Monday November 12 2012 Top 10 Risk Compliance News Events

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_____________________________________________________________ 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

Dear Member, If you had to put Global Systemically Important Banks (G-SIBa) in “buckets”… what would you do? This year, the G-SIBs are shown allocated to buckets corresponding to their required level of additional loss absorbency. This is what the Financial Stability Board and the Basel Committee did:

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

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The additional loss absorbency requirements for G-SIBs will be phased in starting from 2016, initially for those banks identified as G-SIBs in November 2014, and are to be fully met by 2019.

Learn more at Number 10 of our list! At Number 5 of our list you will find the “metaphorical overreach” of the week: “If you will forgive me for a possible metaphorical overreach, one can think of ethical concepts as the white blood cells that make an organization’s “immune system” – its compliance and risk management systems and culture – effective. Extending that same metaphor, conflicts of interest can be thought of as the viruses that threaten the organization’s wellbeing. As in the microbial world, these viruses come in a vast array of constantly mutating formats, and if not eliminated or neutralized, even the simplest virus is a mortal threat to the body. Especially when combined with the wrong culture and incentives, conflicts of interest can do great harm.

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Who said that? Carlo V. di Florio, Director, Office of Compliance Inspections and Examinations, National Society of Compliance Professionals, SEC Read more at Number 5 of our list. Welcome to the Top 10.

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The FSB welcomes the report of the Enhanced Disclosure Task Force The Financial Stability Board (FSB) welcomes the publication of the Report of the Enhanced Disclosure Task Force (EDTF) and views it as a valuable step to improve the quality of risk disclosures. The EDTF’s principles and recommendations for improved bank risk disclosures and leading disclosure practices are designed to provide timely information useful to investors and other users, which together with current regulatory developments and standard setter recommendations can contribute, over time, to improved market confidence in financial institutions.

Report to G20 Finance Ministers and Central Bank Governors on Basel III implementation The G20 Leaders met in Los Cabos in June 2012. At this Summit, they endorsed the work of the Basel Committee on Banking Supervision in monitoring the global implementation of its standards, and urged jurisdictions to meet their commitments. “We welcome progress in implementing Basel II, 2.5 and III and urge jurisdictions to fully implement the standards according to the agreed timelines.”

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Agencies Issue Statement on Supervisory Practices Regarding Financial Institutions and Borrowers Affected by Hurricane Sandy The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (the agencies) recognize the serious impact of Hurricane Sandy on the customers and operations of many financial institutions and will provide regulatory assistance to affected institutions subject to their supervision.

The Recovery and Monetary Policy William C. Dudley, President and Chief Executive Officer

Conflicts of Interest and Risk Governance Carlo V. di Florio Director, Office of Compliance Inspections and Examinations National Society of Compliance Professionals

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Commission Work Programme 2013 “Today's absolute imperative is to tackle the economic crisis and put the EU back on the road to sustainable growth”.

Feedback on comments received from stakeholders to the EBA, EIOPA and ESMA’s Joint Consultation Paper On its proposed response to the European Commission’s Call for Advice on the Fundamental Review of the Financial Conglomerates Directive

Financial crime: a guide for firms Part 1: A firm’s guide to preventing financial crime

This Guide consolidates FSA guidance on financial crime. It does not contain rules and its contents are not binding.

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The Irish banking sector – five challenges Address by Mr Matthew Elderfield, Deputy Governor of the Central Bank of Ireland, to the Association of Compliance Officers in Ireland, University College Cork, Cork

FSB releases reports on progress in implementing the SIFI framework The FSB is releasing three documents on latest steps in implementing the FSB’s policy framework for addressing the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs).

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The FSB welcomes the report of the Enhanced Disclosure Task Force The Financial Stability Board (FSB) welcomes the publication of the Report of the Enhanced Disclosure Task Force (EDTF) and views it as a valuable step to improve the quality of risk disclosures. The EDTF’s principles and recommendations for improved bank risk disclosures and leading disclosure practices are designed to provide timely information useful to investors and other users, which together with current regulatory developments and standard setter recommendations can contribute, over time, to improved market confidence in financial institutions. The FSB encourages banks to continue to strive to improve risk disclosures. The EDTF was formed in May at the initiative of the FSB. The task force represents a unique private sector initiative – one that brings together on a global basis, senior officials and experts from financial institutions, investors, and audit firms – to develop recommendations for enhancing risk disclosure practices by major banks starting with end-year 2012 annual risk disclosures and continuing into 2013 and beyond.

1. Background It has been five years since the beginning of the financial crisis and the public’s trust in financial institutions has yet to be fully restored.

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Investors today are more sensitive to the complexity and opacity of banks’ business models and credit spreads for financials remain persistently higher than for similarly-rated corporates. Moreover, in some markets, banks still need significant liquidity support from the public sector. Many banks are now trading at market values below their book values, which is in marked contrast to the past. Investors and other public stakeholders are demanding better access to risk information from banks; information that is more transparent, timely and comparable across institutions. In response, international regulators and standard setters have taken a range of steps to improve the quality and content of the financial disclosures of banks, including initiatives by the Financial Stability Board (FSB)1 in 2011 and the Senior Supervisors Group2 in 2008. Banks have also made efforts to improve disclosures, both individually and collectively. This report differs in one crucial respect: it has been developed among private sector stakeholders as a joint initiative representing both users and preparers of financial reports. By bringing together the perspectives of leading global banks, investors, analysts and external auditors, this report seeks to establish a benchmark for high-quality risk disclosures, with specific emphasis on enhancements that can be implemented in the short term, particularly in 2012 and 2013 annual reports. High-quality risk disclosures should be viewed as a collective public good given the systemic importance of banks and the contingent liability they represent for taxpayers.

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Poor quality disclosures can result in higher uncertainty premiums, and this can undermine the extension of credit needed to support employment and productive investments in struggling economies, and affect its price. Disclosures that describe risks and risk management practices transparently help to build confidence in the firm’s management, which is particularly important in attracting debt and equity investors and may in turn support higher equity valuations. By enhancing investors’ understanding of banks’ risk exposures and risk management practices, high-quality risk disclosures may reduce uncertainty premiums and contribute to broader financial stability. For well-managed firms, the benefits of proactively enhancing risk disclosures are clear.

2. Objectives and process The Enhanced Disclosure Task Force (EDTF) was established by the FSB in May 2012 following an FSB roundtable in December 2011 of eighty-two senior officials and experts from around the world. The roundtable outlined broad goals for improving the quality, comparability and transparency of risk disclosures, while reducing redundant information and streamlining the process for bringing relevant disclosures to the market quickly. With the goal of improving the risk disclosures of banks and other financial institutions, the primary objectives of the EDTF were to: i. Develop fundamental principles for enhanced risk disclosures; ii. Recommend improvements to current risk disclosures, including ways to enhance their comparability; and iii. Identify examples of best or leading practice risk disclosures presented by global financial institutions.

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Membership of the EDTF had wide geographical representation and included senior executives from leading asset management firms, investors and analysts, global banks, credit rating agencies and external auditors. To organise its work and the resulting recommendations, the EDTF established six workstreams reflecting banks’ primary risk areas, and each task force member was allocated to a workstream so that they comprised both users and preparers of financial reports. The workstreams were as follows: i. risk governance and risk management strategies/business model; ii. capital adequacy and risk-weighted assets; iii. liquidity and funding; iv. market risk; v. credit risk; and vi. other risks. Each workstream analysed current disclosures in its risk area by reviewing a sample of banks’ recent annual and interim reports, Pillar 3 reports and other publicly available information, such as media releases and presentations to investors. On the basis of that analysis, and following extensive discussion among its members, each workstream developed recommendations for enhancing disclosures in its respective risk area, and presented them to the EDTF plenary for further consideration. The task force had plenary meetings in London, New York, Singapore and Frankfurt, and held two additional meetings by telephone.

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During those meetings, the EDTF thoroughly debated and challenged each recommendation proposed by the workstreams. As a result, the recommendations in this report represent the collective views and expertise of the EDTF membership. Also, at key stages in its work, the Co-chairs of the EDTF engaged in dialogue with securities and banking regulators and supervisors, accounting standard-setters, banking associations and other stakeholder organisations located in Europe, North America, Latin America, the Middle East and Asia. Minutes of these meetings were circulated to EDTF members and, during the plenary meetings, the Co-chairs gave oral accounts of these stakeholder organisations’ views on risk disclosure issues, including any initiatives underway to address risk disclosure issues. Prior to its finalisation, a draft of the report was circulated by the EDTF to key stakeholder organisations, including the International Banking Federation and the Institute of International Finance, and feedback was solicited on its content. Working within the EDTF’s compressed timetable for providing comments, these international organisations expeditiously distributed the document to their respective memberships and provided the EDTF with invaluable feedback. The task force considered the input received from its extensive outreach programme as well as the views of the EDTF membership in the development and finalization of this report.

3. Scope and other considerations Scope of the recommendations in this report The fundamental principles are applicable to all banks.

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However, the EDTF has developed the recommendations for enhanced risk disclosures with large international banks in mind, although they should be equally applicable to banks that actively access the major public equity or debt markets. Some of the recommendations, therefore, are likely to be less applicable to smaller banks and subsidiaries of listed banks and the EDTF would expect such entities to adopt only those aspects of the recommendations that are relevant to them. This report was not specifically developed for other types of financial services organisations, such as insurance companies, though the fundamental principles and recommendations contained herein may provide some appropriate guidance. Banks will need to continue to comply with the relevant securities laws and reporting requirements applicable to their activities, and will also need to assess any relevant confidentiality and other jurisdictional legal issues. In addition, all banks, including the large international ones, will need to assess factors specific to their circumstances such as the materiality, costs and benefits of each recommendation in this report. In making these assessments, banks should consider their users’ needs and expectations and may wish to speak directly to their key stakeholders as they begin to implement changes. The EDTF acknowledges that existing jurisdictional differences in accounting and regulatory requirements may affect how banks implement the recommendations, and may make it difficult to achieve full comparability between banks across jurisdictions.

Timing of implementation The EDTF believes that many of the recommendations can be adopted in 2012 or 2013, for example, those that involve only the re-ordering or aggregation of existing disclosures in banks’ reports to enable users to

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find and assimilate information more quickly, or those that are based on information that is already reported to management. However, other recommendations may take longer to develop and implement, particularly where banks need to create new systems and processes to ensure that the information required to support the enhanced disclosure is of high quality, and thus the EDTF envisages enhancements of the risk disclosures of banks continuing after 2013. The EDTF also recognises that banks have other commitments with similar timelines, such as implementing Basel II or Basel III and the Globally Systemically Important Banks (G-SIB) data template. Some of the recommendations are dependent on the finalisation or implementation of particular regulatory rules and, thus, cannot be adopted until then.

Frequency of disclosures This report has been produced in the context of the existing legal and regulatory requirements for banks’ public reporting. Banks produce annual reports, which contain audited financial statements and management commentary (including risk commentary), and interim reports. Some banks also produce preliminary announcements before their annual or interim reports are available. Interim reports and preliminary announcements are intended to provide users with timely updates on the bank’s last annual report. The recommendations do not suggest changing the requirements for interim reporting, which vary from market to market. However, the EDTF thinks that several areas in the report should be disclosed more frequently than in annual reports, and thus that more risk

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disclosures would be included in interim reports than is currently the case. Banks should consider whether their interim reports contain relevant risk information to support the financial information presented and whether such reports provide a sufficient update on top and emerging risks.

Location of disclosures

In making its recommendations, the EDTF generally does not specify where any new disclosure should be made, nor does it suggest that banks change the current location of their reported information when adopting the enhancements. Banks should retain flexibility in what they choose to disclose in their annual reports and other filings, such as their Pillar 3 reports. However, the EDTF expects many of the detailed regulatory capital disclosures will remain in or will be added to the Pillar 3 report. Consistent with the FSB’s recommendation in 2011, the task force advocates, as part of the fundamental principles, that annual reports and Pillar 3 reports should be published at the same time, and believes that this would provide users with complete and timely reporting across the key areas of interest. It is not the intention of this report to create a checklist of all possible risk disclosures or to reproduce existing disclosure requirements set forth in accounting and regulatory standards. Banks will need to assess the recommendations in this report in the light of how they apply the existing disclosure requirements in their jurisdictions. Indeed, those extensive existing requirements may contribute to both preparers’ views that financial reporting is a compliance exercise and users’ difficulties in navigating long annual reports.

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This can be a particular concern for international banks that must meet varying and sometimes overlapping disclosure requirements in different jurisdictions. As a result, some banks may question whether the benefits of increased transparency justify the additional investment in resources, management attention and the potential risks involved in making forward-looking statements. This report addresses these concerns by recommending ways for banks to communicate important disclosures to users more effectively and efficiently.

4. Fundamental principles for risk disclosure The EDTF has collectively identified seven principles for enhancing risk disclosures, which both underpin the recommendations set out in this report and provide an enduring framework for future work on risk disclosures. These principles provide a firm foundation from which to achieve transparent, high-quality risk disclosures that enable users to understand in an integrated manner a bank’s7 business and its risks, and the resultant effects on its performance and financial position. The seven fundamental principles for enhanced risk disclosures are: 1. Disclosures should be clear, balanced and understandable. 2. Disclosures should be comprehensive and include all of the bank’s key activities and risks. 3. Disclosures should present relevant information. 4. Disclosures should reflect how the bank manages its risks. 5. Disclosures should be consistent over time.

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6. Disclosures should be comparable among banks. 7. Disclosures should be provided on a timely basis.

Principle 1: Disclosures should be clear, balanced and understandable. - Disclosures should be written with the objective of communicating

information to a range of users (i.e. investors, analysts and other stakeholders) rather than simply complying with minimum requirements. The disclosures should be sufficiently granular to benefit sophisticated users but should also provide summarised information for those who are less specialised, along with clear signposting to enable navigation through the information. Disclosures should be organised so that key information and messages are prioritised and easy to find.

- There should be an appropriate balance between qualitative and

quantitative disclosures, using text, numbers and graphical presentations. Fair and balanced narrative explanations should provide insight into the implications of the quantitative disclosures and any changes or developments that they portray.

- Disclosures should provide straightforward explanations for more

complex issues. Descriptions and terms should fairly represent the substance of the bank’s activities. Terms used in the disclosures should be explained or defined.

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Principle 2: Disclosures should be comprehensive and include all of the bank’s key activities and risks. - Disclosures should provide an overview of the bank’s activities and its

key risks. They should include a description of how the bank identifies, measures, manages and reports each risk, highlighting any significant internal or external changes during the reporting period and the key actions taken by management in response.

- Disclosures should include informative explanations of important

processes and procedures – as well as underlying cultures and behaviours – that affect the bank’s business and its risk generation or risk management. Disclosures of such items should enable users to obtain an understanding of the bank’s risk management operations and the related governance by the bank’s board and senior management.

- When appropriate and meaningful, disclosures should be

complemented with information about key underlying assumptions and sensitivity or scenario analysis. Such analysis should demonstrate the effect on selected risk metrics or exposures of changes in the key underlying assumptions, both in qualitative and quantitative terms.

Principle 3: Disclosures should present relevant information. - The bank should provide disclosures only if they are material and

reflect its activities and risks – and can be prepared without unreasonable cost. Accordingly, disclosures should be eliminated if they are immaterial or redundant.

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Disclosing immaterial information or information on situations that do not apply to the bank reduces the relevance of its disclosures and undermines the ability of users to understand them. However, when exposures receiving significant current market attention are either immaterial or nonexistent, the bank should acknowledge this fact to reduce uncertainty among users. Moreover, banks should avoid generic or boilerplate disclosures that do not add value or do not communicate useful information.

- Disclosures should be presented in sufficient detail to enable users to

understand the nature and extent of the bank’s risks. Where period-end information may not be representative of the risks, consideration should be given to providing averages and high and low balances during the period. The type of information, the way in which it is presented and the accompanying explanatory notes will differ between banks and will change over time, but information should be reported at the level of detail that users need in order to understand the bank, its risk appetite, its exposures and the manner in which it manages its business and risks, including in stress conditions.

- The bank should explain its business model to provide context for its

business and risk disclosures. In many cases, disclosures will focus on the consolidated group. However, understanding the risks relative to returns embedded in key operating subsidiaries and business divisions – and the way that risks are shared or assets, liabilities, income and costs are allocated across the group – can be key to users’ understanding of the risks to which the group is exposed.

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Principle 4: Disclosures should reflect how the bank manages its risks. - Disclosures should be based on the information that is used for

internal strategic decision making and risk management by key management, the board and the board’s risk committee. Approaches to disclosure should be sufficiently flexible to allow banks to reflect their particular circumstances in both narrative and quantitative terms.

- The bank should explain the risk and reward profile of its activities.

Disclosures should be representative of risk exposures during the period, as well as at the end of the period.

- If disclosure of particularly commercially sensitive or otherwise

confidential information would unduly expose the bank to litigation or other risks, the level of information provided will need to balance confidentiality and materiality.

If material, a bank should assess what information should be provided to ensure users are aware of important issues without disclosing potentially damaging confidential details.

Principle 5: Disclosures should be consistent over time. - Disclosures should be consistent over time to enable users to

understand the evolution of the bank’s business, risk profile and management practices. Core disclosures should not change dramatically but should evolve over time, allowing for inter-period comparisons.

- Changes in disclosures and related approaches or formats (e.g. due to

changes in risk practices, emerging risks, measurement methodologies or accounting or regulatory requirements) should be clearly highlighted and explained.

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Presenting comparative information is helpful; however, in some situations it may be preferable to include a new disclosure even if comparative information cannot be prepared or restated.

Principle 6: Disclosures should be comparable among banks. - Disclosures should be sufficiently detailed to enable users to perform

meaningful comparisons of businesses and risks between different banks, including across various national regulatory regimes. Disclosures that facilitate users’ understanding of the bank’s exposures compared with its competitors are of particular importance in building users’ understanding and confidence as well as reducing the risk of inappropriate comparisons.

Principle 7: Disclosures should be provided on a timely basis. - Information should be delivered to users in a timely manner using

appropriate media (e.g. annual and interim reports, websites, news releases, or regulatory reports). The bank should seek to release to the market all relevant and important risk-based information at the same time (e.g. the annual report and Pillar 3 disclosures). Equally important are regular updates of financial information; users need more frequent updates than just the annual report. This can be accomplished through various means and media; thus banks should endeavour to provide frequent updates to their users to ensure financial information remains up to date.

The EDTF acknowledges that in some cases there will be tension between two or more fundamental principles. For example, under Principles 4 and 5, disclosures are most useful if they provide information that reflects how the bank manages its risks and are consistent over time while, under Principle 6, disclosures should enable

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users to perform meaningful comparisons between banks. Similarly, there can be tension within a single principle. For example, Principle 1 states that disclosures should be clear, balanced and understandable, but users have differing views on the level of detail that is needed to achieve that objective. Even sophisticated users find that some granular disclosures, which may be provided to comply with particular regulatory or accounting requirements, are difficult to use or understand unless they are accompanied by summarised information. Tension may also arise if investors seek information that is too commercially sensitive for banks to disclose. The EDTF believes that these tensions do not reflect a fault or weakness in the fundamental principles but are inevitable given the varying, and sometimes competing, needs of users, preparers and regulators. Banks should endeavour, both individually and collectively, to find an appropriate balance among the principles, and indeed within particular principles, without creating excessive disclosures that will overwhelm users. Users should provide ongoing feedback to banks about whether they are achieving an appropriate balance. It is acknowledged that the applications of the principles will differ between risk areas and may change over time. The aim of the fundamental principles, and the recommendations that follow from them, is to address investors’ concerns about the quality and transparency of banks’ disclosures. However, users already have considerable knowledge of topics such as general business risks, finance and current economic conditions, and a bank’s disclosures are not the sole source of information available to them.

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This report builds on that existing knowledge and information, and seeks to avoid developing disclosures that would duplicate information that should already be known, apparent or readily accessible from other sources.

5. Recommendations for enhancing risk disclosures The EDTF has identified the following recommendations for enhancing risk disclosures. Additionally, there are eight examples in the appendix to this section that illustrate how particular recommendations could be adopted to produce clear and understandable disclosures. Section 6 provides additional commentary that expands on these recommendations.

General 1: Present all related risk information together in any particular report. Where this is not practicable, provide an index or an aid to navigation to help users locate risk disclosures within the bank’s reports. 2: Define the bank’s risk terminology and risk measures and present key parameter values used. 3: Describe and discuss top and emerging risks, incorporating relevant information in the bank’s external reports on a timely basis. This should include quantitative disclosures, if possible, and a discussion of any changes in those risk exposures during the reporting period. 4: Once the applicable rules are finalised, outline plans to meet each new key regulatory ratio, e.g. the net stable funding ratio, liquidity coverage

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ratio and leverage ratio and, once the applicable rules are in force, provide such key ratios.

Risk governance and risk management strategies/business model 5: Summarise prominently the bank’s risk management organisation, processes and key functions. 6: Provide a description of the bank’s risk culture, and how procedures and strategies are applied to support the culture. 7: Describe the key risks that arise from the bank’s business models and activities, the bank’s risk appetite in the context of its business models and how the bank manages such risks. This is to enable users to understand how business activities are reflected in the bank’s risk measures and how those risk measures relate to line items in the balance sheet and income statement. 8: Describe the use of stress testing within the bank’s risk governance and capital frameworks. Stress testing disclosures should provide a narrative overview of the bank’s internal stress testing process and governance.

Capital adequacy and risk-weighted assets 9: Provide minimum Pillar 1 capital requirements, including capital surcharges for G-SIBs and the application of counter-cyclical and capital conservation buffers or the minimum internal ratio established by management. 10: Summarise information contained in the composition of capital templates adopted by the Basel Committee to provide an overview of the main components of capital, including capital instruments and regulatory adjustments.

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A reconciliation of the accounting balance sheet to the regulatory balance sheet should be disclosed. 11: Present a flow statement of movements since the prior reporting date in regulatory capital, including changes in common equity tier 1, tier 1 and tier 2 capital. 12: Qualitatively and quantitatively discuss capital planning within a more general discussion of management’s strategic planning, including a description of management’s view of the required or targeted level of capital and how this will be established. 13: Provide granular information to explain how risk-weighted assets (RWAs) relate to business activities and related risks. 14: Present a table showing the capital requirements for each method used for calculating RWAs for credit risk, including counterparty credit risk, for each Basel asset class as well as for major portfolios within those classes. For market risk and operational risk, present a table showing the capital requirements for each method used for calculating them. Disclosures should be accompanied by additional information about significant models used, e.g. data periods, downturn parameter thresholds and methodology for calculating loss given default (LGD). 15: Tabulate credit risk in the banking book showing average probability of default (PD) and LGD as well as exposure at default (EAD), total RWAs and RWA density for Basel asset classes and major portfolios within the Basel asset classes at a suitable level of granularity based on internal ratings grades. For non-retail banking book credit portfolios, internal ratings grades and PD bands should be mapped against external credit ratings and the number of PD bands presented should match the number of notch -specific ratings used by credit rating agencies.

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16: Present a flow statement that reconciles movements in RWAs for the period for each RWA risk type. 17: Provide a narrative putting Basel Pillar 3 back-testing requirements into context, including how the bank has assessed model performance and validated its models against default and loss.

Liquidity 18: Describe how the bank manages its potential liquidity needs and provide a quantitative analysis of the components of the liquidity reserve held to meet these needs, ideally by providing averages as well as period-end balances. The description should be complemented by an explanation of possible limitations on the use of the liquidity reserve maintained in any material subsidiary or currency.

Funding 19: Summarise encumbered and unencumbered assets in a tabular format by balance sheet categories, including collateral received that can be rehypothecated or otherwise redeployed. This is to facilitate an understanding of available and unrestricted assets to support potential funding and collateral needs. 20: Tabulate consolidated total assets, liabilities and off-balance sheet commitments by remaining contractual maturity at the balance sheet date. Present separately (i) Senior unsecured borrowing (ii) Senior secured borrowing (separately for covered bonds and repos) and

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(iii) Subordinated borrowing. Banks should provide a narrative discussion of management’s approach to determining the behavioural characteristics of financial assets and liabilities. 21: Discuss the bank’s funding strategy, including key sources and any funding concentrations, to enable effective insight into available funding sources, reliance on wholesale funding, any geographical or currency risks and changes in those sources over time.

Market risk 22: Provide information that facilitates users’ understanding of the linkages between line items in the balance sheet and the income statement with positions included in the traded market risk disclosures (using the bank’s primary risk management measures such as Value at Risk (VaR)) and non-traded market risk disclosures such as risk factor sensitivities, economic value and earnings scenarios and/or sensitivities. 23: Provide further qualitative and quantitative breakdowns of significant trading and nontrading market risk factors that may be relevant to the bank’s portfolios beyond interest rates, foreign exchange, commodity and equity measures. 24: Provide qualitative and quantitative disclosures that describe significant market risk measurement model limitations, assumptions, validation procedures, use of proxies, changes in risk measures and models through time and descriptions of the reasons for back-testing exceptions, and how these results are used to enhance the parameters of the model. 25: Provide a description of the primary risk management techniques employed by the bank to measure and assess the risk of loss beyond reported risk measures and parameters, such as VaR, earnings or economic value scenario results, through methods such as stress tests, expected shortfall, economic capital, scenario analysis, stressed VaR or other alternative approaches.

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The disclosure should discuss how market liquidity horizons are considered and applied within such measures.

Credit risk 26: Provide information that facilitates users’ understanding of the bank’s credit risk profile, including any significant credit risk concentrations. This should include a quantitative summary of aggregate credit risk exposures that reconciles to the balance sheet, including detailed tables for both retail and corporate portfolios that segments them by relevant factors. The disclosure should also incorporate credit risk likely to arise from offbalance sheet commitments by type. 27: Describe the policies for identifying impaired or non-performing loans, including how the bank defines impaired or non-performing, restructured and returned-to-performing (cured) loans as well as explanations of loan forbearance policies. 28: Provide a reconciliation of the opening and closing balances of non-performing or impaired loans in the period and the allowance for loan losses. Disclosures should include an explanation of the effects of loan acquisitions on ratio trends, and qualitative and quantitative information about restructured loans. 29: Provide a quantitative and qualitative analysis of the bank’s counterparty credit risk that arises from its derivatives transactions. This should quantify notional derivatives exposure, including whether derivatives are over-the-counter (OTC) or traded on recognised exchanges.

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Where the derivatives are OTC, the disclosure should quantify how much is settled by central counterparties and how much is not, as well as provide a description of collateral agreements. 30: Provide qualitative information on credit risk mitigation, including collateral held for all sources of credit risk and quantitative information where meaningful. Collateral disclosures should be sufficiently detailed to allow an assessment of the quality of collateral. Disclosures should also discuss the use of mitigants to manage credit risk arising from market risk exposures (i.e. the management of the impact of market risk on derivatives counterparty risk) and single name concentrations.

Other risks 31: Describe ‘other risk’ types based on management’s classifications and discuss how each one is identified, governed, measured and managed. In addition to risks such as operational risk, reputational risk, fraud risk and legal risk, it may be relevant to include topical risks such as business continuity, regulatory compliance, technology, and outsourcing. 32: Discuss publicly known risk events related to other risks, including operational, regulatory compliance and legal risks, where material or potentially material loss events have occurred. Such disclosures should concentrate on the effect on the business, the lessons learned and the resulting changes to risk processes already implemented or in progress.

Appendix to Section 5 The following appendix includes eight examples of possible disclosure formats to assist banks in adopting the recommendations in this report.

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These examples reflect instances where investors have suggested that consistent tabular presentation is particularly important to improving their understanding of the disclosed information and facilitating comparability among banks. All numbers included in the Figures are for illustrative purposes. It is understood that differing business models, reporting regimes and materiality will affect how banks provide such information.

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Core Tier 1 (CET1) Capital In addition to those items illustrated on the previous page, the line item ‘other, including regulatory adjustments and transitional arrangements’ may include (as per applicable regime): - common share capital issued by subsidiaries and held by third parties;

- other movements in shareholders’ equity;

- reserves arising from property revaluation;

- defined benefit pension fund adjustment;

- cash flow hedging reserve;

- shortfall of provisions to expected losses;

- securitisation positions;

- investments in own CET1;

- reciprocal cross-holdings in CET1;

- investments in the capital of unconsolidated entities (less than 10%);

- significant investments in the capital of unconsolidated entities

(amount above 10% threshold);

- mortgage servicing rights (amount above 10% threshold);

- deferred tax assets arising from temporary differences (amount above 10% threshold);

- amounts exceeding 15% threshold; and

- regulatory adjustments applied due to insufficient additional tier 1.

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Other ‘non-core’ tier 1 (additional tier 1) capital The line item ‘other, including regulatory adjustments and transitional arrangements’ may include (as per applicable regime): - other ‘non-core’ tier 1 capital (additional tier 1) instruments issued by

subsidiaries and held by third parties;

- unconsolidated investments deductions;

- investments in own additional tier 1 instruments;

- reciprocal cross-holdings;

- significant investments in the capital of unconsolidated entities;

- other investments in the capital of unconsolidated entities;

- grandfathering adjustments;

- regulatory adjustments applied due to insufficient tier 2 capital; and

- currency translation differences.

Tier 2 Capital The line item ‘other, including regulatory adjustments and transitional arrangements’ may include (as per applicable regime): - tier 2 capital instruments issued by subsidiaries and held by third

parties;

- unconsolidated investments deductions;

- investments in own tier 2 instruments;

- reciprocal cross-holdings;

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- significant investments in the capital of unconsolidated entities;

- other investments in the capital of unconsolidated entities;

- collective impairment allowances;

- grandfathering adjustments; and

- currency translation differences.

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6. Additional commentary on areas identified for enhanced risk Disclosures This section describes the EDTF’s views on current risk disclosure practices, recognizing areas of leading practice and those which could be enhanced. The section also reproduces the recommendations and provides additional explanatory guidance designed to place them in context and highlight their importance to users. Banks will need to continue to comply with securities laws and reporting requirements relevant to their operations to ensure that they are not

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breached, and assess appropriate confidentiality and other jurisdictional legal issues, particularly where the disclosure of commercially sensitive information would threaten a bank’s stability or possess the potential to give rise to systemic risk. They will also wish to consider factors specific to their circumstances such as the materiality, costs and benefits of disclosures. The additional commentary accords with the fundamental principles and expands on the recommendations set out in Section 5 of this report. The enhanced disclosures emphasise relevance, consistency or comparability, depending on the importance of the principle to a particular area. Users need to understand how the bank manages risk and be able to make comparisons over time and between reporting organisations. The EDTF recognises that differences in regulatory and accounting requirements in different jurisdictions may make it difficult to achieve comparability and it will take time to improve this, but it remains an aim of enhanced disclosures. The EDTF’s recommendations are organised within the following seven broad risk areas, which are the major categories of risk for banks: 6.1 risk governance and risk management strategies/business model; 6.2 capital adequacy and risk-weighted assets; 6.3 liquidity; 6.4 funding; 6.5 market risk; 6.6 credit risk; and

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6.7 other risks. Many of these risk areas are inter-related. For example, reputational risk may be addressed as part of ‘other risks’ but may also be a key driver of risk governance.

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Report to G20 Finance Ministers and Central Bank Governors on Basel III implementation Introduction and summary The G20 Leaders met in Los Cabos in June 2012. At this Summit, they endorsed the work of the Basel Committee on Banking Supervision in monitoring the global implementation of its standards, and urged jurisdictions to meet their commitments. “We welcome progress in implementing Basel II, 2.5 and III and urge jurisdictions to fully implement the standards according to the agreed timelines.” This report updates the G20 Finance Ministers and Central Bank Governors on the progress made by Basel Committee member jurisdictions in implementing the Basel III standards (including Basel II and Basel 2.5, which now form integral parts of Basel III). It also highlights specific areas that require attention if the goal of achieving timely and consistent implementation is to be achieved. The Basel Committee believes that full, timely and consistent implementation of Basel III by its members is essential for restoring confidence in the regulatory framework for banks and to help ensure a safe and stable global banking system. The transitional phase for implementing the Basel III package commences on 1 January 2013, by when all jurisdictions should have in place the necessary regulations.

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At the time of this report, eight of the 27 member jurisdictions of the Basel Committee have issued their final set of Basel III related regulations, 17 members have published draft regulations, and two members are currently in the process of drafting regulations but have not yet published them. Given their commitment, and the fact that the transitional date is a publically announced one, it is especially important that member jurisdictions that are home to global systemically important banks (G-SIBs) make every effort to issue final regulations as soon as possible in order to meet the transition period deadline. To facilitate proper implementation and follow up, the Basel Committee has begun to assess the consistency of these regulations and progress with implementation against 14 core elements of the Basel framework. As a first step, the Committee conducted detailed assessments of the content and substance of the final regulations implementing the Basel III package in Japan, and the draft regulations in the European Union and the United States. While noting implementation progress in all three jurisdictions, the assessments have identified areas of divergence from the globally agreed Basel standards. In the case of Japan, no material deviations were observed and the jurisdiction is assessed overall as “compliant.” In the European Union and the United States, 4 there were a few deviations in the draft regulations that were assessed to be of a material nature (for securitisation related regulations in the United States, and for regulations covering the definition of capital and the internal ratings-based (IRB) approach in the European Union). All other elements in both jurisdictions were either “compliant” or “largely compliant.”

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Given the importance of making the banking system more resilient, it is essential that the Basel framework is implemented consistently and according to the globally-agreed timelines. The Basel Committee therefore urges the G20 Finance Ministers and Central Bank Governors to call on (i) All Basel Committee jurisdictions to meet the globally agreed deadline; (ii) The European and United States authorities, and others who undergo a Basel Committee regulatory consistency assessment, to close any identified gaps between their regulations and Basel III and; (iii) All jurisdictions to ensure their implementation of Basel III remains timely and consistent with the internationally agreed package of reforms. The Basel Committee also continues to perform detailed analysis of the variations in risk-weighted assets across banks, across jurisdictions and over time, both for assets in the banking book and in the trading book. This report includes preliminary conclusions of this analysis. More detailed assessment reports, potentially including policy recommendations, where appropriate, will be considered by the Committee later in 2012 and in early 2013.

Basel standards In June 2004, a package of reforms known as Basel II introduced more risk-sensitive minimum capital requirements for banks, including an enhanced measurement of credit risk, and capture of operational risk. Basel II also reinforced the requirements by setting out principles for banks to assess the adequacy of their capital and for supervisors to review such assessments to ensure banks have the necessary capital to support their risks.

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It also strengthened market discipline by enhancing disclosure requirements. The deadline for implementation of the Basel II framework by member jurisdictions was the end of 2006. In July 2009, the Committee introduced enhancements to the Basel II framework in response to lessons from the financial crisis. These reforms, referred to as Basel 2.5, relate to the measurement of risks for calculating regulatory capital for securitisation and trading book exposures (Pillar 1), risk management and supervisory review (Pillar 2) and disclosure (Pillar 3). A deadline for implementing these reforms was set for end 2011. In December 2010, the Basel Committee published Basel III, a comprehensive set of reforms to raise the resilience of banks, supplementing Basel II and 2.5 in a number of dimensions. Basel III addresses both firm-specific and broader, systemic risks by: • Raising the quality of capital, with a focus on common equity, and the quantity of capital to ensure banks are better able to absorb losses; • Enhancing the coverage of risk, in particular for capital market activities; • Introducing capital buffers which should be built up in good times so that they can be drawn down during periods of stress; • Introducing an internationally harmonised leverage ratio to serve as a backstop to the risk-based capital measure and to contain the build-up of excessive leverage in the system; • Introducing minimum global liquidity standards to improve banks’ resilience to acute short term stress and to improve longer term funding; and

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• Introducing additional capital buffers for the most systemically important institutions to address the issue of “too big to fail.”

The implementation period for Basel III capital requirements starts from 1 January 2013 and includes transitional arrangements until 1 January 2019. The transitional arrangements are available to give banks time to meet the higher standards, while still supporting lending to the economy. The liquidity requirements, leverage ratio and systemic surcharges come into force in a phased approach starting from 2015. The implementation of these rules will, therefore, be assessed later6 and are not covered in this report.

Design of the Committee’s Basel III Implementation Review Programme In January 2012, the Group of Central Bank Governors and Heads of Supervision (GHOS), the Basel Committee’s oversight body, endorsed the comprehensive process proposed by the Committee to monitor members’ implementation of Basel III. The process consists of the following three levels of review: • Level 1: ensuring the timely adoption of Basel III; • Level 2: ensuring regulatory consistency with Basel III; and • Level 3: ensuring consistency of outcomes (initially focusing on risk-weighted assets). The Basel Committee has published three “Level 1” progress reports. It has completed a “Level 2” review of Japan, and has released preliminary reports on the European Union and the United States.

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In addition, it has commenced an assessment of Singapore. The Committee’s “Level 3” reviews are conducting detailed assessments of banks’ models to compute capital charges for the banking and trading book, based on test portfolios, information obtained from questionnaires and visits to individual banks. The Basel Committee has worked in close collaboration with the Financial Stability Board, (FSB) given the FSB’s role in coordinating the monitoring of implementation of regulatory reforms. The Committee designed its programme to be consistent with the FSB’s Coordination Framework for Monitoring the Implementation of Financial Reforms (CFIM) agreed by the G20. The objectives and the process of each of the three levels of review are as follows.

Level 1: Timely adoption of Basel III The objective of the “Level 1” assessment is to ensure that Basel III is transformed into domestic regulations according to the agreed international timelines. It does not include the review of the content or substance of the domestic rules. Each Basel Committee member jurisdiction’s status is reported in a simple table. Separately, the Financial Stability Institute (FSI) of the Bank for International Settlements is surveying non-Basel Committee member countries and has published the results.

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Level 2: Regulatory consistency The objective of the “Level 2” assessments is to ensure compliance of domestic regulations with the international minimum requirements. The Level 2 assessments are conducted by teams of 6-7 specialists with a diverse range of technical skills from independent jurisdictions. The reviews take place over a period of six months and include a detailed self-assessment, on-site visits and an assessment of the materiality of divergences. Multiple layers of cross-checking and peer review exist to ensure a fair and rigorous process and consistent treatment across reviews. All Basel Committee members will be assessed over time. The Committee decided to prioritise its reviews, focusing first on the home jurisdictions of global systemically important banks (G-SIBs). The first three reviews of the draft regulations in the European Union and the United States, and final rules in Japan have been concluded in September and the reports are available on the BIS website.

Level 3: Risk-weighted assets consistency The objective of the “Level 3” assessments is to ensure that the outcomes of the rules are in line with the intended policy objectives in practice across banks and jurisdictions. It extends the scope of Levels 1 and 2, both of which focus on national rules and regulations, to supervisory implementation at the bank level. The Committee has established two expert groups, one for the banking book and one for the trading book.

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These groups are identifying and analysing areas of material variability and inconsistencies in the calculation of risk-weighted assets (RWAs, or the denominator of the Basel capital ratio). Depending on the outcome, the work may result in policy recommendations to address identified inconsistencies.

Progress and findings to date Level 1 Basel II, which was due to come into force from end 2006, has been implemented in full by three-quarters of member jurisdictions. Of the five countries that have not yet fully implemented Basel II, two are home countries of G-SIBs – China and the United States. Both countries are in the process of assessing their banks’ progress toward meeting all the qualifying criteria for the advanced approaches. The other countries that are still in the process of implementing Basel II are Argentina, Indonesia and Russia. Basel 2.5, which was due to be implemented by Basel Committee members by end 2011, has been implemented by 20 of the 27 member jurisdictions. China, Saudi Arabia and the United States have issued final regulations for Basel 2.5 that come into effect from 1 January 2013. Basel III regulations are due to come into effect from 1 January 2013. While progress can be observed, only eight of the 27 Basel Committee member jurisdictions have thus far issued final regulations – Australia, China, Hong Kong SAR, India, Japan, Saudi Arabia, Singapore and Switzerland.

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This means there is now a high probability that just six of the 29 global systemically important banks identified by the FSB in November 2011 will be subject to Basel III regulations from the globally agreed start date.

Level 2 The assessment of the European Union analysed the 5th Danish compromise versions of the Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD4). The assessment judged 12 of the 14 key components as either “compliant” or “largely compliant”. A “materially non-compliant” rating was assigned in two areas: Definition of capital and internal ratings-based (IRB) approach to credit risk. The review identified a number of areas of material (or potentially material) deviation in the draft regulations relating to the definition of capital, which are described in more detail in the report. For IRB credit risk, the material finding relates to the “permanent partial use” which allows IRB banks to risk-weight sovereign exposures according to the standardised approach (eg subject those claims denominated and funded in local currency to a 0% risk weight). A subsequent review will take place on the final regulations once available. It should be noted that the European Commission disagrees with these conclusions and believes that the findings overstate the degree of divergence from the Basel standards and that the section gradings have not been assigned consistently across jurisdictions. The assessment of Japan was based on final regulations that will come into force from end March 2013 in line with the end of the fiscal year in Japan.

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Each of the 13 key components was assessed as either “compliant” or “largely compliant.” For capital buffers (capital conservation and countercyclical), the domestic rules are not yet in place and hence the finding is “not yet assessed.” The Japanese authorities plan to issue the rules by 2015, ie one year before the 2016 deadline. The overall grade of “compliant” is based on three facts/observations (i) The number of gaps is relatively low, (ii) Gaps were found to be non-material, both in isolation and in aggregate, and (iii) The review recognised secondary legislation as generally binding. The assessment of the United States was based on final rules implementing advanced approaches, the final rule on market risk and three notices of proposed rulemaking (NPRs) issued in June 2012. The assessment has highlighted the overarching issue of prolonged parallel run for banks on the advanced IRB and the advanced measurement approach (AMA), the only available options for credit and operational risk in the United States. At the time of the report, none of the core US banks had received permission to exit the transitional parallel run. As a result, US banks continue to determine their capital requirements based primarily on the Basel I framework, and the review noted there is little incentive for some core banks to move onto the more advanced approaches. The US assessment team judged 12 of the 13 key components as “compliant” or “largely compliant”.

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A “materially non-compliant” rating was assigned to securitisation exposures. It was noted that the US regulatory agencies’ proposed implementation must conform with the prohibition on the use of external credit ratings, as required by the Dodd-Frank Act. The US authorities were unable to demonstrate that their alternative formulation of the rules would not result in weaker capital requirements than the Basel requirements. This will be subject to further follow-up analysis once final rules are in place. The US authorities believe that the US implementation of securitisation is likely to be at least as robust as the Basel standards.

Level 3 Analysis of risk-weighted assets in the banking book The Committee is also evaluating sources of material differences in risk-weighted assets (RWAs) across banks in the banking book. The Committee is assessing the extent to which differences in credit risk parameters based on the IRB approach for credit risk are driven by differences in risk levels or differences in practices – in the latter case the Committee will discuss whether the variations are consistent with relevant Basel standards.

Review of existing studies The Committee has reviewed a wide range of existing analyses of RWAs across banks and countries to assess methodologies and identify possible drivers of RWA differences. The various studies highlighted many potential drivers, most of which suggested that RWA differences are driven by both risk-based and

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practice-based factors, although the relative focus on different drivers vary and no study could pinpoint the definitive causes of RWA differences. The review highlighted important lessons for the Committee’s own analytical work: • There is a need to carry out both top-down and bottom-up analyses while recognising the limitations of each method; • Better analysis would be facilitated by using more complete (including non-public) data sources, and by collecting new and better data directly from selected banks; and • An assessment of differences in specific practices by banks, national supervisors, and other sources such as accounting standards authorities can help better identify and understand ultimate drivers of RWA differences.

Top-down analysis Drawing on these lessons, the Committee is undertaking further top-down analysis using supervisory data collected by the Committee as part of ongoing capital monitoring. The analysis covers 56 large, internationally active banking organisations and 44 non-internationally active banking organisations in 15 jurisdictions. Preliminary findings indicate that corporate and retail exposures are the largest contributors to credit RWA and show the greatest variability in portfolio risk-weights across banks and countries. Risk-weights for bank and sovereign exposures may vary significantly across banks as well, but these asset classes are less significant contributors to credit RWA variations because of their low absolute risk-weights.

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Probability of default (PD) appears to be a significant source of RWA variability for the corporate, bank and sovereign asset classes. Loss given default (LGD) appears to be the more important risk parameter for the retail asset class, although LGD also is an important contributor to RWA variability for corporates.

Bottom-up portfolio benchmarking The Committee is also conducting a bottom-up portfolio benchmarking exercise using a test portfolio of common exposures to supplement its top-down analysis. Thirty-three banks from 13 jurisdictions participated in the exercise by reporting PD and LGD estimates for a set of sovereign, bank, and corporate exposures. The data submitted by the banks is being reviewed to assess the variability of PD and LGD estimates across banks for common obligors and exposures.

Range of practices and on-site visits Recognising the importance of overlaying the analytical work with an assessment of differences in bank and regulatory practices, the Committee has developed a list of potentially important practice-based drivers of RWA differences. This work draws on existing supervisory knowledge and judgement of the significance and prevalence of different practices. Based on this initial list of drivers and taking into account the preliminary findings from the top-down analysis, the Committee has identified certain risk measures (like probability of default) as areas where thematic reviews would be fruitful.

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Depending on the results of these thematic reviews as well as the top-down and bottom-up analytical work, there may be a need to conduct more focused reviews of practices through on-site visits to banks in 2013.

Future direction In early 2013, the Committee expects a final report summarising all findings regarding the relative importance of various sources and drivers of RWA variation, as well as the extent to which RWA differences do or do not reflect underlying differences in risk. Based on the conclusions of the work, the Committee may consider changes related to reporting and disclosure, as well as possible narrowing of the range of practices in some areas. Finally, the Committee will consider recommendations or options for ongoing monitoring and supervisory activities to foster RWA consistency in the future.

Analysis of risk-weighted assets in the trading book The Committee is working on completing the analysis of variability of market risk measures across banks. The analysis is primarily based on publicly available information, but also considers the variability of supervisory data. Furthermore a test portfolio exercise has been undertaken, in which 15 large, internationally active banks participated. The Committee expects to publish some results of this analysis by the end of this year.

Publicly available information and supervisory data The analysis based on publicly available information so far reveals material differences in the ratio of the regulatory measure of market risk

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(market-risk RWA or mRWA) to total trading assets across the selected sample. To the extent that such differences are driven by differences in risk taking – for example as a result of differences in business models or trading strategies – the variation should not be a cause for concern. An analysis of the composition of trading assets provides some support to this view, as it shows that banks with a higher ratio of mRWA to total trading assets typically have a greater proportion of risky trading assets on the balance sheet, including distressed debt and illiquid equity. However, even after addressing these factors, there remains material unexplained variation in mRWA across banks. Other possible factors that might explain such a variation are: • Differences in supervisory approaches (such as the timing of Basel 2.5 adoption); • Differences in the use of capital add-ons or multipliers; • Methodological choices; or • The degree of reliance of banks on internal model approaches versus standardised approaches. A key finding is that data available in public information generally does not appear sufficient to fully explain the variation in mRWA across banks, nor to explain the variation in mRWA for a single bank over time. Limits to the detail of public disclosure can be explained by banks’ desire to keep their trading strategies and positions private for competitive reasons. However these shortcomings in disclosure make cross-bank comparison difficult.

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Some banks provide more detailed and useful disclosures than others and minimal guidance across jurisdictions adds to inconsistencies in content. In some jurisdictions, Basel II Pillar 3 reports were not available for the analysis. The Committee is therefore considering broadening its analysis to investigate the utility of consistent supervisory data in explaining differences in mRWA. An initial finding is that supervisory data collection, while consistent within jurisdictions, is not consistent across jurisdictions. Some jurisdictions collect only limited additional data for supervisory purposes. It must be noted, however, that in some jurisdictions efforts are underway to improve the regulatory data collection related to banks’ trading books. These supervisory efforts may suggest options for more consistent patterns of disclosure across banks.

Test portfolio exercise To further examine the modelling choices that potentially drive differences in mRWA, the Committee conducted a test portfolio exercise. The test portfolios and accompanying questionnaires were designed to cover a range of trading portfolios and trading strategies, which closely represented but were generally less complex than banks’ actual portfolios and trading strategies. A total of 15 large, internationally active banks from nine jurisdictions participated in the exercise. The participating banks calculated for each hypothetical test portfolio the outcome of their internally modelled risk measures and provided detailed

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information regarding their modelling assumptions through supplemental questionnaires. This allowed the Committee to identify modelling choices that drive potential variation in mRWA. To investigate the results in more detail, a programme of on-site visits was initiated in which 9 participating banks were visited by international teams of supervisors. The objective of the visits was to gain further understanding of the market risk models that the banks use and to investigate in more detail the causes of variability identified across banks. The initial results from the test portfolio exercise suggest there is generally less variability observed for internal models that have been in use for a long time. In addition, the variability is generally less for models where there are more regulatory constraints.

Next steps The Committee will further elaborate on the initial findings and possible policy options. Regarding the analysis of public data, one expectation of the outcome of this exercise could be suggestions related to improvements in public disclosures for mRWA calculations. With regard to the analysis of the test portfolio exercise, a final quantification of the level of variability of each internal model for each portfolio in the exercise is expected. The findings will also serve as input for the Committee’s current fundamental review of the trading book.

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The analysis suggests that there is a direct relationship between complexity of risk metric/product and the associated variability of the metric across banks. The current test portfolio exercise was based on a set of plain vanilla portfolios and excluded the most complex market risk models that are used by banks. The Committee believes it is important to consider more complex products and models in a future exercise. A follow-up test portfolio exercise including more complex portfolios is therefore being considered for 2013.

Further work Level 1 The Committee will continue to publish progress reports every six months. The next report will be published in April 2013 showing the position as at end March 2013.

Level 2 A Level 2 assessment of Singapore is underway and the report will be published in April 2013. A review of Switzerland will commence in early 2013 followed by China in the second quarter. Reviews of Australia, Brazil and Canada will commence in the second half of 2013. Follow-up reviews of the European Union and the United States will commence after final regulations are published and will cover the final rules in their entirety.

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The reviews will assess whether identified gaps have been rectified but will also check for issues that were not present in the draft regulations. At present, the Committee is conducting a “lessons learnt” review to reflect on the experience of the first three Level 2 reviews.

Level 3 Findings of the Level 3 assessments for the banking book and trading book will be reported to the Committee around the end of 2012 or early 2013. Further analysis will be conducted in 2013, and, subject to decisions at a later stage, will continue on an ongoing basis. Further policy development work may be necessary to address the findings.

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Agencies Issue Statement on Supervisory Practices Regarding Financial Institutions and Borrowers Affected by Hurricane Sandy WASHINGTON--The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (the agencies) recognize the serious impact of Hurricane Sandy on the customers and operations of many financial institutions and will provide regulatory assistance to affected institutions subject to their supervision. The agencies encourage institutions in the affected areas to meet the financial services needs of their communities. A complete list of the affected disaster areas can be found at www.fema.gov. Lending: Bankers should work constructively with borrowers in communities affected by Hurricane Sandy. The agencies realize that the effects of natural disasters on local businesses and individuals are often transitory, and prudent efforts to adjust or alter terms on existing loans in affected areas should not be subject to examiner criticism. In supervising institutions affected by the hurricane, the agencies will consider the unusual circumstances they face. The agencies recognize that efforts to work with borrowers in communities under stress can be consistent with safe-and-sound banking practices as well as in the public interest.

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Community Reinvestment Act (CRA): Financial institutions may receive CRA consideration for community development loans, investments, or services that revitalize or stabilize federally designated disaster areas in their assessment areas or in the states or regions that include their assessment areas. For additional information, institutions should review the Interagency Questions and Answers Regarding Community Reinvestment (PDF). Investments: Bankers should monitor municipal securities and loans affected by the hurricane. The agencies realize local government projects may be negatively affected. Appropriate monitoring and prudent efforts to stabilize such investments are encouraged. Reporting Requirements: Institutions affected by Hurricane Sandy that expect to encounter difficulty submitting accurate and timely regulatory report data for the September 30, 2012, report date should contact their primary federal regulatory agency to discuss their situation. These regulatory reports include the Consolidated Reports of Condition and Income (Call Report) and holding company Y reports. The agencies do not expect to assess penalties or take other supervisory action against institutions that take reasonable and prudent steps to comply with regulatory reporting requirements if those institutions are unable to fully satisfy those requirements by the specified filing deadlines because of the effects of Hurricane Sandy. The agencies' staffs stand ready to work with affected institutions that may be experiencing problems fulfilling their reporting responsibilities, taking into account each institution's particular circumstances, including the status of its reporting and recordkeeping systems and the condition of its underlying financial records. Publishing Requirements: The agencies understand that the damage caused by the hurricane may affect compliance with publishing and other requirements for branch closings, relocations, and temporary facilities under various laws and regulations.

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Institutions experiencing disaster-related difficulties in complying with any publishing or other requirements should contact their primary federal regulatory agency. Temporary Banking Facilities: The agencies understand that many banks face power, telecommunications, staffing and other challenges in re-opening facilities after the hurricane. In cases where operational challenges persist, the appropriate primary federal regulator will expedite any request to operate temporary banking facilities to provide more convenient availability of services to those affected by the hurricane. In most cases, a telephone notice to the primary federal regulator will suffice initially. Necessary written notification can be submitted later.

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The Recovery and Monetary Policy William C. Dudley, President and Chief Executive Officer Remarks at the National Association for Business Economics Annual Meeting, New York City Good morning. It is a pleasure to have the opportunity to speak at this NABE (National Association for Business Economics) conference today. Having spent more than 20 years as a business economist working in the private sector before joining the Federal Reserve Bank of New York in 2007, I feel right at home here today. My remarks will focus on the economic outlook. I do this with some trepidation, of course. In the private sector there are two adages about forecasting that underscore the need to be humble in this endeavor: First, forecast often. Second, specify a level or a time horizon, but never specify both, together. But more seriously, despite the difficulties in making accurate forecasts, we still need to understand as best we can why the economy is performing the way it is, what that implies about the economic outlook, and, how policymakers can respond to generate better outcomes. We live in a highly complex and uncertain world, but we need to make as much sense out of it as possible.

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As always, what I have to say reflects my own views and not necessarily those of the FOMC (Federal Open Market Committee) or the Federal Reserve System. My attention today will be on three important questions: Why has the U.S. recovery been so sluggish and consistently weaker than expected? What should we, as monetary policymakers, do it about it? What other policy actions are needed to help ensure a timely transition to strong and sustainable growth? The disappointing recovery Turning to the first question, U.S. economic growth has been quite sluggish in recent years. For example, annualized real GDP (gross domestic product) growth has averaged only about 2.2 percent since the end of the recession in 2009. As a consequence, we have seen only modest improvement in the U.S. labor market. Not only has growth been slow, it has also been disappointing relative to the forecasters' expectations. For example, the Blue Chip Consensus have been persistently too optimistic in recent years. This is illustrated in Exhibit 1 which shows how private sector forecasts for 2008 through 2013 have evolved over time.

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Two aspects of this exhibit are noteworthy. First, forecasters have consistently expected the U.S. economy to gather momentum over time. Second, with only one exception, the growth forecasts for each year have been revised downward over time, as the expected strengthening did not materialize. In contrast, as shown in Exhibit 2, there has been no notable pattern of forecast misses for inflation.

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Sometimes, inflation has been a bit higher than expected, other times a bit lower. On balance, inflation has been very close to our 2 percent longer-run objective. Although I have focused on the private forecasting record here, the FOMC participants' forecasts show a similar pattern. It is on the growth side where there have been chronic, systematic misses. In my view, the primary reason for the poor performance of the U.S. economy over this period has been inadequate aggregate demand. There are several explanations for this. Although some were well-known earlier, others have only become more obvious as the recovery has unfolded.

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One reason is the nature of economic recoveries following financial crises. On that basis, the poor performance of the U.S. economy is not unusual—historical experience shows clearly that recoveries following financial crises typically are very slow and difficult. During the credit boom, finance is available on easy terms and the economy builds up excesses in terms of leverage and risk-taking. When the bust arrives, credit availability drops sharply and financial deleveraging occurs. Wealth falls sharply, precautionary liquidity demands increase, desired leverage drops further. In the U.S. case, there were some idiosyncratic elements, such as subprime lending and collateralized debt obligations. But, in the end, the U.S. experience included the major elements of most booms: Too much leverage, too little understanding of risk, too easy credit terms, and then a very sharp reversal. When the bust arrives, over-indebted households and businesses want to increase their saving and liquidity buffers, and financial intermediaries want to raise credit standards. Both responses restrain demand and make a cyclical rebound more difficult. In the U.S. case, because the bust was concentrated in housing, the scope for a strong cyclical recovery was particularly constrained because the interest-rate sensitive sector that would typically lead such a rebound could not recover until the overhang of unsold homes and the impairment of housing finances was corrected. The U.S. recovery has also been subpar because it has been taking place in the context of a weak global economy.

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Historically, after a country experienced a financial crisis, growing foreign demand and currency depreciation have often led to a sharp improvement in the trade account that has put a floor under economic activity. In such circumstances, rising exports substitute for domestic consumption in supporting aggregate demand. This demand, in turn, encourages businesses to hire and invest. In contrast, this time the shock generated by the U.S. housing bust had global consequences, exposing economic vulnerabilities outside of the United States, especially in Europe. Under these circumstances, the scope for trade as a support for U.S. growth, while positive, has been very limited. These two factors—the dynamics following financial crises and the weakness of foreign demand—help explain why U.S. growth has been weak, but I don't think these factors explain why it has been consistently weaker than expected. After all, on the other side of the ledger, the policy response following the crisis has been much more aggressive than is typical. On the monetary policy side, the Federal Reserve cut short-term interest rates close to zero, communicated that short-term rates were likely to stay exceptionally low far into the future, and undertook a series of large-scale asset purchases in order to ease financial conditions further. On the fiscal side, in 2009 the Congress and Administration enacted the largest fiscal stimulus program in history and some of these fiscal actions were renewed (e.g., extended unemployment compensation benefits) and new initiatives undertaken (e.g., the payroll tax holiday) once it became clear that the recovery was faltering.

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Also, there were significant policy actions taken to strengthen the banking system, including forcing banks to recapitalize so that they would have the capacity to sustain their lending. So why has the recovery disappointed? One possibility is that the negative dynamics of a post-bubble environment are even more potent than had been appreciated. Feedback loops may be more powerful and frictions may be larger. In the U.S. case, this is particularly germane with respect to housing and mortgage finance. For example, we have found significant shortcomings in those institutional structures available to support the workout of the overhang of mortgage debt in an efficient and timely manner. A second reason may be the series of additional negative shocks experienced since the initial phase of the financial crisis. The largest of these relate to the crisis in the eurozone. But one could also add the periodic commodity price shocks, the disruptive impact of the tragic Japanese earthquake and tsunami on global trade and production, and the effect of the uncertainties around the impending fiscal cliff on hiring and investing. That said, the shocks since the acute phase of the crisis in the United States were not uniformly negative. Take, for example, the sharp increase in U.S. oil and natural gas production stemming, in part, from the innovations in drilling and extraction technologies. Not only does this rising production directly boost real GDP, but also the large drop in natural gas prices has significantly improved the industrial competitiveness of U.S.-based businesses.

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A third reason for the weaker than expected recovery likely lies in the interplay between secular and cyclical factors. In particular, I believe that demographic factors have played a role in restraining the recovery. The developed world's populations are aging rapidly. In the United States, for example, the baby boom generation, which is a particularly large cohort, is now beginning to retire. As the population ages, this has two consequences. First, the spending decisions of the older age cohorts are less likely to be easily stimulated by monetary policy. That is because such age groups tend to spend less of their incomes on consumer durables and housing. Second, as the population ages and the number of retirees climbs, the costs associated with Social Security, government pensions, and healthcare retirement benefits increase. This creates budgetary pressure and leads to a choice of raising revenue to fund these costs, cutting other government programs, or cutting benefits. Now if this all had been fully anticipated by retirees and near-retirees, then this would already be factored into their spending and saving decisions. But, I doubt that this has been the case. I suspect that many have been surprised by the swift change in economic circumstances as the housing boom went bust. I doubt that many fully anticipated the budget crunch and the prospect that their future retiree and healthcare benefits would likely be curbed or their taxes would have to rise in the future.

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When households begin to anticipate this, they reduce their assessment of their sustainable living standards. This downward reassessment then feeds back to current spending and saving decisions. A fourth reason why the recovery has been slower than expected may be that we overestimated the capacity for fiscal policy to continue to provide support to growth until a vigorous recovery was achieved. On the fiscal side, the authorities can cut taxes or increase spending to support income and demand during the deleveraging phase that follows the financial crisis. But the ability of such stimulus to continue to support economic activity ultimately encounters budgetary limits. For example, the need to keep the long-term fiscal trajectory on a sustainable path limits the size and duration of federal fiscal stimulus measures. For state and local governments, the statutory requirements for balanced budgets meant that fiscal policies turned restrictive relatively quickly once budget surpluses and rainy day funds were exhausted, and this was only temporarily mitigated by federal transfers to the states as part of the initial fiscal stimulus program. Fiscal policy is now a drag rather than a support to growth in the United States, and this will likely continue. Monetary policy I would give each of these four explanations some weight for why the recovery has been consistently weaker than expected. But I would add a fifth, monetary policy, while highly accommodative by historic standards, may still not have been sufficiently accommodative given the economic circumstances. Now let me be clear.

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I believe the evidence overwhelmingly indicates that our monetary policy has been effective in easing financial conditions and supporting economic activity. After reducing the traditional policy tool, the target for the overnight federal funds rate, to close to zero, the Fed has aggressively employed two complementary types of non-traditional tools—asset purchases and forward guidance on the policy rate—to provide additional stimulus through their effects on long term rates and various risk premia. Effective forward guidance on interest rates causes market participants to lower their expectations and uncertainty about future path of interest rates and to anticipate that easier financial conditions will persist well in to the future. This pushes down the yield curve and leads to easier financial conditions. Federal Reserve asset purchases also make financial conditions more accommodative. Such purchases, by taking duration out of private hands, push down term premia and lead to lower long-term rates than would otherwise be the case for any given economic outlook. Agency MBS (mortgage-backed securities) purchases absorb prepayment risk and reduce secondary and primary mortgage rates, stimulating demand for housing and increasing purchasing power through refinancing. Lower long-term rates support the prices of equities and housing, boosting wealth and easing balance sheet constraints, while an accommodative monetary policy stance reduces downside risks for the economy and this leads to lower default risk premia on corporate debt. Our two tools work in a complementary manner.

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Asset purchases strengthen the credibility of the forward guidance on interest rates, while forward guidance provides information about how long the FOMC is likely to hold on to the assets it purchases. My conclusion is that the easing of financial conditions resulting from non-traditional policy actions has had a material effect on both nominal and real growth and has demonstrably reduced the risk of particularly adverse outcomes. Nevertheless, I also conclude that, with the benefit of hindsight, monetary policy needed to be still more aggressive. Consequently, it was appropriate to recalibrate our policy stance, which is what happened at the last FOMC meeting. As I argued in a recent speech, simple policy rules, including the most popular versions of the Taylor Rule, understate the degree of monetary support that may be required to achieve a given set of economic objectives in a post-financial crisis world. That is because such rules typically do not adjust for factors such as a time-varying neutral real interest rate, elevated risk spreads, or impaired transmission channels that can undercut the power of monetary policy. One reason that monetary policy may have been less powerful than normal is that one of the primary channels through which monetary policy influences the real economy—housing finance—has been partially impaired. This has both quantity and price dimensions. Credit availability to households with lower-rated credit scores remains limited and households with homes that have fallen sharply in value have lost most or all of their home equity and this makes it very difficult for them to refinance these mortgages. Federal Reserve MBS purchases have succeeded in driving down mortgage rates to historically low levels.

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But these purchases would have had still more effect on the economy if pass-through rates from the secondary market to the primary market had been higher. As can be seen in Exhibit 3, the Federal Reserve's purchases significantly narrowed the spread between agency MBS and Treasury yields, with the latest round of purchases notably effective in this regard.

But, as shown in Exhibit 4 the spread between primary mortgage rates and agency MBS yields has widened and this has limited the drop in primary mortgage rates.

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The incomplete pass-through from agency MBS yields into primary mortgage rates is due to several factors—including a concentration of mortgage origination volumes at a few key financial institutions and mortgage rep and warranty requirements that discourage lending for home purchases and make financial institutions reluctant to refinance mortgages that have been originated elsewhere. On a related note, higher guarantee fees charges by Fannie Mae and Freddie Mac have increased the fixed cost of originating loans and this has also increased the spread between primary and secondary mortgage rates. Factors limiting pass-through warrant ongoing attention from policymakers. Another reason why monetary policy has become less effective in stimulating the economy is because the impetus from a given level of monetary accommodation likely has become attenuated—that is, less powerful—over time.

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Historically, attenuation has not been important because monetary policy typically has not stayed exceptionally easy for long periods of time. But this time is different and that difference may be important. So how might the monetary policy impulse on economic activity have become attenuated over time? I would suggest two potential channels. The first channel is that monetary policy works, in part, by changing the timing of purchase decisions. If interest rates decline, the drop in financing costs may induce some households to buy a motor vehicle or purchase a home now rather than in the future. Of course, if the car or home is purchased today, this will borrow at least a portion of those sales from the future. There is a limit to how many cars and homes most people will want to buy, given their budget constraints. In this case, as the stimulus from the policy stays in place, the impulse on economic growth will gradually "wear off" as there are fewer and fewer households who can be induced to pull their future planned purchases forward to the present. The same argument applies to mortgage refinancing activity. The stimulus comes from the refinancing activity, which increases the amount of income that borrowers have available for other expenditures. The impetus to growth wears off unless mortgage rates keep dropping, stimulating additional rounds of refinancing activity. The second channel is that low interest rates will gradually reduce the interest income of savers and this could eventually affect their consumption.

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Household interest income has fallen considerably over the past few years. This effect is likely to work quite slowly. The fact that interest rates are low for six months or a year probably does not have much impact on households' expectations of their long-term interest income and thus, does not have much of an impact on consumer spending. But, as low interest rates are sustained, this could eventually lead to a downward adjustment in households' assessments of their interest income over time and influence their spending. One way to look at this is through the prism of forward real interest rates. If interest rate expectations many years forward have fallen, then expectations about the permanent level of interest income should have declined as well. As shown in Exhibit 5, forward real rates five years ahead have declined notably over the past few years.

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This could be a reasonable proxy for savers' expectations. Note that the decline in Exhibit 5 has not been precipitous, it has occurred very gradually over time. However, policymaking is about making choices between available alternatives. In the long run, even savers would be better off in a world in which aggressive monetary policy generates a strengthening recovery that eventually permits the normalization of interest rates, than they would be compared to a circumstance in which the United States allowed itself to fall into a Japan-style trap of low growth and low rates for decades. So I do not view the effect of low rates on savers as a reason to be less accommodative. Rather, in my view, the potential for the monetary policy impulse to be attenuated over time, is an additional reason to be aggressive in terms of the policy response.

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A more front-loaded program would avoid greater attenuation compared with a policy that started out less aggressive but added stimulus gradually over time. This has two benefits. First, it would likely be more successful in generating the desired recovery more quickly. Second, relative to a more back-loaded program, less would ultimately need to be done to achieve the desired set of outcomes. The fact that there are asymmetric payoffs from an economy that is weaker than expected versus one that is stronger than expected, given that we are at the zero lower bound reinforces this conclusion. In particular, if the economy were to continue to underperform, and experienced a severe shock, there would be some risk of getting stuck in a deflationary situation in which monetary policy would be even less effective. At the present time there is no conflict between our employment objective and our inflation objective, as I expect inflation to be at or below our 2 percent longer-run objective over the coming years. But shouldn't we also consider the costs associated with a more aggressive monetary policy of the kind adopted at the last FOMC meeting, especially when we are using non-traditional monetary policy tools? Absolutely. We have carefully evaluated three potential sets of costs and will continue to review them. The first set of costs stems from the risk that the current monetary policy regime could distort asset allocations and lead to renewed financial asset bubbles. We look at this issue on an ongoing basis.

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To date, there is little evidence of problems or excesses, but this could change as the recovery proceeds. If these costs were to rise, we would need to examine what steps could be taken on the macro-prudential front in response. Also, such developments would need to be incorporated into the monetary policy decision-making process. The second set of costs stems from the risk that exit from this regime could prove difficult. In particular, some observers worry that the expansion of the Federal Reserve's balance sheet could ultimately prove inflationary. If that were the case, then I would regard the costs as exceptionally high. Fortunately, I am confident that such fears are misplaced. That is because we now have the ability to pay interest on excess reserves (IOER). This means we can keep inflation in check regardless the size of our balance sheet. If the recovery got underway in earnest and credit demand surged, we could slow down the rate of credit creation by raising the interest rate we pay on excess reserves. Banks wouldn't lend out funds at lower rates than what they can earn from holding reserves with us. As a result, a hike in the IOER would raise the level of interest rates throughout the economy and this would dampen any expansion of credit. Our ability to pay interest on excess reserves is an essential tool that we can use to avoid future inflation problems.

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We are mindful of the fact that there could still be confusion about how exit will take place. This could increase financial market volatility. To reduce this risk, the FOMC has published a set of exit principles. These principles lay out a roadmap about how exit is likely to occur: First, the end of reinvestment of maturing securities; second, an increase in short-term interest rates, and, third, the gradual sale of mortgage backed securities to shrink the magnitude of excess reserves in the system and ultimately to restore the Fed's balance sheet to a predominately all-Treasury portfolio. A degree of humility is appropriate given the lack of experience as to how markets will respond when economic conditions eventually cause investors to anticipate exit. When asset purchases are anticipated to end or when asset sales begin to be anticipated, this will affect term premia in ways that cannot be precisely predicted in advance. That said, I do expect the repricing will prove manageable. We will seek to communicate so as to avoid generating sharp shifts in term premia and in long-term interest rates. Also, we will play close attention to ensure that financial institutions are managing their interest rate risks appropriately. The third set of costs is the impact of higher short-term rates on the Federal Reserve's earnings and balance sheet when exit occurs. When we ultimately raise short-term interest rates, this will squeeze the Fed's net interest margin.

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Also, when the Fed sells long-term assets, there is some prospect for losses on these sales depending on the level of long-term interest rates at the time when such sales occur. This means that the Fed's earning could fall sharply or even turn negative in a given year. We look at this issue very closely to understand the risks here. The good news is that a very large proportion of our liabilities—those associated with currency outstanding—has no interest cost. This mitigates the risk of a sharp net interest margin squeeze. Moreover, our analysis shows that the cumulative income generated over the period in which the balance sheet has been unusually large is likely to exceed normal levels under a wide range of scenarios. In my view, while the costs are real and need to be carefully evaluated, they pale relative to the costs of not achieving a sustainable economic recovery. A failure in that regard would lead to widespread chronic unemployment. Not only would that be tragic for millions of people, but it also would generate chronic shortfalls in the nation's potential output and fiscal capacity. Relative to the costs outlined above, the benefits from avoiding such an outcome seem overwhelming. Cyclical and structural policy Although I favor an aggressive monetary policy in the current situation, I also recognize that monetary policy is not a panacea. We all know that in the long run money is neutral—that is, that while monetary policy can help the economy return to full employment

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following a shock, the full employment level of output, employment and real income depends on factors outside of monetary policy. Also, we must recognize that the strength of the current cyclical recovery will depend importantly on non-monetary policy choices. Other steps are needed to secure the best available economic outcome. In particular, attention should be paid to what could be done to capitalize on the recent stabilization in house prices to improve access to mortgage credit and to foster competition in mortgage origination to ensure a more complete pass-through of low secondary mortgage rates to households. Indeed, if balance sheet dynamics are more important and frictions around housing more powerful than we initially understood, then there should be strong payoff to policies that ease them. At the same time, Congress and the White House should take steps that reduce the short-term and long-term uncertainty over fiscal policy. Currently, households and businesses face elevated short-term uncertainty as to what will happen to tax and spending policies in 2013 and how this will affect the economic outlook. I believe this is restraining hiring and investment today. But families and businesses also face long-term uncertainty about how the country's fiscal challenges will be addressed. Providing greater clarity about the scope and terms of Social Security and Medicare must be helpful, especially in correcting those expectations that are unduly pessimistic. On this score, Social Security is particularly noteworthy. According to a 2011 Pew Research Center poll, more than 40 percent of people aged 18 to 30 believe they will receive no retirement income from Social Security, even though Social Security receipts are estimated to equal about 75 percent of benefits on a sustainable basis under the current regime.

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Congress and the White House should enact a fiscal program that starts with mild restraint, but credibly builds that restraint over time so as to put the nation's debt burden on a clearly sustainable course. Ideally, the program would have broad bipartisan support and provide clarity not just on the near-term outlook, but also about how the major entitlement programs would be adjusted. Also, steps could be taken to increase the productive capacity of the economy over time. Such actions are desirable because a more productive economy will generate higher living standards and have greater fiscal capacity. Let me briefly mention a few steps that could be taken to increase the economy's potential over time—immigration policies that attract workers with scarce skills to the United States; education policies and job retraining programs that build and replenish human capital; spending on infrastructure to remove bottlenecks; tax simplification and the elimination of tax policies that distort investment and saving decisions; regulatory policies that are attentive to costs and benefits and that emphasize getting the incentives right. Counter-cyclical policies and structural policies are not substitutes, they are complements. We need both. The strength of demand today is importantly influenced by expectations about future living standards. The lower the expected path of national income, the less favorable the distribution of that income is expected to be, and the greater the uncertainty over the mix of tax rates and benefits a person or business expects to pay and receive, the less they will spend or invest today. Thus, policies that improve the long-run outlook make a cyclical recovery easier to achieve today.

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Conversely, a monetary policy that promotes a cyclical recovery supports the economy's long-run prospects. Left for too long, long term unemployment will eventually lead to permanent atrophying of skills that will restrain the economy's growth potential. This is also true for the cohort of young workers who are stuck in jobs for which they are overqualified and who are having trouble securing the professional experience that would make them increasingly productive over time. Although the outlook for the U.S. economy remains somewhat cloudy as we look into 2013, I remain a long-run optimist about where we are headed. The long term prospects of the U.S. economy are excellent. The United States leads the world in higher education, technology and innovation and has recently acquired new comparative advantages in energy. We have an exceptionally dynamic labor market, high rates of entrepreneurialism, competitive product markets, and a well-capitalized financial system that relentlessly reallocates capital from one sector to the next in search of higher returns. Even over the next few years, while there are significant downside risks relating to the fiscal cliff and the eurozone, it is possible that the recovery could turn out stronger than expected. The underlying process of balance sheet repair is considerably advanced, housing is recovering and, as that occurs, our newly recalibrated monetary policy could gain additional traction. Thus, if uncertainties about the U.S. fiscal path and the future of the eurozone were resolved in a constructive manner, growth could pick up more vigorously than anticipated.

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This would be a wonderful outcome. The September FOMC statement noted: the Committee expects "that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the recovery strengthens." Consistent with this, if we were to see some good news on growth I would not expect us to respond in a hasty manner. Only as we became confident that the recovery was securely established, would I expect our monetary policy stance to evolve to ensure that it remained appropriate to achievement of our objective: maximum sustainable employment in the context of price stability. Thank you for your kind attention. I would welcome a few questions.

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Conflicts of Interest and Risk Governance Carlo V. di Florio Director, Office of Compliance Inspections and Examinations National Society of Compliance Professionals Thank you for inviting me to speak at this event. Your efforts to strengthen compliance and ethics throughout the private sector are profoundly important. Today I would like to address a topic of perpetual importance to all aspects of compliance and ethics programs, conflicts of interest. I will begin by explaining what I mean by a “conflict of interest,” discuss why conflicts of interest are of particular interest to the Securities and Exchange Commission, and what the SEC and other regulators are currently focusing on regarding conflicts of interest. I will then turn to the role of risk management and risk controls within firms in identifying and managing conflicts of interest, especially the significance of managing conflicts of interest for the criteria laid out in SEC and FINRA compliance program rules and the U.S. Federal Sentencing Guidelines on effective compliance and ethics programs. Of course I begin by noting that views I express here today are my own and do not necessarily reflect the views of the Commission or of my colleagues on the staff of the Commission.

I. Regulators' Interest in Conflicts of Interest. Why are conflicts of interest so important to the Commission’s exam program?

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The National Exam Program (“NEP”) has adopted a risk-based strategy, and we have identified conflicts of interest as a key area for our risk analysis. This is based on the long experience of our exam program that conflicts of interest, when not eliminated or properly mitigated, are a leading indicator of significant regulatory issues for individual firms, and sometimes even systemic risk for the entire financial system. Accordingly, we focus on conflicts of interest as an integral part of our assessment of which firms to examine, what issues to focus on, and how closely to scrutinize. In addition, over the past two years we conducted a sweep on conflicts of interest around confidential information received through investment banking and other business operations, and have just issued a report on that sweep which I will discuss in a few minutes. We also try to flag conflicts of interest that we have identified in our National Examination Risk Alerts and other public statements. Other regulators have a similarly keen focus on conflicts of interest. For example, FINRA is currently conducting a sweep exam of its member firms concerning their efforts to identify and manage conflicts of interest.

II. Conflicts of Interest and the Federal Securities Laws. Last year at this event I spoke about the ways in which ethics underpinned the federal securities regulatory regime. So I should begin by tying ethics to conflicts of interest. If you will forgive me for a possible metaphorical overreach, one can think of ethical concepts as the white blood cells that make an organization’s “immune system” – its compliance and risk management systems and culture – effective.

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Extending that same metaphor, conflicts of interest can be thought of as the viruses that threaten the organization’s wellbeing. As in the microbial world, these viruses come in a vast array of constantly mutating formats, and if not eliminated or neutralized, even the simplest virus is a mortal threat to the body. Especially when combined with the wrong culture and incentives, conflicts of interest can do great harm. This is why the Commission’s National Exam Program (“NEP”) has identified conflicts of interest as a key focus of its risk-based strategy the past few years. Accordingly, conflicts of interest are an integral part of our assessment of which firms to examine, what issues to focus on, and how to examine those issues. What is a “conflict of interest”? It is hardly a term of art. A simple Google search shows that it is used in varying ways in different contexts. I prefer to think of a conflict of interest as a scenario where a person or firm has an incentive to serve one interest at the expense of another interest or obligation. This might mean serving the interest of the firm over that of a client, or serving the interest of one client over other clients, or an employee or group of employees serving their own interests over those of the firm or its clients. This way of thinking about conflicts takes the discussion to a broad consideration of what is the right thing to do as a matter of law and ethical decision-making.

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It also recognizes that there are reputational risks that can be damaging or even fatal to a business organization when people or firms make decisions that may be technically within the letter of the law, but are not in keeping with the spirit of the law and hard to explain to the constituencies with which they must keep faith, such as customers, creditors, investors, or employees. This rubric is useful as far as it goes, but really just about any bad behavior can be explained in terms of conflicts of interest. The types of conflicts that I find most challenging are situations where people who profess to be ethical and clear-thinking are led astray by cultural pressure (poor tone at the top), misaligned financial incentives, herd behavior (everybody else is doing it), or just personal weaknesses –vanity, self-delusion or poor judgment. The best antidote for this type of conflict is a strong ethics program for the organization, as well as a strong internalized sense of ethics by everyone in an organization, manifested in their ability – especially executives, business managers, compliance officers and lawyers – to think independently, rigorously, and objectively. Conflicts of interest exist throughout the commercial world. They are a particularly important challenge for large and complex financial institutions, which can have affiliations that lead to a host of potential conflicts of interest. If these are not carefully managed, this then leads to failure to protect the client’s interests, with attendant regulatory and reputational risks that could be disastrous. Just as important, these businesses are highly dynamic, as new products, activities and trading strategies constantly evolve to meet changing client needs and market conditions.

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This means that new conflicts are constantly arising, and so these firms need to be very disciplined in continually searching for new conflicts and working through how to address them. In addition, approaches to remediating existing conflicts may also require regular reconsideration as circumstances change. Failure to manage conflicts of interest has been a continuing theme of financial crises and scandals since before the inception of the federal securities laws. During the early 1930s, the Pecora hearings held by the Senate Committee on Banking and Currency revealed a vast array of self-dealing and other conflicts of interest throughout the financial markets, such as the use of bank loans to support bank affiliates and affiliate-underwritten securities, and incentives on the part of banks to give investment advice that supported affiliate-underwritten securities. As described by former SEC Chairman Arthur Levitt, “Bank involvement in the securities markets came under close scrutiny after the 1929 market crash. The Pecora hearings of 1933, which focused on the causes of the crash and the subsequent banking crisis, uncovered a wide range of abusive practices on the part of banks and bank affiliates. These included a variety of conflicts of interest; the underwriting of unsound securities in order to pay off bad bank loans; and "pool operations" to support the price of bank stocks.” Chairman Levitt went on to point out that these revelations of uncontrolled conflicts of interest provided much of the impetus for enactment of the Securities Act of 1933 and the Securities Exchange Act of 1934, and the Glass-Steagall Banking Act of 1933. Conflicts of interest were also a strong impetus for the Investment Company Act of 1940 and the Investment Advisor Act of 1940.

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Recent decades have seen numerous examples of conflicts leading to crisis. The 1980s were marked by insider trading scandals such as the Ivan Boesky and Dennis Levine scandals, as well as the demise of the investment bank Drexel Burnham Lambert and the criminal conviction of its star employee Michael Milken following federal civil and criminal charges related largely to Milken’s dealings with Boesky. The 1990s and early 2000s exposed yet more financial scandals. The bursting of the internet bubble in 2000 and 2001 exposed problems with conflicted research analysts who appeared to be influenced in their reports by their firms’ investment banking interests, leading to new regulations of research by FINRA and to provisions in the Sarbanes-Oxley Act dealing with research analyst conflicts of interest. In 2003 the Commission staff “found that the use of brokerage commissions to facilitate the sales of fund shares [was] widespread among funds that rely on broker-dealers to sell fund shares, resulting in the adoption of new rules to prohibit funds from this practice.”5 The financial crisis of 2008 could itself be the basis of a seminar on conflicts of interest. The crisis exposed apparent conflicts of interest in many areas, particularly in the production and sale of mortgage-backed securities, and among credit rating agencies that rated these instruments. For example, as the Financial Crisis Inquiry Commission (“FCIC”) noted in its report, in 2007 the SEC investigated conflicts of interest among rating agencies in evaluating collateralized debt obligation (“CDO”) deals, and issued a report in June 2008 citing conflicts at Moody’s as a major concern. The FCIC report cited many other purported conflicts underlying the crisis, including underwriters assisting CDO managers in selecting collateral, hedge fund managers selecting collateral from their funds to

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place in CDOs that they offered to other investors, and a conflict faced by Citigroup in offering “liquidity puts” that offered it significant fees in the short term but placed significant financial risk on it in the long term. Another prominent recent example is the settlement that the SEC reached with Goldman Sachs, in which that firm paid $550 million to settle charges filed by the Commission, and acknowledged that disclosures made in marketing a subprime mortgage product contained incomplete information as they did not disclose the role of a hedge fund client who was taking the opposite side of the trade in the selection of the CDO. Even since the financial crisis, another illustration of the problems that arise from poorly controlled conflicts of interest arose just this past summer, when Barclays Bank entered into civil and criminal settlements with U.S. and U.K. officials in which it admitted to misconduct related to possible collusion to fix the benchmark London Interbank Offered Rate (“LIBOR”). LIBOR is a critically important benchmark that is used to set short-term interest rates on many derivatives and other financial instruments. The SEC and its staff have a long tradition of focusing on conflicts of interest. As one example, in 2003 then-SEC enforcement director Steven Cutler gave an important speech on the topic of conflicts of interest in 2003 that was a call to action for the financial services industry to institutionalize its controls around conflicts of interest and to monitor and control conflicts at a senior level. Since Cutler’s speech, I believe that the disastrous events leading to the financial crisis of 2008 are further support for the SEC’s concern about properly managing conflicts of interest. It is important to recognize that regulators also have an obligation to be diligent about identifying and addressing conflicts of interest as they emerge.

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When our examination program identifies conduct that may create new risks for the industry, we share our concerns so that senior management, compliance and risk managers are not taken by surprise. One important vehicle by which we communicate key risks, such as conflicts of interest, is through our Risk Alerts, which we began issuing last year. These documents are a window through which we want to offer the public and the financial services industry a view on key risks and to share effective risk management practices that we have observed. These include conflicts of interest that we want to highlight, as well as practices that we have observed to control or mitigate conflicts. I want to also stress that the effective practices that we describe in the risk alert are for informational purposes and do not represent new legal or regulatory requirements. The Commission also recently released a public report of examinations conducted by the NEP, FINRA and the NYSE regarding large broker-dealers’ compliance with the information barriers requirement of Exchange Act Section 15(g). The report illustrates the types of conflicts of interest between a broker-dealer’s obligations toward clients and other business interests that need to be identified and effectively managed in order to satisfy its obligation under Section 15(g) to “establish, maintain and enforce written policies and procedures reasonably designed… to prevent the misuse … of material nonpublic information” by the firm or its associated persons. For example, the report explains that certain groups within broker-dealers routinely engage in discussions with corporate insiders in order to provide advice on strategic activities and financial management issues: these groups include investment banking departments, capital markets or syndicate groups that facilitate capital raising; and derivative sales groups.

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Moreover, certain groups within broker-dealers, such as sales, trading, stock lending or prime brokerage, may obtain non-public information regarding their institutional clients, such as order and position information. Such information, provided on a confidential basis to facilitate services provided to customers, could be misused to further the interests of the broker-dealer, either by giving it an unfair advantage in trading or enabling it to issue research reports based on such information. In addition to discussing possible conflicts of interest between different business units or activities, the report also discusses situations and activities that can give rise to conflicts of interest, such as when a broker-dealer gives an “above-the-wall” classification to certain individuals or groups with the ability to influence trading. The staff was concerned that despite the conflict between their business responsibilities and receipt of material non-public information, the broker-dealers did not impose mitigating controls such as physical barriers, documentation or monitoring on that individual or group. Conflicts that are also an ongoing key focus of the Commission’s National Exam Program as we plan our examinations. Some of the conflicts of interest that are currently a high priority for our examinations include: Compensation-Related Conflicts and Incentives: Retail customers' interests potentially taking a back seat to various financial incentives of a broker-dealer or its representatives in recommendations and sales practices for new or risky products. This includes, for example, the retailization of complex instruments such as structured securities products. It also includes aggressive marketing of retirement products, and whether adequate due diligence is being performed on underlying investment vehicles;

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Lack of oversight of outside business activities of representatives; Incentives to place investors in accounts with fee structures that are high relative to the services provided, such as certain investment adviser or wrap fee accounts; Portfolio Management-Related Conflicts: Investment advisers that prefer one client over another when managing multiple accounts side-by-side, due to financial incentives or personal relationships; Portfolio management activities by fund advisers that involve risks beyond the risk tolerance levels or stated objectives in the prospectus, such as overconcentration in a single issuer or sector, purchasing illiquid securities that appear to deliver higher returns, or a mismatch of fund liquidity to an expectation of fund redemptions; Affiliations between investment advisers and broker-dealers: Whether the client is put into an IA or BD account and the incentives associated with that decision; Incentives of an investment adviser to use an affiliated broker-dealer for executing a client's trade even though the price or other terms of the execution are substandard; Valuation: Incentives of broker-dealers' and investment advisers to provide high marks in pricing relatively illiquid positions; Inflating valuations to attract investors and charge more fees; Transfer agent conflicts: Conflicting incentives where a transfer agents' principals are owners of or affiliated with issuers, vendors, or others involved in the transfer agents' activities (e.g., attorneys, brokers, etc.);

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Exchange conflicts: With regard to exchanges and self-regulatory organizations, blurred lines between SRO business and regulatory functions - for example, conflicts when an official with business-side responsibilities is also involved in regulatory oversight, where he or she may be in a position to affect the performance of competitors; and The conflict between an exchange's responsibilities as an SRO and its business incentive to attract order flow from particular members. In addition to the high-profile cases that I mentioned earlier, conflicts of interest are at the heart of many cases that the Commission brings on a routine basis. For example, just last month the Commission brought a settled administrative proceeding against Focus Point Solutions and the H Group, two Oregon-based investment advisory firms and their owner regarding their failure to disclose compensation through a revenue-sharing agreement and other potential conflicts of interest to clients. As the Commission stated in its press release: “Most notably, Focus Point did not disclose to customers that it was receiving revenue-sharing payments from a brokerage firm that managed a particular category of mutual funds being recommended to Focus Point clients. Because Focus Point received a percentage of every dollar that its clients invested in these mutual funds, there was an incentive to recommend these funds over other investment opportunities in order to generate additional revenue for the firm.” An even more current example came in the past week when, in a joint effort among the enforcement and examination staffs together with the Division of Risk, Strategy and Financial Innovation, the Commission charged a former $1 billion hedge fund advisory firm, Yorkville Advisors

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LLC, and two of its executives with “scheming to overvalue assets under management and exaggerate the reported returns of hedge funds they managed in order to hide losses and increase the fees collected from investors.” The Commission alleged that the defendants “enticed pension funds and other investors to invest in their hedge funds by falsely portraying Yorkville as a firm that managed a highly-collateralized investment portfolio and employed a robust valuation procedure.” This is the latest of seven cases that the Commission has brought from its Aberrational Performance Inquiry, an initiative in which the staff uses proprietary risk analytics to identify hedge funds with suspicious returns. This is proving to be a very effective tool for the staff to identify significant conflicts among private fund registrants, and to use that information to target both examination and enforcement resources. Of course the Commission is not the only financial regulator that is concerned about the management of conflicts of interest in the financial services industry. Other financial regulators also frequently focus on this issue. For example, the Financial Industry Regulatory Authority (“FINRA”) recently announced that it is currently conducting a targeted sweep examination of a number of firms on their approach to identifying and mitigating conflicts of interest, including an identification by each firm of the most significant conflicts that it is currently managing and the processes that the firm has in place to identify and assess whether any of its business practices put the firm’s or its employee’s interests ahead of those of customers. FINRA has explained that the goal of the sweep is to better understand industry practices in this area, and that it will seek to develop potential guidance for the industry based on what it learns from the sweep. Another current initiative by a fellow regulator is the recent publication by the Municipal Securities Rulemaking Board (MSRB”) of a concept

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proposal for public disclosure on its Electronic Municipal Access (“EMMA”) system of certain payments and receipts by brokers, dealers and municipal securities dealers, as well as municipal advisors, of certain financial incentives, such as third-party payments, that may create conflicts of interest. According to the MSRB, this proposal follows a number of civil and criminal prosecutions involving alleged fraudulent activities relating to municipal securities offerings in which undisclosed third-party payments played a role. Given the centrality that controlling conflicts of interest has to the integrity of our financial markets, it is not surprising that managing conflicts has been a key focus of both statutory changes and new rules by the Commission. The Dodd –Frank Act contains numerous provisions relating to conflicts of interest. For example, Title VII contains a number of provisions that explicitly address conflicts of interest in the derivatives market. Similarly, Title IX of the Act requires the Commission to write rules prohibiting or restricting sales practices, conflicts of interest, and compensation schemes for broker-dealers and investment advisers that the Commission deems contrary to the public interest and the protection of investors.

III. Effective Practices for Managing Conflicts of Interest. Turning from how regulators approach conflicts to how firms can assess and mitigate conflicts, I believe that an effective conflicts risk governance framework includes three broad considerations. 1. The first is that there needs to be an effective process, led by a cross-functional leadership team, to identify and understand all conflicts in the business model. These conflicts need to be understood both in

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terms of their practical business implications as wells as in relation to relevant legal standards. This includes a recognition that conflicts are dynamic, and that in addition to continually scanning for new conflicts, each and every conflict that has been identified and addressed needs to be revisited periodically to determine if it is still being appropriately controlled in light of new business circumstances, changing customer profiles, new regulatory obligations, etc. For instance, in our exams of how firms protect material non-public information (MNPI) from inappropriate uses, such as insider trading, we have observed instances where firm programs lagged behind new business strategies that created new sources of MNPI. While the business model evolved, the control framework did not and that exposed these firms to significant risks. It is also important to risk-assess and prioritize which conflicts of interest present the greatest risk to the organization so that resources can be allocated accordingly to mitigate and manage those conflicts effectively both from a compliance risk and reputation risk perspective. 2. The second broad consideration, I believe, is to have a good compliance and ethics program tailored to address the conflicts of interest the firm has identified and prioritized. This is a topic of concern to every broker-dealer and investment adviser, given their supervisory obligations under the federal securities laws. Under the securities laws, registrants are expected to have effective written policies and procedures to prevent violations of the securities laws, and to periodically review the adequacy and effectiveness of those policies and procedures. For instance Rule 206(4)-7 under the Investment Advisors Act and Rule 38a-1 under the Investment Company Act establish such requirements for investment advisors and investment companies. Similar requirements

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also exist for broker-dealers under FINRA rules.19 In my view in order to be adequate and effective these compliance and supervisory policies and procedures must include processes to identify, assess, mitigate and manage conflicts of interest. In addition, for reference purposes the U.S. Federal Sentencing Guidelines (“Guidelines”) since 2004 have provided helpful guidance on many of the key elements of an effective compliance program. The 2004 and 2010 amendments to the Guidelines, as you know, explicitly require an effective compliance and ethics program as a mitigating factor in determining criminal sentences for corporations. The Guidelines list seven factors that are minimally required. I would like to examine each of these factors in turn, and explain how I believe it relates to effectively managing conflicts of interest. I believe that this analysis is also very germane to whether broker-dealers and investment advisers have met their supervisory obligations under the federal securities laws.

Standards and procedures The Guidelines look to companies to “establish standards and procedures to prevent and detect criminal conduct.” The scope of what this may require depends on the size of the organization, as the commentary to the Guidelines suggests, with larger organizations expected to have more formal operations and resources than smaller ones. However, I believe that for any organization, developing a strong process for identifying and managing conflicts of interest is a key means of preventing and detecting not just criminal conduct, but other behavior that may create regulatory or reputational risks for the business. Since new conflicts of interest can arise rapidly as a business grows and evolves, and may become apparent to front-line employees before they

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come to the attention of more senior managers or control functions, communications about these standards and procedures are also an opportunity to emphasize to all employees the importance of their role in recognizing new conflicts of interest, and their responsibility to elevate such conflicts to appropriate control functions. Some firms enhance this process by including conflicts assessment within other processes, such as new product or business approval, conduct customer surveys for potential conflicts, or conduct periodic or ad hoc self-assessments of their business practices.

Oversight The second factor is that the organization’s “governing authority” – typically a board of directors and senior management -- is knowledgeable about the content and operation of the compliance and ethics program and exercises reasonable oversight with respect to its implementation and effectiveness. In order to complement this oversight, some firms establish standing committees, composed of senior executives and senior control personnel, with focused responsibility on conflicts assessment. I believe that, in the financial services world, unremediated conflicts of interest are a leading indicator of the types of problems that a compliance and ethics program is intended to root out. Therefore, I find it difficult to see how the governance structure of a financial services firm can satisfy this factor unless its oversight includes consideration of the effectiveness of the compliance and ethics program in addressing conflicts of interest.

Leadership consistent with effective ethics and compliance program The third factor is that the organization use reasonable efforts to exclude from any position of leadership any individual who has engaged in

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conduct inconsistent with an effective compliance and ethics program – in other words, that the fox is not guarding the henhouse. Again, in my view it would be difficult for a financial services firm could satisfy this standard if any of its business unit heads or senior managers has not shown a commitment to proactively identifying and remediating conflicts of interest in the business model of the organization.

Education and Training The fourth factor is that the organization take reasonable steps to periodically train and otherwise communicate with its leadership, employees and agents about its compliance and ethics program, including its standards and procedures for implementing the program. It follows from what I have already said that, in my view, this training and other communication should include communication about the responsibilities of everyone in the organization regarding identifying, escalating and remediating conflicts of interest. It should be tailored to specific conflicts in the business model and clearly set forth the governance, risk management and compliance procedures to mitigate and manage these conflicts.

Auditing and Monitoring. The fifth factor is to take reasonable steps to ensure that the compliance and ethics program is followed, including monitoring and auditing, as well as periodic testing of the effectiveness of the program, and to have and publicize a system by which employees and agents of the organization can report or seek guidance regarding potential criminal conduct without fear of retaliation. Some firms will discuss with legal and compliance issues prior to a review and then report on issues discovered to any designated conflicts review authority.

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For financial service firms, this auditing, monitoring and testing should, in my view, encompass testing of the effectiveness of the organization’s policies and procedures regarding management of conflicts of interest.

Incentives and discipline The sixth factor is whether the organization has appropriate incentives to support the compliance and ethics program, and appropriate disciplinary measures for failing to take reasonable steps to prevent or detect criminal conduct. I believe that this factor, especially as it relates to incentives, goes to the heart of many problematic conflicts, since these often may involve incentives that an individual has that are inconsistent with duties that he or she owes to the organization, its clients or his or her customers.

Response and prevention The final factor is whether the organization takes reasonable steps to respond to any criminal conduct and to prevent its recurrence, including making any necessary modifications to its compliance and ethics program. In the case of a financial institution, I would think that this response would include a consideration of any conflicts of interest that may have incentivized or otherwise facilitated the bad conduct, and consideration of how any such conflicts can more effectively be barred or remediated. Some firms go further, not only analyzing their weaknesses, but also issues identified at other firms so that the same problems do not happen at their establishment. 3. The third consideration, in my view, is that this process for addressing conflicts of interest is fully integrated in the firm’s overall risk governance structure. The business is the first line of defense responsible for taking, managing and supervising conflicts of interest, like other risks, effectively and in

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accordance with laws, regulations and the risk appetite set by the board and senior management of the whole organization. Key risk and control functions, such as compliance, ethics and risk management, are the second line of defense. They need to have adequate resources, independence, standing and authority to implement effective programs and objectively monitor and escalate conflicts of interest and other risk issues. Internal Audit is the third line of defense and is responsible for providing independent verification and assurance that controls are in place and operating effectively to address conflicts of interest. Finally, senior management and the board of directors need to be engaged. This includes considering the risk that conflicts of interest present throughout key business processes, including strategic planning, capital allocation, performance monitoring and evaluation of business units and individual business leaders. Some of the more effective practices I have observed include having key risk and control functions involved in each of these key processes with senior management and the board so they can provide their independent view on how business units and individual business leaders are doing at managing conflicts and promoting a culture of compliance and ethics. Let me close with a few brief observations for senior managers and independent directors. I believe that your role in conflicts management and ensuring a culture of compliance and ethics is critically important. At the end of the day, managing conflicts is much more than just having a strong compliance program, although that is obviously critical.

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It also requires establishing a culture that, regardless of regulatory requirements, does not tolerate conduct that casts doubt on the organization’s commitment to high ethical standards, and that values the firm’s long-term reputation over any possible short-term benefit from exploiting its clients or customers. Former SEC Chairman Richard Breeden said it best when he stated that “[i]t is not an adequate ethical standard to aspire to get through the day without being indicted.” In addition, while it is undoubtedly helpful to have certain individuals or groups who are tasked with specific roles regarding mitigating conflicts, the responsibility of everyone in the organization to identify conflicts and see that they are managed appropriately should always be emphasized. As leaders in your organizations, that responsibility starts with you. Finally, it is important to think proactively when it comes to conflicts of interest. As I mentioned earlier, in the financial services industry, and likely in other types of organizations as well, conflicts of interest are continually arising in new forms that need to be addressed aggressively and with vision and foresight. Where conflicts of interest are concerned, eternal vigilance and independent oversight are warranted in order to protect an institution’s reputation and brand.

Conclusion Thank you for your attention. I am now happy to answer any questions you may have on this topic.

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Commission Work Programme 2013 Today's absolute imperative is to tackle the economic crisis and put the EU back on the road to sustainable growth. This is the number one task for this generation of Europeans. It calls for a Europe able to compete in the global economy, reshaped to seize the opportunities of the future. It requires the stable macroeconomic environment which true economic and monetary union can bring. It needs a step change in the economy, to release the many strengths Europe can bring to bear in tomorrow's economy of high innovation and high skills. This demands changes to the business environment in the Single Market; it requires that the huge potential of Europe's networks and of the IT revolution is fully exploited; it calls for new skills and help so that those shut out of the labour market today can make their contribution; and it must be shaped by the needs and opportunities of resource efficiency. These are long-term challenges calling for a concerted effort from all sections of society – but in all cases, the EU contribution is a precondition for success. This is why, in the State of the Union address, President Barroso called for new thinking for Europe – to draw the consequences of the challenges we are now facing and that are fundamentally changing our world. There can be no growth without reform and no way of confronting our challenges unless we do it together.

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The State of the Union speech launched ambitious ideas for the long term framing of the EU – a deep and genuine economic union, based on a political union. This vision must be translated into practice through concrete steps, if it is to address the lingering crisis that continues to engulf Europe, and the Euro Area in particular. This 2013 Work Programme sets out the long term vision of what the EU might look like in key policy areas, summarises what is missing today and explains how the Commission will tackle these challenges. By prioritising the right kind of initiatives, the EU can contribute to growth and job creation and can step by step move closer to its longer term vision. The Commission has already tabled a wide range of growth enhancing proposals which are now being negotiated by the co-legislators. Timely adoption and full implementation of these measures would send a crucial signal of confidence to citizens and to investors, helping to reinvigorate economic activity and stimulating much needed job creation. It would add up to a major record of EU action before the June 2014 European Parliament elections. In 2013 the Commission will devote much effort to implementation as an immediate way of delivering on the benefits of EU action. Following the decisions to be taken on the multi-annual financial framework by the end of 2012, during 2013 the Commission will focus on finalizing arrangements for rapid implementation, including through the use of country-specific negotiation mandates to ensure that the priorities supported through EU-funded investment are clearly targeted on growth and jobs. Targeted investment supported by a modern, proreform EU budget can make a decisive contribution to growth, jobs and competitiveness.

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The proposals in this work programme will be tabled during 2013 and in the first part of 2014, bearing in mind the end of the current legislature. In the following sections some of the key action is highlighted to show how the Commission will contribute to filling in the gaps between the EU's objectives and the current situation.

Getting the foundations right: towards genuine Economic and Monetary Union The objective Europe's strength lies in the interconnection of our economies. The single market and the common currency have driven this forward, and the integrated economic policy making at the European level through the European semester is now drawing our economies together as never before. However, the crisis has shown that the single market for financial services can only deliver financial stability, economic growth and jobs if it is matched with a strong single regulatory and supervisory authority at EU level. The next step must be to deepen economic and monetary union with a fully-functioning banking and fiscal union.

What is missing today? A genuine EMU needs a comprehensive approach to tackle the vicious circle of excessive private sector indebtedness, unsustainable sovereign debt and banking sector weakness. The EU lacks a global framework which fills in the gaps in a fully integrated financial services policy, with a single supervisory mechanism for banks and a single rule book to govern all financial institutions.

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It also needs to complete and implement the more effective mechanisms put forward to prevent and correct unsustainable fiscal policies and economic imbalances. Better coordination of tax policies will also be crucial. The progress made through the European semester has also not yet reached its potential in terms of carrying through recommendations into structural reforms in the EU. While not yet complete, our economic governance has already been thoroughly reinforced through the Europe 2020 Strategy, the European Semester, and the implementation of the Six-Pack legislation. Agreement on the Two-Pack legislation is urgent in order to complete further the economic governance. In 2013 the Commission will: - Launch the fourth European Semester through the Annual Growth

Survey; - Follow up on the blueprint for a comprehensive and genuine EMU

which it will publish before the end of 2012; - Propose additional legislation to further enhance stability,

transparency and consumer protection in the financial sector (for example, on the systemic risks related to nonbanks and shadow banking).

The legislation already in place and now being considered adds up to a fundamental reshaping of the EU's financial system. Agreement on banking supervision will put the European financial system on far more secure foundations and act as a springboard for confidence.

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2013 will see the implementation of many of the detailed rules of this package. The same is true for cohesion policy, where the key priorities for growth-enhancing measures and structural reforms brought out in the European semester will be put at the core of new national and regional programmes and where the focus will be on the finalisation of the country-specific mandates for the next generation of structural funds. The Commission will also take action to fight tax fraud and evasion, including an initiative on tax havens, bringing the EU dimension to bear on national efforts to consolidate public finances.

Boosting competitiveness through the Single Market and industrial policy The objective Sustainable growth and job creation need to combine a stable macro-economic environment with the ability to compete in the global economy. Europe has strengths which can give it a competitive edge through a modernised social market economy and can help it to take the lead in the new industrial revolution. The Single Market and fair competition can come together with targeted investment and the right approach to entrepreneurship to exploit the opportunities for growth through new technologies and innovation.

What is missing today? The Single Market needs to continue to adapt to reach the potential for businesses and consumers in a borderless Europe.

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Technological change offers huge possibilities, but it needs to be accompanied by new approaches in areas like procurement, standards, and intellectual property. The EU needs a long-term framework for energy and climate policies so that investment and policy target competitiveness and tackle climate change. Europe falls short on innovation, with obstacles to building new markets and investing in the technologies that will change the way we live, as well as wider issues of attitudes to entrepreneurship and business failure. It also needs the right legal framework to move Galileo towards commercial operations. This is exacerbated by the problems faced by companies, in particular SMEs, in accessing finance in the wake of the crisis, as well as the unnecessary costs of administrative burdens and the impact of some outdated public administrations. Shortcomings in implementation also hold back the full benefits. The recent Single Market Act-II set out 12 new concrete priority actions, to reenergise the Single Market around four main drivers: networks, mobility, the digital economy and cohesion. Following up on its 2012 Communication on a new industrial policy, the Commission will take a fresh look at the single market for products, which makes up 75% of intra-EU trade. These actions follow on the priority actions under the first phase of the Single Market Act, which now need to be agreed quickly. The Commission will work hard with the co-legislators in 2013 to bring these proposals to fruition and full and effective implementation. Key proposals will include:

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- Initiatives to align rules and cut the costs of VAT compliance through a single declaration;

- A legislative proposal to make e-invoicing mandatory for public

procurement will facilitate business-to-government interaction, reduce costs and serve as a pilot for other sectors;

- Initiatives to update and simplify the rules for the circulation of

products in the single market, and identify gaps still blocking free circulation, as well as intensified work on standards, certification and labels;

- As part of Horizon 2020, 2013 will see proposals to launch and develop

a range of major public-private partnerships to bring private and public investment together with the EU budget to drive a common approach to key strategic sectors like pharmaceuticals, air traffic management and nanotechnology, leveraging some €9-10 billion in new investment;

- Initiative on energy technologies and innovation to deliver a

sustainable, secure and competitive energy system; - Proposing a series of major reforms to modernise state aid;

- Modernise our approach to intellectual property rights to ensure that

it is effective and consumer-friendly in the digital world. Energy efficiency is a key area for competitiveness. The Commission will reinforce its cooperation with Member States on the implementation of the energy efficiency directive, the energy labelling and ecodesign legislation. Implementing the strategy for Key Enabling Technologies will also be a key lever of competitiveness. The Commission will deepen its work to help SMEs facing the challenge of financing and implement the Action Plan for entrepreneurship.

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Support from the European Regional Development Fund and the COSME programme will be ready to roll out when the new financing period starts in 2014. New programming of the European Social Fund will also include a particular focus on the provision of skills necessary for successful transition from school to work and for increasing employability of the workforce.

Connect to Compete: Building tomorrow's networks today The objective A fully integrated and interconnected European Single Market covering telecoms, energy and transport is a prerequisite for competitiveness, jobs and growth. Achieving this requires affordable, accessible, efficient and secure network infrastructure. Accelerating the roll out of the digital economy will bring benefits across all sectors, through enhanced productivity, efficiency and innovation. Europe must have state-of-the-art digital networks to retain and build its global competitive position, to be able to handle the explosion in internet use and exchange of data and to fully exploit the efficiency gains and innovative services allowed by major online developments. In energy, significant investments in electricity grids and other energy networks will help make energy supplies more secure, sustainable and competitive. On transport, a fully integrated single market and more efficient networks allowing to switch easily between different modes, would bring huge benefits to citizens and companies, including in urban areas.

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What is missing today? National approaches and a variety of barriers hold back competitiveness and prevent the exploitation of networks on a European scale. Investment is not sufficiently galvanised to support projects which will be the bedrock of Europe's future prosperity and is held back by shortcomings in the regulatory environment. This also holds back the potential for innovation in areas like smart grids and meters, and intelligent transport.

A lack of interoperability increases costs and holds back the level playing field.

Gaps in the regulatory framework hold back business investment and consumer confidence in key areas like payments. Gaps in infrastructure create extra costs and inefficiencies for energy consumers, delay modernization of logistics, and prevent the full exploitation of broadband. In order to continue to fill in the missing links in 2013/14, the Commission will make proposals to: - Modernise Europe's transport and logistics to help companies save

time and energy, as well as reduce emissions, through proposals on rail and freight transport, goods traffic between EU ports, and the Single European Sky;

- Tackle the obstacles to electronic payments;

- Support investment in high speed networks;

- Boost the coverage and capacity of broadband by reducing the cost of

its deployment and freeing up band width for wireless broadband.

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Alongside cohesion policy, the Connecting Europe Facility5 will be one of the EU's most obvious contributions to cutting through these obstacles by stimulating infrastructure. 2013 should see the facility up and running and key choices made on targeting. It should also see project bonds being rolled out to help harness private sector investment. This will go hand in hand with consolidating regulation. More needs to be done to achieve a true European transport area with European rules: proposals on connecting up in the rail sector and on accelerating the implementation of the Single European Sky should be taken forward as priorities. In the field of energy, the latest phase of liberalisation towards the completion of the internal energy market by 2014 must be driven through to make Europe's future energy supply sustainable, competitive and secure. A new framework for national interventions in the energy sector will be a core element to ensure that adequate investments are made and that market interventions are necessary and proportionate.

Growth for jobs: Inclusion and excellence The objective Through its capacity to combine growth and inclusiveness, our social market economy is one of Europe's greatest assets. But today its economy and its society face the threat that the grave problems of high unemployment, increased poverty and social exclusion risk becoming structural.

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The EU dimension must be harnessed to assist Member States to find every opportunity to help people looking for work and to address the mismatch between labour supply and demand. This starts with an active employment policy to help them to have the right skills to be employed and which uses the potential of mobility to the full. The goal should be to find innovative ways to increase educational attainment and labour market participation. Adequate and sustainable social policies and more accessible social services are needed to promote social inclusion and entry into the labour market. The job creation potential of key growth sectors, such as the green economy, ICT and health and social care sectors needs to be fully tapped. To maintain its workforce in the longer term perspective of an ageing society, European labour markets need to be inclusive, mobilising employees of all ages and at all level of qualifications.

What is missing today? Public employment services and employers face a major challenge with the scale of unemployment in Europe, in particular among young persons. To boost the employability levels is key to re-launch growth, taking also into consideration vulnerable groups. The potential for job creation in sectors such as the green economy, ICT, health and is not fully exploited. Education and training systems are not keeping up with changing labour market needs – resulting in shortages in key areas like science, mathematics and e-skills.

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Higher education is not sufficiently connected to research and innovation activities and is slow to build capacity in areas like ICT – which both reflects and contributes to a lack of internationalisation. Life-long learning is still developing, and public policy and business practices do not reflect the need for older workers to extend their working careers. Undeclared work creates an extra challenge. Social protection and social investment should be more effective. Vulnerable groups find it particularly difficult to get into or to return to the labour market. And the potential for labour mobility to fill gaps is held back by problems in the recognition of qualifications, documentation and skills across Member States. Supporting Member States' policies on employment and job creation is one of the highest priorities of the European semester. The Commission will continue in 2013 to work actively with Member States and social partners, in particular on the basis of the youth guarantee and traineeship initiatives to be set out later this autumn. In order to continue to fill in the missing links in 2013/14, the Commission will make proposals to: - Help improve the performance of public employment services and

networking between national employment agencies; - Harness social investment for inclusive growth, through guidance for

policy reforms identified in the framework of European semester, supported by the EU funds such as the European Social Fund;

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- Furthering the internationalisation efforts of higher education, to prepare Europeans for an increasingly global, open and competitive labour market;

- Put in place the right framework for the institutions handling

occupational pensions. Obstacles to mobility remain one of the main lost opportunities of the Single Market. Adoption and implementation of the revision of the Professional Qualifications Directive will be an important step to open up professions. Work should continue to examine and reduce unnecessary restrictions for regulated professions limiting the ability of professionals to work in another Member State. Preparing the new generation of programmes under the European Social Fund will be a major goal for 2013, to ensure that this brings the quickest and most effective support to the modernisation of labour market policies and social inclusion policies, strengthening of education and lifelong learning systems, to ensure that groups like young and long-term unemployed have the right skills for the jobs of the future. A wide range of EU programmes will contribute to these goals, including the European Regional Development Fund, Horizon 2020 and Erasmus for all.

Using Europe's resources to compete better The objective Competitiveness today must be geared to competitiveness tomorrow. There is untapped potential for the EU economy to be more innovative, productive and competitive whilst using fewer resources and reducing environmental damage.

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Less waste should be produced and more re-used and recycled in line with the practice of the best performing Member States. Greater resource efficiency would contribute to growth, jobs and enhanced competitiveness, with reduced costs for business as well as significant benefits for health and the environment, lower greenhouse gas emissions, contained energy bills and new opportunities created for innovation and investment. The EU is particularly well-placed to give policy the long-term dimension required.

What is missing today? European society and the European economy do not yet exploit the full potential for resource efficiency. Much recyclable waste is either exported or sent to landfill. A lack of long-term frameworks holds back planning and investment, most obviously on a climate and energy framework beyond 2020, but also on long term sustainable use of key resources such as air, soil, energy, water, fish and biomass. At the same time, such frameworks can help to galvanise the innovation needed to exploit the potential of the transition to a low-carbon economy in areas like transport, energy and agriculture. In order to continue to fill in the missing links in 2013/14 the Commission will make proposals to: - Provide a long-term perspective on how the EU will move ahead from

its 2020 targets to continue the trajectory towards a low-carbon economy through a comprehensive framework for the period to 2030;

- Frame a new strategy on adaptation to climate change to make

Europe more resilient;

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- Review the waste legislation, to look at how new markets and better recycling can contribute to growth;

- Adapt the EU policy framework for air quality.

At the same time, the finalisation of the new generation of agriculture and fisheries policies and regional and rural development programmes will maximise the opportunity to bring together innovation and job creation with a focus on sustainability. The promotion of a resource efficient "blue economy" will help to release the potential of Europe's maritime areas to contribute to growth. 2013 will also bring the start of the 3rd phase of the EU Emission Trading System (2013-2020).

Building a safe and secure Europe The objective The EU needs to protect its citizens and their rights from threats and challenges and further remove obstacles to circulation of citizens in Europe. This includes fighting crime and corruption, controlling our external borders and ensuring the respect of the rule of law and of fundamental rights, with the right balance between security and mobility. It also needs a well functioning and efficient justice system to support growth, entrepreneurship and attract investors. Equally, the EU works to proactively reduce risks to health, food and product safety, critical infrastructures and disasters. Safe and sustainable use of nuclear energy is a key element.

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What is missing today? Threats to safety and security evolve, and the EU's response needs to reflect this by using technology to tackle safety in food or nuclear energy, by working for the swiftest and most effective disaster response and by deepening cooperation in tackling the increasing cross border dimension of crime. Areas like terrorist financing and the cross border traffic in weapons need particular attention. The EU has a particular responsibility to protect its own financial interests against fraud and corruption, but lacks the full institutional framework required. Mutual trust in areas of safety, security and justice needs to be earned, and the networks and exchanges needed to build this are not always present. Vigilance is also needed to ensure that the fundamental rights of citizens in the EU are protected in full. If people and businesses are to take full advantage of their rights, they need easy access to justice, on equal terms in all countries in cases of cross-border litigation. The Commission will make proposals to continue to fill in the missing links: - Establish a European Public Prosecutor's Office to fight against

crimes affecting the EU budget and protect its financial interests; - Fight traffic in firearms;

- Improve judicial cooperation in both criminal and civil matters;

- Revise legislation on nuclear safety and propose new legislation on

nuclear insurance and liability;

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- With 2013 marked as the European Year of Citizens, the Citizenship Report will review progress in ensuring that EU citizens can readily exercise their rights and identify future action.

The Commission will also implement a variety of important initiatives to promote a virtuous circle of cooperation between national administrations and judicial systems. The ongoing work of the Consumer Protection Cooperation network of enforcement authorities is a core tool for practical enforcement. The first anti-corruption report and the first judicial scoreboard will both offer new tools to encourage best practice to be identified and pursued. Agreement on new arrangements for Schengen governance would also give Member States an important new tool to consolidate mutual confidence in common control of borders. Efforts to reinforce application of existing solidarity mechanisms in immigration will be continued.

Pulling our weight: Europe as a global actor The objective The EU's interests and commitment to values of democracy, the rule of law and human rights depend heavily on what happens beyond its borders. Promoting our values in our immediate neighbourhood and beyond is a priority, by building partnerships with third countries and promoting multilateral solutions to common problems. Collectively, the EU is the largest donor of funds for development cooperation, climate finance and humanitarian aid in the world. We are also the world's largest trading partner.

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When we can deploy the Union's and Member States' resources in an effective and consistent way beyond our borders, and bring together the wide range of instruments available, the EU can have greater impact and influence on the world around us. This helps to deliver the goals of growth, stability and democracy and to meet the goals of policies like tackling poverty and boosting peace and security, as well as pursuing policies like addressing climate change, the environment, transport and energy, and optimising the opportunities for international cooperation in areas such as science and technology. In the year of Croatia's accession, the enlargement process and the neighbourhood strategy continue to provide key tools to support positive change in partners on the EU's doorstep.

What is missing today? On the global stage the EU is a key actor; but more can be done to develop a truly unified approach using different strands of policy and different instruments to reinforce each other. The EU should also ensure closer monitoring of the implementation of its commitments, notably as part of the support provided to countries in transition in its neighbourhood. The external dimension is integral to promoting growth and competitiveness in 2013 and beyond. The EU is pursuing a bilateral trade and investment agenda of unprecedented ambition to complement its efforts at the multilateral level. Negotiations are close to conclusion with such important partners as Canada, Singapore and India, and will hopefully soon be launched with Japan.

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The final recommendations of the EU-US High Level Group on Jobs and Growth may also pave the way for negotiations on an ambitious and comprehensive transatlantic partnership. Japan and the United States are such key partners that successful agreements with these two countries could add 1-1½% to EU GDP and create almost a million jobs. Such agreements would support multilateral liberalisation and regulatory dialogue, and open new markets for European products and services. Scoping exercises with other partners are currently being conducted. 2013 will see a particular focus on consolidating the rule of law firmly at the centre of enlargement policy, consolidating economic and financial stability and promoting good neighbourly relations and closer regional cooperation in areas like trade, energy and transport. Neighbourhood policy will continue to centre on an incentive driven approach, where EU support for reforms follows a clear progress in building democracy and the respect of human rights. Priorities in 2013 will be the 'Deep and Comprehensive Free Trade Areas', mobility partnerships and visa facilitation. The EU has responded to the rapid change in our neighbourhood through the framework of the revised European Neighbourhood Policy, consolidating the Eastern partnership and launching a partnership for shared democracy and prosperity with the Southern neighbours. Our focus in 2013 with our Southern neighbours will be on implementation and delivery, using innovative ways to mobilise political and economic resources to mutual benefit. As the Millennium Development Goals (MDG) Summit approaches in 2015, the EU is working to fulfil its commitments on development assistance, as well as pursuing specific goals of sustainable growth and resilience in the face of crisis.

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It also continues to pursue key negotiations such as reaching a new international climate agreement by 2015. At the same time, as the new generation of external action instruments is finalised, 2013 will be a key year for ensuring that the EU's new development policy orientation – the Agenda for Change – is mainstreamed throughout our relationship with our partners, with a new focus on good governance, inclusive and sustainable growth and stimulating investment in developing countries. It will also see further steps in ensuring an effective and swift crisis response capacity and developing a comprehensive response to crisis prevention, management and resolution. In order to continue to fill in the missing links in 2013/14 the Commission will make proposals to: - Assuming success in ongoing scoping exercises and in current

preliminary discussions, propose negotiating directives for comprehensive trade and investment agreements with relevant partners;

- Put forward coherent EU positions bringing together the Millennium

Development Goals, the post-2015 development agenda and Rio+20.

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Feedback on comments received from stakeholders to the EBA, EIOPA and ESMA’s Joint Consultation Paper on its proposed response to the European Commission’s Call for Advice on the Fundamental Review of the Financial Conglomerates Directive

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Financial crime: a guide for firms Part 1: A firm’s guide to preventing financial crime

This Guide consolidates FSA guidance on financial crime. It does not contain rules and its contents are not binding. • It provides guidance to firms on steps they can take to reduce their financial crime risk. • The Guide aims to enhance understanding of FSA expectations and help firms to assess the adequacy of their financial crime systems and controls and remedy deficiencies. • It is designed to help firms adopt a more effective, risk-based and outcomes focused approach to mitigating financial crime risk. • The Guide does not include guidance on all the financial crime risks a firm may face. The self-assessment questions and good and poor practice we use in the Guide are not exhaustive. • The good practice examples present ways, but not the only ways, in which firms might comply with applicable rules and requirements. • Similarly, there are many practices we would consider poor that we have not identified as such in the Guide. Some poor practices may be poor enough to breach applicable requirements. • The Guide is not the only source of guidance on financial crime. Firms are reminded that other bodies produce guidance that may also be relevant and useful.

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• Guidance in the Guide should be applied in a risk-based, proportionate way. This includes taking into account the size, nature and complexity of a firm when deciding whether a certain example of good or poor practice is appropriate to its business. • This Guide is not a checklist of things that all firms must do or not do to reduce their financial crime risk, and should not be used as such by firms or FSA supervisors.

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The Irish banking sector – five challenges Address by Mr Matthew Elderfield, Deputy Governor of the Central Bank of Ireland, to the Association of Compliance Officers in Ireland, University College Cork, Cork

Completing the task of fixing the Irish banking system is not an end in itself. A healthy functioning banking system is essential to the economic well-being of Ireland. It is essential for breaking the damaging link between a distressed banking system and weak public finances. And it is important for economic recovery that the banks are once again in a position to lend to small businesses and homeowners. But despite the considerable effort that has gone in to recapitalising, shrinking, restructuring and otherwise reforming the banking system, the process is by no means complete and significant challenges remain. How much longer will this process take and what can be done to speed it up? It may be a source of considerable frustration that this process is not yet over, but considering the severity of the banking crisis in Ireland, compounded with the on-going Eurozone debt crisis, it is perhaps not a surprise. What then are the remaining challenges that need to be tackled to speed up and complete the process of fixing the banks?

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I would highlight such challenges: problem portfolios, balance sheet restructuring, profitability, culture and capital. Let me take some time today to talk about each of these in turn.

Problem portfolios While the banks have transferred their troubled commercial property loans to NAMA (and are selling down their non-core portfolios), they retain their legacy portfolio of mortgage, SME and other assets which have a high level of arrears, impairment and embedded losses. A lot of work has been undertaken to assess the quality of these assets and to ensure both that adequate capital is held against them and that adequate accounting provisions are held (following new guidance from the Central Bank). So, a much greater level of capital has been set aside against the risk of loss and higher levels of prudent provisions are now in place. However, more work remains to be done in order to develop a more precise and clear picture of the performance and degree of embedded losses in these portfolios. This is the first challenge. Efforts to date have involved, in the first instance, a top down estimate of portfolio losses and, more recently with the assistance of Blackrock (a consultant used by the Central Bank), a bottom-up loan by loan loss forecast exercise based on conservative modeling assumptions. But there is a remaining task: a case-by-case re-underwriting, involving where possible recovery and where necessary restructuring, of troubled loans. This is crucially important for a number of reasons.

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While the banks still have uncertainty about the granular performance of their loan portfolios, they will be unsure of the exact capital buffer that is in place and the extent to which they have adequate capital for extreme loss developments. To my mind, this encourages an attitude of hoarding capital and provides disincentives to lending. At the end of the summer, there was much debate around a widely reported Central Bank analysis of lending to the small business sector, where we found that loan rejection rates were significantly higher than other EU jurisdictions, excepting Greece, and which to our mind pointed to supply constraints in the banking sector (in addition to problems over credit quality). Uncertainty about the current loan book and the exact losses that will crystallise (and therefore consume capital) are likely a factor in constraining lending. Absent an exercise of even further recapitalisation, the best option is more specificity and understanding of the performance of the legacy loan portfolios – and an exercise in facing up to losses and modifying loans as necessary. The banks’ mortgage portfolios are a case in point and have involved close attention by the Central Bank. At this event last year, I explained how we were initiating a project to require mortgage arrears resolution strategies from all lenders in Ireland. We received these in November of last year and provided feedback to the banks, highlighting the need for more effort on a number of fronts. One major area of concern was the lack of operational capacity in the banks to deal with customers in arrears so we required senior management to commit to a step change improvement in that capacity.

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The plans we received showed significant improvement and we are continuing to monitor progress closely. We also pressed the banks to work harder to develop specialist strategies for their buy to let portfolios. And, crucially, we insisted that the banks develop a broader range of techniques to deal with loans in arrears, drawing on the ideas of the so-called Keane group. In a slight simplification of the position, the banks were relying heavily on the provision of interest only arrangements or the capitalisation of interest arrears, even though these techniques were clearly unsuitable for a sizeable group of customers with unsustainable mortgages as a result of a severe reduction in income. The banks were required to identify a broader range of techniques, including loan modification arrangements such a split mortgages and the introduction of mortgage to rent schemes, and to pilot these during Q3 of this year. These pilots are now mostly concluded (although are dragging on in one or two cases) and the banks are now in starting the process of rolling out the new arrangements more widely. This process offers the prospect of restructuring loans where necessary to avoid customers continually re-defaulting. The Central Bank has studiously avoided prescribing the detail of the loan modification arrangements adopted by the banks and it must necessarily be for the banks themselves to undertake the case-by-case review of customers that is required. However, I would observe that there is significant variability in the approaches that the banks are taking to loan modification.

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That is natural and understandable, and I would not expect a standard approach across so many different institutions, with different portfolios and different types of owners, for so many different customers. But there are some key parameters in the typical loan modification arrangements that might perhaps merit a close side-by-side comparison in due course. For example, a crucial new technique is that of the provision of a split mortgage. This involves rightsizing the performing part of the mortgage based on affordability, as determined by current income, and warehousing the non-performing part. This is to be welcome, but the treatment of the warehoused element merits close attention. For example, is there shared risk between the bank and the customer regarding this element? And is it realistic that full interest accrues on this warehoused element? As the banks move out of their pilot phase on these new techniques and adopt them in their mortgage arrears resolution strategies, our code in this area requires them to publish full details on their websites. So there will shortly be an opportunity for some comparative analysis of the different arrangements that are being promulgated and therefore some public and customer feedback on the design choices that have been made. One important message today is that these efforts underway for mortgage arrears need to be matched for the banks’ SME portfolios. Earlier in the year, the Central Bank commissioned an in-depth analysis of the leading banks operational capacity for SME loan review, recovery and resolution.

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The results were in many respects dismayingly similar to those regarding mortgage arrears operations. For example, the reviews found the following: limited specialist skills, limited ability to scale up to conduct restructuring and resolution activity, inconsistent quality and depth of financial analysis of borrowers, incomplete financial information collected from borrowers, lack of portfolio segmentation and limited use of KPI’s. More fundamentally, it appeared that portfolios were largely subject to rescheduling and extended forbearance rather than a determined effort to restructure loans and deploy a wide range of workout options. Given the extent to which many SMEs entangled themselves in property investment, there is clearly a difficult task facing the banks. The message from this review work is that here too we need to see a step change in operational capacity and a mindset change in terms of tackling, rather than deferring, problems. So, while we will not be rolling out the same extensive regulatory framework as is in place for mortgages and mortgage arrears (due to the different consumer protection standards that are relevant), a key area of regulatory focus in the coming months will be to press the banks to effectively re-underwrite their SME portfolio and more decisively tackle the challenge of recovering and as necessary restructuring problem loans. The banks need to raise their game on the handling of problem SME loans and the Central Bank intends to press them to do just that.

Balance sheet restructuring The second principle challenge facing the Irish banks is of one of balance sheet restructuring. By this, I mean the process of disposing of certain assets in order to strengthen the financial position of the bank and to shrink the size of the balance sheet so that its funding position is more sustainable.

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(I should note that I haven’t set out funding as one of the principal five challenges, which is perhaps unexpected, but this is on the grounds that improving the banks liquidity position and capacity to fund themselves with reduced reliance on the central bank will flow from successfully addressing the other challenges. And indeed while all these are necessary conditions for improved funding, they are not sufficient, as it is clear that sustained access to wholesale markets – apart perhaps from heavily collateralized transactions such as covered bonds and the like – is only realistically likely to occur after the Irish sovereign has fully returned to the market. So: funding is an important and pressing issue, but one that will only be solved after both the foundations of a stronger banking system and sovereign market access have been re-established.) Ireland has demonstrated strong progress with the challenge of balance sheet restructuring. The first phase of this exercise, as is well known, involved the implementation of NAMA. This allowed the transfer of hard to value and poorly performing commercial property assets out of the banking system to improve the balance sheet strength of the Irish banks. The second phase of this exercise, which is now well progressed, has involved the identification and disposal of so-called non-core portfolios. This has less to do with cleaning out poor quality assets – although there are some in this category – but rather reducing leverage in the balance sheet and reliance on central bank funding, by rightsizing the banks’ balance sheets to a sensible proportion relative to their on-going ability to fund themselves. Progress in the disposal of non-core assets has been impressive, with most banks hitting or exceeding their targets and doing so at a lower cost to capital, by achieving better prices, than had been budgeted in our stress test exercise.

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The environment for asset disposals has, however, been getting more difficult, as the Eurozone crisis has widened and the imperative to deleverage has touched other banks as well. The remaining challenge, then, in this space is to make sure that the asset disposal process remains on track and is concluded successfully. However, the Irish authorities have been keen to emphasise that this process should not be at the expense of fire sale prices, so the current market environment may provide a constraint on the ability to reach the endpoint to a predefined schedule. Should that be the end of balance sheet restructuring? One area of debate is whether it is advisable to undertake a third phase of restructuring involving a select number of banks and certain portions of their core portfolios. The objective here would be to trim back the core balance sheets by identifying poor performing or hard to value mortgage assets for transfer out of the banking system. However, important technical issues remain to be solved regarding the suitable vehicle for these assets, and how that would be funded. In short, there may be an opportunity for a new phase of balance sheet restructuring to provide a further strengthening of the banking system – but this is not yet assured.

Profitability The profitability challenge should, I hope, be obvious. It is important that the banks regain profitability in their core businesses so that they can stand on their own feet and no longer rely on taxpayer support.

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In post-crisis Ireland, where it often seems that regard for the banks among the general public is at an all-time low, the prospect of the institutions which have caused so much economic distress, and required so much taxpayer support, earning ever-increasing profits from their activities is understandably met with dismay by those hard pressed consumers that are being charged more. But it is surely preferable that the banking system is able to operate based on the commercial arrangements it has with its customers rather than continuing to have dependence on government and taxpayer assistance. By breaking the nexus between banks and Government, both will be able to access funds at a cheaper rate driving down costs to both bank customers and the taxpayer. The banking system needs to generate retained earnings to bolster its capital position of its own accord, and therefore needs to re-establish its profitability. How is the profitability challenge going? Further balance sheet restructuring will help if it strips out poor performing or high risk assets. Also, crucially, recognition of impaired assets and a granular and diligent re-underwriting of problem portfolios will allow loan book losses to be put in the past. These developments will help, but more is needed to be done, especially while domestic demand remains depressed and inhibits new business growth. At the centre of the profitability equation for the banks is a need to improve their net interest margin. On aggregate, the net interest margin for the three main Irish banks has fallen sharply, from 1.83% in 2007 to 0.82% by the first half of this year.

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Net interest margins remain highly compressed for the banks and will continue to do so while prevailing interest rates are low. Progress on profitability will only be possible in the interim due to gradual re-pricing of assets to reflect the cost of funds. I should also note that in my view we are getting close to the position where the changing circumstances arising from successful implementation of the IMF/EU programme and the introduction of the banking union should permit the full removal of the government guarantee. This will favourably impact on profitability as a result of reduced fees. Realistically, however, the prospects for significant improvement in net interest margins as a driver of profitability will be limited for the immediate future in light of the macro-economic environment. What is in the banks’ own hands, however, is to rigorously tackle their operating costs. The banks need to continue their efforts in this area and the management teams should be commended for tackling tough decisions around staffing levels and branch closures, which are clearly difficult but necessary measures. As a note of caution, it is important that this process of rationalisation does not compromise the risk management infrastructure and IT/operational framework in the banking system. These would be short-term cost savings that sowed the seeds for later problems and painful expense, as we’ve seen in the past and indeed quite recently. So, the Central Bank will encourage bank management to stick to their cost-cutting agenda, but to do so with careful deliberation.

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They do need to maintain the capacity to deliver the needed services to the economy and the general public.

Culture While most of the challenges are financial in nature, there is one that is not but is nevertheless absolutely essential: We need to see a substantial, deeply rooted and sustained change in the culture that operates within the Irish banking system. Cultural change is evidently a complicated, laborious and time-consuming process and will need to touch on the number of dimensions, but at its essence we need to see a fundamental shift in attitudes to risk management and to the treatment of consumers. The financial crisis exposed a corrosive influence at the heart of the way the Irish banks were run and that has had to be decisively tackled. The Central Bank has acted to initiate change in this area and has encouraged improved governance and standards of behaviour. We have introduced a corporate governance code, which is fully enforceable, designed to improve the rigour of oversight of bank management and to broaden the gene pool of bank boardrooms. A new fitness and probity regime is now in place to more rigorously police those who work in the financial services sector. Some 71 of the 73 executive and non-executive directors who were in place at the time of the guarantee have now or will shortly depart the system. But the work of cultural change is by no means complete – indeed it still has a long way to go – and must necessarily be driven by the new boards of the Irish banks.

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They need to set the tone at the top and clearly articulate their expectations of ethical conduct amongst their management team and their staff at large. They need to ensure that the ranks of senior and middle management are subject to renewal and refreshment, to bring some fresh blood into the mix without the baggage of the past and with the motivation to lead the process of change. New standards of behaviour need to be backed up when hard cases of individual conduct come to a head, and not avoided. Recognition of the importance of good risk management, compliance and treating customers fairly needs to become embedded, hardwired into the processes, remuneration, objectives, communications and way of thinking in the Irish banks until it becomes second nature. This is a hard-to-measure and difficult task but needs to be kept at the top of the senior management and Board agenda. It is important to speed the recovery of the banking system, by helping renew the social contract between the banks and society at large and, more tangibly, ensuring that lapses in risk management or consumer care do not lead to further losses, consumer detriment and reputational damage which impede the banks’ and the economy’s path to recovery.

Capital Finally, then, let us turn to the banks’ capital challenge and the question of whether or not they have adequate economic and regulatory capital to operate safely and provide the lending necessary for the economy. As I will explain, this is a complex question and is impacted by a number of factors, some of which appear favourable and some of which do not. Answering this question also involves a considerable number of judgement calls, including the question of the speed with which we want to get to the point that there remains absolutely no doubt about the

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banks’ ability to meet both any future losses and the planned higher international capital standards that are coming down the track. The factors impacting the banks’ capital position are numerous and, of course, are closely related to the previous challenges that I’ve outlined. The extent to which problem loans are successfully recovered or necessarily written off or restructured will be a key factor, as will the extent of progress on balance sheet restructuring (and the costs this imposes along the way). The banks’ ability to return to profitability will allow them to retain earnings so that the capital requirements of the future can be met on their own. But what other elements will bear on the capital challenge? On the positive side, the current starting point is a strong one due to the significant capital injections that have taken place as a result of the previous stress tests of the banking system. Current capital ratios for the leading domestic banks include a healthy buffer above minimum requirements: for example, the total capital ratio for AIB is 19.9%, Bank of Ireland’s is 14.3% and PTSB’s is 21.5%. Above these requirements, the banks have a further buffer of contingent capital instruments to absorb additional potential losses, which is another positive. Also, as noted previously, since the last stress tests the losses on disposal of non-core assets has turned out to be less than predicted. And also in the positive, albeit tentatively, are some early signs of stability in the housing market, at least in the Dublin area. However, there are also adverse developments which could impact the next in-depth assessment of capital.

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While housing prices may have shown signs of stability in the Dublin area, they are still significantly depressed and may have further to decline outside Dublin. The macro-economic environment remains very difficult, with domestic demand depressed and the continuing crisis in the Eurozone weighing on recovery and confidence. The position on mortgage arrears has continued to deteriorate since the last stress test (although, positively, are so far within stress levels) and the introduction of insolvency legislation creates uncertainty as to the future trajectory of losses. And, as I’ve mentioned in previous remarks, we know that in the medium term the Irish banks need to close the gap to meet new international capital standards under Basel 3 and CRD IV. Since we are talking about the speed of the recovery of the banking system and the question of time, it is perhaps useful here to make the distinction between current capital requirements and what one might call the stressed capital position of the banks. Very simply put, the current capital position is the calculation of the banks’ capital requirements against current prevailing minimum regulatory standards and in light of the bank’s current accounting position. As I have just noted, the current capital position of the banks is healthy due to the significant injections of taxpayer and private funds that have taken place. This healthy position appears assured for the immediate future given the buffer between current capital levels and minimum European requirements. However, in the medium term the position becomes more uncertain, principally due to the anticipated strengthening of the minimum EU

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standards, uncertainty around profitability and uncertainty around the exact size of future losses in problem portfolios. This is where the stress capital position comes in: this is an exercise in projecting forwards the level of losses (and of profitability) – and doing so with an overlay of stress to provide an added degree of comfort and conservatism. As you know, this method has been used to good effect to force a significant recapitalisation of the system already. How much uncertainty or risk is there in the medium term capital position for the banks? I’m afraid I’m going to disappoint you and say that we need to wait and see and do another thorough, rigorous and professional job of assessing that very question. This will take place during the course of next year and the Central Bank will again conduct its own independent assessment of the banks’ loan losses, again with the assistance of Blackrock, rather than rely on the banks’ own calculations. We will, as before, call it as we see it. But in the design of this exercise – by ourselves, by the troika, by the European Banking Authority and by the prospective new Eurozone banking supervisor, the ECB (there will be a lot of chefs in this one!) – there will be some important judgement calls regarding the severity of the stress parameters and the methodology to be applied. Fundamentally, there is a public policy choice around living with a currently healthy capital position until the point of need of public support, if indeed that is the case. Call this a just-in-time approach to backstops, if you like.

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Or, alternatively, the stress design can be calibrated to frontload anticipated new regulatory requirements or potential tail events while discounting the prospect of the banks earning their own way to full capital health. The benefit of this latter approach is that it more speedily gets the banks to a position of undeniable capital resilience, so that they should have no deterrent from lending and the residual risk of future support at a later date is eliminated. But this frontloaded design choice is of course potentially costly in terms of adding to the sovereign debt burden. And in this respect, there is a sixth and most fundamental challenge of all, namely breaking the damaging link between the banking system and the government finances. It is clear that this in itself is an essential component of the successful completion of the financial programme for Ireland and a speedy recovery of the Irish banking system. It is hard to think of the Irish banks returning to unsecured market funding before the government does so. And it is hard to think of the Irish banks’ capital position being definitively resolved before the impact of bank debt on government finances has been resolved. This has been the lesson of the Irish programme so far. That huge strides have been made in tackling the banking system problems through decisive and costly actions, but that there are limits to the public policy measures that can be taken without European assistance. The encouraging news is that this was recognised by European policymakers in the Euro group summit at the end of June.

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The damaging linkage between banking systems and sovereign finances has been recognised and it has been accepted that borrowing to recapitalise banking systems adds to the negative feedback loop between the two. I look forward to the outcome of the continuing discussions on the Summit conclusions so they are translated into a specific policy proposal that is indeed effective in breaking the banking-sovereign link. However, there are key steps that need to take place before this can be achieved, most notably the development of the banking union and centralised Eurozone banking supervision. But that is a topic for another day. For now, my point is that in addition to the five domestic challenges for the Irish banking system to more speedily achieve recovery, there is a sixth European challenge where there are positive signs but much work still to be done. This dependence on European developments, however, is no excuse for the banks to delay in tackling the five challenges I have discussed. With apologies in advance for the risk of oversimplification, let me sum this all up in the following way. One way to think about this is that the Irish banks are now out of the critical ward, with more healthy vital signs, following radical surgery and an extensive transfusion of blood from the Irish taxpayer. But as they stagger back to work they are still weak and aren’t contributing to society as they should. They need to demonstrate dedication in getting fully fit: they need to face up to their remaining ailments – by recognising losses – and continue to slim down – both their balance sheets and their costs. The banks now have the uncomfortable task of telling the neighbours

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who donated blood to them that they need to charge them more as customers. And the banks need to approach their new situation with a new culture to show they’ve truly changed their ways. These measures, which are in the hands of the banks’ own management and do not depend on Europe, will help speed them to full recovery.

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FSB releases reports on progress in implementing the SIFI framework The FSB is releasing three documents on latest steps in implementing the FSB’s policy framework for addressing the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs).

1. Update of group of global systemically important banks (G-SIBs) An initial group of G-SIBs was published in November last year. This updated list of G-SIBs is based on end-2011 data. This year, the G-SIBs are shown allocated to buckets corresponding to their required level of additional loss absorbency. This allocation is provisional and will be based in the future on the best and most current available data prior to implementation. The additional loss absorbency requirements for G-SIBs will be phased in starting from 2016, initially for those banks identified as G-SIBs in November 2014, and are to be fully met by 2019. The timelines for the other policy requirements relating to global SIFIs (G-SIFIs), and in particular the timetable for implementation of resolution planning requirements for newly designated G-SIFIs, have also been further specified.

Update of group of global systemically important banks (G-SIBs)

1. In November 2011 the Financial Stability Board published an integrated set of policy measures to address the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs).

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In that publication, the FSB identified an initial group of G-SIFIs, namely 29 global systemically important banks (G-SIBs), using a methodology developed by the BCBS.

2. The November 2011 report noted that the group of G-SIFIs is to be updated annually based on new data and published by the FSB each November.

3. The FSB and BCBS have updated the list of G-SIBs using end-2011 data.

The list of banking groups identified as G-SIBs is reduced by one overall, from 29 to 28.

Compared with the list published in November 2011, two banks have been added to the G-SIB list, and three banks have been removed from it.

4. As noted in 2011, from this year, the list of G-SIBs shows their allocation to buckets corresponding to their required level of additional loss absorbency.

Additional loss absorbency requirements for G-SIBs will be phased in starting from 2016, initially for those banks identified as G-SIBs in November 2014.

5. The quality of data used in applying the identification methodology and to allocate G-SIBs into buckets for additional loss absorbency has improved considerably over the last year.

In addition, several of the underlying data items included in the methodology have been refined to make the calibration more robust.

The BCBS will continue to work to address remaining data quality issues and adopt any necessary methodological refinements before the loss absorbency requirements go into effect.

The scores and the corresponding buckets for G-SIBs are provisional and will be based in the future on the best and most current available data prior to implementation.

6. The group of G-SIBs will be updated in November 2013.

7. The November 2011 report set out the policy requirements relating to G-SIFIs, together with the timetable by which those requirements were to

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be met. For this updated list, as well as for future updates, the following time-lines relating to the requirements will apply:

i) Financial institutions no longer designated as a G-SIFI will continue to be subject to the requirement for recovery and resolution plans to the extent that the firm is assessed by national authorities to be systemically significant or critical in the event of failure.

Authorities are encouraged to continue to apply the other resolution requirements to support resolution planning; however, once a financial institution is no longer designated as a G-SIFI, implementation of those requirements will no longer be subject to peer review by the FSB under its resolvability assessment process.

ii) As set out in the November 2011 report, the additional loss absorbency requirements for G-SIBs will begin to apply from 2016, applying initially to G-SIBs identified in November 2014, using the allocation to buckets for higher loss absorbency at that date.

The requirements will be phased in starting from January 2016 with full implementation by January 2019.

iii) G-SIFIs are required to meet higher supervisory expectations for risk management functions, data aggregation capabilities, risk governance and internal controls.

G-SIBs designated in November 2011 or November 2012 must meet the higher expectations for data aggregation capabilities and risk reporting by January 2016.

G-SIBs designated in subsequent annual updates will need to meet these higher expectations within three years of the designation.

8. The FSB and the standard setting bodies are extending the SIFI framework to other systemically important financial institutions.

i) The FSB and BCBS have finalised a principles-based, minimum framework for addressing domestic systemically important banks (D-SIBs).

National authorities should begin to apply requirements to banks identified as D-SIBs in line with the phase-in arrangements for the G-SIB framework, i.e. from January 2016.

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ii) The International Association of Insurance Supervisors (IAIS) has issued for public consultation its proposed assessment methodology for identifying global systemically important insurers (G-SIIs) as well as policy measures to be applied to G-SIIs.

An initial designation by the FSB of insurance groups as G-SIIs is planned in April 2013.

iii) The FSB, in consultation with IOSCO, will finalise a proposed assessment methodology for identifying systemically important non-bank non-insurance financial institutions over the course of 2013.

G-SIBs as of November 2012 allocated to buckets corresponding to required level of additional loss absorbency

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2. Progress report on Resolution of Systemically Important Financial Institutions Progress in reforming national resolution regimes and advancing recovery and resolution planning for G-SIFIs is encouraging overall. Getting the right legislation in place is essential to countries having the necessary powers to advance resolvability of G-SIFIs and the legal capacity for cross-border border co-operation. Reforms to align resolution regimes with the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institution are not complete and still ongoing in several FSB jurisdictions. Some headway has been made in G-SIFIs resolution planning. Cross-border crisis management groups are now established for nearly all the G-SIFIs designated by the FSB in November 2011 and have initiated discussions on high-level resolution strategies.

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Operational resolution plans and institution-specific cooperation agreements to implement the strategies and plans are on track to be completed during the first half of 2013. However, effective implementation is contingent on the requisite legal frameworks being in place and may also require some adaptation of firms’ financial and organisational structures. The FSB has further work underway to support implementation of the Key Attributes. This includes the development of an assessment methodology for the Key Attributes and further guidance on the application of the Key Attributes to the resolution of non-banks, including insurers, investment firms and financial market infrastructures.

The FSB will be publishing shortly for consultation draft guidance on key aspects of recovery and resolution planning.

Resolution of Systemically Important Financial Institutions Progress Report Summary Since the adoption of the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions (“the Key Attributes”) as a new international standard for resolution regimes in November 2011, many jurisdictions have initiated reforms to align national resolution regimes and institutional frameworks with the Key Attributes. Overall, progress is encouraging.

Implementation of the Key Attributes in national resolution regimes Recent reforms focus on extending the resolution tools to include powers such as bail-in, transfer and bridge bank powers, and on widening the scope of resolution regimes to cover non-bank financial institutions that

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could be systemically critical if they fail, including investment firms, financial market infrastructures (FMIs) and insurers (particularly insurance groups with non-traditional insurance activities). The Key Attributes will need to be applied in a manner that reflects the specificities and objectives of resolution of particular sectors, such as protecting insurance policy holders in resolution; facilitating the rapid return or transfer of holdings of client assets in resolution to protect the interests of customers of investment firms; and ensuring the continuity of critical operations and services of FMIs.

Recovery and resolution planning for G-SIFIs High importance is being given to the effective implementation of the Key Attributes that are directed at global systemically important financial institutions (G-SIFIs). This includes the requirements for cross-border crisis management groups (CMGs), institution-specific cross-border cooperation agreements (COAGs), recovery and resolution plans (RRPs) and resolvability assessments for all G-SIFIs. Considerable but uneven progress has been made in implementing these requirements, guided by CMGs which are now established for nearly all the G-SIFIs designated by the FSB in November 2011. In the course of that work it became clear that recovery planning, resolvability assessments and the development of COAGs are inter-dependent and iterative processes, and progress in these areas is largely dependent on a clearly articulated, high level ‘resolution strategy’ for a firm. Accordingly, the priorities of CMGs were adapted to focus on the development of resolution strategies by end-2012. Recognising that certain aspects of the recovery and resolution planning requirements would benefit from deeper examination and building on the

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experience of its Members to date, the FSB has developed guidance that it is releasing for public consultation on: (i) The nature of the stress scenarios and triggers for recovery actions that should be used in G-SIFIs’ recovery plans; (ii) The development of resolution strategies and associated operational resolution plans tailored to different group structures, drawing on two stylised approaches to resolution - ‘single point of entry’ and ‘multiple point of entry’; and (iii) The identification of the critical functions that would need to be maintained. This guidance is expected to assist those CMGs, authorities and firms at earlier stages of the recovery and resolution planning process and to promote consistency in the approaches of CMGs. Implementation of the remaining G-SIFI resolution planning requirements is on track to be completed during the first half of 2013, after which the implementation of the resolution planning requirements in relation to each G-SIFI will be reviewed through resolvability assessments by resolution authorities and CMGs, and through a resolvability assessment process that the FSB expects to launch in 2013. For financial firms that are no longer designated as G-SIFIs, the implementation of those requirements will not be evaluated through the FSB assessment process. However, such firms will still be required to have RRPs, and national authorities are encouraged to continue to apply the other requirements proportionately to those firms.

Introduction The global financial crisis provided a sharp and painful lesson of the costs to the financial system and the global economy of the absence of effective

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powers and tools for dealing with the failure of systemically important financial institutions (SIFIs). In November 2011, the G20 endorsed the Key Attributes of Effective Resolution Regimes for Financial Institutions (“the Key Attributes”) as a new international standard for resolution regimes, while in June 2012 the G20 Leaders reiterated their commitment to make national resolution regimes consistent with the Key Attributes and expressed their support for the on-going elaboration of RRPs and COAGs for all G-SIFIs. This report describes the progress so far in implementing the Key Attributes, including the specific requirements aimed at G-SIFIs, and the additional work that the FSB is undertaking to advance the effective implementation of the Key Attributes. - Section 1 provides an overview of the status of reforms of national

resolution regimes and the FSB’s initiative to evaluate progress through a first thematic peer review of effective resolution regimes.

- Section 2 reports on additional work underway to support implementation of the Key Attributes, which includes the development of an assessment methodology, work on the application of the Key Attributes to resolution regimes for the non-banking sector, including insurers, FMIs and firms with significant holdings of client assets, and the sharing of relevant information for resolution purposes between all authorities having a role in resolution.

- Section 3 discusses the status of implementation of the set of

resolution planning requirements that specifically apply to G-SIFIs as well as the work on further guidance to support their implementation.

1. Implementation of the Key Attributes 1.1 Overview The Key Attributes set out twelve essential features that should be part of resolution regimes in all jurisdictions (see Text Box 1).

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Their objective is to enable authorities to resolve any financial firm that could be systemically significant or critical in the event of failure, irrespective of its size, the nature of its business or its geographical reach, without severe systemic disruption and without exposing taxpayers to loss.

Text Box 1: The twelve Key Attributes The Key Attributes set out the core elements considered necessary for an effective resolution regime for any type of financial institution, including banks, insurers, securities and investment firms and FMIs: 1. Scope - The regime should cover any financial institution that could be systemically significant or critical if it fails. 2. Resolution authority - The regime should be administered by a resolution authority (or authorities) with a statutory mandate to promote financial stability and the continued performance of critical functions. 3. Resolution powers - The regime should provide for a broad range of resolution powers, including powers to transfer the critical functions of a failing firm to a third party; powers to convert debt instruments into equity and preserve critical functions (‘bail-in within resolution’); powers to impose a temporary stay on the exercise of termination rights under financial contracts (subject to safeguards for counterparties) and impose a moratorium on payments and on debt enforcement actions against the failing firm; and powers to achieve the orderly closure and wind-down of all or parts of the firm’s business with timely pay-out or transfer of insured deposits. 4. Set-off, netting, collateralisation, segregation of client assets - The segregation of client assets should be effective in resolution. Financial contracts, including netting and collateralisation agreements, should be enforceable. However, entry into resolution and the exercise of any resolution powers should not in principle constitute an event that entitles any counterparty

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of the firm in resolution to exercise acceleration or early termination rights under such agreements provided the substantive obligations under the contract continue to be performed (as would be the case if the contracts were transferred to a sound financial firm or bridge institutions). 5. Safeguards - All creditors should receive at a minimum what they would have received in a liquidation of the firm (‘no creditor worse off than in liquidation’ safeguard). Resolution powers should be exercised in a way that respects the hierarchy of claims, subject to some flexibility for authorities to depart from the general principle of equal treatment of creditors of the same class where necessary to contain the potential systemic impact of a firm’s failure or to maximise the value for the benefit of all creditors as a whole. Rights to judicial review should be available for affected parties to challenge actions that are outside the legal powers of the resolution authority. 6. Funding of firms in resolution - Resolution regimes should include funding mechanisms that can provide temporary financing to continue critical operations as part of the resolution of a failing firm. Such funding should be derived, or recovered, from private sources. 7. Legal framework conditions for cross-border cooperation - Resolution regimes should empower and encourage resolution authorities wherever possible to act to achieve a cooperative solution with their foreign counterparties. Authorities should be able to give effect in their jurisdiction to resolution measures taken by a foreign resolution authority. 8. Crisis Management Groups (CMGs) - Home and key host authorities of all G-SIFIs should maintain CMGs with the objective of enhancing preparedness for, and facilitating the resolution of a G-SIFI.

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9. Institution-specific cross-border cooperation agreements (COAGs) - COAGs should be in place between the home and relevant host authorities that need to be involved in the preparation and management of a crisis affecting a G-SIFI. 10. Resolvability assessments - Resolvability assessments should be carried out for all G-SIFIs. Authorities should have appropriate powers to require the adoption of appropriate measures to ensure that a firm is resolvable under the applicable regime. 11. Recovery and resolution planning - Recovery and resolution plans (including high level resolution strategies) should be in place for all firms that may be systemic or critical in the event of failure. 12. Access to information and information sharing - Jurisdictions should remove legal, regulatory or policy impediments that hinder the domestic and cross-border exchange of information - in normal times and during a crisis - necessary for recovery and resolution planning and for resolution.

1.2 Status of reforms of national resolution regimes Reforms are underway in many jurisdictions to align national statutory resolution regimes and institutional frameworks with the Key Attributes. In the US, the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which provides for powers to resolve systemically important financial institutions and requires the preparation of resolution plans, represents an important step towards implementation of the Key Attributes. Likewise, the adoption by the European Commission of a proposal for an EU regime for bank recovery and resolution is critical for advancing consistent reforms across the EU.

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A number of FSB member jurisdictions are in the process of reforming their statutory regimes or have recently introduced legislative changes or other actions to implement the Key Attributes:

- Australia - Australia undertook comprehensive reforms of its crisis resolution framework, which included the introduction of a deposit guarantee regime in 2008. It recently released a consultative document with proposals to further strengthen powers to resolve financial institutions, including insurers and FMIs, as well as non-regulated entities within a financial group in resolution.

- Germany - In Germany, reforms came into force in 2011 that strengthened and expanded crisis management and resolution powers. They include transfer and bridge bank powers, the establishment of a special restructuring fund, and the introduction of a two-stage recovery and reorganisation procedure for banks.

- Netherlands - In May 2012, the Netherlands introduced a new Act on

Special Measures for Financial Institutions which provides a range of new resolution powers to the De Nederlandsche Bank (Dutch Central Bank) and the Dutch Ministry of Finance. These powers include the powers to carry out a sale of a problem institution to a private party or bridge institution by transfer of shares; and the powers to transfer assets and liabilities of a problem institution to a private party or bridge institution, in case of guaranteed deposits with funding from the deposit guarantee scheme.

- Spain – The powers of the Spanish resolution authorities were

significantly expanded in August 2012: Banco de España was provided with additional early intervention powers; the Fund for Orderly Restructuring of Banks (FROB) was given powers to provide temporary financial assistance under a restructuring plan approved by

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Banco de España; and a new legal framework for the resolution of banks was established. That framework enables the FROB to carry out the restructuring or resolution of a failing bank, overriding shareholders’ rights where necessary, and includes powers to impose losses on subordinated liabilities (“limited bail-in”). Resolution tools in Spain now include: sale of assets or business lines of a failing bank; and transfer to a bridge bank or asset management company.

- Switzerland - Switzerland introduced legislative changes in 2008, 2011

and 2012 to strengthen its resolution regime. These included the introduction of a recovery and resolution planning requirements, bridge bank powers and extension of the Swiss Financial Market Supervisory Authority’s (FINMA) resolution powers to insurers and other types of financial institutions.

- United Kingdom - The introduction of the Special Resolution Regime

for UK banks in 2009 gave UK authorities a broad range of resolution powers for failing UK banks. The Financial Services Act adopted in 2010 required banks to have RRPs. UK deposit taking banks and systemic investment firms were required to have completed RRPs by June 2012. In August 2012, the UK Treasury published a consultation paper, accompanied by draft legislation, setting out proposals on enhancing the mechanisms available for dealing with the failure of systemically important non-bank financial institutions and FMIs. The proposal covers four broad groups: investment firms and parent undertakings; central counterparties (CCPs); other FMIs (such as payments systems); and insurers.

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- United States - The orderly liquidation authority established under Title II of the Dodd-Frank Act applies to financial companies and certain of subsidiaries that could be systemically significant or critical in failure. The Dodd-Frank Act also introduced a resolution planning requirement.

Legislative reforms will be necessary in many jurisdictions to fill remaining gaps in the implementation of the Key Attributes. In many jurisdictions the scope of application of the resolution regime remains limited to domestically incorporated banks and does not extend to non-bank financial institutions that could be systemically significant or critical if they fail, such as large investment firms or CCPs. Nor is it clear in many cases whether the national regime extends to branches of foreign financial institutions. A number of jurisdictions do not have the full range of resolution tools called for by the Key Attributes, such as bail-in powers or the authority to impose temporary stays on acceleration or early termination rights in financial contracts. The absence of a clear mandate of resolution authorities to seek cooperation with their foreign counterparts and the lack of legal capacity to give effect to foreign resolution measures may pose significant impediments to cross-border resolutions, if not addressed.

1.3 Thematic peer review to evaluate implementation in FSB member jurisdictions The reform of resolution regimes have been identified as a priority area under the FSB Coordination Framework for Implementation Monitoring (CFIM).

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As a result, the implementation of the Key Attributes by FSB member jurisdictions will undergo intensive monitoring and detailed reporting, with a first thematic peer review of resolution regimes already underway. The objective of the peer review is to evaluate FSB member jurisdictions’ existing resolution regimes and any planned changes to those regimes using the Key Attributes as a benchmark. The review will provide a fuller picture of the status of reforms and the progress made by different jurisdictions across different financial sectors (banking, insurance, securities, and FMIs). The findings will be published in early 2013.

2. Work underway to support effective implementation 2.1 Overview The FSB has further work underway to support implementation of the Key Attributes. An assessment methodology is being developed as guidance for jurisdictions when implementing the Key Attributes and as a tool for the conduct of assessments in the context of peer reviews. The FSB is working with sectoral standard setters to ensure that the methodology reflects sector-specific considerations and to develop further guidance as necessary. In response to external events, including the failure of MF Global, the FSB is undertaking further work on the protection of client assets in resolution. The FSB is also working to address barriers to information exchange amongst relevant authorities, since these have the potential to thwart the development of resolution strategies and plans and their implementation in a crisis.

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2.2 Development of a methodology to assess implementation The FSB is working with representatives of national authorities, the European Commission, the IMF and World Bank, and standard setting bodies (Basel Committee on Banking Supervision (BCBS), Committee on Payment and Settlement Systems (CPSS), International Association of Deposit Insurers (IADI), International Association of Insurance Supervisors (IAIS) and International Organization of Securities Commissions (IOSCO)) to develop an assessment methodology for the Key Attributes. The methodology will complement the Key Attributes by providing criteria against which implementation of each individual Key Attribute can be assessed, and explanatory notes about particular criteria where the FSB considers that further detail or explanation would be useful. It is intended as guidance for jurisdictions when implementing the Key Attributes and as a tool for the conduct of assessments in the context of peer reviews within the FSB framework for implementation monitoring or IMF and World Bank assessments of resolution regimes in the context of Financial Sector Assessment Programs (FSAPs) and Reports on the Observance of Standards and Codes (ROSCs). The FSB plans to consult publicly on a draft of the methodology in the second half of 2013.

2.3 Sector-specific considerations The Key Attributes are an ‘umbrella’ standard for resolution regimes for all types of financial institutions that can potentially be systemically important in failure. Sector-specific resolution regimes should therefore be consistent with the objectives and relevant requirements of the Key Attributes. However, not all resolution powers and features of resolution regimes set out in the Key Attributes are relevant for all sectors.

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Different types of financial firms - even within a particular sector - have distinctive features that need to be reflected in the way in which the powers and tools set out in the Key Attributes are applied when resolving such entities (see Text Box 2). As a consequence, the Key Attributes may require some adaptation for sector-specific application. The FSB is working with standard setters to ensure that the assessment methodology deals comprehensively with the application of individual attributes to different types of financial institutions and sectors. The IAIS is currently analysing the Key Attributes from the perspective of the resolution of insurers and the protection of policy holders. The IAIS consultation document on globally systemically important insurers (G-SIIs) that was released in October 2012 includes a proposal to consider whether to develop a specific template for assessing the resolvability of G-SIIs. It also proposes that resolvability assessments assess the extent of ex ante separation of traditional and non-insurance activities from traditional insurance activities, and that the authorities consider and take all necessary actions to ensure effective resolution, including removing obstacles to the separability of non-traditional and non-insurance activities from traditional insurance activities during a stressed event. The IAIS also proposes, where necessary, to explore with members the need to develop further guidance for inclusion in the FSB’s assessment methodology for the Key Attributes. Similarly, in July CPSS-IOSCO published a consultative report on recovery and resolution of FMIs. The report analyses how the Key Attributes apply to FMIs in a manner that achieves the objective of avoiding systemic disruptions by ensuring the continuity of critical operations and services of FMIs.

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The outcome of that analysis and public consultation will be incorporated into the assessment methodology for the Key Attributes. CPSS-IOSCO are working to provide further guidance on how FMIs should produce viable and robust recovery plans and how these should fit alongside resolution plans.

Text Box 2 – Sector-specific considerations Banks – The full range of resolution powers specified in the Key Attributes should be available to resolution authorities with responsibility for the resolution of banks that could be systemically significant or critical in the event of failure. Insurers – As an international standard the Key Attributes generally also apply to resolution regimes for insurance firms that could be systemically significant or critical in the event of failure. The Key Attributes directed at G-SIFIs (see Text Box 3) apply to any insurer that is designated as a G-SII. The Key Attributes recognise that two resolution tools – portfolio transfer and ‘run-off’’ – are likely to be particularly relevant for the resolution of an insurer. However, when insurers also engage in either non-traditional insurance business or non-insurance business some of the other resolution powers set out in Key Attribute 3 that are not generally aimed at traditional insurance business may be necessary. Financial Market Infrastructure - The key objective of resolution regimes for FMIs needs to ensure uninterrupted continuity of the critical operations and services of a failing FMI. Accordingly, it should ensure the timely completion of payment, clearing and settlement functions by an FMI throughout the period that it is in resolution. The regime should enable authorities to preserve those systemically critical operations and services, either by arranging their orderly transfer to another FMI or bridge institution; by providing participants sufficient

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time to establish and to move to an alternative arrangement; or by the restoring the FMI’s ability to provide those services as a going concern (including by allocating any shortfall in the FMI’s resources across participants or other creditors of the FMI). To achieve these outcomes and taking into account the specificities of different types of FMIs, statutory resolution regimes for FMIs should provide for a broad set of tools and powers consistent with those in the Key Attributes and resolution authorities should apply them in a manner that is consistent with the CPSS-IOSCO Principles for Financial Market Infrastructures. Securities and investment firms - Ensuring the rapid return of client money and assets or their transfer to a sound firm or bridge institution is a key objective of the resolution of securities and investment firms. Resolution authorities therefore require clear powers to transfer holdings of client assets to a performing third party or bridge institution, without the consent of the affected clients (see below 2.4). In order for that power to be exercisable effectively, the regulatory framework needs to include clear rules requiring the segregation and identification of client assets, and compliance with those rules is enforced. As with the exercise of other resolution powers, arrangements are needed to give effect to transfers, or to facilitate recovery by a resolution authority or liquidator, of client assets that are located in other jurisdictions.

2.4 Resolution of firms with significant holdings of client assets The Key Attributes state that an effective resolution regime should ensure the rapid return of segregated client assets and call for clear, transparent and enforceable arrangements that promote the effective segregation of client assets and prompt access to segregated client funds in resolution.

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Greater understanding is needed of how those objectives can be achieved in the case of financial firms with significant holdings of client assets, and particularly where those assets are held in different jurisdictions. The transfer of holdings of client assets to a private sector firm or bridge institution may be the preferred resolution option, given that it maintains continuity of the services provided to the clients and minimises any interruption of access by clients to their assets. Resolution regimes should therefore include a power for resolution authorities to transfer holdings of client assets to a performing third party or bridge institution. The power should be available especially for banks, non-deposit-taking investment firms or broker-dealers, and FMIs that could be systemically significant or critical in the event of failure. No formal arrangements or procedures are currently in place between jurisdictions to facilitate transfers or return of client assets in a cross-border resolution. A foreign resolution authority, foreign administrator or liquidator generally needs to obtain the assistance of the local courts. However, the court process may take time which, as a practical matter, may represent a procedural impediment to rapid transfer or recovery, even where resolution authorities have powers to transfer client assets and assets are segregated and identified. Rapid transfers in a cross-border context could be facilitated if the home resolution authority’s transfer powers were matched by broad transfer powers of the host authority and the latter were able to use those powers to effect a transfer of assets located in its jurisdiction made by the foreign home authority. The FSB has work underway to elaborate further on the nature of the powers resolution authorities need to transfer holdings of client assets to a

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third party or bridge institution, in particular where the firm in resolution is holding client assets in a foreign jurisdiction. Where client assets are held by entities that are located in another jurisdiction, for example, an affiliate of the firm in resolution, a third-party custodian, or other intermediary, differences in the respective national laws relating to way in which client assets are held and protected may give rise to legal disputes as to ownership and entitlement to the assets, and complicate transfers or the rapid return of the assets to clients. The likelihood of disputes, which may take considerable time to resolve, is exacerbated in cases of correlated failures where both the firm that originally received the client assets and the firm that holds them are subject to resolution or insolvency procedures, since the administrators or insolvency appointees of both firms will have a statutory responsibility to maximise value for the clients and creditors of the firm to which they are appointed. Insufficient protection of client assets, and uncertainty about the ownership rights of clients where the firm exercises rights of use over collateral or re-hypothecates client assets, also increases the likelihood of ‘runs’ as clients remove assets from a stressed firm in order to protect their rights. These effects increase the risk of disorderly failure and may undermine authorities’ ability to minimise contagion and preserve financial stability through resolution. Accordingly, when developing resolution plans and conducting resolvability assessments, authorities need to consider the feasibility of executing a transfer of custodial functions to another firm. The FSB is working to develop more explicit guidance on this necessary aspect of resolution planning and resolvability assessments which will specify how the handling of clients assets should be taken into account by authorities when developing resolution plans for firms that hold a significant amount of client assets domestically or in other jurisdictions. Authorities and firms should have a clear understanding, in particular, of:

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(i) The applicable law governing holdings of client assets, in particular where they are held through a chain of intermediaries located in foreign jurisdictions; (ii) Any rights of re-use that may be exercisable; (iii) The rules that apply where there is a shortfall of client assets; (iv) Arrangements in place that ensure that the identity of clients and their assets can be established rapidly and with certainty; and (v) the existence of arrangements, including ‘porting’ arrangements for CCPs, that would facilitate transfers in a crisis.

2.5 Information sharing for resolution purposes and confidentiality To arrive at a group-wide resolution plan and resolvability assessment, home and host authorities will need to share views and information in the CMGs on the functions they consider to be critical and on possible strategies for ensuring the effective resolution of the group. In principle, it should be possible to share relevant information between all authorities that have a role in resolution, subject to adequate confidentiality safeguards. However, differing terms and conditions for information sharing across jurisdictions complicate cross-border cooperation. Constraints on the timely sharing of information between authorities that have responsibilities related to resolution also hamper cooperation. Particular hurdles may arise where information generated for supervisory purposes needs to be shared with non-supervisory authorities that also have a role in resolution, such as central banks (that are not acting in a supervisory capacity), resolution authorities and ministries of finance. The Key Attributes stipulate that sharing of information within CMGs with other authorities with a role in the resolution of a particular firm

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should be possible under the legal frameworks of all jurisdictions, subject to specific conditions being met to protect the confidentiality of the information. The recipient authority should be subject to confidentiality requirements that are equivalent to those that apply to the disclosing authority, with effective sanctions for breach; and should commit not to disclose the information to third parties or the public, to seek prior consent for any onward disclosure of information, and to undertake best efforts to resist disclosure where compelled by statute or legal process, including by employing legal means to challenge an order to disclose. Professional secrecy obligations should generally prohibit officers and employees of authorities from disclosing information acquired in the course of discharging their mandates. In jurisdictions with ‘Freedom of Information’ legislation, exemptions from disclosure requirements should be possible for resolution related information received from foreign authorities. The negotiation of institution-specific cross-border cooperation agreements (COAGs) amongst relevant home and host authorities, as required for each G-SIFI under the Key Attributes (see below), is intended to put in place a more predictable and explicit framework for sharing information for resolution and resolution planning purposes. It will also require authorities to determine whether their legal framework provides the appropriate gateways for information sharing, or whether they need to be revised to allow the sharing information for resolution purposes with the full range of authorities involved in resolution. Many jurisdictions’ legal regimes already have appropriate scope for authorities to improve cross-border and domestic information-sharing for resolution purposes. However, important work remains to be done to address the practical and policy concerns involved in sharing recovery and resolution information.

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The FSB is examining how to address remaining obstacles and improve the on-going work, including institution-specific COAGs currently being developed, to facilitate information sharing for resolution purposes.

3. Key Attributes directed at G-SIFIs 3.1 Overview In November 2011, the FSB released an initial list of institutions designated as G-SIFIs on the basis of a methodology developed by the BCBS. The FSB announced that this list will be reviewed and updated annually. Firms designated as G-SIFIs are subject to specific resolution planning requirements relating to CMGs, COAGs, RRPs and regular resolvability assessments (see Text Box 3).

Text Box 3: Key Attributes directed at G-SIFIs Crisis Management Groups (Key Attribute 8) - CMGs are mandatory for all G-SIFIs. CMGs establish a mechanism for information exchange, cooperation and coordination between the relevant authorities of the home and key host countries of the G-SIFI. Such arrangements enhance preparedness for a crisis and facilitate the management of any such crisis and, if necessary, the orderly resolution of the firm. Institution-specific cross-border Cooperation Agreements (COAGs) (Key Attribute 9) - COAGs must be in place for all G-SIFIs. COAGs support the operations of the CMGs by setting out the objectives and processes for cooperation between the home and relevant host authorities that need to be involved in planning for and carrying out resolution of a G-SIFI.

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They should also define the roles and responsibilities of the authorities pre-crisis (that is, in the recovery and resolution planning phase) and during a crisis; and set out the processes for information sharing and coordination in the development of resolution strategies and the RRPs for the G-SIFI. Recovery and Resolution Plans (RRPs) (Key Attribute 11) - RRPs, consisting of a recovery plan and a resolution plan, are required for all G-SIFIs and any other firms that could be systemically significant or critical if they fail. - The recovery plan (prepared by the firm) should identify options to restore financial strength and viability when the firm comes under severe stress. The responsibility for developing, maintaining and executing the recovery plan lies with the firm. - The resolution plan (prepared by the authorities) should set out how resolution powers would be used to preserve the firm’s systemically important functions, with the aim of making the resolution of any firm feasible without severe disruption and without exposing taxpayers to loss. It includes a resolution strategy agreed by the home authorities in cooperation with key host authorities and an operational resolution plan that provides further detail on how the authorities would implement the strategy. The home resolution authority should lead the development of the group resolution plan for a G-SIFI in coordination with the firm’s CMG. Host resolution authorities may maintain their own resolution plans for the firm’s operations in their jurisdiction, cooperating with the home authority to ensure that the plan is as consistent as possible with the group plan. RRPs are expected to be regularly updated and evolve over time. They should be subject to at least annual reviews by the relevant CMG.

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To promote ownership at top level and ensure that key decision makers are sufficiently informed and involved in the process, the resolution strategies should also be subject to regular reviews by top officials of home and relevant host supervisory and resolution authorities. Resolvability assessments (Key Attribute 10) - Resolvability assessments evaluate the feasibility of resolution strategies and their credibility in light of the likely impact of the firm’s failure on the financial system and the overall economy. Resolvability assessments should help identify any remaining barriers to resolution, and should inform the development and further improvement of the resolution plan.

3.2 Status of implementation of the Key Attributes directed at G-SIFIs Considerable but uneven progress has been made in implementing the G-SIFI-specific recovery and resolution planning requirements. However, it is important to recognise that resolution planning is an iterative process, in which strategies and plans are developed and amended to take account of changing circumstances, including changes in financial markets, firms’ internal organisation and structures, and in national legal resolution regimes and funding arrangements. As such, they need to be maintained as living documents which are improved and updated over time. - Crisis Management Groups - CMGs have been established for nearly

all of the 29 G-SIFIs designated in November 2011. CMG membership includes the prudential supervisor, central bank and, where it is a separate authority, the resolution authority of the home and key host countries. In some cases, the finance ministry of the home or host jurisdiction participates in a restricted manner – restrictions being necessary to protect the confidentiality of firm-specific supervisory information.

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Senior level engagement, with meetings at the level of Heads of Supervision and General Counsel, has proved critical in advancing recovery and resolution planning work within CMGs.

- Recovery plans - Initial reviews of recovery plans have taken place for most G-SIFIs, though in-depth reviews are still in progress. These reviews have highlighted a need for greater severity in the hypothetical stress scenarios and for a more exhaustive analysis with regard to impediments to the implementation of recovery measures, taking into account interconnections between group entities and constraints arising from the legal framework.

- Resolution strategies and operational plans, resolvability assessments

and cooperation agreements - CMGs have been focusing more recently on developing a clearly articulated “resolution strategy” for their respective G-SIFIs. These strategies outline, at a high level, the strategic approach to resolution that is likely to be adopted should the need arise, but they do not prescribe the precise course of action that the authorities will pursue or preclude the development of fall-back options, given the need to consider the circumstances existing at the time of a resolution. The resolution strategies should give the necessary direction to the next stage of work in the CMGs, which should aim to develop detailed operational resolution plans to implement the strategies and to finalise COAGs. Home authorities for each G-SIFI are to propose a basic resolution strategy to key host authorities for discussion within CMGs, with top-level participation, before the end of 2012.

As this work has progressed, it has become clear that certain aspects would benefit from deeper examination, including of the emerging lessons and that it would be beneficial to document this in the form of guidance to CMGs (see Section 3.3).

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3.3 Further guidance for the recovery and resolution planning process To support the work described in Section 3.2, the FSB will shortly be releasing a consultative document (“Recovery and Resolution Planning: Making the Key Attributes Operational” seeking comments from the public on specific aspects of recovery and resolution planning for G-SIFIs: (i) The nature of the stress scenarios and triggers for recovery action that should be used in G-SIFIs’ recovery plans, and the extent to which plans link specific scenarios and triggers to specific recovery options;

(ii) The development of resolution strategies and operational resolution plans tailored to different group structures, drawing on two stylised approaches to resolution: a ‘single point of entry’ approach by which group resolution takes place primarily through action by the home authority at the level of the parent or holding company; and a ‘multiple point of entry’ approach whereby resolution actions are taken by multiple authorities along national, regional or functional lines; and

(iii) The identification of the critical functions and critical shared services that would need to be continued in resolution for reasons of systemic stability.

3.4 Coordination with host jurisdictions with a systemic G-SIFI presence For reasons of operational efficiency, participation in CMGs should be limited to authorities from the home and key host jurisdictions. However, the failure of a G-SIFI may have an impact on financial stability in other host jurisdictions that are not included in the CMG. The Key Attributes therefore provide that home authorities of G-SIFIs should establish a process to ascertain which other jurisdictions assess the local operations of a G-SIFI as systemically important to the local financial system, and should ensure that appropriate arrangements for

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communication, cooperation and information sharing with such non-CMG jurisdictions are in place. Home authorities and CMGs may also wish to consider for this purpose the principles that the BCBS has developed to identify domestic systemically important banks. The FSB will develop further guidance for arrangements and procedures for cooperation and information sharing with host authorities for which a G-SIFI’s operations are locally systemic but that are not represented on the CMG.

3.5 Review process to assess G-SIFI resolvability Implementation of all G-SIFI resolution requirements, including resolution strategy, planning, resolvability assessments and COAGs, will be reviewed through resolvability assessments conducted by the resolution authorities and CMGs as well as through a resolvability assessment process for G-SIFIs that the FSB expects to launch in 2013. The process should ensure adequate and consistent reporting on the implementation of all G-SIFI resolution requirements across institutions. It should help identify instances of incomplete implementation and highlight material recurring issues that need to be addressed at policy level.

3. Progress report on Increasing the Intensity and Effectiveness of SIFI Supervision

This report concludes that further steps are needed to make supervision more proactive and effective. It notes that the IMF-World Bank’s Financial Stability Assessment Programs continue to indicate that problems exist in countries meeting the requirements for effective supervision. The report makes further recommendations to support continuous improvement in SIFI supervision, in particular of G-SIFIs:

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- More intense SIFI supervision. Supervisors should be more proactive

in assessing succession planning, risk culture, the effectiveness of Boards and senior management, and stress testing processes at firms.

- Assessment of effective supervision. Governments should commit to

implement the various standard setters’ Core Principles for effective supervision, including official mandates, resources and independence of supervisors. The IMF and World Bank should actively monitor progress.

- Operational risk. The BCBS should update its capital requirements

for operational risk by the end of 2014, as operational risk has been a prominent factor in recent loss events at financial institutions.

- Supervisory colleges. The FSB and standard setters should intensify

efforts to increase the effectiveness of supervisory colleges, including through the adequate exchange of information and cooperation within core supervisory colleges.

Increasing the Intensity and Effectiveness of SIFI Supervision Progress Report to the G20 Ministers and Governors Executive Summary In the aftermath of the financial crisis, the Financial Stability Board (FSB) and the G20 Leaders identified as a priority the need for more intense and effective supervision particularly as it relates to systemically important financial institutions (SIFIs). Increasing the intensity and effectiveness of supervision is a key pillar of the FSB’s SIFI framework, along with requiring higher loss absorbency and facilitating the resolvability of failing financial institutions. In this third report, members of the FSB Supervisory Intensity and Effectiveness group (SIE) observe that weak risk controls at financial institutions are still being witnessed and there remains room for

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improvement in supervision to ensure that it is effective, proactive and outcomes-focused. The International Monetary Fund (IMF) and World Bank Financial Sector Assessment Program (FSAP) continue to identify problems in the fundamental requirements for effective supervision, such as the core principles for official mandates, resources, and independence. To some extent this underscores a point made in 2010: changes in supervisory intensity and effectiveness are challenging to implement quickly as it takes a change in the preconditions for supervision, as well as changes in culture and different types of skills and resource levels. This report covers areas where supervisory practice is becoming more robust, while noting areas where supervisory practice still needs to be improved. One major change in many countries is a move to more extensive and deeper engagement with systemically important firms. This is evidenced by more frequent interaction with Boards, and in some cases more proactive engagement with firms in relation to their process for filling critical roles. Such efforts require seasoned judgement by supervisors. For some, this will be seen as stepping into areas that typically reside within the remit of the firm’s management; for supervisors it reflects the significant externalities that exist with SIFIs, thereby requiring more robust succession planning and appointment processes for key positions, particularly leaders of key control functions. In addition, this report discusses the need for supervisors to become more active in explicitly assessing risk culture at firms. While light-touch supervision has been clearly rejected, supervisors are re-considering the range of approaches required to ensure effective supervision.

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For example, during the 1990s and early 2000s there was a move away from detailed assessments of profits and losses (P&L) and financial data (which were very time consuming) toward assessments of controls within financial institutions – a necessary move as financial institutions became more complex. However the pendulum may have swung too far away from analysis of the fundamental, strategic risks that underlie the sustainability of financial institutions’ business models. The SIE will explore this issue further, with a view to identifying best practice approaches that could be adopted. In order to remain effective, supervisory focus needs to change with changing risks and circumstances. As an example, this report highlights the importance of zeroing in on operational risk at G-SIFIs, which has been a key risk in recent loss events at financial institutions. This risk will continue to increase as financial institutions seek new ways to generate earnings, such as further expanding into wealth management and other revenue generating areas with low risk-weighted assets and required capital. To the extent that operational risk provides a broad, high level threat to the firm’s business strategy, supervisors should satisfy themselves that Boards and senior management dedicate sufficient attention and resources to the management of operational risk with regard to prevention and control. Moreover, aspects of operational risk, such as business continuity and information security, cannot be addressed by adding capital. No supervisory system can catch everything. The main responsibility for identifying and managing risk rests with each firm’s management, whose risk managers, compliance and internal audit

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personnel will always greatly outnumber the resources available to supervisors. The more – and more sophisticated – activity of financial institutions has increased the array and intensity of the risks to which institutions are exposed. Risk-based supervision seeks to address this through deploying limited supervisory resources to the riskiest institutions and areas, prioritised based on an assessment of the risks therein. Other institutions and areas will, however, continue to present risks and supervisory authorities will lack the resources to examine everything. As such, supervisory approaches and areas of focus need to be periodically reviewed to confirm that, for instance, institutions and areas previously classified as “low or moderate risk” still warrant this assessment. Effective supervision requires finding the right balance between focusing on areas of higher risk while also ensuring some periodic coverage of all aspects, including, for example, those that might prove risky ex post. Striking the right balance is an ongoing challenge; however, regulatory developments since the global financial crisis should allow supervisors to explore and leverage off deeper information sets and analysis. This may include the information that can be made available from central repositories and other centralised sources of financial data to track anomalies in the market, and information from implementation of recovery and resolution plans which provide supervisors with new insights. The financial system is composed of institutions of many forms and shapes. While supervisory approaches to second-tier institutions in some countries might still rely on more traditional, risk-based approaches that

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call for a lesser degree of (or no) supervisory intensity, both the events during the crisis (e.g. Northern Rock) and recent events (e.g. the Spanish crisis) clearly demonstrate that small institutions can pose their own challenges to stability as a result of geographic and product concentration. The overall supervisory strategy needs to be mindful of such vulnerabilities. Finally, supervisors need to be equipped with the mandate, independence and resources to reduce the likelihood of SIFI failures. Resource constraints at supervisory authorities was an area identified in the 2011 FSB report as hampering progress toward improving the intensity and effectiveness of supervision. To get at the crux of this issue, SIE members completed a survey aimed at assessing the resource constraints at supervisory authorities, particularly in the oversight of SIFIs and G-SIFIs. In addition, the IMF reviewed nine recent FSAP assessments regarding the adequacy of supervisory resources. Collectively, they describe some of the challenges supervisory agencies face in building the capacity required for the supervision of financial institutions, in particular of G-SIFIs. An immediate challenge is determining the supervisory staff required, not only in regard to numbers but also seniority and skill mix. In summary, while the intensity of supervision has increased since the crisis, much remains to be done to support continuous improvement in SIFI supervision, in particular of G-SIFIs. When done well, however, effective and high quality supervision leads to more robust discussions with institutions and early responses to inadequately controlled risk-taking, from which both sides gain.

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To support continuous improvement, the report draws some recommendations that flow from the discussions among members of the SIE group.

List of recommendations: More intense SIFI supervision The following recommendations are aimed at intensifying SIFI supervision but they are also applicable for the supervision of financial institutions more generally. 1. Supervisors should adopt proactive approaches to assess succession planning and set performance expectations for key positions within SIFIs (e.g. CEOs, CROs, Internal Auditors), elements that should no longer be regarded as only internal matters for financial institutions. At a minimum, supervisors should require that firms have robust processes in place to ensure effective talent management and succession planning for leaders of control functions and other key positions. They also should be informed of the rationale for appointments to such positions in advance of the appointments being made. 2. Supervisory interactions with Boards and senior management should be stepped up, in terms of frequency and level of seniority, as should the assessment of the effectiveness of Boards and senior management. Supervisors should satisfy themselves that SIFIs have a robust process in place to assess applicants for Board-level or senior management positions and should be informed of the rationale for Board appointments in advance of such announcements. 3. Supervisory authorities should continually re-assess their resource needs; for example, interacting with and assessing Boards require particular skills, experience and adequate level of seniority.

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Multi-year resource plans, supervisory training programs, long-term career paths and development of “soft” skills, such as leadership and communication skills, are essential. The SIE will review supervisory approaches to and emphasis on training programs in the coming year. 4. Supervisors of G-SIFIs need to ensure that the stress testing undertaken for G-SIFIs is comprehensive and commensurate with the risks and complexities of these institutions and should advance further with the implementation of the BCBS Principles for Sound Stress Testing Practices. 5. Supervisors should further explore ways to formally assess risk culture, particularly at G-SIFIs. Establishing a strong risk culture at financial institutions is an essential element of good governance. Metrics such as audit findings not being closed and employee survey results could allow conclusions about culture to be reached on an ongoing basis and before major issues arise due to weak risk cultures. Supervisors should also expect financial institutions to be proactive in this regard. The SIE will discuss supervisory practices and approaches toward assessing risk culture. 6. Supervisors need to evaluate whether their approach to and methods of supervision remain effective or have, for example, moved too far toward focusing on adequacy of capital and control systems, and away from detailed assessments of sources of profits and financial data. The SIE will explore this further, including resource implications relative to the benefits of increasing focus in the latter areas. 7. Supervisors need to consider putting in place additional data management and analysis processes for the information available from a range of sources, such as that collected by trade repositories and other

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centralised sources of financial data, so that key players in markets and market anomalies are identified. Supervisors should explore how this new information could be useful in the supervision of SIFIs. 8. By the end of 2013, the FSB SIE group should report on progress toward addressing these issues and set out best practices or recommendations for how to enhance the effectiveness of supervision in each of the above areas.

Assessment of effective supervision 9. The FSB’s initiative on promoting adherence to regulatory and supervisory standards focuses on banking supervision, insurance supervision and securities regulation and views the IMF-World Bank FSAPs and ROSCs as central mechanisms for promoting implementation of the BCBS, IAIS and IOSCO core principles. However, there are differences in the assessment methodology and ratings nomenclature in regard to the: (i) Use of discretion in the assessments to take account of proportionality and materiality; (ii) Degree to which standards are aspirational versus minimum requirements; and (iii) Messages communicated given the different terminology for ratings, particularly when applied to core principles that address similar areas. As the FSB places increased reliance on FSAPs and ROSCs and focuses on SIFIs (which can be from any sector), the FSB, in collaboration with the IMF, World Bank and standard setters, should examine the pros and cons of harmonising the assessment methodology and ratings nomenclature.

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10. Emphasis must continue to be placed on the fundamental requirements for effective supervision, particularly in regard to official mandates, resources, and independence as FSAPs and ROSCs continue to indicate problems in these areas. The BCBS, IAIS, and IOSCO core principles provide a clear benchmark for what is needed to achieve effective supervision, and the enhanced BCBS and IAIS core principles raise the bar by placing greater emphasis on these issues. Governments should commit to implementing the BCBS, IAIS and IOSCO core principles for effective supervision and the IMF/World Bank should actively monitor progress toward full implementation through FSAPs and ROSCs. In addition, the FSB should enhance its monitoring of these areas, leveraging for example on the FSB Implementation Monitoring Network exercise, to ensure that adherence to these core principles becomes a matter of ongoing attention and public disclosure. 11. The IAIS should follow-up on its findings from the self-assessment exercise against ICP 23 on group-wide supervision, including the challenges and prerequisites for effective group-wide supervision and ensuring supervisors have the powers to act at the level of the holding company. The IAIS should report to the SIE by end 2013 on the progress made toward achieving group-wide supervision and equipping supervisors with the appropriate powers to act at the level of the holding company.

Operational risk 12. The recent spate of high-profile, and potentially solvency-threatening, operational risk events and failures have added some urgency to fundamentally reviewing the BCBS approach toward capital for operational risk.

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The BCBS should update its capital requirements for operational risk by the end of 2014. 13. The BCBS should conduct a peer review on implementation of its Principles for the Sound Management of Operational Risk by June 2014. The BCBS should supplement the review with an assessment of the additional guidance needed on operational controls within capital markets and trading businesses. 14. The BCBS should conduct a study of its Supervisory Guidelines for the Advanced Measurement Approaches by end 2015 to assess whether any changes are necessary to enhance their effective implementation and to bring more consistency to supervisory approaches in this area. 15. The IAIS should maintain its timeline for launching a peer review in 2014 to assess effective implementation of ICP 16 on enterprise risk management for solvency purposes and ICP 17 on capital adequacy, as both principles cover operational risk.

Supervisory colleges 16. The FSB, in collaboration with the standard setters, should intensify efforts to increase the effectiveness of supervisory colleges, particularly for G-SIFIs. Given the strong interest and expectation of colleges expressed through the G20 process, it is critical that the FSB further consider ways to ensure adequate exchange of information and cooperation within core supervisory colleges, as well as avenues to promote joint decision making processes in the future. The FSB should submit a report to the September 2013 G20 Summit which sets out policy recommendations to address the issues identified as hindering the effectiveness of core supervisory colleges. 17. The BCBS and IOSCO should monitor the establishment and composition of core (and universal) colleges as well as assess the activity

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of new colleges and frequency of existing colleges (as the IAIS does) and report progress to the FSB on an annual basis.

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

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

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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

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Monday November 12 2012 Top 10 Risk Compliance News Events

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