Grant Thornton Banking Regulation: unravelling the regulatory spaghetti - march 2014
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Transcript of Grant Thornton Banking Regulation: unravelling the regulatory spaghetti - march 2014
Banking Regulation Unravelling the regulatory spaghettiGRANT THORNTON FINANCIAL SERVICES GROUP
2 BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI
are regulatory change
initiatives
THE AVERAGE RETURN ON EQUITYfor the world’s 13 largest
investment banks
MAY FALL TO 6-9% BY 2017
More than in the second quarter of 2013
SPAN
NIN
G
PAGES
More than half of organisations have
REGULAR DUPLICATION of activity across departments
JUST OVER ONE DAY PER WEEK
Compliance officers spend on average tracking and analysing regulatory developments and amending policies and procedures
is preventing
of organisations consider that guidance and support from the regulator is inadequate
of banks consider that they are ineffective at co-ordinating individual compliance projects
REGULATORY CHANGE
79%of financial
leaders
50
3 5
from addressing their business priorities
88% of organisations
55 2300regulatory changes were issued in the US
consider that a proactive approach to compliance
can be a source of
competitive advantage
%
PROJECTS
60%
BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI 3
Introduction
Several years after the economic meltdown, banks are still struggling to navigate the waves of regulation designed to avoid further crises. The necessity to re-regulate an industry that lacked transparency was indisputable; however, what started as a global action plan soon became a puzzle of diverging national agendas.
Banking institutions currently face multiple challenges: not only are they required to comply with a torrent of incohesive rules emanating from various jurisdictions, they must also build relationships with an array of new financial supervisors. Despite a slight shift in the regulatory reform agenda from policymaking to implementation, there is still uncertainty stemming from ever-changing implementation deadlines and endlessly varying guiding principles.
It is commonly agreed that legal harmonisation would be the ideal solution for global organisations; nevertheless, owing to national socio-economic idiosyncrasies, a coordinated policy response appears unrealistic.
Although the regulatory reform has unprecedented consequences for banks’ business models, the ambivalence of most initiatives prevents effective strategic planning. Under these circumstances, adopting a reactive approach might seem the most sensible, if not the only, option. Yet, proactive institutions will gain competitive advantage through implementation synergies, subsequently limiting the strain on their financial performance.
devoted to compliance issues has increased by
50IN EUROPE
%
Management time
4 BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI
Volume of regulation
Although some might argue that banks have always faced regulatory-induced change, the recent upsurge is incomparable. Grant Thornton’s research suggests that as many as 60 legislative initiatives are currently underway in Europe for banks alone. These legislative proposals are usually supplemented by consultation papers and interminable reviews. A large amount of regulation should not typically present a challenge; nonetheless, volume is accompanied by issues harder to surmount.
While the regulatory panorama might be clearer than before, uncertainty remains the most poignant problem. Some key precepts in crucial reforms are yet to be determined. In these circumstances, defining the scope and the objectives of a stand-alone regulatory change programme is challenging. It is not unusual for the final regulation to present substantial differences from the initial proposal. Moreover, the majority of rules and guidelines are open to interpretation, which can lead to incongruent implementation.
Additionally, regulators are becoming increasingly unpredictable: in the UK, banks have had to comply with leverage ratio requirements five years before they were initially expected. On a similar note, the asset-quality review undertaken by the European Central Bank uses a Common Equity Tier 1 (CET1) ratio of 8%; which is the equivalent of requiring compliance with the Capital Requirements Regulation several years before the date originally set.
Banks face a formidable challenge: they must simultaneously catch up with rules that should have previously been implemented, keep abreast of current changes and attempt to plan for future developments. The stretch of their analysis and execution capabilities is already showing signs of hindering quality, compliant delivery.
“The regulatory
panorama remains uncertain. Defining the
scope and the objectives of a stand-alone regulatory
change programme in these circumstances is
very challenging.”
BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI 5
Global
Regional
Local
The multi-jurisdictional nature of regulatory regimes is increasing pressure on firms with a global presence to manage ever-increasing volumes of legislation and assess interdependencies, synergies and impact.
Multi-jurisdictional Regulatory Landscape
Conduct and Culture Regulatory Reform Capital and Liquidity Derivatives Trading
Bank Resilience and Stress Testing
Shadow Banking and Funds
Consumer and Investor Protection Systemic Risk Market Integrity
Compensation
DFA: Say on Pay
Liikanen
FTT
SSM
CRAs
CSDs
Banking Reform Act
Basel III
CRD 4 (CRR & CRD)
DFA Collins Amendment
COREP/FINREP
IFRS 9
BCBS Review of Securitisation
EMIR
CCPs
Dodd Frank Act: Title VII
DFA: Swaps Push Out
HFT
DFA Volcker Rule
Short Selling
JOBS
Liikanen
CCAR
ECB Stress Testing
AQR
FDSF
UCITS IV, V & VI
AIFMD
FSB review Shadow Banking
RDR
DFA Title X
MIFID II/ MIFIR
UK CASS
MCD
MMR
PRIPs
BRRD
FSB guidance on RRP
UK RRP guidance
Living Wills – DFA.II
SRM
Data Protection
FATCA
MLD4
Benchmarks
MAD/MAR
6 BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI
Multi-jurisdictional nature
In the early stages of the economic crisis, the G20 committed to launch a coordinated reform of the financial system. It was thought that, given the interconnectedness of global markets, a harmonised response was necessary. The initial consonance was short-lived; nevertheless, some broad categories can be drawn from the original guidelines.
The primary solutions regulators sought to impose can be divided in three categories: reforms seeking to enhance financial stability, structural changes that will oblige some banks to ‘ring-fence’ certain parts of their business and rules that impose higher procedural standards. Although certain legal initiatives benefit from standardised application, the majority have been ‘customised’ by national regulators.
These domestic twists, as well as the differences in scope and timing, distort competition; frequently, they result in duplication and contradiction. For instance, as Table 1 shows, the approach adopted by the US, the UK and the EU towards the structural reform of the banking sector is substantively different. The proposals were drafted independently; the lack of dialogue and interaction between the proposing bodies were the main causes of the discordant responses.
Recovery and Resolution Planning
In November 2011, the Financial Stability Board published ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’ which established a global recovery framework for banks. However, soon after, national regulators started introducing additional requirements and timelines. Host authorities are reluctant to rely on the regulatory oversight of the home country. Therefore, foreign banks are being asked to operate as subsidiaries rather than as branches, which involves complying with local standards on capital, liquidity, stress testing and risk management.
The lack of cross-border coordination not only poses fundamental structural challenges, locking capital and resources in each jurisdiction increases the cost of doing business exponentially.
BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI 7
UK Europe USRule ICB: Vickers Report Liikanen Report Dodd Frank Act: Volcker Rule,
Swap Push-OutReform objectives To separate retail banking
from investment banking to ensure the protection of retail deposits
To reduce the probability and impact of banks' failure, to ensure the continuation of vital economic functions performed by banks and to protect vulnerable retail clients
Volcker Rule was originally proposed to restrict US banks from making certain kinds of speculative investments that do not benefit their customers
Swap Push-Out aims to force risky derivative activities out of a bank into separately capitalised swap entities
Applicability A firm will be subject to the ring-fencing regime if it carries on the core activity of accepting deposits. Exemptions to the rule exist
Credit institutions that have been identified as GSIIs
Credit Institutions that have total assets amounting to at least EUR30 billion and trading assets of at least EUR70 billion or 10% of their total assets
Volcker: US banks, non-US banks registered as foreign banking institutions
Swaps: FDIC insured institutions
Ring fencing type Retail ring fence Trading entity Swaps entityActivities permitted in the deposit bank
Small amount of hedging
Trade finance, project finance
Corporate lending
Taking deposits
Financial leasing
Payment services
Issuing and administering other means of payment
Money broking, safekeeping and administration of securities
Credit reference services
Safe custody services
Issuing electronic money
Core banking activities
Certain derivatives
Activities explicitly segregated from the deposit bank
Most wholesale and investment banking activities
Proprietary trading
Certain investment activities relating to hedge funds
Proprietary trading ban
Certain types of swaps
Trading in the majority of derivative types
Banks are also affected by the proliferation of regulatory bodies: the European System of Financial Supervision (ESFS), the European Banking Authority (EBA) and the European Securities Market Authority (ESMA) are some of the new Supervisors launched in Europe. Firms need to build relationships with these institutions and comply with their multiple reporting requirements, which is stretching their often obsolete reporting capabilities.
Some regulators have started to question the effectiveness of such a complex system. The stringent nature of most of the reforms banks need to comply with is prompting a shift of traditional banking activities towards sectors that still benefit from minimal regulatory scrutiny. The Financial Stability Board acknowledges the dangers of shadow banking. Nonetheless, regulatory pressures will continue to increase for banking institutions; thus as volume, complexity and reporting obligations intensify, a proactive approach to management and mitigation will be essential.
Table 1: Regulatory approaches to ring-fencing
“Global initiatives have been
‘customised’ by national regulators. Differences in scope and timing not only distort competition, they also result in duplication
and contradiction.”
8 BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI
Impact on financial performance
The disjointed regulatory landscape is straining banks’ RoEs. Firms face multifaceted economic challenges: in addition to the colossal costs arising from dealing with multi-jurisdictional demands, banks are being prohibited from revenue generating activities. While often overlooked, the opportunity costs of diverting senior management attention from business creation can be substantial.
1Boston Consulting Group
0%
5%
10%
15%
20%
25%
30%
35%
40%
No change 1-10% 11-25% 26-50% 51-75% 76-100% 101-200%
Increase of CCOs time dedicated to legal, compliance and regulatory issues
Percentage of increase in time
Some of the most pessimistic predictions anticipate that the average Return on Equity for the world’s largest investment banks may fall to 6% – 9% by 2017 due to legal pressures1. Although measuring the economic impact of certain legal initiatives, such as capital requirements, can be relatively straightforward; firms often struggle to project the true cost of compliance. The fragmented nature of many of the regulatory change programmes only adds to the problem.
Europe
US
Source: Thomson Reuters
“Progressive organisations will embrace financial
challenges as an opportunity to initiate radical changes. An assessment of the viability of business lines and products
seems inevitable.”
BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI 9
Higher capital requirements will have a greater impact on Systemically Important Institutions, particularly those that operate across highly interconnected networks. Additionally, some of the banks’ traditional sources of revenue, such as proprietary trading, face prohibition. Others, including over-the-counter (OTC) derivatives, are anticipated to come under increasing pressure due to rules that will alter the structure of the OTC derivatives market.
Banks’ financial resources are not only being drained by the cost of future compliance. The bill for the disreputable behaviour of many institutions during ‘boom-time’ is astronomic: it is estimated that the total cost of misconduct so far for major banks amounts to $100 billion2.
The adoption of a narrow definition of regulatory costs can lead to an underestimation of their real impact on the institution’s financial performance. Despite the uncertainty surrounding global reforms, reacting to each regulation individually is certainly the most costly solution. Moreover, a ‘wait and see’ attitude will result in strategic stagnation. Progressive organisations will embrace the current financial challenges as an opportunity to initiate radical changes; an assessment of the viability of business lines and products seems inevitable. Such decisions must be based on an holistic understanding of the regulatory landscape.
-5
0
5
10
15
20
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Median RoE for selected Investment banks
2Research London School of Economics
Source: Grant Thornton research
10 BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI
Challenges faced by the compliance function
Traditionally the compliance function held a dual role: compliance officers needed to both advise management on implementation matters and give assurance to the board that the business was operating compliantly.
While compliance teams have historically owned regulatory change, they tended to operate reactively; implementing new rules individually and prioritising according to the nearest deadline.
Traditional compliance functions were not constructed to cope with the plethora of new multi-jurisdictional regulations. Moreover, in many global organisations, regulatory teams frequently operate in silos. Therefore, holistic coordination of change initiatives is an impossible task within the current operating model.
A recent survey revealed that the biggest challenge for Heads of Compliance is tracking new legal requirements and implementing them across the firm. Indeed, it appears that the volume of regulatory change, coupled with both the inauguration of implementation programmes and increasing supervisory expectations, leaves compliance officers with only one day a week to track and analyse regulatory changes. Consequently, the risks of missing an integral development have never been greater.
Typical week of a compliance officer
15%
6%
7%
16%
56%
Tracking and analysing regulatory developments
Board reporting
Amending policies and procedures
Liaison with control functions
Other compliance tasks (monitoring, training, provide advice)
Source: Thomson Reuters
BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI 11
Compliance teams are clearly over-stretched, firms do not have enough qualified staff to deal with the regulatory burden. Nevertheless, the real problem is not the lack of resources, but the fact that banks’ compliance processes have not significantly changed since the crisis, despite the radically different regulatory panorama they now face. The responsibilities for managing emerging sources of regulatory risk are unclear.
Given the increasing demands that the compliance function is facing, progressive firms need to embed a compliance risk monitoring framework within the organisation. Banks often forget that compliance is not a role exclusive to the compliance team. In order to be effective, it needs to be fully integrated into day-to-day business operations. Moreover, owing to the current strain on resources, teams within the first line of defence must understand and contribute to routine monitoring.
Compliance risk management is a collaborative process that should leverage various control functions. These challenges are not unique to compliance teams; the importance of the roles played by risk, finance and treasury functions has increased since the crisis. They now play a central part in the implementation and management of the regulatory agenda.
Regardless of how regulatory responsibilities are allocated, a collective and collaborative approach is essential to eliminate duplication. Furthermore, the establishment of a business architecture and governance model that informs and guides impacted parties will be at the heart of achieving regulatory compliance.
The growing demand for more granular levels of information is testing the limits of database technology. Banks’ IT costs represent 7.3% of their revenue, yet they still do not possess the capacity to aggregate the correct data quickly, accurately and across multiple geographies. The evolution of data management should be aligned to the firm’s operational goals and to the regulators’ demands.
Greatest challenges faced by compliance
Implementation of regulatory change
Tracking regulatory change
UK regulator changes
Sanctions
Fraud
Enforcement
Resources
Training staff
More intensive supervision
MonitoringSource: Thomson Reuters
“Compliance management is a
collaborative process that should leverage various control functions. The development of a firm-wide single view dashboard is fundamental to implementing a more proactive approach to
regulatory management.”
12 BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI
Governance and Accountability
It is generally accepted that inadequate governance, accountability and incentivisation within Financial Institutions were key contributing factors to the failure of the global banking system.
Regulators are placing particular emphasis on certain categories of risks, such as conduct. Banks’ boards need to set the tone from the top and ensure that values are appropriately communicated and understood. Still, accountability remains a significant challenge across the industry. Policy-makers consider that holding financial leaders accountable is the most powerful way to encourage the right behaviour.
In the UK, the Parliamentary Commission on Banking Standards proposed to discard the Approved Persons Regime and replace it with a Senior Managers Regime that will only cover those individuals that are, in effect, senior decision-makers. All applications to perform a Senior Manager Function will be supplemented by a ‘statement of responsibilities’ specifying all the affairs of the firm that the individual is accountable for. Furthermore, a criminal offence for ‘reckless misconduct in the management of a bank’ has been approved. Those found guilty could be sentenced to up to seven years and/or receive an unlimited fine.
It appears that regulatory pressures will prompt Financial Institutions to reconsider every aspect of today’s governance and control structures. Enhanced Management Information, escalation points and attestations will be necessary to achieve an optimal organisational structure. A clear definition of roles and responsibilities, as well as business objectives and acceptable risks will be paramount.
In order to meet the regulator’s expectations, a radical change of culture will be necessary: firms will need to ensure that their risk appetite and remuneration policies guarantee fair outcomes for customers, while simultaneously satisfying the demands of regulators and shareholders.
The influence the regulatory agenda is asserting on business strategies is profound. Consequently, top-down governance is imperative. Nevertheless, regulatory knowledge is seldom leveraged sufficiently at senior levels to inform strategic planning. Indeed, in many organisations, the pre-crisis problem of inadequate and fragmented oversight persists.
Given the interconnectedness between regulatory reform and business strategy, governance frameworks need to be strengthened to ensure the integration of the organisation’s risk appetite and strategic planning. It is essential to fortify the data and IT structures that support risk governance and business decisions.
BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI 13
Importance of a single view
Given the complicated regulatory panorama, banks’ tendency to react to regulation is not surprising. It is not unusual for banking institutions to delay implementation, the fear of being the first one to interpret and apply new rules is comprehensible.
Moreover, investment banks have traditionally focused on short-term revenues; therefore long-term planning has proved difficult to embed culturally. Nevertheless, the tendency to focus on imminent requirements often results in isolated and ineffective regulatory change initiatives.
Leading organisations must understand the importance of adopting a framework that promotes a single, firm-wide view of existing and projected reforms; a golden source of regulatory information. By recognising the impact of the rules across different business segments firms will be able to categorise, prioritise and implement regulatory initiatives successfully.
Furthermore, banks often underestimate the importance of engaging with the regulator at an early stage. An assessment of potential reforms when they are at the consultation phase can lead to effective lobbying.
For instance, the ‘Barnier Rule’ initially prohibited activities for ‘the sole purpose of making a profit for own account without actual or anticipated client activity’. Nevertheless, the rule had to be tailored to avoid a negative impact in the real economy and capital markets. Exemptions will be a relief for the industry.
As the regulatory agenda continues to evolve, the importance of a standardised and coherent firm-wide approach to regulatory requirements becomes crucial. Increasing internal awareness and understanding is a core component of establishing a culture of regulatory awareness. Moreover, a golden source of regulatory information will promote collaboration and reduce cross-functional duplication.
It is imperative that firms underpin their decision making with a reliable foundation of information from which to base strategic and commercial decisions. Establishing a more proactive and sustainable approach to regulation remains key within a flexible yet consistent operational framework.
The development of a firm-wide single view regulatory dashboard is fundamental to implementing a more proactive approach to regulatory management. Increased awareness and understanding will foster both long-term planning and a culture of regulatory responsiveness.
“Financial Institutions often underestimate the
importance of engaging with the regulator at an early stage.
An assessment of potential reforms when they are at the
consultation phase can lead to effective lobbying.”
14 BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI
Conclusion
Regulatory pressures will abide; consequently, it is imperative to change the manner in which this matter is addressed.
The multi-faceted nature of the regulatory challenges firms face requires a fully integrated operational function to proactively manage the plethora of multi-jurisdictional regulatory initiatives.
The establishment of a firm-wide single view dashboard is fundamental for the implementation of a proactive approach to regulatory management. Greater regulatory awareness and understanding will not only facilitate long-term planning, it will also ensure more effective management of impending requirements. Moreover, compliance teams will be able to focus on mandatory reporting and monitoring activities - true third-line responsibilities.
Given the influence the regulatory agenda is asserting on businesses’ strategies, expert regulatory representation at C-level is now essential. Proactive organisations that establish a solid governance framework capable of linking business and regulatory strategy will be those that succeed.
An actively managed cross-functional regulatory change portfolio and standardised impact analysis will support identification of synergies and leverage opportunities to increase implementation efficiencies. The successful implementation of Grant Thornton’s Regulatory Architecture model will reduce regulatory uncertainty and mitigate ‘regulatory unknowns’.
Despite the importance of the regulatory reform, legal initiatives should inform firms’ strategies, not dictate them. A holistic understanding of regulatory requirements will undoubtedly reduce the need to amend strategic objectives.
BANKING REGULATION UNRAVELLING THE REGULATORY SPAGHETTI 15
“Proactive organisations that establish a solid
governance framework capable of linking business
and regulatory strategy will be those that
succeed.”
© 2014 Grant Thornton UK LLP. All rights reserved.
‘Grant Thornton’ refers to the brand under which the Grant Thornton member firms provide assurance, tax and advisory services to their clients and/or refers to one or more member firms, as the context requires.
Grant Thornton UK LLP is a member firm of Grant Thornton International Ltd (GTIL). GTIL and the member firms are not a worldwide partnership. GTIL and each member firm is a separate legal entity. Services are delivered by the member firms. GTIL does not provide services to clients. GTIL and its member firms are not agents of, and do not obligate, one another and are not liable for one another’s acts or omissions.
This publication has been prepared only as a guide. No responsibility can be accepted by us for loss occasioned to any person acting or refraining from acting as a result of any material in this publication.
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