Evolving Banking Regulation EMA Edition

FINANCIAL SERVICES Evolving Banking Regulation EMA Edition

The journey continues – the clock is ticking… February 2013

kpmg.com Giles Williams Jim Low Simon Topping Partner Partner Principal Financial Services Financial Services Financial Services Regulatory Center Regulatory Center Regulatory Center of Excellence of Excellence of Excellence EMA region Americas region ASPAC region KPMG in the UK KPMG in the US KPMG in China

About this report This report is part of a regional series developed by KPMG’s network of regulatory experts. The insights are based on discussion with our firms’ clients, our professionals’ assessment of key regulatory developments and through our links with policy bodies in each region.

For other regional reports, please contact [email protected] or see www.kpmg.com/regulatorychallenges

KPMG Marketing and Project teams We would to like to thank members of the Marketing and Project teams who have helped us develop this report:

Weronika Anasz KPMG in China Vinkal Chadha KPMG in India Charlotte Beck KPMG in the UK Meghan Meehan KPMG in the US Sarah Saunders KPMG in Canada Brittany Spriggs KPMG in the US

Contents

Foreword 2

Executive Summary 4

Regulatory Pressure Index 6

Challenging times 10

Challenge 1: 13 Responding to each individual regulatory initiative. Challenge 2: 20 Responding to the combined and cumulative impact of regulatory initiatives. Challenge 3: 22 Combining regulatory reform challenges with other challenges – and shaping strategic direction and business models accordingly. Challenge 4: 26 Restoring confidence and trust in banks by tackling the deep-seated issues of culture and behavior. A view from Asia-Pacific 28 A view from the Americas 30

The regulatory landscape 32 An update on regulatory reforms in Europe, the Middle East and Africa (EMA).

Abbreviations 43

Acknowledgements 44

Foreword

Welcome to this year’s Evolving Banking Regulation for the Europe, Middle East and Africa region. In previous years, we provided a global overview of regulatory reforms and their impacts on the banking sector. The pace of regulatory change and implementation now varies significantly across the key regions of EMA, ASPAC and the Americas, bringing with it unique challenges. This year’s regional editions highlight these Jeremy Anderson, CBE challenges, alongside a snapshot of global regulatory activity Chairman, Global Financial Services and what it means for banking, in 2013 and beyond.

As we look forward to the year ahead, This year, we highlight the strategic and Senior management are having to focus the global financial system remains operational challenges that the waves simultaneously on two very different fragile and unstable. Meanwhile, the of regulatory reform will pose for banks aspects of their businesses. One is regulatory reform agenda continues to in Europe in 2013 and beyond. We also the internal re-engineering of corporate look far from a finished product, five and present a snapshot of how the regulatory and risk governance, and making a half years after the financial crisis began measures implemented in the Americas crucial changes to the roles of Risk and in the summer of 2007. and Asia-Pacific regions will affect Compliance functions. The other is a Regulatory reform was intended to major European banks with significant response to external pressures, from the make financial institutions and markets operations in those regions. market and regulators, to restructure, more transparent, less complex and less As I discuss these regulatory reforms alter the mix of business activities and leveraged. But progress has been limited with the senior management of banks, innovate in order to reduce costs and because many of the reforms are still in I am struck by the magnitude of the raise revenue during a period of the early stages of implementation, other challenges they face. First, banks are economic stagnation in Europe and slow reforms remain on the drawing board, being pulled in many directions at growth in the rest of the world. and crisis intervention measures are still once. The regulators want banks to We are also seeing that those banks in place in many countries. As the IMF be prudent. Customers want lower that undertake the fastest, smartest remarked in its Global Financial Stability banking costs. Banks’ creditors want transformation are most likely to Report of October 20121, “although to make sure they get their money succeed. Timidity in the face of turmoil there has been some progress over back. Shareholders want them to be is unlikely to win the day. My over-riding the past five years, financial systems profitable. There inevitably have to be sense, as I review the new financial have not come much closer to those trade-offs here, and striking the right regulations at various stages of desirable features.” balance is proving difficult for both the implementation and the uncertain In last year’s report, we focused on banks and their regulators. economic climate, is that simplicity is two main areas: the prospective impact Second, banks face a wide range of the best rule to follow. Given a choice of the Basel 3 package of regulatory regulatory reforms – both individually and for banks between two paths – whether reforms across regions and countries, collectively. There is then the even more they are strategies, processes, structures and the development of a ‘second wave’ important challenge of deciding what or services – the simpler one is likely of regulatory reforms, focused primarily these regulatory reforms – together with to prove more successful. on addressing the systemic risks inherent all the other drivers of the business – So what do we see as the future of in the structure of the financial system mean for each bank’s strategy and banking in the EMA region? Europe’s itself and the systemically important business model; and implementing banking industry is likely to see significant banks within it. effectively the necessary changes. consolidation – and to remain highly

1. Global Financial Stability Report, IMF, October 2012.

Executive Summary

The strategic and operational challenges to their collective impact, not just more than just a compliance exercise. facing European banks have never implement each one separately. This report aims to provide a guide been greater. Banks are also struggling to restore through the maze. We consider the The regulatory reform agenda is public trust and confidence, much of strategic and operational challenges perhaps the biggest driver of strategic which was wrecked by the financial banks face as they re-assess their and operational change – managing crisis and successive scandals, from business models. Every activity and this is a key challenge for the industry. the mis-selling of retail financial products process needs to be re-evaluated. In our Banks have to contend with a multitude to the manipulation of LIBOR. view, the future of banking will see a of new rules – global, regional and While policymakers continue to return to the old-fashioned virtues of national – with each jurisdiction moving influence the shape of banking through trust and relationship-building, but it will at its own pace and applying its own new regulation, the second major driver be combined with new technologies interpretation to commonly agreed of change is responding to economic that enable financial institutions to deliver high level principles. The momentum conditions and competitive forces that the highest-quality customer service for regulatory reform has also been are driving yet more upheaval for the at a lower cost than before. reinforced by the political and populist sector and its players. Europe, in We then provide an update on the responses to the financial crisis. particular, remains in a state of flux. regulatory landscape, from measures to As a result, banks have to respond As a result of these drivers, banks are in deal with capital adequacy; systemic to a wide spectrum of regulatory the midst of a multi-year transition and risk; resolution planning; and shadow initiatives, from capital and liquidity will emerge from it in a very different banking. In addition, increasing requirements to corporate governance, shape than when they went in. emphasis is being placed on new and from derivatives to the design of retail Grasping the opportunities from upcoming rules to protect consumers, products, and from resolution to this challenging environment is easier a focus that can be seen not just in new remuneration. The interfaces between said than done. Navigating the regulatory consumer regulations but in fines and these various initiatives make it crucial maze requires great concentration other measures designed to change for banks to consider and respond and attention to detail – and this is far corporate cultures.

Regulatory Pressure Index

Regulatory Reform, Policies Year EMA US ASPAC Impacts for Banks and Objectives

Reform: 2010 4 4 2 • Basel 3 requirements continue to prove a considerable challenge for all banks globally, with many in the West struggling Capital 2011 5 4 3 to raise capital in a time of deep uncertainty, and banks Objectives: continuing to deleverage. The shortfall against Basel 3 • Increase both the quantity 2012 5 5 4 requirements in Europe is significant. and quality of capital buffers in • In addition, the Basel Committee on Banking Supervision is also order to reduce the possibility reviewing the trading book and model-based Risk Weighted of bank failures Assets (RWAs). Policies: • In Asia, capital has become the current focus, as it is the aspect • Basel 3 (Global) of Basel 3 with the most imminent implementation date of • CRR/ CRD 4 (Europe) January 1, 2013, or soon thereafter. Although banks in Asia can • Dodd-Frank (US) generally meet the new requirements with little difficulty at • Capital Surcharges (FSB) present, there is an emerging concern that the requirements could potentially act as a constraint on balance sheet growth in the years ahead. • In the US, there is continuing regulatory scrutiny of capital quality and plans. Stress testing efforts remain an important element of these assessments, with 30 US institutions with over US$50 billion in consolidated assets subject to either the Comprehensive Capital Analysis and Review (CCAR) or the Capital Plan Review (CapPR). In addition, the proposed intermediary holding company construct for foreign banks in the US will require adherence to US capital requirements and has strategic implications.

Regulatory Pressure Index continued

Regulatory Reform, Policies Year EMA US ASPAC Impacts for Banks and Objectives

Reform: 2010 5 4 4 • Most banks identify liquidity/funding as the issue that is of Liquidity greatest importance to them. The recent changes to the 2011 5 4 5 calculation of the liquidity coverage ratio (LCR) – by extending Objectives: the range of assets qualifying as high quality liquid assets and • Ensure that banks have enough 2012 4 4 5 lowering the assumed run-off rates of liabilities – may ease liquid assets to meet a potential concerns somewhat. run on funds • At the same time, supervisors are struggling to determine how Policies: best to implement the new requirements in Asia, where funding • Basel 3 (Global) markets may be less developed than in the other regions. This • CRR (Europe) remains a difficult issue in Asia. • While the Federal Reserve is still expected to implement the LCR in the US, the scope and timing remains unclear. More broadly, liquidity risk assessments remain less robust than supervisory efforts around capital. As the regulators begin to analyze the significant data that is being captured from institutions through new reporting mechanisms, greater scrutiny and emphasis on liquidity is likely. In the interim, regulators continue to carefully review liquidity, with emphasis on interagency guidance issued in 2010, as well as a greater emphasis on horizontal (cross-institutional) examinations.

Reform: 2010 5 5 1 • Large global banks have to meet increased capital requirements, Systemic Risk prepare RRPs and are subject to enhanced supervision. 2011 5 5 2 • Europe will be affected by a significant number of proposals: Objectives: the UK’s Independent Commission on Banking (ICB), the EU • Reduce risks to financial 2012 5 5 3 Liikanen proposals (and additional national measures, eg. France stability, from the structure of and Germany), particularly regarding separation. We also await the financial services sector the outcomes of the EU Recovery and Resolution Directive or the failure of a systemically (RRD) and Banking Union. important financial institution • We are not seeing a major push from supervisors in the Asia- Policies: Pacific region on systemic risk at present. Clearly, with further • Capital Surcharges (FSB) progress in the development of Recovery and Resolution Plans, • Dodd-Frank (US) this will change. • Crisis Management Proposals • In the US, the Volcker Rule will affect firms across the globe, (US, EU) while the US has also proposed tougher treatment of foreign • Structural Change (US, UK, banks operating in the region. The FRB proposals on foreign Germany, France and possibly banks, with a possible requirement for an intermediary holding the EU) company structure, is a significant shift from the virtual holding • Federal Reserve Bank (FRB) company structure and represents a material increase in proposals (US) regulatory requirements.

Reform: 2010 4 5 2 • In Europe, the supervisory authorities (including the EBA) are Supervision playing a key role in developing a single rule book and a more 2011 5 5 3 consistent supervisory approach. Meanwhile, the European Objectives: Central Bank (ECB) will begin to take responsibility for banking • Ensure that banks are properly 2012 4 4 2 supervision in the eurozone from 2014. supervised, proportionately to • The regulatory environment remains challenging for financial the nature, size and complexity institutions in the US, as new requirements are being of their business established and non-traditional institutions become subject to Policies: a more intensive and intrusive supervisory regime. Tolerance • New supervisory structures, levels remain low and examiners are taking stronger actions, eg. in the US, UK, and Europe including enforcement actions, against a range of institutions. • More intrusive and challenging In addition, consumer protection issues remain a key area of supervision emphasis as the Consumer Financial Protection Bureau (CFPB) • Dodd-Frank (US) continues to build out its program. • Supervisors in Asia are generally comfortable that they have appropriate structure and powers, and it seems unlikely we will see a major shift in supervisory approach or focus. However, supervisors will have to consider imminently whether changes are required in the supervision of (domestic) systemically important banks.

Key: 5 = significant pressure 3 = moderate pressure 1 = low pressure

Regulatory Pressure Index continued

Regulatory Reform, Policies Year EMA US ASPAC Impacts for Banks and Objectives

Reform: 2010 4 4 4 • In Europe, banks will need to meet the corporate governance Governance requirements in CRD 4 and the Markets in Financial 2011 4 4 4 Instruments Directive (MiFID 2), while systemically important Objectives: banks will be subject to the Financial Stability Board’s (FSB) • Ensure that Boards have sufficient 2012 4 5 3 conclusions on risk governance and the Basel Committee’s skills, experience and availability to Principles on risk data aggregation and reporting. The FSB assume full accountability for the review of risk governance will maintain – and in some cases decisions taken by the organization increase – the pressure on banks to improve their governance. Policies: • The rulemaking around governance requirements in Dodd- • CRD 4 (Europe) Frank suggests that requirements are being tightened even • MiFID 2 (Europe) further. For example, regulators in the US are looking to • EBA Governance Guidelines significantly increase the expectations around directors’ (Europe) knowledge and prior experience with risk management issues. In addition, other governance changes suggest a potential blurring of the line between oversight and direct management of an institution. While the emerging standards apply in particular to directors on the risk committee, there is the risk that examiners will apply similar expectations to other directors, with potential consequences for the composition of boards. • While enhancing governance and Board oversight remains an important policy objective in Asia, we have not seen many supervisors prioritizing this at present. This likely reflects that supervisors in the region do not feel that the need for cultural change is as great in Asian institutions. The focus in Asia is generally more on risk management and oversight through implementation of Basel 2 advanced approaches.

Reform: 2010 4 3 1 • In Europe, amendments to CRD 4 tabled by the European Remuneration Parliament may result in limits on bonuses as a proportion 2011 3 3 1 of base salary. Objectives: • In the US, regulators continue to expect enhancements to • Regulate excessive 2012 4 3 1 compensation processes, driven in part by the results of the remuneration practices 2011 horizontal examination report. Policies: • This is not attracting much attention in Asia, where excessive • FSB principles on remuneration remuneration has not been an issue in local institutions. (Global) • Dodd-Frank (US)

Reform: 2010 3 4 1 • In Europe, a flood of rules, including the review of MiFID 2; Customer Treatment Packaged Retail Investment Products (PRIPS); the UK Retail 2011 4 4 2 Distribution Review (RDR); and new product intervention Objectives: powers for the conduct-focused regulators are evolving to • Protect the customer, help 2012 4 4 2 protect the customer. the customer make informed • In the US, regulators continue their focus on protecting the investment decisions and consumer as evidenced by recent CFPB enforcement ensure that the products sold actions. Recent focus has moved beyond the banks to the customer suit his/her themselves to their vendors in order to determine their ability investment profile to manage compliance and consumer protection. Policies: • Although still not a major focus in Asia, we are starting to see • MiFID (Europe) more jurisdictions launch enhancement initiatives in this area, • Dodd-Frank (US) typically more in relation to investment products than general • CASS Directive (Europe) banking products. Given that this is a key focus of regulatory • RDR (UK) reform in the US and Europe, it is likely that we will see • PRIPs (Europe) increased interest in this area in Asia.

Regulatory Reform, Policies Year EMA US ASPAC Impacts for Banks and Objectives

Reform: 2010 4 4 1 • There has been a lot of activity in traded markets regulation Traded Markets throughout 2012. The Dodd-Frank Act (DFA) in the US, 2011 4 4 2 the European Market Infrastructure Regulation (EMIR) Objectives: and aspects of MiFID 2 in Europe all have an impact on • Reduce risk in the wholesale 2012 4 4 3 the structure of wholesale markets and in particular how markets and regulate the Over the derivatives are traded, cleared, settled and reported. As Counter (OTC) derivatives market these reforms move into the implementation phase, they Policies: pose significant challenges for all market participants. • Dodd-Frank (US) • Key ASPAC markets are beginning to formulate policies • MiFID (Europe) in response to the G20 agenda on derivatives. • EMIR (Europe) • G20 (Global)

Reform: 2010 3 3 3 • Still awaiting resolution of the debate on whether banks Accounting and should move to an expected loss, rather than impairment, 2011 3 3 3 approach to provisioning. Disclosure • The IASB and FASB have proposed new financial Objectives: 2012 3 3 2 instrument impairment models that are likely to accelerate • Consider whether accounting recognition of loan losses and reduce capital for accounting policies need to be revised purposes. Although initially a joint proposal between the and the additional disclosures Boards, the FASB has recently proposed a separate current that may be required expected credit loss (CECL) model for upfront recognition • Move to expected loss provisioning of credit losses expected over the life of loans and investment securities. Policies: • Enhanced Disclosure Task Force (EDTF) • IFRS 9 recommendations on improving disclosure by banks, • CoREP including the justification for internal model based risk • EDTF recommendations weightings that are substantially below both industry endorsed by the G20 and FSB averages and standardised risk weightings. • Financial Instruments and Leasing • Disclosure requirements to reconcile the US GAAP and Convergence Projects IFRS accounts may create an additional reporting burden. As Dodd-Frank is implemented, Title VII will have an impact on accounting for OTC derivatives. Companies will need to monitor carefully. • Not an area currently receiving a lot of attention in Asia. Several supervisors are focusing on provisioning and requiring banks to top up provisions above the level suggested by accounting requirements.

Reform: 2010 n/a n/a n/a • Foreign Account Tax Compliance Act (FATCA) introduces Financial Crime and Tax a new withholding tax regime and will place a significant 2011 4 4 3 burden on many banks, affecting operations, IT, front office Objectives: and a number of areas of their business. • Prevent market abuse and 2012 3 4 4 • As elsewhere, FATCA is a significant issue for firms in financial crime ASPAC, with notable challenges being the effective and • Ensure that investors comply timely development of compliant systems/data/policies. with the relevant tax authorities As institutions become aware of the complexities involved, • Use tax as a means of paying for this is now becoming more urgent. some of the costs of the crisis • In Europe, the LIBOR rate-fixing scandal has led to large Policies: fines. The Market Abuse Regulation (MAR) is being • FATCA (US) amended to outlaw manipulation of benchmarks such as • FTT (Europe) LIBOR, boosting minimum fines for insider trading and • MAD/MAR (Europe) proposing criminal sanctions on anybody found to have • Anti-Money Laundering (AML) manipulated benchmarks. • The introduction of a Financial Transactions Tax (FTT) by 11 EU member states will have implications for European firms’ compliance and will be a significant challenge and costly exercise for banks. • Another area of increasing focus is Anti-Money Laundering (AML) compliance and associated Know Your Customer (KYC) regulations.

Key: 5 = significant pressure 3 = moderate pressure 1 = low pressure

The banking industry is at a major inflection point – change The regulatory agenda Five and a half years since the start is unavoidable. Banks face challenges from multiple sources, of the financial crisis in the summer of including the external macro-economic environment; their 2007, the extensive ‘more of everything’ competitors and the emergence of new competitors; and the programme of regulatory reform is far from complete. Some elements (for continuous struggle to increase efficiency, control costs and example, Basel 3, OTC derivatives maintain margins. But the single most pervasive driver of and key elements of the EU consumer change is the regulatory agenda. agenda) are reasonably complete in their design and their transposition into EU legislation, but are yet to be implemented. Indeed, 2013 will be the first year of implementation for many of these initiatives. Other elements (for example, recovery and resolution planning, the additional capital, governance and supervision requirements for systemically important banks, the review of capital requirements for banks’ trading books, and eurozone banking union) are

becoming increasingly clear as concepts, Banks will therefore have to deal with a clients are taking to this challenging but details remain uncertain. Here, 2013 combination of implementing existing environment has been multi-faceted – will be a year of developing the detail and initiatives, awaiting the detail in areas and in some cases disjointed. Developing turning this into specific requirements where the direction of travel is clear, a comprehensive outlook across the for banks. and dealing with new initiatives, where regulatory landscape and an understanding Finally, some elements (for example, major decisions have not yet been taken. of its overall impact on business is shadow banking, the use of macro- We discuss all of these elements in becoming critical. Dealing with issues on prudential tools, and decisions on The regulatory landscape on page 32. an individual basis is both ineffective and whether to apply the Liikanen report However, we first set out an overview often misses the point. Nor is it sufficient recommendations) remain on the of how banks are approaching this for banks to focus only on regulations drawing board. For these elements, change journey and some of the key that are currently being implemented – 2013 will be a year of decision-taking, challenges they will be addressing banks must not take their eyes off the with implementation some years away. along the way. The approach that many regulatory developments that lie ahead.

Understanding the regulatory agenda

The regulatory response to the financial crisis has taken the form of a series of initiatives focused on: Remuneration Liquidity Systemic risk and capital buffers Improve the safety and soundness of individual banks and thus reduce the Sy Governance nd st Capital a c e likelihood of banks failing. This is through e ap m c n i io t ic a combination of more robust financial n a a is l r b i n v s r resources and proposals to make banks r u k e e f a f v p e easier to resolve – through either pre- n u

o Regulatory r

d s s emptive structural changes (eg. Liikanen Supervision G Agenda Structural proposals) or planning ahead in the and change event a bank runs into trouble (RRP). reporting C Customer and markets ustomer a Change the structure and practice within nd markets both wholesale and retail financial Customer Financial markets to increase transparency, treatment crime improve efficiency, and enhance the Market quality of customer outcomes by infrastructure changing incentive structures and requiring a more diligent assessment of customer activities and needs.

Governance and supervision The number of individual policies more effective planning and change Improve the people and infrastructure facing banks seems endless. But the management (Challenges 2 and 3 – with which banks govern their business. objectives of many are highly see page 12). This underpins the rest of the regulatory interdependent with other similar agenda. The composition, consistency initiatives. Understanding this and effectiveness of governance, risk connectivity allows you to move from and control frameworks must be re- tackling each policy as it comes visited to deliver a model which is fit for (Challenge 1 – see page 12) to a more the future. thematic approach which supports

Developing a comprehensive outlook across the regulatory landscape and an understanding of its overall impact on business is becoming critical.

The journey from regulation to transformation

Institutions with sufficient resources and foresight are now progressing from reviewing regulation to designing the major transformation needed to position for success in the changing landscape. Challenge 4

Restoring customer focus and trust by tackling the deep-seated Challenge 3 issues of culture and behavior Combining regulatory • Change cultures and reform challenges behaviors to meet customer expectations and regulatory with other challenges – requirements and deliver Challenge 2 shaping business models sustainable growth. accordingly • Changing customer needs require innovation and Responding to the • Develop business, structural investment – and new combined and and operating models in full means of compliance. cumulative impact of compliance with the new regulatory initiatives and developing regulatory regime – while still attracting Challenge 1 • Regulations are not investors. introduced in a vacuum. • Continue to improve Responding to individual • Identify and assess the efficiency while complying regulatory initiatives inter-relationships between with new regulations. regulatory initiatives to • Compliance with detailed support transformational requirements. change. • Meeting new and expanding reporting requirements.

This is necessary – any one regulation can cause banks to change their business models – but it is not sufficient to view regulatory reforms in isolation...

Maturity of organizational response

Many banks in the region are shrinking the range of services they offer as they restructure their balance sheets, in particular by disposing of non-core assets.

relatively small, but the shortfalls have internal models to calculate capital Challenge 1 already forced many banks to re-assess requirements can drive down their their strategies and business models. capital requirements by enhancing Responding to individual their data, models, systems and regulatory initiatives To comply with Basel 3 capital ratios, processes. For example, more banks are: complete data sets, an improved • Raising new capital – some stronger recognition of netting and collateral, The main focus for many of our clients banks have been able to issue and more refined allocation of continues to be around implementation new capital, while weaker banks exposures to internal rating of a handful of critical policy initiatives, in some European countries have grades can generate lower capital as described below. received injections of capital from requirements. But increasing scrutiny governments. Retained earnings from policymakers and supervisors Capital have become an important source of is likely to limit the benefits here. Banks are already monitoring closely capital, as banks cut back on dividend where they stand against the Basel 3 and bonus payments. Retrenchment is the order of the day. minimum capital and leverage ratios – • Closing some business lines, selling Many banks in the EMA region are and taking action to meet them. Many assets and slowing the growth of new shrinking the range of services they offer banks have also been subject to pressure lending – the cost of new capital and as they restructure their balance sheets, from the European Banking Authority declining rates of return on equity in particular by disposing of non-core (EBA) – through its stress tests based have forced banks to restructure and assets. Banks are focusing on core on a 9 percent core equity tier 1 capital slim their balance sheets as a means banking services, with a clear focus on ratio – national regulators and the of driving up capital ratios. But as the retail, wealth management and corporate markets to go beyond the Basel 3 chart below shows, balance sheets of business, and on re-pricing these minimum capital ratios, in terms of the largest banks remain far in excess activities in an attempt to generate an both amounts and the speed of of their pre-bubble average. acceptable rate of return on equity and implementation. For some banks, the • Optimizing the calculation of risk- on assets. remaining scale of adjustment may be weighted assets – banks using

European G-SIFIs – average balance sheet size, 2000–2012

2.0 2.0 1.8 1.8 1.6 1.6 US$ trillion 1.4 1.4 1.2 1.2 1.0 1.0 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0 0 Size of balance sheet Size 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2 011 Q3 2012

Source: Capital IQ, 2012

Liquidity Four other challenges on liquidity for Banks will have to adjust to Meeting the Liquidity Coverage Ratio banks are: differences between their (LCR) and the Net Stable Funding Ratio • The (re)pricing of both assets and (NSFR) will remain a major challenge for liabilities to reflect the true cost of evolving national regimes and many banks, even after the revisions to funding; the final version of the Recovery the LCR announced recently by the Basel • The external and internal reporting and Resolution Directive (RRD). Committee on Banking Supervision requirements – and the systems and (see details on page 33).To meet even controls required to support them – the revised LCR, many banks will need to for the monitoring of banks’ positions make expensive changes to their balance against these new liquidity ratios, sheets – by holding larger amounts of including the importance of assessing low-yielding assets that are counted as the potential impact of various stress high quality liquid assets in the calculation tests and alternative scenarios; of the LCR, replacing short-term • As with capital, the increasing wholesale deposits with retail and longer- ‘localization’ of financial markets, term wholesale deposits, and reducing making it more difficult to conduct committed facilities.3 global, intra-group funding operations Banks also need to consider their because national regulators do not continuing ability to meet the LCR under want liquidity to flow across borders. the prospective conditions of stronger However, at least in the eurozone, the balance sheet growth, a reduction in the creation of a banking union under a volume of government bond issuance legal framework may make it easier for and the reduction of central bank banks to conduct intra-group treasury provision of liquidity. operations across the eurozone; and As with the LCR, the NSFR penalizes • Additional regulatory initiatives that short-term wholesale liabilities and will have an impact on funding and encourages banks to increase their liquidity. For example, there are a funding through retail deposits, longer- number of policy proposals on the term wholesale liabilities and capital agenda of the FSB and the EU to take instruments. In addition, on the asset regulatory action around repurchase side of their balance sheets, banks may agreements (repos), ranging from need to reduce their long-term lending additional reporting for banks to through the sale of assets and a shift in mandatory haircuts on repos. Such the types of lending that they undertake proposals could have a significant to ease funding requirements. impact on the wholesale funding However, there are limits on the market. extent to which banks collectively can attract more retail deposits, since the Recovery and resolution planning and total sum of available deposits tends bail-in liabilities to grow slowly, and other banks will be The draft Recovery and Resolution chasing after the same depositors, Directive (RRD) has already acted as a thereby pushing up the interest rates ’wake-up call’ to banks in many European paid on them and making retail deposits countries who had previously made only less stable as a source of funding. In limited progress on resolution planning. short, banks’ funding costs are likely to The EBA’s recent announcement go up and the yield on high-quality liquid requiring plans from Europe’s 39 largest assets to go down. cross-border banks in advance of the final 3. See Liquidity – A bigger challenge than capital, KPMG, May 2012

© 2013 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. RRD will accelerate the effort needed. Where more progress has been made, economic functions that are regarded as The implementation of the requirements such as in the UK and the Netherlands, being critical; the extent to which national will generate major challenges for banks will have to adjust to differences authorities require banks to change their banks, in terms of both their legal and between their evolving national regimes business activities and their legal and operational structures and the costs of and the final version of the RRD. Smaller operational structures in advance to recovery planning and bail-in liabilities. banks will need to discuss with their reduce the cost and complexity of Banks will need to: national authorities what relief they resolution; and the use of resolution • Develop recovery plans based on might obtain from these requirements, tools and powers by national authorities. severe stresses and scenarios, with depending on the nature, size, complexity These potential inconsistencies are in prospective actions linked to specific and systemic risk of their business. addition to the existing differences in triggers; Internationally active firms will have a insolvency law across jurisdictions. • Develop resolution packs to enable particular interest in any lack of consistency Banks also face a period of continuing national authorities to take a view in national standards, and in cross-border uncertainty before the RRD and the on whether effective and credible resolution arrangements – both within resolution powers of the authorities are resolution plans can be constructed – the EU and globally. Such firms will face finalized – and probably for even longer banks will have to provide extensive major challenges in responding to any before effective cross-border resolution information to their national resolution divergences in requirements across measures are introduced. authorities; countries, and any lack of cooperation • Make whatever changes are required and consistency in their application. Structural separation by the authorities to improve the Actions required by one regulator to The various proposals for structural credibility and effectiveness of bolster the stability of economic separation – the Liikanen recovery and resolution planning, functions in their jurisdiction could recommendations in the European including higher amounts of contingent conflict with business or regulatory Union, and national initiatives in the capital and funding to underpin priorities elsewhere. In the long run, these US, UK, Germany and France – pose recovery, and changes to business tensions may produce a more localized a number of key challenges for banks. activities and legal entity and operational structure for the largest banks. There is continuing uncertainty about operational structures to facilitate Even within the European Union, where these proposals will end up. resolution; and national authorities may take different In the European Union, the main issue • Hold whatever amounts and types of approaches in areas such as the stresses is whether and how the Liikanen bail-in liabilities are required by national and scenarios that a recovery plan should recommendations will be taken forward, authorities. Such liabilities are likely cover; the extent to which national while for the national initiatives a to be expensive for banks, because authorities require banks to make their number of important details remain to unsecured and uninsured creditors will recovery plans more robust; the detailed be resolved – not least in the definition demand a higher return to reflect the information to be provided within of exactly which activities will be removal of implicit state support. resolution packs; the financial and prohibited, limited or ring-fenced.

Market infrastructure change – The buy-side key dates The effects of market infrastructure which asset is most cost effective for reforms will be felt not just by the ‘sell their purposes, where they would like By early 2013: side’ parties offering derivatives as a to trade and who with – as relevant Dodd-Frank – firms need to be service for risk mitigation. The ‘buy- rules could be different depending prepared to deliver against side’ firms – who use derivatives to on any of these variables. They need requirements as a foreign Swap manage their commercial financial risks robust reporting systems which can Dealer or Swaps Participant, where – are also swept up by the rules. Most demonstrate whether or not their applicable. Firms need to have other financial services firms are subject trading activity is eligible for exemptions. determined which regulatory to the clearing requirement. They also retain accountability for requirements are relevant to Non-financial firms are exempt – to fulfilling new reporting and possibly risk their business and the impact the extent that they can continuously mitigation requirements (confirmation, they may have. demonstrate the trades are undertaken reconciliation), even where these are to hedge commercial risks, or otherwise in practice outsourced to counterparties EMIR – firms need to be in a fall below the regulatory threshold. or other market infrastructures. position to begin delivering against Even so, non-financial users will see Significant investment in systems a phased implementation plan which the price of risk mitigation increase as and supporting compliance capability commences with the final publication banks pass on higher operating and is therefore needed, on top of higher of EMIR, currently expected in financial costs associated with both fees and prices. Q1 2013. cleared and non cleared derivatives. MiFID – firms need to be actively They also face choices around how reviewing policy developments and they would like their collateral treated, considering the implications for implementation plans against other related initiatives. The effects of market infrastructure reforms will be felt not just by the ‘sell side’ parties offering derivatives as eventually be across key markets, and a service for risk mitigation. the extent to which home country The ‘buy-side’ firms – who supervisors of parent banks will be prepared to accept compliance with use derivatives to manage host country rules by foreign subsidiaries. their commercial financial The central clearing of derivative risks – are also swept up by transactions will require processes and systems capable of identifying when a the rules. particular asset, in a particular jurisdiction and with a particular counterparty, is subject to clearing. In Europe, the definition of the venue on which cleared trades must be executed is still pending in the review of MiFID, and may take months (or years) to be finalized.

Many of our clients are currently working A second challenge for the management Banks are being challenged through changes to data and trading of collateral is that many assets which to implement – and to be able systems to identify changes needed and might be used as collateral under current gaps which will require new information. regulations will be ‘locked up’ under new to demonstrate the effective Operational infrastructure must be rules which allow banking clients to opt working of – a range of improved extended to ensure connectivity to for their assets to be kept separately and corporate governance practices. key market infrastructures. But this not re-used (individual segregation). is complicated, as none of these Banks will need to introduce enhanced infrastructures are yet authorised under processes and governance frameworks EMIR, technical specifications are yet to cope with the possibility of a dramatic to be issued, and multiple relationships increase in the number of client money may be needed to cover all asset classes accounts. Some brokerage businesses and geographies. Business and financial will struggle to source funding without the models must be re-configured to reflect ability to make use of client collateral. new costs, fees, pricing and capital Enhanced reporting requirements considerations. pose a major challenge for both buy and All market participants have expressed sell side market participants. The scope concern over the detailed rules emerging of new reporting will eventually be around the amount and treatment of amplified by new requirements to extend collateral to support both centrally pre-and post-trade information to new cleared and remaining OTC trades. Many asset classes including OTC derivatives, of our clients have initiated significant under proposals in the review of MiFID. change programs to help them identify New data requirements, including more accurately where eligible collateral collateral information and daily mark to instruments sit within their organizations market reporting as well as extended and how this collateral is being used. counterparty data, are proving difficult to The more advanced banks are looking source quickly and reliably. Finally, where at how they can improve or develop trades cross borders in any way it systems which allow them to optimize remains unclear which trades will be use of these instruments on a real time subject to reporting in which jurisdictions basis, often on behalf of clients. These and how these requirements can be activities are already coming under fulfilled. scrutiny from policymakers. Doing Larger banks have already begun the so requires significant data on what journey of implementing the necessary collateral is acceptable – at what price – change to fulfil clearing requirements; by which counterparty, and whether many smaller banks still have a long way collateral could be deployed more to go. Only the largest participants are profitably elsewhere. likely to find that the return on equity for In principle, clearing and collateral a broad base of business exceeds the transfer will be exempt for intra-group combined costs of funding, capital and trades under EMIR. In practice, the extensive operational and compliance criteria required to gain an exemption requirements. Smaller banks may have may not be met by all affiliates, increasing to find a niche – geographic, asset class the cost and complexity of intra-group or counterparty – where they have a funding and risk management. competitive advantage.

Supervision Governance In response, senior management are Banks are already on the receiving end Poor standards of corporate governance having to revisit whether they give of more intrusive and more challenging were one cause of the financial crisis, so appropriate attention to the full breadth supervision. This covers not only the standard-setters and supervisors have of risks arising from their activities, more traditional areas of supervisory been active in setting and monitoring and whether the existing governance interest, such as capital and systems and banks’ performance against a higher framework is effective in defining clear controls, but also much more intensive and more challenging set of standards. accountabilities for the identification, supervisory focus on liquidity, recovery Banks are being challenged to implement measurement and management of and resolution planning, the composition – and to be able to demonstrate the all risks and their control within the and capability of Boards, remuneration effective working of – a range of business. The relative roles of business (of senior executives, traders and improved corporate governance management and independent control customer sales staff), business models practices, including: functions are under particular scrutiny, as and product design. • The active involvement of the Board in is the definition and focus on operational This trend of more intensive establishing the bank’s strategy, risk risk – a source of major risk failures supervision of an expanding range of appetite, capital adequacy assessment reported in the last year, including further banks’ activities is likely to continue. (ICAAP) and culture and values; mis-selling, manipulation of markets, The Financial Stability Board has • The appointment of non-executive and money laundering breaches. emphasized the importance of more directors with experience and intensive supervision for systemically expertise in banking, with the important banks, and has given a clear willingness and ability to challenge message that these banks should be at the senior executive team, and with the top end of the spectrum of bank the time available to perform their practices – demonstrating good practice roles effectively; rather than merely acceptable practice. • The effective working of the key Board Meanwhile, in the eurozone, the transfer committees – audit, risk, remuneration of banking supervision to the ECB may and nominations; and lead to a tougher supervisory approach • The effectiveness of risk governance, for some banks. Those subject to direct including the role of the Chief Risk ECB supervision, or ECB oversight of Officer (CRO) in providing the Board their national banking supervisor, will also of a bank with an enterprise-wide face uncertainties about how exactly this view of risk and an evaluation of the new system of banking supervision will risks inherent in significant changes to operate in practice – and there is some the bank’s strategy, business model nervousness about whether the style and operations; the ability of the of supervision will create further bank to meet high standards of risk challenges. data aggregation and reporting; and the ability of the Board to assess the adequacy and effectiveness of the bank’s controls.

Banks need to consider the combined and cumulative impact of all these proposals on their business models and on their legal entity and operating structures.

1. Structural change requirements to simplify group Challenge 2 Banks need to assess and respond structures, and structural changes to the collective impact of pressures to facilitate single or multiple entry Responding to the combined for structural change, including: resolution approaches; and cumulative impact of • Structural separation between retail • Pressure to establish subsidiaries and regulatory initiatives and investment banking, and the specific structures in some countries. prohibition of some trading activities, as The US recently proposed that major a result of the Volcker rule in the US, the foreign banks establish holding Most banks are dealing with the major Independent Commission on Banking companies for all US subsidiaries; and new regulations one by one. This may recommendations in the UK, proposals • Ring-fencing of subsidiaries (and seem a logical approach, but it poses a for structural separation in Germany and branches) by host country authorities risk of missing key inter-relationships France, and the possible implementation seeking to protect their domestic and co-dependencies. Banks need to of the Liikanen recommendations in depositors and national economies consider the combined and cumulative the European Union; from problems in banking groups, impact of all these proposals on their • Additional structural restrictions and to enable host authorities to business models and on their legal entity imposed on individual banks by the resolve local entities. and operating structures. The magnitude resolution authorities, to enable those of reform may threaten the viability authorities to construct credible and of existing business activities and effective resolution plans. These structures, requiring a step change if restrictions could include further ring- the bank is to emerge with a viable fencing of critical economic functions, franchise.4 We highlight four key inter- limits on intra-group transactions and 4. See The Cumulative Impact of Regulation, KPMG in the Netherlands, relationships here. the use of shared support services, September 2012

2. Re-pricing of products and services requirement. For example, secured • Capital requirements – the capital Almost all regulatory reform initiatives funding may be attractive to both banks requirements for unsecured/ have an impact on costs, and should and their creditors as a source of longer- uncollateralized exposures have, in therefore be reflected in pricing decisions term funding, but this may conflict general, increased by more than those and – where significant – in decisions on with a requirement on banks to hold a for secured/collateralized exposures; the business activities undertaken. minimum amount of bail-in liabilities • Contingency planning and stress • Capital – higher capital ratio and with requirements on banks to hold tests – banks are being required requirements will increase the overall unencumbered liquid assets to meet to hold buffer stocks of collateral cost of doing business, in particular the LCR requirement. And the use of to protect themselves against the for highly capital-intensive exposures, mortgages as security will in practice possibility of being downgraded and while actual and prospective increases increase the amount of stable funding having to put up additional collateral in the risk weighting of various types of required under the NSFR. Another as a result; exposure (in particular for trading book example is the likelihood of increasing • Derivatives – the central clearing risks and counterparty exposures) will capital requirements on banks’ holdings of derivatives will require more have a material impact on the pricing of sovereign debt, which would alter derivatives trades to be collateralized, of these activities; the balance between the value of these with higher quality assets; and • Liquidity – the LCR and NSFR assets to banks for capital adequacy • Systemic risk and shadow banking – introduce new funding costs for banks, and liquidity purposes. proposals here include limits on which will need to be priced into both The other pressure on banks is the re-hypothecation of collateral liabilities and assets; essentially timing, as they need to ensure through enhanced segregation of • Resolution and bail-in liabilities – that they meet regulatory requirements client assets and higher collateral banks will need to factor in the costs on a continuous basis. This will require requirements on repo and other of the reduction in implicit government careful planning, especially as improving secured lending transactions. support and, in effect, the transfer economic conditions generate balance of these costs from taxpayers to sheet growth and central banks seek to Taking the opportunity to combine the holders of bail-in liabilities; and reduce their provision of liquidity. liquidity planning and the impact of • Ring-fencing – requirements for the central clearing of derivatives with structural separation and the ring- 4. Collateral management an overall assessment of collateral fencing of local subsidiaries and A number of regulatory reform initiatives management is key. Our clients are branches will increase the costs of will increase the demand for collateral looking at how they can improve data, doing business, in particular from by banks. These initiatives include: systems and processes to support capital and liquidity being trapped • Liquidity – banks will be required to better real time assessments of what within individual entities and therefore hold high quality liquid assets that collateral is available and its most not available to the rest of banking have to be unencumbered, and which effective deployment. groups. cannot therefore be used as collateral Together, these pressures may lead for other purposes; some banks to consider significant Inevitably there will be a trade-off • Resolution and bail-in liabilities changes to their group structures, between client willingness to accept – wholesale depositors will have and to their national and international higher prices and lower returns. an incentive to lend to banks on a business activities. secured basis to avoid the threat of 3. The capital and liquidity interface being bailed-in if a bank has to be The increasing number and complexity resolved. Movement of funds across The other pressure on banks of regulatory requirements reinforces borders in an RRP focused world is essentially timing, as they two pressures on banks. One of these could become more challenging need to ensure that they meet is conflicts: moves by banks to meet one on the one hand, and increasingly regulatory requirement may worsen necessary for intra-group purposes regulatory requirements on a their position in relation to a different on the other; continuous basis.

that were centralized nationally, return on equity – as shown in the chart Challenge 3 regionally or globally, combined with the below. Yet the cost of compliance is exploitation of internal synergies through soaring and, along with it, the amount Combining regulatory reform the consolidation of core IT systems and of investment in the systems required challenges with other challenges – integrated operations centres to drive to enable banks to monitor themselves and shaping strategic direction and efficiency improvements. Regulatory and and to report to the authorities. The unit business models accordingly. business model pressures are forcing cost of supplying retail services is rising banks to consider taking a different sharply – for example, the cost of running approach, with a move away from single branch networks usually makes up Although banks face a wide range of IT platforms and a single set of shared around 75 percent of a retail bank’s total challenges, including macro-economic services towards establishing each distribution costs6 – but banks find it and competitive, we focus primarily business unit with its own operational difficult to pass on these costs to their here on the more internal operational centre. Banks are being pressed by customers because they are perceived challenges facing banks, and on how national supervisors to repatriate core as public utilities. One method of these ever-present and continuing activities from regional or global shared reducing costs would be to close retail challenges interface with the current services to their respective domestic branches, but this carries reputational waves of regulatory reform. Developing jurisdictions. Successful new models risk. In some European countries where a new operating model will not, in itself, have not yet fully emerged, but they may governments are now significant position a bank to succeed in the new look radically different from the old one. shareholders it is politically difficult to market – this is only part of the overall The centralized bank may become a thing cut back on banking services. But in challenge. Even if the operating model of the past, replaced by an entity that is countries such as Spain, the number of is very sophisticated, it will not realize more local. branches is falling sharply as banks try its full potential unless there is a strong Second, banks historically pursued new ways to acquire more customers governance framework surrounding it.5 a strategy of volume growth. Now, with fewer outlets. however, the industry is shrinking and The success of both of these shifts Moving away from the old models overall economic growth in Europe is from earlier banking models will depend The banking model of the past two stagnating, at best. Given subdued on banks increasing their efficiency decades can be characterised in two market conditions, significant cost in the current environment, which will ways. First, banks were seeking reduction is critical in closing the gap require something more deep-rooted economies of scale through services between current and long-run median than conventional downsizing. With

Median return on equity (Net income over total shareholder funds; in percent)

20 20

15 15

10 10

5 5

0 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Banks Non-bank ﬁnancials Non-ﬁnancial corporations 1995–2010 average

Source: Bloomberg; BIS calculations.

Developing a new operating `quick win’ cost reductions increasingly have withdrawn or are likely to pull out. model will not, in itself, position exhausted, many of our clients have now But the more established players are initiated fundamental reviews of business likely to stay. Many of them are making a bank to succeed in the new areas and supporting infrastructure. higher profits there than in their home market – this is only part of the They are facing up to difficult choices not country, partly because their costs overall challenge. just about what businesses to be in, as are lower. described above, but also about where Spanish banks have disposed of their to invest for growth with increasingly non-core assets, including insurance scarce capital. Previous high margins subsidiaries and asset-management in many organizations were sustained companies. In France and Switzerland, through starving core infrastructure and banks are pulling out of business areas, functions of the necessary development restricting client activity and making to generate efficiencies and support significant staffing cuts. In the UK, more effective risk management and while many banks have not yet reduced compliance. their suite of products, this will have to The focus is now shifting to come. The Swiss bank, UBS, recently sustainable cost reduction supported announced that it is divesting its non-core by targeted investment in simplifying business and moving to more of a wealth operations, such as straight-through management and private banking focus. processing that minimizes human input Other European investment banks are in bank processes – increasing efficiency also taking large steps in changing their and embedding controls; first-time business models, pulling out of some resolution, where processes such as markets and focusing business activities opening a bank account would be done elsewhere, for example, Deutsche in one step rather than multiple stages; Bank’s recent public announcement and greater use of self-service channels that it is reducing non-core risk-weighted in which customers conduct more bank assets. activities without the need for human The scale of these changes can intervention by the bank.7 Banks may already be seen in the slow but steady at least not need to make expensive reduction in bank headcount, post-crisis. investments in user interfaces for their There was a 6.5 percent drop in EU retail customers, since many of their bank employment between 2008 and clients have smart phones and tablets 20118, while in the last year, 29 major that can do the work. banks announced job cuts of at least 160,0009. And there will be more to Shifting geographies and international come as banks continue to restructure. business models Many global and European banks are also re-evaluating their international footprint and structure, re-assessing key elements such as where they book business and legal entity structures. Some are rationalising and simplifying

their legal entity structures, and 5. See Optimizing banking operating models: From strategy to implementation, KPMG in the UK, September 2012 considering the relative merits of 6. Trends in Retail Banking Channels: Improving Client Service and Operating Costs, CapGemini, 2012 branch and subsidiary structures. 7. See Optimizing banking operating models: From strategy to implementation, KPMG in the UK, September 2012 In Eastern Europe, the international 8. Source: European Banking Sector Facts and Figures, European Banking Federation, 2012 banks that never gained a foothold either 9. Source: Thomson Reuters, November 2012

© 2013 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Optimising Business and Control applied across the business. The operations. The additional pressures Functions recent BCBS principles for Risk Data generated by separating or structuring The changes in business model, Aggregation and Risk Reporting, businesses by activity or geography may combined with specific changes in published in January 2013, lay the also mean that the current IT architectures regulation, together create major new groundwork for a way forward by at the heart of global banks will require challenges for the core business and requiring greater consistency of risk extensive re-work in order to better control functions of banks – finance, information across the business, to reflect new operating models, new risk, treasury and compliance. These enable more accurate and timely data organization structures and new functions must change the way in which aggregation, while emphasizing the regulatory regimes. they interact, both with each other and importance of business ownership over The existing architectural and IT with front line business management, risk data, risk reporting, and its effective platform structure within a bank often if they are to increase the effectiveness control. While costly and complex, reflects what was required to support and efficiency of their services. New implementing these proposals well historic legal entity and regulatory business models and extensive new provides businesses with significant reporting structures. There are significant regulations require new approaches opportunities. architectural challenges presented by the to building and operating an effective risk The regulatory agenda affects every need to adopt radically different operating and compliance framework. Control aspect of how a bank controls compliance models and reporting requirements, for functions must play a critical role in of its operations. The challenge of how to instance to create greater control of shaping and delivering necessary manage capital, liquidity – and collateral – individual business units on a standalone business change to ensure compliance becomes crucial to optimizing business basis, while still being able to create end is built in – rather than bolted on – to key decisions and returns. This is where to end process efficiencies and end to business processes. business managers, risk, finance and end control environments to deliver an A critical challenge is re-balancing the treasury come together. The scarcity integrated picture of the Group to accountabilities of risk and compliance and cost of both capital and funding management or external regulators. functions relative to business managers. requires a more integrated approach There are increasing and potentially Lack of clarity over ownership and to capital buffers, supported by more conflicting demands for changes to understanding of the full set of risks comprehensive and inclusive re-charging certain key processes, for instance, client by business managers has led to a to businesses. And reliable data, which on boarding processes and regulated or lack of focus and investment on the can be generated and aggregated advised sales processes. These changes identification, measurement and control quickly, will be a critical enabler. could be driven by business management, of many risks. Risk functions have eg. operational cost reduction achieved instead found themselves acting as IT investment through improved operational efficiency the owners, operators, advisers and Maintaining consistent and reliable data (better process automation), or cost assurers of both risks and controls. to support management and financial reduction through improving the Light touch policies applied from the analysis – covering everything from line proportion of transactions delivered Group level have allowed divergence in management decision support requests, by customer self-service (increased practices, language, measurement and through to formal regulatory reporting – leverage of digital channels) or they reporting of risk and controls. This lack is a huge challenge for many banks, in could be driven by a desire for increased of clarity and consistency has led to the face of the spider’s web of legacy revenues, for instance by enabling a inefficiencies through duplicated effort, systems and multiple, separate pools better sales process for new products and also the operational gaps at the of data which are common today. from better managing the servicing heart of so many operational failures Banks will have to continue to invest of the banking back book products. throughout 2012. heavily in technology if they need These changes will potentially affect Regulators have observed this and extensive changes to their operating the same people, processes and have re-emphasized the role of business models as a result of regulatory technologies as other regulatory driven management in risk and control, and are requirements, for instance to separate changes, for instance, to address or looking for improved practices which are high street banking from ‘casino’ banking monitor Conduct Risk.

Maintaining consistent and Much, although not all, of the change Most crucially, banks themselves reliable data to support demand comes from regulators, need better data management ie. including: underpinning improvements in data management and financial • Increased requirements for data from governance, data ownership, data analysis is a huge challenge banks to improve the ability of both management and in how data is for many banks. micro- and macro prudential regulators consumed across front and back- to understand better the financial office functions, financial reporting system and the risks to financial teams, etc in order that authenticated stability. Regulators are demanding and accurate data can be leveraged more information from banks about to gain a deeper, richer view of their their credit and market risk exposures, customers through data analytics their liquidity positions, and their for instance. interactions with other parts of the financial system, including shadow For many, the main challenge is the The traditional approach to providing a banking. fragmented application and data new regulatory reporting requirement • Increasingly detailed and granular data architecture with pockets of data within a bank has often been to develop a from banks relating to compliance with distributed across different silos, specific additional IT solution comprising regulatory rules. Regulators in Europe resulting in data redundancy, data data collection, data storage and reporting. are working on Common Reporting duplication and data inconsistency. It is quite normal to have multiple, parallel Standards (COREP) that promise Banks have invested huge sums in processes and multiple, parallel solutions to establish a common framework building complex systems to meet producing essentially similar outputs based on common formats. This reporting and compliance requirements, quite separately. The parallel processes, may eventually standardize reporting often with significant ongoing challenges teams and technologies might exist solutions and processes – and reduce in keeping the systems and data up to because the output of one is intended duplication – but it is likely to take date as a result of, for example, in-flight for internal management and another several years. The use of Extensible projects and emerging regulations. is for the external regulator, or because Business Reporting Language (XBRL) is A few organizations have been able one process is controlled by Finance designed to help banks to standardize to adopt a more radical approach of and another is controlled by Risk, or and analyze data, however switching significantly rationalizing applications, because one is a business unit reporting from legacy structures and standards data repositories and End User Computing function and the other is a Group to new formats will not be a trivial tools to make processes and systems reporting capability. exercise. smaller, more efficient and more flexible. It is also much more common for • Higher standards of data aggregation These organizations can look at the projects to deliver additional solutions and data reporting by banks, to enable forthcoming portfolio of changes with to the architecture than for a project to them to identify and monitor risks significantly greater confidence. actually decommission platforms, more accurately and in a more timely databases or infrastructure. The underlying manner, and to be in a position to data and reporting architecture has run stress and scenario tests more therefore become increasingly complex, effectively. In future, regulators will increasingly fragmented and increasingly require reports that go deeper into difficult to standardise and control the underlying health of particular year by year. Few banks have had the businesses and their ability to cope bandwidth, appetite, or budget to take with external shocks. Regulators a step back and work out what the right emphasize the need for this enhanced solution really is for the bank going capacity not only to meet regulatory forward, rather they have had to deal demands but also to improve risk with individual projects in isolation. governance in the banks themselves.

However, although regulation, rules, Although regulation, rules, codes, Challenge 4 codes, professional bodies and even professional bodies and even enforcement might all help to generate enforcement might all help Restoring customer focus and trust and preserve momentum around cultural in banks by tackling the deep-seated change, they will never be enough. to generate and preserve issues of culture and behavior. Ultimately, culture is something that momentum around cultural only the banks themselves can change. So the real challenge is to recognize change, they will never be A combination of the financial crisis, all the forces that have generated poor enough... the continuing mis-selling of financial behaviors and to introduce cultures and products in many countries, the LIBOR behaviors that result in outcomes that fixing scandal and the continuing are more closely aligned with customer incidence of market abuse and money expectations and regulatory laundering, has not only undermined requirements. confidence in banks but also raised Some banks have begun to address fundamental questions about their these cultural and behavioral issues culture and behavior. Intense political in the context of customer treatment. focus has continued – for example, In Europe, British and Irish banks have the Parliamentary Commission on taken the lead in focusing more on the Banking Standards in the UK. These customer, and the rest of the Europe, developments have in turn led to a Middle East and Africa region seems growing recognition from the most to be moving in the same direction, senior levels in banks of the need for with specific policy developments in cultural change. Germany and South Africa, for example. In part, culture and behavior is being Some are moving back to a more addressed through regulatory reform. traditional, branch-based model. Others Capital and liquidity measures are are looking at reducing the number of designed to increase the cost of branches to keep costs down, but risk-taking; structural separation making better use of new technology – measures should highlight the need in payments, mobile and online banking, for banks to take different approaches as well as online communication and to their retail and investment banking social media – to connect with and activities; resolution measures are provide services to customers. designed to reduce risk-taking by Sustainable improvements in efficiency removing the prospect of government require both innovation and a deep support if banks fail; governance understanding of the customer’s measures are intended to heighten the requirements. Customers want cheaper, focus of Boards and senior management faster services that respect their time. on risk; remuneration measures are They also want a secure and trustworthy designed to reduce the incentives for relationship with their bank and financial inappropriate and excessive risk-taking; advice that is relevant, useful and timely. and conduct measures increasingly It may seem difficult, not to mention focus on both the design and distribution contradictory, to improve customer of financial products and on the service at a time when banks are also incentives of retail customer-facing seeking to cut costs, but this is a sales and advice staff. fundamental objective in the new era

Banks that place customers at the centre of what they do are likely to enhance their reputations.

of banking. In fact, good customer both retail and wholesale – where interventionist, in terms of what banks service is actually cheaper to deliver customers are unable or unwilling to should look like (for example, the various than poor customer service, not least engage on an informed basis. The old interventions on bank structure), the because of the cost of internal resources, mantra of ‘what is good for business business models that banks can pursue, remediation and financial penalties must also be good for customers’ has what banks should do (for example the following poor customer service. been shown to be seriously flawed, with pressure on banks to maintain lending, Banks that place customers at the too many cases of banks placing their in particular to small and medium size centre of what they do are likely to own interests ahead of the interests of enterprises in their home country), what enhance their reputations. Banks should their customers. Moreover, the industry products banks should sell, and how they be able to shift away from a focus on has been very slow to recognize and should advise on or sell these products. short-term transactions and return to address these problems, or to accept There have been two main drivers building a longer-term relationship with that the cultural and behavioral issues of this: the enormous costs to society clients, if they operate on the basis of cannot be solved simply by high-level of bank failures and the succession of customer-centricity, prudence and statements about ‘putting customers scandals involving banks. mindfulness of reputation. first’ and by blunt adjustments to However, many banks will find it remuneration structures. There is a clear difficult to achieve the necessary shifts need to assess and prepare for what in culture and behavior. It is important to will be good for long-term business. recognize that short-term profitability Another key challenge is that some may not be closely aligned with the fair decisions may no longer be solely for treatment of customers and good the banks themselves to take. Politicians customer service, especially in markets – and regulators have become more

A view from Asia-Pacific

European banks face a multitude It is clear that there are many factors seeking to enhance the cost-efficiency of issues in Asia, as a result of for European banks to consider when of their operations in Asia. requirements emanating from the planning their strategies and assessing Interestingly, however, the idea of international supervisory bodies and their regulatory compliance requirements splitting core banking and trading national/regional supervisory bodies; in Asia. Key considerations include: activities – currently the subject of much and because of consequent actions debate in Europe and the US – has not by host supervisors. Subsidiarization and separation been taken up by supervisors in Asia, We have not yet seen the full extent where trading activities are generally of the restructuring of European banking modest and not seen as a concern. groups that will be required if the Several supervisors in Asia have explicitly Independent Commission on Banking continued to endorse the universal and Liikanen proposals are implemented, trading model that tends to be the norm and if European supervisors require in Asia – they see no need to split trading substantial restructuring to make from other banking activities. major European banking groups more This means that the shape of ‘resolvable’. (We discuss current European banks’ trading activities in European proposals in more detail on Asia and their legal entity structure for pages 36–37.) trading are likely to be influenced more Host supervisors in Asia are clearly by home country/European requirements anticipating that such restructuring than local requirements. will push the priority and support given to Asian operations further down The liquidity challenge the pecking order. And the natural Liquidity is another issue where local response of host supervisors in such requirements come into play. Several circumstances is likely to be to apply Asian supervisors are indicating that, additional ring-fencing requirements notwithstanding whatever requirements on the local operations of foreign banks, home supervisors may place on the including subsidiarization (or locked-up group, they will also be subject to local branch capital), particularly when requirements. This is likely to mean that the activities in the local market are they will need to increasingly fund their substantial and/or of a retail nature. To local operations on a largely stand-alone date, we have seen several supervisors basis, with limited reliance on intra-group in Asia considering subsidiarization. funding. There is also the possibility There is a need to balance protecting the (as in Hong Kong) of these requirements local market with encouraging continuing applying to foreign banks that operate involvement by foreign banks. as branches, as well as to subsidiaries. Several regulators in the region have In addition to the issue of the scope of also been tightening up on outsourcing, application of the liquidity requirements, particularly cross-border, and including there is also the issue in many Asian intra-group, which may present an markets of the shortage of assets obstacle to some European banks meeting the definition of high quality

© 2013 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. liquid assets, which further complicates It is quite possible that we will see Where will we end up? meeting the requirements. a substantial increase in the business Looking a little further ahead, Asian This issue of funding is key for booked in Asia, as a number of supervisors are now considering what European banks – and foreign banks investment banks are understood to requirements to impose on domestic generally – that have largely relied be looking at their (global) booking systemically important banks (D-SIBs). hitherto on global (intra-group) or local models – in particular, considering These may also be applied to some local wholesale (interbank) funding and lack booking their Asian OTC derivatives operations of European banks and are retail funding penetration in Asia. On the business in Asia rather than offshore. likely to include requirements to develop other hand, those European banks with local Recovery and Resolution Plans a strong retail presence in the region are Implementing Basel 3 (RRPs). well placed. Implementation of Basel 3 in Asia is far So, although we may be moving from straightforward for international towards something more like a level Re-evaluating the geographical banks. While they will tend to be most playing field in terms of the minimum footprint familiar with the Basel standards and the standards on capital, liquidity, leverage, Subsidiarization (requiring local home country/European requirements, RRPs and so on, it is clear that there capitalization), local funding and the the requirements in each Asian will remain considerable differences localization of key functions and systems jurisdiction may differ in important in requirements (such as the timing will all tend to raise costs and possibly respects – there is no central of implementation and the scope change the cost/benefit equation coordinating body in Asia promoting of application) from jurisdiction to significantly. It is not surprising that some a consistent regional approach. In jurisdiction. European and other banks are evaluating a number of cases we have seen More detail on the specific challenges their geographical footprint in Asia, regulators in the region – in China facing banks in the region can be found considering which markets they want and Singapore, for example – setting in Evolving Banking Regulation 2013 – to operate in. Ultimately, the funding requirements above the Basel minimums ASPAC Edition.10 issue is causing the greatest amount in areas such as capital adequacy of soul-searching. This is likely to be and leverage, in order to reflect the the number one factor in shaping the characteristics of the local market. European banks’ operations in Asia. Unlike Basel 2, which international We have already seen deleveraging banks were generally able to implement Several regulators in the region and drawing back from lending by some first in their home market and then roll have also been tightening up on European (and other foreign) banks. out subsequently to other geographies, outsourcing, which may present The possible scaling back of operations in the case of Basel 3, now that many in Asia by some does, however, present Asian countries are Basel committee an obstacle to some European opportunities for ‘stayers’ to acquire members and implementing to the banks seeking to enhance the business (on both the asset and liability same timeline, banks may well need cost-efficiency of their operations side) and add to scale. to implement in multiple geographies Generally, foreign banks, including simultaneously. Indeed, several in Asia. European banks, remain committed to territories – including Australia, China, their Asian operations. For many, Asia Hong Kong and Singapore – look like they is where they anticipate growth and an will be implementing Basel 3 ahead of 10. Evolving Banking Regulation 2013 – ASPAC Edition, KPMG, opportunity to rebuild their profitability. Europe and the US. February 2013

A view from the Americas

Regulatory uncertainty Derivatives rules It is critical for banks to continue While US financial regulators have In July 2012, the CFTC released to monitor developments, as continued to make progress in the proposals for the applicability of its rulemaking and interpretation required new derivatives clearing requirements some level of extraterritorial for implementation of the Dodd-Frank to cross-border swaps. Its key proposals compliance is likely to be required. Wall Street Reform and Consumer were: Protection Act (Dodd-Frank), much • US and foreign firms dealing in swaps uncertainty remains. Some rules, with US persons will be expected to including requirements for resolution register as a Swaps Dealer (SD) or and recovery plans, adoption of Basel 3, Major Swaps Participant (MSP) as and the Volcker Rule ban on proprietary appropriate if a de minimis threshold trading are in general targeted directly at of US$8 billion notional value in swaps the global activity of US headquartered is contracted with US persons per institutions or the domestic activity annum across all non-US affiliates; of foreign owned US subsidiaries. • Non-US SDs will be subject to ‘entity These alone, once finalized, will result level requirements’, including business in significant changes for foreign firms conduct standards and additional in their US operations and also may annual reporting requirements, change the nature of business transacted but they can apply for substituted with US institutions elsewhere. compliance; As with other regulators, US • Additional ‘transactional requirements’ policymakers are keen to ensure that any (eg. clearing obligation, margin activity which could affect the stability of requirements and segregation) the US financial system is subject to its will apply only to trades where one (or very similar) rules and that activity party is a US person, but substituted which is substantially associated with compliance is again possible; and US markets or US counterparties cannot • Dealing with a branch of a US-based readily move offshore to circumvent institution will not subject a non-US SD these rules. Proposals have been to transaction requirements or count released by US regulators in this regard towards calculating the threshold for over the last twelve months. However, registration as a foreign SD. significant criticism from policymakers and financial institutions alike means that the requirements have yet to be finalized. It is critical for banks to continue to monitor developments, as some level of extraterritorial compliance is likely to be required.

Capital Many banks face massive shortfalls in Banks may need to hold even The Basel 3 capital requirements were meeting the Basel 3 capital requirements. due to be implemented on January 1, Applying the final (as from 2019) Basel 3 higher amounts of capital to 2013. In the European Union, the standards to banks’ end-2011 balance meet a wide and expanding European Commission largely copied out sheets shows a shortfall across 44 range of additional capital the Basel 3 standards into a proposed internationally active European banks Capital Requirements Regulation (CRR) of €200 billion of common equity tier 1 requirements. and revised Capital Requirements (CET1) capital against the 7 percent Directive (CRD 4) in July 2011. But the minimum ratio, and a further shortfall Directive has still not been finalized as of €26 billion across 112 domestic discussions continue between the European banks12. The results show some Commission, the EU Council and the progress from previous impact studies – European Parliament. It is, however, these shortfalls are around 20 percent expected that the CRR and CRD 4 will smaller than at end-June 2011. be agreed in 2013, with implementation Banks may not have as long as the beginning January 1, 2014. This is not Basel 3 transition timetable suggests a serious delay, because many of the in meeting these shortfalls. National new standards are due to be phased in supervisors, the European Banking 12. European Banking Authority: Results of the Basel III monitoring by 2019. Authority (EBA), investors, market exercise based on data as of 31 December 2011, September 2012

Revisions to the LCR should have a positive impact on bank lending and the real economy, by reducing the costs to banks of meeting the LCR.

analysts and rating agencies are already models was also picked up in a review Stable Funding Ratio (NSFR) is intended putting pressure on banks to meet the by the European Banking Authority to ensure that banks hold sufficient Basel 3 requirements more rapidly than with a sample of 19 major banks’ Pillar 3 stable funding (capital and long-term the transition timetable. reports. They criticized banks for not debt instruments, retail deposits and Banks may also need to hold even providing adequate ‘back-testing’ wholesale funding with a maturity longer higher amounts of capital to meet a disclosures that compare actual and than one year) to match their medium wide and expanding range of additional expected losses over a period of at least and long-term lending. capital requirements. These include three years. A report from the Enhanced The LCR is due to become a minimum capital surcharges on global and national Disclosure Task Force (EDTF), a private requirement on banks in 2015 and the systemically important banks; the sector working group created by the NSFR in 2018. According to the EBA, implementation of macro-prudential Financial Stability Board in May 2012, internationally active European banks tools such as the counter-cyclical capital emphasized the need for banks to report faced large shortfalls against both these buffer and cyclical adjustments to in more detail and on a much more new liquidity ratios at the end of 2011, sector-specific capital requirements; consistent basis to enable analysts to with an average LCR of 72 percent and the implementation by some European reach a clearer view of how risk weighted NSFR of 93 percent. However, banks countries of the new ‘systemic risk assets correlate with risk and with actual will obtain some relief from the revisions buffer’ that has been added to CRD 4 loss experience. to the LCR announced by the Basel and can be used by national authorities Finally on capital, the 44 internationally Committee in January 2013, following to mitigate long-term structural systemic active European banks in the EBA a series of impact studies, industry risks such as the size of a country’s impact study also had collectively a comment and discussions. banking sector as a proportion of GDP; small shortfall against the proposed These revisions to the LCR will relax the continuing application of ‘Pillar 2’ leverage ratio (2.9 percent on average the earlier Basel 3 proposals in three supervisory add-ons; and individual banks against a minimum leverage ratio of main ways. First, banks will be given more choosing to hold their own buffers over 3 percent to be applied as a binding time to build up their liquidity buffers, and above minimum regulatory and requirement from 2018). This may with the minimum LCR requirement supervisory requirements. become more problematic for banks set at 60 percent from January 1, 2015, Higher capital requirements are if regulators begin to focus more on then increasing by 10 percentage points also likely to arise from regulatory ‘simple’ rules and begin to press for each year until the permanent minimum adjustments to the denominator of the a tougher minimum leverage ratio in requirement of a 100 percent ratio is capital ratio. The Basel Committee is that context. reached in 2019. consulting on introducing higher capital Second, banks will be able to hold a requirements on banks’ trading books Liquidity wider range of high quality liquid assets, and is reviewing why the risk weightings Although much attention has focused with the inclusion of equities, securities on both banking and trading book on the Basel 3 capital adequacy backed by residential mortgages, and a exposures differ by so much across requirements, the forthcoming global wider range of corporate bonds – albeit banks that use their own internal risk standards for managing liquidity risk are with restrictions on the quality of these models and are so much lower than the likely to pose an even greater challenge assets, the imposition of large haircuts standardised risk weightings. This may for some banks. on the value of each asset that can be result in stricter requirements on internal Basel 3 proposes two key liquidity counted, and narrow limits on the total risk models, and a greater focus by ratios. The Liquidity Coverage Ratio (LCR) amount of such assets that can be supervisors on capital ratios calculated is designed to strengthen the ability included in a bank’s high quality liquid using the standardised risk weightings, of banks to withstand adverse shocks. assets. or introducing capital floors based on It will require banks to hold sufficient Third, banks will be subject to less these, even for banks that use their own high-quality liquid assets (including severe assumed ‘run-off rates’ on some internal risk models. cash, government bonds and other of their liabilities and commitments. This theme of how banks can justify liquid securities) to meet a severe cash These revisions should have a positive the risk weightings derived from internal outflow for at least 30 days. The Net impact on bank lending and the real

In the European Union, it is still not clear where, how and when the capital surcharges for both G-SIBs and D-SIBs will be covered in EU legislation.

economy, by reducing the costs to Capital surcharges June 2012. This follows the Financial banks of meeting the LCR and, more The Basel Committee has developed a Stability Board’s ‘key attributes’ for specifically, through the more generous set of five criteria for identifying global resolution, including requirements on treatment of committed facilities and systemically important banks (G-SIBs), banks and national authorities. The trade finance and by encouraging the and has established a range of capital primary requirements are: securitization of good quality mortgages. surcharges (additional core equity • The recovery plans that firms will need In Europe and elsewhere, the revisions tier 1 capital) to be applied to these to put in place, with the EBA mandated should also make it easier to apply the banks. The intention is to update the to develop robust and severe stress LCR to all banks, not just the large list of G-SIBs and to consider the capital and scenario tests that a bank should internationally active banks. surcharges that should apply to each be able to recover from, not only Since the European Commission of them in November each year. through contingent capital and liquidity copied the earlier versions of the two Surcharges will begin to be applied from arrangements but also by selling liquidity ratios from Basel 3 into the January 2016 (with full implementation assets and business lines if necessary; draft Capital Requirements Regulation, by January 2019), for G-SIBs identified • The information that firms will have it is expected that these revisions to in November 2014. to provide to enable the authorities to the LCR will be implemented in full At November 2012, the list of G-SIBs draw up resolution plans for each firm in Europe. included 28 banks, with four of them – national resolution authorities (and Meanwhile, the Basel Committee subject prospectively to a 2.5 percentage colleges of such authorities for cross- has re-affirmed its intention to introduce points capital surcharge. border groups) will then have to assess the NSFR – but it was always intended Meanwhile, national authorities are whether a credible resolution plan can to allow a longer observation period for also expected to identify banks that be constructed. The emphasis here this second ratio, with implementation are of national systemic importance will be on how easily critical functions as a binding requirement on banks (so-called D-SIBs), and similarly to and core business lines could be from 2018. impose capital surcharges on them, legally and economically separated to although the Basel Committee has ensure their continuity, how access Systemic risk been much less prescriptive about both to payment and settlement systems In addition to the Basel 3 package of how D-SIBs should be identified and could be maintained, whether service tougher capital and liquidity standards, the range of capital surcharges that level agreements would remain in which in Europe will be applied to all might be imposed. Considerable national place during resolution, the adequacy credit institutions and major investment discretion has been left here. of management information systems, firms, the international standard-setting In the European Union, it is still not and the impact of group structure, authorities have also been focusing clear where, how and when the capital intra-group exposures and other intra- on a wide range of measures directed surcharges for both G-SIBs and D-SIBs group arrangements on the potential primarily at systemically important banks. will be covered in EU legislation. This will separability of particular functions or The purpose of these measures is have an impact on the extent of national business lines; to reduce: discretion available with respect to • A common minimum set of powers • The likelihood of a systemically D-SIBs, and on the interplay between under which national authorities could important bank failing in the first place; these capital surcharges and other capital require firms to improve their recovery • The costs (to the rest of the financial requirements, including ‘Pillar 2’ capital plans and to change in advance their system and to the wider economy) of add-ons for individual banks and the businesses and structures to make the failure of a systemically important national application of sector-wide them easier and less costly to resolve; bank; and systemic risk buffers. • A requirement for firms to hold ‘bail-in’ • The implicit or explicit public subsidy liabilities that could be written off in to systemically important banks, Recovery and Resolution Planning the event of a resolution. The RRD by removing the need for taxpayer- In the European Union, the European would require national resolution funded support of a failing systemically Commission published a draft Directive authorities to be given powers to important bank. on Recovery and Resolution (RRD) in trigger a bail-in of liabilities if a bank

goes into resolution. The authorities Resolution in practice could then write down (or convert into equity) the claims of the creditors In December 2012, the Bank of England • Sufficient debt issuance at holding of a failing bank. This would extend and the US Federal Deposit Insurance company level to enable the group beyond capital instruments to a wide Corporation (FDIC) issued a joint paper to be recapitalized in a resolution range of uninsured and unsecured on the resolution of global systemically through the conversion of this debt liabilities. The RRD also includes important financial institutions. The into equity; and provisions for a deposit guarantee most important aspect of this paper • Using this holding company debt scheme (but not insured deposits) to was confirmation that the Bank of to make loans to subsidiaries, so bear some of the losses of a bank in England intends to follow where that subsidiaries can be supported resolution. As currently drafted, the possible a top-down ‘single point of in a resolution through writing off RRD does not set a minimum ratio entry’ approach to the resolution of these loans. for banks’ holdings of bail-in liabilities, major banking groups, where bail-in but suggests that national authorities liabilities are held in the ultimate parent An alternative approach could be should determine this on a bank-by- company of the group. This is not applied to a major banking group that bank basis, taking into account the inconsistent with the RRD, although is funded mostly through retail deposits. amount of bail-in liabilities that would in general the RRD is based more on This would apply the provision in be required to meet the resolution a ‘multiple points of entry’ approach, the RRD to treat a deposit guarantee objectives and to enable a bank to be whereby each subsidiary of a group scheme as a creditor that can be recapitalized, which is a function of would hold its own bail-in liabilities. bailed-in, with the costs of this falling its size, business model, risk profile The main implication of a ‘single on other banks that have to fund and the systemic importance of point of entry’ approach to resolution the scheme. each bank; is that major UK (and US) banking It is not yet clear how far colleges • A common minimum set of powers groups would have to put into place: of resolution authorities will be able and tools which national authorities • A group structure based on a parent to commit to resolution strategies could use to resolve a failing firm; and holding company; in advance. Other supervisors hosting • The pre-funding of national resolution • The ring-fencing of (domestic and US or UK cross-border groups have funds. overseas) subsidiaries that undertake yet to comment on whether they critical economic activities, so that agree with the proposed approach. The RRD applies to all credit institutions the continuity of these activities can and to major investment firms, rather be more easily maintained in than just to banks or systemically a resolution; important firms – although national authorities can apply the requirements proportionately to non-systemic firms. It remains unclear when the RRD will be finalized and implemented. The original intention was that the RRD would come into force in mid-2013 and be transposed into national legislation by the end of 2014. Provisions relating to the bail-in tool would not apply until the beginning of 2018, to allow time for existing liabilities to mature, to avoid deleveraging and to align with the full implementation of the new capital requirements.

Resolution of client assets ‘multiple’ omnibus pools of client money, The French Government published draft Important steps are being taken to potentially grouped by business line. legislative proposals for bank ring-fencing protect the assets of customers in the The benefit would be to keep assets in December 2012. Banking groups will event of the insolvency of the financial from more stable activities separate and have to establish a separate legal entity institution holding the investments. therefore more readily resolvable in the to undertake proprietary trading in In the past, customers might have event of an insolvency. In practice, the financial instruments and investment in assumed that, if their assets were introduction of yet more accounts could and unsecured transactions with hedge segregated, they would be able to gain add to disputes, further complicating funds. These separate entities could access to them quickly if the institution the return of funds. not take insured deposits, conduct collapsed. But the collapse of Lehman high frequency trading operations, or Brothers and MF Global proved this to Structural separation undertake certain transactions in financial be a false assumption. Various forms of structural separation instruments linked to agricultural The Client Assets Sourcebook are being developed or discussed at commodities. (CASS) Resolution Pack, which went European Union level and in individual Deposit-taking banks could continue into effect in the UK in October 2012, countries such as the UK, US, Germany to conduct certain own account dealing attempts to provide a framework for and France. Although the details differ, activities which contribute to financing clients to reclaim their assets in such the common purpose is to reduce the real economy, including the provision extreme situations. Banks are required systemic risk in large banking groups of investment services to clients, clearing to provide a complete database of by reducing the extent to which retail financial instruments, hedging (with information on customers, counterparties, deposits can be used to fund investment the aim of reducing exposures to risks systems and accounting records within banking activities and more generally the related to their credit or market activities), 48 hours of the appointment of an extent to which retail and investment market making (acting as intermediary), insolvency practitioner. Clients and their banking can be inter-connected within group investment activity (buying and assets change on a continual basis, so a banking group; and separation would selling securities with the intention financial institutions will need to update make it easier resolve a complex banking of maintaining a durable holding) and their CASS Resolution Pack on a daily group and to preserve the continuity treasury activities. These restrictions basis. The EU is pursuing similar initiatives of critical retail deposit-taking and will apply to larger French banks, the within other policy papers, including related functions. French subsidiaries of foreign banking EMIR and the proposed Regulation for In the UK, the government has put groups, financial holding companies Central Securities Depositories, which forward draft legislation to implement the or mixed financial companies, and introduce requirements for individual recommendations of the Independent investment firms. segregation. Commission on Banking (ICB). This Similar plans are also being discussed In September 2012, the UK FSA also would ring-fence retail and SME deposit in Germany. The German Federal released a Consultation Paper proposing taking in a separate legal entity within a Government issued in February 2013 extensive change to the UK CASS banking group, where at least £25 billion a Draft Bill outlining bank ring-fencing regime. It initially proposes rules to of such deposits are taken. Ring-fenced proposals. While the final rules are far amend the UK CASS regime to allow retail banks would then be more from certain, the aim is for the proposals for the option of individual segregation restricted in their ability to undertake to come into effect from 31 January 2014. provided for under EMIR (where clients, derivative and other transactions than Deposit-taking banks will not be allowed both direct and indirect, must be under the Liikanen recommendations, to undertake proprietary trading (unless offered the option of holding assets in a although in both cases the precise details in relation to client-driven business, for segregated account in their own name remain to be decided. And retail banks example the hedging of positions held only, rather than an omnibus account, would have to hold loss-absorbing with clients), or to undertake loan or with no option for re-use of the assets capacity of up to 17 percent of risk- guarantee deals with hedge funds or by the receiving institution). weighted assets, in the form of a leveraged alternative investment funds. This concept is extended in a minimum core equity tier 1 capital ratio These activities would have to be secondary Consultation and Policy of 10 percent and debt instruments undertaken in a separate legal entity Paper, which introduces the idea of that were subject to bail-in provisions. (which can be part of the same group

© 2013 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. structure), and the deposit-taking bank The Liikanen proposals must be sufficiently protected from the risks of the trading entity. These At the European Union level, the portfolio, basic hedging services for restrictions will apply if the specified Liikanen Group published its final report non-banking clients, and securities investment banking activities exceed on reforming the structure of the EU underwriting. They could also €100 billion, or if they constitute more banking sector in October 2012. The undertake corporate and household than 20 percent of the balance sheet of European Commission is consulting lending, trade finance, interbank a bank whose balance sheet exceeds on which, if any, of the report’s lending, loan syndication, simple €90 billion. recommendations might be carried securitizations, and private wealth All of the proposals attempt in some forward as EU legislative proposals. management and asset management. form to minimize the impact on smaller, The main recommendation in the Transactions between the trading simpler institutions. But some challenges Liikanen report was that banks’ entity and a deposit bank would have have become apparent, and it is not clear proprietary trading and other significant to be on market terms and be subject how these will be addressed in practice. trading activities (assets and derivative to large exposure rules on interbank • Although interaction between ring- positions incurred in the process of exposures. Both the trading entity fenced banks and other banks is market-making; credit exposures to and the deposit bank would have to allowed for the purposes of treasury hedge funds, prime brokers, structured meet independently all the capital and risk management, policing this investment vehicles and similar requirements under CRR/CRD 4. boundary – and ring-fencing more entities; and private equity investments) This separation of activities would generally – will prove tricky for both should be ring-fenced in a separate only be mandatory if trading activities banks and supervisors. legal entity. Such trading entities could are a significant proportion of a bank’s • Where and how critical internal remain as part of a banking group but total assets or if they are large enough operations and infrastructure should could not be funded by insured to be of importance to financial stability. sit is another dilemma. Anything deposits and could not supply retail The report suggests metrics of (i) other than full replication between payment services. assets held for trading or available for the entities introduces potentially Meanwhile, deposit banks (banks sale of at least 15–25 percent of a de-stabilizing inter-dependencies, but that use insured deposits as a source bank’s total assets, and (ii) an absolute the cost of this option is potentially funding) could continue to use threshold of €100 billion of trading enormous. derivatives for their own asset and assets. These metrics would capture • It remains unclear how these liability management purposes, sales around 20 to 25 large EU banks and proposals will affect banks’ activities and purchases of assets in the liquidity some smaller specialist trading banks. outside their home jurisdiction – and this may require significant change to local entities and licenses. All of the proposals attempt in some form to minimize the impact on smaller, simpler institutions. But some challenges have become apparent, and it is not clear how these will be addressed in practice.

The establishment of a banking union and a single supervisory mechanism is intended to strengthen the euro, by breaking the link (in the future) between a nation’s banks and its sovereign debts.

Banking Union in the eurozone Supervision In addition to the general moves to The leaders of the EU member states more intensive and more challenging agreed at their summit in June 2012 supervision in many countries, the that the European Central Bank (ECB) international regulatory agenda for should supervise all of the eurozone’s systemically important banks includes a 6,000 banks. The establishment of a growing number of specific supervisory banking union and a single supervisory initiatives. These include: mechanism is intended to strengthen the euro, by breaking the link (in the More effective supervision of future) between a nation’s banks and systemically important banks: its sovereign debts. In countries such The FSB has published a series of papers as Greece and Italy, governments with on the effective supervision of SIFIs. weak finances have relied on banks to These papers indicate where supervisory buy their securities, while in Ireland and efforts may be focused over the next Spain the costs of government rescues few years. The most recent paper, in of failing banks have dragged down November 2012, focused on the need their governments’ finances. for supervisors to: One purpose of moving banking • Increase their interactions with the supervision to the ECB would be to national economy (total assets Boards of SIFIs; take a tougher supervisory approach exceeding 20 percent of the GDP of the • Make formal assessments of risk to bank financing of government debt member state of establishment, unless culture in SIFIs; and more generally to reduce the these assets are below €5 billion). • Consider whether supervisory efforts likelihood of bank failures through The ECB will take on supervisory have moved too far in concentrating tougher supervision that was less responsibility for at least the two or on capital adequacy and controls influenced by national pressures. three most significant banks in each systems, and whether they need to In addition, the original vision for member state, leaving the supervision look more closely at SIFIs’ sources eurozone banking union included a of smaller banks to be carried out by of profits and financial data; single resolution fund and single deposit national authorities under guidelines set • Enhance their analysis and assessment guarantee scheme for the eurozone, by the ECB. The ECB will also be able of operational risk (in part because thereby introducing a sharing of some to issue specific orders for a country, some SIFIs are shifting into private of the costs of resolving failing banks. category of banks or class of risk. Also, wealth management and related However, a common resolution fund any banks covered by the incoming activities); and and a common deposit guarantee European Stability Mechanism could • Increase the effectiveness of scheme are not on the agenda for the be put under the direct supervision supervisory colleges. moment, because of their daunting of the ECB. cost and a lack of political agreement. Non-eurozone member states Risk governance: The FSB launched In December 2012, EU Finance will be able to opt-in to banking union. a thematic review of risk governance Ministers reached an agreement in Safeguards have been agreed for in April 2012. This review will focus their negotiations over the Single member states that do not opt in, in on Board risk committees, risk Supervisory Mechanism (SSM), under particular with respect to EBA decisions management (including the Chief Risk which the ECB will initially supervise on rules, binding technical standards, Officer function) and internal audit; up to 300 of the eurozone’s banks and dispute mediation. and on how supervisors assess the from March 2014. These banks meet Those banks directly affected will effectiveness of these functions. one or more criteria relating to their need clarity on how exactly the ECB will The first stage of the review was a absolute size (total assets of more than operate as a banking supervisor, and questionnaire to national authorities €30 billion) and to their importance to a how it will relate to national supervisors. on existing regulatory requirements on risk governance and how supervisors

The European Commission has consulted on the risks arising from shadow banking and intends to publish another paper on this during the first quarter of 2013.

assess the effectiveness of risk principles within three years of being • Money markets – strongly contested governance. This review can be designated as a D-SIB. Supervisors proposals are being discussed for expected to result in a set of high level may also apply the principles to other either a floating asset value for money standards for firms, and some guidelines banks (and indeed to non-banks) on a market shares or the introduction of on what supervisors should be doing in proportionate basis. bank-like capital requirements – and for this area, especially with respect to potential limits on the assets in which systemically important banks. The FSB Shadow banking funds can invest. published a further paper on risk Some alternative channels of financial governance in February 2013. intermediation contributed to the build-up Meanwhile the European Commission of systemic risks ahead of the financial has consulted on the risks arising from Risk data aggregation and risk crisis; and the much tougher regulation shadow banking and intends to publish reporting: The Basel Committee issued and supervision of banks is likely to drive another paper on this during the first in January 2013 a set of principles on some financial intermediation into less quarter of 2013. The responses to the risk data aggregation and risk reporting. regulated sectors, thereby possibly initial consultation indicated growing One key driver of this initiative was the generating financial stability risks in support for the increased regulation frustration of supervisors in receiving the future. of shadow banking, with banks picking inadequate (or much delayed) answers In response to this, the FSB up strongly on the regulatory arbitrage from banks in response to requests recommended in November 2012 argument here. The European for information on exposures to risks, new global regulations to contain these Commission can therefore be expected which in turn raised questions about risks. The objective of the FSB’s work to work up its proposals under similar how effectively banks are managing is to ensure that shadow banking is headings to the FSB. their risks and are reporting risks subject to appropriate oversight and We can also expect the Commission accurately to their senior management regulation to address risks to financial to base its proposals as much on the and Boards. The 14 principles cover: stability emerging outside the regular principle of preventing regulatory • The accuracy, integrity, completeness, banking system, while not inhibiting arbitrage (ie. imposing bank-like timeliness and adaptability of sustainable non-bank financing models regulations on non-banks) as on whether aggregated risk data; that do not pose such risks. The approach shadow banking poses systemic risk. • The accuracy, comprehensiveness, is designed to be proportionate to clarity, usefulness, frequency and financial stability risks, using as a starting Markets distribution of risk management point those institutional categories that The European Union is taking part in reports, including to the Board and were a source of problems during the the global initiative to shift the opaque senior management; crisis. The primary workstreams are: US$700 trillion OTC market off bank • The importance of Boards and • Shadow banking and regulated balance sheets and into central clearing, senior management exercising banks’ interaction with shadow so that a central counterparty (CCP) strong governance over a bank’s banking entities – Efforts here are clearing house would absorb losses risk data aggregation capabilities, focused on identifying the types of if either counterparty defaults. The risk reporting practices and IT activity that may create systemic new rules will also encourage the capabilities; and risk and suggesting potential policy standardization and electronic trading • The need for supervisors to review responses to deal with each of these; of derivatives, and force nearly all and evaluate a bank’s compliance • Repos and securities lending – derivatives trades to be reported. with the three sets of principles listed controversial proposals are being above, and to take remedial action developed for minimum haircuts on EMIR as necessary. assets, alongside more accepted These requirements are being proposals for central clearing and implemented in the European Union G-SIBs are expected to be able to meet additional reporting; and primarily through the European Market these principles by 2016 (with self- • Securitizations – codifying emerging Infrastructure Regulation (EMIR) which assessments beginning this year); national proposals for risk retention of was finalized in summer 2012. The and D-SIBs should be able to meet the assets issued. European Securities and Markets

© 2013 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Authority (ESMA) has since finalized acknowledging that legal and market keen to maintain flexibility in how detailed standards for the trading of differences will mean that perfectly they negotiate and allow these derivatives linked to interest rates, aligned rules are not feasible. Further operations. currencies, equities, credit and work is required before a final framework commodities. However, these are is agreed. Financial Crime subject to final approval by the European Many large investment banks were Parliament, currently anticipated in MiFID/MiFIR found during 2012 to have colluded in Spring 2013, after which the new Complementary rules to EMIR in contributing false rates at which they requirements will be phased in. Europe which determine the mandatory would agree to lend to one another, The earliest of these will be trade execution venue for centrally cleared in numerous currencies and markets. confirmations for all derivatives trades derivatives may not be introduced until These rates were then used by market and collection of data for reporting later. These are covered under the bodies to set the official offer rates purposes once Trade Repositories review of the Markets in Financial referenced in most lending and are authorised to accept the trade Instruments Directive (MIFID 2), which derivatives contracts, resulting in some information. However, the likely timeline will result in a revised Directive and a banks gaining commercial advantage. for authorizing central counterparties new Markets in Financial Instruments The London Interbank Offered Rate and determining instruments eligible for Regulation (MIFIR). The combined (LIBOR) rate-fixing scandal has led to clearing may push initiation of clearing documents will set out wide ranging large fines on a number of international requirements into early 2014. change for the operation of financial financial institutions. The cost of banks markets. They will include new getting it wrong in this way is significant – BCBS requirements requirements for the type and operation leading European banks have recently The long awaited BCBS requirements of trade execution venues, as well as incurred US$5 billion in regulatory setting out margin arrangements for extending existing pre- and post-trade penalties, including money laundering non-centrally cleared trades had been transparency reporting beyond equities fines and LIBOR fines and settlement expected by the end of 2012, but were to new asset classes. Both have been figures.13 delayed following major push back from subject to significant objection from the industry. Many argued that the industry and may yet be subject to Market Abuse Directive/Regulation volume and complexity of the required change before rules are final. In addition, (MAD/MAR) collateral movement would seize up new areas are introduced, including The Market Abuse Regulation (MAR) these markets. As a result, policymakers enhanced supervision and potential is being amended to outlaw the continue to work towards developing restrictions over high frequency trading manipulation of LIBOR and other a standard which encourages central and commodities trading. benchmarks, while boosting minimum clearing, mandates adequate collateral Alongside these market infrastructure fines for insider trading. The proposals to protect non-centrally cleared trades proposals, changes are proposed include criminal sanctions on anybody from major exposure when markets to the existing investor protection found to have manipulated benchmarks move, but at the same time allows the framework, including how clients are such as LIBOR. Although MAR retains market to operate effectively as a means classified, documentation supporting the original focus of MAD – to drive more of financial risk mitigation. assessments of their suitability for consistent approaches by supervisors An important development towards particular products, and additional to preventing and punishing market harmonizing clearing standards for OTC disclosures or possible limits on how abuse across the European Union – derivatives was agreed in December intermediaries are remunerated for minimum penalties will be strengthened 2012, when regulators issued a joint recommending particular products. and more tightly harmonized across statement of operating principles and Third country access to European the 27 countries by putting them into areas of cooperation in the regulation markets is also being scrutinized, but a Regulation, which is directly binding, of the cross-border derivatives market. efforts to harmonize and intensify regardless of national laws. The emphasis was on the need to avoid standards have been subject to major In the meantime, the UK has duplication, conflict or gaps, while debate by individual EU members already taken unilateral action to

The European Union is continuing to push ahead with measures to strengthen the protection of customers and investors in ways that will have far-reaching effects on bank processes and governance.

construct a more independent process income from clients who do not reply Tax for setting benchmarks and subject to inquiries about their nationality. Financial Transaction Tax (FTT) it to supervision by the FSA (soon to Because imposition of the FATCA In the EU, 11 member states have agreed become the FCA), rather than industry withholding tax would render US to introduce an FTT. Finance Ministers self-regulation. investments and the provision of from these countries have agreed an services involving US investments enhanced cooperation procedure, which Anti-Money Laundering (AML) uneconomic, FATCA in effect presents allows other nations to join later, if they Major failures by global banks in meeting foreign investors and foreign financial wish. The application of FTT would be AML requirements are likely to drive service providers with a choice of based on the country of origin of the additional scrutiny of operational and models. If a foreign investor or financial firm or its client, regardless of where governance arrangements, in order to services provider wishes to participate the trading takes place – for example, ensure compliance. This is an ongoing in or offer services with respect to a transaction carried out in London by global development. US markets, it must commit to the a German bank would be taxed by the transparency required by FATCA German government. FATCA compliance. If not, a more localized By extending the scope of assets Banks and asset managers in Europe investment or business model must covered, governments hope to limit any are preparing for the implementation of be adopted. evasion of the tax a new US law, the Foreign Account Tax After a series of negotiations, Compliance Act (FATCA), with which they some governments have entered The consumer agenda must start to comply by January 2014. into agreements with the US authorities In October 2011, the G20 called for In January 2013, the US Department on the sharing of information. To avoid financial consumer protection to be of Treasury and the Internal Revenue breaking European privacy laws, strengthened by new laws and Service (IRS) released the much- banks and fund managers in Germany, supervisory agencies to address the anticipated final regulations. In finalizing Britain, France, Spain and Italy will issues of fair treatment of consumers, the FATCA rules, Treasury and the IRS have to report details of account proper disclosure and improved financial made efforts to minimize burdens, holders to their governments, which education. Addressing consumer risk where possible, and to address the will then provide the information to and ensuring consumer protection is issue of local law conflicts. The key the Internal Revenue Service. These seen to be critical in rebuilding trust in provisions include: governments will not collect withholding the world’s financial services sector. • Harmonization with intergovernmental tax because the US government will This has been carried forward in part by agreements have received the information about the development of a set of consumer • Relaxation of certain documentation clients’ nationality. protection principles by the Organisation and due diligence requirements Banks that operate from several for Economic Cooperation and • An expanded scope of ‘grandfathered jurisdictions are likely to have to tailor Development (OECD)14. obligations’ their response to the law depending The European Union is continuing • Liberalization of requirements for on where the particular subsidiary to push ahead with measures to certain retirement funds and savings is located, such as Spanish banks strengthen the protection of customers accounts operating in Latin America. Financial and investors in ways that will have • Limited relief for foreign financial institutions undertaking both banking far-reaching effects on bank processes institutions (FFIs) – continued and fund management will have to and governance. transition rule. decide which part is responsible for One key element of the EU’s compliance or whether they will need measures is MiFID 2, which aims to The legislation targets tax evasion to report separately. With the release improve investor protection and promote and requires financial institutions to of the final regulations, banks will have better market transparency. MiFID 2 identify American account-holders. to address a suite of operational issues, They must deduct a 30 percent to ensure effective data collection 13. Source: Factiva 14. See Moving consumer protection to the front line, Evolving withholding tax on American-sourced and reporting. Insurance Regulation Page 40, KPMG, February 2012

The capabilities and behaviors of the Board and senior management of banks are now scrutinized much more closely by supervisors.

strengthens requirements on investment The European Supervisory Authorities are run – and will require considerable firms when conducting due diligence and (ESAs) announced in their January 2013 work by the institutions to improve their disclosure to clients; tightens the limits Joint Committee Work Programme that governance. on sales of securities to customers; they will prioritize consumer protection Supervisory focus on remuneration enhances measures of product suitability throughout 2013, focusing on three core in banks continues. In part, this is a for clients and bans commissions paid work streams: consumer protection; continuation of the focus on the to independent financial advisers. product oversight and governance; and remuneration of senior bankers that has Final agreement of MiFID 2 is not retail products – which incorporates the been under way since 2009, with the expected until Q3 2013. But some proposed EU legislation on Packaged focus on setting variable remuneration member states have been pressing Retail Investment Products (PRIPs). on the basis of risk-adjusted and long- ahead with their own initiatives. For The Sub-Committee on Consumer term returns, and employing a number example, in the Netherlands, all Protection and Financial Innovation will of techniques to link variable pay more commissions paid to distributors, facilitate work on selling practices and closely to performance, to defer whether or not the sales are advised, conduct of business applying to PRIPs, payment, and to allow for claw-back. will be banned from the beginning of to ensure appropriate convergence The supervisory focus on 2013; and in the UK a similar ban will be and consistency. remuneration is also beginning to imposed on all investment advisers as consider the appropriateness of part of the Retail Distribution Review, Governance, remuneration and culture incentives for less senior staff, which came into effect at the beginning Strengthened corporate governance particularly where this could have an of 2013. is seen as an important way to improve impact on potential mis-selling. the safety and soundness of banks; Finally, supervisors have begun to Other elements of the EU’s measures to improve the treatment of their focus more on the culture of banks. include: customers; and to restore trust in There is a growing recognition that one • Proposed EU legislation on Packaged banks. The capabilities and behaviors key driver of poor decision-making ahead Retail Investment Products (PRIPs), of the Board and senior management of of the financial crisis, and of successive which focuses on the harmonization banks are now scrutinized much more mis-selling episodes and other scandals of pre-contract disclosures and rules closely by supervisors. The supervisory in both retail and wholesale banking, for selling investment products. initiatives described above on risk was poor cultural standards in many Investment product providers will governance and on risk data aggregation banks. These, in turn, translated into be required to produce standardized and reporting are also part of this picture. poor standards of behavior. However, disclosure documents for products In the European Union, additional embedding a culture more focused sold to retail investors; requirements on governance have on customers and risk management, • A revised Insurance Mediation been included in the proposed CRD 4 rather than on risk-taking, is proving Directive (IMD 2) and the coordination and MiFID 2 Directives. These include challenging. Banks and their supervisors of laws relating to Undertakings for new requirements on the Board to are considering how different cultures Collective Investment in Transferable take responsibility for strategy, risk, can be established and then reinforced Securities (UCITS 5), which together internal governance and the effective through the interaction of accountabilities, aim to increase consumer protection oversight of senior management; and measures and incentives. through greater transparency, to establish effective risk, nomination harmonized and enhanced sales and remuneration committees. Non- practices and changes to incentives; executive directors are required to and devote sufficient time to performing their • The European Securities and Markets duties, with specific limits imposed on Authority is looking closely at the the number of directorships that may be protection of consumers, developing held by an individual. The functions of training standards for the industry and chairperson and chief executive should contributing to the enhancement of be separated. These measures should go common disclosure rules. some way in strengthening how banks

BCBS Basel Committee on Banking Supervision PRIPs Packaged Retail Investment Products CASS Client Assets Sourcebook RDR Retail Distribution Review CCPs Central Counterparties RRD Recovery and Resolution Directive CET1 Common Equity Tier 1 Capital RRP Recovery and Resolution Planning CFPB Consumer Financial Protection Bureau RWA Risk Weighted Assets CFTC Commodity Futures Trading Commission SEC Securities and Exchange Commission COREP Common Reporting Framework SD Swaps Dealer CRD 4 Capital Requirements Directive 4 SIFIs Systemically Important Financial Institutions CRR Capital Requirements Regulation SIBs Systemically Important Banks D-SIB Domestic Systemically Important Bank UCITS Undertaking for Collective Investments in EBA European Banking Authority Transferable Securities EDTF Enhanced Disclosure Task Force XBRL Extensible Business Reporting Language EMA Europe, Middle East and Africa EMIR European Market Infrastructure Regulation ESAs European Supervisory Authorities ESMA European Securities and Markets Authority FATCA Foreign Account Tax Compliance Act FDIC Federal Deposit Insurance Corporation FCA Financial Conduct Authority FFI Foreign Financial Institution FSA Financial Services Authority (UK) FSB Financial Stability Board FTT Financial Transaction Tax G-SIB Global Systemically Important Bank G-SIFI Global Systemically Important Financial Institution ICB Independent Commission on Banking IFRS International Financial Reporting Standards IHC Intermediate Holding Company IIF Institute of International Finance IMF International Monetary Fund IRS Internal Revenue Service LCR Liquidity Coverage Ratio LIBOR London Interbank Offered Rate MAD Market Abuse Directive MAR Market Abuse Regulation MiFID Markets in Financial Instruments Directive MiFIR Markets in Financial Instruments Regulation MSP Major Swap Participant NSFR Net Stable Funding Ratio OECD Organisation for Economic Cooperation and Development OTC Over the Counter PPI Payment Protection Insurance PRA Prudential Regulatory Authority

We would like to acknowledge the contribution of our colleagues from across our global network of firms who helped develop this report:

Editorial team Contributors

Kara Cauter Marcel Aellen Steven Hall Director, Financial Services Dr. iur. Attorney at Law Partner, Financial Risk Management Regulatory Center of Excellence, Senior Manager, Financial Services KPMG in the UK EMA region KPMG in Switzerland T: +44 20 7311 5883 KPMG in the UK T: +41 44 249 4597 (Office Zurich) E: [email protected] T: +44 20 7311 6150 T: +41 31 384 7735 (Office Berne) E: [email protected] E: [email protected] Tim Howarth Partner, Risk Consulting Clive Briault Lukas Annen KPMG in the UK Senior Adviser, Financial Services Manager, Financial Services T: +44 20 7311 6640 Regulatory Center of Excellence, KPMG in Switzerland E: [email protected] EMA region T: +41 44 249 29 39 KPMG in the UK E: [email protected] Marie-Christine Jolys T: +44 20 7694 8399 Partner, Financial Services E: [email protected] Tom Brown KPMG in France Global Sector Leader, Investment T: + 33 1 5568 6970 Rachael Kinsella Management E: [email protected] Senior Manager, Marketing KPMG in the UK Regulatory Center of Excellence, T: +44 20 7694 2011 Alima Keita EMA region E: [email protected] Audit Supervisor KPMG in the UK KPMG in France T: +44 20 7694 4583 Iain Cummings T: +33 1 5568 9264 E: [email protected] Partner, Financial Services E: [email protected] KPMG in the UK T: +44 20 7311 5240 Dr. Markus Lange E: [email protected] Partner, Head of Financial Services Legal Richard Cysarz KPMG in Germany Partner, Financial Services T: +49 69 951195 530 KPMG in Poland E: [email protected] T: +48 2 2528 1061 E: [email protected] Age Lindenbergh Partner, Financial Services Belinda Du Plessis KPMG in the Netherlands Associate Director, Financial Services T: +31 206 56 7965 Regulatory and Compliance Services E: [email protected] KPMG in South Africa T: +27 82 714 5660 E: [email protected]

Richard McCarthy Francisco Uria Eileen Toledano UK Head of Capital Markets Partner, Financial Services Head of Financial Services KPMG in the UK KPMG in Spain KPMG in Israel T: +44 20 7694 2785 T: +34 9 1451 3067 T: +972 3684 8000 E: [email protected] E: [email protected] E: [email protected]

Victor Mendoza Tim Schabert Nick Urry Partner, Financial Services Director, Financial Services Partner Global Head of Banking Tax Practice KPMG in Germany KPMG in the UK KPMG in Spain T: +49 221 2073 5947 T: +44 20 7694 2330 T: +34 9 1456 3488 E: [email protected] E: [email protected] E: [email protected] Michael Schneebeli Rob Voster Bill Michael Partner, Financial Services Senior Manager, Financial Services UK Head of Financial Services KPMG in Switzerland KPMG in the Netherlands KPMG in the UK T: +41 44 249 4712 T: +31 206 56 8439 T: +44 20 7311 5292 E: [email protected] E: [email protected] E: [email protected] Michiel Soeting Neil Miller Global Head of Energy and Natural Global Head of Islamic Finance Resources KPMG in Dubai KPMG in the UK T: +971 4424 8999 T: +44 20 7694 3052 E: [email protected] E: [email protected]

Klaus Ott Sophie Sotil Partner, Financial Services Senior Manager, Financial Services KPMG in Germany KPMG in France T: +49 69 9587 2684 T: +33 15568 7474 E: [email protected] E: [email protected]

Jon Pain Pietro Stovigliano Head of Financial Services Associate Partner, Financial Services Risk Consulting KPMG in Italy KPMG in the UK T: +39 0 267 6431 T: +44 20 7694 4160 E: [email protected] E: [email protected]

Jeremy Anderson Jim Low Chairman, Partner, Financial Services Global Financial Services Regulatory Center of Excellence KPMG Americas Region T: +44 20 7311 5800 KPMG in the US E: [email protected] T: +1 212 872 3205 E: [email protected] David Sayer Global Head of Banking Simon Topping KPMG in the UK Principal, Financial Services T: +44 20 7311 5404 Regulatory Center of Excellence, E: [email protected] ASPAC region KPMG in China Michael J Conover T: +852 2826 7283 Global Sector Leader, E: [email protected] Capital Markets KPMG in the US T: +1 212 872 6402 E: [email protected]

Giles Williams Partner, Financial Services Regulatory Center of Excellence EMA region T: +44 20 7311 5354 E: [email protected]

[email protected] www.kpmg.com/regulatorychallenges

© 2013 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Printed in the UK. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

Produced by KPMG’s Global Financial Services Practice in the UK. Designed by Mytton Williams Publication name: Evolving Banking Regulation EMA Edition Publication number: 121467 Publication date: February 2013