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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, TheFinancialStabilityBoard(FSB)publishedtodayathematicpeerreviewonriskgovernance. Riskgovernancecollectivelyreferstotheroleandresponsibilitiesoftheboard,thefirm-wideCROandriskmanagementfunction,andtheindependentassessmentoftheriskgovernanceframework. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  2. P age |2 • Boardresponsibilitiesandpractices:Theboardisresponsibleforensuringthatthefirmhasanappropriateriskgovernanceframeworkgiventhefirm’sbusinessmodel,complexityandsizewhichisembeddedintothefirm’sriskculture. • Howboardsassumesuchresponsibilitiesvariesacrossjurisdictions. • Firm-wideriskmanagementfunction:TheCROandriskmanagementfunctionareresponsibleforthefirm’sriskmanagementacrosstheentireorganisation,ensuringthatthefirm’sriskprofileremainswithintheriskappetitestatement(RAS)asapprovedbytheboard. • Theriskmanagementfunctionisresponsibleforidentifying,measuring,monitoring,andrecommendingstrategiestocontrolormitigaterisks,andreportingonriskexposuresonanaggregatedand disaggregatedbasis. • Independentassessmentoftheriskgovernanceframework:Theindependentassessmentofthefirm’sriskgovernanceframework playsacrucialroleintheongoingmaintenanceofafirm’sinternalcontrols,riskmanagementandriskgovernance. • Ithelpsafirmaccomplishitsobjectivesbybringingadisciplinedapproachtoevaluateandimprovetheeffectivenessofriskmanagement,controlandgovernanceprocesses. • Thismayinvolveinternalparties,suchasinternalaudit,orexternalresourcessuchasthird-partyreviewers(e.g.,auditfirms,consultants). • Thisisanexcellentdocumentforriskmanagers.ReadmoreatNumber1ofourlist InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  3. P age |3 Also… Ilikeit.Niceandclear: “Principalriskistheriskthatabankpaysawaythecurrencybeingsold,butfailstoreceivethecurrencybeingbought.Principalriskcanbethemostseriousriskbecausetheamountatriskcanbeequaltothefullvalueofthetrade. ReplacementcostriskistheriskthatanFXcounterpartywilldefaultbeforeatradehassettledandthatthebankmustreplaceitwithanewtradeandadifferentcounterpartyatcurrentmarketprices(potentiallylessfavourableexchangerate). Liquidityriskistheriskthatacounterpartywillnotsettleanobligationforfullvaluewhendue.Liquidityriskdoesnotimplythatacounterpartyisinsolventsinceitmaybeabletosettletherequireddebitobligationsatsomeunspecifiedlatertime.” Great,cleardefinitions,inthe“Supervisoryguidanceformanagingrisksassociatedwiththesettlementofforeignexchangetransactions”fromtheBankofInternationalSettlements. ReadmoreatNumber4belowWelcometotheTop10list. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  4. P age |4 FSBpublishespeerreviewonriskgovernance TheFinancialStabilityBoard(FSB)publishedathematicpeerreviewon riskgovernance. Thereporttakesstockofriskgovernancepracticesatbothnational authoritiesandfirms,notesprogressmadesincethefinancialcrisis,identifiessoundpracticesandoffersrecommendationstosupportfurtherimprovements. GovernorDanielK.Tarullo Dodd-FrankAct BeforetheCommitteeonBanking,Housing,andUrbanAffairs,U.S.Senate,Washington,D.C. InterviewwithCarlosMontalvo,ExecutiveDirector ofEIOPA,conductedbyGarryBooth,Reactionsmagazine(theUK) CanyouexplainwhattheinterimSolvencyIImeasures,sometimesknownasSolvency1.5,encompass? InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  5. P age |5 Supervisoryguidanceformanagingrisksassociatedwiththesettlementofforeignexchangetransactions Thepurposeofthisguidanceistoprovideupdatedguidancetosupervisorsandthebankstheysuperviseon approachestomanagingtherisksassociatedwiththesettlementofFX transactions. FinancialServicesSector DraftrecommendationstotheCharteredInstituteofInternalAuditors Followingthecrisisinthefinancialsystemoverthepastfewyearsawidespreadreviewofgovernanceinfinancialinstitutionshasbeentakingplace. ItwasinevitablethattheroleofInternalAuditwouldbebroughtintothatprocess. TheFinancialTransactionTax(FTT) On14February2013theEuropeanCommissionadoptedaproposalfora CouncilDirectiveimplementingenhancedcooperationintheareaof financialtransactiontax,whichmirrorsthescopeandobjectivesofitsoriginalFTTproposalofSeptember2011. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  6. P age |6 SpeechbyAndrewBailey ManagingDirector,PrudentialBusinessUnitattheCharteredInstitute’sNicholasBarbonLectures,London SuitabilityofmembersoftheManagementBodyandKeyFunctionHolders EMIR:FrequentlyAskedQuestions Note:TheRegulation(EU)No648/2012oftheEuropeanParliamentandoftheCouncilof4July2012onOTCderivatives,centralcounterparties(CCPs)andtraderepositories(TRs)(EMIR)enteredintoforceon16August2012. However,manyprovisionsrequiretechnicalstandardstobedevelopedbyESMAandtheactualdateofapplicationoftheseprovisionswilldependonthedateofentryintoforceofthetechnicalstandards(seesectionontimingformoredetails) CorporateandRiskGovernance: TheIAIS’Self-AssessmentandPeerReviewonICPs4,5,7and8 TheIAIShaslaunchedtheSelf-AssessmentandPeerReview(SAPR)onCorporateandRiskGovernance. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  7. P age |7 FSBpublishespeerreviewonriskgovernance TheFinancialStabilityBoard(FSB)publishedtodayathematicpeerreviewonriskgovernance. Thereporttakesstockofriskgovernancepracticesatbothnational authoritiesandfirms,notesprogressmadesincethefinancialcrisis,identifiessoundpracticesandoffersrecommendationstosupportfurtherimprovements. Therecentglobalfinancialcrisisexposedanumberofriskgovernanceweaknessesinmajorfinancialinstitutions,relatingtotherolesandresponsibilitiesofcorporateboardsofdirectors(the“board”),the firm-wideriskmanagementfunction,andtheindependentassessmentof riskgovernance. Withouttheappropriatechecksandbalancesprovidedbytheboardandthesefunctions,acultureofexcessiverisk-takingandleveragewasallowedtopermeateinmanyofthesefirms. Thepeerreviewfoundthat,sincethecrisis,nationalauthoritieshavetakenseveralmeasurestoimproveregulatoryandsupervisoryoversightofriskgovernanceatfinancialinstitutions. Thesemeasuresincludedevelopingorstrengtheningexistingregulationorguidance,raisingsupervisoryexpectationsfortheriskmanagementfunction,engagingmorefrequentlywiththeboardandmanagement,andassessingtheaccuracyandusefulnessoftheinformationprovidedtotheboardtoenableeffectivedischargeoftheirresponsibilities. Nonetheless,moreworkisnecessary. Inparticular,nationalauthoritiesneedtobetterassesstheeffectivenessofafirm’sriskgovernanceframework,andmorespecificallyitsriskculture, InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  8. P age |8 tohelpensurethesoundmanagementofriskthroughtheeconomiccycle. Supervisorswillneedtostrengthentheirassessmentofriskgovernanceframeworkstoencompassanintegratedviewacrossallaspectsoftheframework. Thepeerreviewalsosurveyed36banksandbroker-dealersthatFSBmembersdeemedassignificantforthepurposeofthereview. Theevaluationoftheirresponsesindicatesthatmanyofthebestriskgovernancepracticesatsurveyedfirmsarenowmoreadvancedthannationalsupervisoryguidance,anoutcomethatmayhavebeenmotivatedbyfirms’needtoregainmarketconfidence. Despitetheseconsiderablestrides,significantgapsremaininanumberofareas,particularlyintheriskmanagementfunction. Atthecoreofstrongriskmanagementisaneffectiveriskappetiteframework,andfirms’progresstodateisuneveninitsdevelopment,comprehensivenessandimplementation. Veryfewfirmswereabletoidentifyclearexamplesofhowtheyusedtheir riskappetiteframeworkinstrategicdecision-makingprocesses. Drawingfromthefindingsofthereview,thereportidentifiesalistofsoundriskgovernancepracticesthatwouldhelpfirmscontinuetoimprovetheirriskgovernanceandnationalauthoritiestoassessitseffectiveness. Thereviewalsosetsoutseveralrecommendationstargetingareaswheremoresubstantialworkisneeded,inparticular: 1.Nationalauthoritiesshouldstrengthentheirregulatoryandsupervisoryguidanceforfinancialinstitutionsanddevoteadequateresourcestoassesstheeffectivenessofriskgovernanceframeworks. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  9. P age |9 Standardsettingbodiesshouldreviewtheirprinciplesforgovernance,takingintoconsiderationthesoundriskgovernancepracticessetoutinthereport. TheFSBshouldexplorewaystoformallyassessriskcultureatfinancialinstitutions. TheFSBshouldprovidegeneralguidanceonthekeyelementsthatshouldbeincludedinriskappetiteframeworksandestablishacommonnomenclaturefortermsusedinriskappetitestatements. TiffMacklem,ChairmanoftheFSB’sStandingCommitteeonStandardsImplementation(SCSI),said: “Thereviewusefullypullstogethergoodriskgovernancepracticesandidentifiesfollow-upworkthatneedstobedonebynationalauthoritiestostrengthentheirabilitytoassesstheeffectivenessoffirms’riskgovernanceframeworks. Recentheadlineeventssurroundingactivitiesatsomelargefinancialinstitutionsunderscoretheimportanceofpromotingandimplementingasoundriskculture.” SweeLianTeo,Chairofthepeerreviewteamonriskgovernance,said:“Whilemeasureshavebeentakentoimproveriskgovernance,thereview showedthattherearestillgapsthatneedtobeaddressedbybothfirmsandsupervisors. Thereportsetsoutrecommendationsthatwillhelpsupervisorseverywhereraisethebarontheirexpectationsforriskgovernancesothatfirms’practicescontinuetoimprovethroughchangingenvironments.” Notes TheFSBhasbeenestablishedtocoordinateattheinternationalleveltheworkofnationalfinancialauthoritiesandinternationalstandardsettingbodiesandtodevelopandpromotetheimplementationofeffective InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  10. P age |10 regulatory,supervisoryandotherfinancialsectorpoliciesintheinterestoffinancialstability. Itbringstogethernationalauthoritiesresponsibleforfinancialstabilityin24countriesandjurisdictions,internationalfinancialinstitutions, sector-specificinternationalgroupingsofregulatorsandsupervisors,and committeesofcentralbankexperts. TheFSBalsoconductsoutreachwith65otherjurisdictionsthroughitssixregionalconsultativegroups. ThepeerreviewonriskgovernanceisthethesixththematicpeerreviewconductedbytheFSBandthefirstthematicreviewusingtherevisedobjectivesandguidelinesfortheconductofpeerreviewssetforthintheDecember2011HandbookforFSBPeerReviews. ThematicreviewsfocusontheimplementationandeffectivenessacrosstheFSBmembershipofinternationalfinancialstandardsdevelopedbystandard-settingbodiesandpoliciesagreedwithintheFSBinaparticularareaimportantforglobalfinancialstability. Thematicreviewsmayalsoanalyseotherareasimportantforglobalfinancialstabilitywhereinternationalstandardsorpoliciesdonotyetexist. Theobjectivesofthereviewsaretoencourageconsistentcross-countryandcross-sectorimplementation;toevaluate(wherepossible)theextent towhichstandardsandpolicieshavehadtheirintendedresults;andtoidentifygapsandweaknessesinreviewedareasandtomakerecommendationsforpotentialfollow-up(includingviathedevelopmentofnewstandards)byFSBmembers. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  11. P age |11 ThematicReviewonRiskGovernancePeerReviewReport Foreword FinancialStabilityBoard(FSB)memberjurisdictionshavecommitted,undertheFSBCharterandintheFSBFrameworkforStrengthening AdherencetoInternationalStandards,toundergoperiodicpeerreviews. Tofulfilthisresponsibility,theFSBhasestablishedaregularprogramme ofcountryandthematicpeerreviewsofitsmemberjurisdictions. ThematicreviewsfocusontheimplementationandeffectivenessacrosstheFSBmembershipofinternationalfinancialstandardsdevelopedbystandard-settingbodiesandpoliciesagreedwithintheFSBinaparticularareaimportantforglobalfinancialstability. Thematicreviewsmayalsoanalyseotherareasimportantforglobalfinancialstabilitywhereinternationalstandardsorpoliciesdonotyetexist. Theobjectivesofthereviewsaretoencourageconsistentcross-countryandcross-sectorimplementation;toevaluate(wherepossible)theextent towhichstandardsandpolicieshavehadtheirintendedresults;andtoidentifygapsandweaknessesinreviewedareasandtomakerecommendationsforpotentialfollow-up(includingviathedevelopmentofnewstandards)byFSBmembers. Thisreportdescribesthefindingsofthethematicpeerreviewonriskgovernance,includingthekeyelementsofthediscussionintheFSBStandingCommitteeonStandardsImplementation(SCSI). Executivesummary Therecentglobalfinancialcrisisexposedanumberofgovernanceweaknessesthatresultedinfirms’failuretounderstandtheriskstheyweretaking. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  12. P age |12 Inthewakeofthecrisis,numerousreportspaintedafairlybleakpictureofriskgovernanceframeworksatfinancialinstitutions,whichconsistsofthethreekeyfunctions:theboard,thefirm-wideriskmanagementfunction,andtheindependentassessmentofriskgovernance. Thecrisishighlightedthatmanyboardshaddirectorswithlittlefinancialindustryexperienceandlimitedunderstandingoftherapidlyincreasingcomplexityoftheinstitutionstheywereleading. Toooften,directorswereunabletodedicatesufficienttimetounderstandthefirm’sbusinessmodelandtoodeferentialtoseniormanagement. Inaddition,manyboardsdidnotpaysufficientattentiontoriskmanagementorsetupeffectivestructures,suchasadedicatedriskcommittee,tofacilitatemeaningfulanalysisofthefirm’sriskexposuresandtoconstructivelychallengemanagement’sproposalsanddecisions. Theriskcommitteesthatdidexistwereoftenstaffedbydirectorsshorton bothexperienceandindependencefrommanagement. Theinformationprovidedtotheboardwasvoluminousandnoteasilyunderstoodwhichhamperedtheabilityofdirectorstofulfiltheirresponsibilities. Moreover,mostfirmslackedaformalprocesstoindependentlyassesstheproprietyoftheirriskgovernanceframeworks. Withouttheappropriatechecksandbalancesprovidedbytheboard,theriskmanagementfunction,andindependentassessmentfunctions,acultureofexcessiverisk-takingandleveragewasallowedtopermeatein theseweaklygovernedfirms. Further,withtheriskmanagementfunctionlackingtheauthority,statureandindependencetoreininthefirm’srisk-taking,theabilitytoaddressanyweaknessesinriskgovernanceidentifiedbyinternalcontrolassessmentandtestingprocesseswasobstructed. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  13. P age |13 Thepeerreviewfoundthat,sincethecrisis,nationalauthoritieshavetakenseveralmeasurestoimproveregulatoryandsupervisoryoversightofriskgovernanceatfinancialinstitutions. Thesemeasuresincludedevelopingorstrengtheningexistingregulationorguidance,raisingsupervisoryexpectationsfortheriskmanagementfunction,engagingmorefrequentlywiththeboardandmanagement,andassessingtheaccuracyandusefulnessoftheinformationprovidedtotheboardtoenableeffectivedischargeoftheirresponsibilities. Nonetheless,moreworkremains;nationalauthoritiesneedtostrengthentheirabilitytoassesstheeffectivenessofafirm’sriskgovernance,andmorespecificallyitsriskculturetohelpensuresoundriskgovernancethroughchangingenvironments. Supervisorswillneedtoundergoasubstantialchangeinapproachsinceassessingriskgovernanceframeworksentailsforminganintegratedviewacrossallaspectsoftheframework. Thepeerreviewalsoaskedsupervisorstoevaluateprogressmadebytheirsurveyedfirm(s)towardenhancedriskgovernanceinsevenareas. Toprovidesomeconsistencytothisexercise,thereviewteamdevelopedhigh-levelcriteriatoassistsupervisoryevaluationsoffirms’progress,drawingfromacompilationofrelevantprinciples,recommendationsandsupervisoryguidance. Thehigh-levelcriteriawereviewedasfundamentalprerequisitesforriskgovernanceframeworks. Thisevaluationfoundthatmanyofthebestriskgovernancepracticesatsurveyedfirmsarenowmoreadvancedthannationalguidance. Thisoutcomemayhavebeenmotivatedbyfirms’needtoregainmarketconfidenceratherthanregulatoryrequirements. Firmshavemadeparticularprogressin: InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  14. P age |14 • assessingthecollectiveskillsandqualificationsoftheboardaswellastheboard’seffectivenesseitherthroughself-evaluationsorthroughtheuseofthirdparties; • institutingastand-aloneriskcommitteethatiscomposedonlyofindependentdirectorsandhavingacleardefinitionofindependence; • establishingagroup-widechiefriskofficer(CRO)andriskmanagementfunctionthatisindependentfromrevenue-generatingresponsibilitiesandhasthestature,authorityandindependencetochallengedecisionsonriskmadebymanagementandbusinesslines;and • integratingthediscussionsamongtheriskandauditcommitteesthroughjointmeetingsorcross-membership. • Althoughmanysurveyedfirmshavemadeprogressinthelastfewyears,significantgapsremain,relativetothecriteriadeveloped,particularlyinriskmanagement. • Therewerealsodifferencesinprogressacrossregionswithfirmsinadvancedeconomieshavingadoptedmoreofthedesirableriskgovernancepractices. • Theresultsofthesupervisoryevaluationsweregroupedby: • allsurveyedfirms; • firmsidentifiedbytheFSBandBaselCommitteeonBankingSupervision(BCBS)asglobalsystemicallyimportantfinancialinstitutions,orG-SIFIs;and • firmsthatresideinadvancedeconomies(AEs)oremergingmarket anddevelopingeconomies(EMDEs). • Insummary,acrossthesevenareasevaluated,firmshavemadethemostprogressindefiningtheboard’sroleandresponsibilities,andreasonableprogressintheirapproachtoriskgovernanceandtheindependentassessmentofriskgovernance. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  15. P age |15 • Thesupervisoryevaluations,however,indicatethatsurveyedfirmsshouldcontinuetoworktowarddefiningtheresponsibilitiesoftheriskcommitteeandstrengtheningtheirriskmanagementfunctionsasnearly 50percentofsurveyedfirmsdidnotmeetalloftheevaluationcriteriain theseareas. • Bytypeofinstitution,surveyedG-SIFIsaremoreadvancedthanotherfinancialinstitutionsindefiningtheresponsibilitiesoftheboardandriskcommittee,conductingindependentassessmentsofriskgovernance,providingrelevantinformationtotheboardandriskcommittee,andtosomeextentmoreadvancedintheriskmanagementfunction. • Theseresultssupportthefindingthatthefirmsintheregionshardesthitbythefinancialcrisishavemadethemostprogress. • Meanwhile,supervisoryevaluationsoffirmsthatresideinEMDEsshowthatnearly65percentdidnotmeetallofthecriteriafortheriskmanagementfunction. • Thesegapsneedimmediateattentionbybothsupervisorsandfirms.Othersignificantfindingscomingoutofthereviewincludethefollowing: • Nationalauthoritiesdonotengageonasufficientlyregularandfrequentbasiswiththeboard,riskcommitteeandauditcommittee.Severaljurisdictionsholdsuchmeetingsonlyonceayearoronanas-needed basis. • GoodprogresshasbeenmadetowardelevatingtheCRO’sstature,authority,andindependence. • Inmanyfirms,theCROhasadirectreportinglinetothechiefexecutiveofficer(CEO)andarolethatisdistinctfromotherexecutivefunctionsandbusinesslineresponsibilities(e.g.,no“dual-hatting”). • Thiselevation,however,needstobesupportedbytheinvolvementoftheriskcommitteeinreviewingtheperformanceandsettingtheobjectivesoftheCRO,ensuringthattheCROhasaccesstotheboardandrisk InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  16. P age |16 • committeewithoutimpediment(includingreportingdirectlytotheboard/riskcommittee),andfacilitatingperiodicmeetingswithdirectorswithoutthepresenceofexecutivedirectorsorothermanagement. • Moreworkisneededonthepartofbothnationalauthoritiesandfirmsonestablishinganeffectiveriskappetiteframework(RAF).Assessingafirm’sRAFisachallengingtaskthatrequiresgreaterclarityandanelevatedlevelofconsistencyamongnationalauthorities. • Supervisoryexpectationsfortheindependentassessmentofinternalcontrolsystemsbyinternalauditorotherindependentfunctionwerewell-establishedpriortothecrisis. • Assuch,thisisanareathatdemonstratedrelativelysoundpracticesacrosstheFSBmembershipatbothnationalauthoritiesandfirms. • However,nojurisdictionhadspecificexpectationsforinternalaudittoperiodicallyprovideafirm-wideassessmentofriskmanagementorriskgovernanceprocesses. • Nearlyallfirmshaveanindependentchiefauditexecutive(CAE)whoreportsadministrativelytotheCEOandtheauditcommitteechairandwhodirectlyreportsauditfindingstoapermanentauditcommittee. • However,thereisstillroomforimprovingtheCAE’saccesstodirectorsbeyondthoseontheauditcommittee. • Drawingfromthefindingsofthereview,includingdiscussionswithindustryorganisationsaswellasriskcommitteedirectorsandCROsofseveralfirmsthatparticipatedinthereview,thereportidentifiessomeofthebetterpracticesexemplifiedbynationalauthoritiesandfirmstocollectivelyformalistofsoundriskgovernancepractices(seeSectionV). • Italsodrawsonsomeoftherelevantprinciplesandrecommendationsforriskgovernancepublishedbyotherorganisationsandstandardsettingbodies. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  17. P age |17 • Noonesingleauthorityorfirm,however,demonstratedallofthesesound practices. • Thisintegratedandcoherentlistofsoundpracticesaimstohelpnational authoritiestakeamoreholisticapproachtoriskgovernance,ratherthanlookingateachfacetinisolation,andmayprovideabasisfor considerationbyauthoritiesandstandardsettingbodiesastheyreviewtheirguidanceandstandardsforstrengtheningriskgovernancepractices. • Thereviewsetsoutseveralrecommendationstoensuretheeffectivenessofriskgovernanceframeworkscontinuetoimprovebytargetingareaswheremoresubstantialworkisneeded. • Whilethereviewfocusedonbanksandbroker-dealersthataresystemicallyimportant,theserecommendationsapplytoothertypesoffinancialinstitutions,includinginsurersandfinancialconglomerates. • Recommendations: • Toensurethatfirms’riskgovernancepracticescontinuetoimprove,FSBmemberjurisdictionsshouldstrengthentheirregulatoryandsupervisoryguidanceforfinancialinstitutions,inparticularforSIFIs,and devoteadequateresources(bothinskillsandquantity)toassesstheeffectivenessofriskgovernanceframeworks. • Inparticular,nationalauthoritiesshouldconsiderthefollowingsoundriskgovernancepractices: • Setrequirementsontheindependenceandcompositionofboards,includingrequirementsonrelevanttypesofskillsthattheboard,collectively,shouldhave(e.g.,riskmanagement,financialindustryexpertise)aswellasthetimecommitmentexpected. • Holdtheboardaccountableforitsoversightofthefirm’sriskgovernanceandassessifthelevelandtypesofriskinformationprovidedtotheboardenableeffectivedischargeofboardresponsibilities. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  18. P age |18 Boardsshouldsatisfythemselvesthattheinformationtheyreceivefrommanagementandthecontrolfunctionsiscomprehensive,accurate,completeandtimelytoenableeffectivedecision-makingonthefirm’sstrategy,riskprofileandemergingrisks. Thisincludesestablishingcommunicationproceduresbetweentheriskcommitteeandtheboardandacrossotherboardcommittees,mostimportantlytheauditandfinancecommittees. SetrequirementstoelevatetheCRO’sstature,authority,andindependenceinthefirm. ThisincludesrequiringtheriskcommitteetoreviewtheperformanceandobjectivesoftheCRO,ensuringtheCROhasunfetteredaccesstotheboardandriskcommittee(includingadirectreportinglinetotheboardand/orriskcommittee),andexpectingtheCROtomeetperiodicallywithdirectorswithoutexecutivedirectorsandmanagementpresent. TheCROshouldhaveadirectreportinglinetotheCEOandadistinct rolefromotherexecutivefunctionsandbusinesslineresponsibilities(e.g.,no“dual-hatting”). Further,theCROshouldbeinvolvedinactivitiesanddecisions(fromariskperspective)thatmayaffectthefirm’sprospectiveriskprofile(e.g.,strategicbusinessplans,newproducts,mergersandacquisitions,internalcapitaladequacyassessmentprocess,orICAAP). Requiretheboard(orauditcommittee)toobtainanindependentassessmentofthedesignandeffectivenessoftheriskgovernanceframeworkonanannualbasis. Engagemorefrequentlywiththeboard,riskcommittee,auditcommittee,CEO,CRO,andotherrelevantfunctions,suchastheCFO,toassessthefirm’sriskculture(e.g.,the“toneatthetop”),whetherdirectorsprovideeffectivechallengetomanagement’sproposalsanddecisions,andwhethertheriskmanagementfunctionhastheappropriateauthoritytoinfluencedecisionsthataffectthefirm’sriskexposures. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  19. P age |19 Therelevantstandardsettingbodies(e.g.,BCBS,IAIS,IOSCO,OECD)shouldreviewtheirprinciplesforgovernance,takingintoconsiderationthesoundriskgovernancepracticeslistedinSectionV. Riskcultureplaysacriticalroleinensuringeffectiveriskgovernanceenduresthroughchangingenvironments. TheFSBSupervisoryIntensityandEffectivenessgrouphasagreedtoimplementtherecommendationfromthe2012FSBprogressreportonenhancedsupervisiontoexplorewaystoformallyassessriskculture,particularlyatG-SIFIs. ThisworkshouldbecompletedbySeptember2013. Toimprovetheirabilitytoassessfirms’progresstowardmoreeffectiveriskmanagement,nationalauthoritiesshouldprovideguidanceonthekeyelementsthatareincorporatedineffectiveriskappetiteframeworks. Toenablefirmstodefineframeworkswithaminimumamountofcomparabilitydespitetheirfirm-specificnature,acommonnomenclaturefortermsusedinriskappetitestatements(e.g.,“riskappetite”,“riskcapacity”,“risklimits”)shouldbeestablished. TheFSBSupervisoryIntensityandEffectivenessgroup,incollaborationwithrelevantstandardsetters,hasagreedtofinalisethisworkbytheendof2013. TheFSBshouldconsiderlaunchingafollow-upreviewonriskgovernanceafter2016(i.e.,aftertheG-SIFIpolicymeasuresbegintobephasedin),toassessnationalauthorities’implementationoftherecommendationstostrengthentheirsupervisoryguidanceandoversightofriskgovernance. ThereviewalsoshouldincludetheG-SIFIsidentifiedin2014bytheFSBincollaborationwiththeBCBSandIAIS. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  20. P age |20 (ImportantPart) IncreasingtheintensityandeffectivenessofsupervisiontoreducethemoralhazardposedbySIFIsisakeycomponentoftheFSB’spolicymeasures,endorsedbyG20Leaders. Sincetheonsetoftheglobalcrisis,supervisorshaveintensifiedtheiroversightoffinancialinstitutions,particularlySIFIs,soastoreducetheprobabilityoftheirfailure. Specifically,supervisoryexpectationsofriskmanagementfunctionsandoverallriskgovernanceframeworkshaveincreased,asthiswasanareathatexhibitedsignificantweaknessesinmanyfinancialinstitutionsduringtheglobalfinancialcrisis. Whilesupervisorsareresponsibleforassessingwhetherafirm’sriskgovernanceframeworkandprocessesareadequate,appropriateandeffectiveformanagingthefirm’sriskprofile,thefirm’smanagementisresponsibleforidentifyingandmanagingthefirm’srisk. InOctober2011,theFSBagreedtoconductathematicpeerreviewonriskgovernancetoassessprogresstowardenhancingpracticesatnational authoritiesandfirms(banksandbroker-dealers). Forpurposesofthisreview,riskgovernancecollectivelyreferstotheroleandresponsibilitiesoftheboard,thefirm-wideCROandriskmanagementfunction,andtheindependentassessmentoftheriskgovernanceframework(seeChart2). InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  21. P age |21 • Boardresponsibilitiesandpractices:Theboardisresponsibleforensuringthatthefirmhasanappropriateriskgovernanceframeworkgiventhefirm’sbusinessmodel,complexityandsizewhichisembeddedintothefirm’sriskculture. • Howboardsassumesuchresponsibilitiesvariesacrossjurisdictions. • Firm-wideriskmanagementfunction:TheCROandriskmanagementfunctionareresponsibleforthefirm’sriskmanagementacrosstheentireorganisation,ensuringthatthefirm’sriskprofileremainswithintheriskappetitestatement(RAS)asapprovedbytheboard. • Theriskmanagementfunctionisresponsibleforidentifying,measuring,monitoring,andrecommendingstrategiestocontrolormitigaterisks,andreportingonriskexposuresonanaggregatedand disaggregatedbasis. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  22. P age |22 -Independentassessmentoftheriskgovernanceframework:Theindependentassessmentofthefirm’sriskgovernanceframework playsacrucialroleintheongoingmaintenanceofafirm’sinternalcontrols,riskmanagementandriskgovernance. Ithelpsafirmaccomplishitsobjectivesbybringingadisciplinedapproachtoevaluateandimprovetheeffectivenessofriskmanagement,controlandgovernanceprocesses. Thismayinvolveinternalparties,suchasinternalaudit,orexternalresourcessuchasthird-partyreviewers(e.g.,auditfirms,consultants). InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  23. P age |23 GovernorDanielK.Tarullo Dodd-FrankAct BeforetheCommitteeonBanking,Housing,andUrbanAffairs,U.S.Senate,Washington,D.C. ChairmanJohnson,RankingMemberCrapo,andothermembersofthecommittee,thankyoufor theopportunitytotestifyonimplementationoftheDodd-FrankWall StreetReformandConsumerProtectionActof2010(Dodd-FrankAct). Intoday'stestimony,IwillprovideanupdateontheFederalReserve'srecent activitiespertinenttotheDodd-FrankActanddescribeourregulatoryandsupervisoryprioritiesfor2013. TheFederalReserve,inmanycasesjointlywithotherregulatoryagencies,hasmadesteadyandconsiderable progressinimplementingtheCongressionalmandatesintheDodd-FrankAct,thoughobviouslysomeworkremains. Throughoutthiseffort,theFederalReservehasmaintainedafocuson financialstability. Intheprocessofruledevelopment,wehaveplacedparticularemphasisonmitigatingsystemicrisks. Thus,amongotherthings,wehaveproposedvaryingtheapplicationoftheDodd-FrankAct'sspecialprudentialrulesbasedontherelativesizeandcomplexityofregulatedfinancialfirms. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  24. P age |24 Thisfocusonsystemicriskisalsoreflectedinourincreasinglysystematicsupervisionofthelargestbankingfirms. RecentRegulatoryReformMilestones Strongbankcapitalrequirements,whilenotalonesufficienttoguaranteethesafetyandsoundnessofourbankingsystem,arecentraltopromotingtheresiliencyofbankingfirmsandthefinancialsectorasawhole. Capitalprovidesacushiontoabsorbafirm'sexpectedandunexpectedlosses,helpingtoensurethatthoselossesarebornebyshareholdersratherthantaxpayers. Thefinancialcrisisrevealed,however,thattheregulatorycapitalrequirementsforbankingfirmswerenotsufficientlyrobust. Italsoconfirmedthatnosinglecapitalmeasureadequatelycapturesabankingfirm'srisksofcreditandtradinglosses. Agoodbitofprogresshasnowbeenmadeinstrengtheningandupdatingtraditionalcapitalrequirements,aswellasdevisingsomecomplementarymeasuresforlargerfirms. Asyouknow,inDecember2010theBaselCommitteeonBankingSupervision(BaselCommittee)issuedtheBaselIIIpackageofreformstoitsframeworkforminimumcapitalrequirements,supplementinganearliersetofchangesthatincreasedrequirementsforimportantclassesoftradedassets. Lastsummer,theFederalReserve,theOfficeoftheComptrolleroftheCurrency(OCC),andtheFederalDepositInsuranceCorporation(FDIC)issuedforcommentasetofproposalstoimplementtheBaselIIIcapitalstandardsforalllarge,internationallyactiveU.S.bankingfirms. Inaddition,theproposalswouldapplyrisk-basedandleveragecapitalrequirementstosavingsandloanholdingcompaniesforthefirsttime. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  25. P age |25 TheproposalsalsowouldmodernizeandharmonizetheexistingregulatorycapitalstandardsforallU.S.bankingfirms,whichhavenotbeencomprehensivelyupdatedsincetheirintroductiontwenty-fiveyearsago,andincorporatecertainnewlegislativeprovisions,including elementsofsections171and939AoftheDodd-FrankAct. TohelpensurethatallU.S.bankingfirmsmaintainstrongcapitalpositions,theBaselIIIproposalswouldintroduceanewcommonequitycapitalrequirement,raisetheexistingtier1capitalminimumrequirement,implementacapitalconservationbufferontopoftheregulatoryminimums,andintroduceamorerisk-sensitivestandardizedapproachforcalculatingrisk-weightedassets. Large,internationallyactivebankingfirmsalsowouldbesubjecttoasupplementaryleverageratioandacountercyclicalcapitalbufferandwouldfacehighercapitalrequirementsforderivativesandcertainothercapitalmarketsexposurestheyhold. Takentogether,theseproposalsshouldmateriallyreducetheprobabilityoffailureofU.S.bankingfirms--particularlytheprobabilityoffailureofthelargest,mostcomplexU.S.bankingfirms. InOctober2012,theFederalReservefinalizedrulesimplementingstresstestingrequirementsundersection165oftheDodd-FrankAct. Consistentwiththestatute,therulesrequireannualsupervisorystresstestsforbankholdingcompanieswith$50billionormoreinassetsandanynonbankfinancialcompaniesdesignatedbytheFinancialStabilityOversightCouncil(Council). Therulesalsorequirecompany-runstresstestsforabroadersetof regulatedfinancialfirmsthathave$10billionormoreinassets. ThenewDodd-FrankActsupervisorystresstestrequirementsaregenerallyconsistentwiththestressteststhattheFederalReservehasbeenconductingonthelargestU.S.bankholdingcompaniessincetheSupervisoryCapitalAssessmentPrograminthespringof2009. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  26. P age |26 ThestresstestsallowsupervisorstoassesswhetherfirmshaveenoughcapitaltoweatherasevereeconomicdownturnandcontributetotheFederalReserve'sabilitytomakeassessmentsoftheresilienceoftheU.S.bankingsystemunderadverseeconomicscenarios. Thestresstestsareanintegralpartofourcapitalplanrequirement,which providesastructuredwaytomakehorizontalevaluationsofthecapitalplanningabilitiesoflargebankingfirms. TheFederalReservealsoissuedinDecemberoflastyearaproposaltoimplementenhancedprudentialstandardsandearlyremediationrequirementsforforeignbanksundersections165and166ofthe Dodd-FrankAct. TheproposalisgenerallyconsistentwiththesetofstandardspreviouslyproposedforlargeU.S.bankholdingcompanies. TheproposalgenerallywouldrequireforeignbankswithalargeU.S.presencetoorganizetheirU.S.subsidiariesunderasingleintermediateholdingcompanythatwouldserveasaplatformforconsistentsupervisionandregulation. TheU.S.intermediateholdingcompaniesofforeignbankswouldbesubjecttothesamerisk-basedcapitalandleveragerequirementsasU.S.bankholdingcompanies. Inaddition,U.S.intermediateholdingcompaniesandtheU.S.branchesandagenciesofforeignbankswithalargeU.S.presencewouldberequiredtomeetliquidityrequirementssimilartothoseapplicabletolargeU.S.bankholdingcompanies. Theproposalsrespondtofundamentalchangesinthescopeandscaleof foreignbankactivitiesintheUnitedStatesinthelastfifteenyears. TheywouldincreasetheresiliencyandresolvabilityoftheU.S.operationsofforeignbanks,helpprotectU.S.financialstability,andpromotecompetitiveequityforalllargebankingfirmsoperatingintheUnitedStates. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  27. P age |27 ThecommentperiodforthisproposalclosesattheendofMarch. Prioritiesfor2013 TheFederalReserve'ssupervisoryandregulatoryprogramin2013willconcentrateonfourtasks: ContinuingkeyDodd-FrankActandBaselIIIregulatoryimplementationwork; Furtherdevelopingsystematicsupervisionoflargebankingfirms; Improvingtheresolvabilityoflargebankingfirms;and Reducingsystemicriskintheshadowbankingsystem. CarryingForwardtheKeyDodd-FrankActandBaselIIIRegulatoryImplementationWork Capital,Liquidity,andOtherPrudentialRequirementsforLargeBankingFirms. Giventhecentralityofstrongcapitalstandards,atopprioritythisyearwillbetoupdatethebankregulatorycapitalframeworkwithafinalruleimplementingBaselIIIandtheupdatedrulesforstandardized risk-weightedcapitalrequirements. Thebankingagencieshavereceivedmorethan2,000commentsontheBaselIIIcapitalproposal. Manyofthecommentshavebeendirectedatcertainfeaturesoftheproposedruleconsideredespeciallytroublingbycommunityandsmallerregionalbanks,suchasthenewstandardizedriskweightsformortgagesandthetreatmentofunrealizedgainsandlossesoncertaindebtsecurities. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  28. P age |28 Thesecriticismsunderscorethedifficultyinfashioningstandardizedrequirementsapplicabletoallbanksthatbalancerisksensitivitywiththeneedtoavoidexcessivecomplexity. Here,though,Ithinkthereisawidespreadviewthattheproposedruleerredonthesideoftoomuchcomplexity. Thethreebankingagenciesarecarefullyconsideringtheseandallcommentsreceivedontheproposalandhopetofinalizetherulemakingthisspring. TheFederalReservealsointendstoworkthisyeartowardfinalizationofitsproposalstoimplementtheenhancedprudentialstandardsandearlyremediationrequirementsforlargebankingfirmsundersections165and166oftheDodd-FrankAct. Aspartofthisprocess,weintendtoconductshortlyaquantitativeimpactstudyofthesingle-counterpartycreditlimitselementoftheproposal. Oncefinalized,thesecomprehensivestandardswillrepresentacorepartofthenewregulatoryframeworkthatmitigatesrisksposedbysystemicallyimportantfinancialfirmsandoffsetsanybenefitsthatthesefirmsmaygainfrombeingperceivedas"toobigtofail." Wealsoanticipateissuingnoticesofsomeimportantproposedrulemakingsthisyear. TheFederalReservewillbeworkingtoproposearisk-basedcapitalsurchargeapplicabletosystemicallyimportantbankingfirms. ThisrulemakingwillimplementforU.S.firmstheapproachtoasystemicsurchargedevelopedbytheBaselCommittee,whichvariesinmagnitudebasedonthemeasureofeachfirm'ssystemicfootprint. FollowingthepassageoftheDodd-FrankAct,whichcalledforenhancedcapitalstandardsforsystemicallyimportantfirms,theFederalReservejoinedwithsomeotherkeyregulatorsfromaroundtheworldin InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  29. P age |29 successfullyurgingtheBaselCommitteetoadoptarequirementofthissortforallfirmsofglobalsystemicimportance. AnotherproposedrulemakingwillcoverimplementationbythethreefederalbankingagenciesoftherecentlycompletedBaselIIIquantitativeliquidityrequirementsforlargeglobalbanks. Thefinancialcrisisexposeddefectsintheliquidityriskmanagementoflargefinancialfirms,especiallythosewhichreliedheavilyonshort-termwholesalefunding. Thesenewrequirementsincludetheliquiditycoverageratio(LCR),whichisdesignedtoensurethatafirmhasasufficientamountofhighqualityliquidassetstowithstandaseverestandardizedliquidityshockovera30-dayperiod. TheFederalReserveexpectsthattheU.S.bankingagencieswillissueaproposalin2013toimplementtheLCRforlargeU.S.bankingfirms. TheBaselIIIliquiditystandardsshouldmateriallyimprovetheliquidityriskprofilesofinternationallyactivebanksandwillserveasakeyelementoftheenhancedliquiditystandardsrequiredundertheDodd-FrankAct. VolckerRule,SwapsPush-out,andRiskRetention. Section619oftheDodd-FrankAct,knownasthe"Volckerrule,"generallyprohibitsabankingentityfromengaginginproprietarytradingoracquiringanownershipinterestin,sponsoring,orhavingcertainrelationshipswithahedgefundorprivateequityfund. InOctober2011,thefederalbankingagenciesandtheSecuritiesandExchangeCommissionsoughtpubliccommentonaproposaltoimplementtheVolckerrule. TheCommodityFuturesTradingCommissionsubsequentlyissuedasubstantiallysimilarproposal. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  30. P age |30 Therulemakingagencieshavespentthepastyearcarefullyanalyzingthenearly19,000publiccommentsontheproposalandhavemadesignificantprogressincraftingafinalrulethatisfaithfultothelanguageofthestatuteandmaximizesbanksafetyandsoundnessandfinancialstabilityattheleastcosttotheliquidityofthefinancialmarkets,creditavailability,andeconomicgrowth. Section716oftheDodd-FrankActgenerallyprohibitstheprovisionof federalassistance,suchasFDICdepositinsuranceorFederalReservediscountwindowcredit,toswapdealersandmajorswapparticipants. TheFederalReserveiscurrentlyworkingwiththeOCCandtheFDICtodevelopaproposedrulethatwouldprovideclarityonhowandwhenthesection716requirementswouldapplytoU.S.insureddepositoryinstitutionsandtheiraffiliatesandtoU.S.branchesofforeignbanks. Weexpecttoissueguidanceontheimplementationofsection716beforetheJuly21,2013,effectivedateoftheprovision. Toimplementtheriskretentionrequirementsinsection941oftheDodd-FrankAct,theFederalReserve,alongwithotherfederalregulatory agencies,issuedinMarch2011aproposalthatgenerallywouldforcesecuritizationsponsorstoretainatleast5percentofthecreditriskoftheassetsunderlyingasecuritization. Theagencieshavereviewedthesubstantialvolumeofcommentsontheproposalandthedefinitionofaqualifiedmortgageintherecentfinal"ability-to-pay"ruleoftheConsumerFinancialProtectionBureau(CFPB). Asyouknow,theCFPB'sdefinitionofqualifiedmortgageservesasthefloorforthedefinitionofexemptqualifiedresidentialmortgagesintheriskretentionframework. Theagenciesareworkingcloselytogethertodeterminenextstepsintheriskretentionrulemakingprocess,withaviewtowardcraftingadefinitionofaqualifiedresidentialmortgagethatisconsistentwiththelanguage InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  31. P age |31 andpurposesofthestatuteandhelpsensurearesilientmarketforprivate-labelmortgage-backedsecurities. ImprovingSystematicSupervisionofLargeBankingFirms Giventheriskstofinancialstabilityexposedbythefinancialcrisis,theFederalReservehasreorienteditssupervisoryfocustolookmorebroadlyatsystemicrisksandhasstrengtheneditsmicro-prudentialsupervisionoflarge,complexbankingfirms. WithintheFederalReserve,theLargeInstitutionSupervisionCoordinatingCommittee(LISCC)wassetuptocentralizethesupervisionoflargebankingfirmsandtofacilitatetheexecutionofhorizontal,cross-firmanalysisofsuchfirmsonaconsistentbasis. TheLISCCincludesseniorstafffromvariousdivisionsoftheBoardandfromtheReserveBanks. Itfostersinterdisciplinarycoordination,usingquantitativemethodstoevaluateeachfirmindividually,relativetootherlargefirms,andaspartofthefinancialsystemasawhole. OnemajorsupervisoryexerciseconductedbytheLISCCeachyearisaComprehensiveCapitalAnalysisandReview(CCAR)ofthelargestU.S.bankingfirms. Buildingonsupervisoryworkcomingoutofthecrisis,CCARwasestablishedtoensurethateachofthelargestU.S.bankholdingcompanies Hasrigorous,forward-lookingcapitalplanningprocessesthateffectivelyaccountfortheuniquerisksofthefirmand Maintainssufficientcapitaltocontinueoperationsthroughouttimesofeconomicandfinancialstress.CCAR,whichusestheannualstresstestasakeyinput,enablestheFederalReservetomakeacoordinated,horizontalassessmentoftheresilienceandcapitalplanningabilitiesof InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  32. P age |32 thelargestbankingfirmsand,indoingso,createscloserlinkagebetweenmicro-prudentialandmacro-prudentialsupervision. LargebanksupervisionattheFederalReservewillincludemoreofthesesystematic,horizontalexercises. ImprovingtheResolvabilityofLargeBankingFirms Oneimportantgoalofpost-crisisfinancialreformhasbeentocountertoo-big-to-failperceptionsbyreducingtheanticipateddamagetothefinancialsystemandeconomyfromthefailureofamajorfinancialfirm. Tothisend,theDodd-FrankActcreatedtheOrderlyLiquidationAuthority(OLA),amechanismdesignedtoimprovetheprospectsforanorderlyresolutionofasystemicfinancialfirm,andrequiredalllargebankholdingcompaniestodevelop,andsubmittosupervisors,resolution plans. Certainothercountriesthatarehometolarge,globallyactivebankingfirmsareworkingalongroughlyparallellines. TheBaselCommitteeandtheFinancialStabilityBoardhavedevotedconsiderableattentiontotheorderlyresolutionobjectivebydevelopingnewstandardsforstatutoryresolutionframeworks,firm-specificresolutionplanning,andcross-bordercooperation. Althoughmuchworkremainstobedonebyallcountries,the Dodd-FrankActreformshavegenerallyputtheUnitedStatesaheadofitsglobalpeersontheresolutionfront. SincethepassageoftheDodd-FrankAct,theFDIChasbeendevelopingasingle-point-of-entrystrategyforresolvingsystemicfinancialfirmsundertheOLA. AsexplainedbytheFDIC,thisstrategyisintendedtoeffecta creditor-fundedholdingcompanyrecapitalizationofthefailedfinancialfirm,inwhichthecriticaloperationsofthefirmcontinue,but InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  33. P age |33 shareholdersandunsecuredcreditorsabsorbthelosses,culpablemanagementisremoved,andtaxpayersareprotected. KeytotheabilityoftheFDICtoexecutethisapproachistheavailabilityofsufficientamountsofunsecuredlong-termdebttosupplementequityinprovidinglossabsorptioninafailedfirm. InconsultationwiththeFDIC,theFederalReserveisconsideringthemeritsofaregulatoryrequirementthatthelargest,mostcomplexU.S.bankingfirmsmaintainaminimumamountoflong-termunsecureddebt. Aminimumlong-termdebtrequirementcouldlendgreaterconfidencethatthecombinationofequityownersandlong-termdebtholderswould besufficienttobearalllossesattheconsolidatedfirm,therebycounteractingthemoralhazardassociatedwithtaxpayerbailoutswhileavoidingdisorderlyfailures. ReducingSystemicRiskintheShadowBankingSystem MostofthereformsIhavediscussedareaimedataddressingsystemicriskposedbyregulatedbankingorganizations,andallinvolveactiontheFederalReservecantakeunderitscurrentauthorities. Importantasthesemeasuresare,however,itisworthrecallingthatthetriggerfortheacutephaseofthefinancialcrisiswastherapidunwindingoflargeamountsofshort-termfundingthathadbeenmadeavailabletofirmsnotsubjecttoconsolidatedprudentialsupervision. Today,althoughsomeofthemostfragileinvestmentvehiclesandinstrumentsthatwereinvolvedinthepre-crisisshadowbankingsystemhavedisappeared,non-depositshort-termfundingremainssignificant. Insomeinstancesitinvolvesprudentiallyregulatedfirms,directlyorindirectly. Inothersitdoesnot. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  34. P age |34 Thekeyconditionoftheso-called"shadowbankingsystem"thatmakesitofsystemicconcernisitssusceptibilitytodestabilizingfundingruns,somethingthatismorelikelywhentherecipientsoftheshort-termfundingarehighlyleveraged,engageinsubstantialmaturitytransformation,orboth. Manyofthekeyissuesrelatedtoshadowbankingandtheirpotentialsolutionsarestillbeingdebateddomesticallyandinternationally. U.S.andglobalregulatorsneedtotakeahard,comprehensivelookatthesystemicriskspresentinwholesaleshort-termfundingmarkets. AnalysisoftheappropriatewaystoaddressthesevulnerabilitiescontinuesasaprioritythisyearfortheFederalReserve. Intheshortterm,though,thereareseveralkeystepsthatshouldbetakenwithrespecttoshadowbankingtoimprovetheresilienceofourfinancialsystem. First,theregulatoryandpublictransparencyofshadowbankingmarkets,especiallysecuritiesfinancingtransactions,shouldbeincreased. Second,additionalmeasuresshouldbetakentoreducetheriskofrunson moneymarketmutualfunds. TheCouncilrecentlyproposedasetofseriousreformoptionstoaddressthestructuralvulnerabilitiesinmoneymarketmutualfunds. Third,weshouldcontinuetopushtheprivatesectortoreducetherisksinthesettlementprocessfortri-partyrepurchaseagreements. Althoughanindustry-ledtaskforcemadesomeprogressontheseissues,theFederalReserveconcludedthatimportantproblemswerenotlikelytobesuccessfullyaddressedinthisprocessandhasbeenusingsupervisoryauthorityoverthepastyeartopressforfurtherandfasteractionbytheclearingbanksandthedealeraffiliatesofbankholdingcompanies. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  35. P age |35 Theamountofintradaycreditbeingprovidedbytheclearingbanksinthetri-partyrepomarkethasbeenreducedandisscheduledtobereducedmuchfurtherinthecomingyearsasaresultoftheseefforts. Butvulnerabilitiesinthismarketremainaconcern,andaddressingthesevulnerabilitieswillrequirethecooperationofthebroadarrayofparticipantsinthismarketandtheirfederalregulators. TheFederalReservewillcontinuetoreporttoCongressandpubliclyon progressmadetoaddresstherisksinthetri-partyrepomarket. Inadditiontotheseconcretestepstoaddressconcreteproblems,regulatorsmustcontinuetocloselymonitortheshadowbankingsectorandbewaryofsignsthatexcessiveleverageandmaturitytransformationaredevelopingoutsideofthebankingsystem. Conclusion Thefinancialregulatoryarchitectureisstrongertodaythanitwasintheyearsleadinguptothecrisis,butconsiderableworkremainstocompleteimplementationoftheDodd-FrankActandthepost-crisisglobalfinancialreformprogram. Overthecomingyear,theFederalReservewillbeworkingwithotherU.S.financialregulatoryagencies,andwithforeigncentralbanksandregulators,toproposeandfinalizeanumberofongoinginitiatives. Inthisendeavor,ourgoalistopreservefinancialstabilityattheleastcosttocreditavailabilityandeconomicgrowth. Wearefocusedonthemonitoringofemergingsystemicrisks,reducingtheprobabilityoffailureofsystemicfinancialfirms,improvingthe resolvabilityofsystemicfinancialfirms,andbuildingupbuffersthroughoutthefinancialsystemtoenablethesystemtoabsorbshocks. Aswetakethisworkforward,itisimportanttorememberthatpreventingafinancialcrisisisnotanendinitself. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  36. P age |36 Financialcrisesareprofoundlydebilitatingtotheeconomicwell-beingofthenation. Thankyouforyourattention.Iwouldbepleasedtoansweranyquestionsyoumighthave. Notes DanielK.TarullotookofficeonJanuary28,2009,tofillanunexpiredtermendingJanuary31,2022. PriortohisappointmenttotheBoard,Mr.TarullowasProfessorofLawatGeorgetownUniversityLawCenter,wherehetaughtcoursesin internationalfinancialregulation,internationallaw,andbankinglaw. PriortojoiningtheGeorgetownLawfaculty,Mr.TarulloheldseveralseniorpositionsintheClintonadministration. From1993to1998,Mr.Tarulloserved,successively,asAssistantSecretaryofStateforEconomicandBusinessAffairs,DeputyAssistanttothePresidentforEconomicPolicy,andAssistanttothePresidentforInternationalEconomicPolicy.HealsoservedasaprincipalonboththeNationalEconomicCouncilandtheNationalSecurityCouncil.From1995to1998,Mr.TarulloalsoservedasPresidentClinton'spersonalrepresentativetotheG7/G8groupofindustrializednations. Mr.TarullowasborninNovember1952inBoston,Massachusetts.HereceivedhisA.B.fromGeorgetownUniversityin1973andhisM.A.fromDukeUniversityin1974.In1977,Mr.TarulloreceivedhisJ.D.(summacumlaude)fromtheUniversityofMichiganLawSchool,whereheservedasArticleandBookReviewEditoroftheMichiganLawReview. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  37. P age |37 InterviewwithCarlosMontalvo,ExecutiveDirectorofEIOPA,conductedbyGarryBooth,Reactionsmagazine(theUK) CanyouexplainwhattheinterimSolvencyIImeasures,sometimesknownasSolvency1.5, encompass? PerhapsIshouldstartwithadisclaimer:IthinkthenameSolvency1.5isunfortunate. WearenotbuildingfromSolvencyI,wearepreparingforRiskBasedSupervision. EIOPAwillissueGuidelinesaddressedtonationalsupervisorsonhowtoproceedintheinterimphaseleadinguptoSolvencyII. TheseGuidelineswillcoverthesystemofgovernance,includingriskmanagementsystemandaforwardlookingassessmentoftheundertaking'sownrisks(basedontheORSAprinciples),pre+applicationofinternalmodels,andreportingtosupervisors. FormoreinformationyoumaywishtoconsulttheEIOPAOpiniononinterimmeasuresregardingSolvencyII: https://eiopa.europa.eu/fileadmin/tx_dam/files/publications/opinions/EIOPA_Opinion+Interim+Measures+Solvency+II.pdf InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  38. P age |38 DoestheproposalhaveacceptanceamongEUcountrysupervisors?Willeveryonemoveforwardtogether? TheabovementionedOpinionofEIOPAwasfirstwelcomed,andthenapprovedbytheEIOPABoardofSupervisors,whichconsistsofthenationalsupervisoryauthoritiesoftheEUMemberStates. EIOPAexpectsthatallourBoardofSupervisorsmembersarecommittedtosetthegroundstodevelopaconsistentandconvergentsupervisoryapproachwithrespecttothepreparationofSolvencyII. EIOPA'sGuidelineswillensurethatimportantaspectsofthenewregimewillbephasedin,takingintoaccountdueproportionality. However,bynaturetheseInterimGuidelinesaresoftregulation(i.e.usedonasocalled"ComplyorExplainbasis"),sotherewillbenosanctionsifsomeNationalSupervisoryAuthorities(NSAs)donotfullycomplywiththeGuidelinesatthisstage. Whyhaveyoudecidedtoissueguidelines(Spring2013)?What'sintheguidelines? IntheabsenceofafinalagreementonSolvencyIIinthescheduledtimeline,EIOPAhasexpressedanopinioninordertoensureandenhancesoundriskbasedsupervisionandpreparetheindustryforthefinalSolvencyIIDirective. InsteadofreachingconsistentandconvergentsupervisionintheEU,differentnationalsolutionsmayemergetothedetrimentofagoodfunctioninginternalmarket. InordertoavoidthisscenarioEIOPAdecidedtodevelopguidelinesandtotakealeadinthepreparatoryprocessaimedataconsistentandconvergentapproachwithrespecttothepreparationofSolvencyII. EIOPAGuidelineswillallowsupervisorsandundertakingstobebetterpreparedfortheapplicationofthenewregulatoryframework. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  39. P age |39 Tocutalongstoryshort,theguidelinesareanexcellentwayforallpartiestousetheextratimeofthedelayasawaytobebetterpreparedforimplementation. TheCROofglobalreinsurerrecentlytoldme,'Weareexperiencingeverincreasingrequirementsforinternalmodelapproval,witheachcountry carryingoutitsownassessment,withlimitedrelationtoproportionality... Thisprocessconsumesalotofresourceswithoutcreatingvalueithasevenstartedtodestroyvalue.AndthesituationmightgetevenworseuntilthefullformalimplementationofallSolvencyII'sthreepillarsin2015/16(oreven17). ItismysincerehopethatEIOPAwillhavethepowertoconvincelocalsupervisorstosticktotheoriginalintention:aprinciplebasedapproachfollowingtheprincipleofproportionality.' What'syourresponse? TherequirementsfortheuseofinternalmodelsaresetoutintheSolvencyIIDirective,andwillindeedbefurtherdevelopedintheupcomingimplementingmeasures,andEIOPAstandardsandguidelines. Suchrequirementswillhavetobefulfilledbyallundertakings(irrespectiveoftheirsize)iftheywanttouseaninternalmodelforSCR calculationsunderSolvencyII. EIOPAhasbeensupportingtheroleofInternalModelsinariskbasedframework,evenaftertheexperienceoftheBankingsector,wheremodelswhichweretooprinciplebasedhadasignificantroleinthecrisis. Thissupportshouldbeacknowledged,andtheneedtolearnfromwhathappenedaswell. EIOPArecognisesthattheusesoftheinternalmodelwillvaryfromundertakingtoundertakingandwillpointouttoNSAsthattheyhavetoassesscompliancewithrequirementsbasedonproportionality,according InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  40. P age |40 tothenature,scaleandcomplexityoftherisksandbusinessoftheundertaking. Havingsaidthat,itisfairtosaythatEIOPArecognisesthatdifferencesbetweensupervisorycultures,MemberStates'legalregimesandanumberofresourcesavailable,haveled,intheshortterm,tosomeinconsistenciesinthesupervisoryapproacheswithrespecttointernalmodelreviewsinpreapplication. Preciselybecauseofthat,whenyoulookatourWorkProgramandobjectivesfor2013onwards,youwillseethatEIOPAisbuildingaCenterofExpertiseforInternalModelsthatwillworkonenhancingconsistencyandsupportingthosesupervisorsthatmayneedhelpachievingit. There’sbeenalotofuncertaintyaroundtheimplementationdateofSolvencyII.Realistically,whenwilltheprojectbecompleted? Let’sstartwithwhatmattersmost:SolvencyIIwillbeimplemented,andthereshouldbenodoubtsaboutit. Ontheapplicationdate,weareconfidentthattheframeworkwillbeapplicablein2016thoughIcannotgiveyou100%reassurancebecausethedecisionisnotmadeattheEIOPAlevel. ThedecisionhastobemadebyagreementbetweentheEuropean Council,EuropeanParliamentandtheEuropeanCommission. IcanconfirmthatEIOPAwilldothenecessaryworktomaketheimplementationofSolvencyIIhappenonJanuary2016. Butlet’sbeclear,oncewesettlethependingissueofLongTermGuarantees,partiesmustavoidthetemptationofreopeningmoreissues. SolvencyIIisagoodframework,itwillnotbeperfectonday1,butthisshouldnotbeanobstacletostart. DrElkeKoenig,presidentoftheGermansupervisorBafinrecentlysaidofSolvencyII,“Youhavecreatedamassivelycomplexsystemwhichis InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  41. P age |41 probablyonlyfullyunderstandableforthosethathavecreatedit.”What’syourresponse? Thebasisofthesystemisquitesimple:itstrivesforriskbasedsupervisionthatincorporatestransparency,callsforaclearunderstandingofriskandgoodgovernance. Sotheideaissimplebutthewayithastobetranslatedintoaregulatoryframeworkiscomplex. SoDrKoenigisrightinthatsense. Whyisitsocomplex? Iwouldsaythatitiseverybody’sresponsibility(theregulators,theEuropeanCommission). Butinmanycasesthecomplexityisalsobeingdrivenbytheindustry. Whatcanwedotomakethingslesscomplex? Weneedtoenhancetheprincipleofproportionalitywhilebearinginmindthatthesameobjectivescanbemetindifferentwaysinparticular forthecompaniesthatarenotdoingcomplicatedbusiness,forSMEsetc. EIOPAisalsoaimingatreducingpartofthiscomplexity,withinitiativessuchasanITtoolkitforundertakingsthatcouldincludeawaytocalculatetheSCR,etc. Wedon’tjustacknowledgetheproblem,wetrytocomewithsolutions. AnotherCROtoldmethatregulatorsappeartonolongerfollowtheoriginalSolvencyIIframeworkrouteofprinciplebasedregulation. Forexample,theLevelThreeproposaltoaddacompliancefunctionandanactuarialfunction,withtheaddedrequirementthatnopersoncanbesimultaneouslyresponsibleformorethanonefunction. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  42. P age |42 ShouldSolvencyII,asaprinciplebasedregime,forcecompaniestomakesuchdepartmentalchanges? Iwassurprisedatthisquestion. TheactionstheCROrefersto,areexplicitlycapturedinthelevel1Directive(articles46and48). Thereisafullarticleontheactuarialfunction(Article48)thatcontainsnumberofrequirements. Thelevel1textisprinciplebasedandthereisasecondlevelwhichgetsintomorenittygrittydetailstodowithbestpracticearoundthecomplianceandactuarialfunctions. Buttheprincipleofproportionalityshouldalwaysbekeptinmind.Furthermore,theintentionofSolvencyIIisnottoforcecompaniestodo theirbusinessinonewayoranother. Itshouldensurethatrisksareaddressedandthatthemeanstodoso,subjecttoproportionality,areimplemented. Onthatbasiswearenotgoingtoforcecompaniestorecruitapersontobeacomplianceofficeroranythinglikethat. Whatweexpectisthattheycomplywiththeprinciplesstatedinlevels1and2–complyinasoundwaybutnotinthesamewayforallthecompanies. Someindividualsinterprettheprinciplesasprescriptivebutitisnotourintentiontotellcompanieshowtostructuretheirbusiness. Weusethewordactuarialfunctionbutfunctiondoesnotmeanperson.Soinatinycompanyyoucouldhaveanactuarialfunctionthatdoesnot havetobeperformedbya‘pure’actuarybutinsteadbysomeonewhohas strongmathematicalknowledge. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  43. P age |43 ArecountrysupervisorsstrayingfromtheoriginalSolvencyIIscript? Ourdutyistomakesurethatall27NSAsunderstandtheprincipleofriskbasedsupervisioninaconvergentwayandapplyitconsistently. Someofourmembershavetoldusthattheyneedtoenhanceriskmanagement,internalcontrols,ordisclosure. Sotheyhadsomeinternalprojectsonholdbecausetheseprojects weretobechannelledviaSolvencyII,whichisthesameforeverybody. NowSolvencyIIisnotcominginJanuary2014astheyexpectedandtheywanttomoveinthoseareas. SoexactlythenecessitytoavoidthedevelopmentofnationalsolutionswasstatedinEIOPAOpiniononInterimMeasuresRegardingSolvencyII,wherewearetalkingaboutnumberofareasforwhichtherewillbeinterimguidelinestargetedtoenhancepreparednesstowardsSolvency2. TheseGuidelinesindicatethatsupervisorsaresupportingtheoriginalideaofconvergenceandharmonization,theybelieveintheconceptofriskbasedsupervision,andEIOPAistakingtheleadtoensurethatimplementationwilltakeplaceinaconsistentway. EIOPAwantsto“pavethewayforfurthermutualunderstandingandfutureconvergencebetweentheEUandtheU.S.oninsuranceregulationandsupervision”. ButmanypeopleintheUSarguestronglyagainstconvergence.Whyisconvergenceimportantinyouropinion? Theconvergenceisimportantforouroverridingaim,whichistodevelopstrongglobalregulatoryandsupervisorystandards. ThepurposeoftheEU+USInsuranceDialogueistoenhancemutualunderstandingandcooperationaswellastopromotebusinessopportunity,consumerprotectionandeffectivesupervision. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  44. P age |44 Weremainrespectfullyawareofthecommonalitiesanddifferencesofbothregimes,continuetostrivetoaddressimportantissuesintechnicaldetail,andmay,overtime,movetowardimprovedcompatibilitythatwillbenefitinsuranceconsumers,industryparticipants,andtheeconomy. ThereisagrowingviewthatSolvencyIIwillleadtorestructuringinthere/insuranceindustrywithM&Aandconsolidationtofollow.Doyouagreethiscouldbeanunintendedconsequence? Ihavebeenhearingthisforthelast15yearsandalsooftenaskedthisquestionatconferencesbyrepresentativesofsmallercompanies. AndIusedtogivesuchanexample: IliketobuybooksandIbuymybooksinatinybookshopinMadrid.Theownerreadsalotandheknowswhatthecustomerlikesandalways givesmegreatrecommendations. IcouldbuymybooksatBarnes&NobleoratAmazon.ButaslongasIgetsuchalevelofservice[frommylittlebookshop]Iwillneverdothat. Ifsmallerinsurancecompaniesunderstandtheneeds,bringaddedvaluetotheircustomersandalsounderstandthespecificsofthebusinesstheyunderwrite,theywillsucceed. TheywillevenbenefitfromSolvencyIIbecauseitgivesthemtheright incentivestohavebetterriskmanagement. Asforcompaniesthataresubjectedtorestructuringormergers,theywillfacesuchissuesbecausetheirproblemsarerelatedtoglobalisationand nottoSolvencyII. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  45. P age |45 Supervisoryguidanceformanagingrisksassociatedwiththesettlementofforeignexchangetransactions ThepurposeofthisguidanceistoprovideupdatedguidancetosupervisorsandthebankstheysuperviseonapproachestomanagingtherisksassociatedwiththesettlementofFXtransactions. Thisguidanceexpandson,andreplaces,theBCBS'sSupervisoryguidanceformanagingsettlementriskinforeignexchangetransactionspublishedinSeptember2000. SincetheBCBS'sSupervisoryguidanceformanagingsettlementriskinforeignexchangetransactions(2000)waspublished,theforeignexchangemarkethasmadesignificantstridesinreducingtherisksassociatedwiththesettlementofFXtransactions. SubstantialFXsettlement-relatedrisksremain,however,notleastbecauseoftherapidgrowthinFXtradingactivities. Thedocumentprovidesamorecomprehensiveanddetailedviewongovernancearrangementsandthemanagementofprincipalrisk,replacementcostriskandallotherFXsettlement-relatedrisks. Inaddition,itpromotestheuseofpayment-versus-paymentarrangements,wherepracticable,toreduceprincipalrisk. Theguidanceisorganizedintoseven"guidelines"thataddressgovernance,principalrisk,replacementcostrisk,liquidityrisk,operationalrisk,legalrisk,andcapitalforFXtransactions. Thekeyrecommendationsemphasizethefollowing: InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  46. P age |46 AbankshouldensurethatallFXsettlement-relatedrisksareeffectivelymanagedandthatitspracticesareconsistentwiththoseusedformanagingothercounterpartyexposuresofsimilarsizeandduration. AbankshouldreduceitsprincipalriskasmuchaspracticablebysettlingFXtransactionsthroughtheuseofFMIsthatprovidePVParrangements. WherePVPsettlementisnotpracticable,abankshouldproperlyidentify,measure,controlandreducethesizeanddurationofitsremainingprincipalrisk. Abankshouldensurethatwhenanalysingcapitalneeds,allFXsettlement-relatedrisksshouldbeconsidered,includingprincipalrisk andreplacementcostriskandthatsufficientcapitalisheldagainstthesepotentialexposures,asappropriate. Abankshouldusenettingarrangementsandcollateralarrangementstoreduceitsreplacementcostriskandshouldfullycollateraliseits mark-to-marketexposureonphysicallysettlingFXswapsandforwardswithcounterpartiesthatarefinancialinstitutionsandsystemicallyimportantnon-financialentities. Annex FXsettlement-relatedrisksandhowtheyarise 1.IntheperiodbetweenFXtradeexecutionandfinalsettlement,abankisexposedtoanumberofdifferentrisks. Therisksvarydependingonthetypeofpre-settlementandsettlementarrangements. AbankneedstounderstandtherisksassociatedwithFXtransactionsinordertoadequatelymanagethem. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  47. P age |47 SectionAdescribesprincipalrisk,replacementcostriskandliquidityrisk.SectionBidentifiesanddescribesthepresenceofoperationalandlegalrisksbetweentradeexecutionandfinalsettlement. Finally,SectionCdiscussesthevariouspre-settlementandsettlementarrangementsandtheirimpactonrisks. Forthepurposesofexposition,therisksaredescribedfromthepointofviewof“abank”andafailedFX“counterparty”ofthatbank.SectionAdescribestherisksrelatingtoasingleFXtradebetweenabankanditscounterparty. ThisisgeneralisedtomultipletradesinSectionsBandC. A.Risksrelatingtocounterpartyfailuretodelivertheexpectedcurrency ThethreemainrisksassociatedwithFXtransactionsareprincipalrisk,replacementcostriskandliquidityrisk,whichariseduetothepossibilitythatacounterpartymayfailtosettleanFXtrade. Thisfailuremaybetemporary(egoperationalorliquidityproblemsofthecounterparty)orpermanent(egcounterparty’sinsolvency). Abankmaybecomeawareofapotentialfailureatanytimebetweentradingandthecompletionofsettlement,particularlyiftheproblemisduetoinsolvency. However,sometimes,abankmayonlyknowthataproblemhasoccurredonoraftersettlementdaywhenitdoesnotreceivethecurrencythatthecounterpartywasexpectedtodeliver. Initially,abankmaynotbeabletoidentifythecauseofthefailure,nordeterminewhetherthefailureistemporaryorpermanent. Abankisexposedtoprincipalrisk,replacementcostriskandliquidityriskuntilitreceivestheboughtcurrencywithfinality. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  48. P age |48 Principalrisk Principalriskistheriskthatabankpaysawaythecurrencybeingsold,butfailstoreceivethecurrencybeingbought. Principalriskcanbethemostseriousriskbecausetheamountatriskcan beequaltothefullvalueofthetrade. Principalriskexistswhenabankisnolongerguaranteedthatitcan unilaterallycancelthepaymentofthecurrencyitsold(theunilateral cancellationdeadline). Giventhatabank’sunilateralpaymentcancellationdeadlinemaybeoneormorebusinessdaysbeforethesettlementdate,thisriskcanlastforasignificantperiodoftime. Replacementcostrisk ReplacementcostriskistheriskthatanFXcounterpartywilldefaultbeforeatradehassettledandthatthebankmustreplaceitwithanewtradeandadifferentcounterpartyatcurrentmarketprices(potentiallylessfavourableexchangerate). Assuch,thebankmayincuralossrelativetotheoriginaltrade.Replacementcostriskexiststhroughouttheperiodbetweentradeexecutionandfinalsettlement. Liquidityrisk Liquidityriskistheriskthatacounterpartywillnotsettleanobligationforfullvaluewhendue. Liquidityriskdoesnotimplythatacounterpartyisinsolventsinceitmaybeabletosettletherequireddebitobligationsatsomeunspecifiedlatertime. Liquidityriskexistsinadditiontoreplacementcostrisk. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  49. P age |49 • Whetheradefaultisjustareplacementcostproblemorturnsintoaliquidityshortagedependsonwhetherabankcanreplacethefailedtradeintimetomeetitsobligationsor,atleast,toborrowthenecessarycurrencyuntilitcanreplacethetrade. • Inprinciple,liquidityriskcanexistthroughouttheperiodbetweentrade executionandfinalsettlement. • Inpractice,theprobabilityoftheproblemmaterialisingasaliquidityshortageandareplacementcostdependsonmanyfactors,including: • Thetimingofthedefault.Thecloserthedefaultistothesettlementdate,thelesstimeabankhastomakeotherarrangements. • Whetherabankhasalreadyirrevocablypaidawaythecurrencyitisselling.Ifso,thebankmayhavefewerliquidassetsavailabletopayforthereplacementtradeortouseascollateraltoborrowthecurrencyitneeds. • Thenatureofthetrade.Thelessliquidthecurrencybeingpurchasedand/orthelargerthevalueofthetrade,theharderitmaybetoreplace. • 11.Abankmayfindithardtopredicttheprobabilityofaliquidityshortage,asitcannotmakeasoundjudgmentbasedsolelyonnormalmarketconditions. • However,thereisastrongpositivecorrelationbetweenacounterpartydefaultandilliquidmarkets(iethedefaultmaybethecauseofthemarketilliquidityoraneffectofit). • Inaddition,tradesthatareeasytoreplaceinnormalconditionsmaybeimpossibletoreplacewhenmarketsarelessliquidandexperiencingstressedconditions. • B.Operationalandlegalrisks • 12.AbankmayalsofaceFXsettlement-relatedriskscausedbyweaknessesinitsownoperationsandweaknessesinthelegal InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

  50. P age |50 enforceabilityofcontractualtermsandthegoverninglawapplicabletoitstransactions. Ifabankhasinadequateoperationalcapabilitiesorifthereareweaknessesinthelegalbasisforthepre-settlementandsettlementarrangements,itcanfaceincreasedprincipalrisk,replacementcostriskandliquidityriskrelatingtocounterpartyfailure. Operationalriskistheriskoflossduetoexternaleventsorinadequateorfailedinternalprocesses,peopleandsystems. Thisdefinitionincludeslegalriskandexcludesstrategicandreputationalrisk. Inadequateskillsandinsufficientprocessingcapacitymayincreasepotentialexposures. Theseweaknessescancauseoperationaldelays,inaccurateconfirmationandreconciliation,oraninabilitytoquicklycorrectorcancelpayment instructions. Legalriskoccurswhenacounterparty’scontractualFXobligationsarenon-binding,unenforceableandsubjecttolossbecause: Theunderlyingtransactiondocumentationisinadequate; Thecounterpartylackstherequisiteauthorityorissubjecttolegaltransactionrestrictions; Theunderlyingtransactionorcontractualtermsareimpermissibleand/orconflictwithapplicablelaworregulatorypolicies;or Applicablebankruptcyorinsolvencylawslimitoraltercontractualremedies. 16.Legalproblemsmayaffectsettlementofaforeignexchangetransaction. InternationalAssociationofRiskandComplianceProfessionals(IARCP) www.risk-compliance-association.com

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