonarrowthepotentialforvariationinthefuture. Thesepolicyoptionscomplementimportantpolicyinitiativesthatarealreadyunderway,includingworkondisclosures–notablyasrecommendedbytheEnhancedDisclosureTaskForce(EDTF)–andthefundamentalreviewofthetradingbook. Furtherdetailoftheabovefindingsandthepotentialpolicyoptionsaresetoutinthereport. Analysisofpubliclyavailabledata TheanalysisofpubliclyavailabledatashowssignificantdifferencesacrossindividualbanksinthesizeofregulatorymRWAsrelativetotradingassets. Acrossthebanksinthesample,theaverageriskweightingoftradingassetsvariesfromaround10%tonearly80%,withmostbanksbetween15%and45%. Suchdifferencescouldbejustified,providedthattheyaredrivenbydifferencesinactualrisktakingandbusinessmodels. Inthisregard,thepublicdataprovidessomeindicationthatdifferencesinthecompositionandsizeoftradingpositionsarecorrelatedwithmRWAs. Forexample,bankswithagreaterproportionofilliquidtradingassets,includingholdingsofdistresseddebtandilliquidequity,tendtoreportslightlyhigheraverageriskweightingoftheirtradingassets. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  14. P age |14 However,thiscorrelationdoesnotfullyexplainvariationsacrossbanksandtheobservationsarebasedononlyasmallsubsetofbanks. So,whilethereissomeevidencethatvariationsinmRWAscanbe explainedbyactualrisktaking,thereareindicationsthataconsiderablepartofthevariationcannotbeexplainedbythatfactor. Instead,theanalysissuggeststhatotherfactorsmayalsobedrivingtheobservedvariationsacrossbanksandjurisdictions: Differencesinsupervisoryapproachesandrequirements,contributingtodifferencesinthelevelsofrelianceontheinternalmodelsapproach,aswellasanasynchronousadoptionofBasel2.5. Forexample,duringtheperiodunderreview,nineoutof16banksinthesampleweresubjecttoBasel2.5. TheremainingsevenbanksbecamesubjecttoBasel2.5standardson1January2013. Differencesinmethodologiesandmodellingchoicesformarketriskregulatorycapitalcalculations. Forexample,thecurrentBaselframeworkallowsbankstochoosedifferenthistoricaldataperiodsforvalue-at-risk(VaR)orusedifferentmethodstoarriveataregulatorycapitalfigure. Analysingpublicdatarequirestakingintoaccountdifferencesinaccountingregimestoallowforappropriatecomparisonacrossjurisdictions. Forexample,animportantdifferenceconcernsthenettingofderivatives. Nettingcanleadtomaterialdifferencesinthewaytradingassetsaremeasuredandaccountingregimesdifferregardingthedegreeofnettingpermitted. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  15. P age |15 Totheextentpossible,thepublicdatausedinthisreportisadjustedforthedifferencesinnettingacrossaccountingregimes. Otheraccountingdifferencesthatmayplayarole,suchastherulesforclassifyingassetsintotheaccountingtradingbook,couldnotbecorrectedforandsomeofthevariationinmRWAsrelativetotradingassetsmaystemfromthesedifferences. Lookingmorecloselyatthefindings,andinparticulardriversofvariation notrelatedtorisk,theanalysisindicatesasignificantdisparityinrelianceoninternalmodels. TheportionofmRWAsthatiscalculatedwithinternalmodelscanrangefromapproximately10%tonearly80%forthesampleofbanksacrossjurisdictions. BeforetheimplementationofBasel2.5,thegreateruseofinternalmodelswouldtendtoresultinloweraveragemRWAsduetotherecognitionofdiversificationandnettingbenefits. However,withtheimplementationofBasel2.5thisrelationshipmaybe reversingasbankswithinternalmodelsarenowrequiredtocapitaliseforsVaR(stressedvalue-at-risk),IRC(incrementalriskcharge)andCRM(comprehensiveriskmeasure)underthenewregime,resultinginhigherobservedlevelsofmodelledcapitalchargesincomparisontopriorperiods. OtherfactorsthatcouldexplainvariationinmRWAsincluderegulatoryandinternalcapitaladd-onsandtheuseofregulatorymultipliershigherthantheminimumof3,whichareappliedatthediscretionofsupervisorsasageneralincentivetoimprovemodelsandriskmanagementsystems. Thisinformationis,however,nottransparentinpublicdisclosuresanditsimpactcouldnotbeexaminedusingpubliclyavailabledata. Instead,thehypotheticaltestportfolioexerciseallowedexaminationoftheimportanceoftheregulatorymultiplierinmoredetail,theresultsofwhicharepresentedinChapter2. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  16. P age |16 Asasecondstep,theCommitteeconsideredusingsupervisorydata,butitwasfoundthatthestructureandcontentofperiodicsupervisoryfinancialreportsoutliningtheconditionandincomeoffinancialinstitutionsisdisparateacrossjurisdictions. Thisdisparityresultedindeemingtheutilityofpublicsupervisorydataasrelativelylowwhenattemptingtoperformacross-jurisdictionalcomparisonofmRWAsandtheunderlyingdrivers. Fromthebeginningoftheanalysis,itwasunderstoodthatpublic disclosureshavehistoricallynotprovidedstakeholderswithenoughinformationtoappropriatelyassessandcomparemRWAsandregulatorycapitalacrossbanksandjurisdictions. Theobservationsinthisreportcorroboratethatfinding,asthefullscopeofmRWAdispersionacrossbankscouldnotbefullyexplainedbypubliclyavailableinformation. Whilesomebanksprovidemoredetaileddisclosurethanothers,ingeneralpublicdisclosuresdidnotprovidesufficientlygranularinformationtoestablishconclusivelywhatisdrivingthedifferences. Hypotheticaltestportfolioexercise DuetothelimitationsencounteredwhenattemptingtousepublicandsupervisorydatatoinvestigatevariabilityofmRWAs,ahypotheticaltestportfolioexercisewasundertakentoinvestigatethelevelofvariabilityofmRWAsstemmingfrominternalmodels. Atotalof15internationallyactivebankswithsignificanttradingassetsparticipatedinthisexercise. Followingthereceiptoftheresults,nineoftheparticipatingbanksreceivedanon-sitevisitbyaninternationalteamofsupervisors. ThesevisitsallowedtheCommitteetobetterunderstandthemodellingchoicesandotherfactorsthatmightunderlietheobserveddifferencesin resultsforeachportfolio. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  17. P age |17 • Themodellingofindividualpositionsexhibitedwidevariationsinsomecases,butthisreducedasportfoliosbecamemorediversified(andmorerealistic). • Thissuggeststhewidevariationfornarrowly-focusedportfoliosdidnotcompoundasadditionalpositionswereadded,butratherwasreducedasidiosyncraticissuesbecamelessprominent. • Furthermore,fromaregulatorycapitalperspective,theresultfortheaggregateportfolioisthemostimportant,asitisatthethislevelthatregulatorycapitalrequirementsaregenerallydetermined. • Thehigh-levelresultsoftheexercisehighlighttwomainsourcesofdifferencesinmRWAs: • Differencesinthemodelchoicesmadebybanks,and • Differencesinsupervisorypractices,includingtheuseofsupervisorymultipliers. • Thesesourcesofdifferenceswerealsoindicatedintheanalysisofpublic data. • IntheexerciseforahypotheticaldiversifiedportfoliotherewasasubstantialdifferencebetweenthebankreportingthelowestmRWAsandthatreportingthehighest. • Ofthis,aroundone-quarterwasduetosupervisorymultiplieralone: • Variationcausedbybanks’modelchoices:Thecurrentmarketriskrequirementsallowflexibilityforbankstomakeavarietyofchoiceswhen developinginternalmodels. • Thehypotheticaltestportfolioexercise,andsubsequenton-sitevisits,allowedthegrouptoidentifythemostimportantmodelchoicesthatdrivevariationinmRWAs. • OneimportantobservationisthatthereisgenerallymorevariabilityinmRWAsfromthenew,morecomplex,IRCmodelsthanVaRandsVaR models. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  18. P age |18 • Supervisorsmayalsoinfluenceoutcomesherebydetermining,withintheirnationalframeworks,theextentofmodellingoptionsavailabletobanks. • Variationcausedbydifferencesinsupervisorymultipliers:WhencalculatingmRWAsfromVaRandsVaRmodels,theresultsofmarketriskinternalmodelsareconvertedtoacapitalrequirementbyapplyingamultiplier. • Themultiplierisatleast3,butcanbehigheratthesupervisor’sdiscretion. • Intheexercise,significantvariationwasobservedinthemultiplierstobeappliedtotheoutputofbanks’modelsandthisvariationhasadirectimpactonvariabilityofreportedmarketriskcapitalrequirements. • Themultipliersfortheparticipatingbanksintheexerciseshoweda considerablerange,from3to5.5. • Keymodellingchoicesthatdrivevariability • Thetestportfolioexerciseprovidedclearevidencethatdifferencesinmodellingchoicescanbeveryimportantdriversofvariabilityacrossbanks. • Thegroupwasabletoidentifythemostimportantmodellingchoicesthatdrivevariationinoutcomes: • ForVaRandsVaRmodels: • Lengthofdataperiodforcalibratingandtheweightingschemeapplied; • Aggregationapproachacrossassetclassesandacrossspecificandgeneralrisk; • Thechoiceofwhethertoscaleaone-dayriskestimatetoa10-day measureorestimateriskover10daysdirectly;and InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  19. P age |19 • 4.Approachtochoosingstressperiod(forsVaR)andtheresultingstressperiodcalibration. • ForIRCmodels: • Theoverallmodellingapproach(theuseofspread-basedmodelsortransitionmatrix-basedmodels); • Calibrationofthetransitionmatrixandtheinitialcreditratingassignedtopositions;and • Correlationassumptionsacrossobligors. • InadditiontohighlightingthelevelofvariationofmRWAsfrominternalmodels,andthemostimportantmodellingchoicesdrivingthevariability,theexercisehighlightedadirectrelationshipbetweencomplexityofriskmetric/productandtheassociatedvariabilityofthemetricacrossbanks. • TherelativelymorecomplexIRCmodelsintheexercisedisplayedmuchmorevariabilitythanVaRandsVaRmodels,andportfolioscontaininglesssimpleproductsalsotypicallyshowedmorevariabilityinresults. • ThissuggestsconsideringasecondphaseofanalysistoexplorespecificmethodologicalissuesrelatedtomorecomplexproductsandCRMmodels. • Whilsttheexercisehighlightedthatsomemodellingchoicesaremoreconservativethanothers,inmostcasesthisresultisduetothenatureoftheportfoliostested(hypotheticalportfoliosmadeofsimplelongandshortpositions)andeachchoicecouldbeaggressiveorconservativefordifferentportfoliosandmarketconditions. • Forexample,ashortdatasetwilltendtoproduceamoreconservativeoutcomeinperiodsofhighvolatility,butalessconservativeoutcomeduringperiodsofverylowvolatility. • Theimportantresultisthehighlightingoftheareasofflexibilityinrulesthatdrivevariationratherthanwhichchoiceisthemostprudent. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  20. P age |20 Potentialpolicyissuesforfutureconsideration Asnotedabove,theanalysisshowsthereisaconsiderablevariationinaveragemRWAsfortradingassetsandthatonlyapartofthedifferencescanbeexplainedbyvariationinactualrisktakingorbusinessmodels. WhilesomeamountofvariationinmRWAsisexpectedinanyregime basedoninternalmodelsandviewsmaydifferastowhatisanacceptableamountofvariation–todevelopa“variationbenchmark”wouldrequirefurtheranalysiswhichwasbeyondthescopeofthisreport–thefindingsin thisreportsuggestadirectionforfuturepolicyworkthatcouldnarrowdownthepotentialvariationinoutcomes. Theanalysishighlightsthreepotentialtypesofpolicyoptionsthatcould beconsideredinthefuture: ImprovementofpublicdisclosureandregulatorydatacollectiontoaidtheunderstandingofmRWAs; Narrowingdownthemodellingchoicesforbanks;and Afurtherharmonisationofsupervisorypracticeswithregardtomodelapprovals(toreducethelevelofvariationinmRWAs). AsecondphaseofanalysismayresultinexploringfurtherpotentialtypesofpolicyoptionstoaddressspecificmethodologicalissuesrelatedtomorecomplexproductsandCRMmodels. Atthisstage,thefollowingsuggestionsforpolicyoptionsshouldnotbeseenascomprehensive,noraspre-emptinganyspecificpolicymeasures,butratheraspotentialdirectionsforfutureworktobeconsideredbytherelevantBaselCommitteeworkinggroups. Furthermore,thepotentialpolicymeasuresshouldnotbeseenasmutuallyexclusive:somecombinationofthethreecouldbeappropriategoingforward. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  21. P age |21 Itshouldalsobenotedthatthereareimportanttrade-offsbetweenmodel harmonisationandtheusetestrule. Strictharmonisationofinternalmodelsmaymakeitmoredifficulttoimplementthe“usetest”rule,iearequirementforbankstonotjustdevelopmodelstosatisfyregulators,butalsotousethosemodelsintheirinternalriskmanagement. Furthermore,modelsharmonisationmayhavepro-cyclicaleffectsstemmingfromahighcorrelationbetweenbanks’capitaladequacyrequirements. Improvingpublicdisclosure Regardingpublicdisclosures,thepotentialpolicyoptionsshouldbeseeninthebroadercontextoftheregulatoryandindustryworkonpublic disclosures,notablybytheCommittee’sWorkingGrouponDisclosureandtheEnhancedDisclosureTaskForce(EDTF),whichhasrecentlypublisheditsreportonpublicdisclosurebybanks. ThefindingsinthisanalysissupporttherecommendationsandproposalsintheEDTFreporttoenhancethepublicdisclosureofregulatoryRWAsformarketriskandpromotefurtherworkonPillar3disclosurerequirementsformarketrisk. Basedontheresultsofthisanalysis,disclosurescouldbeimprovedbyincludingmoregranularinformationregardingthecomponentsofmRWAs,theVaRandothermarketriskmodelsusedforregulatorycapitalpurposes. WhenperformingthecrossjurisdictionalcomparisonofmRWAstheCommitteefoundingeneralthatdisclosurescouldbecleareronthedriversofmarketrisk,beoutlinedmoreconsistentlyacrossjurisdictions,beprovidedonamoretimelyandconsistentbasis,andprovidemorerelevantinformationtotheirusersthatisbasedoninformationpresentedtomanagement,riskcommitteesandboardsofdirectorsfordecisionmakingpurposes. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  22. P age |22 Suggestionsforimprovingthequality,contentandconsistencyofdisclosuresrelatedtomRWAsthatcouldbeconsideredincludethefollowing: Commonstandardsforthefrequencyofreporting–lessthanhalfofthebanksinthesamplereportedinformationonaquarterlybasis; CommonstandardsforexplanationsofthedriversofthechangeinmRWAsfromperiodtoperiod; AmoregranularandconsistentsegmentationofthecomponentsofmRWAstofacilitateadeeperrecognitionofabank’smarketrisks; Disclosureofkeymodellingchoices,particularlythosehighlightedbythehypotheticaltestportfolioexerciseasdrivingthegreatestvariationintheresultsofmodels;and Disclosureofkeydifferencesinmodelsusedforinternalriskmanagementandthoseusedforregulatorycapitalcalculations. Itwasfoundthatbanksseldomdirectlyreportthe10-day99%VaRusedinregulatorycapitalcalculations. ThesesuggestionsarecloselyinlinewiththeearlierEDTF’srecommendations. Anotherpotentialareaforfuturepolicyworkconcernsharmonisationand/orconsistencyofthecontentandaccessibilityofsupervisoryandregulatoryreportsacrossjurisdictions. Narrowingdownbanks’modellingchoices Futurepolicyworkthatmightconsidernarrowingdownthemodellingchoicesforbanks,andthereforereducevariability,needstoconsiderthebroadercontextofthefundamentalreviewofthetradingbook,whichiscurrentlybeingundertakenbytheBaselCommittee’sTradingBookGroup. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  23. P age |23 • ThisworkreflectstheCommittee’sincreasedfocusonachievingaregulatoryframeworkthatcanbeimplementedconsistentlybysupervisorsandwhichachievescomparablelevelsofcapitalacrossjurisdictions. • Whiletheremaybepracticallimitstonarrowingthemodellingchoicesforbanksunderaninternalmodels-basedapproach,thelistofmodellingchoicesthatwerethestrongestpotentialdriversofvariability,setoutabove,providesareasforconsiderationtodirectlyreducevariability,for example: • CloselydefiningthemodellingapproachfortheIRCmodel,includingtheassumptionsusedformigrationanddefaultprobabilitiesandthecorrelationstructure; • ReducingtheflexibilityinchoosingthelengthofhistoricaldatatocalibrateVaRmodels;and • Definingasinglescalingapproachtoobtaina10-dayVaRandsVaRmeasure. • Theseareascanbeconsideredinadditiontopolicyoptionswhichalreadyformpartofthefundamentalreviewofthetradingbook,namely: • Strengtheningtherelationshipbetweenstandardisedapproachesandinternalmodelstobeabletobenchmarkinternalmodelresults; • MovingfromseparateVaRandsVaRbasedmeasurestoasingleExpectedShortfallbasedmeasure;and • Enhancingregulatoryoversightthroughamoregranularapprovalprocessofinternalmodels. • Furtherharmonisingsupervisorypractices • Another,potentiallycomplementary,approachtoaddressthevariabilityacrossmodeloutcomesindirectlywouldbetodevelopadditionalsupervisoryguidanceforupholdingconsistentmodelstandardsandapprovingtheuseofmodels,includingtheuseofsupervisorymultipliers. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  24. P age |24 Othermorestructuralchangescouldincludecreatinganinternationalteamthatactivelymonitorsinternationalmodellingstandards. Inthisregard,increasedsupervisoryscrutinyofmodelscouldaddresssomeofthedriversofvariationthathavebeenidentified. Atthesametime,itshouldbenotedthattheBaselframeworkincertainareasallowsforsupervisorydiscretiontoappropriatelyreflectdomesticcircumstances. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  25. P age |25 GovernorElizabethA.Duke AttheSoutheasternBankManagementandDirectorsConference,UniversityofGeorgia,TerryCollegeofBusiness, Duluth,Georgia TheFutureofCommunityBanking IwouldliketothanktheTerryCollegeof BusinessattheUniversityofGeorgiafortheopportunitytodiscussthefutureofcommunitybankingatthisannualconferenceforbankofficersanddirectors. Communitybanksplayanimportantroleinournation'sfinancialsystem,andIbelievethatthefutureofcommunitybankingisbright. Butthatisnottosaythatitwillbeeasy. Success,asalways,willrequireenergeticandengagedmanagersandboardmemberswhoaresensitivetothefinancialneedsoftheircommunities,vigilanttoeconomicconditions,andadaptivetochangingregulatoryrequirements. Ihearfromalotofcommunitybankerswhoareconcernedthatthe communitybankingmodelmightnotsurvive. Manypaintapicturesobleakthattheyseeonlypersonalretirementorsaleofthebankasviablestrategies. Icompletelyunderstandhowtiringitistofightafinancialcrisisandsurviveadeeprecessionfollowedbyaweakrecoveryonlytoconfrontwhatseemstobeatsunamiofnewregulations. Ifeltallofthosesameemotionsin1991. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  26. P age |26 Iwasacommunitybankerthen. Wehadsurvivedthesavingsandloancrisiswithsomebruises,butwewerestillstanding. TheFinancialInstitutionsReform,RecoveryandEnforcementActof1989(FIRREA)hadbeenfollowedbytheFederalDepositInsuranceCorporationImprovementAct(FDICIA)in1991. IhadmorenewregulationsstackedonmydeskthanIhademployeesin thebank.Mybankhadjustreachedthe$100millionmarkintotalassetsthroughthepurchaseoftwobranchesfromafailingthrift. Evenmoredauntingformepersonally,wasthesuddendeathofmybank'schiefexecutiveofficer(CEO),leavingmeasthenewCEO. Frankly,Ididn'tknowhowIwasgoingtotackleallthatlayinfrontofus.Butthosedarkdaysin1991werefollowedby15yearsofexceptionallystrongperformanceforallbanks,includingmyown. Andthoseexperiences--thegoodandthebad--givemeconfidencein predictingabrightfutureforcommunitybankingtoday. Justastheseedsofacrisisareoftensowninearlierboomtimes,strengthcanbeforgedduringthetoughtimesthatfollowacrisis. Aswedidintheearly1990s,bankersandregulatorstodayhavelearnedfromthelessonsofthecrisisandaredeterminednottorepeatthemistakesofthepast. Creditmetricsarenowimprovinginmostbanksasproblemloanshavebeenaddressedandresolvedandnewcreditunderwritinghasbeenquite restrictiveforanumberofyears. Depositgrowthhasoutpacedloandemandandrelianceonwholesalefundinghasbeenreduced.Capitalpositionsarestronger. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  27. P age |27 Theinterestmarginpressurebanksfacetodayispartlyduetolowinterestratesandpartlyduetoweakloandemand,bothofwhichareconsequencesofasluggisheconomy. Astheeconomicrecoverygainsmomentum,however,bothoftheseconditionsshouldreverseandgivebankerstheopportunitytodeploytheliquidityandcapitaltheyhaveamassedtothebenefitoftheirshareholdersandtheirlocaleconomies. CommunityBankersAreBeingHeard Evenastheyanticipateeconomicrecovery,however,communitybankersworrythattheburdenofnewregulationsmayinhibittheirabilitytolendintheircommunitiesorprohibitivelyincreasethecostsofsuchlending. Wecertainlyunderstandthisconcern. FederalReserveresearchovertheyearshasconfirmedthattheburdenof regulationsfallsdisproportionatelyonsmallerbanks. SupervisorsattheFederalReserveBankofMinneapolishaverecentlytriedtoquantifythiseffect. Todoso,theyusedsurveydatatoestimatetherelativenumberofnew employeesthatbanksofdifferentsizesmightneedtohireinresponsetothesameregulatoryrequirement. UsingCallReportdatafrom2011,theyestimatedintheirpreliminaryanalysisthathiringoneadditionalemployeewouldreducethereturnonassetsby23basispointsforthemedianbankinthegroupofsmallestbanks,thosewithtotalassetsof$50millionorless. Toputthisestimateinperspective,suchadeclinecouldcauseabout13percentofthebanksofthatsizetogofromprofitabletounprofitable. Asacomparison,giventhesameincreaseinregulation,theyassumebanksbetween$500millionand$1billionwouldhirethreeemployeesand InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  28. P age |28 experienceadeclineofabout4basispointsinreturnonassetsforthemedianbank. Whilethisisstillasignificanteffect,veryfewbanksinthisgroupwouldgofrombeingprofitabletounprofitableasaresultoftheregulatoryburden. Regulatoryoverreactiontoacrisisisalwaysarisk. Butthistime,Ithinkcommunitybankershavebeenmoresuccessfulthantheyrealizeinmakingthecaseagainst"one-size-fits-all"regulation. Ican'trememberatimewhenIhaveseenmoreregulatoryproposalsdraftedthatdifferentiatebetweenbanksbasedonsizeorcomplexity. Iurgeyoutocontinuetoidentifytheregulatoryrequirementsthatarethemostoneroustoyourbusinessmodel,andcontinuetosuggestalternativestoachievethoseregulatoryobjectivesinalessintrusiveway. Infact,mostoftheregulationsrequiredbytheDodd-FrankWallStreetReformandConsumerProtectionAct(theDodd-FrankAct)aredirectedprimarilyatlarger,systemicallyimportantbanks,andmanyoftheAct'sprovisionsspecificallyexemptcommunitybanks. Forexample,bankswithlessthan$10billionintotalassetswereexemptedfromanumberofthedebitinterchangerestrictions,andearlystudiesindicatethatthoseexemptionsareworking. Inaddition,formalstresstestingwasrequiredonlyforbankswithtotalassetsof$10billionormore. Inimplementingtheserequirementsforthelargerbanks,thebankregulatoryagenciesspecificallyindicatedthatcapitalstresstestingwouldnotberequiredforcommunitybanks. Thisdoesnotmeanthatcommunitybanksareexemptedfromprudentriskmanagement,butratherthatsmallerbanksshouldthinkaboutthenegativeshocksthatcouldaffecttheirbusinessinthefutureandtailor InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  29. P age |29 theirrisk-managementprocedurestotherisksandcomplexitiesoftheirindividualbusinessmodels. TheConsumerFinancialProtectionBureau(CFPB)recentlyreleasedfinalrulesdefining"qualifiedmortgages"thatincludesafeharborsformortgagesthatmeetspecificloantermandpricingcriteria,includingcertainballoonloansmadebycommunitybanksinruralorunderservedareas. Atthesametime,theyissuedanewproposalthatcontainsadditionalcommunitybankexceptions,aswellasaquestionaboutthetreatmentofloanstorefinanceballoonpaymentsonmortgagesthatcommunitybanksmayalreadyhaveontheirbooks. Notingthatsmallerinstitutionshavealreadydemonstratedthattheygenerallydoagoodjobofservicingtheloanstheyoriginateandthattheinvestmentsnecessarytomeettherequirementswouldbeundulyonerousforinstitutionsthatserviceasmallnumberofloans,theCFPBalsoexemptedmostcommunitybanksfrommanyoftheprovisionsofnewservicingrequirements. Ithinksuchexceptionsareespeciallyimportantbecause,asIdiscussedinarecentspeechandwilltouchuponlaterinmyremarks,FederalReserveresearchhasshownthat Communitybanksareimportantlendersinthemortgagemarket, Thosemortgageloansrepresentasignificantportionofcommunitybanklending,and Communitybanksarequiteresponsibleintheirpractices. AttheFederalReserve,wehaveformalizedourprocessforconsideringtheuniquecharacteristicsofcommunitybanksaswecraftregulatoryandsupervisorypolicies. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  30. P age |30 Afewyearsago,wecreatedasubcommitteeoftheBoard,whichIchair,thatmakesrecommendationsaboutmattersrelatedtocommunitybanksupervisionandregulation. Thissubcommitteereviewsallregulatoryproposalsandsupervisoryguidancewithaneyetowardthepossibleeffectsoncommunitybanks. RememberingthedayswhenIhadtofindtimetoreadallthosenewregulationsstackeduponmydesk,Ihaveinsistedthatallnewproposalsandrulesstartwithaclearstatementoftheirapplicabilitytocommunitybankssothatbankerscanspendtheirtimeontherulesandguidancethatapplytothem. Thisapproachwasputintopracticeinadifferentwaylastyear,whenthebankingagenciesissuedproposalsforcapitalregulationsthatincorporatedrequirementsoftheDodd-FrankActandtheBaselagreement. Tohelpcommunitybanksidentifytheprovisionsthataffectedthemandsubmittheircommentsmoreeasily,theproposalincludedashortsummaryoftheprovisionsthatweremostlikelytoaffectcommunitybanks. Wereceivedmorethan2,000comments,manyfromcommunitybanks,andwearereviewingthem. It'stooearlyintheprocesstoknowhowweandtheotheragenciesaregoingtoaddresstheissuesraised,orwhenfinalrulesmaybereleased. ButwhatIcanpromiseisthatbeforeweissuefinalcapitalrules,wewilldoeverythingpossibletoaddresstheconcernsthathavebeenexpressed bycommunitybankersandstillachievethegoalofhavingstronglevelsofhigh-qualitycapital--builtupoverareasonableandrealistictransitionalperiod--inbanksofallsizes,includingcommunitybanks. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  31. P age |31 CommunityBankResearch Tohelpusbetterunderstandcommunitybankissues,oursubcommitteeestablishedaninformalworkinggroupofeconomistsfromboththe researchandsupervisionfunctionsintheFederalReserveSystem. Thegroupisfocusedonunderstandingthefactorsthatinfluencetheviabilityandperformanceofcommunitybanksincluding,importantly,theeffectofregulatorychangesandtheirassociatedcostsandbenefits. MembersofthisworkinggroupareexploringanumberofinterestingtopicsthatIhopewillhelpustobetterunderstandtheissuesthataffectcommunitybanksand,whereappropriate,haveapracticalimpacton howwesupervisethesebanks. DeterminantsofCommunityBankProfitability Forexample,arecentstudyundertakenbytwoFederalReserveBoardeconomistsexploresthedeterminantsofcommunitybankprofitabilityfrom1992through2010. Thefindingsindicatethatanumberofbankcharacteristicsarestronglycorrelatedwithperformance,includingrelativebanksize,portfoliocomposition,andmanagementquality. Withinthegroupofbankswithlessthan$1billionintotalconsolidatedassetsincludedinthisstudy,largerbanksizeisassociatedwithsignificantlyhigherprofitability. Communitybankswithhigherportfoliosharesofrealestateloansearnsignificantlylowerprofits,whilethosewithhigherportfoliosharesofconstructionloansearnhigherprofitsthroughmostofthestudyperiod. But,perhapsnotsurprisingly,thelatterrelationshipdoesnotholdfor2008through2010,whengreaterrelianceonconstructionlendingisassociatedwithlowerprofitability. Managerialquality,asmeasuredbythemanagementcomponentofthebanks'regulatoryratings,isstronglyrelatedtobankprofitability. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  32. P age |32 Moreover,thestrengthoftherelationshipincreasesduringandimmediatelyafterthefinancialcrisis,confirmingthatmanagementqualityisparticularlyimportantduringtimesofeconomicstress. Factorsoutsidethecontrolofbankmanagement,however,arealsoimportantlyrelatedtoprofitability,particularlyoverthepastseveralyears. Forinstance,itisnotsurprisingthatcommunitybanksoperatinginmarketsexperiencinghighunemploymentrateshavebeenlessprofitablesincethefinancialcrisis. Perhapslessobviousisthatinurbanmarkets,communitybankprofitabilitytendstodecreaseasthesizeofthemarketincreases. Onemightsuspectthatthisrelationshipderivesfromamorecompetitivelandscapeinlargerurbanareas;however,norelationshipbetweenmarketconcentrationandprofitsisevidentinurbanmarkets. Incontrast,inruralareas,highermarketconcentrationisassociatedwithhighercommunitybankprofitabilitythroughoutmostofthestudyperiod. Inaddition,thestudyfindsthatcommunitybanksoperatinginruralmarketsconsistentlyearnhigheraverageratesofreturnthandocommunitybanksoperatinginurbanmarkets. Inaseparateanalysisofdepositmarketcompetitionthatmayformthebasisforanewresearchpaper,oneresearcherhasdocumentedthecompetitivestrengthofcommunitybanks,especiallyinruralmarkets. Althoughthenationwideshareoftotaldepositsheldbybankswithassetslessthan$10billionhasdeclinedoverthepastdecade,inruralmarkets,theirdepositmarketsharehasincreasedslightly. Moreover,bankswithassetslessthan$10billionretainedtheirshareofruralmarketdepositsthroughouttherecentrecessionandrecovery. Atamoremicrolevel,bankswithassetslessthan$10billiongainedmarketshareinmorethantwo-thirdsofruralbankingmarketsandin nearlyhalfofurbanmarketsbetween2003and2012. Expansionofdepositinsuranceduringthecrisislikelyhelpedallbanksretaindepositsandmayhavechangedcompetitionsomewhat. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  33. P age |33 Depositinsurancehasnowbeenpermanentlyincreasedfrom$100,000to $250,000perdepositor,buttheunlimiteddepositinsurancefornoninterest-bearingtransactionaccountswasallowedtoexpireattheendof2012. Wearewatchingdepositmovementcarefully,butsofarhaveseenlittleevidenceofdepositsmovingoutofthebankingsystemor,assomehadfeared,movingfromsmallerbankstolargerbanksperceivedas"toobigtofail." Myownexpectationisthat,givenalloftheenhancedregulatoryrequirementsthatapplytolargerbanks,thoselargerbankswillfocustheireffortsonlargeurbanmarketsandthatcommunitybankswillbeevenmorecompetitiveandmorevitaltotheeconomicwell-beingofrural,suburban,andsmallurbanmarkets. CharacteristicsofThrivingCommunityBanks ResearchersattheFederalReserveBankofSt.Louistookadifferentapproachtomeasuringcommunitybanksuccess. Studyingbankswithtotalassetslessthan$10billion,theresearchersattemptedtoidentifythedifferencesbetweenbanksthattheyclassifiedas"thriving"andthosethattheyclassifiedas"surviving." Bankswereidentifiedas"thriving"iftheymaintainedthehighest supervisoryrating,acompositeCAMELS"1,"continuouslyfrom2006throughtheendof2011. Approximately700banksmetthiscondition. Theroughly4,500banksinthestudythatdidnotqualifyasthrivinganddidnotfailormergeoutofexistenceduringtheperiodwereclassifiedas"surviving." Aftercategorizingthebanks,thefirstphaseofanalysislookedatthelocationandsizeofthethrivingbanks. Thrivingbankswerefoundin40ofthe50statesbutwereconcentratedinstateswithlargereconomiccontributionsfromagricultureandenergy,whichhelduprelativelywellduringthedownturn. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  34. P age |34 ThefewestthrivingbankswerefoundontheWestCoastandintheSoutheast,whererealestatevaluesfellthemost. ThispatternisconsistentwithpreviousFederalReservestudies,whichfoundthatbankperformanceisheavilyaffectedbythelocaleconomy,butIthinkitisimportanttonotethateveninstateswithhighunemploymentratesorsharpdeclinesinpropertyvalues,somecommunitybankswereabletothrive. TheSt.Louisstudydidnotfindthethrivingbankstobeconcentratedinanyparticularsizerange. Manyhadtotalassetslessthan$50millionasofDecember2011,butothershadtotalassetsbetween$1billionand$10billion. Andthrivingbanksdidmorethanjustratewellwithsupervisors--thethrivingbanksoutperformedthesurvivingbanksonawiderangeofperformanceindicators,includingreturnonassets,returnonequity,loanlosses,provisionexpense,efficiencyratio,assetgrowth,netinterestmargin,andnetnoninterestmargin. Lookingatbalancesheetstructure,whentheresearcherscomparedthecharacteristicsofthrivingbankswithsurvivingbanks,theyfoundthatthethrivingbankshadlowerlevelsofloans-to-total-assetsandweremorereliantoncoredeposits. Thrivingbanksalsohadlowerconcentrationsincommercialrealestate(CRE)lendingandmuchlowerconcentrationsinconstructionandland developmentloans. Instead,thrivingbankswereslightlymoreconcentratedinone-to four-familymortgageloansheldinportfolio,aswellasconsumerloans. Despitetheseoverallbalancesheetfindings,theresearchersalsonotedthewidediversityofbusinessmodelsthattheyfoundamongthethrivingbanks. Recognizingthatalargepartofgoodperformancecomesfromfactorsthataremoredifficulttomeasurestatistically,theresearchersexaminedasampleofcommentsinexaminationreportsandfoundthatthrivingbanksbenefitedfromastrongandlocalizedcustomerservicefocuswith InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  35. P age |35 highvisibilityinthecommunity,conservativeunderwriting,andproductsthatwereprofitableandmetcustomerneeds. Theysupplementedtheirreviewofexaminationreportsbyinterviewingmanagementatsomeofthethrivingbanks. Thebankerstheyinterviewedattributedtheirsuccesstostrongtiestothecommunity,relationshipbanking,conservativeunderwriting,andafocusonproductsandmarketstheyunderstood. TheseresultswerestrikinglysimilartotheresultsofinterviewsinseparatestudiesattheFederalReserveBankofKansasCity10andtheFederalReserveBankofRichmond. Thesestudiesconfirmwhatexperiencehasalreadytaughtme:Communitybanksthathavedeeptiestothecommunity,engagedmanagersanddirectors,conservativeunderwriting,andstrongriskmanagementcannotonlysurvive,butthrive,eveninadverseconditions. UsingResearchtoShapeSupervisoryGuidanceonLending WhilemuchofourregulatoryworkrecentlyhasinvolvedimplementingtherequirementsoftheDodd-FrankAct,wearealsocontinuingtoreviewthelessonswelearnedduringthecrisisandtheresultsofourrecentresearch. Inmostcases,thisworkismorelikelytoresultinsupervisoryguidancethanregulation. Supervisoryguidanceiscommonlyviewedasameanstorestrictactivitybut,infact,duringthecrisismuchoftheguidanceweissuedactuallydirectedbankersandbankexaminerstotakeabalancedapproach. Forexample,weissuedguidanceurgingbankstocontinuetomakeloanstoallqualifiedborrowersand,inparticular,tocontinuelendingtocreditworthysmallbusinesses. Wealsoissueddetailedguidanceaboutcommercialrealestateworkoutstoencourageprudentmodificationsofrealestateloans. Lendingistheprimarysourceofincomeformostcommunitybanksandalsothegreatestsourceofrisk. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  36. P age |36 Asyoudevelopyourbusinessplans,someofthemostimportantdecisionsyouwillmakerelatetolending. Intheplanningprocess,banksshoulddefinetheportionofthelendingportfoliotheyplantoallocatetodifferentloancategories,theinvestmentstheyarewillingtomaketodevelopexpertiseandtomanagecreditandcompliancerisk,andthelevelsofcreditandinterestraterisktheyarewillingtoassume. SoIthoughtitmightbehelpfultoreviewsomerecentdevelopmentsinloantypesthatareatthecoreofcommunitybanklending. ResidentialMortgageLending Residentialmortgagelendingwasattheheartofthefinancialcrisisand hasbeenthetargetofextensivenewregulationandsupervisoryattention,includingtherulesissuedbytheCFPBthatIdiscussedearlier. Ithinkcommunitybanksareinanespeciallydifficultpositionwithrespecttoresidentialmortgagelending. Ontheonehand,communitybanksdonotappeartohaveengagedinmanyofthemoreproblematicpracticesthatledtothecrisis. Andtheirrateofseriouslydelinquentresidentialmortgageloansissignificantlylowerthantheoverallrateofseriousdelinquenciesonsuchloansmadetoprimeborrowers,indicatingthatcommunitybankslargelyhavemanagedtheirexistingportfoliosresponsibly. Ontheotherhand,residentialmortgageloansmadebycommunitybanksdofrequentlysharesomecharacteristics,suchashigherratesandballoonpayments,withthesubprimelendingthatprovedtobesodisastrous. Atthesametime,mortgagelending,whichaveragesaboutone-fourthofcommunitybankloanportfolios,isanimportantproductlineforcommunitybanks. Further,FederalReserveresearchindicatesthattheresidentialmortgageloansmadebycommunitybanksmakeupasmallbutvitalpartofcreditavailabilityinthehousingmarket. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  37. P age |37 Thechallengeforregulatorsistodesignmortgageregulationstoaddresspracticesthathaveprovedharmfultoconsumersorfinancialstabilitywithoutinhibitinglendingtocreditworthyborrowers. Thechallengeforcommunitybankersistoreviewthefullbodyofnewregulationscoveringmortgagelendingandtodeveloptheexpertiseandcontrolsystemsnecessarytocomplywiththeseregulationswhileremainingactiveinthisimportantmarket. IthinkitisunfortunatewhenIhearsomebankerssaythattheywillstopofferingmortgagesiftheycan'tmakethemthesamewaythattheyalwayshave. WhileIcertainlyunderstandtheirfrustration,Istillbelievethat communitybankerscanrespondwithinthenewenvironmentbycreatingproductsthatareprofitableandmeettheneedsoftheircustomers,whilestillmanagingtheirinterestrateandfundingrisks. Evenwithsomeregulatoryexceptions,compliancewithnewmortgageregulationslikelywillrequirechangestoprocessingsystemsandextensivestafftraining. Butitisalsopossiblethatthesystemsandexpertisenecessarytomakequalifiedmortgagesforthebank'sbookscouldalsobeusedtooriginateloansforsale. Formanycommunitybanks,thiscouldrepresentanewrevenueopportunityandanewalternativetoofferthebank'scustomers. CommercialRealEstateLending Forcommunitybanks,itwasCRElending--inparticular,lendingfor constructionandlanddevelopment--thatcausedthemostproblemsduringthecrisis. Asyoumayknow,in2006thefederalbankingagenciesissuedsupervisoryguidancethatsetforthscreeningcriteriabasedoncertain typesofCREconcentrationsandrapidgrowthofCREportfolios. TheseguidelinescontainedspecificnumericalthresholdsfortheratiosofconstructionandtotalCRElendingtoaninstitution'stotalcapital,aswellasforidentifyingrapidgrowthofsuchlending. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  38. P age |38 Thesecriteriawereneverintendedtoresultinhardcaps,butwereinsteadmeanttotriggerconversationsbetweenabankanditssupervisorsabout thebank'sabilitytomanagetherisksarisingfromtheseconcentrations. Afterourexperienceinthefinancialcrisis,especiallyconsideringthesevereproblemsincommercialrealestatemarkets,wewereinterestedin understandinghowcommunitybankswereaffectedbytheguidanceandwhetherthescreeningcriteriasetforthintheguidancewereeffectiveindicatorsofrisk. Inthatregard,FederalReservestaffhasworkedwithourcounterpartsattheOfficeoftheComptrolleroftheCurrencytoanalyzehowbanks'holdingsofCREloanshaveevolvedsincetheguidancewasissued. Wehavelearnedafewinterestingthingsbasedonthefindingsofthisresearch. Forexample,thenumberofinstitutionsthatexceedatleastoneofthetwoscreeningcriteriahasdeclinedsubstantiallyfrom2006tothepresent. Whilemuchofthisdeclineseemstohaveresultedfromthecontractionofconstructionportfoliosinthewakeofthecrisis,banksthatexceededthecriteriawhentheguidancewasissuedappeartohaveexperiencedabiggerdeclineintotalCREloansthancanbeexplainedbytheadverseeconomicenvironmentalone. Thisfindingcouldindicatethatthethresholdsareindeedbeinginterpretedashardcaps. Moreover,itwasapparentthatbanksthatexceededthecriterionforconstructionandlanddevelopmentwerefarmorelikelytohavefailedovertheperiodfrom2007to2011thanwerethosebanksthatexceededthecriterionforoverallCREexposuresandportfoliogrowth. Wenowrecognizetheimportanceoftherapidgrowthcriterion,whichmayhavereceivedlessattentionthanthecriteriaforconstructionandoverallCRElendingconcentrations. WeintendtousethefindingsofthisresearchtohelpclarifyourcommunicationandtrainingforexaminersandbankersaroundCRElendingconcentrations. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  39. P age |39 SmallBusinessLending Thereisprobablynoloancategoryinwhichcommunitybankers'localknowledgeanddeeptiestothecommunityaremoreimportantthansmallbusinesslending. TheFederalReserveSystemhasaprojectunderwaytotrytoimproveourunderstandingofsmallbusinesscreditmarkets,whichwouldofcourseincludecommunitybanks. Onechallengewehavefacedisthatitisdifficulttomeasurelendingtosmallbusinessesprecisely. Foronething,smallbusinessownersfrequentlytaptheirpersonalhomeequity,creditcards,orloanssecuredbycommercialrealestatethattheyowntofinancetheirbusinessoperations,whichmeanssuchborrowingisnotreportedassmallbusinesslending. Butthereisalsonodefinitionofsmallbusinessborrowersforthereportingofsmallbusinesslendingasaloancategory. However,smallloanstobusinesses--commercialandindustrialloansandCREloanswithoriginalprincipalamountsoflessthan$1million--arereportedseparatelyandcanbeusedasaproxyforsmallbusinesslending. Usingthismeasure,wecanestimatetheimportanceofsmallbusinesslendingtocommunitybanksandtheimportanceofcommunitybankstosmallbusinesses. AsofSeptember2012,bankswith$10billionorlessinassetsaccounted formorethan98percentofallcommercialbankinginstitutions,buttheyheldlessthan20percentofbankingindustryassets. However,theyheldmorethanhalfofoutstandingsmallloanstobusinesses. Forsuchinstitutions,thesesmallloanstobusinessesrepresentnearly20percentoftheirtotaldomesticlendingandslightlymorethan40percentoftheirtotalcommerciallending. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  40. P age |40 Smallbusinesslendingislikelyevenmoreimportanttosmallerbanksthanthesestatisticsshowbecausetheseloansareidentifiedbythesizeoftheloanratherthanthesizeoftheborrower. Ibelieveitisprobablethatmanyofthelargerbusinessloansmadebythesesmallerbankswerealsomadetosmallbusinessborrowers. Attheotherendofthespectrum,bankingorganizationswithmorethan $50billioninassetsaccountedforlessthanonepercentofinstitutions,butheld75percentoftheassets. Holdingalmost40percentofoutstandingsmallloanstobusinesses,theselargebanksareimportantsmallbusinesslenders,butsmallloanstobusinesseswerenotasignificantsegmentoflargebankloanportfolios. Theyrepresentedlessthanfivepercentofthesebanks'totaldomesticlending. Thesestatisticsdemonstratetheimportanceofcommunitybankstosmallbusinessandthecorrespondingimportanceofsmallbusinesslendingtothecommunitybankingbusinessmodel. Indevelopingpoliciesforsmallbusinesslending,Ithinkitiscriticallyimportantforbankboardsofdirectorstoinsistonappropriateriskmanagementthatretainstheflexibilitytousethebankers'knowledgeoftheircustomers'businesstotheirbestadvantage. Anditisequallycriticalthatsupervisorsdeveloptoolstomeasurethe overalleffectivenessofriskmanagementinsmallbusinesslendingwithoutbeingoverlyprescriptiveforindividualloans. Conclusion IwouldliketoendwhereIbegan.Ithinkthefutureforcommunitybankingisbright. Irecognizethattheregulatorychangesunderwayarenotwithoutcosttocommunitybanks. ButIalsoknowthatweattheFederalReservearedoingourbesttoavoidaddingtoregulatoryburdenwhereverpossibleaswerespondtotheworst InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  41. P age |41 excessesofthefinancialcrisisandmaketheU.S.financialsystemmoreresilient. Researchishelpfulinthiseffortbutitisalsoimportanttomaintainanongoingdialoguewithcommunitybankersandtoactivelysolicitcommentonregulatoryproposals. SoIurgeyoutocontinuetocommunicateaboutthechallengesthatregulationsposeforcommunitybanks. Moreimportantly,Iknowthatthenaturaladvantagesfoundincommunitybanks--deepcommunityties,dailyinteractionbetweenseniormanagersofbanksandtheircustomers,andthedexteritytocustomizefinancialsolutions--havenotbeendiminishedinanyway. Yes,theregulatoryenvironmentischallengingandtheeconomyremainsweakinmanyareas. Butallourresearchshowsthatwithcreative,engagedbankersandstrong risk-managementprocesses,communitybankscancontinuetonotonlysurvivebuttothrive. Thankyouverymuchforyourattention,andIwouldbeinterestedin hearingyourthoughts. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  42. P age |42 SpeechbyPatrickSpens,HeadofMarketMonitoring,theFSA,attheFuturesOptionsAssociationComplianceForum GoodafternoonanditisapleasuretobeabletospeaktoyouthisafternoonmynameisPatrickSpens. IamtheHeadofMarketMonitoringwhichwillbecomepartofthefutureFinancialConductAuthorityorFCA. IwasaskedheretospeakregardingtheFSA’sexpectationsonfirm’sobligationswithrespecttothemonitoringofordersandtransactions,specificallyinresponsetoaletterfromtheFSAandothercompetentauthoritiessenton14December2012. FirstlyIwishtoprovidesomecontexttobothmyroleandthesoontobeestablishedFCA’sobjectivesandphilosophy. Mykeyresponsibilitiescanbedefinedasfollows: pursuingtheFSA’scredibledeterrencestrategythroughmarket  conductenquiriesandinvestigationswhichcanthenleadtotargetedenforcementactions,underbothcivilandcriminalregimes; educatingmarketparticipantsabouttheirobligationswithrespect  tomarketabuseandtransactionreporting; enhancingourmarkets’surveillancetoolkitwhichincludes  interrogatingtransactiondatatoassessrisksandidentifytrendsthroughourTransactionReportingdatabase-ZEN; supervisingthetransactionreportingandmarketabuseregimes;  and  influencingEuropeanpolicyagendasintheseareas. TheFCA’soverallstrategicobjectiveisto‘makemarketsworkwell’. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  43. P age |43 • Additionallyitwillhavethreeoperationalobjectivesofensuringconsumerprotection,marketintegrityandcompetitionisintheinterestsofconsumers. • ThekeydifferencesastohowtheFCAwillregulateconductwillbethrough;newlegislativepowersandtools,anewapproachtoregulating andsupervisingfirmsandmostimportantlyachangeinculturethatwillenhancealllevelsofconsumerprotection. • MovingforwardintotheFCA,ourviewisthatconductriskcanoftenbemoreefficientlyaddressedthroughthematicandeducationalwork. • Weintendtoexecuteahigherproportionofourconductpriorities,throughthistypeofworkorcommunication. • Ithereforeaddressthereasonformebeingstoodbeforeyou. • TheletterwassentundercoordinationfrommultipleEuropean regulators,thoughsomeofyoumayquestionthegenesisoftheletter. • ESMAissuedacallforevidencefromanyregulatorswhohadseenevidenceoflayeringorspoofingwithintheirfinancialmarkets. • We,astheFSA,responded,andfromthis,theletterthatyoureceivedwasborn. • Toaddressthequestionof‘whydidIreceivethisletter’,thiscommunicationwassentto: • UKfirmswhicharemembersofUKorcontributorcountriesregulatedmarkets;and • noncontributorcountryfirmsorthirdcountryfirmswhicharemembersoftheUKregulatedmarkets(e.g.USfirmsorLuxembourgishfirms) • SomemayquestionwhysuchaletterwassentundercoordinationofESMA. • AstechnologyinconjunctionwiththeMarketsinFinancialInstrumentsDirective(MiFID)continuestobreakdowngeographicaland InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  44. P age |44 jurisdictionalbordersIbelievewewillseeevermorecooperationbetweenEuropeanregulators. Suchcooperationwillspanpolicysetting,supervisoryissuesandregulatoryinvestigations. Thisletterisademonstrationofsuchanapproach. TheFSAiswellversedincross-borderinvestigations–jointlyundertakencriminalproceedingsfromtheWestCoastoftheUnitedStates,totheislandofMayotteintheIndianOceanwithFrenchauthoritiesasaresultofourmarketabuseinvestigations. Weregularlyseekassistancefrom,andprovideassistancetoothercompetentauthoritiesinmarketabuseinvestigationsaroundtheglobe. TheFCAwillcontinuetoprogressinvestigationsacrossborderstofurtheritscredibledeterrencestrategy. WhatdoestheFSAexpectoffirms’monitoringprocedures? Toaddresstheprimaryreasonformebeingstoodbeforeyou–whatmonitoringandcontrolsdoestheFSAexpectfirmstohaveinplace? ESMAsetoutguidelinesformarketparticipantsinrelationtosystemsandcontrolsinanautomatedtradingenvironment–applicablefortradingplatformsandinvestmentfirmsalikein2012. OurletterhighlightedsomeoftheprinciplesfromtheseESMAguidelines -organisationalrequirementstopreventmarketabuse(inparticularmarketmanipulation)inanautomatedtradingenvironment. Asagroupyouhavediversebusinessmodels,diverseclientbases,andtradediverseassetclasses,forthisreasontherecanbenosinglesurveillancemodelorsystemwhichshouldbefollowedtoensurecompliancewiththeregulation. MonitoringshouldensurecompliancewithMiFID,andtheCodeofMarketConduct. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  45. P age |45 Asmemberfirmsofexchangesandplatforms,monitoringshouldalsoensurecompliancewithrulesandregulationsassetoutbyyourplatforms. TheFSAexpectsthatfirmswillhaveappropriatesystemsinplacetomonitorthatmessagesbeingsentorreceivedarecompliant. LayeringandSpoofingwashighlightedasaconcernthroughourMarketWatchpublication(IssueNo.33)inAugust2009. Layeringinvolvesenteringmultipleordersatdifferentpricesononesideoftheorderbookat,orslightlyawayfrom,thetouch. Thishastheeffectofmovingthesharepriceasthemarketadjuststothefactthattherehasbeenanapparentshiftinthebalanceofsupplyordemand. Thisisthenfollowedbyatradeortradesontheoppositesideoftheorderbookwhichtakeadvantageof,andprofitfrom,thesharepricemovementengenderedbythemultiplelayeringorders. Thisisinturnfollowedbythedeletionofthelargelayeringorders,andbyarepetitionofthisbehaviourinreverseontheothersideoftheorderbook. Whatdoesappropriatemean? Weexpectfirmstoperformsurveillanceinasclosetorealtimeaspossible. Monitoringshouldensurethatyoursystemshavesufficienttimegranularitythatyouareabletoidentifyanystrategiesorindividualordersthatarepotentiallyabusive,andretaintheoptiontoblockorlimitordersfromenteringaplatform. Suchasystemshouldbecapableofhandlingthevolumeofmessagesbeingsent,orreceivedinthecaseofplatforms. Anysysteminplacewillrequirehumaninterventionandjudgementduringtheprocesstodeterminethelevelofsuspicionandwhetherthiswarrantsadisclosuretotherelevantcompetentauthority. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  46. P age |46 Staffundertakingmonitoringshouldbesufficientlytrainedtounderstandthestrategiesthatmaybeundertakenandregulationsrelatingtomarketabuse,specificallymarketmanipulation. Staffundertakingmonitoringshouldhavesufficientauthoritytochallengeandtakenecessaryactionwhenreviewingtradingflows. Asafirmyoushouldensureyouhaveappropriatesystemsandgovernanceinplacethatreferralsofsuspiciousbehaviouraremadewhereappropriate,andinatimelyfashion. Aspartofoursupervisoryprocesswemaychoosetoquestionanynearmisses–wheresuspicioustradinghasbeenescalatedbutnotreportedtotheFSA–thathaveresultedfromyourmonitoringandsurveillance. Wewouldexpectyoutodemonstrateafullaudittrailofdecisiontaking,andtherationaleforthese. DMAproviders Iwishtodwellondirectmarketaccess(DMA)providers,andthe responsibilityyouhaveforthetradingofyourclients. Withoutadequatesystemsandcontrolsinplaceyouleaveyourselvesexposedtorisksoutsideofyourcontrol. Iwouldurgeyoutoconsiderwhethersystemsandcontrolsinplacearesufficientlyadvancedandrobusttomonitoreffectively. Youareremindedthatyouremainsolelyresponsibleforallorderssubmittedunderyourtradingcodes. Whenprovidingdirectmarketaccess,thosestaffundertakingmonitoringshouldunderstandthescaleandcomplexityofaclient’strading,andtheirhistoricaltradingbehaviour. Limitsshouldexistaroundclientstradingtoensurefairandorderlytrading,withautomaticrejectionofordersthatviolatesuchparameters. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  47. P age |47 AsDMAprovideryoushouldretainabsolutecontroloveranypre-tradecontrols,clientsofDMAshouldnothavetheabilitytomodifysuchcontrols. Alltradesshouldpassthroughpre-tradecontrolsbeforebeingsenttoaregulatedmarket–notdoingsoisprohibitedunderMiFID. Itisprudenttoregularlyreviewclients’duediligence,andassesswhetherlimitsinplaceareadequate. Atintervalswhichyoudeemappropriateyoushouldconsiderwhetherthetradingpatternsobservedareconsistentwiththeclient’sstatedtradingobjectives. Anymonitoringsystemsemployedbyfirmsshouldbeabletoseparatelyidentifyordersreceivedfromclientsasopposedtoproprietarytrades,withtheabilitytoimmediatelysuspendorhaltoneclient’saccessifrequired. Previouslywehavevisitedfirmswhohavepurchasedcomplex off-the-shelfsystemsinordertogeneratealerts,yetalertswereeithernotreviewed,reviewedinanuntimelymanner,ortherewasafailuretoescalateanyconcerns. Whateveryoursolution,ithastobeappropriateforyourbusinessandreviewedonaregularbasistomakesureitcontinuestobefitforpurpose. Education–afocusofMarketMonitoring In2012ourMarketMonitoringteamreceivedsignificantpresscoveragewhenwereiteratedtofirmstheirobligationsundertheSuspiciousTransactionReport(STR)regime. TheSTRregimeplacesanobligationonregulatedfirmstonotifytheFSAofanyreasonablesuspicionsofmarketabuse. WebelievetheSTRregimehasbeenworkingwellandweappreciatethegoodqualitysubmissionofSTRsthatwereceivefrommanyfirms. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  48. P age |48 • STRshavebecomeacentralpillarofourcredibledeterrenceagendaandwerelyonfirmssubmittinggoodqualitySTRstomaintainconfidencein thefinancialsystem. • Notwithstandingthis,Iwrotetoallfirmswhohavethepermission‘arrangingdealsininvestments’toremindthemoftheirobligations. • ThepurposeoftheSTRletter,andtheletteronlayeringandspoofing,wasoneandthesame–education. • IwillsharewithyounowsomeoftheresponsesreceivedaspartofourSTRwork. • Thesehighlightedtheneedforustocontinueaneducationalagenda. • Fromafirmofferinglifeinsurance: • ‘Forusasuspicioustransactionwouldbeifsomeonetookoutapolicyonsomeoneelseandthenshotthemdead;we’dcertainlyreportthat…’ • ‘STRs?Shorttradingrules?PleaseadviseandIwillprovidealltheinformationwehaveonthesubject.’ • ‘Weareastrictagencybrokerdealingmainlywithregulatedinstitutionalfundmanagementgroups,soperhapsthescopeordesiretomanipulatepricesismitigated’–thefirmcallthemselvesa‘boutiqueinvestmentbank’ • ‘Wedonotdealonthebasisofinsiderinformationorotherwiseknowinglycommitmarketabuse’ • WithinMarketMonitoringwewishtoattempttoensurethateducationisasimportantaslitigation,andtheprogressionofmarketabuseenquiries. • Whilstenforcementoutcomesrelatedtomarketabuseserveasadeterrentandmessagetothemarket,wevieweducationasagreatermitigantofmarketabuse. • Mymessagetoyouisthatwearethefinallineofdefence,youarethefrontlineandweareinthistogether. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  49. P age |49 STRsandtheESMAguidelines AsIhavesaid,werelyonfirmssubmittinggoodqualitySTRsinordertodeliverourmarketabuseagenda. Thisisverymuchapartnershipandhencewearekeentoeducatefirmssothatwecanworktowardsthejointobjectiveofmarketintegrity. STRswillremainacentralpillarofourmarketabuseenquires. However,aswecontinuallyenhanceourtechnologyyouwillreceivegreaterchallengeonfailuretosubmitSTRs,whichinturnwillbringyourmarketabusesystemsandcontrolsintoquestion. Iremindyouthatfirmswithsystemsandcontrolsdeemednotsufficientmaybesubjecttoeithersupervisoryorenforcementaction. Wewillalwaysbeproportionateinourapproachlookingatthefullsuiteofsupervisorytoolsavailable,withenforcementreservedforthemostegregiouscases. WemayseektovisitanyregulatedfirmtohelpassesstheadequacyofthesystemsandcontrolsinplacetocomplywithboththeESMAguidelinesandUKregulation–aswemovetomorethematic-basedsupervision,visitsofthisnaturewillbecomeacommonfeature. Whilstwenormallyexpecttogivereasonablenoticeofavisit,onrareoccasionswemayseektoaccesspremiseswithoutnotice. Theprospectofunannouncedvisitsisintendedtoencouragefirmstocomplywiththerequirementsandstandardsundertheregulatorysystematalltimes. AsourSTRsupervisoryfocusdevelopswewillquestionnotonlythequantityreceivedrelativetotransactionvolumesbutthequalityandtimelinessofSTRssubmitted. WhenfirmsaresubmittingSTRsyoushouldclearlyarticulatetherationalefordeemingthetransaction(s)tobesuspicious–whetherbasedonabnormalbehaviourrelativetotradinghistory,orrepetitivebehaviour. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  50. P age |50 Wherefirmsfailtoprovidesuchinformationwewillendeavourtocontactfirmstounderstandthereasonsforsuspicion. TheSTRrules,specificallySUP15.10statethatanSTRshouldbesubmitted‘withoutdelay’. Wewouldexpectfirmstonotifytheregulatoratthepointofhavingreached‘reasonablegroundsforsuspicion’,regardlessofwhetheranyinternalreportintothetradingwascomplete. ShouldafirmwishtocontinueaninternalinvestigationtheFSAishappytoreceivecopiesoffinalreports,regardlessoftheiroutcome. Duetoevidentialchallengesposedfromdelayednotificationwewillbelookingtodiscusswithfirmswherewedonotviewtheirsubmissionsastimely. ApointIfeelworthreiteratingisthattheSTRregimeisnotlimitedtoequityproducts.Perhapsunsurprisingly,thevastmajorityofSTRswereceiveareinrespectofequity-linkedproducts,but,forexample,thebondandcommoditymarketsarejustasimportant,andwewouldencouragethesamelevelofscrutinyfromfirms. SwiftTrade IwishtodrawyourattentiontoacasethatwasrecentlyupheldbytheUpperTribunal–SwiftTrade. WefinedSwiftTrade£8mforknowinglyengaginginmanipulativetrading,inthisinstancelayering. Thetribunaldescribedtheactivityas‘asseriousacaseofmarketabuseasmightbeimagined’,notingfurtherthat‘thiswasaprolonged,cynicalcourseofmarketabusecommittedbyacompanywhich...exhibitedawholesaledisregardofregulatoryrequirements:itwas,inshort,acompanywhichactedasiftherulesdidnotapplytoit,andmodifieditsbehaviour...onlyinorderthatitmightcarryondoingwhatithadbeendoingbefore,butwithbetterconcealment’. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

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