Please note there will be no RegNews published on 18th September.
FCA chair on collaboration and modernisation of regulation
In a speech at the Eurofi Financial Forum 2023, Ashley Alder, recently appointed Chair of the Financial Conduct Authority, reflected on the significance of international cooperation in the face of evolving challenges in the financial sector, notably the impact of artificial intelligence (AI).
He began by highlighting the recent UK-EU Memorandum of Understanding on Regulatory Cooperation in Financial Services, emphasising the interconnectedness of the UK and EU financial services sectors and the benefits of constructive collaboration.
Alder also addressed two major areas of focus: climate and crypto. Regarding climate, he stressed the need for sustainability-related reporting standards at the global level to help combat the climate emergency. He welcomed the International Sustainability Standards Board’s endorsement of climate reporting standards and noted the UK aims to enhance climate reporting by consulting on critical guidance for climate transition plan disclosures.
On the topic of crypto, Alder stressed the necessity for international collaboration to tackle the risks associated with crypto businesses that operate across national borders. He highlighted ongoing efforts within the IOSCO Fintech Task Force to develop critical global standards for crypto and digital assets.
Alder also touched on the importance of addressing financial stability concerns, particularly in non-bank financial intermediation (NBFI). He stressed the need for close cooperation and data sharing among regulators and market participants to properly manage risks in wholesale markets.
Domestically, Alder acknowledged significant reforms to come following the UK’s passage of the Financial Services and Markets Act which has formalised “what will be a multi-year, intensive programme to tailor financial services regulation to UK markets“.
He emphasised too the principles of effective, proportionate reforms, collaboration with global partners, promotion of strong global regulatory standards, and consideration of costs to globally active firms in rule development. Alder also highlighted areas where the EU and UK are pursuing similar reforms, for example in consolidated tape reform, illustrating opportunities for mutual learning and collaboration.
Concluding, Alder stressed the importance of global collaboration, strong regulatory frameworks, and international alignment in addressing the complex challenges facing the financial services industry and advocated for effective cooperation to ensure market stability, sustainability, and prosperity for both the EU and the UK.
Reflections on the 2023 banking turmoil
In a speech at the same event, Pablo Hernández de Cos, Chair of the Basel Committee on Banking Supervision and Governor of the Bank of Spain, considered some of the issues from the banking crisis of March 2023.
Hernández de Cos reminded the audience that, in just 11 days – from 8 to 19 March 2023 – four banks with total assets of about $900 billion were shut down, put into receivership or rescued. This was followed by the failure of a fifth bank with roughly $230 billion in assets on 1 May 2023.
He identified several weaknesses as follows, noting that these weaknesses are of deep concern, as they demonstrate that some banks’ boards and senior management failed in their most elementary responsibilities of overseeing and challenging a bank’s strategy and risk tolerance.
- Fundamental shortcomings in the management of traditional banking risks, such as interest rate risk and liquidity risk.
- A failure to appreciate how various risks could compound one another.
- Inadequate and unsustainable business models, with an excessive focus on growth and short-term profitability.
- A poor risk culture and ineffective senior management and board oversight.
- A failure to adequately respond to supervisory feedback and recommendations.
- These weaknesses are of deep concern, as they demonstrate that some banks’ boards and senior management failed in their most elementary responsibilities of overseeing and challenging a bank’s strategy and risk tolerance.
Hernández de Cos went on to cover six important takeaways to enhance strong and effective supervision of the banking sector.
- The need to understand banks’ business models: Supervisors need to understand how banks make money and what risks they are exposed to. This includes understanding the banks’ lending practices, investment strategies, and funding sources. By understanding the banks’ business models, supervisors can identify potential vulnerabilities and take steps to address them.
- The importance of effective governance and risk management: Banks need to have strong governance and risk management systems in place to identify, measure, monitor, and mitigate risks. This includes having a board of directors that is independent and effective, a risk management function that is well-staffed and competent, and a risk culture that is embedded throughout the organization.
- The challenges of overseeing liquidity risk: Liquidity risk is the risk that a bank will not be able to meet its financial obligations when they come due. This can happen if there is a sudden withdrawal of deposits or if the bank’s assets become illiquid. Supervisors need to monitor banks’ liquidity risk closely and take steps to mitigate it, such as requiring banks to hold sufficient liquid assets.
- The importance of supervisory judgment: Supervisors need to use their judgment to ensure that the intent, as well as the letter, of regulation is addressed. This means going beyond simply enforcing rules and regulations to taking a more proactive approach to identifying and addressing risks.
- The need to review supervisory toolkits: Supervisors need to regularly review their toolkits to ensure they are sufficient to drive concrete action at banks. This includes having a range of tools available, such as supervisory recommendations, enforcement actions, and financial penalties.
He finished his speech by identifying four regulatory issues he feels would benefit from further analysis. They were as follows:
- Liquidity: The liquidity standards in Basel III may need to be reviewed, particularly in light of the significant liquidity outflows experienced by some banks during the turmoil. The design of the LCR and NSFR may need to be changed to make it easier for banks to use their liquid assets in times of stress. The role of digitalization and social media in liquidity outflows also needs to be considered.
- Interest rate risk: The current regulatory treatment of interest rate risk in the banking book (IRRBB) may need to be strengthened. This could involve moving towards a Pillar 1 capital framework for IRRBB.
- Regulatory capital: The definition of regulatory capital may need to be revised to take into account unrealised interest rate losses on fixed income assets and the risks from second-round fire sales. The role of Additional Tier 1 (AT1) capital instruments in the capital framework also needs to be reviewed.
- Application of the Basel Framework: The definition of an “internationally active bank” may need to be revised to take into account the systemic implications of the failure of a bank.
Concluding, Hernández de Cos noted: “I am pleased to note that there is broad agreement to prioritise further work to strengthen supervisory effectiveness, including identifying issues that could merit additional guidance at a global level. In addition, the Committee will pursue additional follow-up analytical work based on empirical evidence to assess whether specific features of the Basel Framework performed as intended during the turmoil, such as liquidity risk and interest rate risk in the banking book. And we will continue to coordinate with other global forums and standard-setting bodies on cross-cutting issues.”
SEC: domestic agenda and international partnerships
Not to be outdone, SEC commissioner Jaime Lizárraga also addressed the same conference and provided a summary of reforms aimed at bolstering oversight of the nation’s financial markets.
Lizárraga highlighted the robust and targeted nature of the SEC’s reform agenda, driven by well-informed approaches involving various stakeholders. The agenda covers critical aspects such as digital finance, cybersecurity, market transparency, and decision-useful disclosures, all intended to enhance market resilience and ensure investor protection, irrespective of their scale.
One pivotal aspect of the reforms pertains to US equity markets, which account for a substantial portion of the world’s share trading, averaging over half a trillion dollars per day. Proposed reforms focus on improving transparency and competition within these markets, shedding light on access fees, best execution practices, and enhancing pricing competitiveness for retail investors.
Addressing the burgeoning challenges in technology-driven interactions with investors, Lizárraga emphasised the need to prevent technology misuse by firms that could lead investors to decisions favouring the company over the investor. This is especially important given the increasing influence of social media as a source of information for new investors.
Lizárraga also noted proposed rules to improve transparency and reduce systemic risk in the US Treasury market, which plays a crucial role in public finance and monetary policy. This proposal aims to make the market more resilient by increasing transactions subject to central clearing.
Within the public company space, long-overdue rules have been adopted, addressing executive accountability and aligning incentives with performance. Measures have been taken to strengthen investor protections related to insider trading, aligning with the increased demand for standardised environmental, social, and governance (ESG) disclosures.
Looking forward, the SEC aims to enhance disclosures regarding human capital management and board diversity, recognising the value of intangible assets and their impact on investors. The agenda also includes rules on various financial aspects like open-end funds, money market funds, SPACs, and corporate share repurchases, demonstrating a comprehensive and far-reaching modernisation effort.
In conclusion, Lizárraga stressed the importance of modernising the regulatory framework to align with current realities, increase transparency, and strengthen enforcement powers against fraudulent practices, ultimately boosting market integrity and investor confidence. He emphasised the shared goal of promoting fair and transparent markets through robust oversight, once again acknowledging the importance of international cooperation while respecting each jurisdiction’s unique needs.
BIS and IDB partner to foster Innovation in Latin America
The Bank for International Settlements (BIS) and the Inter-American Development Bank (IDB) have partnered to foster innovation and financial inclusion in Latin America. The partnership will focus on developing technology that can help to modernise the region’s financial systems.
The first collaboration between the two institutions will be on Project FuSSE (Fully Scalable Settlement Engine). Project FuSSE aims to design and test backend functionality that can be adapted to multiple types of infrastructures, allowing them to process a continuously growing number of transactions.
The partnership will benefit from the expertise of each institution as well as from central banks in the region. The BIS’s experience in technical experimentation and its global scope will be complemented by the IDB’s knowledge of the regional systems and their interactions.
The partnership is a significant milestone in the efforts of the BIS and the IDB to promote financial inclusion and development in Latin America.
A selected summary of key developments for regulated financial institutions
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