1. P a g e | 1International Association of Risk and ComplianceProfessionals (IARCP)1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750 www.risk-compliance-association.comTop 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped theweeks agenda, and what is nextDear Member,Franz Kafka hassaid that alawyer is apersonwhowritesa10,000-word document and callsitabrief.Lou, a member of theIARCP, reminded it tome.He thanksus for the 210+ pagesof thepreviousTop 10 list, but hecomplainsthat it takestoomuch time to readit!Toomuch time(herepeated).And, he cannot resist the temptation. If there is somethinginterestinginhis hands, hewill read it.Lou, if you cannot resist TH IStemptation, the Top 10list is the leastofyour problems.Ok, thisweeksTop 10list is under 200pages!What should wedo?Should wehave audioaswell? - talk is cheap... untillawyersget involved :)This week westart (Number 1) witha great overview of theBasel IIIimplementationin Europe. And, it takesonlyabout 60 pagestoread!International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com

2. P a g e | 2If you flyfrom NY toDC you can studyit (weather,check in time anddelays have beentaken intoaccount).What would you prefer to read?TheAuditing Standards of thePCAOB?No.According to JamesR. Doty, Chairman of the PCAOB (at Number 3 ofour list) Thecurrent PCAOB standardsincludeboth interim standards(the"AU" standards, whichhave accretedover time, aswrittenby theprofession) and 16additional standards, promulgated bythePCAOB (the"AS" standards). As printed, thesestandards run to over 2,000pages. Tonavigatethesestandards can, weare told, provedaunting.Oh, no. Theyare not serious.TheAU andASstandards to restore investorconfidence.JamesR. Doty alsosaid:I shall stop there, and wont suggest thisreorganizationproject will rival the Code ofHammurabi or CharlemagnescodificationsLook at the picture. TheCode of Hammurabiis a well-preservedBabylonian lawcode, datingback toabout 1772BC.It is one of the oldest deciphered writingsofsignificant length in theworld.Thesixth Babylonian king, Hammurabi, enactedthe code, and partialcopiesexist on a human-sizedstone stele and variousclaytablets.At least wehave the Top 10list in adobeacrobat format.Can you imaginereceivingcopies similar tothepicture?International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 3. P a g e | 3Provisionsof the Code of Hammurabi addressissuesconcerningrelationshipssuch asinheritance, divorce, paternityand behavior.There is nothing about corporategovernance. Enron collapsedin 2001(waylater).Oneof themost well-knownof Hammurabislawsis:If aman put out theeye of another man, hiseye shall beput out.It is more like Sarbanes-Oxley, than Basel III.I can seeat thepicture the king and themanagement consultant explainingthetop 10list of the time.Welcometo thisbrief Top 10 list.BestRegards,GeorgeLekatisPresident of the IARCPGeneral Manager, ComplianceLLC1200G Street NW Suite800,Washington DC20005,USATel: (202) 449-9750Email: lekatis@risk-compliance-association.comWeb: www.risk-compliance-association.comHQ:1220N. Market Street Suite804,Wilmington DE 19801,USATel: (302) 342-8828International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 4. P a g e | 4CRD IV/ CRRFrequentlyAsked QuestionsThefinancial crisisrevealed vulnerabilitiesin the regulationandsupervision of the bankingsystem at European and global level.Thepackage agreedby Council and Parliament buildson thelessonslearnt from the recent crisisthat hasshownthat lossesin thefinancialsectorcan beextremelylargewhenadownturnisprecededbyaperiod ofexcessivecredit growth.An overviewGuidance on Leveraged LendingTheOffice of theComptrollerof theCurrency, the Board of Governorsof theFederal Reserve System, and the Federal Deposit InsuranceCorporation(collectively, the agencies) have jointlyissued the attached supervisoryguidanceon leveragedlending, whichappliesto all national banks,federal savingsassociations,andfederal branchesandagenciesof foreignbanks(collectively, banks).This guidancewaspublished in the Federal Register on March22, 2013,and replacessimilar guidanceissued in April 2001(2001guidance).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 5. P a g e | 5Statement on the Proposed Framework forReorganization of PCAOB AuditingStandardsJamesR. Doty, ChairmanPCAOB Open Board Meeting, Washington, D.C.It should come asnosurprise toany professionalperson that auditingliteratureis extensive.This reflectstheevolution of businessprocesses,globalizationofeconomies,technological changes.Public consultation on Guidelinesrelated to thepreparation for Solvency IIThe European Insurance and Occupational PensionsAuthority (EIOPA) launched a public consultation onGuidelinesrelated tothepreparationfor Solvency II.The purpose of the Guidelines is to support both NationalCompetent Authorities (NCAs) and undertakings in theirpreparation for the SolvencyII requirements.TheGuidelinescover the areasthat EIOPAconsiders fundamental toensure effectivepreparation for SolvencyII: system ofgovernance, includingrisk management; forwardlookingassessment oftheundertakingsownrisk(basedontheOwnRiskandSolvencyAssessment (ORSA) principles);submission of informationtoNationalCompetent Authorities(NCAs); pre-applicationof internal models.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 6. P a g e | 6Supervisory framework for measuring andcontrolling large exposuresOneof the keylessonsfrom thefinancial crisisisthat banksdid not alwaysconsistentlymeasure,aggregate and control exposurestosinglecounterparties acrosstheir books andoperations.And throughout historytherehavebeeninstancesofbanksfailing due toconcentrated exposurestoindividualcounterparties(egJohnsonMattheyBankersin theUK in 1984,theKorean bankingcrisisin the late 1990s).Largeexposuresregulation hasarisen asa tool for containingthemaximum lossa bank could facein the event of a sudden counterpartyfailure to a level that doesnot endanger thebankssolvency.ChairmanBen S.BernankeMonetary Policy and the Global EconomyAt the Department of Economicsand STICERD(Suntoryand Toyota International CentresforEconomicsand RelatedDisciplines)Public Discussion inAssociationwiththeBank ofEngland, LondonSchoolofEconomics,London, UnitedKingdomFor me, perhapsthecentral insight isthat the recent crisis, despite itsmanyexotic features, wasin fact a classicfinancial panic--asystemwiderun of "hot money" awayfrom assetswhosevaluessuddenlybecameuncertain.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 7. P a g e | 7CIMA signsMoU with Successor Entitiestothe UKsFSAOn 1 April, 2013, the United Kingdoms FinancialServices Act 2012 enters into force, and functionspreviouslyexercisedby the Financial ServicesAuthority (FSA) will now be exercised by three separate entities.Thesearethe Prudential RegulationAuthority (PRA), the FinancialConduct Authority (FCA) and the Bank of England.CIMA has signed Memorandaof Understanding (MoU) withthe PRAandtheFCA, successoragenciestotheFSA.ThePRA a subsidiaryof the Bank of England will be responsibleforprudential supervision of deposit takers,insurersand significantinvestment firms.Recent economic and financialdevelopmentsin IcelandSpeechby Mr Mr Gumundsson, Governor oftheCentral Bank of Iceland, at the 52ndAnnualGeneralMeetingof theCentral Bank of Iceland,ReykjavkAs weconvenefor the52ndAnnual GeneralMeetingof the Central Bank of Iceland, the domestic economicrecoverythat began in mid-2010continues, although it hassloweddown in recentmonths.At least to a degree, the slowdownis due to developmentsinternationally.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 8. P a g e | 8Toward a stronger financial marketinfrastructure for Canada taking stockRemarksbyMsAgathe Ct, DeputyGovernorof the Bank of Canada, to theAssociation forFinancial Professionalsof Canada (MontrealChapter)I am going to takeadvantageof this audienceof financial professionalstotalk about financial market infrastructure, a subjectthat affects everysingleperson in onewayor another you, becauseof the nature of yourwork,more than others.Financial regulation Australia in theglobal landscapeAddress by Mr Glenn Stevens,Governor of theReserveBank ofAustralia, totheAustralianSecuritiesand InvestmentsCommission (ASIC)Annual Forum, SydneyIt is alsoimportant to remember thatAustralia, along with all other jurisdictionsthatsign up tointernational standards, will be evaluated by our peers.Soits worthspellingout our approach tosome keyissues.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 9. P a g e | 9CRD IV/ CRRFrequentlyAsked Questions1. CONTEXTWhya revision of the Capital requirementsdirective isnecessary?Thefinancial crisisrevealed vulnerabilitiesin the regulationandsupervision of the bankingsystem at European and global level.Thepackage agreedby Council and Parliament buildson thelessonslearnt from the recent crisisthat hasshownthat lossesin thefinancialsectorcan beextremelylargewhenadownturnisprecededbyaperiod ofexcessivecredit growth.Institutionsentered the crisiswith capital of insufficient quantityandquality.Tosafeguard financial stability, governmentshad to provideunprecedentedsupport to thebankingsector in many countries.Theoverarchinggoalof thenewrulesistostrengthentheresilienceoftheEU banking sector soit wouldbe better placed to absorb economicshockswhile ensuringthat bankscontinue to financeeconomicactivityand growth.What lessonshave welearnt from the crisis?First and foremost the crisis revealed an absolutenecessityof enforcingthecooperationof monetary, fiscaland supervisoryauthoritiesacrosstheglobe.Crossborder developmentswereobserved toolate, crossborder impactswereverydifficult toanalyse.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 10. P a g e | 10Secondly, some institutionsin the financial system appearedtoberesilient and readytoabsorb alsoenormousmarket shocks.Other institutions,evenwithsimilarcapital levels,appeared tobeunabletoprotect themselves.Thecrucial differencesbetweenthe twowerefound in: the qualityandthelevel of the capital base, the availabilityof the capital base, liquiditymanagement and the effectivenessof their internal and corporategovernance.Theselessonsjustifiedamending the Basel agreement, and accordinglyreplacingthe CRD with a new regulatoryframeworkincluding aRegulation (CRR hereinafter) and a Directive (CRDIV hereinafter).Thirdly, cross border failures of international financial groups appearedan insurmountable challenge for nationally accountable authorities; as aconsequence, several banks needed the intervention of the state in ordertostayafloat.Theknowledgethat bankscould havebeen resolved, alsoin a crossborder context, wouldhave changed thebalanceof powerbetweenpublicauthoritiesand banks, withtheformer having more toolsat their disposalthan just thepublic purse and the bail-out option, and the latternot beingable toenjoythe best of all worlds:privatizegains, socializelosses.This wouldhave put a dent on banks risk appetite.This justifiesthe Commissionslegislativeproposal for bank recoveryand resolution adoptedon June 6, 2012.And this alsoexplainswhy, during thenegotiations,at the initiativeoftheEP, rules on remuneration werestrengthened.Why did existing rules (including Basel 1/Basel 2) not stop thecrisisfrom happening?Thecurrent EU bank capital frameworkis represented by the CapitalRequirementsDirective(CRD) comprising Directives2006/48/EC and2006/ 49/ EC and reflectingtheproposalsof the Basel Committeefor theBasel II Framework(Basel II) and TradingBook Review.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 11. P a g e | 11It coversboth credit institutionsand investment firms and stipulatestheminimum amountsof ownfinancial resourcesthat banksmust have inorder to cover the risksto whichtheyareexposed.Thefinancial crisishasunveileda number of shortcomingsof Basel IIandnecessitatedunprecedentedlevelsof publicsupport in order torestore confidenceand stability in the financial system.In particularsthe followingdrawbacksof theexistingframeworkwereidentified:capital that wasactuallynot loss-absorbing, failing liquiditymanagement, inadequategroup widerisk management and insufficientgovernance.In this regard, theG-20Declarationof 2April 2009conveyed thecommitment of theglobal leaderstoaddressthe crisiswithinternationallyconsistent effortsto, among others,improve thequantityandqualityof capital in thebanking system, introducea supplementarynon-risk based measure tocontain the build-up of leverage, develop aframeworkfor stronger liquiditybuffersat financial institutionsandimplement therecommendationsof the Financial Stability Board(FSB)20tomitigatethepro-cyclicality.In responseto themandategiven by theG-20, in September 2009theGroupofCentral Bank GovernorsandHeadsofSupervision(GHOS), theoversight bodyof theBaselCommittee(seebelowsection2), agreedonanumber of measuresto strengthen theregulation of the bankingsector.Thesemeasureswereendorsedby FSB and the G-20leadersat theirPittsburghSummit of 24-25September 2009.In December 2010,the BaselCommitteeissueddetailed rulesof newglobal regulatory standardson bank capital adequacyand liquiditythatcollectivelyare referred to asBasel III.2. BASEL III, CRD IV AND IN TERNATIONAL LEVELPLAYING FIELDWhat is the Basel Committee?TheBasel Committeeon Banking Supervision(BCBS) hasthetask ofdeveloping international minimum standardson bank capital adequacy.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 12. P a g e | 12It is basedat the headquartersof the Bank for International Settlements(BIS) in Basel, Switzerland.Thememberscome fromArgentina, Australia, Belgium, Brazil, Canada, China, France, Germany,Hong KongSAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico,theNetherlands,Russia, SaudiArabia, Singapore,SouthAfrica, Spain, Sweden,Switzerland, Turkey, theUnited Kingdom and theUnitedStates.TheEuropean Commission and theEuropean Central Bank areobservers.What is "Basel III"?TheBCBS developsminimum standardson bank capital adequacy.Thesehave evolved over time.Followingthefinancial crisis, the Basel Committeehasrevieweditscapital adequacystandards(seeabovesection 1).Basel III is theoutcome of that review, with thenumber threecomingfrom it beingthethird configuration of thesestandards.What is"Basel III" proposing to make banks stronger?Better and more capitalSeveral banksappeared tohave a capitalbaseon their balancesheetmeetingthe regulatorystandards, which, however, turned out to benotalwaysavailablewhen needed for lossabsorption. Some contractsrestrictedtheabsorption of lossesor there weresimplyno liquid assetsmirroring thebalancesheet capital figure.Basel III now prescribesstrict criteriaiii that must be met by ownfundsinstruments, in order toensure that theycan effectively absorb bankslossesalsoin timesof stress.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 13. P a g e | 13More balanced liquidityAmajor problem wasthe lack of liquid assetsand liquid funding duringthecrisis referred toas"themarket driedup".BaselIII requiresbankerstomanagetheir cashflowsand liquiditymuchmore intensethan before, topredict theliquidityflowsresultingfromcreditors claimsbetter thanbefore, and tobe ready for stressedmarketconditionsby havingsufficient "cash" available, both in theshort termand in the longer run.Leverage back stopJust in casethe calculatedrisk weightsof Basel 2 and 2.5containerrors,modelscontain errors,or new productsare developed and riskweightsare not measured preciselyyet, a traditional back stopmechanism limitsthegrowthof thetotal balancesheetascomparedtoavailableownfunds.Amaximum leverageof 12used to be a ruleof thumb in thedays thatbankswerenot regulatedyet.Today, given the sophistication of risk weight determination, theleverageratiowill be an additional checking tool for supervisors.Asthistool is new for theinternational framework, it wasagreed that dataand experience must be gathered before an effective leverage ratio can beintroduced asa bindingrequirement in each jurisdiction.Capital requirements for derivatives(Counter party credit risk)Basel III alsoenhancesthe existingcapital requirementsfor bankderivativetransactionsand the so-calledcounterpartycredit risk thatstemsfrom them.Aderivativeis an instrument whosevaluedependson anotherinstrument, underlying it.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 14. P a g e | 14Derivativesareusedforgoodreasonsin banksriskmanagement, but thecrisisrevealed that exposuresand lossescould be material, and that areview of the treatment in the supervisory frameworkwasjustified.Theframeworkalsoincludesthe treatment of bank exposuresto centralcounterparties(CCPs).CCPisanentitythat interposesitselfbetweenthetwocounterpartiestoatransaction, becoming the buyer toeveryseller and the seller toeverybuyer.ACCPs main purposeis tomanage therisk that could ariseif onecounterpartyis not ableto make the required paymentswhenthey aredue i.e. defaultson thedeal.Capital Buffers (see section 10below)Do CRD IV and CRR fully implement "Basel III"?The EU has actively contributed to developing the new capital, liquidityand leverage standards in the Basel Committee on BankingSupervision, while making sure that major European bankingspecificitiesand issuesare appropriatelyaddressed.Thenew rules thereforerespect thebalanceand level of ambition ofBasel III.However, there are tworeasonswhyBasel III cannot simplybecopy/ pasted intoEU legislation.First, Basel III is not a law.It is thelatest configuration of an evolving set of internationallyagreedstandardsdeveloped by supervisorsand central banks.That hasto now gothrough a processof democratic control asit istransposedintoEU (and national) law.It needsto fit withexistingEU (and national) lawsor arrangements.Furthermore, while theBasel capital adequacyagreementsapplytointernationallyactivebanks, in theEU it hasalwaysappliedtoall banks(more than 8,300) aswell asinvestment firms.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 15. P a g e | 15This wide scope is necessary in the EU where banks authorised in oneMember State can provide their services across the EUs single marketand assuch aremore than likely toengagein cross-borderbusiness.Also, applying theinternationallyagreedrules only toa subset ofEuropean banks wouldcreatecompetitivedistortionsand potential forregulatoryarbitrage.TheEU hashad totake theseparticularcircumstancesintoaccountwhentransposingBasel III intoEU law.What is Europe adding to "Basel III"?As explained above, themost fundamental changeisthat, inimplementingthe Basel III agreement within theEU, wemove from anuni-dimensional type of worldwhereyou have onlycapital asa prudentialreference,to multi-dimensional regulation and supervision, whereyouhavecapital, liquidityand theleverageratio whichisimportant, becausethiscoversthewholebalancesheet of thebanks.Andeven within capital, thereis a much cleaner definition and more realistictargets.In additiontoBaselIII implementation, theproposal introducesanumber of important changestothebanking regulatory framework.In the Directive:Remuneration.In order totackle excessiverisk takingtheremuneration frameworkhasbeen further strengthenedwithregard to therequirementsfor the relationship betweenthevariable (or bonus) component of remunerationand thefixedcomponent (or salary).From 2014onwards,thevariablecomponent of thetotalremuneration shall not exceed 100% of thefixed component of thetotal remuneration of material risk takers.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 16. P a g e | 16Exceptionally, and under certainconditions,shareholder canincreasethismaximum ratio to 200%.Enhanced governance: CRDIV strengthenstherequirementswithregard to corporategovernancearrangementsandprocessesand introducesnew rulesaimed at increasingtheeffectivenessof risk oversight by Boards, improvingthe statusoftheriskmanagement function and ensuringeffectivemonitoringbysupervisorsof risk governance.Diversity. Diversity in board composition should contributetoeffectiveriskoversight byboards,providingfor a broader rangeof viewsand opinionand thereforeavoidingthe phenomenon ofgroup think.CRDIV thereforeintroducesa number of requirements,inparticular asregardsgender balance.Enhanced transparency. CRDIV improvestransparencyregardingthe activitiesof banks and investment fundsin differentcountries,in particular asregards profits,taxesand subsidiesindifferent jurisdictions.This is consideredessential for regainingthe trust of EU citizensin thefinancial sector.Systemic risk buffer (seesection 10 below)Global systemic institutionbuffer (seesection 10below)Other systemic institution buffer (seesection 10 below)Finally, the new rulesseek toreducetothe extent possiblerelianceby credit institutionson external credit ratingsby:International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 17. P a g e | 17a)requiringthat all banks investment decisionsarebasednot onlyon ratingsbut alsoon their own internal credit opinion, andb)that bankswith a material number of exposuresin a givenportfolio develop internal ratingsfor that portfolio instead ofrelying on external ratingsfor the calculationof their capitalrequirements.In the Regulation:A sin gle ru le b ook : For the first time a singleset ofharmonisedprudentialrulesiscreatedwhichbanksthroughout theEU must respect.EU headsof stateand government hadcalled for a "singlerulebook" in the wakeof the crisis.This will ensure uniform applicationof Basel III in all MemberStates,it will closeregulatory loopholesand will thuscontributetoa more effectivefunctioning of the Internal Market.Thenew rules remove a largenumber of national optionsanddiscretionsfrom theCRD, and allowsMember Statesto applystricter requirementsonlywheretheseare justifiedby nationalcircumstances(e.g. real estate), needed on financial stabilitygroundsor becauseof a banksspecific risk profile.How is possible to ensure an international level playing field?Thefinancial system is global in nature and it is not stronger than itsweakest link.It is thereforeimportant that all countriesimplement internationalbankingstandards, includingBaselIII.TheEU hascontinuousand constructivediscussionswithitsinternational partners most notablytheUS regarding theirInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 18. P a g e | 18implementationof theBasel agreementsin a proper and timely mannerand - more in general - on cross-border financial servicesregulatoryissues.Whatsthe timeline and implementation of the legislativeproposalsand how it relatesto the timelines andimplementation in other G20 countries?Theoriginal Commission proposal followedthetimelinesasagreedintheBasel Committeeand in theframeworkof theG20: entryintoforceofthenew legislationon 1January 2013,and full implementationon 1January 2019,in linewith the international commitments.Given the detailed discussionsduring thelegislativeprocess, thedate ofentryintoforce is now expected to be in [tobe confirmed], in order toallowfor final technical legal checks and translationsin all EU officiallanguages.Thedate of applicationwill be 1January 2014,withfull implementation(in linewith the original Commission proposal) on 1January2019.Todate, about half of themember jurisdictionsof the Basel Committeehaveadoptedthe final rulesimplementing(parts of) Basel III.Theremainingjurisdictionsare expectedto adopt the final rulessometime this year.What the EU will do if other jurisdictionsdo not implement?TheEU hasaninterestinincreasingtheresilienceof itsbankingsystem.AsBaselIII aimstoachievethat objective,it isin principleinourinteresttoimplement it.While there is alwaysa short term risk of regulatory arbitrageif onejurisdictiongoesfurther than other jurisdictions,in the longer term it isclearlybeneficial asmarket participantsbenefit from a stable, safeandsoundfinancial system.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 19. P a g e | 19Even so, there may be areaswherean international level playing field ismore important alsoin the short run (e.g. thenew elementsof Basel III).TheCommission is thereforecloselymonitoring the consistentimplementationof BaselIII acrosstheglobe and would need todraw allthenecessaryconclusionsin due time should other key jurisdictionsnotfollowsuit.3. STRUCTURE OF THE NEW REGULATORYFRAMEWORKWhyare there twolegal instruments?Why also a regulation?Theproposal dividesthe current CRD (Capital RequirementsDirective)intotwolegislativeinstruments:a directivegoverning the accesstodeposit-takingactivities and a regulation establishingtheprudentialrequirementsinstitutionsneed to respect.While Member Stateswill have to transposethe directiveintonationallaw,the regulation isdirectlyapplicable, whichmeansthat it createslawthat takesimmediateeffect in all MemberStatesin the same wayasanationalinstrument, without anyfurtheractiononthepart ofthenationalauthorities.This removesthe major sourcesof national divergences(differentinterpretations,gold-plating).It alsomakestheregulatory processfaster and makes it easier toreact tochangedmarket conditions.It increasestransparency, asone rule aswrittenin the regulation willapplyacrossthesinglemarket.Aregulationissubject tothesamepoliticaldecision makingprocessasadirectiveat European level, ensuringfull democraticcontrol.Last but not least, this proposal marksa thorough review of EU bankinglegislationthat hasdeveloped over decades.Theresult is a more accessibleand readablepieceof legislation.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 20. P a g e | 20What goes in which instrument?Areas of thecurrent CRD wherethe degreeof prescriptionis lowerandwherethe linkswithnational administrativelawsare particularlyimportant will stay in the form of a directive.This concernsin particular thepowersand responsibilitiesof nationalauthorities(e.g. authorisation, supervision, capital buffers andsanctions), the requirementson internal risk management that areintertwinedwithnational company law aswell asthe corporategovernanceprovisions.By contrast, thedetailed and highly prescriptiveprovisionsoncalculatingcapital requirementstake theform of a regulation.4. SINGLE RULE BOOKWhat is the single rule book?In June 2009, the European Council called for theestablishment of a"European singlerulebook applicabletoall financial institutionsin theSingleMarket."Thesinglerulebook aims toprovidea singleset of harmonisedprudential ruleswhichinstitutionsthroughout the EU must respect.This will ensure uniform applicationof Basel III in all MemberStates.It will closeregulatory loopholesand will thuscontributetoa moreeffectivefunctioningof theSingleMarket.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 21. P a g e | 21TheCommission suggestsremoving national optionsand discretionsfrom theCRD, and achievingfull harmonisation by allowingMemberStatestoapplystricter requirementsonlywheretheseareneededonfinancial stabilitygroundsor becauseof a banks specificrisk profile.Whyisthe single rule book important?Today, European banking legislationis based on a Directivewhichleavesroom for significant divergencesin national rules.This hascreated a regulatorypatchwork, leadingto legaluncertainty, enablinginstitutionsto exploit regulatoryloopholes,distortingcompetition, and makingit burdensome for firmsto operate acrosstheSingleMarket.For example:- Securitisation was at the core of the financial crisis. Previous globaland EU standards(Basel II, CRD I) addressed some of the risks byspecific capital requirements(includingfor all liquidityfacilities).However,many MemberStatesdid not follow,benefitingfrom atransitional opt-out.In a fullyintegratedmarket such assecuritisation, it waseasyforcross-bordergroupstoissuetheir securitisationtitlesin thoseMember Statesthat opted out rather than in Member Stateswhichapplied thestandards.- Followingtheexperiencewith securitisation in thefinancialcrisis,CRD II introducedharmonised rulestotighten the conditionsunder whichinstitutionscould benefit from lowercapitalrequirementsfollowinga securitisation (includinga harmonisednotion of significant risk transfer).But several Member Stateshavenot transposedthis by the end of2010asrequired.- Thefinancial crisishasshown that reliableinternal risk models areimportant for institutionsto anticipatestressand hold appropriatecapital.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 22. P a g e | 22However,requirementsfor, and accordinglytheimplementationof, internal ratingsbased risk models vary from one Member State toanother.As a result, capital requirementsfor comparable exposuresdiffer, leadingpotentiallytoan level playing field and regulatoryarbitrage.- Atough definitionof capital is a keyelement of Basel III.However,experiencewithCRD I hasshownthat Member Statesintroducedenormousvariationswhen transposingthe directivedefinitionintonational law.Even wherethe requirementsof the directive wereclear, someMemberStatesdid not correctlytransposethem.In some cases,theCommission had toopeninfringementproceedings,taking manyyears, in order to force theseMemberStatestocomplywiththedirective.- Asinglerulebook basedon a regulation will addresstheseshortcomingsand will therebylead toa more resilient, moretransparent, and more efficient European banking sector:- Amore resilient European banking sector:Asinglerulebookwillensure that prudential safeguardsarewhereverpossibleappliedacrosstheEU and not limited to individual Member States.Thecrisishighlightedtheextent towhichMemberStateseconomiesare interconnected.TheEU isa sharedeconomicspace.What affectsone country could affect all.It is not realistic tobelievethat unilateral action bringssafetyin thiscontext.If a Member State increasesthe capital requirementsfor domesticinstitutions,institutionsfrom other Member Statescan continuetoprovidetheir serviceswithlowerrequirements and at a competitiveadvantage- unlessother countriesfollowsuit.This givesalsorisetoregulatory arbitrage.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 23. P a g e | 23Institutionsaffected by the higher capital requirementscouldrelocatetoanother Member Stateand continuetoprovidetheirservicesin theoriginal Member State by meansof a branch.- Amore transparent European banking sector:Asinglerulebookwillensure that institutions financial situationis more transparent andcomparable acrosstheEU - for supervisors, deposit-holdersandinvestors.Thefinancial crisishasdemonstratedthat the opaquenessofregulatoryrequirementsin different MemberStateswasa majorcauseof financial instability.Lackoftransparencyisanobstacletoeffectivesupervisionbut alsotomarket and investor confidence.- Amore efficient European banking sector:Asinglerulebookwillensurethat institutionsdonot havetocomplywith27differingsetsofrules.Will Member Stateshave the possibility to require a higher basiccapital requirement?TheEU in generalandtheeuroareain particularhaveaveryhighdegreeof financial and monetary integration.Decisionson the level of capital requirementsthereforeneed tobe takenfor thesinglemarket asa whole, asthe impact of such requirementsisfelt by all MemberStates.FinancialstabilitycanonlybeachievedbytheEU actingtogether;not byeach MemberState on itsown.For example, if EU capital requirementsare set toolow, an individualMemberStatecannot escaperisksto financial stabilityby simplyincreasingrequirementsfor itsown institutions.Unlessother Member Statesfollowsuit, foreign institutions branchescan continuetoimport risk.Higher levelsof capital requirementsin one MemberState wouldalsodistort competitionand encourage regulatoryarbitrage.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 24. P a g e | 24For example, institutionscould be encouragedto concentrate riskyactivitiesin MemberStateswhich onlyimplement the minimumrequirements.Therefore, capital requirementsneedtobe set at a level that isappropriatefor theEU asa whole.That is why, accordingto thepoliticalagreement, thecapitalrequirementscannot be increasedbynational authorities(e.g. 6% CET 1insteadof 4,5%), unlessa specificadd-on is justified followinganindividual supervisory review or based on systemic risk ormacro-prudential concerns(Systemic risk, Global systemic institutionsandOther systemic institutionsbuffersand Pillar 2, seesection10below).Will Member Statesstill retain some flexibility under the SingleRule Book?MemberStateswill retain some possibilitiestorequire their institutionstohold more capital (seebelow a tableincludingall possibleflexibilityoptions detailed description of variouscapital buffersisprovidedinsection 10below).For example, Member Stateswill retain the possibilityto set highercapitalrequirementsforrealestatelending, therebybeingabletoaddressreal estatebubbles.If theydo, thiswill alsoapplytoinstitutionsfrom other Member Statesthat do businessin that Member State.Moreover,each MemberStateis responsiblefor adjustingthelevel of itscountercyclical buffer toitseconomic situation and to protecteconomy/ banking sector from anyother structural variablesand fromtheexposure of thebankingsector toany other risk factorsrelatedtorisks to financial stability.Furthermore, MemberStateswouldnaturallyretain current powersunder "pillar 2", i.e. the abilityto imposeadditional requirementson aspecific bank followingthe supervisoryreview processInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 25. P a g e | 25TheCommission toowill have the power toincreaseprudentialrequirementsin all areassubject to specific conditions(seetablebelow)International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 26. P a g e | 26What is "Pillar 2"?What will change?Pillar 2 refers tothepossibilityfor national supervisorsto imposea widerangeof measures- includingadditionalcapital requirements onindividual institutionsor groupsof institutionsin order toaddresshigher-than-normal risk.Theydosoon the basisof a supervisoryreview and evaluationprocess, during whichthey assesshow institutionsare complying withEU bankinglaw,the riskstheyfaceand theriskstheypose to thefinancial system.Following this review, supervisors decide whether e.g. the institutionsrisk management arrangements and level of own funds ensure a soundmanagement and coverageof the riskstheyfaceand pose.If the supervisor findsthat the institutionfaceshigher risk, it can thenrequirethe institutionto hold more capital.In taking this decision, supervisors should notably take into account thepotential impact of their decisions on the stability of the financial systemin all other MemberStatesconcerned.The proposal clarifies that supervisors can extend their conclusions totypes of institutions that, belonging to the same region or sector, faceand/ orposesimilar risks.How will thisaffect those Member Statesthat have alreadydecided to gofurther than Basel III or are planning to do so?SomeMember States(e.g. Spain) have alreadydecided to goabovetheminimum levelsof capital foreseen by Basel III.Some(e.g. Sweden, Cyprus) have indicatedtheir intention to start doingso.Others (e.g. UK) have national processesunder waythat considerrequiringalevel of ownfundsaboveBasel III from parts oftheir bankingsector.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 27. P a g e | 27In some instances,Member Stateshave alsodecided to introducemorequicklythechangesforeseen under Basel III that increasethequalityofcapital aswell.According to the political agreement, MemberStatesare free toanticipatethe full implementation of Basel III and hencemove to thecapital requirementsforeseen for 1January 2019already today, shouldtheysowish.While Member Stateswill not be able toexceedthe level of own fundsrequirement set by the political agreement, theycan usethe instrumentsof flexibilityforeseen by that agreement, namely thecounter-cyclicalbuffer, the systemic risk buffer, the global and other systemic institutionbuffers,and Pillar 2.5. CAPITALWhat is bank capital?Capital can be definedin different ways.Theaccountingdefinition of capital is not the same asthe definitionused for regulatory capital purposes.For bankingprudential requirementspurposes,capital is not obtainedsimplybydeductingthevalueof an institutions liabilities(what it owes)from itsassets(what it owns).Regulatorycapital ismore conservativethan accountingcapital.Onlycapital that is at all timesfreely availableto absorblossesqualifiesasregulatory capital.Additional conservatism is added by adjustingthis measure of capitalfurther by e.g. deducting assetsthat may not have a stablevalue instressed market circumstances(e.g. goodwill) and not recognisinggainsthat have not yet been realised.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 28. P a g e | 28What is the capital adequacy requirement?It is the amount of capital an institutionis required to hold comparedtotheamount of assets, to cover unexpected losses.In the CRD, this is calledminimum own fundsrequirement and isexpressedasa percentage.Whyiscapital important?Thepurposeof capital istoabsorb thelossesthat abank doesnot expecttomake in thenormal courseof business(unexpectedlosses).Themore capital a bank has, the more lossesit can suffer before itdefaults.If a firm owesmore than it owns(itsassetsare worthlessthanitsliabilities),it cannot pay itsdebt and is therebyinsolvent.If a bank haslesscapital than the requirement amount, supervisorscantake measurestoprevent insolvency.How is it calculated?It is thevalue of a banks capital asa percentageof its riskweightedassets(RWA).Theformula issimple:capital / RWA> 8%.What are risk-weighted assets?When assessinghow much capital an institutionneedstohold, regulatorsweigh an institutions assetsaccording to theirrisk.Safeassets(e.g. cash) are disregarded;other assets(e.g. loansto otherinstitutions)are consideredmore risky and get a higher weight.Themoreriskyassetsaninstitutionholds,themorecapitalit hastohave.In additiontorisk weighingon balancesheet assets,institutionsmustInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 29. P a g e | 29havecapital alsoagainst risksrelatedtooff balancesheetexposuressuchasloan- and credit card commitments.Thesearealsoriskweighed.What is the difference between Tier 1and Tier 2 capital?Capital comesin different formsthat servedifferent purposes.There aretwotypesof capital:- Going concern capital:this allowsan institutiontocontinueitsactivitiesand helpstoprevent insolvency. Thepurest form isCommon EquityTier 1(CET1) capital. Goingconcern capital isconsideredTier 1capital.- Goneconcern capital:this helps ensuringthat depositorsand seniorcreditorscan be repaid if the institutionfails. One exampleof thiskind of capital is institutiondebt. Gone concern capital isconsideredTier 2 capital.-What wasthe problem with capital during the crisis?Banksand investment firmsdid not all havesufficient amountsof capitalandthecapital theyhad wassometimesof poor qualityasit wasnotreadilyavailable toabsorb lossesastheymaterialised.Toprevent institutionsfrom defaulting, public fundshad to be used toprop up institutions.How do you proposeto increase the quality and quantity ofcapital?In line with Basel III, the proposal strengthens institutions capital baseby increasing the amount of own funds institutions need to hold and byrestrictingwhat countsasown funds.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 30. P a g e | 30Today, banks and investment firms need to have a total capital of at least8% of risk weightedassets.Tomorrow, while the total capital an institution will need to hold remainsat 8%, the share that hastobe of the highest quality common equitytier1(CET1) increasesfrom 2% to4.5%.Thecriteria for each instrument will alsobecome more stringent.Furthermore, theproposal harmonisestheadjustmentsmade to capitalin ordertodeterminetheamount ofregulatorycapitalthat it isprudent torecognisefor regulatorypurposes.This new harmonised definition would significantly increase the effectivelevel of regulatory capital institutionswouldbe required to have.One unit of Basel II capital is therefore not the same as one unit of BaselIII capital.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 31. P a g e | 31Is the political agreement only going to increase the formerminimum level of capital?No, thebasicownfundsrequirement staysat 8% orrisk-weightedassets.However,in linewith Basel III, theproposal alsocreatesfive newcapitalbuffers:thecapital conservationbuffer, thecounter-cyclical buffer, thesystemic risk buffer, the global systemic institutionsbuffer and the othersystemic institutionsbuffer (seesection on capital buffers).Naturally, on top of all theseown fundsrequirements,supervisorsmayadd extra capital to cover for other risksfollowinga supervisoryreview(seequestion on Pillar 2 above) and institutionsmay alsodecidetoholdanadditional amount of capital on their own.How can institutions increase their capital ratio tomeet the newrequirements?Institutionscan increasetheir capital ratio in twoways:- Increasecapital:An institution can increaseitscapital by eitherissuingnew sharesand/ or not pay dividendsto itsshareholders,i.e.toretain profits.Thesenew sharesand retainedprofitsbecomeincludedin itscapitalbase.Providedtheydonot increasetheir risk-weightedassets(RWAs), this increasestheir capital ratio.- Reduceassetsand their risk weight:An institutioncan alsocut backon lending, sell loanportfoliosand/ or make lessrisky loansandinvestments,therebyreducing itsRWAs, whichhastheeffect of - foragiven amount of capital - increasingitscapital ratio (capital/ RWA).When will these provisionsstart to apply?Basel III foreseesa substantial transitionperiodbeforethenew capitalrequirementsapply in full.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 32. P a g e | 32This is toensurethat increasingthe resilienceof institutionsdoesnotundulyaffect lendingtothe real economy (i.e. to ensure that institutionsdonot cut back on lendingand investments).Theprovisionsrelatedto the level of own fundswill accordinglybephased in asof [the 1January2014.Capital instrumentsthat will not meet thenew, stricter eligibility criteriawill be phased out over 10years in order tohelp to ensure a smoothtransitionto thenew rules.Do the new rulesallow Member States to implement Basel IIIfaster than foreseen by the Basle timetable?Basel III foreseesa gradual transition to the stricter standards, with fullimplementationasof 1January 2019.The political agreement proposal foresees the same transition period butallows Member States to implement the stricter definition and/ or level ofcapital more quicklythan is required byBasel III.Do the new rulesdepart from the Basel III definition of capital?No. The Regulation takesexactlythe same approach asBasel III byimposing14strict criteria that any instrument wouldhave tomeet toqualify, withappropriate adaptationtothecriteriafor instrumentsissuedbynon-joint stock companiessuch asmutuals, cooperativebanksandsavingsinstitutions.Thefull substanceof Basel III is perfectlytranslated intotheEuropeanlaws.Becauseof the absenceof a common EU concept of commonshares,the legal form of thehighest qualityform of capital isnotrestrictedto "ordinary shares".This doesnot affect the substanceasCET1must meet 14 strict criteria.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 33. P a g e | 33What are the conditions capital instruments have to meet toqualify asCommon Equity Tier 1instruments?Article 26 of the CRR states that capital instrument can only qualify asCommon Equity Tier 1 instruments if a number of conditions are met.Thesecan be summarisedasfollows(for full details, seearticle):theyare issued directlyby theinstitution;they are paid up and their purchase is not funded by theinstitution;they meet a number of conditions as regards theirclassification (e.g. they qualify as capital for accounting andinsolvencypurposes);they are clearly and separately disclosed on institutionsfinancial statementsbalancesheet;theyare perpetual;theprincipal amount of the instrumentsmay not be reducedor repaid unlesstheinstitution ise.g. liquidated.Moreover, the provisions governing the instruments should notindicate that the principal amount of the instruments would ormight be reduced or repaid other than in the liquidation of theinstitution;the instruments meet a number of conditions as regardsdistributions (e.g. no preferential distributions intime, distributions may be paid only out of distributableitems, the conditions governing the instruments do not include acap or other restriction on the maximum level ofdistributions, the level of distributions is not determined on thebasis of the amount for which the instruments werepurchased, etc);International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 34. P a g e | 34compared to all the capital instruments issued by theinstitution, the instruments absorb the first and proportionatelygreatest share of losses as they occur, and each instrument absorbslosses to the same degree as all other Common Equity Tier 1instruments;the instruments rank below all other claims in the event ofinsolvencyor liquidationof the institution;the instruments entitle their owners to a claim on theresidual assets of the institution, which, in the event of itsliquidation and after the payment of all senior claims, isproportionate to the amount of such instruments issued and is notfixed or subject to a cap;the instrumentsare not secured, or guaranteed by any entityin the group (e.g. the institution, its subsidiaries, the parentinstitution or itssubsidiaries, etc);the instruments are not subject to any arrangement thatenhances the seniority of claims under the instruments ininsolvencyor liquidation.Theseconditionsensure that only the highest qualitycapitalinstrumentsqualify asCET1.Do the new rulesrecognise only ordinary sharesas CommonEquity Tier 1or could other instruments be recognised aswell?Towarrant recognitionin thehighest qualitycategoryof regulatorycapital, a capital instrument must be of extremelyhigh qualityand mustabsorb lossesfullyasthey arise.The14 criteria for Common EquityTier 1capital agreed in Basel III areextremelystrict bydesign. Onlyinstrumentsof thehighestqualitywouldbecapableof meeting them.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 35. P a g e | 35Provided an instrument met thosestrict criteria - includingin respect ofitslossabsorbencyit wouldqualify asCommon EquityTier 1capital.What are minority interests and what amount of minorityinterestscan be recognised?Minorityinterestsare capital in a subsidiarythat is ownedbyothershareholdersfrom outsidethe group.Theyare particularlyimportant in the EU, asEU banking groupsoftenhavesubsidiariesthat are not fullyowned by theparent company buthaveseveral other owners.Basel III recognisesminorityinterestsand certain capital instrumentsissuedby subsidiaries(e.g. hybridsand subordinateddebt) tobeincludedin the capital of thegroup only wherethosesubsidiariesarebanks(or are subject to thesame prudential requirements) and up tothelevel of thenew minimum capital requirementsand the capitalconservation buffer.Thepolitical agreement recognisesminority interestsup to andincludingthe Pillar 2 requirement. This is a simpleresult of the fact thattheEU legislationdoesput at the disposal of SupervisoryAuthorityseveral additional buffers(seesection 10).What will be the treatment of significant holdingsin insurancecompanies?Basel III requiresbanks todeduct significant investmentsinunconsolidatedfinancial entities, includinginsuranceentities,from thehighestqualityform of capital (CET1).Theobjectiveis toprevent thedouble counting of capital, i.e. toensurethat the bank is not bolsteringitsown capital withcapital that is alsoused to support the risks of an insurancesubsidiary.Thepolitical agreement allowsan updated version of the FinancialConglomeratesDirective(FICOD) approach, whichallowsconsolidationInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 36. P a g e | 36ofbankingandinsuranceentitiesin agroup, tocontinuetobeusedasanalternativeto theBasel III deductionapproach.What are Deferred TaxAssets (DTAs) and what will be theirtreatment?Deferred TaxAssets(DTAs) areassetsthat may beused toreducetheamount of future tax obligations.Basel III treats DTAsdifferentlydependingon how much theycan berelied upon whenneeded to help a bank toabsorblosses.Where their valueis lesscertain to be realised, theymust be deductedfrom capital.However,Basel hassubsequentlyclarifiedthat DTAs that aretransformedon amandatory and automatic basisintoa claim on theStatewhen an institutionmakes a losswouldbe one of the forms ofDTAs for which deduction would not be warranted.Thepolitical agreement implementstheaboveBasel rules.What is the Basel I floor and will its application be prolonged?Basel II requiresmore capital to be held by banks for riskier businessthan wouldbe requiredunder Basel I.Forlessriskybusiness, BaselII requireslesscapitaltobeheldthanBaselI. This is what Basel II wasdesigned to do: to be more risksensitive.Toensure banksdonot hold toolittleregulatorycapital, Basel II set aflooron the amount of capital required, whichis 80% of thecapital thatwouldbe required under BaselI.While the floor required bythe original CRD expired by theend of2009,the CRD III reinstatedit until end-2011.In the light of the continuingeffectsof thefinancial crisisin thebankingsectorand the extensionof the BaselI flooradopted by theBaselCommitteeon BankingSupervision in July2009, thepolitical agreementreinstatesthe floorin 2014,to be applied until 2017.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 37. P a g e | 37However,national authoritieswouldbe ableto waivethe requirementunder strict conditions.It alsointroducesa requirement for a continuousrevision of theneed forsuch a floor sinceit should not be maintainedin placelonger than isstrictlynecessary.What will be the cut-off date for recognising instruments that donot meet the eligibility criteria?ToensureasmoothtransitiontothenewBaselIII rules,instrumentsthatare currentlyused that donot meet thenew rules have to be phased outover a 10-year period, providedtheywereissued prior tothe date ofagreement of thenew rules by Basel(12September 2010). Under BaselIII, instrumentsissuedafter thecut-off date wouldneed to comply withthenew rulesor wouldnot be recognisedfrom 1January2013.Thepolitical agreement setsthecut-off date at 31December 2011.What will be the treatment of instruments no longer eligible asCET1?Thepolitical agreement phasesthem out over a 10-year period. Forinstrumentsinjectedbya government prior tothedateof entryintoforceof the regulationthepolitical agreement is tofullyrecognisethem inCET1capital for a 5-year period.Thenew rules require institutionsto hold more capital againstinvestmentsinhedgefunds,realestate,venturecapitalandprivateequitythan theyhave done toup now.Why isthat?Thecurrent CRD (points66-67ofAnnex VI, Part 1)statesthatcompetentauthoritiesmay applya 150%risk weight to"exposuresassociatedwithparticularlyhigh riskssuch asinvestmentsin venturecapital firms andprivateequityinvestments".However,what particularlyhigh risks arehas not been defined.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 38. P a g e | 38Thelackofobligationcombinedwiththelackofacleardefinitionhasledtodifferent assessmentsand risk weightsgranted to thesame type ofexposures.On thebasisof an advicefrom CEBS(Committeeof European BankingSupervisors,thepredecessorof EBA), the Commission now proposestorequirebankstoassign a 150%risk weight tothesetypes of exposures(investmentsin venture capital firms, alternativeinvestment fundsandspeculativerealestatefinancingaswellas"exposuresthat areassociatedwith particularlyhigh risks").The proposal now also clearly defines the criteria that supervisors shoulduse when an exposure is associated with such risks and requires EBA todevelop guidelinesin that respect.What is the role of contingent capital in the new framework?TheCRR requires all instrumentsrecognised in theAdditional Tier 1capital of a credit institutionor investment firm tobe writtendown, orconvertedintoCommon Equity Tier 1instruments, whenthe CommonEquityTier 1capital ratioof the institutionfallsbelow 5.125%.Thenew rules donot recognise other formsof contingent capital for thepurposesof meetingregulatory capital requirements.What is hybrid capital?What role does it play?Hybrid capital is aterm used todescribeformsof capital instrument thathavefeaturesof both debt and equityinstruments.Such instrumentsin issue during thecrisis proved not to be sufficientlylossabsorbent.Thenew rules buildsupon theimprovementsmadeunder CRD II to thequalityof hybrid Tier 1capital instruments,introducingstricter criteriafor their inclusion in Additional Tier 1capital.As explainedabove, thisincludesa requirement for all such instrumentstoabsorblossesbybeing written down, or converted intoCommonEquityTier 1instruments,whenthekeymeasureof acredit institutionorInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 39. P a g e | 39investment firmssolvency- the Common Equity Tier 1capital ratio-fallsbelow 5.125%.6.LIQUIDITYWhat Rulesdoesthe Regulation establish on liquidity buffers?Thecrisishasshownthat institutions did not hold sufficient liquidmeans(e.g. cash). Whenthecrisishit, manyfirmswereshort of liquidity.This contributed to the demiseof several financial institutions.While a number of Member Statescurrentlyimposesome form ofquantitativeregulatorystandard for liquidity, noharmonised regulatorytreatment existsat EU level.Basel III introducestwonew ratiosand foreseesin each caseanobservation period in order toidentify and addresspossibleunintendedconsequences.TheBCBS will make thenecessarychanges,if any, before2015or2018,respectively.Thereforesubject to the observation period(seebelow) theRegulationestablishestwonew liquiditybuffers:- First, toimprovetheshort-term(overathirtydayperiod) resilienceoftheliquidityrisk profileof financial institutions,there isa LiquidityCoverage Requirement (LCR).- Second, toensure that an institution hasan acceptableamount ofstablefunding to support the institutionsassetsand activitiesoverthemedium term (over a one year period), there is a Net StableFundingRequirement (NSFR);How will the liquidity coverage ratio (LCR) be introduced?The observation period will start immediately after adoption of theRegulation and institutions will be required to report to nationalInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 40. P a g e | 40authoritiestheelementsthat areneededtoverify that theyhaveadequateliquiditycoverage.Theywill dothis in a uniform way, with standard reportingformatstobedeveloped by the EBA.On thebasisof thesereports,EBA will prepare reportsfor submission totheCommission.The Commission will have a delegated power to specify the detailedliquiditycoveragerequirement for implementationin 2015.What istheimpact of the Basel Committee decision thisJanuaryon the LCR?Many observersincludingthe Commissionwereconcernedthat theoriginal calibrationof the LCR wastoosevere.In a time of economic difficulty, there wereconcernsthatimplementationof theLCR asoriginallyforeseen by theBaselCommitteein December 2010could have an adverse impact on the realeconomybypromotinga shift from lending(loanassets) tomore liquidassets(e.g. cash, central bank deposits) asinstitutionsprepared tomeetthenew LCR requirements.For thisreason theCommission attachesmuch importancetotheobservation period after whichthedetailedLCR will be specified.Theseconcernswerealsorecognised by theBasel Committee.On 7 January2013,the BaselCommitteeissuedthetext of a revisedLiquidityCoverageRatio(LCR) whichhad been endorsedby thegoverningbody of the Basel Committee, namely, the Group of CentralBank Governors and Headsof Supervision (GHOS).This text includedarevisedtimetablefor thephase-in of thestandard.Thesame day, CommissionerMichel Barnier alsoissueda pressreleasewelcomingtherevisedagreement unanimously reachedby theBaselCommittee.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 41. P a g e | 41The package of amendments to the LCR as originally formulated in 2010including its phasing-in, addresses concerns previously identified by theCommission.However,thefinal formulation of the LCR is still not completeandimportant work is still continuingunder the BaselCommittee.Thereforethe approach for the final adoption of theLCR under EU lawin 2015ismaintained, namely full use of the observation periodandadoption of the detailedLCR bythe Commission taking account of theEBA Reportsand international developmentssuch asthe final BaselLCR standard.What will be the time schedule for implementation of the LCR?Becauseof concernsthat toorapid implementationof theoriginal LCRcouldhavedetrimentalimpact onthereal economy,thetext publishedbytheBasel committeeon 7th January2013,proposed a minimumphasing-in of the LCR over 5years starting with60% of the LCR in2015,rising progressivelytoreach 100% in 2019.However,given the important role liquiditymismatchesplayed in thefinancial crisis,the Union legislatorsconsidered it more appropriatetohavea somewhat faster implementationschedulethan Basel.TheRegulation thereforesetsthe followingschedulefor LCRimplementation:60% in 201570% in 201680% in 2017,and100%in 2018.In other wordsunder the Regulation 100% LCR implementation will bereached in 2018,i.e. one year earlier than Basel.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 42. P a g e | 42But whydoesthe Regulation phase in the LCR oneyear fasterthan Basel?Thefinancial crisisthatstartedin2007showedthat liquidityisabsolutelykey for the resilienceof institutionsin stresssituations.Thetreatment of liquidityisfundamental, both for the stabilityof banksaswell asfor their rolein supportingwidereconomicrecovery.Therefore,tohighlight this importance,theUnion co-legislatorsdecidedtoadvancefull implementationof the LCR by one year sothat a 100%LCR will already applyin 2018.However,if appropriate and in the light of a report tobe preparedbyEBA taking intoaccount the economicsituation aswell asEuropeanspecificitiesand international regulatorydevelopments, the Commissionis empoweredtodefer the 100% phase-in of the LCR until 1January 2019and apply in 2018a 90% LCR, in linewith the Basel schedule.Is an institution alwaysobliged to have a LCR ratio above 100%?No.In a stressed situation an institution may be obliged to make use of itsliquid assets with the result that its LCR ratio (temporarily) falls below100%.This point hasbeenspecificallyrecognisedin the text publishedby theBasel committee on 7th January 2013.However,it should be noted that even in this situation, under theRegulationaninstitutionisrequiredtoimmediatelynotify thecompetentauthoritiesand submit a plan for the timely restorationof the LCR ratioabove100%.Doesthat mean there are no new liquidity rulesuntil 2015?No. Again tounderlinetheimportanceofavoidingliquiditymismatches,from thedate of adoption, the Regulation alreadyestablishesa generalInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 43. P a g e | 43requirement that institutionsneed tohold liquid assetstocover their netcashoutflowsin stressed conditionsover a thirtyday period.However,thisis a general requirement and not a detailed ratiorequirement aswhenthen LCR entersintoforcein 2015.Will it be possible to accelerate the implementation of the LCRat national level?Yes. Before the LCR becomes a binding minimum standard in2015, Member States may maintain or introduce binding minimumstandards for liquidity coverage requirements and require LCR levelsup to 100% beforethe LCR is fullyintroducedat a rate of 100% in 2018.How doesthe Regulation implement the 7 January 2013revisedBasel agreement regarding an extended definition of liquidassetsand revised outflow rates?TheCommissionattachesaspecial importancetotheobservationperiodin order to properlyassesstheimpact of thenew liquidityrequirementson institutionsand financial marketsand ensure requirementsaredefinedand calibratedin the most appropriate manner.ThisiswhytheRegulationdoesnot fix at thisstageaclosedlist of liquidassets.Instead, it specifiesa minimum list of itemsthat shall be considered asliquid, while theEBAshall report to theCommission by 31December2013on appropriateuniform definition of high and extremelyhighliquidityand credit qualityof liquid assets.In its report, the EBAshall consider a variety of assets, includingRetailMortgageBacked Securities(RMBS) of high liquidityand creditquality, localgovernment bonds, commercial paper, equities listed on arecognisedexchange, corporatebonds, and soon.Pendingtheuniform definitionof liquidassets,institutionsshall identifyand report themselvesin a givencurrency, assetsthat are respectivelyofhigh and extremely high liquidityand credit quality.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 44. P a g e | 44At the same time, competent authorities may provide general guidancethat institutionsshall followin identifying thoseassets.In the same manner, the EBAshall report to the Commissionon thecalibration of inflowand outflow rates.It should benoted that EBA shall in particularreport on theneed for anymechanismsto restrict thevalue of liquidityinflows, e.g. by establishinganappropriateinflowcap;aswellasreport onanymechanismstorestrictthecoverage of liquidityrequirementsbycertain categories of liquidityassets,e.g. by establishinga minimum percentagefor liquid assetsofextremelyhigh liquidityand credit quality.Note that in itsreport, the EBAshall takedue account of internationalregulatorydevelopments.TheCommission isempoweredtospecifythedetailed liquiditycoveragerequirements.When will the net stable funding requirement come into force?Thesame basic approach will be followedfor theNSFR, namelya longobservation period beforeadoption of thestandard intoUnion law.However,workon the NSFR hasnot progressed asfar asthat on theLCR andthereisstill averyconsiderableamount ofdevelopment worktobecarried out by theBasel Committee.Thereforein thelight of theresultsof theobservation period and reportstobe preparedby EBA, theCommission will prepare, if appropriate,alegislativeproposal by 31December 2016to ensurethat institutionsusestablesourcesof funding, takingfull account of the diversity of theEuropean banking sector.Doesthat mean there are no NSFR rulesuntil 2018?No. Several years before any bindingminimum standards for net stablefundingrequirementsmay be specifiedunder Union law,theRegulationalready establishesthe general rulefrom 1January2016that institutionsshall ensure that long term obligationsare adequately met withaInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 45. P a g e | 45diversityof stablefunding requirementsunder both normal and stressedconditions.What is the role of covered bonds in the composition of theliquidity buffer?For theLCR, a particular focusof the observation period will be set onthedefinition of liquid assets.EBA will test different criteriaformeasuringhow liquid securities areunder stressedmarket conditions.Thiswill preparethegroundforadecisionbefore2015that willultimatelydeterminetheeligibility criteria for the twotiersof the liquiditybuffer.For theNSFR, the Commissionwill analyse how such a structuralrequirement plays out acrossthediverseEU banking sector, notablyasregards itsabilitytoprovidelong-term funding to support therealeconomy.7. LEVERAGEWhyreducing leverage in the banking sector?Leverage is an inherent part of bankingactivity; assoon asan entitysassetsexceeditscapital baseit islevered.TheCommission doesnot proposeto eliminateleverage, but to reduceexcessive leverage.Thefinancial crisishighlightedthat credit institutionsand investmentfirmswerehighly levered, i.e. theytook on more and more assetson thebasisof an increasinglythin capital base.What is the Leverage Ratio?In linewithBasel III, theCommission thereforeproposestostart theprocessof introducinga leverageratio.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 46. P a g e | 46Theleverageratio is definedasTier 1capital divided by a measureofnon-risk weightedassets.What purpose doesthe Leverage Ratio serve?Thepurposeof the leverageratio is tohave a simpleinstrument thatoffersa safeguard against the risksassociatedwith the risk modelsunderpinningrisk weightedassets(e.g. that the model is flawedor thatdata ismeasuredincorrectly).Theultimateaim is alsotoconstrain leverageand tobringinstitutionsassetsmore in linewith their capital in order to help mitigatedestabilisingdeleveragingprocessesin downturn situations.Will institutions be required to have a Leverage Ratio above acertain value?Sincethe LeverageRatiois a new regulatory tool in the EU, there isalack of informationabout the effectivenessand the consequencesofimplementingit asa binding (Pillar 1) measure.It is thereforeimportant to gather more information before makingtheleverageratioa bindingrequirement.In linewithBasel III, theCommission thereforeproposesa step by stepapproach:- Initiallyimplement the LeverageRatio asa Pillar 2 measure;- Data gatheringon thebaseof thoroughlydefinedcriteria asof 1January 2014;- Publicdisclosureasof 2015;- Report bythe end of 2016including, whereappropriate, a legislativeproposaltointroducethe leverageratio asa binding measureasof2018.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 47. P a g e | 47Whyinstitutions should disclose their leverage ratio asof 1January 2015?Doesthat not effectively make it a bindingrequirement in view of market pressure?Requiring the disclosure of the Leverage Ratio isin line with the EUspush to introduce more transparency in the financial sector ingeneral, and thebanking sector in particular.It is alsofullyin linewithBasel III rules.Even in the absenceof such a requirement, the market wouldalmostcertainlydemand institutionstodisclosetheinformation on theirLeverage Ratioand punish thoseinstitutionsthat wouldnot discloseitbymeansof raisingtheir cost of capital.How dothenewrulesaddresstheconcernsthat theintroductionof the Leverage Ratio would have significant negative impactson trade finance and lending to small and mediumenterprises, to name just two areas?There isnt currentlysufficient informationin order toestimate thepreciseimpact of theLeverageRatio.That is whythe LeverageRatio will not be introduced outright asabindingmeasure, but rather asa Pillar 2 measure (i.e. the judgement onwhetherornot theleverageratioof aparticularinstitutionistoohigh andwhetherthat institution should hold more capital asa consequencewillbeleft to thesupervisorof that institution).Furthermore, that is whytheproposal foreseesan extended observationperiod during whichthenecessarydata will be gathered, and a review toestimatetheimpact oftheLeverageRatiobasedonthosedatathat wouldthen inform thedecision on the introduction of the LeverageRatioasabindingmeasure.TheRegulation applies lowerconversion factorsto trade relatedoff-balancesheet itemsthanthoseinitiallyprovided in theCommissionsinitial proposal.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 48. P a g e | 48This intendsto mitigate the impact of theleverageratioon trade financeoperationsand lendingto SMEs.How dothenewrulestake into account variousbusinessmodelsthroughout the Union and addressthe issue of low-risk type ofbusinessprofiles?Thereview of the leverageratiowill includethe identificationofinstitutionsbusinessmodels and whetherthe level of theleverageratioshould be the same for all types of businessmodels.If deemed appropriate, several levelsof theleverageratiomay beintroduced in order toreflect the overall risk profile, the businessmodeland size of institutions.8. COUNTERPARTY CREDIT RISKWhat will be the treatment of counterparty credit risk arisingfrom derivatives?Buildingon theRegulation on OTC derivativesand marketsinfrastructures(EMIR) (IP/10/1125), the new rulesincreasethe ownfundsrequirementsassociatedwithcredit institutions and investmentfirms derivativesthat are traded over-the-counter("OTCderivatives", for furtherdetails see MEMO/ 09/ 314andMEMO/ 10/ 410) and securitiesfinancingtransactions(e.g. repurchaseagreements).The new rules also amend the current treatment of institutions exposureto central counterparties (CCPs)iv stemming from those transactions, aswell asexchange-tradedderivativestransactions,in the followingway:- Unlike under existingrules, exposurestoa CCP will be subject to anownfundsrequirement.Thesizeof the requirement will depend on the type of exposure:tradeexposurestoa CCP (e.g. exposuresduetocollateral postedtotheCCP) will be subject to a substantiallysmallerown fundsrequirementthanexposuresduetocontributionstotheCCPsdefaultInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 49. P a g e | 49fund. This is becausedefault fund contributionscan be usedformutualisinglossesdue to thedefault of another clearingmember.- Compared toexposuresfrom bilaterallyclearedtransactions, exposurestoCCPs will be subject to lowerown fundsrequirementsaslong asthe CCP will meet certain requirements(inthespecific, they will need tomeet the requirementslaid down inEMIR or besubject toequivalent rules,in caseof a third-countryCCP).If the CCP will not meet thosecriteria, thentrade exposureswill besubjecttothebilateral treatment and default fund contributionswillbesubject to a high ownfundsrequirement.How will the new rulesaffect non-financial corporatesand their use ofnon-centrallycleared OTC derivatives?Thepolitical agreement reachedby the co-legislatorsexemptsnon-centrallycleared OTC derivativetransactionsbetweenbanksandnon-financialcorporatesfromthenewBasel3capitalrequirement fortheso-calledCredit ValuationAdjustment risk, whensuch transactionsdonot exceed relevant thresholdsthat arespecified in EMIR.9. SUPERVISIONHow do the new rulesstrengthen supervision?Regulation, nomatter how good, cannot overcome poor supervision.Thefinancial crisisbrought thispoint on theagenda.As a result, the EU hasalreadytaken stepsto strengthensupervision, notablywiththe creationof the three European SupervisoryAuthoritiesand theEuropean System of Financial Supervision(MEMO/ 10/434).Thenew rules strengthen banking supervisionfurther by requiringtheannual preparation of a supervisoryprogramme for each supervisedinstitutionon thebasisof arisk assessment;greaterand moresystematicuseof on-sitesupervisoryexaminations;more robuststandardsandmoreintrusiveand forward-lookingsupervisoryassessments.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 50. P a g e | 5010.CAPITAL BUFFERSWhat the new rulesprovide for asregardsthe capital buffers?On thebasisof theBasel provisionsthe followingcapital buffersareintroducedCapital conservation bufferThecapital conservation buffer is a new prudential tool introducedbyBasel III.It is a capital buffer of 2.5% of total exposures of a bank that needs to bemet with an additional amount of the highest qualityof capital (i.e. CET1capital).It sitson top of the4.5% CET1 capital requirement (seeSection 5 oncapital above).As itsname indicates,thebuffers objectiveis toconservea bankscapital.When a bank breachesthe buffer, i.e. whenitsCET1capital ratiofallsbelow7%, automatic safeguardskick inandlimit theamount of dividendandbonuspaymentsa bank can make.Thefurtherthebank eatsintothebuffer,thestricterthelimitsbecome.This preventsthe bankscapital tobe further eroded by suchpayments.Countercyclical bufferThecountercyclical buffer is another new prudential tool introducedbyBasel III.As the name indicates,thepurposeof this buffer is tocounteract theeffectsof theeconomiccycle on bankslendingactivity, thusmakingthesupplyof credit lessvolatileand possiblyeven reducetheprobability ofcredit bubblesor crunches.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 51. P a g e | 51It works asfollows: in good times, i.e. where an economyis booming andcredit growth is strong, it requires a bank tohave an additional amount ofcapital (asin thecaseof thecapital conservation buffer, CET1capital).Thispreventsthat credit becomestoocheap(thereisacost tothecapitalthat a bank must have) and that bankslend toomuch.If a bank doesnot haveenough capital tofill this buffer, thesamerestrictionsasin thecaseof the capital conservation buffer kick in.When theeconomic cycle turns, and economic activityslowsdownoreven contracts,this buffer can be released (i.e. thebank isnolongerrequiredto havetheadditional capital).This allowsthebank tokeep lendingtothe real economy or at leastreduceitslendingby lessthanwouldotherwisebethe case.Global systemic institution bufferFollowingEP proposedamendmentsthepolitical agreement includesamandatorysystemic risk buffer of CET1capital for banksthat areidentifiedby the competent authorityasgloballysystemically important.Theidentificationcriteria and the allocation intocategoriesofSIFI-ness are in conformitythe G-20agreedG-SIFI criteriaandincludesize, crossborder activitiesand interconnectedness.Themandatory surcharge will be between1and 3.5% CET 1and applyfrom 1January 2016onwards.TheG-SII a"surcharge" reflectsthecostofbeingsystemicallyimportantandprovidesand reducesthemoral hazard of implicit support andbail-out by taxpayer money.TheFinancial StabilityBoardsprovisional list of 28globalSIFIs,includes19 European global SIFIs.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 52. P a g e | 52Other systemic institution bufferIn additiontothe mandatoryGlobal SII buffer the politicalagreementprovidesfor a supervisoryoption for a buffer on other systemicallyimportant institutions.This includesdomesticallyimportant institutionsaswell asEUimportant institutions.In order toprevent adverseimpactson theinternalmarket there isframingin the form of thecriteria usedtoidentify O-SIIs, anotification/justificationprocedure and an upper limit of 2% CET1.TheO-SII buffer is applicablefrom 2016onwardsbut MemberStateswantingtoset higher capital for certain banksearlier can use thesystemic risk buffer.Theoptional O-SII buffer CET1capital is recognisedfor meeting theconsolidatedmandatory G-SII buffer requirement.In additiontothese capital buffersthe new rules provide for a:Systemic risk bufferEach Member State may introducea Systemic Risk Buffer of CommonEquityTier 1for thefinancialsector or oneor more subsetsof thesector, in order toprevent and mitigatelong term non-cyclical systemicor macroprudential riskswiththepotential of seriousnegativeconsequencesto the financial system and thereal economyin a specificMemberState.Until 2015,in caseof buffer ratesof more than 3%, MemberStateswillneed prior approval from theCommission, whichwill take intoaccounttheassessmentsof the European Systemic RiskBoard (ESRB) and theEBA.From 2015onwardsand for buffer ratesbetween3 and 5 % the MemberStatessettingthebuffer will have to notify theCommission, theEBA, and theESRB.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 53. P a g e | 53TheCommission will providean opinionon the measure decidedand ifthisopinion isnegative, the MemberStateswill have to "complyorexplain".Bufferrates above 5% will need tobe authorized by the Commissionthrough an implementingact, takingintoaccount the opinionsprovidedbytheESRB and by the EBA.11. CORPORATE GOVERNANCEHow doesCRD IV improve corporate governance?Thenew Directive introducesclear corporate governance arrangementsandmechanismsfor institutions.Theserulesconcern the compositionof boards, their functioningandtheir rolein risk oversight and strategy in order toimprovetheeffectivenessof risk oversight by Boards.Thestatusandtheindependenceoftheriskmanagement function isalsoenhanced.Supervisorswill play an explicit role in monitoring risk governancearrangementsof institutions.Themeasuresadopted should help avoid excessiverisk-takingbyindividual institutionsand ultimatelythe accumulationof excessiveriskin thefinancial system.Theprincipleof proportionality, taking intoaccount the size andcomplexityof theactivitiesoftheinstitutionaswellasdifferent corporategovernancemodels, appliesto all measures.Corporate governance Does CRD IV impose diversity?Diversityin board composition shouldcontributetoeffectiveriskoversight by boards,providing for a broader rangeof viewsand opinionandthereforeavoidingthe phenomenon of group think.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 54. P a g e | 54What doesCRD IV do to improve transparencyregarding theactivities of banks and investment fundsin different countries?Increasedtransparencyregarding the activitiesof institutionswhichoperateon a multi-national basis, and in particular asregardsprofits,taxesandsubsidiesindifferent jurisdictions,isessential forregainingthetrust of EU citizensin the financial sector.Under CRD IV, MemberStateswill have to ensurethat institutionsdisclosethis type of information, by MemberState and by third countryin whichtheyhave operations.TheCommission will, however, first assessthepotential impact of someof thesedisclosureobligationsand, if appropriate, make a proposal toamend the scope and/ or modalitiesof disclosure.Whyreforming only CRD IV (banks and investment firms) anddisregarding other sectors(insurance, investment funds)?This may lead toinconsistenciesbetweendifferent sectorsand it isdifficult to justify whyin banksthere should be a limitationof thenumber of board mandates, separation betweenCEO/ Chairfunctions,boarddiversity, and not in insurancecompaniesorinvestment funds.Thecorporate governancefailings whichcontributedtothe financialcrisisoccurred mostlyin banks.Also, existingrulesin thebanking sectorare of a very general nature ascomparedtoinsuranceor investment fund legislationwhererulesoninternalorganisationand risk management aremuch more detailed andprecise.That is whywestart with reforming corporate governancein creditinstitutionsand investment firms.However,for thesake of consistencyand in order toavoid regulatoryarbitragebetweensectors, it will be necessarytoreview the existinglegislationin other sectors(Solvency II, UCITSDirective) toalignit, whennecessary, tothe outcome of the final text of the CRD IVpackage.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 55. P a g e | 55Nevertheless, thespecificitiesof each sector should be taken intoaccount, and therulesshouldnot necessarilybe identical forbanks,insurancecompaniesand investment funds.12.REMUNERATIONWhat are the existing rulesregarding remuneration?In order toensure that remunerationpoliciesdonot give incentivestotake riskswhichundermine sound and effectiverisk management andwhichexacerbateexcessiverisk-takingbehaviour,CRD III introducedin2010a number of technical criteria underpinningthe total remunerationpolicies(includingsalariesand discretionarypension benefits) of creditinstitutionsand investment firms in relation tocategoriesof staff whoseprofessional activitieshave a material impact on their risk profile(material risk takers).Theseincluded in particular the followingrequirementsregardingthestructure of remuneration:- a substantial portion, and in any event at least 50 %, of any variableremuneration should consist of equity-linked instruments;and- a substantial portion of the variable remuneration component, and inanyevent at least40 % to 60 % (the latterin thecaseof a variableremuneration component of a particularlyhigh amount) should bedeferred over a period of not lessthan three to five years.While providing that fixed and variable components of totalremuneration should be appropriately balanced and that the fixedcomponent should represent a sufficiently high proportion of the totalremuneration (allowing the possibility to pay no variableremuneration), it was left to the institutions to set the appropriateratios between the fixed and the variable component of the totalremuneration.CRD III did not set any maximum ratio between the fixed and thevariablecomponent.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 56. P a g e | 56Institutions also have an obligation to disclose to the public informationregarding the remuneration policy and practices for material risktakers[iii].What are the new, additional rules introduced by CRD IV?CRD IV essentially carries over the existing provisions of CRD IIIrelatingtoremuneration.It also introduces additional transparency and disclosure requirementsrelating to the number of individuals earning more than EUR 1millionper year.Furthermore, in order totackle excessiverisk takingthe remunerationframeworkhasbeenfurther strengthened withregard to therequirementsfor therelationship betweenthevariable(or bonus)component of remuneration and the fixed component (or salary).Thekey elementsof thenew rule, whichwill apply toremunerationawardedfor servicesand performancefrom 2014onwards,are thefollowing:- Thevariablecomponent of the total remuneration shall not exceed100%of the fixed component of thetotal remuneration of materialrisk takers;- Theshareholders,ownersor membersof the institutionmay, withaqualified majority involvingeither a minimum representationrequirement for sharesor equivalent ownershiprightsof 50 % and avoting majorityof twothirdsor nominimum representationrequirement and a 75 % voting majority, approve a higher maximumlevel of thevariablecomponent provided that this level doesnotexceed200%ofthefixedcomponent ofthetotalremuneration. In thiscontext, forthepurposesofcalculatingthemaximum ratio,theuseofdeferred and bail-in-ableinstrumentsis specificallyencouraged through the applicationof a notional discount factor toup to25% of total variable remunerationprovided that it is paid ininstrumentswhichare deferred for more than fiveyears; and- Thecompetent authoritiesaretobeinformedof recommendationstoshareholdersandof theresult ofanyshareholdervote, whichshall notInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 57. P a g e | 57conflict with institutions obligationsto maintaina sound capitalbase.TheEBA iscalledupon toprovidefurther technicalguidanceasregardsthenotional discount factor and the Commission will review theapplication and the impact of the new rulesin due course.Do the new rulesapply to the remuneration of all staff?No. The rules apply only for categories of staff whose professionalactivities have a material impact on their risk profile, such as seniormanagement, risk takers, staff engaged in control functions and anyemployee receiving total remuneration that takes them into the sameremuneration bracket assenior management and risk takers.The EBA is called upon to develop draft regulatory standards withrespect to qualitative and appropriate quantitative criteria to identifythesecategoriesof staff.Do the new rulesapplyto all institutions andinvestment firmsinthe EU?Yes.Moreover, the rulesalsoapplytoi)subsidiariesestablishedoutside the EEA of institutionswhichhavetheir head office in the EEAandii)subsidiariesestablished insidetheEEAof institutionswhichhavetheir head office outsidethe EEA.CRD IV providesthat "[t]heapplicationof the [remunerationprovisions]shall be ensured by competent authorities for institutionsat group, parentcompanyandsubsidiarylevels,includingthoseestablishedin offshorefinancial centres".This provision already existed in CRD III. TheCommission will reviewtheapplicationand theimpact of this rule in due course.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 58. P a g e | 5813.SANCTIONSWhat exactly the new rules provide for regarding sanctions? Theproposalwill require Member Statesto providethat appropriateadministrativesanctionsandmeasurescanbeappliedtoviolationsofEUbankinglegislation.For thispurpose, theDirectivewillrequirethem tocomplywithcommonminimum standardson:- typesand addresseesof sanctions,- thelevel of fines,- thecriteriato betakenintoaccount by competent authoritieswhenapplying sanctions,- thepublication of sanctions,-themechanism toencourage reportingof potential violations.Theseprovisionsarewithout prejudicetotheprovisionsof nationalcriminal law.Whythe introducing provisionson sanctions in the revision ofthe CRD?The"CRD IV" packagefundamentallyoverhaulsthesubstantiveprudential rulesapplicabletoinstitutions.But theserules will onlyachievetheir objectiveif theyare effectivelyandconsistentlyenforcedthroughout the EU.This requiresthat competent authoritieshave at their disposal not onlysupervisorypowersallowingthem toeffectivelyoversee credit institutionsbut alsosufficientlystrictandconvergent sanctioningpowerstorespondadequatelyto theviolations(which may neverthelessoccur), and preventfuture violations.However,thebanking sector is one of theareaswherenationalsanctioningregimesare divergent and not alwaysappropriateto ensuredeterrence.For example, in thebankingsector themaximum amount of finesprovided for in caseof a violation is unlimitedor variablein five MemberInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 59. P a g e | 59States,more than 1million euro in nineMember States, and lessthan150000euro in seven Member States.Thosemaximum levels,in thelatter group in particular, appear toberather small, especiallyin view of the largesize of thebankinggroupsoperatingin several of theseStates. For more examplesseeMEMO/ 10/660Therefore, thenew frameworkprovidesfor the introduction of rules toreinforceand approximate national sanctioningregimes.Banking supervision is based on supervisory measures toprevent violations and restore banks viability whywouldsanctions be necessary?When a bank is in distress, the first priority is in fact to save and not tosanctionit.In fact, the new rules are not introducing harmonised sanctions forviolationsof minimum capital requirements.But sanctionsare key to ensure other rules are respected for example ifbanks dont report to supervisors as required, and thereby makesupervision ineffective,or if banksact without authorisation.What it is planned to ensure that breachesare actuallyprosecuted and that appropriate sanctionsare actually handeddown?The new rulesmake sure that all supervisors have the possibility, that istosayare empowered, to imposeeffectivesanctions.National supervisors remain mainly responsible for the actualapplication of sanctions.In order to ensure that breaches are actually prosecuted and ensureconvergence for sanctions handed down, we require supervisors to put inplace whistle blowing programmes to improve detection ofviolations, and propose convergence on the factors to be taken intoaccount whenimposingsanctionsin each individual case.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com 60. P a g e | 60Prosecution is highly case specific and in the realm of nationalauthorities (with the exception of Credit Rating Agencies), so the reachof EU legislativeaction is limited.Therefore, peer reviews conducted by the ESAs (Art 30(2)(d) of the ESARegulations explicitly refers to sanctions) are an important tool to ensurefurther convergence, and once the legislative framework in all MemberStates on what supervisors can do will have converged following ourinitiative, weplace big hopeson them.What hashappened to the initial idea of criminal sanctions?Criminalsanctionscanhaveanimportant deterrent effect inparticularonindividuals,and can thereforebe appropriatein certain instances.UnderArt 83(2) TFEU, theEU cantakeactiononcriminalsanctionsbutonlyunder limitedcircumstances.We will further assess whether EU action on criminal sanctions isnecessary for the financial services area as a whole and will decide aboutappropriatefurther action on that basis.Lis