Monday May 28 2012 - Top 10 risk and compliance management related news stories and world events...

P a g e | 1

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)

www.risk-compliance-association.com

International Association of Risk and Compliance Professionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com

Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's

agenda, and what is next

George Lekatis President of the IARCP

Dear Member, Are you fit and proper? Yes, risk and compliance management professionals, auditors, senior managers and board members must be fit and proper, and the definition is becoming more interesting. For example, in Article 42 of the Solvency II Directive of the EU, we read: Article 42 Fit and proper requirements for persons who effectively run the undertaking or have other key functions 1. Insurance and reinsurance undertakings shall ensure that all persons who effectively run the undertaking or have other key functions meet at all times the following requirements: (a) Their professional qualifications, knowledge and experience are adequate to enable sound and prudent management (fit); (b) They are of good repute and integrity (proper).

http://www.risk-compliance-association.com/

P a g e | 2



2. Insurance and reinsurance undertakings shall notify the supervisory authority of any changes to the identity of the persons who effectively run the undertaking or are responsible for other key functions, along with all information needed to assess whether any new persons appointed to manage the undertaking are fit and proper. 3. Insurance and reinsurance undertakings shall notify their supervisory authority if any of the persons mentioned in paragraphs 1 and 2 have been replaced because they no longer fulfil the requirements referred to in paragraph 1. Later, we had some interesting technical measures where we can learn more: Persons who effectively run the undertaking or have other key functions are not limited to the members of the administrative, management or supervisory body, but could include other persons such as senior managers. The other “key functions” are those considered critical or important in the system of governance and include at least the risk management, the compliance, the internal audit and the actuarial functions. Other functions may be considered key functions according to the nature, scale and complexity of an undertaking’s business or the way it is organised. Minimum standards are therefore set concerning the fitness and propriety of corporate officers who occupy key management positions. Insurers need to demonstrate that these persons are adequately qualified and proper to do their jobs. This is the reason insurers and reinsurers compete to hire qualified professionals, and Solvency ii is often called "The Risk and Compliance Managers' Full Employment Act" Insurers and reinsurers headquartered outside the EU ('third-country

P a g e | 3



insurers') are also affected. Solvency ii includes specific rules for branches of direct insurers headquartered outside the EU which are similar to those applied to branches of insurers headquartered within the EU. Many non-EU countries try hard to become Solvency ii Equivalent. Equivalence assessments aim to ensure that the third country regulatory and supervisory regimes provide a similar level of policyholder / beneficiary protection as the one provided under the Solvency II Directive. In case of a positive equivalence determination Member States are required to treat reinsurance contracts concluded with undertakings having their head office in the third country whose regime has been deemed equivalent, in the same manner as reinsurance contracts concluded with an undertaking which is authorised under the Solvency II Directive. In case of a positive equivalence determination Member States shall not require the localisation within the Community of assets held to cover the technical provisions covering risks situated in the Community, nor assets representing reinsurance recoverables. *** Welcome to the Top 10 list.

P a g e | 4



The fit and proper requirements…

Tribunal upholds FSA decision to ban and fine former UBS advisers £1.3m for not being fit and proper in relation to an unauthorised trading scheme 21 May 2012

Remarks by Thomas J. Curry Comptroller of the Currency Before the Exchequer Club

We welcome the Private Company Council (PCC) The Financial Accounting Foundation (FAF) Board of Trustees established a new body to improve the process of setting accounting standards for private companies

P a g e | 5



Speech by Andrea Enria, Chairperson of the European Banking Authority

Financial integration and stability in Europe: the role of the European Banking Authority

23 May 2012, at the 15th China Beijing International High Tech Expo China Financial Summit 2012

Rasheed Mohammed Al Maraj: Corporate governance and Shari’a compliance in Bahrain Welcome speech by His Excellency Rasheed Mohammed Al Maraj, Governor of the Central Bank of Bahrain, at the AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions) Annual Shari’a Conference, Manama, May 2012.

A route for Europe

Address by Mario Draghi, President of the ECB, at the day in memory of Federico Caffè organised by the Faculty of Economics and the Department of Economics and Law at the Sapienza University, Rome, 24 May 2012

Gabriel Bernardino, Chairman of EIOPA EIOPA, Solvency II and the Loss Adjusting Profession General Assembly of the European Federation of Loss Adjusting Experts

P a g e | 6



Risk Management opportunities in the public sector Information implicit rather than explicitly expressed Can automated deep natural-language analysis unlock the power of inference?

Testimony Before the US Senate Committee on Banking, Housing and Urban Affairs, Washington, DC CFTC Chairman Gary Gensler May 22, 2012

Challenges facing the Swiss National Bank Speech by Mr Thomas Jordan, Chairman of the Governing Board of the Swiss National Bank, to the General Meeting of Shareholders of the Swiss National Bank, 27 April 2012.

P a g e | 7



The fit and proper requirements…

Tribunal upholds FSA decision to ban and fine former UBS advisers £1.3m for not being fit and proper in relation to an unauthorised trading scheme

21 May 2012 The Upper Tribunal (Tax and Chancery Chamber) has directed the Financial Services Authority (FSA) to fine Sachin Karpe £1.25 million and Laila Karan £75,000 and ban them both from performing any role in regulated financial services for failing to act with integrity, in breach of Principle 1 of the FSA’s Statements of Principles and Code of Conduct for Approved Persons (“APER”) and for not being fit and proper persons. Between January 2006 to January 2008, Karpe was Desk Head of the Asia II Desk at UBS AG (UBS) international wealth management business in London. Between February 2007 and January 2008, Karan worked as a Client Advisor on the Asia II Desk, reporting directly to Karpe. The Asia II Desk provided services to customers resident in India, or of Indian origin.

Karpe

During the relevant period Karpe carried out substantial unauthorised

trading, predominantly in FX instruments, with a gross value of billions of

pounds across 39 customer accounts.

P a g e | 8



He also made unauthorised transfers and loans between client accounts

in order to conceal losses arising from the unauthorised trading.

He directed others (including Karan) to assist him in arranging the

transfers and loans, and creating false documentation for the

unauthorised trading.

His scheme resulted in substantial losses for 21 customers.

UBS has since paid compensation to the affected customers in excess of

US$42 million.

Karpe also established an investment structure to enable a major (Indian

resident) customer (via an investment fund incorporated in Mauritius) to

breach Indian law in clear contravention of UBS guidelines.

Ultimately, the customer invested over US$250 million in the fund.

Karpe deliberately and repeatedly misled compliance in order to

accommodate his customer.

Karpe also misled UBS and senior management about paying

compensation to a customer using monies from another customer

account.

The Tribunal found that:

“Mr Karpe induced others serving on his desk to participate in what was

an obviously dishonest course of conduct...we infer that the whole

motivation was to benefit him indirectly and in the long term by obtaining

new clients through his apparent prestige, increasing funds under

management and thereby advancing his career and increasing his

bonuses.”

The Tribunal accepted that the compliance failings at UBS might have

created an environment within which staff could “get away with”

misconduct – however, this was no excuse for Karpe’s sustained

dishonesty.

P a g e | 9



Karan

Karan did not instigate the unauthorised trading; however, she was aware

that unauthorised activity was occurring on some customer accounts for

which she was responsible.

Between February 2007 and January 2008, rather than escalating this

knowledge, Karan assisted Karpe in concealing the unauthorised activity.

In particular, Karan prepared false, handwritten telephone attendance

notes purporting to record customer instructions she had received when

she had taken no such instructions; routed transactions through a

suspense account in order to conceal their origin and destination; signed

a number of UBS documents recording the approval of transactions on

the accounts without having received instructions or authorisation from

the customers; and failed to escalate her knowledge of unauthorised loans

between customers.

Ms Karan also failed to escalate her knowledge that Mr Karpe had misled

UBS and senior management about paying compensation to a customer

using monies from another customer account.

The Tribunal noted that:

“We recognise that Ms Karan had been placed in an extremely awkward

situation through the manipulation of Mr Karpe.

The fact, however, is that over and over again she chose to go along with

and, on occasions, to facilitate Mr Karpe’s wrongdoing.”

Tracey McDermott, acting director of enforcement and financial crime,

said:

“Karpe exploited and abused his position of trust, and persuaded more

junior employees to engage in misconduct to assist him.

Such behaviour is in breach of his obligations to his employer, his clients

and his colleagues as well as to the regulator.

It has no place in the financial services industry.

P a g e | 10



We welcome the Tribunal’s confirmation that as well as banning Karpe, a

significant financial penalty should also be imposed.

This sends a clear message of the consequences of such behaviour.

“Karan sought to categorise herself as a victim in this matter. The

Tribunal (as had the FSA) recognised that she did not initiate the

misconduct, and was placed in a difficult position by Karpe.

However, the findings and the resulting sanctions send a clear message

that an approved person must take responsibility for their own actions.

Where an approved person is aware that colleagues are engaging in

misconduct, we expect them to blow the whistle, not to become involved

themselves.

“Those who take on the responsibility of being an approved person

should be in no doubt about our commitment to take the strongest action

to tackle behaviour which falls below the high standards we expect.”

In November 2009 the FSA fined UBS £8million for systems and controls

failures in relation to the unauthorised activity which occurred on the Asia

II Desk.

In December 2011 Jaspreet Singh Ahuja and in November 2009 Andrew

Cumming, both former Asia II Desk client advisers, were banned and

fined £150,000 and £35,000 respectively.

P a g e | 11



Remarks by Thomas J. Curry Comptroller of the Currency Before the Exchequer Club

Thank you for inviting me back to the podium of the Exchequer Club, which is home to so many good friends and colleagues.

It is a great honor to come before you as Comptroller of the Currency. Twenty-nine distinguished Americans have held the office since the OCC was founded nearly 150 years ago, and I’m proud to be the bearer of their legacy. After all that has happened over the past half-decade, I feel fortunate indeed to assume the responsibilities of the office at a time when the system of national banks and federal thrifts is on the mend and returning to a satisfactory condition. On average, balance sheets are stronger, earnings are improving, and the number of problem institutions and institutional failures, while still too high, is declining. Asset quality has been improving over the past several years. Among our largest banks, charge-off rates have fallen across all product lines, with reductions of 50 percent or more from 2009 levels in credit cards, commercial and industrial lending, and commercial real estate.

P a g e | 12



Better asset quality has enabled banks and thrifts to trim new provisions for loan-losses, increasing the resources available for their own and their customers’ use. Some asset concentrations remain embedded in institutions’ portfolios, particularly in residential real estate, but they are mitigating the risks such concentrations entail. Capital now stands at its highest level in a decade, system-wide – the result of increased earnings, low dividend payouts, new capital issuances, and reductions in risk-weighted assets. And with a strong base of deposits, banks and thrifts have the liquidity they need to handle any reasonable contingency. These improving measures of financial health do not mean that the institutions we supervise are out of the woods. Loan demand remains sluggish, as the economy continues to under-perform. Non-interest income is down, and the yield curve continues to be unfavorable. These factors all bear watching, keeping in mind that failures in the fundamentals of sound credit underwriting and balanced growth drove the decline from which we’re still recovering. Our economic prospects – local, regional, national and international – depend on a banking system that is both safe and sound. But as the industry continues to heal from the credit and capital market challenges of the financial crisis, it is evident that another type of risk is gaining increasing prominence. That is operational risk—generally defined as the risk of loss due to failures of people, processes, systems, and external events.

P a g e | 13



The risk of operational failure is embedded in every activity and product of an institution – from its processing, accounting, and information systems to the implementation of its credit risk management procedures. Managing operational risk requires banks and thrifts to control the straightforward things – like ensuring that legal documents are properly signed and contain accurate information – as well as the more multifaceted ones, like validating the inputs, assumptions, and algorithms in their risk models. Operational risk is heightened when these systems and procedures are most complex. Given the complexity of today’s banking markets and the sophistication of technology that underpins it, it is no surprise that the OCC deems operational risk to be high and increasing. Indeed, it is currently at the top of the list of safety and soundness issues for the institutions we supervise. This is an extraordinary thing. Some of our most seasoned supervisors, people with 30 or more years of experience in some cases, tell me that this is the first time they have seen operational risk eclipse credit risk as a safety and soundness challenge. Rising operational risk concerns them, it concerns me, and it should concern you. We all know about the damage operational deficiencies can cause. Inadequate systems and controls were a primary reason for the recent problems in mortgage servicing and foreclosure documentation practices—problems that have had a big impact on the reputation and financial condition of the large banks that were implicated in those practices, on the timely clearing of non-performing loans, and on the general housing market.

P a g e | 14



Those banks did a poor job supervising both their own internal processes and the providers to which they outsourced some of these functions, and they are paying the price for their mistakes. Operational risk for institutions of all sizes can arise also from flawed risk assessment and risk management systems within the institution. For community institutions with credit concentrations, a flawed assessment of risk can lead to inadequate controls and insufficient risk management systems. For the largest institutions, the challenges here can be exceedingly complex. One example takes the form of faulty risk assessment and risk management of the inter-relationship of risks in different markets on the value of the institution’s assets. Too often, we have seen conspicuous and expensive examples of the toll that one form of operational risk—flawed risk models—can take. This so-called "model risk" is a species of operational risk, and is an important supervisory issue. Together with the Federal Reserve, we issued supervisory guidance on model risk management about a year ago. This replaced previous OCC guidance on model validation and emphasized the importance of approaching model risk as an important focus of risk management for institutions that make material use of models. The guidance stresses the need for ongoing monitoring and analysis to ensure that models are likely to continue to perform as expected. In line with that guidance, and in view of the complexity of some models, institutions should be comparing their model results to the results of

P a g e | 15



alternative approaches, and should supplement model results with other information and analysis. This helps avoid narrow reliance on single approaches, which can increase the risk of model failures and the related operational losses. The OCC has directed the institutions we supervise to comply with this guidance, and we actively apply it through our ongoing supervisory processes. Yet, as banks and thrifts face greater resource constraints and higher compliance costs, they may feel greater pressure to economize on systems and processes in order to enhance their income and operating economies—and therefore may be at greater danger of those systems and processes breaking down. All institutions, regardless of size, must resist the temptation to under-invest in the systems and controls they need to prevent greater risk and larger losses in the future. They should take their cues from the cases in which such breakdowns have occurred. Many examples exist in addition to those I’ve just described. For example, where financial institutions have been less than vigilant about the IT security of processors with whom they contract to provide merchant processing services, breaches have occurred, and millions of credit and debit account holders were impacted. Banks and thrifts lacking adequate controls over their third-party marketing relationships have unwittingly given their blessing to consumer financial products with unfair and deceptive characteristics, exposing the institution to sanctions by the OCC for unfair and deceptive practices. And we’ve seen institutions outsourcing such functions as debt collection but not taking adequate care to ensure that the third-party contracted to perform those functions follows the laws and regulations governing them.

P a g e | 16



The result has been regulatory penalties and reputational damage. Let me say that the OCC is very supportive of efforts by the banks and thrifts it supervises to operate efficiently and to offer a wide range of products and services that provide value to the consumer. That’s what a safe and sound banking system must do, and sometimes those goals are best advanced through partnerships with third-parties. But when a bank or thrift enters into a third-party relationship, it must understand that it does not wipe its hand of responsibility for the quality and characteristics of the products that are offered to its customers through this channel—even if those products are not marketed with the institution’s brand. Due diligence in identifying, measuring, and monitoring the risk from third-party relationships, and establishing mechanisms for controlling and continuously monitoring those risks, is thus an essential part of managing operational risk, which in turn affects its safety and soundness. An area where the intersection of operational and other risks is very evident today concerns Bank Secrecy Act and anti-money laundering compliance. When things go wrong in those areas, not only is the integrity of the institution’s operations compromised, but national security and drug trafficking interdiction goals can be undermined, as well. This, too, affects institutions of all sizes, even though it’s large banks that are most likely to make the headlines when they are found to have BSA/AML deficiencies. But the OCC also is finding a rising number of BSA/AML problems in, and taking appropriate supervisory and enforcement actions against, midsize and community institutions, for problems that include ineffective account monitoring, inadequate tracking of high-risk customers and bulk cash transactions, and lapses in monitoring suspicious activity.

P a g e | 17



BSA/AML compliance is inherently difficult. It combines the challenges of sifting through large volumes of transactions to identify features that are suspicious, with the presence of criminal and possibly terrorist elements dedicated to and expert in concealing the nature of the transactions they undertake. Rendering BSA/AML compliance more challenging is the fact that BSA/AML risks are constantly mutating, as criminal and terrorist elements alter their tactics to avoid detection and penetrate our defenses. They move quickly from one base of operations to another, finding sanctuary in places where law enforcement, or sympathy for U.S. policy objectives are weakest. Thus, success is often transient where BSA/AML is involved, and efforts must be constantly re-energized. Controls that may be entirely adequate today may prove inadequate for tomorrow’s risks and threats. However, it is critical that banks and thrifts instill strong cultures and oversight processes. Management needs to focus on key controls and maintain knowledgeable and sufficient staff. We can never underestimate the determination and ingenuity of our adversaries—and we must be equal to that risk as it evolves. This, I recognize, is a major challenge. If we are to defend the security of our financial system and our nation—as we must—industry and government cooperation is crucial. As regulators, one of our most important jobs is to identify risk trends and bring them to the industry’s attention in a timely way.

P a g e | 18



No issues loom larger today than operational risk in all its dimensions, the manner in which all risks interact, and the importance of managing those risks in an integrated fashion across the entire enterprise. These themes are a supervisory priority for us at the OCC today and they should similarly command the attention of the industry. Thank you.

Note:

Thomas J. Curry was sworn in as the 30th Comptroller of the Currency on April 9, 2012.

The Comptroller of the Currency is the administrator of national banks and chief officer of the Office of the Comptroller of the Currency (OCC).

The OCC supervises more than 2,000 national banks and federal savings associations and about 50 federal branches and agencies of foreign banks in the United States.

These institutions comprise nearly two-thirds of the assets of the commercial banking system.

P a g e | 19



We welcome the Private Company Council (PCC) Financial Accounting Foundation Establishes New Council to Improve Standard Setting for Private Companies Washington DC, May 23, 2012—After seeking and considering extensive public comment, the Financial Accounting Foundation (FAF) Board of Trustees today established a new body to improve the process of setting accounting standards for private companies. The new group, the Private Company Council (PCC), will have two principal responsibilities. Based on criteria mutually developed and agreed to with the Financial Accounting Standards Board (FASB), the PCC will determine whether exceptions or modifications to existing nongovernmental U.S. Generally Accepted Accounting Principles (U.S. GAAP) are necessary to address the needs of users of private company financial statements. The PCC will identify, deliberate, and vote on any proposed changes, which will be subject to endorsement by the FASB and submitted for public comment before being incorporated into GAAP.

P a g e | 20



The PCC also will serve as the primary advisory body to the FASB on the appropriate treatment for private companies for items under active consideration on the FASB’s technical agenda. “The Trustees believe that the plan approved today will improve the standard-setting process and give private company stakeholders additional assurance that their concerns will be thoroughly considered and addressed,” said FAF Board of Trustees Chairman John J. Brennan following a meeting of the Trustees in Washington DC. “This structure represents a significant improvement over our original proposal because of the very valuable suggestions we received from a broad cross section of concerned and interested constituents.” FAF President and CEO Teresa S. Polley said: “The plan approved by the Trustees strikes an important balance. On one hand, the plan recognizes that the needs of public and private company financial statement users, preparers, and auditors are not always aligned. But at the same time, the plan ensures comparability of financial reporting among disparate companies by putting in place a system for recognizing differences that will avoid creation of a ‘two-GAAP’ system.” The private company plan approved today generally follows the outline of the initial Trustee proposal announced last October, but includes several significant changes and improvements. In response to stakeholder concerns, the Trustees changed the process through which FASB considers Council recommendations for private company exceptions or modifications to GAAP from one of ratification to one of endorsement. The final plan stipulates that the Council Chair will not be a FASB member; that the Council will hold meetings more frequently than originally proposed; and that its size will be smaller than initially suggested.

P a g e | 21



“The establishment of the PCC will help the FASB improve upon the efforts already under way to better serve the needs of private company financial statement users, preparers, and practitioners,” said FASB Chairman Leslie F. Seidman. Key elements of the Private Company Council responsibilities and operating procedures include:

Agenda Setting Working jointly, the PCC and the FASB will mutually agree on criteria for determining whether and when exceptions or modifications to GAAP are warranted for private companies. Using the criteria, the PCC will determine which elements of existing GAAP to consider for possible exceptions or modifications by a vote of two-thirds of all sitting members, in consultation with the FASB and with input from stakeholders.

FASB Endorsement Process If endorsed by a simple majority of FASB members, the proposed exceptions or modifications to GAAP will be exposed for public comment. At the conclusion of the comment process, the PCC will redeliberate the proposed exceptions or modifications and forward them to the FASB, who will make a final decision on endorsement, generally within 60 days. If the FASB endorses the proposals, they will be incorporated into GAAP. If the FASB does not endorse, the FASB Chairman will provide the PCC Chair with a written explanation, including possible changes for the PCC to consider that could result in FASB endorsement.

Membership and Terms

P a g e | 22



The PCC will comprise 9 to 12 members, including a Chair, all of whom will be selected and appointed by the FAF Board of Trustees. The PCC Chair will not be a FASB member. Membership of the PCC will include a variety of users, preparers, and practitioners with substantial experience working with private companies. Members will be appointed for a three-year term and may be reappointed for an additional term of two years. Membership tenure may be staggered to establish an orderly rotation. The PCC Chair and members will serve without remuneration but will be reimbursed for expenses.

FASB Liaison and Staff Support A FASB member will be assigned as a liaison to the PCC. FASB technical and administrative staff will be assigned to support and work closely with the PCC. Dedicated full-time employees will be supplemented with FASB staff with specific expertise, depending on the issues under consideration.

Meetings During its first three years of operation, the PCC will hold at least five meetings each year, with additional meetings if determined necessary by the PCC Chair. Deliberative meetings of the PCC will be open to the public, although the Council may hold closed educational and administrative sessions. Most of the meetings will be held at the FAF’s offices in Norwalk, Connecticut, but up to two meetings each year may be held elsewhere.

P a g e | 23



All FASB members will be expected to attend and participate in deliberative meetings of the PCC, but closed educational and administrative meetings may be held with or without the FASB.

Oversight The FAF Board of Trustees will create a special-purpose committee of Trustees, the Private Company Review Committee (Review Committee), which will have primary oversight responsibilities for the PCC. The Review Committee will hold both the PCC and the FASB accountable for achieving the objective of ensuring adequate consideration of private company issues in the standard-setting process. The Review Committee will be chaired by a Trustee with substantial experience in private company accounting issues. Oversight activities will be ongoing, and will include monitoring of PCC meetings, among other activities.

FAF Trustees’ Three-Year Assessment The PCC will provide quarterly written reports to the FAF Board of Trustees. The FAF Trustees will conduct an overall assessment of the PCC following its first three years of operation to determine whether its mission is being met and whether further changes to the standard-setting process for private companies are warranted. The complete report establishing the PCC, including background materials, key discussion issues considered by the Trustees, and PCC responsibilities and operating procedures, will be available on the FAF website next week. The FAF Board of Trustees will issue a call for nominations for members of the PCC via the FAF website in the next few weeks.

P a g e | 24



About the Financial Accounting Foundation The FAF is responsible for the oversight, administration, and finances of both the Financial Accounting Standards Board (FASB) and its counterpart for state and local government, the Governmental Accounting Standards Board (GASB). The Foundation is also responsible for selecting the members of both Boards and their respective Advisory Councils.

About the Financial Accounting Standards Board Since 1973, the Financial Accounting Standards Board has been the designated organization in the private sector for establishing standards of financial accounting and reporting. Those standards govern the preparation of financial reports and are officially recognized as authoritative by the Securities and Exchange Commission and the American Institute of Certified Public Accountants. Such standards are essential to the efficient functioning of the economy because investors, creditors, auditors, and others rely on credible, transparent, and comparable financial information. For more information about the FASB, visit our website at www.fasb.org.

P a g e | 25



Speech by Andrea Enria, Chairperson of the European Banking Authority

Financial integration and stability in Europe: the role of the European Banking Authority

23 May 2012, at the 15th China Beijing International High Tech Expo China Financial Summit 2012 Dear CHITEC host, Ladies and Gentlemen, It is a pleasure to have been invited to address you this morning at the China Financial Summit 2012. Given the very difficult environment we are facing in the financial markets, and especially in the European banking sector, this conference provides an excellent opportunity to give this international gathering some insight into the recently established European Banking Authority, the EBA, including the role it plays in tackling the crisis, and in strengthening the regulatory framework for European banks. While the immediate challenges are dominating our thoughts at present, it is also important that we continue to develop the structural changes necessary to deliver a more secure and stable banking environment for the long term.

P a g e | 26



The extent of the problems which have beset the global financial system over the last five years are unprecedented in modern times and have exposed serious weaknesses in financial regulation and supervision. In his February 2009 report, Jacques de Larosière pointed to the belief that in the run up to the commencement of the crisis in 2007, financial regulation and supervision had been too weak and provided the wrong incentives. Lack of adequate macro-prudential supervision, ineffective early warning mechanisms, lack of frankness and cooperation between supervisors and lack of common decision making process were among the key lessons learned from the crisis. We had a Single Market, closely integrated especially after the introduction of the euro, but the regulatory and supervisory environment has remained very diverse, notwithstanding the efforts for harmonisation. A key component of the European response to addressing these deficiencies was the establishment of the European System of Financial Supervision on 1 January 2011. This includes the European Systemic Risk Board (ESRB), in charge of macroprudential supervision, and the three European supervisory authorities, the EBA for banking, ESMA for securities and markets and EIOPA for insurance and occupational pensions. The EBA has been given a wide-ranging mandate. In the field of supervision, while the day-to-day oversight of banks’ safety and soundness remains a responsibility of national authorities, the EBA has been entrusted with key responsibilities. These include the regular conduct of risk assessments, which should also lead to the establishment of a risk dashboard, and of area-wide stress tests, aimed at ensuring the resilience of European banks in front of adverse shocks.

P a g e | 27



The EBA also fosters cooperation between home and host authorities and actively participates in and oversees the work of supervisory colleges for cross-border groups. Additional tasks are envisaged in the area of crisis management where the EBA is in charge of coordinating recovery and resolution plans for the major European banking groups. In the area of rule making, the EBA plays a major role in the establishment of the so-called Single Rulebook – i.e. technical rules truly uniform throughout the European Union, adopted through legal instruments that are directly binding in all the 27 Member States of the Union. Last but not least, we have been entrusted with the responsibility for monitoring and tackling consumer issues. Let me first give you an overview of the EBA’s role and activities in relation to micro prudential supervision, and namely to the Authority’s efforts in tackling the financial crisis.

The EBA’s efforts in tackling the crisis

The EBA’s initial priorities were centered on the challenges raised by the deterioration of the financial market environment. In the first part of 2011, we conducted a stress test exercise, aimed at assessing the capital adequacy of the largest European banks in front of adverse macroeconomic developments. The exercise focused on credit and market risks and also, in recognition of the risks that subsequently crystallised, incorporated sensitivity to movements in funding costs. Banks were required also to assess the credit risk in their sovereign portfolios.

P a g e | 28



In many respects, I believe the exercise was successful: in order to achieve the tougher capital threshold, anticipating many aspects of the new Basel standards, banks raised €50bn in fresh capital in the first four months of the year; we set up a comprehensive peer review exercise, which ensured consistency of the results across the European Single Market, notwithstanding the many differences in national regulatory frameworks; the exercise included an unprecedented disclosure of data (more than 3200 data points for each bank), including, amongst other things, detailed information on sovereign holdings. However, the progress of the stress test was tracked by a significant further deterioration in the external environment. The main objective of restoring confidence in the European banking sector was not achieved, as the sovereign debt crisis extended to more countries, thus reinforcing the pernicious linkage between sovereigns and banks. Soon after the completion of the stress test, most EU banks, especially in countries under stress, experienced significant funding challenges. In this context, the IMF and the European Systemic Risk Board (ESRB), called for coordinated supervisory actions to strengthen the EU banks’ capital positions. The EBA assessment was that without policy responses, the freeze in bank funding would have led to an abrupt deleveraging process, which would have hurt growth prospects and fuelled further concerns on the fiscal position of some sovereigns, in a negative feedback loop. We then called for coordinated action on both the funding and the capitalisation side. While advising the establishment of an EU-wide funding guarantee scheme, the EBA focused its own efforts on those areas where it had control, primarily bank capitalisation.

P a g e | 29



To this end, the EBA’s Board of Supervisors, comprising the heads of all 27 national supervisory authorities, discussed and agreed that a further recapitalisation effort was required as part of a suite of coordinated EU policy measures. This resulted in the EBA issuing a Recommendation that identified a temporary buffer to address potential concerns over EU sovereign debt holdings and required banks to reach 9% Core Tier 1. The total shortfall identified was €115 bn. The measure, agreed in October 2011 and enacted in December 2011, seeks that Supervisory Authorities should require those banks covered by its Recommendation to strengthen their capital positions by end of June 2012. The Recommendation was swiftly followed by the ECB’s long term refinancing operations (LTROs), arguably the key “game changer” in this context. The LTROs allowed banks to satisfy their funding needs in front of a significant amount of liabilities to roll over in 2012, thus preventing a massive credit crunch. The recapitalisation was a necessary complementary measure: while banks needed unlimited liquidity support, to keep supporting the real economy, they had to be asked to accelerate their action to repair balance sheets and strengthen capital positions. When the process is completed, European banks will be in a much stronger position, also vis-à-vis their main peers at the global level. The EBA is, in general, satisfied with the progress made in the fulfilment of this Recommendation and notes that the actions taken by the bulk of banks include capital strengthening and adequate recognition of losses.

P a g e | 30



In addition, three banks identified as having weaknesses have subsequently undergone restructuring processes and will no longer exist in the same form as at the moment of the stress test. We have put a lot of efforts to avoid that banks reached the target ratio by cutting asset levels instead of raising capital, thus reducing credit availability for corporates, especially small and medium enterprises and households. However, a deleveraging process is needed in the banking sector. It has already started, with a different pace in different areas of the global financial system and needs to be accomplished in an ordered fashion. The first step has been the increase in capital levels, long overdue and one of the cornerstones of the regulatory reforms endorsed by the G20 Leaders. The second step requires a reduction in size of balance sheets, especially by addressing non-performing assets and de-risking in areas such as capital market activities and real estate lending, which grew too much in the run-up to the crisis. The third step entails a refocusing of business models, especially towards more stable funding structures and the gradual exit from the extraordinary support measures put in place by central banks. I am convinced that without an ordered deleveraging process, through a significant strengthening of capital and a selective downsizing of asset levels, we would fail addressing the fragilities that are preventing banks from performing their fundamental functions.

Supervisory Colleges

The misalignment between the international nature of the major banking groups and a national system of supervision has been a contentious subject for many years.

P a g e | 31



In the years preceding the crisis and in an effort to improve supervision, colleges of supervisors were established, to varying extents, for major banking groups. However, as the financial stresses developed in 2008, these structures did not work effectively in a large number of cases. The already difficult situation was compounded by the lack of dialogue and information exchange between supervisory authorities, as national priorities took precedence in the decision making process. Given the problems which this lack of cooperation presented, there was a clear need to radically overhaul the voluntary structures which existed. This need has manifested itself in legislative changes to the Capital Requirements Directive (CRD), the primary European legislation that implements the Basel accord for banking in the EU, and in specific provisions incorporated into the mandate of the EBA. Supervisory colleges are now required for all cross border banking groups operating in the European Economic Area and the EBA has been granted full participation rights as a competent authority. The EBA staff are attending supervisory colleges of the major systemically important groups in Europe and go to these meetings with a clearly defined goal of promoting and monitoring the efficient, effective and consistent functioning of colleges as well as fostering the coherent application of the EU law by supervisors. Also, since 2011, European colleges are the forum in which the consolidating supervisor and the competent authorities responsible for the supervision of subsidiaries are required to reach a joint decision on the capital of the group and the relevant subsidiaries. The formal system of joint risk assessments, which underpins this process, and the drive to make the core supervisory decision on capital, represents a major step forward in the coordination of cross border supervisory processes.

P a g e | 32



I am glad to say that in many of these meetings for banking groups which have operations outside the European Union, consolidating supervisors will often invite supervisors from countries outside the EU so that they can give a first hand account of the risks being run in the entities they oversee. The EBA strongly believes the work to implement these arrangements has to be strengthened in order to improve the effectiveness of supervision for cross-border groups. Good progress has been made in many quarters. For instance, national authorities are coming to their joint decisions on the capital of a banking group using the common structures and templates set out in guidelines issued by the EBA. However, there is still a long way to go to enhance consistency in supervisory outcomes and to achieve adequate levels of information exchange and cooperation.

Crisis Management

It is at these times of intense challenge, that structures and relationships are most tested, and we actually see how well coordination of supervision works at an international level- and see most clearly where fault lines continue to exist. Before I give you some views on what is happening within the EU regulatory community, I need to forcefully make the point that primary responsibility to enhance preparedness for a crisis situation lies with the banks themselves. Banks must learn the lessons of the crisis and materially improve their risk management processes. They must embed into their processes the capacity to perform real stress tests and make sure they are well equipped to withstand severe adverse market developments.

P a g e | 33



Part of this process will involve the development of effective Recovery and Resolution Plans (RRPs) and the identification of the steps to be taken when the viability of the firm is at risk. The guidance of the Financial Stability Board is a key benchmark in this area. For cross-border groups in the European Union, colleges of supervisors will develop plans for the coordination of supervisory action in emergency situations. Colleges are supplemented by the Cross-Border Stability Groups (or “crisis colleges”), which bring together fiscal authorities, central banks and supervisors. But the lesson of the crisis is that voluntary cooperation arrangements are not enough. Stronger legal and institutional underpinnings are needed to enforce effective crisis management and resolution tools in the European Single Market. An important step has already been taken to strengthen the European institutional setting with the provisions set out in our founding Regulation, which gives the EBA responsibilities in areas such as the monitoring of colleges, the development of Recovery and Resolution Plans and the conduct of EU-wide stress tests. In addition, when an emergency situation is declared by the European Council, the EBA has been given the power to address specific recommendations to national supervisory authorities with a view to coordinating their actions and, if necessary, apply European decisions directly to individual institutions in case of inaction by national authorities. Nonetheless, the structures are not complete and a more formal role for the EBA in crisis management will depend on the outcome of the

P a g e | 34



European Commission’s work on new legislation for bank recovery and resolution, due out soon. The legal underpinning for crisis resolution needs to be fully harmonised in order to allow for an integrated process, with close cooperation between the authorities involved. This should allow interconnecting national resolution procedures so as to ensure an integrated approach for cross-border firms, ensuring an equitable treatment of creditors in all jurisdictions. At the same time, mechanisms should be in place to constrain the actions of national authorities and drive towards coordinated, firm-wide solutions. Over time, the EBA’s role in this area is likely to grow substantially, including its role in mediating between conflicting interests of national authorities as serious problems emerge.

Rule Making and the Single Rulebook

As proposed by de Larosière in his report, the EBA now has the capacity to draft directly applicable rules, by means of regulatory and implementing standards that will then be adopted by the European Commission as EU Regulations and thereby become directly binding in the whole EU, without the need for national implementation. This process will help eliminate many of the inconsistencies which have arisen from options, national discretions, and the different interpretations adopted when previous rules were transposed into national legislation by the 27 EU Member States. Materially reducing the fragmentation in the EU regulatory regime will provide greater certainty to market participants and stronger foundations for convergence in supervisory practices. Based upon the current legislative proposals for the implementation of Basel 3, about 200 deliverables will be expected from the EBA, including

P a g e | 35



proposals for around 100 Technical Standards such as on the definition of capital, capital buffers, liquidity, remuneration, and the leverage ratio. This will be essential to ensure level playing field and avoid in the future that the regulatory lever is used to attract business in national market places or to favour national champions, a process that has played a great role in the relaxation of regulatory standards in the run up to the crisis. The EBA can also issue Guidelines and Recommendations which are not legally binding, albeit the EU national supervisory authorities need to indicate publicly whether they intend to comply, and if this is not the case they will need to publicly explain the reasons. The EBA can also conduct peer reviews in order to make sure that the common standards and guidelines are effectively applied in a consistent and effective fashion.

Conclusions

Ladies and gentlemen, Today I tried to convey to you an overview on the difficult challenges the EBA is facing. In our first 16 months of activity, we have already done a huge effort to strengthen the capital position of EU banks and to restore confidence in their resilience. The work is not over in this area. The liquidity support provided by the ECB avoided an abrupt deleveraging process, but banks are still in the process of repairing and downsizing their balance sheets and of refocusing their core business. We, as supervisors, need to accompany this process and do our utmost to ensure that it occurs in an ordered fashion, without adverse consequences on the financing of the real economy.

P a g e | 36



In the coming months we have to complete the preparation for the implementation of the reforms agreed by the G20 Leaders, in particular Basel 3. It is a major challenge for regulators across the world and the EBA is establishing close contacts with fellow supervisors in other countries, including China, to ensure that there is always an open dialogue and a common commitment to strengthening the safety and soundness of banks. In the EU, this challenge is compounded with our resolve to set up a much more uniform regulatory setting for all the banks operating in the Single Market, with the so called Single Rulebook. Strengthening regulation is not enough if it is not coupled with more effective supervision, especially for those large and complex groups that are active on a cross-border basis and may generate systemic risks across jurisdictions. This requires identifying best supervisory practices and ensuring convergence towards these benchmarks, as well as strengthening cooperation within colleges of supervisors. This has surely a strong European dimension, due to the relevance of cross-border business within the Single Market, but requires also close cooperation with supervisors in other regions. We are surely committed to bringing our contribution to the success of this endeavour.

P a g e | 37



Rasheed Mohammed Al Maraj: Corporate governance and Shari’a compliance in Bahrain Welcome speech by His Excellency Rasheed Mohammed Al Maraj, Governor of the Central Bank of Bahrain, at the AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions) Annual Shari’a Conference, Manama, 7 May 2012.

Excellencies, distinguished guests, ladies and gentlemen, this conference comes at an important time for the Islamic financial sector. This conference is focussing on six key areas that both the standard setters and the financial sector must work together upon if Islamic finance is to continue to grow and achieve its full potential. So I thought in this Welcome Address I would talk about one area where the Central Bank, as a regulator and as a member of AAOIFI has a special interest. And that subject is Governance. AAOIFI currently has issued seven standards relating to governance and two standards with respect to ethics. Deficiencies in Governance at financial institutions have been repeatedly highlighted in the past five years following the commencement of the Global Financial Crisis in 2007. Three of the standards issued by AAOIFI specifically refer to governance.

P a g e | 38



The first of these standards concerns the Audit & Governance Committee. In practice, this standard requires the Audit Committee to do rather more than just to review a financial institution’s accounting practices and audit plan. It requires the Committee to review the use of Restricted Investment Accounts’ funds. It emphasises the need to ensure that funds are invested in accordance with terms agreed with the customer. Too often over the past five years we have seen how the interests of customers at both conventional and Islamic banks have been neglected as bank management have focussed on bonuses and share price. If banks neglect customers’ interests, then they will lose those customers. This theme of looking after the interests of customers is carried on in the AAOIFI Governance Principles paper issued in 2005. In particular Principle 3 of this paper warns against inequitable treatment of fund providers. The 2009 AAOIFI Corporate Social Responsibility paper also focuses on dealing responsibly with clients and “par excellence” customer service. If you couple the governance standards with the ethics paper for employees of financial institutions, you find a formidable set of requirements, principles and standards relating to putting the interests of customers first. So against this background of improving levels of disclosures, the CBB will be making further efforts through its review of its corporate governance and business conduct rules to raise the bar for corporate governance.

P a g e | 39



The review of the CBB corporate governance requirements has already finished its first stage of internal review. The next will be consultation with the financial sector.

Coupled with governance is Shari’a. This is one of the themes of this conference. From the perspective of the CBB as a regulator, we have noted that all too often, the approach of banks, particularly conventional banks has been to start with a conventional transaction or product and then try to give it a finishing coat of Shari’a compliant paint. Financial institutions must not regard Shari’a compliance as the finishing touch to product development. Instead, product development needs to start from Shari’a principles: i.e. Islamic financial institutions must become Shari’a driven. And that is why this conference and the next set of consultations by AAOIFI are going to be so important. If financial institutions and standards setters can address the interest of customers, governance and Shari’a compliance satisfactorily then we can look forward to Islamic finance continuing its growth and reaching its full potential.

Notes

The Accounting and Auditing Organization for Islamic Financial Institutions(AAOIFI) is an Islamic international autonomous non-for-profit corporate body that prepares accounting, auditing, governance, ethics and Shari'a standards for Islamic financial institutions and the industry. Professional qualification programs (notably CIPA, the Shari’a Adviser and Auditor "CSAA", and the corporate compliance program) are

P a g e | 40



presented now by AAOIFI in its efforts to enhance the industry’s human resources base and governance structures. AAOIFI was established in accordance with the Agreement of Association which was signed by Islamic financial institutions on 1 Safar, 1410H corresponding to 26 February, 1990 in Algiers. Then, it was registered on 11 Ramadan 1411 corresponding to 27 March, 1991 in the State of Bahrain.

As an independent international organization, AAOIFI is supported by institutional members (200 members from 45 countries, so far) including central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry, worldwide. AAOIFI has gained assuring support for the implementation of its standards, which are now adopted in the Kingdom of Bahrain, Dubai International Financial Centre, Jordan, Lebanon, Qatar, Sudan and Syria. The relevant authorities in Australia, Indonesia, Malaysia, Pakistan, Kingdom of Saudi Arabia, and South Africa have issued guidelines that are based on AAOIFI’s standards and pronouncements.

P a g e | 41



A route for Europe Address by Mario Draghi, President of the ECB, at the day in memory of Federico Caffè organised by the Faculty of Economics and the Department of Economics and Law at the Sapienza University, Rome, 24 May 2012 A teacher, says Eco, “teaches that everyone must become individual and different”. Professor Federico Caffè, albeit with a coherent vision and deeply held convictions, was a teacher. He taught his students to think for themselves and did not pass on a binding creed. He helped his students – economists, thinkers, servants of the state and of the institutions, alert citizens – to discover themselves. I’ll start with the subject which, without a doubt, was the most precious to Caffè, namely welfare. Probably nothing in his intellectual heritage is more topical than this painful protest of his: one cannot, he would say, “ accept the idea that an entire generation of young people should consider themselves as having being born at the wrong time and having to suffer job insecurity as an inevitable fact”.

Work: a European matter

“ Full employment is not only a means of increasing production..., it is an end in itself, since it leads to overcoming the servile attitude of those who find it hard to obtain a job opportunity or live in constant fear of being deprived of one.

P a g e | 42



In other words, the benefits of full employment are considered as well, and above all, in terms of human dignity.”

These words of Caffè do not surprise those who knew him and those who have read his works.

They express the fundamental inspiration of his professional and public life: it is a duty of economic policy to act so that the economy can get as close as possible to full employment.

In 1975, he formulated it more precisely:

“ The goal of dignified work for all, however, is not compatible either with situations of privilege, which have now become destabilising, nor with excessive labour and social security rights, which results in job opportunities evaporating away” .

The issue that Caffè raises here is one of fairness. We find it again today: the international crisis has affected everyone, and young people especially.

In the European Union, between 2007 and 2011 the unemployment rate rose by 5.8 percentage points among the 15-24 year olds, by 3.5 points among the 25-34 year olds and by 1.8 points in the 35-64 age range.

Qualitatively, the profile is similar almost everywhere; the clear exception is Germany, where the unemployment rate among 15 to 24 year olds in the first quarter of 2012 was 8%; in Italy it was 34.2%, in Spain 50.7% and the euro area average was 21.9%.

These trends reflect a fundamental question: they confirm the particular vulnerability of this essential part of our workforce.

The unequal sharing of the “cost of flexibility”, only affecting young people, an eternal flexibility with no hope of stabilisation, leads among other things to companies not investing in young people, whose skills and talents often decline in jobs with low added value.

The underuse of their resources reduces growth in various ways: it makes the creation of start-ups less likely – and they are on average more innovative than others – it causes a decline in skills in the long run,

P a g e | 43



slowing down the assimilation of new technology and acting as a brake on efficient production processes. In addition to undermining society’s sense of fairness, it is a waste that we cannot afford.

I think it’s essential to ask how economic policy conducted in various Member States has done its duty in the way desired by Caffè.

Social progress is one of the key objectives of the European integration process:

“The Union shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress …

It shall combat social exclusion and discrimination, and shall promote social justice and protection, equality between women and men, solidarity between generations and protection of the rights of the child”.

(Article I-3 of the draft European Constitution). Welfare is not only a remedy for the failure of insurance markets, but also a tool to promote inclusion, solidarity and a sense of fairness.

In the three post-war decades (the so-called “Golden Age”), which especially in Europe were marked by high growth rates, use of advanced technologies, high growth employment, stable lifetime employment, welfare started to emerge, at different times and on different scales depending on the country, as an integrated system that protects its citizens from significant risks.

The European model redistributes many more resources for social purposes than the US and Japanese systems: on the eve of the crisis, the total expenditure on pensions, unemployment benefit, for children and families was, in relation to GDP, more than twice that of the US and Japan.

This can take different forms as regards the composition of social policies and the degree of labour protection.

In Italy, with an overall welfare spending ratio of GDP in line with that of the rest of Europe, spending on support for the unemployed, for

P a g e | 44



households, particularly those at risk of falling into poverty, is at a level less than half that of elsewhere in Europe, while spending on pensions is significantly higher.

The weakness of the “social shock absorbers” is that relatively high job protection for those in employment is accompanied by weaker protection for those out of work, contrary to what happens in the Nordic models, where the so-called “flexisecurity” combines an extensive social safety net with less job protection.

In some countries, even if, 40 years on, the assumptions of that model are still valid, reflections on it began some time ago.

Structural factors have changed the context within which the European social model operates: the growing competition from emerging countries, the reorganisation of production processes on a global basis, the speed of innovation, the increasing fragmentation of career paths with ever looser ties to a “permanent position”, the greater instability of families, declining fertility, the prospective decrease in the workforce, an ageing population.

The set of risks faced by individuals throughout their life has changed significantly.

The social protection systems are therefore constantly evolving; substantial corrections have taken place in recent years in many countries, including France, the United Kingdom and Germany, the country where the reform process began a decade ago.

In Italy, the recent pension reform which approves the full transition to a contribution system completes the necessary correction of the pension spending dynamics which was started years ago.

As Germany shows very well, large and effective welfare systems can be made more efficient without compromising social goals.

We are living at a critical juncture in the history of the Union.

P a g e | 45



The sovereign debt crisis has exposed serious weaknesses in the institutional framework; in this context, the difficulties in finding common solutions are having a negative impact on market valuations.

The extraordinary measures taken by the ECB have gained us time; they have preserved the functioning of monetary policy.

But we have now reached a point where European integration, in order to survive, needs a bold leap of political imagination.

It is in this sense that I have referred to the need for a “growth compact” alongside the well-known “fiscal compact”.

A growth compact rests on three pillars and the most important one, from a structural viewpoint, is political: the economic and financial crisis has challenged the myopic belief that monetary union could remain just that, and not evolve into something closer, more binding, into an arrangement whereby national sovereignty on economic policy is replaced by the Community ruling.

If the governments of the Member States of the euro define jointly and irrevocably their vision of what the political and economic construct that supports the single currency will be and what the conditions to reach that goal together should be.

This is the most effective answer to the question everyone is asking: “Where will the euro be in ten years’ time?”.

The second pillar is that of structural reforms, especially, but not only, in the product and labour markets.

The completion of the single market and the strengthening of competition are crucial for growth and employment. Labour market reforms that combine flexibility and mobility with a sense of fairness and social inclusion are essential.

Growth and fairness are closely connected: without growth, and the events of recent months also reflect this, the temptation to “circle our wagons” gains strength, and solidarity weakens.

P a g e | 46



Without fairness, the economy breaks up into multiple interest groups, no common good emerges as a result of social and economic interaction, and there are negative effects on the capacity to grow.

Recent Italian history has no shortage of examples.

These reforms have long been indispensable in a global economy very different to the one which witnessed the creation of the institutions still operating today.

In the political structure that will emerge from the crisis it is likely and desirable that for these reforms a system of European rules will be introduced similar to that for the fiscal compact, a discipline leading over time to the European harmonisation of objectives and tools.

The third pillar is the revival of public investment: the use of public resources to push forward investment in infrastructure and human capital, research and innovation at national and European levels.

(The proposed strengthening of the EIB and the reprogramming of Union structural funds in favour of less-developed areas go in this direction).

Thus, a growth compact complements the fiscal compact, because there can be no sustainable growth without orderly public finances.

In this regard I have noted on other occasions the extraordinary progress made by all governments of the euro area in terms of fiscal consolidation, but, once the emergency is overcome, they need to make improvements by cutting current spending and taxation.

Let me now consider some issues more directly related to the ECB’s monetary policy and action.

Objectives and instruments

The first issue involves the relationship between objectives and instruments of economic policy in a macroeconomic reference model that changes over time.

P a g e | 47



For Caffè, one of the first scholars of Frisch and Tinbergen, the optimal allocation of tools and objectives occurred in the reference model prevalent in the 1970s, in which the goal of economic policy was to make best use of the available resources, in particular full employment.

In pursuit of this goal, monetary policy was subordinated to fiscal policy, with an ancillary role for the central bank vis-à-vis the Treasury.

The reference macro-model was based on a static mechanism of elaborating expectations, which were formed by extrapolating from past observations to the future.

This mechanism amplified the immediate effect of public spending on aggregate demand.

Monetary policy – in charge of credit conditions – was entrusted with the task of alleviating, through a careful policy of accommodation, the impact that government borrowing would have exerted on the cost of private debt.

The central bank was financing the Treasury by creating money.

Under these conditions, an increase in public spending could “add demand” – where this would be lacking for the goal of full employment – without taking away resources from other uses.

Since then, the theory of economic policy has followed two paths that have led it to invert the ranking of relative potential of tools and to enhance the definition and measurement of the objective.

As for the instruments, a different theory of the formation of expectations – no longer extrapolative – has highlighted the strong impact of monetary policy and has weakened the expected effects of fiscal policy.

In the models that we use today, agents, when formulating their expectations, are attentive to the sustainability conditions of the choices in the long term.

Economic policies deemed unsustainable in the long run are ineffective. For example, an active deficit-financed fiscal policy is limited by fears

P a g e | 48



about the government’s ability to refinance the debt from which that policy originates.

These fears may lead to behaviours that weaken the private sector – or, at worst, completely neutralise – the impact of public spending as a means of controlling demand.

Monetary policy, by contrast, is strengthened by this.

Acting through the expectations channel, it can have a lasting effect on the expected flows of financial revenue.

Affecting the real rate of intertemporal discount, it can deeply affect decisions on savings and consumption.

The definition of the objective is now wider.

Price stability has become an essential parameter in defining and measuring prosperity.

From taking a relaxed approach to inflation and considering it secondary, nowadays low and predictable inflation is a pre-eminent criterion of economic performance.

Why?

High inflation hits savings – and therefore investment and future consumption – with a tax on real returns that rewards the risk of uncertain inflation.

Low inflation, however, frees up resources that individual choices can allocate to increasing the fixed capital.

A policy that neglects inflation gradually destabilises the economy.

The costs of uncertainty about the value of the money, initially unimportant, then overlooked, subsequently become evident, and then are judged intolerable.

At that point, voters express a strong preference for policies that promise rapid disinflation.

P a g e | 49



But such policies impose high costs in terms of job losses, which have to be included in the dynamic calculation of the costs of inflation.

Also, it should not be forgotten that inflation affects the poor more than the rich, and is therefore a tax on the weaker members of society.

Under the influence of the neo-classical synthesis of Samuelson and Solow, the long-term correlation between inflation and growth was perceived as positive in the early 1970s: a slight increase in inflation would have led – within limits – to an increase in employment and growth.

But by the end of that decade, studies by Bob Lucas and Tom Sargent were to show that long-term inflation and growth are not correlated.

Monetary policy, while very effective in the short term, only affects inflation in the medium and long term. It is, in other words, neutral.

Today, new models and advanced computational techniques allow us to simulate the effects of inflation on incentives to save and to work, on the formation of physical capital, and therefore on the prospects for growth.

The correlation has become negative: higher inflation reduces growth and employment.

For example, vector autoregressive models with non-constant parameters allow the identification of a range of values that quantify the cost in terms of growth failure for every two percentage point increase in steady-state inflation.

This cost implies lower growth of between 3 and 5 percentage points over a period of ten years.

Finally, monetary policy is a powerful tool.

When used improperly, it may cause permanent damage.

But it can become an effective, stabilising factor and contribute to collective prosperity in an independent and active way.

P a g e | 50



The sine qua non for this is to build monetary policy decisions into a systematic and predictable strategy, based on price stability, which drives expectations and guides the economy but doesn’t shock it.

This is perhaps the most important practical difference to what was studied in the early 1970s.

The ECB’s monetary policy strategy

The ECB’s monetary policy strategy is based on the new theory of the instruments I have tried to outline, and takes into account the enrichment of the theory of objectives, which emphasises the contributions of price stability to the “general prosperity”.

It also provides continuity for a monetary tradition in continental Europe that has ensured inflation-free growth for more than 60 years.

The strategy is based on the objective of “maintaining price stability” that the Treaty has entrusted to the central bank and the quantitative definition that the Governing Council subsequently gave the objective.

The studies I have mentioned helped to define a range within which inflation is no longer a factor that distorts economic choices.

The ECB pursues, as an objective of monetary stability in the medium term, an inflation rate below, but close to, 2%, which is the upper limit of this range.

The macroeconomic model on which the ECB’s monetary policy strategy rests is imbued with contemporary macroeconomics, based on dynamic optimisation and on the centrality of forward-looking expectations.

At the same time, the model is broader and well structured and corrects the simplifications of the pre-crisis neo-Keynesian paradigm with its prescriptive approach to optimal monetary policy.

The weakness of this paradigm was, and is, its inability to recognise the importance of financial frictions and the role of credit and money.

P a g e | 51



This has to do with the fragility of the theoretical foundations that formalise the links between the real economy, financial imbalances and the level of confidence.

Ignoring money is tantamount to assuming an absence of risk and uncertainty.

Without risk, Keynes would have said, there would be no money.

The preference for liquidity is not justified in an economy without uncertainty.

But the neo-Keynesian model excludes the possibility of default.

In it, risks in the financial sector can be isolated and therefore have no effect on the real economy.

The financial crisis has clearly highlighted the weaknesses of this system.

Macroeconomic theory has begun to reflect on the neo-Keynesian system and these studies are now one of the liveliest areas of analysis.

These studies – at least their early results – confirm the farsightedness of some of strategic choices of the ECB.

Liquidity, money, credit have always been – since 1998, when the Bank received its mandate from the founders of the monetary union – qualifying variables of the ECB’s reference model and its strategy.

The monetary analysis requires a constant monitoring of banks’ assets and liabilities as sources of information on the assessment of risk in the markets and the economy as a whole.

This analysis commits the Governing Council to adjust the tenor of monetary policy to ensure the long-term growth of monetary aggregates and credit consistent with the potential for economic expansion.

In this sense, the monetary pillar of the strategy can be interpreted as a strategic reinforcement that helps to prepare correction mechanisms in situations where macroeconomic imbalances are having difficulty in manifesting themselves in inflationary pressures.

P a g e | 52



The monetary analysis gave important warning signals in the years preceding the crisis regarding the existence of deep macroeconomic and financial imbalances.

In the autumn of 2005, in conditions of inflation observed and projected to be “normal”, the ECB’s monetary analysis began to record a change in the composition of M3 growth: from a model of growth explained by money demand factors – that we would define as irrelevant to the evolution of spending and prices – to a dynamic associated with increased credit creation – that is, to banks’ money supply factors.

These changes were accepted as indications that the tenor of monetary policy, despite the moderation of inflationary pressures observed and projected, had become too lax.

A new cycle of monetary policy tightening was initiated in December of that year, based on considerations inspired by the monetary pillar, where monetary and financial stability is an intermediate objective for attaining a more balanced development of macroeconomic variables and hence price stability over the long term.

In a globalised world, the international financial crisis has not spared the euro area. But today we know that preventive action by the ECB, implemented mainly by considering monetary indicators, has mitigated the impact on incomes and inflation.

The two operations of three-year refinancing (LTROs)

The monetary analysis has also been an essential strategic tool in diagnosing and managing the crisis.

In this regard, the analysis that led to the more recent non-standard monetary policy measures can illustrate how the systematic monitoring of banks’ liabilities – money in its broadest sense – can provide guidance on the risks faced by the economy as a whole.

Towards the end of 2011, with a decision unprecedented in the history of the euro, the ECB’s Governing Council decided to conduct two three-year refinancing operations.

P a g e | 53



At the end of February, or when the second three-year operation was completed, the net increase in loans granted to counterparties was around €520 billion.

The motivation for the two operations can be summarised by the following strategic view.

A central bank is mandated with the crucial task of ensuring the sufficient supply of liquidity to sound bank counterparties in return for adequate collateral.

In normal times, “sufficient liquidity” means a volume of refinancing in line with the need for banks to meet the obligatory reserve requirements and the financing of other independent factors which explain the growth over time in the demand for money.

In times of increased financial instability, “sufficient liquidity” indicates a volume of available central bank money which avoids the risk that – under such market conditions – the temporary inability of banks to provide refinancing leads to insolvency and thus to a situation of widespread default.

In neither of the two cases – normal times or crisis periods – can the central bank be considered responsible for the survival of bank counterparties that are close to bankruptcy.

The two long-term refinancing operations achieved the purpose for which they were intended.

In an environment of a near-shutdown of private credit markets, banks were not able to refinance their assets and were unable to maintain their level of exposure to households and businesses.

The extensive long-term refinancing allowed for the partial and temporary substitution of private credit with central bank money and thus avoided a disorderly process of credit to the economy running dry.

Nevertheless, these operations were not without their criticism. These can be summarised in three points:

P a g e | 54



1. The growth in liquidity following the two operations will ultimately lead to inflation;

2. The Eurosystem’s balance sheet is exposed to unprecedented and uncontrollable risks;

3. Such operations have reinforced the perverse link between banks and sovereign debtors and may be considered a violation of the prohibition of financing public debt with central bank money, laid down in Article 123 of the Treaty.

And, the opposite – but conceptually equivalent – criticism that these operations did not provide the economy with finance.

As regards the first point, it is again pertinent to refer to strategy: in the medium to long term, the inflation dynamic reflects developments in broader monetary aggregates.

Conditions that encourage the creation of inflation or speculative bubbles are generated by strong and sustained growth in money and credit, not necessarily as a result of an increase in liquidity granted by the central bank to the banking sector.

This liquidity constitutes a precautionary supply for sight liabilities that the banks have towards households, non-financial corporations and other banks.

The sight liabilities, i.e. deposits, and not the supply of liquidity, demonstrate a high statistical correlation to the price dynamics of goods and assets.

Today, monetary developments do not allow for the identification of risks of inflation or pressure on asset prices in the medium term.

As regards the second point, the main criticism related principally to the expansion of collateral accepted by the national central banks of the Eurosystem as a guarantee in return for liquidity extended to credit institutions.

In particular, doubts were raised regarding credit claims that became eligible with the decisions taken in December 2011.

P a g e | 55



These doubts are founded on an incorrect understanding of the guarantees that are requested by the national central banks to protect against the risk that central bank liquidity is not repaid.

In particular, the discount applied to the nominal value of credit claims provided as security in refinancing operations is very high.

This means that, for credit claims deposited as collateral with a nominal value of €100, the national central banks accepting the new collateral provide, on average, the equivalent of around €47 in liquidity.

This discounting represents a powerful method for absorbing the credit risk involved in such operations.

It is also worth highlighting the fact that the main elements of risk control continue to be shared by the Eurosystem: the criteria for acceptance and measures for controlling risk are approved by the Governing Council, which is also responsible for the continuous monitoring of the effectiveness of all of the measures for mitigating risk.

With regard to the third point, it is undeniable that, in some countries in particular (especially Spain and Italy), banks used some of the liquidity acquired via the three-year long-term refinancing operations for temporary investments in government bonds.

Today, central banks do not have an instrument for the precise and targeted allocation of credit to a sector or in favour of a specific financial use.

Those who accuse the ECB of an indirect violation of the prohibition on financing public debt with central bank money are making the same conceptual mistake as those who accuse the ECB of not having forced the banks to the use the funds acquired via the LTROs to supply credit to the private sector.

In the first case, banks would have had to have been forced not to purchase government securities, and in the second case, to give credit to the private sector.

P a g e | 56



Both groups of accusers forget that the policy of precise allocation of credit was a norm in various countries until the end of the 1970s.

In the 1980s the operational system for monetary policy was radically redefined, principally on account of the heavily distorting effects of such an operational framework on economic activity.

Moreover, legal arguments relating to the Treaty and to the current contractual form of repos underlying the LTROs, as well as considerations relating to feasibility, would make it difficult to reinstate such a framework.

Finally, the behaviour of credit institutions with respect to households and businesses is not uniform across countries: while some countries saw negative credit developments, others saw growth in credit, in some cases even significant growth.

In Italy, but also in the vast majority of euro area countries, the fall in loans recorded in December has come to a halt, avoiding a much more severe risk of credit restriction which would have had far more serious consequences for growth and monetary stability than the ones we are seeing currently.

The Bank Lending Survey registered a gradual normalisation of interest rates set by banks and of the criteria for granting loans to companies.

The continued anaemic developments in lending reflect the weakness in demand and the worsening of creditworthiness resulting from an adverse economic cycle.

Furthermore, in the countries most adversely affected by the crisis, banks are rationing credit on account of certain prevalent contractual structures.

P a g e | 57



The large-scale participation in the February operation, in which around 800 banks obtained funding, and the composition of counterparties in terms of their size and type implies that the distribution of liquidity has been widespread and could be even more so in the near future.

Furthermore, this widespread distribution of liquidity is also of advantage to small and medium-sized enterprises with which smaller banks have closer relationships.

We would wish for the liquidity provided to end up as credit to the private sector. This is the motivation behind the new non-standard monetary policy instrument.

Central bank credit to banks has been a complement to – rather than a substitute for – private credit: in the first quarter of this year, the amount of bonds issued was equal to the total issued in 2011 as a whole, which shows that the operations, at least in the first few months of the year, provided the markets with liquidity, reactivating a number of credit channels.

The two LTROs removed one of the obstacles – the only one over which the ECB has any influence – to credit, namely a lack of liquidity.

The ECB cannot do anything to make up for a lack of capital, to change intermediaries’ risk perceptions, or to remove other structural obstacles present at national level.

More generally, the size and complexity of the two LTROs is such that it will take time for all of their positive effects on the euro area economy to be fully felt.

However, it is essential for growth and employment that credit institutions regain their ability to provide refinancing to the economy.

P a g e | 58



Gabriel Bernardino, Chairman of EIOPA

EIOPA, Solvency II and the Loss Adjusting Profession General Assembly of the European Federation of Loss Adjusting Experts

Ladies and Gentlemen, It is a privilege and pleasure to be here at the General Assembly of the European Federation of Loss Adjusting Experts. I would like to start with a thank you to the organizers and to the President of FUEDI Mr. Rui de Almeida for inviting me to participate in this event. In my presentation today, I will touch on three main issues: I. What is EIOPA, the European Insurance and Occupational Pensions Authority for whom I have the privilege to serve as chairman; II. How Solvency II can contribute to the improvement of risk management; III. The loss adjusting profession, its relevance for the insurance market and the overall society.

P a g e | 59



What is EIOPA? EIOPA is the European supervisory authority for the insurance and occupational pensions sectors. We are a young organisation: in January, we completed our first year as a European agency, one of the three European Supervisory Authorities in the financial system. We are an independent Union body with legal personality, accountable to the European Parliament and the Council. We clearly see our mission, tasks and responsibilities. We see EIOPA’s mission in protecting public interest by contributing to the short, medium and long term stability and effectiveness of the financial system, for the EU citizens and economy. This mission is pursued by promoting a sound regulatory framework and consistent supervisory practices in order to protect the rights of policyholders, pension scheme members and beneficiaries and contribute to the public confidence in the European Union’s insurance and occupational pensions sectors. This is a very important mission if we realize the relevance of insurance and occupational pensions in the daily life of citizens and on the development of the economy. The objectives of the new European supervisory authorities, and particularly of EIOPA, are extremely relevant: - Contribute to a stable and effective financial system;

- Promote sound regulation and supervision;

- Enhance customer protection;

P a g e | 60



- Ensure the transparent, efficient and orderly functioning of the markets;

- Contribute to international supervisory coordination;

- Avoid regulatory arbitrage;

- Ensure equal conditions of competition; and

- Implement appropriate regulation and supervision of risks.

In order to fulfil these objectives, EIOPA has important powers. We develop technical standards that become binding for all insurance undertakings in the EU and issue guidelines and recommendations that national supervisors apply on a “comply or explain” basis. We settle disagreements between national supervisory authorities in crossborder situations and have a coordinating role in crisis situations. EIOPA monitors the correct application of the EU law in the different Member States, by using, if necessary, its powers of investigation in local markets. EIOPA and national supervisors are independent from one another, but closely cooperate with one another. EIOPA does not substitute local authorities. It has its own powers and responsibilities, but day to day supervision remains a task of the national authorities. The key decision organ of EIOPA is the Board of Supervisors, where the heads of the national supervisory authorities are represented. However, it is very important to mention that the EIOPA Regulation provides that members of the Board of Supervisors must act with independence and within the sole interest of the European Union.

P a g e | 61



Most of our decisions are taken by simple majority, some by qualified majority. EIOPA wants to represent an added value to European consumers and to the European supervisory landscape. In order to fulfil its mandate, EIOPA is building up its own resources and exploiting the knowledge and experience of its Members. This is a very important element. We want to create a truly European supervisory culture. A culture based on best and robust practices. In order to create this culture, I want to bring together all the national supervisory authorities. All of them have an important contribution to make.

EIOPA’s regulatory tasks EIOPA has been working on Solvency II, advising the EU Commission on the Level 2 implementing measures. We have also been developing draft technical standards and guidelines on around 40 different areas of Solvency II. We are doing this in a transparent way by informally consulting with key stakeholders. We plan to publicly consult as soon as the legal framework will allow us to do that. In order to facilitate the preparatory work of insurance undertakings for Solvency II, we launched a number of important public consultations in

P a g e | 62



areas such as the Own Risk and Solvency Assessment (ORSA) and Supervisory Reporting and Public Disclosure, including the Solvency II XBRL Taxonomy. We continued to work on the Solvency II specifications for example by issuing a joint report on calibration of non life risk factors in the standard formula. EIOPA also provided input into the Commission’s revision of the Insurance Mediation Directive (IMD) by carrying out an extensive survey of national laws providing for sanctions (both criminal and administrative) for violations of the provisions of the IMD. The Commission’s legislative proposal (IMD2) is expected soon and I am aware that the Commission intends to capture loss adjusters under the scope of IMD2. Also, on the regulatory side, we delivered our advice to the Commission on the revision of the IORP Directive. Stability and consumer protection were at the core of our advice. We advocate the use of a consistent and realistic measurement of all assets and liabilities and proposed the adoption of a Key Information Document (KID), containing the fundamental elements about performance, costs, charges and risks of defined contribution schemes. I believe that this will help to increase the confidence of consumers in this type of plans.

Oversight At EIOPA, we are committed and motivated to contribute to the creation of a truly European supervisory culture: a culture that promotes stability, enhances transparency and fosters consumer protection. A culture based on intelligent and effective regulation which does not stifle innovation.

P a g e | 63



That is why in the area of oversight we took as a priority our participation in the colleges of supervisors, contributing to a more consistent practice. In the course of 2011, colleges of supervisors with at least one physical meeting or teleconference were organized for 69 European insurance groups. Last year, we set an annual action plan for colleges of supervisors and were monitoring its actual implementation. In February 2012, EIOPA issued the report on the functioning of colleges in 2011 and the Action Plan 2012 for colleges of supervisors. In the Action Plan, we defined clear timelines within the colleges for the setting up of an appropriate work plan to deal with the group internal model validation process.

Consumer protection and financial innovation Consumer protection and financial innovation are priority areas for EIOPA. We have prepared Guidelines and a Best Practices Report on Complaints Handling by Insurers. With these Guidelines, we intend to fill an existing regulatory gap at EU level and promote convergence of regulatory practice. They were the subject of a public consultation at the end of last year and are due to be finalised in the second quarter of 2012. At the end of last year, EIOPA published a Report on Financial Literacy and Education Initiatives by national competent authorities; it was a stock take of existing structures/processes in Member States. This was in line with a requirement under our empowering legislation to review and coordinate such initiatives.

P a g e | 64



We collected data on consumer trends amongst our Members authorities. This helped us to prepare an Initial Overview, analysing and reporting on those trends. This Overview was published this year in February. The Overview identified three key trends: (i) Consumer protection issues around Payment Protection Insurance (PPI) (ii) Development of unit linked life insurance and (iii) Increased use of comparison websites by consumers. This is just the start of our ongoing monitoring of consumer trends. And finally, we focused on disclosure and selling practices of Variable Annuities. This exercise was brought about by the fact that some variable annuities products may achieve outcomes that are not easy for consumers to understand. We consulted on a draft Report at the end of last year and its final version was published this year in April. Finally, last year, we organized our first EIOPA Consumer Strategy Day where we had the opportunity to discuss important consumer issues with different stakeholders.

Financial stability EIOPA was also active in the financial stability domain by assessing the resilience of the EU insurance sector to major shocks through the EU wide stress test exercise and by testing different scenarios on the low yield stress test which shows that the insurance industry would be negatively affected if a scenario were to materialize where yields remain low for a prolonged period of time.

P a g e | 65



EIOPA also issues, on a bi-annual basis, Financial Stability Reports. One of the conclusions we made in our December publication is that “due to significant natural catastrophes during the examined period, reinsurers suffered above average losses. Furthermore, life insurers may be subject to the risk of having insufficient liquidity, which can be emphasised by banking-related transactions, e.g. through “liquidity swaps” and similar products as well as due to increasing surrenders”. Furthermore, EIOPA is contributing to macro-prudential discussions and risk analysis in the context of the European Systemic Risk Board, supported by the establishment of the EIOPA Risk Dashboard.

International relations EIOPA is fully aware of the importance of international relations in a globalized world. In this area, we provided final advice to the European Commission on the assessment of the Solvency II equivalence of the Swiss, Bermudan and Japanese supervisory systems and we have started to contribute to the development of robust international standards by actively participating in the work of the International Association of Insurance Supervisors (IAIS). During 2011, EIOPA maintained its regulatory and supervisory dialogues with the US National Association of Insurance Commissioners (NAIC), the China Insurance Regulatory Commission, the Japanese Financial Services Authority and the Latin American Association of Insurance Supervisors. EIOPA also enhanced its regular exchanges with the US Federal Insurance Office (FIO) in the context of FIO’s responsibilities for insurance law harmonisation at US federal level and in the area of international relations.

P a g e | 66



EIOPA’s values I would like to say a couple of words about EIOPA’s values. In our daily activities and relations with our members and stakeholders, we are governed by the principles of Independence, Responsibility, Integrity, Transparency, Efficiency and Team Spirit. We aim to be a modern, competent and professional organization that is aware of the expectations of European citizens and wants to ensure that they all are taken on board in our strategies and actions. Our goal is to act independently in an effective and efficient way towards the creation of a common European supervisory culture – and this should not be just empty words. We consider it our shared responsibility to build a sound framework for the future of insurance activities; a framework that takes into account the specificities of their business models. I would like to assure you that we are ambitious in fulfilling our obligations towards EU citizens and businesses and I am confident that together we will succeed.

Solvency II As you know, Solvency II is the new regulatory regime for the EU insurance industry and will be implemented on 1 January 2014. Solvency II will bring a better alignment between risk and capital, promoting good risk management practices and fostering transparency. Regulatory regimes are always a result of a balancing act between different objectives. Solvency II will provide an appropriate basis for increased policyholder protection and will contribute to reinforce financial stability, allowing

P a g e | 67



insurance companies to continue to play their natural countercyclical role in times of stressed markets. Gladly, the Solvency II regime is increasingly being perceived as more than a “check the box” regulatory exercise that determines capital requirements. It requires the European insurance industry to critically analyze its risks, and in the process, assess the true costs attached to them. Today, I would like to talk to you particularly about risk management, which I think is of particular relevance for your profession. Now, more than ever, insurers need to rely on strong risk management capabilities in order to deal with the different challenges posed by the economic slowdown, the financial market volatility, the stress on sovereign debt, the demographic changes and the evolving pattern of natural catastrophes. During the last decade, not only risk management itself but also its practical application underwent a major transformation. Improvements in modelling methodology, significant development of new internal control instruments, increasing investors’ and analysts’ pressure as well as a new generation of risk managers with a more holistic view arriving in the company’s also triggered change. Companies which invested, early and continuously, in establishing an effective and well integrated risk management are now taking the benefits from that strategic decision. It should not come as a surprise that insurance and reinsurance undertakings are at the forefront of applying sound and robust practices of risk management. After all, insurance is in itself a risk management tool and thus the industry possess a wide range of specific know-how and experience in this area.

P a g e | 68



Nevertheless, from an historical perspective, risk management has not been viewed as a relevant element of the insurance regulatory regime. This has changed with Solvency II. I believe that appropriate risk management is a cornerstone of any modern risk-based regulatory regime and consequently has its own role in the supervisory process. Solvency II is mostly known for its risk-based capital requirement calculation. However, it is essential to recognize that one of the most important elements in this regime is the heavy reliance on robust risk management practices. Under the Solvency II regime, insurance and reinsurance undertakings must have in place an effective risk management system comprising strategies, processes and reporting procedures necessary to identify, measure, monitor, manage and report, on a continuous basis the risks, at an individual and at an aggregated level, to which they are or could be exposed, and their interdependencies. Importantly, risk management cannot be seen as a point in time procedure. It is a continuous process that should be used in the implementation of the undertaking’s overall strategy and should allow an appropriate understanding of the nature and significance of the risks to which it is exposed, including its sensitivity to those risks and its ability to mitigate them. Taking into consideration some lessons learned from the financial crisis, Solvency II identifies a number of elements which are particularly relevant for a robust implementation of a risk management system: • First of all, it is paramount to recognize the ultimate responsibility of the

P a g e | 69



management body in ensuring that the implemented risk management system is suitable, effective and proportionate to the nature, scale and complexity of the risks inherent in the business. • Secondly, the risk management system needs to be documented and communicated to the relevant management and staff, to ensure it is embedded within the business. • Thirdly, an effective risk management system should cover all material risks the undertaking might be exposed to. • Finally, and significantly, the risk management system must be integrated into the organizational structure of the undertaking and its decision-making processes. From a supervisory perspective, the insurance undertaking’s risk management system must be comprehensive, covering at least areas like underwriting and reserving, asset–liability management, investment, liquidity and concentrations, operational risk and reinsurance and other risk mitigation techniques. In each of these areas, supervisors have been transparent in their expectations towards undertakings. Let me touch particularly on the area of underwriting and reserving. Underwriting risk is at the centre of the insurance business. The risk of loss or of adverse change in the value of insurance liabilities, due to inadequate pricing and reserving assumptions is clearly related to the quality of the information available and its management. Consequently, supervisors expect that suitable processes and procedures will be in place to ensure the reliability, sufficiency and adequacy of both the statistical and accounting data to be considered both in the underwriting and reserving processes.

P a g e | 70



As part of the system of governance, insurance undertakings should be required to employ personnel with the skills, knowledge and expertise necessary to discharge the responsibilities allocated to them properly. Furthermore, insurance undertakings should ensure that effective systems are in place to prevent conflicts of interest and that potential sources of conflicts of interest are identified and procedures are established in order to ensure that those involved with the implementation of the undertaking’s strategies and policies understand where conflicts of interest could arise and how such conflicts are to be addressed. Furthermore, the undertaking should ensure that all policies and procedures established for underwriting are applied by all distribution channels of the undertaking insofar as they are relevant for them and that they have in place adequate claims management procedures which should cover the overall cycle of claims: receipt, assessment, processing and settlement, complaints and dispute settlement and reinsurance recoverables. I believe that the practical implementation of these requirements is of fundamental relevance for the loss adjusting profession.

The Loss Adjusting profession The profession of loss adjuster is crucial for the insurance business and for the society. The services provided by loss adjusters to insurers and other customers should be based on professionalism, independence and impartial and accurate assessment of claims. These are indeed the key words of your federation. Your role is particularly sensitive in the relationship between insurers and their clients and claimants.

P a g e | 71



You have a particularly relevant role when dealing with major catastrophes. I am aware that, during the years of its existence, FUEDI made a lot of efforts in maintaining high standards of professional conduct and competence, high educational standards as well as unified standards of customer services. I believe that these efforts represent a priceless contribution to the fully integrated and reliable insurance market of the European Union and to the overall reinforcement of consumer protection. I am sure that, in the near future, the loss adjusting profession will be further recognized at the EU level. In my opinion, it is fundamental to assure that all loss adjusters working in the EU follow strict rules of professional conduct including maintaining qualities of integrity and impartiality and are bound by sound loss adjusting practices. It is also my belief that proper self-regulation is an important tool in this area, but nevertheless, some basic principles should be incorporated in the EU regulatory framework. I am looking forward to work in close cooperation with your profession and with the insurance industry to ensure increased confidence for policyholders and beneficiaries in the insurance sector. Thank you.

P a g e | 72



Very Interesting – Risk Management opportunities in the public sector Information implicit rather than explicitly expressed

Can automated deep natural-language analysis unlock the power of inference? Program to assist war fighters with planning and decision-making by inferring implicit information in text, filtering redundancy and connecting like documents.

P a g e | 73



Much of the operationally-relevant information relied on in support of DoD missions may be implicit rather than explicitly expressed, and in many cases, information is deliberately obfuscated and important activities and objects are only indirectly referenced. Automated, deep natural-language understanding technology may hold a solution for more efficiently processing text information. When processed at its most basic level without ingrained cultural filters, language offers the key to understanding connections in text that might not be readily apparent to humans. DARPA created the Deep Exploration and Filtering of Text (DEFT) program to harness the power of language. Sophisticated artificial intelligence of this nature has the potential to enable defense analysts to efficiently investigate orders of magnitude more documents so they can discover implicitly expressed, actionable information contained within them. The development of an automated solution may rely on contributions from the linguistics and computer science fields in the areas of artificial intelligence, computational linguistics, machine learning, natural - language understanding, discourse and dialogue analysis, and others. “Overwhelmed by deadlines and the sheer volume of available foreign intelligence, analysts may miss crucial links, especially when meaning is deliberately concealed or otherwise obfuscated,” said Bonnie Dorr, DARPA program manager for DEFT. “DEFT is attempting to create technology to make reliable inferences based on basic text. We want the ability to mitigate ambiguity in text by stripping away filters that can cloud meaning and by rejecting false information. To be successful, the technology needs to look beyond what is explicitly expressed in text to infer what is actually meant.”

P a g e | 74



DEFT will build on existing DARPA programs and ongoing academic research into deep language understanding and artificial intelligence to address remaining capability gaps related to inference, causal relationships and anomaly detection. “Much of the basic research needed for DEFT has been accomplished, but now has to be scaled, applied and integrated through the development of new technology,” Dorr said. As information is processed, DEFT also aims to integrate individual facts into large domain models for assessment, planning and prediction. If successful, DEFT will allow analysts to move from limited, linear processing of insurmountable quantities of data to a nuanced, strategic exploration of available information.

Notes - Deep Exploration and Filtering of Text (DEFT) Department of Defense (DoD) operators and analysts collect and process copious amounts of data from a wide range of sources to create and assess plans and execute missions. However, depending on context, much of the information that could support DoD missions may be implicit rather than explicitly expressed. Having the capability to automatically extract operationally relevant information that is only referenced indirectly would greatly assist analysts in efficiently processing data. Automated, deep natural-language processing (NLP) technology may hold a solution for more efficiently processing text information and enabling understanding connections in text that might not be readily apparent to humans. DARPA created the Deep Exploration and Filtering of Text (DEFT) program to harness the power of NLP.

P a g e | 75



Sophisticated artificial intelligence of this nature has the potential to enable defense analysts to efficiently investigate orders of magnitude more documents so they can discover implicitly expressed, actionable information contained within them. By building on the NLP technologies developed in other DARPA programs and ongoing academic research into deep language understanding and artificial intelligence, DEFT aims to address remaining capability gaps related to inference, causal relationships and anomaly detection. Improving human language technology to incorporate these capabilities is essential for enabling automated exposure of important content to facilitate analysis. As a further aid to analysis, DEFT also aims to enable the capability to integrate individual facts into large domain models as information is processed to support assessment, planning, prediction and the initial stages of report writing. If successful, DEFT will allow analysts to move from limited, linear processing of huge sets of data to a nuanced, strategic exploration of available information. The development of an automated solution may involve contributions from the linguistics and computer science fields in the areas of artificial intelligence, computational linguistics, machine learning, natural - language understanding, discourse and dialogue analysis, and others.

P a g e | 76



Testimony Before the US Senate Committee on Banking, Housing and Urban Affairs, Washington, DC CFTC Chairman Gary Gensler May 22, 2012

Good morning Chairman Johnson, Ranking Member Shelby and members of the Committee. I thank you for inviting me to today’s hearing on implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), international harmonization of swaps market reforms, and the Commodity Futures Trading Commission’s (CFTC) role in overseeing markets for credit derivative products, such as those traded by JPMorgan Chase’s Chief Investment Office. I also thank my fellow Commissioners and CFTC staff for their hard work and commitment on implementing the legislation. I’m pleased to testify along with Securities and Exchange Commission (SEC) Chairman Schapiro. Swaps, now comprising a $700 trillion notional global market, were developed to help manage and lower risk for commercial companies. But they also concentrated and heightened risk in international financial institutions.

P a g e | 77



And when financial entities fail, as they have and surely will again, swaps can contribute to quickly spreading risk across borders. As the financial system failed in 2008, most of us learned that the insurance giant AIG had a subsidiary, AIG Financial Products, originally organized in the United States, but run out of London. The fast collapse of AIG, a mainstay of Wall Street, was again sobering evidence of the markets’ international interconnectedness. Sobering evidence, as well, of how transactions booked in London or anywhere around the globe can wreak havoc on the American public. Recently, we’ve had another stark reminder of how trades overseas can quickly reverberate with losses coming back into the United States. According to press reports, the largest U.S. bank, JPMorgan Chase, just suffered a multi-billion dollar trading loss from transactions in London. The press also is reporting that this trading involved credit default swaps and indices on credit default swaps. It appears that the bank here in the United States is absorbing these losses. And as a U.S. bank, it is an entity with direct access to the Federal Reserve’s discount window and federal deposit insurance. I am authorized by the Commission to confirm that the CFTC’s Division of Enforcement has opened an investigation related to credit derivative products traded by JPMorgan Chase’s Chief Investment Office. Although I am unable to provide any specific information about a pending investigation, I will describe generally the Commission’s oversight of the swaps markets, the entities and products in our jurisdiction, and the Dodd-Frank reforms relevant to credit default swaps, and in particular index credit default swaps.

P a g e | 78



The role the unregulated swaps market played in the 2008 crisis led to a new international consensus that the time had come for comprehensive regulation. Swaps, which were basically not regulated in Asia, Europe and the United States, should now be brought into the light of regulation. When President Obama gathered together the G-20 leaders in Pittsburgh in 2009, they agreed that the swaps market needed to be reformed and that such reform should be completed by December 2012. In 2010, Congress and the President came together and passed the historic Dodd-Frank Act. The goal of the law is to: - Bring public market transparency and the benefits of competition to

the swaps marketplace;

- Protect against Wall Street’s risks by bringing standardized swaps into centralized clearing; and

- Ensure that swap dealers and major swap participants are specifically

regulated for their swap activity.

Despite different cultures, political systems and financial systems, we’ve made significant progress on a coordinated and harmonized international approach to reform.

Japan passed reform legislation in 2010, and has made real progress on their clearing mandate.

Further, they have a proposal before their Diet on the use of trading platforms, as well as post-trade transparency.

The European parliament last month adopted the European Market Infrastructure Regulation (EMIR) that includes mandatory clearing, reporting and risk mitigation for derivatives.

P a g e | 79



And the European Commission has published proposals providing for both pre-trade and post-trade transparency.

Other major jurisdictions, including the largest provinces in Canada, have the legislative authority and have made progress on swaps reform.

Implementation of Dodd-Frank Swaps Market Reforms

The CFTC has made significant progress in completing the reforms that will bring transparency to the swaps market and lower its risk to the rest of the economy.

During the rule-writing process, we have benefitted from significant public input.

CFTC Commissioners and staff have met over 1,600 times with the public and we have held 16 public roundtables on important issues related to Dodd-Frank reform.

We are consulting closely with other regulators on Dodd-Frank implementation, including the SEC, the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and other prudential regulators.

This coordination includes sharing many of our memos, term sheets and draft work product.

In addition, we are actively consulting with international regulators to harmonize our approach to swaps oversight, and share memos, term sheets and draft work product with our international counterparts as well.

We substantially finished our proposal phase last spring, and then largely reopened the mosaic of rules for additional public comments.

We have accepted further public comment after the formal comment periods closed.

P a g e | 80



The agency received 3,000 comment letters before we proposed rules and more than 28,000 comment letters in response to proposals.

Last summer, we turned the corner and started finalizing rules. To date, we’ve completed 33 rules with less than 20 more to go.

The Commission is turning shortly to the rule to further define the terms “swap” and “security-based swap,” the second of the two key joint further definition rules with the SEC.

The staff recently has put forth to the Commission a final rule for our consideration.

It is essential that the two Commissions move forward on the further product definition rulemaking expeditiously.

Consistent with the provisions of the Dodd-Frank Act, the proposal states the CFTC regulates credit default swaps on broad-based security indices, while the SEC regulates them on narrow-based security indices (as well as credit default swaps on single name securities or loans).

Under the proposal, most of the credit default swap indices compiled by the leading index provider, Markit, generally would be broad-based indices.

These indices would generally include, but not be limited to, Markit’s CDX North American Investment Grade, as well as its CDX North American High Yield.

While the credit default swaps based on these indices would be swaps under CFTC jurisdiction, the SEC would retain certain anti-fraud and anti-manipulation enforcement authorities over them as well, as it had prior to Dodd-Frank.

P a g e | 81



Transparency

The Dodd-Frank financial reform shines bright lights of transparency – to the public and to regulators – on the swaps market for the benefit of investors, consumers, retirees and businesses in America.

Transparency is critical to both lowering the risk of the financial system, as well as reducing costs to end-users.

The more transparent a marketplace is to the public, the more efficient it is, the more liquid it is, and the more competitive it is.

The CFTC has completed key rules on transparency that, for the first time, provide a detailed and up-to-date view of the physical commodity swaps markets so regulators can police for fraud, manipulation and other abuses.

We have begun to receive position information for large traders in the swaps markets for agricultural, energy and metal products.

We also finished a rule establishing registration and regulatory requirements for swap data repositories, which will gather data on all swaps transactions.

Starting this summer, real-time reporting to the public and to regulators will begin for interest rate and credit default swaps with similar reporting on other swaps later this year.

Also later this year, market participants will benefit from the transparency of daily valuations over the life of their swaps.

By contrast, in the fall of 2008, there was no required reporting about swaps trading.

This month, we completed rules, guidance and acceptable practices for designated contract markets (DCMs).

P a g e | 82



DCMs will be able to list and trade swaps, helping to bring the benefit of pre-trade transparency to the swaps marketplace.

Looking forward, we have two important remaining transparency rules to complete related to block sizes and swap execution facilities (SEFs).

The trading of credit default swap indices will benefit from the transparency provided on SEFs.

The Japanese and European transparency proposals, as well as initiatives well underway in other jurisdictions, will further align international reform efforts and benefit the public.

Central Clearing

For over a century, through good times and bad, central clearing in the futures market has lowered risk to the broader public.

Dodd-Frank financial reform brings this effective model to the swaps market.

Standard swaps between financial firms will move into central clearing, which will significantly lower the risks of the highly interconnected financial system.

The CFTC has made significant progress on central clearing for the swaps market.

We have completed rules establishing new derivatives clearing organization risk management requirements.

To further facilitate broad market access, we completed rules on client clearing documentation, risk management, and so-called “straight-through processing,” or sending transactions immediately to the clearinghouse upon execution.

P a g e | 83



In addition, the Commission has adopted important customer protection enhancements.

The completed amendments to rule 1.25 regarding the investment of funds bring customers back to protections they had prior to exemptions the Commission granted between 2000 and 2005.

Importantly, this prevents use of customer funds for in-house lending through repurchase agreements.

Clearinghouses also will have to collect margin on a gross basis and futures commission merchants will no longer be able to offset one customer’s collateral against another and then send only the net to the clearinghouse.

And the so-called “LSOC rule” (legal segregation with operational comingling) for swaps ensures customer money is protected individually all the way to the clearinghouse.

Furthermore, Commissioners and staff have gotten a lot of feedback from market participants on additional customer protection enhancements, including through a public roundtable.

Staff is actively seeking further public input through our website and further meetings. Staff will use this outreach and review to put forward recommendations to the Commission for consideration.

In addition, the National Futures Association and the CME Group have proposals for greater controls for segregation of customer funds.

CFTC staff is working with these self-regulatory organizations on their proposals.

CFTC staff now is preparing recommendations for the Commission and for public comment on clearing requirement determinations.

P a g e | 84



The Commission’s first determinations will be put out for public comment this summer and hopefully completed this fall.

They will begin with key interest rate products, as well as a number of CDX and iTraxx credit default swap indices.

There is a great deal of consistency among the major jurisdictions on the clearing requirement, and the CFTC’s timeframe broadly aligns with both Japan and Europe.

Currently, clearing exists for much of the standardized interest rate swaps, as well as for credit default swap indices, done between dealers.

The major clearinghouses providing swaps clearing are registered with the CFTC.

Moving forward, the Commission will consider a final rule on the implementation phasing of the clearing requirement and the end-user exception related to non-financial companies.

Swap Dealers

Regulating banks and other firms that deal in derivatives is central to financial reform.

Prior to 2008, it was claimed that swap dealers did not need to be specifically regulated for their swaps activity, as they or their affiliates already were generally regulated as banks, investment banks, or insurance companies.

The crisis revealed the inadequacy of relying on this claim.

While banks were regulated for safety and soundness, including their lending activities, there was no comprehensive regulation of their swap dealing activity.

P a g e | 85



Similarly, bank affiliates dealing in swaps, and subsidiaries of insurance and investment bank holding companies dealing in swaps, were not subject to specific regulation of their swap dealing activities.

AIG, Lehman Brothers and other failures of 2008 demonstrate what happens with such limited oversight.

The CFTC is well on the way to implementing reforms Congress mandated in Dodd-Frank to regulate dealers and help prevent another AIG.

The Commission has finished sales practice rules requiring swap dealers to interact fairly with customers, provide balanced communications and disclose conflicts of interest before entering into a swap.

In addition, this agency has finalized internal business conduct rules to require swap dealers to establish policies to manage risk, as well as put in place firewalls between a dealer’s trading, and clearing and research operations.

We completed in April a joint rule with the SEC further defining the terms “swap dealer” and “securities-based swap dealer,” which is pivotal to lowering the risk they may pose to the rest of the economy.

Based on completed registration rules, dealers will register after we finalize the second major definition rule with the SEC: the further definition of the terms “swap” and “securities-based swap.”

Swap dealers who make markets in credit default swap indices would be amongst those dealers who may have to register with the CFTC.

Following Congress’ mandate, the CFTC also is working with our fellow financial regulators to complete the Volcker rule, which prohibits certain banking entities from engaging in proprietary trading.

P a g e | 86



In adopting the Volcker rule, Congress prohibited banking entities from proprietary trading, an activity that may put taxpayers at risk.

At the same time, Congress permitted banking entities to engage in certain activities, such as market making and risk mitigating hedging.

One of the challenges in finalizing a rule is achieving these multiple objectives.

The international community is closely coordinating on margin requirements for uncleared swaps, and is on track to seek public comment in June on a consistent approach.

This is critical to reducing the opportunity for regulatory arbitrage.

The CFTC’s proposed margin rule excludes non-financial end-users from margin requirements for uncleared swaps.

I’ve been advocating with global regulators that we all adopt a consistent approach.

The Commission is working with fellow regulators here and abroad on an appropriate and balanced approach to the cross-border application of Dodd-Frank swaps market reforms.

The CFTC will soon seek public comment on guidance regarding the cross-border application of Title VII rules.

Market Integrity/Position Limits

Financial reform also means investors, consumers, retirees and businesses in America will benefit from enhanced market integrity.

Congress provided the Commission with new tools in Dodd-Frank to ensure the public has confidence in U.S. swaps markets.

P a g e | 87



Rules the CFTC completed last summer close a significant gap in the agency’s enforcement authorities.

The rules implement important Dodd-Frank provisions extending our enforcement authority to swaps and prohibited the reckless use of manipulative or deceptive schemes.

Thus, for example, the CFTC has clear anti-fraud and anti - manipulation authority regarding the trading of credit default swaps indices.

Also, the CFTC now can reward whistleblowers for their help in catching market misconduct.

Congress also directed the CFTC to establish aggregate position limits for both futures and swaps in energy and other physical commodities.

In October 2011, the Commission completed final rules to ensure no single speculator is able to obtain an overly concentrated aggregate position in the futures and swaps markets.

The Commission’s final rules require compliance for all spot-month limits 60 days after the CFTC and SEC jointly adopt the rule to further define the term “swap” and “securities-based swap” and for certain other limits, following a collection of a year’s worth of large trader swap data.

Two associations representing the financial industry, however, are challenging the agency’s final rule establishing those limits in court.

The Commission is vigorously defending the Congressional mandate to implement position limits in court.

Last week, the Commission approved a proposed rule that would modify the CFTC’s aggregation provisions for limits on speculative positions.

P a g e | 88



The proposal would permit any person with a 10 to 50 percent ownership or equity interest in an entity to disaggregate the owned entity’s positions, provided there are protections and firewalls in place to ensure trading decisions are made independently of one another.

The proposal was a response to a Working Group of Commercial Energy Firms (WGCEF) petition seeking relief from the aggregation provisions of the position limits rule.

Position limits is another area where there has been close international coordination.

The G-20 leaders endorsed an International Organization of Securities Commissions (IOSCO) report last November noting that market regulators should use position management regimes, including position limits, to prevent market abuses.

The European Commission has proposed such a position management regime to the European Parliament.

Cross-border Application of Dodd-Frank’s Swaps Reforms

The Dodd-Frank Act states in Section 722(d) that swaps reforms shall apply to activities outside the United States if those activities have “a direct and significant connection with activities in, or effect on, commerce” of the United States.

CFTC staff will soon be recommending to the Commission to publish for public comment a release on the cross-border application of swaps market reforms.

It will consist of interpretive guidance on how these reforms apply to cross-border swap activities.

It also will include an overview as to when overseas swaps market participants, including swap dealers, can comply with Dodd-Frank

P a g e | 89



reforms through reliance on comparable and comprehensive foreign regulatory regimes, or what we call “substituted compliance.”

There is further work to be done on the CFTC cross-border release, but the key elements of the staff recommendations are likely to include:

- First, when a foreign entity transacts in more than a de minimis level of U.S. facing swap dealing activity, the entity would register under the CFTC’s recently completed swap dealer registration rules.

- Second, the release will address what it means to be a U.S. facing transaction.

I believe this must include transactions not only with persons or entities operating in the United States, but also with their overseas branches.

In the midst of a default or a crisis, there is no satisfactory way to really separate the risk of a bank and its branches.

Likewise, I believe this must include transactions with overseas affiliates that are guaranteed by a U.S. entity, as well as the overseas affiliates operating as conduits for a U.S. entity’s swap activity.

- Third, based on input the Commission has received from market participants, the staff recommendations will include a tiered approach for requirements for overseas swap dealers. Some requirements would be considered entity-level, such as for capital, risk management and recordkeeping. Some requirements would be considered transaction-level, such as clearing, margin, real-time public reporting, trade execution and sales practices.

- Fourth, such entity-level requirements would apply to all registered swap dealers, but in certain circumstances, overseas swap dealers could comply with these requirements through substituted compliance.

P a g e | 90



- Fifth, such transaction-level requirements would apply to all U.S.

facing transactions, but for certain transactions between an overseas swap dealer (including a foreign swap dealer that is an affiliate of a U.S. person) and counterparties not guaranteed by or operating as conduits for U.S. entities, Dodd-Frank may not apply.

For example, this would be the case for a transaction between a foreign swap dealer and a foreign insurance company not guaranteed by a U.S. person.

In putting together this release, we've already benefitted from significant input from market participants. Throughout our nearly 60 rule proposals, we’ve consistently asked for input on the cross-border application of swaps reforms. Commenters generally say they support reform. But in what some of them call a “clarification,” we find familiar narratives of the past as to why many swaps transactions or swap dealers should not be regulated. Some commenters have expressed the view that if a transaction is done offshore, it should not come under Dodd-Frank. Others contend that as long as an offshore dealer is regulated in some capacity elsewhere, many of the Dodd-Frank regulations applicable to swap dealers should not apply. The law, the nature of modern finance, and the experiences leading up to the 2008 crisis, as well as the reminder of the last two weeks, strongly suggest this would be a retreat from much-needed reform. When Congress and the Administration came together to draft the Dodd-Frank Act, they recognized the lessons of the past when they expressly set up a comprehensive regulatory approach specific to swap dealers.

P a g e | 91



They were well aware of the nature of modern finance: financial institutions commonly set up hundreds if not thousands of “legal entities” around the globe with a multitude of affiliate relationships. When one affiliate of a large, international financial group has problems, it’s accepted in the markets that this will infect the rest of the group. This happened with AIG, Lehman Brothers, Citigroup, Bear Stearns and Long-Term Capital Management.

Implementation Phasing

As we move on from the rule-writing process, a critical part of our agenda is working with market participants on phased implementation of these reforms. We have reached out broadly on this topic to get public input. Last spring, we published a concepts document as a guide for commenters, held a two-day, public roundtable with the SEC, and received nearly 300 comments. Last year, the Commission proposed two rules on implementation phasing relating to the swap clearing and trading mandates and the swap trading documentation and margin requirements for uncleared swaps. We have received very constructive public feedback and hope to finalize the proposed compliance schedules in the next few months. In addition to these proposals, the Commission has included phased compliance schedules in many of our rules. For example, both the data and real-time reporting rules, which were finalized this past December, include phased compliance. The first required reporting will be this summer for interest rate and currency swaps. Other commodities have until later this fall.

P a g e | 92



Additional time delays for reporting were permitted depending upon asset class, contract participant and in the early phases of implementation. The CFTC will continue looking at appropriate timing for compliance, which balances the desire to protect the public while providing adequate time for industry to comply with reforms.

Resources Confidence in the futures and swaps markets is dependent upon a well-funded regulator. The CFTC is a good investment of taxpayer dollars. This hardworking staff of 710 is just 10 percent more than what we had in the 1990s though the futures market has grown fivefold. The CFTC also will soon be responsible for the swaps market – eight times bigger than the futures market. Picture the NFL expanding eightfold to play more than 100 football games in a weekend, leaving just one referee per game, and, in some cases, no referee. Imagine the mayhem on the field, the resulting injuries to players, and the loss of confidence fans would have in the integrity of the game. Market participants depend on the credibility and transparency of well-regulated U.S. futures and swaps markets. Without sufficient funding for the CFTC, the nation cannot be assured that the agency can adequately oversee these markets.

P a g e | 93



Conclusion

Nearly four years after the financial crisis and two years since the passage of Dodd-Frank, it’s critical that we fully implement the historic reforms of the law. It’s critical that we do not retreat from reforms that will bring greater transparency and competition to the swaps market, lower costs for companies and their customers, and protect the public from the risks of these international markets. In 2008, the financial system and the financial regulatory system failed. The crisis plunged the United States into the worst recession since the Great Depression with eight million Americans losing their jobs, millions of families losing their homes and thousands of small businesses closing their doors. The financial storms continue to reverberate with the debt crisis in Europe affecting the economic prospects of people around the globe. The CFTC has made significant progress implementing reform having largely finished the rule proposals, and now having completed well over half of the final rules. We are on schedule to complete the remaining reforms this year, but until we do, the public is not fully protected. Last Updated: May 22, 2012

Note

Gary Gensler was sworn in as the Chairman of the Commodity Futures Trading Commission on May 26, 2009. Chairman Gensler previously served at the U.S. Department of the Treasury as Under Secretary of Domestic Finance (1999-2001) and as Assistant Secretary of Financial Markets (1997-1999).

P a g e | 94



He subsequently served as a Senior Advisor to the Chairman of the U.S. Senate Banking Committee, Senator Paul Sarbanes, on the Sarbanes - Oxley Act, reforming corporate responsibility, accounting and securities laws. As Under Secretary of the Treasury, Chairman Gensler was the principal advisor to Treasury Secretary Robert Rubin and later to Secretary Lawrence Summers on all aspects of domestic finance. The office was responsible for formulating policy and legislation in the areas of U.S. financial markets, public debt management, the banking system, financial services, fiscal affairs, federal lending, Government Sponsored Enterprises, and community development. In recognition of this service, he was awarded Treasury’s highest honor, the Alexander Hamilton Award. Prior to joining Treasury, Chairman Gensler worked for 18 years at Goldman Sachs, where he was selected as a partner; in his last role he was Co-head of Finance. Chairman Gensler is the co-author of a book, The Great Mutual Fund Trap, which presents common sense investment advice for middle income Americans. He is a summa cum laude graduate from the University of Pennsylvania’s Wharton School in 1978, with a Bachelor of Science in Economics and received a Master of Business Administration from the Wharton School’s graduate division in 1979. He lives with his three daughters outside of Baltimore, Maryland.

P a g e | 95



Thomas Jordan: Challenges facing the Swiss National Bank Speech by Mr Thomas Jordan, Chairman of the Governing Board of the Swiss National Bank, to the General Meeting of Shareholders of the Swiss National Bank, 27 April 2012. Mr President of the Bank Council Dear Shareholders Dear Guests Also from a monetary policy perspective, the Swiss National Bank (SNB) has experienced another difficult year. In 2011, the escalation of the European sovereign debt crisis triggered a very substantial appreciation of the Swiss franc. In order to avert major damage to the Swiss economy, and work against the threat of a deflationary trend, the SNB had to react fast with exceptional measures. I would like to begin by giving you a review of economic developments and monetary policy in 2011. Then I will present our assessment of the international economic outlook and its impact on the Swiss economy.

P a g e | 96



I will also outline the outlook for price stability. I will conclude by explaining the SNB’s reflections on current monetary policy. First, let me begin by reviewing the events of last year.

Review of 2011

In terms of the economic cycle, the year 2011 certainly began well. Overall, economic activity was lively, and the situation on the labour market improved further. Despite the appreciation of the Swiss franc in 2010, goods exports were robust during the first few months of the year. However, in spring 2011, the international economic recovery stalled. This was attributable to several different factors. In major advanced economies, stimuli from fiscal policies diminished. Moreover, in the second quarter in particular, international economic growth suffered from the effects of the Japanese earthquake and tsunami. The destruction of production plants for important intermediate goods for the electronics industry led to substantial supply problems worldwide, which resulted in production losses. Finally, the concerns about fiscal problems in many advanced economies increased. In particular, the risk that the European sovereign debt crisis might escalate hung like a sword of Damocles over the outlook for the entire international economy. The debt crisis did indeed escalate in the second half of the year.

P a g e | 97



While, initially, it was only the small peripheral states of the euro area that encountered problems because of their high levels of debt, the loss of confidence increasingly affected the larger economies of Europe as well. At the same time, there was growing concern about the stability of European banks. Given these developments, uncertainty in financial markets increased sharply in the second half of the year. At the same time, the demand for safe-haven investments soared. As we all know, these investments include those in the Swiss franc. The Swiss currency had already gained in value in the second quarter. However, between July and the beginning of August, it appreciated very substantially within a very short period. In August 2011, the Swiss franc reached an all-time high against both the euro and the US dollar, in both nominal and real terms. Ladies and Gentlemen, in August 2011, the Swiss franc was massively overvalued, according to any yardstick. In addition, in practically the same period, the international economic environment had become noticeably gloomier. This situation presented an acute risk to our economy, as well as carrying the threat of a deflationary trend. Consequently, the SNB reacted fast and announced an unscheduled interest rate reduction on 3 August. In addition, from this moment onwards, it increased the supply of Swiss franc liquidity by a hitherto unprecedented amount, in several steps, with the aim of weakening the Swiss currency. Overall, the liquidity measures achieved the expected results.

P a g e | 98



They brought about significantly lower interest rates in the Swiss franc money market – interest rates that were, at times, even negative. This tended to weaken the attractiveness of Swiss franc investments. Thus the upward trend of the Swiss franc against the euro was checked for the time being. However, the exchange rate remained very volatile, due to the persistence of negative reports from abroad, and at the end of August the Swiss franc appreciated again. In this market environment, which was extremely uncertain and nervous because of the European debt crisis, the liquidity measures were ultimately insufficient to halt the appreciation of the Swiss franc. In recognition of this fact, the SNB decided to introduce a measure which was exceptional in every respect. On 6 September, the SNB set a minimum exchange rate of CHF 1.20 per euro. It stated that it would enforce this minimum rate with the utmost determination and was prepared to buy foreign currency in unlimited quantities for this purpose. This policy is still in force, without any restriction. The impact on the Swiss economy of the deterioration in the international environment as well as the exchange rate movements in July and August had been steadily increasing. Economic activity weakened significantly over the course of 2011 and the pressure on profit margins intensified further in many industries. However, in the past few months there have been growing signs that the economic situation in Switzerland has stabilised as a result of the minimum exchange rate.

P a g e | 99



Thus the minimum exchange rate of CHF 1.20 per euro has, to date, proved to be effective. It has reduced the very substantial overvaluation of the Swiss franc. Moreover, the extreme exchange rate fluctuations which had been experienced previously have been lessened. This has given business leaders a better basis for planning, thereby clearly limiting the damage inflicted by the appreciation of the Swiss franc on the real economy. However, apart from the exchange rate, future economic growth in our country will once again depend on developments in the international economy. That is why I will now present to you our assessment of the international economic outlook.

Economic outlook and outlook for price stability

The latest economic statistics suggest that the international economic recovery will continue, although growth rates are likely to be on the low side by comparison with typical recovery phases. The debt reduction process which private households in the US are currently undergoing and the consolidation of government finances in several European countries, in particular, are dampening economic activity in the short term. Nevertheless, the recovery should gradually gain some strength. However, it is by no means certain that this moderately positive scenario for the international economy will become reality. The international environment continues to be highly uncertain. The European sovereign debt problem still presents the biggest risk.

P a g e | 100



It is unclear whether the measures taken so far will really succeed in defusing the situation permanently. Consequently, the sovereign debt crisis still has the potential to seriously affect the international financial system as well as international economic development. What does this international environment mean for the Swiss economy? The year 2012 is likely to be another difficult one. At CHF 1.20 against the euro, the Swiss currency is still overvalued and presents major challenges to our economy. Many companies have been forced to reduce their prices, which has lowered their turnover in nominal terms. Companies exposed to international competition, with considerable depth of production in Switzerland, in particular, are facing pressure on their profit margins. An additional factor is the muted outlook for the international economy. Combined with the continued high level of uncertainty with respect to the European debt problem, this is likely to limit the willingness to invest in Switzerland. However, there are reasons for a certain degree of confidence as far as our economy is concerned. For instance, the low level of interest rates is still having a stimulating effect on the economy. Domestic demand continues to be supported by high immigration. In addition, the repercussions of the high Swiss franc value are not only negative.

P a g e | 101



For example, imported preliminary products for companies and consumer goods for households have become cheaper. Finally, Swiss firms and their employees have made huge efforts to deal with this difficult situation. Overall, the SNB expects moderate economic growth of close to 1% for the year 2012. This modest economic momentum is likely to be reflected in a moderate increase in unemployment over the course of the next few quarters. The expected economic activity is lower than would be the case for normal capacity utilisation. This means there will be no inflationary pressure from this source. Our conditional inflation forecast of mid-March 2012 shows that there is no risk of inflation in Switzerland in the foreseeable future. The forecast also makes it clear that the threat of a deflationary trend has been kept in check. Inflation rates are only temporarily negative. Nevertheless, the monetary policy challenges for the SNB remain very considerable. I would now like to go into a little more detail on our reflections on monetary policy, particularly with respect to the minimum exchange rate.

Reflections on Swiss monetary policy

After being announced on 6 September 2011, the minimum exchange rate was rapidly attained. When our press release was issued, at exactly 10 am, the euro was trading at a little over CHF 1.12.

P a g e | 102



Within minutes, the exchange rate exceeded the CHF 1.20 mark. Seen from the outside, this may have created the impression that a minimum exchange rate can simply be generated by pressing a button and that such an exchange rate is a normal monetary policy measure which is straightforward to implement. That is far from being the case. A minimum exchange rate is an extreme measure, only to be introduced in a situation of massive overvaluation, with the aim of averting the worst developments. It is neither a panacea capable of solving all the problems facing the Swiss economy, nor can it simply be implemented for any desired level, free of any risk. On the contrary. A minimum exchange rate can only be successfully implemented if there is a clear economic justification for its introduction, such as a massive overvaluation resulting from adverse developments on the foreign exchange market. Within the framework of a system of flexible exchange rates, it is also important that it be internationally accepted, and that it is not seen as a competitive depreciation. Finally, a vital element in the successful implementation of such an exchange rate is the central bank’s credibility, in other words, the belief that the central bank will indeed defend the minimum exchange rate, if need be. Financial markets are constantly changing their assessment of risks. A situation may also occur in which the market decides to test the defence of the minimum exchange rate.

P a g e | 103



Consequently, the SNB is present in the foreign exchange market at all times and is always prepared to purchase unlimited quantities of euros at CHF 1.20 per euro, in order to enforce the minimum exchange rate. When trading took place at less than CHF 1.20 per euro, it was only for a few seconds and resulted from market idiosyncrasies. Since 6 September, the best rate in the market for the sale of euros against Swiss francs has never fallen below CHF 1.20. The SNB was thus able to successfully enforce the minimum exchange rate even under extremely difficult conditions. These considerations clearly show that the introduction of a minimum exchange rate is associated with risks. Under certain circumstances, implementing such a rate can lead to a very considerable expansion of foreign currency reserves. The SNB is prepared to bear the risk. Indeed, in summer 2011, the situation had become so acute that, by early September, the SNB felt that there was no longer any alternative to introducing a minimum exchange rate. Doing nothing would have had an extremely negative impact on our economy. Even at a rate of CHF 1.20 per euro, the Swiss franc remains overvalued. We are acutely aware that considerable challenges still remain for the Swiss economy, despite the minimum exchange rate. One particular reason for this is the fact that the international economy is recovering at only a moderate pace. In addition, there is a very high level of uncertainty in the international environment.

P a g e | 104



An appreciation of the Swiss franc at the current time would again expose Switzerland to considerable risks and, once more, endanger both price stability and the stabilisation of the economy. Given this situation, the SNB will enforce the minimum exchange rate with the utmost determination. If developments in the international economy are worse than foreseen, or if the Swiss franc does not weaken further as expected, renewed downside risks for price stability could emerge. Should the economic outlook and the threat of deflation require it, the SNB is prepared at any time to take further measures. As you will probably have deduced from this account, seen from today’s vantage point, interest rates in Switzerland are likely to remain low for a while yet. This expansionary monetary policy is indispensable from the point of view of the economy as a whole. In that it has significantly reduced the threat to the economy and the threat of a deflationary trend, the current monetary policy is also contributing to financial stability – in the short term. Both a deep recession and a deflationary trend would pose a threat to the banking system. In the longer term, a period of low interest rates carries the risk that imbalances will build up. In Switzerland, the current low-interest-rate period has now lasted for over three years. We are – in fact – currently observing increasing signs of adverse developments in the Swiss mortgage and real estate market for residential property.

P a g e | 105



The explanatory power of fundamental factors in explaining the developments in residential real estate prices is decreasing steadily, while the volume of mortgage loans in comparison to GDP has never been so high. Should these imbalances increase further, considerable risks to financial stability could emerge. Given this situation, the SNB has strongly advocated the introduction of a countercyclical capital buffer in Switzerland. This buffer would not be a permanent increase in equity requirements for banks. It is only to be activated temporarily in the event of excessive growth in domestic mortgage lending. As soon as lending growth weakens again, the buffer can be deactivated. An instrument of this kind was examined in detail last year by a working group headed by the Federal Department of Finance, to which both FINMA and the SNB also belonged. The group proposed that the buffer be introduced rapidly so that a suitable instrument would be in place, in case the imbalances in the Swiss mortgage and real estate market increased further.

Concluding remarks Ladies and Gentlemen, as you will have gathered from my remarks today, the challenges facing the SNB have not diminished. Consequently, it is all the more important that we are able to devote our complete attention to our tasks, now and in the future. The SNB’s monetary policy decisions are directed purely and solely at fulfilling its statutory mandate.

P a g e | 106



It is our responsibility to ensure price stability. In doing so, we take account of the development of the economy and make a contribution to the stability of the financial system. The SNB pursues a monetary policy that serves the interests of the country as a whole, and we fulfil this mandate as an independent central bank. To do this, we continue to rely on the total commitment of our staff, whom I would like to thank – also in the name of my colleague, Jean-Pierre Danthine – for their hard work and their solidarity with the SNB. We thank our shareholders for their continuing support. And we thank you all for taking such a great interest in the activities of the SNB. Finally, we would also like to thank our former colleague and Chairman of the SNB Governing Board, Philipp Hildebrand, for the good collaboration we enjoyed over the years. We very much regret his resignation and the circumstances leading up to it. Thank you for your attention

Notes

Mandate The Swiss National Bank conducts the country’s monetary policy as an independent central bank. It is obliged by Constitution and statute to act in accordance with the interests of the country as a whole.

P a g e | 107



Its primary goal is to ensure price stability, while taking due account of economic developments. In so doing, it creates an appropriate environment for economic growth.

Price stability Price stability is an important condition for growth and prosperity. Inflation and deflation, by contrast, impair economic activity. They complicate decision-making by consumers and producers, lead to misallocations of labour and capital, result in income and asset redistributions, and put the economically weak at a disadvantage. The SNB equates price stability with a rise in the national consumer price index of less than 2% per annum. Deflation – i. e. a protracted decline in price levels – is considered to be equally detrimental to price stability. The SNB takes its monetary policy decisions on the basis of an inflation forecast.

Implementation of monetary policy The SNB implements its monetary policy by steering liquidity on the money market and thereby influencing the interest rate level. The three-month Swiss franc Libor serves as its reference interest rate. In addition, since 6 September 2011, a minimum exchange rate for the euro against the Swiss franc has also applied.

Cash supply and distribution The SNB is entrusted with the note-issuing privilege.

P a g e | 108



It supplies the economy with banknotes that meet high standards with respect to quality and security. It is also charged by the Swiss Confederation with the task of coin distribution.

Cashless payment transactions In the field of cashless payment transactions, the SNB provides services for payments between banks. These are settled in the interbank payment system (SIC system) via sight deposit accounts held with the SNB.

Asset management The SNB manages the currency reserves, the most important component of its assets. Currency reserves engender confidence in the Swiss franc, help to prevent and overcome crises, and may be utilised for interventions in the foreign exchange market.

Financial system stability The SNB contributes to the stability of the financial system. Within the context of this task, it analyses sources of risk to the financial system, oversees systemically important payment and securities settlement systems and helps to promote an operational environment for the financial sector.

International monetary cooperation Together with the federal authorities, the SNB participates in international monetary cooperation and provides technical assistance.

P a g e | 109



Banker to the Confederation The SNB acts as banker to the Confederation. It processes payments on behalf of the Confederation, issues money market debt register claims and bonds, handles the safekeeping of securities and carries out money market and foreign exchange transactions.

Statistics The SNB compiles statistical data on banks and financial markets, the balance of payments, direct investment, the international investment position and the Swiss financial accounts.

P a g e | 110



Certified Risk and Compliance Management Professional (CRCMP) Distance learning and online certification program. Companies like IBM, Accenture etc. consider the CRCMP a preferred certificate. You may find more if you search (CRCMP preferred certificate) using any search engine. The all-inclusive cost is $297. What is included in the price:

A. The official presentations we use in our instructor-led classes (3285 slides) The 2309 slides are needed for the exam, as all the questions are based on these slides. The remaining 976 slides are for reference. You can find the course synopsis at: www.risk-compliance-association.com/Certified_Risk_Compliance_Training.htm

B. Up to 3 Online Exams You have to pass one exam. If you fail, you must study the official presentations and try again, but you do not need to spend money. Up to 3 exams are included in the price. To learn more you may visit: www.risk-compliance-association.com/Questions_About_The_Certification_And_The_Exams_1.pdf www.risk-compliance-association.com/CRCMP_Certification_Steps_1.pdf

http://www.risk-compliance-association.com/Certified_Risk_Compliance_Training.htm

http://www.risk-compliance-association.com/Certified_Risk_Compliance_Training.htm

http://www.risk-compliance-association.com/Questions_About_The_Certification_And_The_Exams_1.pdf

http://www.risk-compliance-association.com/Questions_About_The_Certification_And_The_Exams_1.pdf

http://www.risk-compliance-association.com/CRCMP_Certification_Steps_1.pdf

http://www.risk-compliance-association.com/CRCMP_Certification_Steps_1.pdf

P a g e | 111



C. Personalized Certificate printed in full color. Processing, printing, packing and posting to your office or home.

D. The Dodd Frank Act and the new Risk Management Standards (976 slides, included in the 3285 slides) The US Dodd-Frank Wall Street Reform and Consumer Protection Act is the most significant piece of legislation concerning the financial services industry in about 80 years. What does it mean for risk and compliance management professionals? It means new challenges, new jobs, new careers, and new opportunities. The bill establishes new risk management and corporate governance principles, sets up an early warning system to protect the economy from future threats, and brings more transparency and accountability. It also amends important sections of the Sarbanes Oxley Act. For example, it significantly expands whistleblower protections under the Sarbanes Oxley Act and creates additional anti-retaliation requirements. You will find more information at: www.risk-compliance-association.com/Distance_Learning_and_Certification.htm

http://www.risk-compliance-association.com/Distance_Learning_and_Certification.htm

http://www.risk-compliance-association.com/Distance_Learning_and_Certification.htm

P a g e | 112



Visit our Risk and Compliance Management Speakers Bureau The International Association of Risk and Compliance Professionals (IARCP) has established the Speakers Bureau for firms and organizations that want to access the expertise of Certified Risk and Compliance Management Professionals (CRCPMs) and Certified Information Systems Risk and Compliance Professionals (CISRCPs). The IARCP will be the liaison between our certified professionals and these organizations, at no cost. We strongly believe that this can be a great opportunity for both, our certified professionals and the organizers. To learn more: www.risk-compliance-association.com/Risk_Management_Compliance_Speakers_Bureau.html

www.risk-compliance-association.com/Risk_Management_Compliance_Speakers_Bureau.html

www.risk-compliance-association.com/Risk_Management_Compliance_Speakers_Bureau.html

http://www.risk-compliance-association.com/

P a g e | 113



http://www.risk-compliance-association.com/New_Member_Orientation_Newsletters.html

Date post:	19-May-2015
Category:	Economy & Finance
Upload:	compliance-llc
View:	509 times
Download:	0 times

Monday May 28 2012 - Top 10 risk and compliance management related news stories and world events...

Economy & Finance