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        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,

Which is the difference between good
deleveraging and bad deleveraging?
According to Dr Andreas Dombret, Member
of the Executive Board of the Deutsche
Bundesbank, good deleveraging means scaling back the exposure to
other financial intermediaries, whereas bad deleveraging means that
lending to the real economy is being reduced.
Dr Andreas Dombret is one of my favourite speakers. In Number 2 of our
list he asks the question:
Will 2012 go down in history as an “annus horribilis” or rather as an
“annus mirabilis”, or neither?
He starts from the originator of the “annus horribilis”, Queen Elizabeth,
that used the phrase to describe her feelings about the year 1992, and he
goes on with the fire at Windsor Castle. Many people use the metaphor of
a large-scale fire to explain the economic term of a “systemic” event.
The fire spread so rapidly due to a city’s narrow streets and the
“interconnectedness” of houses.
The fire in the financial markets was stopped by the ECB, by the two
firewalls EFSF and ESM as well as by the governments announcing that
they would improve the financial system.
Thus 2012 is an “annus mirabilis”.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
Page |2


He also remembered Peter Bernstein, the financial historian from the US,
that illustrated his point by citing the anecdote of a Moscovite professor
of statistics, who refused to go to the air-raid shelter during World War II
bomb attacks.
The professor argued: “See, Moscow has seven million inhabitants.
Why should I expect to be one who will be hit?”
His neighbours were astonished, when he came back to the shelter the
next night.
Now the professor’s argumentation was:
“Moscow has seven million inhabitants and one elephant. Last night the
elephant was hit.”
More at Number 2 of our list.

In Number 1 this week we have the speech of Richard W. Fisher,
president and CEO of the Federal Reserve Bank of Dallas.

He speaks about the “the injustice of being held hostage to large financial
institutions considered too big to fail”.

I enjoyed what he remembered:

One is reminded of the comment French Prime Minister Clemenceau
made about President Wilson’s 14 points:

“Why 14?” he asked. “God did it in 10.”

Were that we only had 14 points of financial regulation to contend with
today.

Read more at Number 1 below.

Welcome to the Top 10 list.



      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
Page |3




Richard W. Fisher, president and CEO of the
Federal Reserve Bank of Dallas.

Ending 'Too Big to Fail': A Proposal for
Reform Before It's Too Late (With Reference
to Patrick Henry, Complexity and Reality)
Remarks before the Committee for the Republic
Washington, D.C. · January 16, 2013




Dr Andreas Dombret
Member of the Executive Board of the Deutsche
Bundesbank

Challenges for financial stability – policy and
academic aspects

Dinner Speech at the Joint Conference of the
Deutsche Bundesbank, the Technical University
Dresden and the Journal of Financial Stability




Preserving the safety and security of
Malaysia’s banking system

Speech by Mr Encik Abu Hassan Alshari Yahaya, Assistant Governor of
the Central Bank of Malaysia, at the launch of the e-Banking Fraud
Awareness Campaign, Kuala Lumpur

     _____________________________________________________________
    International Association of Risk and Compliance Professionals (IARCP)
                     www.risk-compliance-association.com
Page |4




Comments received on the
consultative report "Recovery
and resolution of financial
market infrastructures
South Africa, Financial Services Board (FSB) has requested the SAFEX
Clearing Company (Pty) Limited (SAFCOM) and Strate Limited to
provide feedback.




Opening Remarks at Investor Advisory
Committee Meeting

By Chairman Elisse Walter
U.S. Securities and Exchange Commission
Washington, D.C. January 18, 2013




Tougher credit rating
rules confirmed by
European Parliament's
vote

New rules on when and how credit rating agencies may rate state debts
and private firms' financial health were approved by Parliament on
Wednesday.



     _____________________________________________________________
    International Association of Risk and Compliance Professionals (IARCP)
                     www.risk-compliance-association.com
Page |5




FSA UK

Risk to Customers from Financial
Incentives

Consumer trust and confidence in financial
services is essential.




Ensuring the smooth functioning of money
markets

Speech by Mr Benoît Coeuré, Member of the
Executive Board of the European Central Bank,
at the 17th Global Securities Financing Summit,
Luxembourg, 16 January 2013.




Michel BARNIER

The European banking union, a precondition
to financial stability and a historical step
forward for European integration




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
Page |6




Understanding the European Banking
Union
In June 2012, EU leaders agreed to deepen
economic and monetary union as one of the remedies of the current crisis.

At that meeting (European Council of 28/29 June), the leaders discussed
the report entitled 'Towards a Genuine Economic and Monetary Union',
prepared by the President of the European Council in close collaboration
with the President of the European Commission, the Chair of the
Eurogroup and the President of the European Central Bank.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
Page |7




Richard W. Fisher, president and CEO of the
Federal Reserve Bank of Dallas.

Ending 'Too Big to Fail': A Proposal for
Reform Before It's Too Late (With Reference
to Patrick Henry, Complexity and Reality)
Remarks before the Committee for the Republic
Washington, D.C. · January 16, 2013

It is an honor to be introduced by my college
classmate, John Henry. John is a descendant of the
iconic patriot, Patrick Henry.

Most of John’s ancestors were prominent colonial
Virginians and many were anti-crown. Patrick,
however, was the most outspoken.

Ask John why this was so, and he will answer: “Patrick was poor.”

However poor he may have been, Patrick Henry was a rich orator.

In one of his greatest speeches, he said:

“Different men often see the same subject in different lights; and
therefore, I hope that it will not be thought disrespectful to those
gentlemen if, entertaining as I do, opinions of a character very opposite to
theirs, I shall speak forth my sentiments freely, and without reserve.

This is no time for ceremony … [it] is one of awful moment to this
country.”

Patrick Henry was addressing the repression of the American colonies by
the British crown.


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
Page |8


Tonight, I wish to speak to a different kind of repression—the injustice of
being held hostage to large financial institutions considered “too big to
fail,” or TBTF for short.

I submit that these institutions, as a result of their privileged status, exact
an unfair tax upon the American people.

Moreover, they interfere with the transmission of monetary policy and
inhibit the advancement of our nation’s economic prosperity.

I have spoken of this for several years, beginning with a speech on the
“Pathology of Too-Big-to-Fail” in July 2009.

My colleague, Harvey Rosenblum—a highly respected economist and the
Dallas Fed’s director of research—and I and our staff have written about
it extensively.

Tomorrow, we will issue a special report that further elucidates our
proposal for dealing with the pathology of TBTF.

It also addresses the superior relative performance of community banks
during the recent crisis and how they are being victimized by excessive
regulation that stems from responses to the sins of their behemoth
counterparts.

I urge all of you to read that report.

Now, Federal Reserve convention requires that I issue a disclaimer here: I
speak only for the Federal Reserve Bank of Dallas, not for others
associated with our central bank.

That is usually abundantly clear.

In many matters, my staff and I entertain opinions that are very different
from those of many of our esteemed colleagues elsewhere in the Federal
Reserve System.


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
Page |9


Today, I “speak forth my sentiments freely and without reserve” on the
issue of TBTF, while meaning no disrespect to others who may hold
different views.

The Problem of TBTF

Everyone and their sister knows that financial institutions deemed too big
to fail were at the epicenter of the 2007–09 financial crisis.

Previously thought of as islands of safety in a sea of risk, they became the
enablers of a financial tsunami.

Now that the storm has subsided, we submit that they are a key reason
accommodative monetary policy and government policies have failed to
adequately affect the economic recovery.

Harvey Rosenblum and I first wrote about this in an article published in
the Wall Street Journal in September 2009, “The Blob That Ate Monetary
Policy.”

Put simply, sick banks don’t lend. Sick—seriously undercapitalized —
megabanks stopped their lending and capital market activities during the
crisis and economic recovery.

They brought economic growth to a standstill and spread their sickness
to the rest of the banking system.

Congress thought it would address the issue of TBTF through the
Dodd–Frank Wall Street Reform and Consumer Protection Act.

Preventing TBTF from ever occurring again is in the very preamble of the
act.

We contend that Dodd–Frank has not done enough to corral TBTF banks
and that, on balance, the act has made things worse, not better.



      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 10


We submit that, in the short run, parts of Dodd–Frank have exacerbated
weak economic growth by increasing regulatory uncertainty in key
sectors of the U.S. economy.

It has clearly benefited many lawyers and created new layers of
bureaucracy.

Despite its good intention, it has been counterproductive, working
against solving the core problem it seeks to address.

Defining TBTF

Let me define what we mean when we speak of TBTF.

The Dallas Fed’s definition is financial firms whose owners, managers
and customers believe themselves to be exempt from the processes of
bankruptcy and creative destruction.

Such firms capture the financial upside of their actions but largely avoid
payment—bankruptcy and closure—for actions gone wrong, in violation
of one of the basic tenets of market capitalism (at least as it is supposed to
be practiced in the United States).

Such firms enjoy subsidies relative to their non-TBTF competitors.

They are thus more likely to take greater risks in search of profits,
protected by the presumption that bankruptcy is a highly unlikely
outcome.

The phenomenon of TBTF is the result of an implicit but widely
taken-for-granted government-sanctioned policy of coming to the aid of
the owners, managers and creditors of a financial institution deemed to
be so large, interconnected and/or complex that its failure could
substantially damage the financial system.

By reducing a TBTF firm’s exposure to losses from excessive risk taking,
such policies undermine the discipline that market forces normally assert
on management decision making.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 11


The reduction of market discipline has been further eroded by implicit
extensions of the federal safety net beyond commercial banks to their
nonbank affiliates.

Moreover, industry consolidation, fostered by subsidized growth (and
during the crisis, encouraged by the federal government in the
acquisitions of Merrill Lynch, Bear Stearns, Washington Mutual and
Wachovia), has perpetuated and enlarged the weight of financial firms
deemed TBTF.

This reduces competition in lending.

Dodd–Frank does not do enough to constrain the behemoth banks’
advantages. Indeed, given its complexity, it unwittingly exacerbates
them.

Complexity Bites

Andrew Haldane, the highly respected member of the Financial Policy
Committee of the Bank of England, addressed this at last summer’s
Jackson Hole, Wyo., policymakers’ meeting in witty remarks titled, “The
Dog and the Frisbee.”

Here are some choice passages from that noteworthy speech.

Haldane notes that regulators’ “… efforts to catch the crisis Frisbee have
continued to escalate.

Casual empiricism reveals an ever-growing number of regulators …

Ever-larger litters have not, however, obviously improved the watchdogs’
Frisbee-catching abilities.

[After all,] no regulator had the foresight to predict the financial crisis,
although some have since exhibited supernatural powers of hindsight.

“So what is the secret of the watchdogs’ failure?

      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 12


The answer is simple.

Or rather, it is complexity … complex regulation … might not just be
costly and cumbersome but sub-optimal. … In financial regulation, less
may be more.”

One is reminded of the comment French Prime Minister Clemenceau
made about President Wilson’s 14 points:

“Why 14?” he asked. “God did it in 10.”

Were that we only had 14 points of financial regulation to contend with
today.

Haldane notes that Dodd–Frank comes against a background of
ever-greater escalation of financial regulation.

He points out that nationally chartered banks began to file the
antecedents of “call reports” after the formation of the Office of the
Comptroller of the Currency in 1863.

The Federal Reserve Act of 1913 required state-chartered member banks
to do the same, having them submitted to the Federal Reserve starting in
1917.

They were short forms; in 1930, Haldane noted, these reports numbered
80 entries.

“In 1986, [the ‘call reports’ submitted by bank holding companies]
covered 547 columns in Excel, by 1999, 1,208 columns.

By 2011 … 2,271 columns.”

“Fortunately,” he adds wryly, “Excel had expanded sufficiently to capture
the increase.”

Though this growingly complex reporting failed to prevent detection of
the seeds of the debacle of 2007–09, Dodd–Frank has layered on copious
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 13


amounts of new complexity. The legislation has 16 titles and runs 848
pages.

It spawns litter upon litter of regulations: More than 8,800 pages of
regulations have already been proposed, and the process is not yet done.

In his speech, Haldane noted—conservatively, in my view—that a survey
of the Federal Register showed that complying with these new rules
would require 2,260,631 labor hours each year.

He added: “Of course, the costs of this regulatory edifice would be
considered small if they delivered even modest improvements to
regulators’ ability to avert future crises.”

He then goes on to argue the wick is not worth the candle.

And he concludes: “Modern finance is complex, perhaps too complex.
Regulation of modern finance is complex, almost certainly too complex.

That configuration spells trouble. As you do not fight fire with fire, you do
not fight complexity with complexity.

[The situation] requires a regulatory response grounded in simplicity, not
complexity. Delivering that would require an about-turn.”

The Dallas Fed’s Proposal: A Reasonable ‘About-Turn’

The Dallas Fed’s proposal offers an “about-turn” and a way to mend the
flaws in Dodd–Frank. It fights unnecessary complexity with simplicity
where appropriate.

It eliminates much of the mumbo-jumbo, ineffective, costly complexity of
Dodd–Frank.

Of note, it would be especially helpful to non-TBTF banks that do not
pose systemic or broad risk to the economy or the financial system.


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 14


Our proposal would relieve small banks of some unnecessary burdens
arising from Dodd–Frank that unfairly penalize them.

Our proposal would effectively level the playing field for all banking
organizations in the country and provide the best protection for taxpaying
citizens.

In a nutshell, we recommend that TBTF financial institutions be
restructured into multiple business entities.

Only the resulting downsized commercial banking operations—and not
shadow banking affiliates or the parent company—would benefit from
the safety net of federal deposit insurance and access to the Federal
Reserve’s discount window.

Defining the Landscape

It is important to have an accurate view of the landscape of banking today
in order to understand the impact of this proposal.

As of third quarter 2012, there were approximately 5,600 commercial
banking organizations in the U.S.

The bulk of these—roughly 5,500—were community banks with assets of
less than $10 billion.

These community-focused organizations accounted for 98.6 percent of all
banks but only 12 percent of total industry assets.

Another group numbering nearly 70 banking organizations—with assets
of between $10 billion and $250 billion—accounted for 1.2 percent of
banks, while controlling 19 percent of industry assets.

The remaining group, the megabanks—with assets of between $250
billion and $2.3 trillion—was made up of a mere 12 institutions.

These dozen behemoths accounted for roughly 0.2 percent of all banks,
but they held 69 percent of industry assets.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 15




The 12 institutions that presently account for 69 percent of total industry
assets are candidates to be considered TBTF because of the threat they
could pose to the financial system and the economy should one or more of
them get into trouble.

By contrast, should any of the other 99.8 percent of banking institutions
get into trouble, the matter most likely would be settled with
private-sector ownership changes and minimal governmental
intervention.

How and why does this work for 99.8 percent but not the other 0.2
percent?


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 16


To answer this question, it helps to consider the sources of regulatory and
market discipline imposed on each of the three groups of banks.

Let’s look at two dimensions of regulatory discipline: Potential closure of
the institution and the effectiveness of supervisory pressure on bank
management practices.

Do the owners and managers of a banking institution operate with the
belief that their institution is subject to a bankruptcy process that works
reasonably quickly to transfer ownership and control to another banking
entity or entities?

Is there a group of interested and involved shareholders that can exert a
restraining force on franchise-threatening risk taking by the bank’s top
management team?

Can management be replaced and ownership value wiped out? Is the firm
controlled de facto by its owners, or instead effectively
management-controlled?

In addition, we ask: To what extent do uninsured creditors of the banking
entity impose risk-management discipline on management?

This analytical framework is summarized in the following slide:




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 17




Looking across line 1, it is clear that community banks are subject to
considerable regulatory and shareholder discipline.

They can and do fail.

In the last few years, the Federal Deposit Insurance Corp. (FDIC) has
built a reputation for regulators carrying out Joseph Schumpeter’s
concept of “creative destruction” by taking over small banks on a Friday
evening and reopening them on Monday morning under new ownership.

“In on Friday, out by Monday” is the mantra of this process.

Knowing the power of banking supervisors to close the institution,
owners and managers of community banks heed supervisory suggestions
to limit risk.


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 18


Community banks often have a few significant shareholders who have a
considerable portion of their wealth tied to the fate of the bank.

Consequently, they exert substantial control over the behavior of
management because risk and potential closure matter to them.

Since community banks derive the bulk of their funding from federally
insured deposits, they are simple rather than complex in their capital
structure and rarely have uninsured and unsecured creditors.

“Market discipline” over management practices is primarily exerted
through shareholders.

Of the three groups, the 70 regional and moderate-sized banking
organizations depicted in line 2 are subject to a broader range of market
discipline.

Like community banks, these institutions are not exempt from the
bankruptcy process; they can and do fail.

But given their size, complexity and generally larger geographic footprint,
the failure resolution and ownership transfer processes cannot always be
accomplished over a weekend.

In practice, owners and managers of mid-sized institutions are
nonetheless aware of the downside consequences of the risks taken by the
institution.

Uninsured depositors and unsecured creditors are also aware of their
unprotected status in the event the institution experiences financial
difficulties.

Mid-sized banking institutions receive a good dose of external discipline
from both supervisors and market-based signals.

TBTF megabanks, depicted in line 3, receive far too little regulatory and
market discipline.

      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 19


This is unfortunate because their failure, if it were allowed, could disrupt
financial markets and the economy. For all intents and purposes, we
believe that TBTF banks have not been allowed to fail outright.

Knowing this, the management of TBTF banks can, to a large extent,
choose to resist the advice and guidance of their bank supervisors’ efforts
to impose regulatory discipline. And for TBTF banks, the forces of
market discipline from shareholders and unsecured creditors are limited.

Let’s first consider discipline from shareholders.

Having millions of stockholders has diluted shareholders’ ability to
prevent the management of TBTF banks from pursuing corporate
strategies that are profitable for management, though not necessarily for
shareholders.

As we learned during the crisis, adverse information on poor financial
performance often is available too late for shareholder reaction or credit
default swap (CDS) spreads to have any impact on management
behavior.

For example, during the financial crisis, shares in two of the largest bank
holding companies (BHCs) declined more than 95 percent from their
prior peak prices and their CDS spreads went haywire.

The ratings agencies eventually reacted, in keeping with their tendency to
be reactive rather than proactive.

But the damage from excessive risk taking had already been done.

And after the crisis?

Judging from the behavior of many of the largest BHCs, with limited
exception, efforts by shareholders of these institutions to meaningfully
influence management compensation practices have been slow in
coming.

So much for shareholder discipline as a check on TBTF banks.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 20


Unfortunately, TBTF banks also do not face much external discipline
from unsecured creditors.

An important facet of TBTF is that the funding sources for megabanks
extend far beyond insured deposits, as referenced by my mention of CDS
spreads.

The largest banks, not just the TBTF banks, fund themselves with a wide
range of liabilities.

These include large, negotiable CDs, which often exceed the FDIC
insurance limit; federal funds purchased from other banks, all of which
are uninsured, and subordinated notes and bonds, generally unsecured.

It is not unusual for such uninsured/unsecured liabilities to account for
well over half the liabilities of TBTF institutions.

If market discipline were to be imposed on TBTF institutions, one would
expect it to come from uninsured/unsecured depositors, creditors and
debt holders.

But TBTF status exerts perverse market discipline on the risk-taking
activities of these banks.

Unsecured creditors recognize the implicit government guarantee of
TBTF banks’ liabilities.

As a result, unsecured depositors and creditors offer their funds at a lower
cost to TBTF banks than to mid-sized and regional banks that face the
risk of failure.

This TBTF subsidy is quite large and has risen following the financial
crisis.

Recent estimates by the Bank for International Settlements, for example,
suggest that the implicit government guarantee provides the largest U.S.
BHCs with an average credit rating uplift of more than two notches,

      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 21


thereby lowering average funding costs a full percentage point relative to
their smaller competitors.

Our aforementioned friend from the Bank of England, Andrew Haldane,
estimates the current implicit TBTF global subsidy to be roughly $300
billion per year for the 29 global institutions identified by the Financial
Stability Board (2011) as “systemically important.”

To put that $300 billion estimated annual subsidy in perspective, all the
U.S. BHCs summed together reported 2011 earnings of $108 billion.

Add to that the burdens stemming from the complexity of TBTF banks.

Here is the basic organization diagram for a typical complex financial
holding company:




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     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 22


To simplify a complex issue, one might consider all the operations other
than the commercial banking operation as shadow banking affiliates,
including any special investment vehicles—or SIVs—of the commercial
bank.

Now, consider this table.

It gives you a sense of the size and scope of some of the five largest
BHCs, noting their nondeposit liabilities in billions of dollars and their
number of total subsidiaries and countries of operation (according to the
Financial Stability Oversight Council):




For perspective, consider the sad case of Lehman Brothers.

More than four years later, the Lehman bankruptcy is still not completely
resolved.

      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 23


As of its 10-K regulatory filing in 2007, Lehman operated a mere 209
subsidiaries across only 21 countries and had total liabilities of $619
billion.

By these metrics, Lehman was a small player compared with any of the
Big Five.

If Lehman Brothers was too big for a private-sector solution while still a
going concern, what can we infer about the Big Five in the table?

Correcting for the Drawbacks of Dodd–Frank
Dodd–Frank addresses this concern. Under the Orderly Liquidation
Authority provisions of Dodd–Frank, a systemically important financial
institution would receive debtor-in-possession financing from the U.S.

Treasury over the period its operations needed to be stabilized. This is
quasi-nationalization, just in a new, and untested, format.

In Dallas, we consider government ownership of our financial
institutions, even on a “temporary” basis, to be a clear distortion of our
capitalist principles.

Of course, an alternative would be to have another systemically important
financial institution acquire the failing institution.

We have been down that road already.

All it does is compound the problem, expanding the risk posed by the
even larger surviving behemoth organizations.

In addition, perpetuating the practice of arranging shotgun marriages
between giants at taxpayer expense worsens the funding disadvantage
faced by the 99.8 percent remaining—small and regional banks.

Merging large institutions is a form of discrimination that favors the
unwieldy and dangerous TBTF banks over more focused, fit and
disciplined banks.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 24


The approach of the Dallas Fed neither expands the reach of government
nor further handicaps the 99.8 percent of community and regional banks.

Nor does it fight complexity with complexity.

It calls for reshaping TBTF banking institutions into smaller, less -
complex institutions that are: economically viable; profitable;
competitively able to attract financial capital and talent; and of a size,
complexity and scope that allows both regulatory and market discipline to
restrain excessive risk taking.

Our proposal is simple and easy to understand. It can be accomplished
with minimal statutory modification and implemented with as little
government intervention as possible.

It calls first for rolling back the federal safety net to apply only to basic,
traditional commercial banking.

Second, it calls for clarifying, through simple, understandable
disclosures, that the federal safety net applies only to the commercial
bank and its customers and never ever to the customers of any other
affiliated subsidiary or the holding company.

The shadow banking activities of financial institutions must not receive
taxpayer support.

We recognize that undoing customer inertia and management habits at
TBTF banking institutions may take many years.

During such a period, TBTF banks could possibly sow the seeds for
another financial crisis. For these reasons, additional action may be
necessary.

The TBTF BHCs may need to be downsized and restructured so that the
safety-net-supported commercial banking part of the holding company
can be effectively disciplined by regulators and market forces.


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 25


And there will likely have to be additional restrictions (or possibly
prohibitions) on the ability to move assets or liabilities from a shadow
banking affiliate to a banking affiliate within the holding company.

To illustrate how the first two points in our plan would work, I come back
to the hypothetical structure of a complex financial holding company.

Recall that this type of holding company has a commercial bank
subsidiary and several subsidiaries that are not traditional commercial
banks: insurance, securities underwriting and brokerage, finance
company and others, many with a vast geographic reach.

Where the Government Safety Net Would Begin and End
Under our proposal, only the commercial bank would have access to
deposit insurance provided by the FDIC and discount window loans
provided by the Federal Reserve.

These two features of the safety net would explicitly, by statute, become
unavailable to any shadow banking affiliate, special investment vehicle of
the commercial bank or any obligations of the parent holding company.

This is largely the current case—but in theory, not in practice.

And consistent enforcement is viewed as unlikely.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 26




Reinforced by a New Covenant
To reinforce the statute and its credibility, every customer, creditor and
counterparty of every shadow banking affiliate and of the senior holding
company would be required to agree to and sign a new covenant, a simple
disclosure statement that acknowledges their unprotected status.

A sample disclosure need be no more complex than this:




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This two-part step should begin to remove the implicit TBTF subsidy
provided to BHCs and their shadow banking operations.

Entities other than commercial banks have inappropriately benefited
from an implicit safety net.

Our proposal promotes competition in light of market and regulatory
discipline, replacing the status quo of subsidized and perverse incentives
to take excessive risk.

As indicated earlier, some government intervention may be necessary to
accelerate the imposition of effective market discipline.

We believe that market forces should be relied upon as much as
practicable.



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However, entrenched oligopoly forces, in combination with customer
inertia, will likely only be overcome through government-sanctioned
reorganization and restructuring of the TBTF BHCs.

A subsidy once given is nearly impossible to take away.

Thus, it appears we may need a push, using as little government
intervention as possible to realign incentives, reestablish a competitive
landscape and level the playing field.

Why Protect the 0.2 Percent?
My team at the Dallas Fed and I are confident this simple treatment to the
complex problem and risks posed by TBTF institutions would be the
most effective treatment.

Think about it this way: At present, 99.8 percent of the banking
organizations in America are subject to sufficient regulatory or
shareholder/market discipline to contain the risk of misbehavior that
could threaten the stability of the financial system.

Zero-point-two percent are not.

Their very existence threatens both economic and financial stability.

Furthermore, to contain that risk, regulators and many small banks are
tied up in regulatory and legal knots at an enormous direct cost to them
and a large indirect cost to our economy. Zero-point-two percent.

If the administration and the Congress could agree as recently as two
weeks ago on legislation that affects 1 percent of taxpayers, surely it can
process a solution that affects 0.2 percent of the nation’s banks and is less
complex and far more effective than Dodd–Frank.

Making a Time of ‘Awful Moment’ a Time of Promise
The time has come to change the decision making paradigm.

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There should be more than the present two solutions: bailout or the
end-of-the-economic-world-as-we-have-known-it.

Both choices are unacceptable.

The next financial crisis could cost more than two years of economic
output, borne by millions of U.S. taxpayers.

That horrendous cost must be weighed against the supposed benefits of
maintaining the TBTF status quo.

To us, the remedy is obvious: end TBTF now. End TBTF by
reintroducing market forces instead of complex rules, and in so doing,
level the playing field for all banking institutions.

I return to Patrick Henry. He noted that “it is natural to man to indulge in
the illusions of hope.

We are apt to shut our eyes against a painful truth, and listen to the song
of that siren till she transforms us.”

We labor under the siren song of Dodd–Frank and the recent run-up in
the pricing of TBTF bank stocks and credit, indulging in the illusion of
hope that this complex legislation will end too big to fail and right the
banking system.

We shut our eyes to the painful truth that TBTF represents an ongoing
danger not just to financial stability, but also to fair competition.

The Dallas Fed offers a modest but, we believe, far more effective fix to
Dodd–Frank. This plan is not without its costs.

But it is less costly than all the alternatives put forward and it seriously
reduces the likelihood of another horrendous and costly financial crisis.

This need not be a time of “awful moment.” It should instead be a time of
promise.

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Treating the pathology of TBTF now would be a big step toward a more
stable and prosperous economic system, one that relies on fundamental
principles of capitalism rather than regulatory complexity and increasing
government intervention.

Thank you.




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Dr Andreas Dombret
Member of the Executive Board of the
Deutsche Bundesbank

Challenges for financial stability –
policy and academic aspects

Dinner Speech at the Joint Conference of the
Deutsche Bundesbank, the Technical
University Dresden and the Journal of
Financial Stability

2012: An “annus horribilis” or an “annus mirabilis” or neither?
Your Magnificence Professor Müller-Steinhagen,
Mister State Minister Doctor Beermann,
Ladies and Gentlemen:
The turn of the year gives me the chance to relate
my discussion of some of the future challenges
for financial stability to a résumé of the previous
year.
Please allow me to do this from a European perspective and let me start
with a seemingly innocent question:
Will 2012 go down in history as an “annus horribilis” or rather as an
“annus mirabilis”, or neither?
The answer to this question is less trivial than it appears at first. Let’s look
to the origins of the words “annus horribilis” and “annus mirabilis”.
To see this please note that the originator of the “annus horribilis”,
Queen Elizabeth, used it to describe her feelings about the year 1992.
At the time, her Majesty was talking about, among others, the fire at
Windsor Castle, but one might also read it as a comment about what
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happened in the financial sector in 1992 when the markets forced the UK
to leave the European Exchange Rate Mechanism.
More recently, the Queen’s remarks sound as a comment about the
financial and economic development of 2012.
Please also note that many people use the metaphor of a large-scale fire to
explain the economic term of a “systemic” event.
Thus her Majesty is worth quoting in more length: “1992 is not a year on
which I shall look with undiluted pleasure.
In the words of one of my more sympathetic commentators it has turned
to be an “annus horribilis”.
I suspect that I am not alone in thinking it so. Indeed I suspect that there
are very few people or institutions unaffected by the last months of
worldwide turmoil and uncertainty.”
According to various measures 2012 was a year of considerable systemic
tensions.
Indeed, the indicators were approaching - but did not quite reach - the
sad levels seen in the second half of 2008 and in the first half of 2009 -
which was without doubts a very difficult period in the financial and
economic history.
Therefore, one might be tempted to classify 2012 as an “annus horribilis”.
I wish to challenge this view.
Will 2012, with hindsight, possibly go down in history as an “annus
mirabilis”? Absurd, you may think.
But on second thought this notion seems less absurd than it first appears.
Let us not forget that the famous poem of John Dryden entitled “annus
mirabilis” was inspired from major events in the year 1666.
A very difficult year, to put it mildly, a year in which the Great Fire
destroyed 80% of the city of London.


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The fire spread so rapidly due to the city’s narrow streets and the
“interconnectedness” of houses.
The battle to stop the fire was considered to have been won by two
factors: the strong east winds died down, and the Tower of London
garrison used gunpowder to create effective firebreaks to stop the fire
from spreading further eastwards.
Dryden’s view was that God had performed miracles for England.
The King promised to improve the streets.
Well, some may say, so it is in 2012.
The fire in the financial markets was stopped by the ECB, by the two
firewalls EFSF and ESM as well as by the governments announcing that
they would improve the financial system.
Thus 2012 is an “annus mirabilis”.
But as you know, miracles need to be acknowledged either by the pope or
by the scientific community.
So let us check whether a miracle was at work in 1666.
And what I am going to say now about 1666 can be understood as a
metaphorical warning about what could happen if we do not draw the
right policy conclusion from the events of 2012.
Despite numerous radical proposals, London was rebuilt using essentially
the same street plan which was in use before the fire.
So the miracle is that nothing similar to the Great Fire has happened in
the following years.
The lesson of this story is quite clear.
The financial system needs better rules than in the years preceding the
crisis.
We need a resilient financial system.
We need a strong supervision. We need effective macroprudential
instruments.
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We need to know how these instruments will work, which is a challenge
for the scientific community as well as for macroprudential policy makers.
Otherwise, we would be putting our trust in a miracle.
And we need to understand the complicated interactions between the
financial and the real economy, which is the topic of your conference.
Links between the Financial System and the Real Economy
Take, for example, the LTROs which provided banks with liquidity for a
period of three years.
These LTROs have made the links between the public and the banking
sector in some countries closer, not wider meaning that the system is even
more vulnerable to systemic contagion than before.
Another example is the issue of deleveraging and forbearance.
In Europe, many banks’ balance sheets are too large.
Most of you probably agree that it is necessary for these banks to shrink
their balance sheets.
At the same time, some fear that deleveraging cuts off corporations from
their financing sources.
From a theoretical viewpoint, however, a distinction needs to be made
between good and bad deleveraging.
Good deleveraging, for instance, means scaling back the exposure to
other financial intermediaries whereas bad deleveraging means that
lending to the real economy is being reduced.
The problem with this view is that, in practice, the distinction is not at all
so clear-cut.
The issue becomes even more complicated, when we additionally
introduce the concept of forbearance, i.e. postponing the act of declaring
a doubtful loan to be a doubtful loan.
What is the best response to this issue?


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The first answer is transparency. At this point, transparency is more easily
said than done.
But we need it, particularly in the context of a banking union and possible
bank recapitalisations.
And transparency is especially important with a view to legacy assets and
forbearance of the problem banks.
How do we proceed further?
Repairing the banks’ balances sheets and injecting capital is one answer.
However, some fear that repairing balance sheets has procyclical effects
and could damage the availability of credit for the real economy.
In my view, however, repairing balance sheets will have a long-term
positive impact on potential output growth more than offsetting the
possible short-term cyclical effects.
The Limits of State Interventions
I often hear that the banks were responsible for the crisis. But can
governments do better?
As you know, one reason for the financial crisis was the use of risk models
based on assumptions, which concentrated on expected values rather
than tails.
Peter Bernstein, the financial historian from the US, illustrated this point
by citing the anecdote of a Moscovite professor of statistics, who refused
to go to the air-raid shelter during World War II bomb attacks.
The professor argued: “See, Moscow has seven million inhabitants.
Why should I expect to be one who will be hit?”
His neighbours were astonished, when he came back to the shelter the
next night.
Now the professor’s argumentation was:
“Moscow has seven million inhabitants and one elephant. Last night the
elephant was hit.”
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If regulators and banks essentially use the same models for their risk
management, why should we expect a better financial stability outcome?
Of course, one solution is to improve our models.
But I do not think that this is the end of the story.
I rather believe that regulators can do better if they acknowledge their
own limitations.
Regulators should employ the market mechanism to find the best risk
management tools.
In an ideal world the market is a discovery process.
First, each individual agent knows better what is good for him.
But at the end of the discovery process – in theory – we will get the best
risk management tools, if – and this “if” is the decisive word here – if
banks with weak risk management processes are allowed to fail, having to
leave the market.
This is one reason why resolving the “too-big-to-fail”-problem needs to
be a top priority on the regulatory agenda.
As far as I can judge, we are only beginning to understand how
well-established instruments like the capital ratio work and what effect
they have on the banks’ behaviour.
And there are other new macroprudential instruments where our
knowledge is even more limited.
Take the counter-cyclical buffer.
The idea is simple and compelling. When the regulators identify a bubble
developing, this buffer is activated, thereby leading banks to reduce their
lending.
If all works well, this buffer prevents the exuberances altogether, or at
least mitigates it.
However, it is not clear how the buffers should be calibrated in order to
achieve better financial stability.
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Moreover, not much is known about possible time lags.
In the worst situation, these buffer effects are not counter- but
pro-cyclical.
Things become even more complicated if different instruments are
applied at the same time.
As you can easily see, there are many questions waiting to be answered,
many problems waiting to be resolved.
When I think about what we know how macroprudential instruments
work, traffic lights come to my mind.
To prevent pedestrians from crossing the street when the traffic light is
red the authorities actually installed buttons that pedestrians could press
to shorten the red phase.
And it turned out to be a success: fewer pedestrians crossed the street
when the lights were red.
However, what the pedestrians did not know was that pushing the
buttons had no effect on the duration of the red phase.
Please do not misunderstand me: I do not believe that macroprudential
instruments are useless. Quite the contrary is true.
What I want to highlight is that we cannot expect to prevent all future
crises from happening.
It is an illusion to believe that we can finetune our instruments such that
they have exactly the effect we want them to have.
Recently, Otmar Issing wrote in the Frankfurter Allgemeine Zeitung:
“The attempt to prevent each kind of crisis is just as hopeless as harmful.
… The guiding principle of the market paradigm of action and liability
for the consequences (of these actions) should be valid without
exemption.”



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Taking this into consideration, the effects and the interdependence of
macroprudential instruments may turn out to be a very fruitful research
area.
To sum up, every intervention in the market needs to be justified by
market failures, something that, unfortunately, is not hard to find in many
areas of the financial system.
There is no guarantee, however, that governments can do a better job.
But at least the state has an incentive taking into account the negative
externalities of banks’ decisions and thus to minimise tax payers’ losses.
When the state is aware of its own limitations there is a good chance that
the outcome will be better than one in which the financial system is left to
its own devices.
Newton’s “annus mirabilis”
There was one famous scientist for whom 1666 was indeed an “annus
mirabilis”.
Isaac Newton made revolutionary inventions and discoveries in calculus,
motion, optics and gravitation.
As such, 1666 was later referred to Isaac Newton's “annus mirabilis”.
It is the year when Isaac Newton was said to have observed an apple
falling from a tree and hit upon gravitation.
He afforded the time to work on his theories due to the closure of
Cambridge University.
In his own words: “All this was in the two years 1665 and 1666, for in those
days I was in the prime of my age of invention, and minded mathematics
and philosophy more than at any time since.”
Nowadays, Newton’s experience might inspire you to invent and discover
macroprudential mechanisms which policy makers could put to
appropriate use in practice.
Then the year 2012 might, in hindsight, turn out to have been a genuine
“annus mirabilis”.
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I wish you all a very successful conference.
Thank you for your attention.




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Preserving the safety and security of
Malaysia’s banking system

Speech by Mr Encik Abu Hassan Alshari Yahaya, Assistant Governor of
the Central Bank of Malaysia, at the launch of the e-Banking Fraud
Awareness Campaign, Kuala Lumpur

It is my pleasure and honour to be invited to launch this joint e-Banking
fraud awareness campaign.

I would like to thank the Association of Banks in Malaysia for this
invitation and the coordinated efforts in undertaking this important
awareness campaign.

A significant initiative

This campaign is indeed a very important initiative for the banking
industry in Malaysia.

This is the first time that all banks have come together in a concerted
effort to help create greater awareness of online fraud with the
cooperation of CyberSecurity and the Police Force.

This is to be lauded as all stakeholders have a role to play in preserving
the safety and security of the banking system.

Maintaining confidence in online banking services

Online transactions have been growing at a rapid pace over the years.

Over the last decade, the use of electronic payments has increased at an
average annual growth of 23.4%.

In 2012, Malaysian households and businesses performed more than 300
million financial transactions with a value close to RM15 trillion via
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electronic channels comprising mainly funds transfers, bill payments,
top-up for prepaid cards, purchases of phone cards and payments for
investments in the capital market.

Among the electronic channels, internet banking is the most popular.

Fundamental to the growth of internet banking over the years is the
confidence which the public has in its convenience and security.

This is something that we cannot take for granted and must be
continuously preserved.

Advancement in technology and innovation has resulted in greater
consumer convenience and enhanced efficiency.

However, the same technology and innovation have also created new
methods of perpetrating fraud that could be executed faster and with
greater reach.

Cyber criminals have been active ever since the advent of the internet, and
are constantly finding new ways to defraud innocent victims.

Safety and security of transactions in the banking system is fundamental
in ensuring consumer confidence.

Hence, an important function and responsibility of the Central Bank is
to ensure online transactions can be made in a safe and efficient manner
in the economy, in the pursuit of monetary and financial stability
objectives.

The need for constant vigilance & cooperation

This fight that the banks are launching today is something that requires
the support of all parties.

We are aware of the creative ways in which criminals have attempted to
deceive customers over the years and measures were required to be taken
by the banks to protect the customers.
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While it is good to know that banks have played their roles in investing in
robust security systems, they must also ensure that customers play their
part in protecting their own assets and savings.

The reminder and greater awareness from the Banks through this
campaign is timely.

It will not only reinforce the need for constant vigilance from all parties,
but also help create an environment where everyone is risk conscious and
responsible in protecting the interests of each other.

These initiatives would not achieve the desired outcomes without
effective communication, and the media has a critical role to play in
conveying the message from the banks.

We have always acknowledged the importance of the media and I would
like to record Bank Negara Malaysia’s appreciation for the assistance
rendered by the media in creating awareness of this issue in the past.

We hope that with the support of the media on this occasion too, this
campaign will be a success, and the public will have heightened levels of
understanding and vigilance over this issue.

On behalf of Bank Negara Malaysia, I would like to thank all the banks
for taking this initiative to undertake this joint e-banking awareness
campaign.

Our thanks also to Cyber Security and the Police Force for your ongoing
efforts to collaborate with the banking industry.

I wish all of you the best and assure you that Bank Negara Malaysia will
continuously support you in this noble effort.




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Comments received on the
consultative report "Recovery
and resolution of financial
market infrastructures
South Africa, Financial Services
Board (FSB) has requested the
SAFEX Clearing Company (Pty) Limited (SAFCOM) and Strate Limited
to provide feedback.

Introduction
On the 31st of July 2012, a consultative report on the Recovery and
Resolution of Financial Market Infrastructures was issued by the
Committee on Payment and Settlement Systems (CPSS) and the
International Organization of Securities Commissions (IOSCO).

Subsequently the Financial Services Board (FSB) has requested the
SAFEX Clearing Company (Pty) Limited (SAFCOM) and Strate Limited
to provide feedback and commentary on the report.

This report serves as a consolidation of Strate Limited’s and SAFCOM’s
views on the contents of the document.

Background
Strate Limited is a licensed Central Securities Depository (CSD) for the
electronic settlement of financial instruments in South Africa.
Strate handles the settlement of a number of securities including equities
and bonds for the Johannesburg Stock Exchange (JSE) as well as a range
of derivative products such as warrants, Exchange Traded Funds (ETFs),
retail notes and tracker funds.
It is also responsible for the settlement of money market securities to its
portfolio of services. It provides services to issuers for their investors in
terms of the Companies Act and Securities Services Act (SSA), 2004.
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SAFEX Clearing Company (Pty) Limited operates as a clearing house for
the Johannesburg Stock Exchange derivatives markets. It was
incorporated in 1987 and is based in South Africa.

As of October 2008, SAFEX Clearing Company (Pty) Limited operates as
a subsidiary of the JSE.

General Comment
In compiling a response to the request for comment by CPSS-IOSCO,
Strate has reviewed the Consultative Report, the Key Attributes of
Effective Resolution Regimes for Financial Institutions (issued by the
Financial Stability Board) as well as the Principles for Financial Market
Infrastructure and the associated recommendations for Regulators.
Strate believes that the Consultative Report has been generally well
thought out and represents a comprehensive assessment of the likely
impacts in the event of FMI default or failure as well as an effective
guideline to assist individual FMI’s in the development of an appropriate
and effective Recovery and Resolution plan.
The broad differentiation between those FMI’s that assume credit risk
and those that do not is also considered most appropriate to take into
account the different roles and responsibilities of individual FMI’s.
It is, however, very clear from this exercise that a comprehensive review of
the Resolution Regimes contained in current and proposed future
legislation will need to be undertaken to ensure that the ideals contained
in the referenced documents are suitably entrenched and understood.
Specific responses to questions raised:
The following responses and comments have been put forward for each of
the specific questions raised in the Recovery and Resolution of Financial
Market Infrastructures report.
1. In what circumstances, and for what types of FMI, can a statutory
management, administration or conservatorship offer an appropriate
process within which to ensure a continuity of critical services?


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The consideration as to whether statutory management, administration
or conservatorship would offer the most appropriate process within which
to ensure the continuity of critical services is, in our opinion, directly
linked to the speed with which such an arrangement could be effectively
implemented within the framework provided in local legislation rather
than the type of FMI.
This does, however, also link to question 2 below.
2. Are there powers beyond those of a standard insolvency practitioner
that a statutory manager, administrator or conservator would require in
these circumstances?
Potentially, yes.
This assessment can, however, only be completed with a full legislative
review in the particular jurisdiction to ensure that the appointed authority
has the necessary authorities already outlined in the Consultative Paper.
Key to this assessment will be the ability to ensure the speedy assumption
of control by the appointed authority.
3. Is tear-up an appropriate loss allocation arrangement prior to resolution
of a CCP?
If so, in what circumstances?
Unable to comment – not applicable to Strate
4. To what extent should the possibility of a tear-up in recovery be
articulated in ex ante rules?
Unable to comment – not applicable to Strate.
5. Should there be a limit to the number of contracts that are eligible for
tear-up?
Unable to comment – not applicable to Strate.
6. How should the appropriate haircuts be determined?
Unable to comment – not applicable to Strate.

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7. What qualitative or quantitative indicators of non-viability should be
used in determining the trigger for resolution for different types of FMI?
Key to this decision is the role of the particular FMI. In the case of
non-credit risk bearing FMI’s the indicators would tend to be qualitative
rather than quantitative once the primary measurement of adequate
reserves has been addressed.
In the case of Strate, this would include many elements assessed by its
lead regulator in terms of the annual licence renewal process (including
such things as competencies, quality of service delivery, operational
capacities, robustness of existing technology etc.).
8. What loss allocation methods must be available to a resolution
authority, and for which types of FMI?
Could or should these resolution powers include tear-up, cash calls or a
mandatory replenishment of default fund contributions by an FMI’s
direct participants?
Does it make a difference if the losses are from a defaulting member or
are made up of other losses (e.g. losses in investments made by the FMI)?
In what circumstances, and by what methods, should losses be passed on
beyond the direct participants – e.g. to the clients or FMI shareholders –
in resolution?
To the extend applicable to Strate, losses in investments made by the FMI
would be allocated directly to its shareholders rather than to its
participants in any way.
9. What, if any, special considerations or methods should be applied when
allocating losses whose maximum value cannot be capped (e.g. when
allocating potential losses that might arise from open and uncapped
positions at a CCP)?
Unable to comment – not applicable to Strate.
10. How should equity in FMIs be treated in resolution scenarios: should
it be written down in all circumstances?


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From a Strate perspective, and given the nature of the risks borne by the
CSD, no need for differentiation in the treatment of equity write-downs
could be identified.
11. Are there circumstances in which loss allocation in resolution should
result in a different distribution of losses to losses borne in insolvency?
Does it make a difference if the losses stem from a defaulting member or
are made up of other losses (e.g. losses in investments made by the FMI
or resulting from operational risks)?
Given the profile of Strate it is not envisaged that there should be any
difference in the loss allocation regardless of whether by resolution or
insolvency.
12. Should an FMI’s rules for addressing uncovered losses be taken into
account when calculating whether creditors are no worse off in resolution
than in liquidation?
Unable to comment – not applicable to Strate.
13. Are there any circumstances in which the ability to exercise
termination rights as a result of the use of resolution powers should
outweigh the objective of ensuring continuity?
Given the profile of Strate this would only apply to contracts for services
from third parties and to the extent that the ability to exercise termination
rights relates to non-core services, this may assist in minimizing the
immediate negative financial impacts on the FMI.
It is unlikely that one would wish to invoke the early termination of core
services as part of a resolution process.
14. Are there any circumstances in which a temporary stay on exercising
termination rights should apply for any event of default and not just where
triggered by the resolution measures?
As with 13. above, the profile of Strate reduces the need to exercise, or
indeed temporarily stay, termination rights whether as a result of default
or resolution.


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15. Are there any circumstances in which a moratorium with a suspension
of payments to unsecured creditors may be appropriate when resolving an
FMI? Should this be limited to certain types of FMI and/or certain types
of payment?
The benefit of introducing a suspension of payments to unsecured
creditors to assist in the resolution of an FMI such as Strate would be
minimal and, given the specific nature of the role that Strate plays in the
market, is unlikely to affect (either positively or negatively) its ability to
continue settling or processing transactions which are processed directly
between counterparties through the Central Bank payment system or, as
is the case with Corporate Events processing, through Trust accounts
which could effectively be ring-fenced from the FMI itself.
16. If so, should resolution authorities retain the discretion to apply a
moratorium and, if so, what restrictions (if any) on its use would be
appropriate (e.g. scope, duration or purpose)?
Given the response to 15 above, this is not considered relevant to Strate
other than to the extent that the Resolution Authority may wish to defer
payment on non-core services in terms of existing powers.
No special powers are considered necessary.
17. Should the bail-in tool be available to collateral, margin (including
initial margin) and other sources of funds if they would bear losses in
insolvency?
Unable to comment – not applicable to Strate.
18. In what circumstances and for what types of FMI should wider loss
recovery arrangements exist beyond the FMI’s own rules and the
resolution powers of the resolution authority?
Not applicable to Strate as it does not assume principal risk in any of the
transactions it processes. The CSD Rules already cover the CSD
adequately in this respect.
19. In conducting a resolvability assessment of an FMI, what factors
should authorities pay particular attention to?


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 49


The assessments outlined in Annexure II of the Key Attributes of
Effective Resolution Regimes for Financial Institutions issued by the
Financial Stability Board are considered sufficiently comprehensive to
conduct a resolvability assessment.
20. In addition, is the summary of the application of the Key Attributes to
FMIs provided in the annex sufficiently detailed to support the
development of recovery and resolution regimes for FMIs?
Are there specific areas where more detail could be provided?
If so, which areas and what additional detail should be provided?
Are any of the key attributes not applicable to a particular type of FMI?
If so, which key attribute(s) and why not?
Other than those areas already identified in the Annex as being not
applicable to an FMI like Strate, no additional areas could be identified
and no additional detail is considered necessary to assist Strate, in
consultation with its Lead Regulator, in the development of an
appropriate Resolution Plan.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 50




Opening Remarks at Investor Advisory
Committee Meeting
By Chairman Elisse Walter
U.S. Securities and Exchange Commission
Washington, D.C. January 18, 2013

Good morning. It is a pleasure to be with you
today, and to make my first public appearance as
SEC Chairman with you, a group who has
chosen to dedicate yourselves to looking at the
issues we face through the eyes of the investors we are dedicated to
protect.

As you know, although I am new to the role of
Chairman, I am proud to have worked at the SEC both
as a staff member and a Commissioner for a total of
more than two decades.

I have made the SEC the cornerstone, and the heart, of my career because
I strongly believe that the SEC’s mission of investor protection and
market stability is critical to the function of and confidence in the
financial system as a whole…and especially because I believe that
investors need and deserve an effective advocate within the Federal
government.

Today, thanks to our exceptional staff and strong leadership team, I
believe that we are executing our role as the investor’s advocate boldly
and effectively, at a time when our role has become more important than
ever.

This is a challenging and exciting time for the Commission.

Commissioners and the staff are considering a number of complex and
important issues and working hard on rules that will have a profound and
positive impact on investors and our markets for years to come.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 51


I am currently working with the other Commissioners to prioritize the
many agenda items before us and to set a realistic timetable for executing
on those priorities.

With these discussions still under way, I can’t yet give you too many
details.

I will say, though, that I am confident that completing the remaining
rulemakings and other projects mandated by the Dodd-Frank Act and the
JOBS Act will be at the top of the list.

And despite the often-mentioned 2-2 divide, I find that my fellow
commissioners — as well as Commission staff — are eager to find
common ground and move forward in a practical and effective manner.

I’m also on something of a listening tour -- clarifying my own thoughts
and keeping an appropriate perspective by listening to ideas, questions
and complaints from people in and out of the agency.

And, that is why I am here today — to listen to you.

The Investor Advisory Committee is the right idea, and particularly at this
critical juncture in the history of our markets.

Over the last decade, the retail investing landscape has become
increasingly complex, populated by products, strategies, technologies,
opportunities, and risks that simply didn’t exist just a short time ago.

And, on top of the changes that arise more or less organically from in the
marketplace, important new legislation is reshaping the terrain, as well.
Just 21 months after Dodd Frank, the most significant financial reform
bill in decades, was enacted — and created this committee — the JOBS
Act brought another seismic shift in the way companies, particularly
small and emerging ones, raise capital and how individual investors
participate in that process.

Against this backdrop, the decisions confronted by individual investors
— decisions that are absolutely critical to the course of their lives and the
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 52


lives of their families — and the information and advice they receive when
they make these decisions, are becoming more complex even as the
stakes grow higher.

As some of you may know, when I think about the SEC’s role at a time
like this, I like to think of my very dear — if completely imaginary — Aunt
Millie, a retail investor with a modest portfolio, looking towards a secure
retirement — hopefully in the near term — and some fun with her family
during her golden years.

Now, as dear to me as she is, Aunt Millie is no hedge fund manager.

So when she sits down with her financial professional, and the talk turns
to ETFs and target date funds, crowdfunding or her professional’s fees, I
want the SEC’s presence to be felt there in that office — whether or not
she even knows anything about the SEC (although MY Aunt Millie is, of
course, qvelling at her niece’s recent promotion), I want the SEC to be
there looking out for her, helping her make sense of the environment in
which she is investing her future security.

Aunt Millie and her fellow retail investors are unique among the major
stakeholders in the financial system: they aren’t members of a trade
association, and they don’t exactly spend a lot of time (or any time for that
matter) following the Federal Register, monitoring the SEC, or —
although I am trying to improve this — submitting substantive comments
on proposed rules and concept releases.

Like most retail investors, Aunt Millie is under-informed and
underrepresented in the regulatory process.

That is why, in the midst of continuing and significant changes in the
markets, your work is so important.

You help represent these retail investors with a visibility and
sophistication that ensures that their needs and interests are carefully
considered.


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 53


You help us keep the playing field level for all investors, including and
especially investors like Aunt Millie and her compatriots.

Your first set of recommendations to the Commission, on proposed rules
that would lift the restriction on general solicitation in certain private
placements, reflects your commitment to that task.

I deeply appreciate the effort and thoughtfulness that went into crafting
the recommendations.

In addition, your ability to work together and provide recommendations
that were unanimously supported by the Committee is heartening to me
and serves as an example to us all.

In a short time, you have established yourselves as an effective
organization and a critical component of the ongoing regulatory dialogue
that affects every American investor.

I look forward to our continuing collaboration as you address other
matters of critical importance in a relentlessly evolving financial world.

Thank you for what you have accomplished already and for what I know
you will continue to do. I said earlier that we were still sorting out all of
our priorities for the days ahead, but one of them is certainly this:
continuing the close relationship that I believe we already have.

And, since I’m here as part of my listening tour and not my talking tour,
it’s probably time for me to stop talking and start listening to any
questions and comments you may have.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 54


Fulfilling the Commission’s Statutory Responsibility to Respond
to IAC’s Recommendations

By Commissioner Luis A. Aguilar, U.S. Securities and Exchange
Commission, Investor Advisory Committee Meeting
Washington, D.C., January 18, 2013

I want to welcome the members of the Investor Advisory Committee to
the Committee’s third in-person meeting. I also want to thank you for
your continuing focus on the many issues confronting investors.

Your input to the Commission is vital to highlight the initiatives that serve
to benefit and protect investors, as well as to deter the Commission from
undertaking initiatives that undercut or dismantle existing investor
protections.

It is critical that initiatives undertaken by the Commission fulfill its
mission of protecting investors.

As the Investor Advisory Committee, you are the Committee focused on
the needs of investors and your recommendations are critical to
facilitating that the Commission is operating to fulfill its mission.

Congress clearly had this in mind when it codified this Committee in
Section 911 of the Dodd-Frank Act and mandated how the Committee
would operate.

This Committee has already demonstrated that it takes its responsibilities
seriously.

For example, on October 12, 2012, the Committee sent the Commission
seven unanimous recommendations regarding the SEC Rulemaking to
Lift the Ban on General Solicitation and Advertising in Rule 506
Offerings.

I commend you for the hard work that you have undertaken, as reflected
in the recommendations we received and which are available on the SEC
website.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 55


It is now incumbent on the Commission to act. As required by Section 911
of the Dodd-Frank Act, the Commission is required to “review the
findings and recommendations of the Committee.”

In particular, the statute specifies that, “each time the Committee
submits a finding or recommendation to the Commission,” the
Commission is required to

“… promptly issue a public statement –

(A) assessing the finding or recommendation of the Committee; and

(B) disclosing the action, if any, the Commission intends to take with
respect to the finding or recommendation.”

The importance of this obligation is underscored by the fact that the law
requires that the Commission itself assess the Committee’s
recommendations and determine how best to respond to them.

This is a responsibility of the Commission – not one that has been
delegated to the staff.

To that end, I look forward to the Commission issuing the required
response assessing your October 2012 recommendations.

It is imperative that this Committee’s recommendations be treated with
the serious consideration that the law mandates.

I look forward to the Committee’s on-going efforts and to what the
Committee has to say.

Thank you.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 56




Tougher credit rating rules confirmed by European Parliament's
vote

New rules on when and how credit rating agencies may rate state debts
and private firms' financial health were approved by Parliament on
Wednesday.

They will allow agencies to issue unsolicited sovereign debt ratings only
on set dates, and enable private investors to sue them for negligence.

Agencies' shareholdings in rated firms will be capped, to reduce conflicts
of interest.

MEPs also ensured that the ratings are clearer by requiring agencies to
explain the key factors underlying them.

Ratings must not seek to influence state policies, and agencies
themselves must not advocate any policy changes, adds the text.

The rules have already been provisionally agreed with the Council.

"We are taking some steps forward with this new regulation, fully in line
with its basic spirit, which is to enable firms to do their own internal
ratings.

These should provide viable, comparable and reliable alternatives to
those of the rating oligopoly", said lead MEP Leonardo Domenici (S&D,
IT).


      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 57


Set dates for sovereign debt ratings
Unsolicited sovereign ratings could be published at least two but no more
than three times a year, on dates published by the rating agency at the end
of the previous year.
Furthermore, these ratings could be published only after markets in the
EU have closed and at least one hour before they reopen.
Agencies to be liable for ratings
Investors who rely on a credit rating could sue the agency that issued it
for damages if it breaches the rules set out in this legislation either
intentionally or by gross negligence, regardless whether there is any
contractual relationship between the parties.
Such breaches would include, for example, issuing a rating compromised
by a conflict of interests or outside the published calendar.
Reducing over-reliance on ratings
To reduce over-reliance on ratings, MEPs urge credit institutions and
investment firms to develop their own rating capacities, to enable them to
prepare their own risk assessments.
The European Commission should also consider developing a European
creditworthiness assessment, adds the text.
By 2020 no EU legislation should directly refer to external ratings, and
financial institutions must not be any more obliged to automatically sell
assets in the event of a downgrade.
Capping shareholdings
A credit rating agency will have to refrain from issuing ratings, or disclose
that its ratings may be affected, if a shareholder or member holding 10 %
of the voting rights in that agency has invested in the rated entity.
The new rules will also bar anyone from simultaneously holding stakes of
more than 5% in more than one credit rating agency, unless the agencies
concerned belong to the same group.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 58


The Domenici report on the regulation was adopted by 579 votes to 58,
with 60 abstentions and that on the directive by 599 votes to 27, with 68
abstentions.
Article 1
Subject matter
This Regulation introduces a common regulatory approach in order to
enhance the integrity, transparency, responsibility, good governance and
independence of credit rating activities, contributing to the quality of
credit ratings issued in the Union, thereby contributing to the smooth
functioning of the internal market while achieving a high level of
consumer and investor protection.
It lays down conditions for the issuing of credit ratings and rules on the
organisation and conduct of credit rating agencies, including their
shareholders and members, to promote credit rating agencies'
independence, the avoidance of conflicts of interest and the enhancement
of consumer and investor protection.
This Regulation also lays down obligations for issuers, originators and
sponsors established in the Union regarding structured finance
instruments.
Article 5ba
Over-reliance on credit ratings in Union law
Without prejudice to its right of initiative, the Commission shall continue
to review references to credit ratings in Union law which trigger or have
the potential to trigger sole or mechanistic reliance on credit ratings by
competent authorities or financial market participants, with a view to
eliminating all references to ratings in Union law by 1 January 2020,
provided that appropriate alternatives to credit risk assessment have been
identified and implemented.
Article 6a
Conflicts of interest concerning investments in credit rating
agencies
1. A shareholder or a member of a credit rating agency holding at least 5 %
of the capital or the voting rights in a credit rating agency or in a company

      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 59


which has the power to exercise dominant influence or control over the
registered credit rating agency, shall be prohibited from:

(a) holding 5 % or more of the capital of any other credit rating agency;

(b) having the right or the power to exercise 5 % or more of the voting
    rights in any other credit rating agency;

(c) having the right or the power to appoint or remove members of the
    administrative, management or supervisory body of any other credit
    rating agency;

(d) being member of the administrative, management or supervisory
    body of any other credit rating agency;

(e) exercising or having the power to exercise dominant influence or
    control over any other credit rating agency.
The prohibition referred to in point (a) of the first subparagraph does not
apply to holdings in diversified collective investment schemes, including
managed funds such as pension funds or life insurance, provided that the
holdings in diversified collective investment schemes do not put him or
her in a position to exercise significant influence on the business
activities of those schemes.
Article -8a
Sovereign debt ratings
1. Sovereign debt ratings shall be issued in a manner, which ensures that
the individual specificity of a particular Member State has been analysed.
A statement announcing revision of a given group of countries shall be
prohibited, if not accompanied by individual country reports.
Those reports shall be made publicly available.
2. Public communications other than credit ratings, rating outlooks or
accompanying press releases, as referred to in point 5 of Part I of Section
D of Annex I, which relate to potential changes of sovereign ratings shall
not be based on information stemming from the sphere of the rated entity,
where such information has been released without the consent of the
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 60


rated entity, unless it is available from generally accessible sources or
unless there are no legitimate reasons for the rated entity not to give its
consent to the release of the information.
3. A credit rating agency shall, taking into consideration the provisions in
second subparagraph of Article 8(5), publish on its website and send to
ESMA on an annual basis, in accordance with point 3 of Part III of
Section D of Annex I, a calendar at the end of the month of December for
the next 12 months, setting a maximum of three dates for the publication
of unsolicited sovereign ratings and related outlooks and setting the dates
for the publication of solicited sovereign ratings and related outlooks.
Such dates shall be set on a Friday.
4. Deviation of the publication of sovereign rating or related rating
outlooks from the calendar shall only be possible in as much as this is
necessary for the credit rating agency to comply with its obligations under
Article 8(2), Article 10(1) and Article 11(1) and shall be accompanied by a
detailed explanation of the reasons for the deviation from the announced
calendar.
Article 8c
Use of multiple credit rating agencies
1. Where an issuer or a related third party intends to mandate at least two
credit rating agencies for the credit rating of the same issuance or entity,
the issuer shall consider the possibility to mandate at least one credit
rating agency which does not have more than 10 % of the total market
share and which can be evaluated by the issuer as capable for rating the
relevant issuance or entity, provided that, based on the list of ESMA
mentioned in paragraph 2, there is a credit rating agency available for
rating the specific issuance or entity.
Where the issuer does not mandate at least one credit rating agency
which does not have more than 10 % of the total market share, this shall
be recorded.
2. With a view to facilitating the evaluation by the issuer under paragraph
1, ESMA shall annually publish on its website a list of registered credit
rating agencies, indicating their total market share and the types of
ratings issued, which can be used by the issuer as a starting point for its
evaluation.
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 61


3. For the purposes of this Article, the total market share shall be
measured by annual turnover generated from credit rating activities and
ancillary services, at group level.
Article 35a
Civil liability
1. Where a credit rating agency has committed intentionally or with gross
negligence any of the infringements listed in Annex III having an impact
on a credit rating, an investor or issuer may claim damages from that
credit rating agency for damage caused to them due to that infringement.
An investor may claim damages under this Article where it establishes
that it has reasonably relied, in accordance with Article 5a or otherwise
with due care, on a credit rating for a decision to invest into, hold onto or
divest from a financial instrument covered by that credit rating.
An issuer may claim damages under this Article where it establishes that
it or its financial instruments are covered by that credit rating and the
infringement was not caused by misleading and inaccurate information
provided by the issuer to the credit rating agency, directly or through
information publicly available.
5. Civil liability as referred to in paragraph 1 may be limited in advance
only where all of the following conditions are complied with:
(a) the limitation is reasonable and proportionate; and

(b) the limitation is allowed by the relevant national law as determined in
    accordance with paragraph 5a.
Where a limitation of civil liability does not comply with the conditions
referred to in the first subparagraph it shall have no legal effect.
5a. The terms “damage”, “intention”, “gross negligence”, “reasonably
relied”, “due care”, “impact”, “reasonable” and “proportionate” which
are referred to in this Article but are not defined in this Regulation, shall
be interpreted and applied in accordance with the applicable national law
as determined by the relevant rules of private international law.
Matters concerning the civil liability of a credit rating agency and which
are not at all covered by this Regulation shall be governed by the
      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
P a g e | 62


applicable national law as determined by the relevant rules of private
international law.
The competent court to decide on a claim for civil liability brought by an
investor shall be determined by the relevant rules of private international
law.
5b. This Article does not exclude further civil liability claims in
accordance with national law.




      _____________________________________________________________
     International Association of Risk and Compliance Professionals (IARCP)
                      www.risk-compliance-association.com
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Monday January 28 2013 Top 10 Risk Compliance News Events

  • 1. Page |1 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, Which is the difference between good deleveraging and bad deleveraging? According to Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, good deleveraging means scaling back the exposure to other financial intermediaries, whereas bad deleveraging means that lending to the real economy is being reduced. Dr Andreas Dombret is one of my favourite speakers. In Number 2 of our list he asks the question: Will 2012 go down in history as an “annus horribilis” or rather as an “annus mirabilis”, or neither? He starts from the originator of the “annus horribilis”, Queen Elizabeth, that used the phrase to describe her feelings about the year 1992, and he goes on with the fire at Windsor Castle. Many people use the metaphor of a large-scale fire to explain the economic term of a “systemic” event. The fire spread so rapidly due to a city’s narrow streets and the “interconnectedness” of houses. The fire in the financial markets was stopped by the ECB, by the two firewalls EFSF and ESM as well as by the governments announcing that they would improve the financial system. Thus 2012 is an “annus mirabilis”. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 2. Page |2 He also remembered Peter Bernstein, the financial historian from the US, that illustrated his point by citing the anecdote of a Moscovite professor of statistics, who refused to go to the air-raid shelter during World War II bomb attacks. The professor argued: “See, Moscow has seven million inhabitants. Why should I expect to be one who will be hit?” His neighbours were astonished, when he came back to the shelter the next night. Now the professor’s argumentation was: “Moscow has seven million inhabitants and one elephant. Last night the elephant was hit.” More at Number 2 of our list. In Number 1 this week we have the speech of Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas. He speaks about the “the injustice of being held hostage to large financial institutions considered too big to fail”. I enjoyed what he remembered: One is reminded of the comment French Prime Minister Clemenceau made about President Wilson’s 14 points: “Why 14?” he asked. “God did it in 10.” Were that we only had 14 points of financial regulation to contend with today. Read more at Number 1 below. Welcome to the Top 10 list. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 3. Page |3 Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas. Ending 'Too Big to Fail': A Proposal for Reform Before It's Too Late (With Reference to Patrick Henry, Complexity and Reality) Remarks before the Committee for the Republic Washington, D.C. · January 16, 2013 Dr Andreas Dombret Member of the Executive Board of the Deutsche Bundesbank Challenges for financial stability – policy and academic aspects Dinner Speech at the Joint Conference of the Deutsche Bundesbank, the Technical University Dresden and the Journal of Financial Stability Preserving the safety and security of Malaysia’s banking system Speech by Mr Encik Abu Hassan Alshari Yahaya, Assistant Governor of the Central Bank of Malaysia, at the launch of the e-Banking Fraud Awareness Campaign, Kuala Lumpur _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 4. Page |4 Comments received on the consultative report "Recovery and resolution of financial market infrastructures South Africa, Financial Services Board (FSB) has requested the SAFEX Clearing Company (Pty) Limited (SAFCOM) and Strate Limited to provide feedback. Opening Remarks at Investor Advisory Committee Meeting By Chairman Elisse Walter U.S. Securities and Exchange Commission Washington, D.C. January 18, 2013 Tougher credit rating rules confirmed by European Parliament's vote New rules on when and how credit rating agencies may rate state debts and private firms' financial health were approved by Parliament on Wednesday. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 5. Page |5 FSA UK Risk to Customers from Financial Incentives Consumer trust and confidence in financial services is essential. Ensuring the smooth functioning of money markets Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank, at the 17th Global Securities Financing Summit, Luxembourg, 16 January 2013. Michel BARNIER The European banking union, a precondition to financial stability and a historical step forward for European integration _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 6. Page |6 Understanding the European Banking Union In June 2012, EU leaders agreed to deepen economic and monetary union as one of the remedies of the current crisis. At that meeting (European Council of 28/29 June), the leaders discussed the report entitled 'Towards a Genuine Economic and Monetary Union', prepared by the President of the European Council in close collaboration with the President of the European Commission, the Chair of the Eurogroup and the President of the European Central Bank. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 7. Page |7 Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas. Ending 'Too Big to Fail': A Proposal for Reform Before It's Too Late (With Reference to Patrick Henry, Complexity and Reality) Remarks before the Committee for the Republic Washington, D.C. · January 16, 2013 It is an honor to be introduced by my college classmate, John Henry. John is a descendant of the iconic patriot, Patrick Henry. Most of John’s ancestors were prominent colonial Virginians and many were anti-crown. Patrick, however, was the most outspoken. Ask John why this was so, and he will answer: “Patrick was poor.” However poor he may have been, Patrick Henry was a rich orator. In one of his greatest speeches, he said: “Different men often see the same subject in different lights; and therefore, I hope that it will not be thought disrespectful to those gentlemen if, entertaining as I do, opinions of a character very opposite to theirs, I shall speak forth my sentiments freely, and without reserve. This is no time for ceremony … [it] is one of awful moment to this country.” Patrick Henry was addressing the repression of the American colonies by the British crown. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 8. Page |8 Tonight, I wish to speak to a different kind of repression—the injustice of being held hostage to large financial institutions considered “too big to fail,” or TBTF for short. I submit that these institutions, as a result of their privileged status, exact an unfair tax upon the American people. Moreover, they interfere with the transmission of monetary policy and inhibit the advancement of our nation’s economic prosperity. I have spoken of this for several years, beginning with a speech on the “Pathology of Too-Big-to-Fail” in July 2009. My colleague, Harvey Rosenblum—a highly respected economist and the Dallas Fed’s director of research—and I and our staff have written about it extensively. Tomorrow, we will issue a special report that further elucidates our proposal for dealing with the pathology of TBTF. It also addresses the superior relative performance of community banks during the recent crisis and how they are being victimized by excessive regulation that stems from responses to the sins of their behemoth counterparts. I urge all of you to read that report. Now, Federal Reserve convention requires that I issue a disclaimer here: I speak only for the Federal Reserve Bank of Dallas, not for others associated with our central bank. That is usually abundantly clear. In many matters, my staff and I entertain opinions that are very different from those of many of our esteemed colleagues elsewhere in the Federal Reserve System. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 9. Page |9 Today, I “speak forth my sentiments freely and without reserve” on the issue of TBTF, while meaning no disrespect to others who may hold different views. The Problem of TBTF Everyone and their sister knows that financial institutions deemed too big to fail were at the epicenter of the 2007–09 financial crisis. Previously thought of as islands of safety in a sea of risk, they became the enablers of a financial tsunami. Now that the storm has subsided, we submit that they are a key reason accommodative monetary policy and government policies have failed to adequately affect the economic recovery. Harvey Rosenblum and I first wrote about this in an article published in the Wall Street Journal in September 2009, “The Blob That Ate Monetary Policy.” Put simply, sick banks don’t lend. Sick—seriously undercapitalized — megabanks stopped their lending and capital market activities during the crisis and economic recovery. They brought economic growth to a standstill and spread their sickness to the rest of the banking system. Congress thought it would address the issue of TBTF through the Dodd–Frank Wall Street Reform and Consumer Protection Act. Preventing TBTF from ever occurring again is in the very preamble of the act. We contend that Dodd–Frank has not done enough to corral TBTF banks and that, on balance, the act has made things worse, not better. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 10. P a g e | 10 We submit that, in the short run, parts of Dodd–Frank have exacerbated weak economic growth by increasing regulatory uncertainty in key sectors of the U.S. economy. It has clearly benefited many lawyers and created new layers of bureaucracy. Despite its good intention, it has been counterproductive, working against solving the core problem it seeks to address. Defining TBTF Let me define what we mean when we speak of TBTF. The Dallas Fed’s definition is financial firms whose owners, managers and customers believe themselves to be exempt from the processes of bankruptcy and creative destruction. Such firms capture the financial upside of their actions but largely avoid payment—bankruptcy and closure—for actions gone wrong, in violation of one of the basic tenets of market capitalism (at least as it is supposed to be practiced in the United States). Such firms enjoy subsidies relative to their non-TBTF competitors. They are thus more likely to take greater risks in search of profits, protected by the presumption that bankruptcy is a highly unlikely outcome. The phenomenon of TBTF is the result of an implicit but widely taken-for-granted government-sanctioned policy of coming to the aid of the owners, managers and creditors of a financial institution deemed to be so large, interconnected and/or complex that its failure could substantially damage the financial system. By reducing a TBTF firm’s exposure to losses from excessive risk taking, such policies undermine the discipline that market forces normally assert on management decision making. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 11. P a g e | 11 The reduction of market discipline has been further eroded by implicit extensions of the federal safety net beyond commercial banks to their nonbank affiliates. Moreover, industry consolidation, fostered by subsidized growth (and during the crisis, encouraged by the federal government in the acquisitions of Merrill Lynch, Bear Stearns, Washington Mutual and Wachovia), has perpetuated and enlarged the weight of financial firms deemed TBTF. This reduces competition in lending. Dodd–Frank does not do enough to constrain the behemoth banks’ advantages. Indeed, given its complexity, it unwittingly exacerbates them. Complexity Bites Andrew Haldane, the highly respected member of the Financial Policy Committee of the Bank of England, addressed this at last summer’s Jackson Hole, Wyo., policymakers’ meeting in witty remarks titled, “The Dog and the Frisbee.” Here are some choice passages from that noteworthy speech. Haldane notes that regulators’ “… efforts to catch the crisis Frisbee have continued to escalate. Casual empiricism reveals an ever-growing number of regulators … Ever-larger litters have not, however, obviously improved the watchdogs’ Frisbee-catching abilities. [After all,] no regulator had the foresight to predict the financial crisis, although some have since exhibited supernatural powers of hindsight. “So what is the secret of the watchdogs’ failure? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 12. P a g e | 12 The answer is simple. Or rather, it is complexity … complex regulation … might not just be costly and cumbersome but sub-optimal. … In financial regulation, less may be more.” One is reminded of the comment French Prime Minister Clemenceau made about President Wilson’s 14 points: “Why 14?” he asked. “God did it in 10.” Were that we only had 14 points of financial regulation to contend with today. Haldane notes that Dodd–Frank comes against a background of ever-greater escalation of financial regulation. He points out that nationally chartered banks began to file the antecedents of “call reports” after the formation of the Office of the Comptroller of the Currency in 1863. The Federal Reserve Act of 1913 required state-chartered member banks to do the same, having them submitted to the Federal Reserve starting in 1917. They were short forms; in 1930, Haldane noted, these reports numbered 80 entries. “In 1986, [the ‘call reports’ submitted by bank holding companies] covered 547 columns in Excel, by 1999, 1,208 columns. By 2011 … 2,271 columns.” “Fortunately,” he adds wryly, “Excel had expanded sufficiently to capture the increase.” Though this growingly complex reporting failed to prevent detection of the seeds of the debacle of 2007–09, Dodd–Frank has layered on copious _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 13. P a g e | 13 amounts of new complexity. The legislation has 16 titles and runs 848 pages. It spawns litter upon litter of regulations: More than 8,800 pages of regulations have already been proposed, and the process is not yet done. In his speech, Haldane noted—conservatively, in my view—that a survey of the Federal Register showed that complying with these new rules would require 2,260,631 labor hours each year. He added: “Of course, the costs of this regulatory edifice would be considered small if they delivered even modest improvements to regulators’ ability to avert future crises.” He then goes on to argue the wick is not worth the candle. And he concludes: “Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex. That configuration spells trouble. As you do not fight fire with fire, you do not fight complexity with complexity. [The situation] requires a regulatory response grounded in simplicity, not complexity. Delivering that would require an about-turn.” The Dallas Fed’s Proposal: A Reasonable ‘About-Turn’ The Dallas Fed’s proposal offers an “about-turn” and a way to mend the flaws in Dodd–Frank. It fights unnecessary complexity with simplicity where appropriate. It eliminates much of the mumbo-jumbo, ineffective, costly complexity of Dodd–Frank. Of note, it would be especially helpful to non-TBTF banks that do not pose systemic or broad risk to the economy or the financial system. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 14. P a g e | 14 Our proposal would relieve small banks of some unnecessary burdens arising from Dodd–Frank that unfairly penalize them. Our proposal would effectively level the playing field for all banking organizations in the country and provide the best protection for taxpaying citizens. In a nutshell, we recommend that TBTF financial institutions be restructured into multiple business entities. Only the resulting downsized commercial banking operations—and not shadow banking affiliates or the parent company—would benefit from the safety net of federal deposit insurance and access to the Federal Reserve’s discount window. Defining the Landscape It is important to have an accurate view of the landscape of banking today in order to understand the impact of this proposal. As of third quarter 2012, there were approximately 5,600 commercial banking organizations in the U.S. The bulk of these—roughly 5,500—were community banks with assets of less than $10 billion. These community-focused organizations accounted for 98.6 percent of all banks but only 12 percent of total industry assets. Another group numbering nearly 70 banking organizations—with assets of between $10 billion and $250 billion—accounted for 1.2 percent of banks, while controlling 19 percent of industry assets. The remaining group, the megabanks—with assets of between $250 billion and $2.3 trillion—was made up of a mere 12 institutions. These dozen behemoths accounted for roughly 0.2 percent of all banks, but they held 69 percent of industry assets. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 15. P a g e | 15 The 12 institutions that presently account for 69 percent of total industry assets are candidates to be considered TBTF because of the threat they could pose to the financial system and the economy should one or more of them get into trouble. By contrast, should any of the other 99.8 percent of banking institutions get into trouble, the matter most likely would be settled with private-sector ownership changes and minimal governmental intervention. How and why does this work for 99.8 percent but not the other 0.2 percent? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 16. P a g e | 16 To answer this question, it helps to consider the sources of regulatory and market discipline imposed on each of the three groups of banks. Let’s look at two dimensions of regulatory discipline: Potential closure of the institution and the effectiveness of supervisory pressure on bank management practices. Do the owners and managers of a banking institution operate with the belief that their institution is subject to a bankruptcy process that works reasonably quickly to transfer ownership and control to another banking entity or entities? Is there a group of interested and involved shareholders that can exert a restraining force on franchise-threatening risk taking by the bank’s top management team? Can management be replaced and ownership value wiped out? Is the firm controlled de facto by its owners, or instead effectively management-controlled? In addition, we ask: To what extent do uninsured creditors of the banking entity impose risk-management discipline on management? This analytical framework is summarized in the following slide: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 17. P a g e | 17 Looking across line 1, it is clear that community banks are subject to considerable regulatory and shareholder discipline. They can and do fail. In the last few years, the Federal Deposit Insurance Corp. (FDIC) has built a reputation for regulators carrying out Joseph Schumpeter’s concept of “creative destruction” by taking over small banks on a Friday evening and reopening them on Monday morning under new ownership. “In on Friday, out by Monday” is the mantra of this process. Knowing the power of banking supervisors to close the institution, owners and managers of community banks heed supervisory suggestions to limit risk. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 18. P a g e | 18 Community banks often have a few significant shareholders who have a considerable portion of their wealth tied to the fate of the bank. Consequently, they exert substantial control over the behavior of management because risk and potential closure matter to them. Since community banks derive the bulk of their funding from federally insured deposits, they are simple rather than complex in their capital structure and rarely have uninsured and unsecured creditors. “Market discipline” over management practices is primarily exerted through shareholders. Of the three groups, the 70 regional and moderate-sized banking organizations depicted in line 2 are subject to a broader range of market discipline. Like community banks, these institutions are not exempt from the bankruptcy process; they can and do fail. But given their size, complexity and generally larger geographic footprint, the failure resolution and ownership transfer processes cannot always be accomplished over a weekend. In practice, owners and managers of mid-sized institutions are nonetheless aware of the downside consequences of the risks taken by the institution. Uninsured depositors and unsecured creditors are also aware of their unprotected status in the event the institution experiences financial difficulties. Mid-sized banking institutions receive a good dose of external discipline from both supervisors and market-based signals. TBTF megabanks, depicted in line 3, receive far too little regulatory and market discipline. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 19. P a g e | 19 This is unfortunate because their failure, if it were allowed, could disrupt financial markets and the economy. For all intents and purposes, we believe that TBTF banks have not been allowed to fail outright. Knowing this, the management of TBTF banks can, to a large extent, choose to resist the advice and guidance of their bank supervisors’ efforts to impose regulatory discipline. And for TBTF banks, the forces of market discipline from shareholders and unsecured creditors are limited. Let’s first consider discipline from shareholders. Having millions of stockholders has diluted shareholders’ ability to prevent the management of TBTF banks from pursuing corporate strategies that are profitable for management, though not necessarily for shareholders. As we learned during the crisis, adverse information on poor financial performance often is available too late for shareholder reaction or credit default swap (CDS) spreads to have any impact on management behavior. For example, during the financial crisis, shares in two of the largest bank holding companies (BHCs) declined more than 95 percent from their prior peak prices and their CDS spreads went haywire. The ratings agencies eventually reacted, in keeping with their tendency to be reactive rather than proactive. But the damage from excessive risk taking had already been done. And after the crisis? Judging from the behavior of many of the largest BHCs, with limited exception, efforts by shareholders of these institutions to meaningfully influence management compensation practices have been slow in coming. So much for shareholder discipline as a check on TBTF banks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 20. P a g e | 20 Unfortunately, TBTF banks also do not face much external discipline from unsecured creditors. An important facet of TBTF is that the funding sources for megabanks extend far beyond insured deposits, as referenced by my mention of CDS spreads. The largest banks, not just the TBTF banks, fund themselves with a wide range of liabilities. These include large, negotiable CDs, which often exceed the FDIC insurance limit; federal funds purchased from other banks, all of which are uninsured, and subordinated notes and bonds, generally unsecured. It is not unusual for such uninsured/unsecured liabilities to account for well over half the liabilities of TBTF institutions. If market discipline were to be imposed on TBTF institutions, one would expect it to come from uninsured/unsecured depositors, creditors and debt holders. But TBTF status exerts perverse market discipline on the risk-taking activities of these banks. Unsecured creditors recognize the implicit government guarantee of TBTF banks’ liabilities. As a result, unsecured depositors and creditors offer their funds at a lower cost to TBTF banks than to mid-sized and regional banks that face the risk of failure. This TBTF subsidy is quite large and has risen following the financial crisis. Recent estimates by the Bank for International Settlements, for example, suggest that the implicit government guarantee provides the largest U.S. BHCs with an average credit rating uplift of more than two notches, _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 21. P a g e | 21 thereby lowering average funding costs a full percentage point relative to their smaller competitors. Our aforementioned friend from the Bank of England, Andrew Haldane, estimates the current implicit TBTF global subsidy to be roughly $300 billion per year for the 29 global institutions identified by the Financial Stability Board (2011) as “systemically important.” To put that $300 billion estimated annual subsidy in perspective, all the U.S. BHCs summed together reported 2011 earnings of $108 billion. Add to that the burdens stemming from the complexity of TBTF banks. Here is the basic organization diagram for a typical complex financial holding company: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 22. P a g e | 22 To simplify a complex issue, one might consider all the operations other than the commercial banking operation as shadow banking affiliates, including any special investment vehicles—or SIVs—of the commercial bank. Now, consider this table. It gives you a sense of the size and scope of some of the five largest BHCs, noting their nondeposit liabilities in billions of dollars and their number of total subsidiaries and countries of operation (according to the Financial Stability Oversight Council): For perspective, consider the sad case of Lehman Brothers. More than four years later, the Lehman bankruptcy is still not completely resolved. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 23. P a g e | 23 As of its 10-K regulatory filing in 2007, Lehman operated a mere 209 subsidiaries across only 21 countries and had total liabilities of $619 billion. By these metrics, Lehman was a small player compared with any of the Big Five. If Lehman Brothers was too big for a private-sector solution while still a going concern, what can we infer about the Big Five in the table? Correcting for the Drawbacks of Dodd–Frank Dodd–Frank addresses this concern. Under the Orderly Liquidation Authority provisions of Dodd–Frank, a systemically important financial institution would receive debtor-in-possession financing from the U.S. Treasury over the period its operations needed to be stabilized. This is quasi-nationalization, just in a new, and untested, format. In Dallas, we consider government ownership of our financial institutions, even on a “temporary” basis, to be a clear distortion of our capitalist principles. Of course, an alternative would be to have another systemically important financial institution acquire the failing institution. We have been down that road already. All it does is compound the problem, expanding the risk posed by the even larger surviving behemoth organizations. In addition, perpetuating the practice of arranging shotgun marriages between giants at taxpayer expense worsens the funding disadvantage faced by the 99.8 percent remaining—small and regional banks. Merging large institutions is a form of discrimination that favors the unwieldy and dangerous TBTF banks over more focused, fit and disciplined banks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 24. P a g e | 24 The approach of the Dallas Fed neither expands the reach of government nor further handicaps the 99.8 percent of community and regional banks. Nor does it fight complexity with complexity. It calls for reshaping TBTF banking institutions into smaller, less - complex institutions that are: economically viable; profitable; competitively able to attract financial capital and talent; and of a size, complexity and scope that allows both regulatory and market discipline to restrain excessive risk taking. Our proposal is simple and easy to understand. It can be accomplished with minimal statutory modification and implemented with as little government intervention as possible. It calls first for rolling back the federal safety net to apply only to basic, traditional commercial banking. Second, it calls for clarifying, through simple, understandable disclosures, that the federal safety net applies only to the commercial bank and its customers and never ever to the customers of any other affiliated subsidiary or the holding company. The shadow banking activities of financial institutions must not receive taxpayer support. We recognize that undoing customer inertia and management habits at TBTF banking institutions may take many years. During such a period, TBTF banks could possibly sow the seeds for another financial crisis. For these reasons, additional action may be necessary. The TBTF BHCs may need to be downsized and restructured so that the safety-net-supported commercial banking part of the holding company can be effectively disciplined by regulators and market forces. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 25. P a g e | 25 And there will likely have to be additional restrictions (or possibly prohibitions) on the ability to move assets or liabilities from a shadow banking affiliate to a banking affiliate within the holding company. To illustrate how the first two points in our plan would work, I come back to the hypothetical structure of a complex financial holding company. Recall that this type of holding company has a commercial bank subsidiary and several subsidiaries that are not traditional commercial banks: insurance, securities underwriting and brokerage, finance company and others, many with a vast geographic reach. Where the Government Safety Net Would Begin and End Under our proposal, only the commercial bank would have access to deposit insurance provided by the FDIC and discount window loans provided by the Federal Reserve. These two features of the safety net would explicitly, by statute, become unavailable to any shadow banking affiliate, special investment vehicle of the commercial bank or any obligations of the parent holding company. This is largely the current case—but in theory, not in practice. And consistent enforcement is viewed as unlikely. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 26. P a g e | 26 Reinforced by a New Covenant To reinforce the statute and its credibility, every customer, creditor and counterparty of every shadow banking affiliate and of the senior holding company would be required to agree to and sign a new covenant, a simple disclosure statement that acknowledges their unprotected status. A sample disclosure need be no more complex than this: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 27. P a g e | 27 This two-part step should begin to remove the implicit TBTF subsidy provided to BHCs and their shadow banking operations. Entities other than commercial banks have inappropriately benefited from an implicit safety net. Our proposal promotes competition in light of market and regulatory discipline, replacing the status quo of subsidized and perverse incentives to take excessive risk. As indicated earlier, some government intervention may be necessary to accelerate the imposition of effective market discipline. We believe that market forces should be relied upon as much as practicable. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 28. P a g e | 28 However, entrenched oligopoly forces, in combination with customer inertia, will likely only be overcome through government-sanctioned reorganization and restructuring of the TBTF BHCs. A subsidy once given is nearly impossible to take away. Thus, it appears we may need a push, using as little government intervention as possible to realign incentives, reestablish a competitive landscape and level the playing field. Why Protect the 0.2 Percent? My team at the Dallas Fed and I are confident this simple treatment to the complex problem and risks posed by TBTF institutions would be the most effective treatment. Think about it this way: At present, 99.8 percent of the banking organizations in America are subject to sufficient regulatory or shareholder/market discipline to contain the risk of misbehavior that could threaten the stability of the financial system. Zero-point-two percent are not. Their very existence threatens both economic and financial stability. Furthermore, to contain that risk, regulators and many small banks are tied up in regulatory and legal knots at an enormous direct cost to them and a large indirect cost to our economy. Zero-point-two percent. If the administration and the Congress could agree as recently as two weeks ago on legislation that affects 1 percent of taxpayers, surely it can process a solution that affects 0.2 percent of the nation’s banks and is less complex and far more effective than Dodd–Frank. Making a Time of ‘Awful Moment’ a Time of Promise The time has come to change the decision making paradigm. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 29. P a g e | 29 There should be more than the present two solutions: bailout or the end-of-the-economic-world-as-we-have-known-it. Both choices are unacceptable. The next financial crisis could cost more than two years of economic output, borne by millions of U.S. taxpayers. That horrendous cost must be weighed against the supposed benefits of maintaining the TBTF status quo. To us, the remedy is obvious: end TBTF now. End TBTF by reintroducing market forces instead of complex rules, and in so doing, level the playing field for all banking institutions. I return to Patrick Henry. He noted that “it is natural to man to indulge in the illusions of hope. We are apt to shut our eyes against a painful truth, and listen to the song of that siren till she transforms us.” We labor under the siren song of Dodd–Frank and the recent run-up in the pricing of TBTF bank stocks and credit, indulging in the illusion of hope that this complex legislation will end too big to fail and right the banking system. We shut our eyes to the painful truth that TBTF represents an ongoing danger not just to financial stability, but also to fair competition. The Dallas Fed offers a modest but, we believe, far more effective fix to Dodd–Frank. This plan is not without its costs. But it is less costly than all the alternatives put forward and it seriously reduces the likelihood of another horrendous and costly financial crisis. This need not be a time of “awful moment.” It should instead be a time of promise. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 30. P a g e | 30 Treating the pathology of TBTF now would be a big step toward a more stable and prosperous economic system, one that relies on fundamental principles of capitalism rather than regulatory complexity and increasing government intervention. Thank you. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 31. P a g e | 31 Dr Andreas Dombret Member of the Executive Board of the Deutsche Bundesbank Challenges for financial stability – policy and academic aspects Dinner Speech at the Joint Conference of the Deutsche Bundesbank, the Technical University Dresden and the Journal of Financial Stability 2012: An “annus horribilis” or an “annus mirabilis” or neither? Your Magnificence Professor Müller-Steinhagen, Mister State Minister Doctor Beermann, Ladies and Gentlemen: The turn of the year gives me the chance to relate my discussion of some of the future challenges for financial stability to a résumé of the previous year. Please allow me to do this from a European perspective and let me start with a seemingly innocent question: Will 2012 go down in history as an “annus horribilis” or rather as an “annus mirabilis”, or neither? The answer to this question is less trivial than it appears at first. Let’s look to the origins of the words “annus horribilis” and “annus mirabilis”. To see this please note that the originator of the “annus horribilis”, Queen Elizabeth, used it to describe her feelings about the year 1992. At the time, her Majesty was talking about, among others, the fire at Windsor Castle, but one might also read it as a comment about what _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 32. P a g e | 32 happened in the financial sector in 1992 when the markets forced the UK to leave the European Exchange Rate Mechanism. More recently, the Queen’s remarks sound as a comment about the financial and economic development of 2012. Please also note that many people use the metaphor of a large-scale fire to explain the economic term of a “systemic” event. Thus her Majesty is worth quoting in more length: “1992 is not a year on which I shall look with undiluted pleasure. In the words of one of my more sympathetic commentators it has turned to be an “annus horribilis”. I suspect that I am not alone in thinking it so. Indeed I suspect that there are very few people or institutions unaffected by the last months of worldwide turmoil and uncertainty.” According to various measures 2012 was a year of considerable systemic tensions. Indeed, the indicators were approaching - but did not quite reach - the sad levels seen in the second half of 2008 and in the first half of 2009 - which was without doubts a very difficult period in the financial and economic history. Therefore, one might be tempted to classify 2012 as an “annus horribilis”. I wish to challenge this view. Will 2012, with hindsight, possibly go down in history as an “annus mirabilis”? Absurd, you may think. But on second thought this notion seems less absurd than it first appears. Let us not forget that the famous poem of John Dryden entitled “annus mirabilis” was inspired from major events in the year 1666. A very difficult year, to put it mildly, a year in which the Great Fire destroyed 80% of the city of London. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 33. P a g e | 33 The fire spread so rapidly due to the city’s narrow streets and the “interconnectedness” of houses. The battle to stop the fire was considered to have been won by two factors: the strong east winds died down, and the Tower of London garrison used gunpowder to create effective firebreaks to stop the fire from spreading further eastwards. Dryden’s view was that God had performed miracles for England. The King promised to improve the streets. Well, some may say, so it is in 2012. The fire in the financial markets was stopped by the ECB, by the two firewalls EFSF and ESM as well as by the governments announcing that they would improve the financial system. Thus 2012 is an “annus mirabilis”. But as you know, miracles need to be acknowledged either by the pope or by the scientific community. So let us check whether a miracle was at work in 1666. And what I am going to say now about 1666 can be understood as a metaphorical warning about what could happen if we do not draw the right policy conclusion from the events of 2012. Despite numerous radical proposals, London was rebuilt using essentially the same street plan which was in use before the fire. So the miracle is that nothing similar to the Great Fire has happened in the following years. The lesson of this story is quite clear. The financial system needs better rules than in the years preceding the crisis. We need a resilient financial system. We need a strong supervision. We need effective macroprudential instruments. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 34. P a g e | 34 We need to know how these instruments will work, which is a challenge for the scientific community as well as for macroprudential policy makers. Otherwise, we would be putting our trust in a miracle. And we need to understand the complicated interactions between the financial and the real economy, which is the topic of your conference. Links between the Financial System and the Real Economy Take, for example, the LTROs which provided banks with liquidity for a period of three years. These LTROs have made the links between the public and the banking sector in some countries closer, not wider meaning that the system is even more vulnerable to systemic contagion than before. Another example is the issue of deleveraging and forbearance. In Europe, many banks’ balance sheets are too large. Most of you probably agree that it is necessary for these banks to shrink their balance sheets. At the same time, some fear that deleveraging cuts off corporations from their financing sources. From a theoretical viewpoint, however, a distinction needs to be made between good and bad deleveraging. Good deleveraging, for instance, means scaling back the exposure to other financial intermediaries whereas bad deleveraging means that lending to the real economy is being reduced. The problem with this view is that, in practice, the distinction is not at all so clear-cut. The issue becomes even more complicated, when we additionally introduce the concept of forbearance, i.e. postponing the act of declaring a doubtful loan to be a doubtful loan. What is the best response to this issue? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 35. P a g e | 35 The first answer is transparency. At this point, transparency is more easily said than done. But we need it, particularly in the context of a banking union and possible bank recapitalisations. And transparency is especially important with a view to legacy assets and forbearance of the problem banks. How do we proceed further? Repairing the banks’ balances sheets and injecting capital is one answer. However, some fear that repairing balance sheets has procyclical effects and could damage the availability of credit for the real economy. In my view, however, repairing balance sheets will have a long-term positive impact on potential output growth more than offsetting the possible short-term cyclical effects. The Limits of State Interventions I often hear that the banks were responsible for the crisis. But can governments do better? As you know, one reason for the financial crisis was the use of risk models based on assumptions, which concentrated on expected values rather than tails. Peter Bernstein, the financial historian from the US, illustrated this point by citing the anecdote of a Moscovite professor of statistics, who refused to go to the air-raid shelter during World War II bomb attacks. The professor argued: “See, Moscow has seven million inhabitants. Why should I expect to be one who will be hit?” His neighbours were astonished, when he came back to the shelter the next night. Now the professor’s argumentation was: “Moscow has seven million inhabitants and one elephant. Last night the elephant was hit.” _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 36. P a g e | 36 If regulators and banks essentially use the same models for their risk management, why should we expect a better financial stability outcome? Of course, one solution is to improve our models. But I do not think that this is the end of the story. I rather believe that regulators can do better if they acknowledge their own limitations. Regulators should employ the market mechanism to find the best risk management tools. In an ideal world the market is a discovery process. First, each individual agent knows better what is good for him. But at the end of the discovery process – in theory – we will get the best risk management tools, if – and this “if” is the decisive word here – if banks with weak risk management processes are allowed to fail, having to leave the market. This is one reason why resolving the “too-big-to-fail”-problem needs to be a top priority on the regulatory agenda. As far as I can judge, we are only beginning to understand how well-established instruments like the capital ratio work and what effect they have on the banks’ behaviour. And there are other new macroprudential instruments where our knowledge is even more limited. Take the counter-cyclical buffer. The idea is simple and compelling. When the regulators identify a bubble developing, this buffer is activated, thereby leading banks to reduce their lending. If all works well, this buffer prevents the exuberances altogether, or at least mitigates it. However, it is not clear how the buffers should be calibrated in order to achieve better financial stability. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 37. P a g e | 37 Moreover, not much is known about possible time lags. In the worst situation, these buffer effects are not counter- but pro-cyclical. Things become even more complicated if different instruments are applied at the same time. As you can easily see, there are many questions waiting to be answered, many problems waiting to be resolved. When I think about what we know how macroprudential instruments work, traffic lights come to my mind. To prevent pedestrians from crossing the street when the traffic light is red the authorities actually installed buttons that pedestrians could press to shorten the red phase. And it turned out to be a success: fewer pedestrians crossed the street when the lights were red. However, what the pedestrians did not know was that pushing the buttons had no effect on the duration of the red phase. Please do not misunderstand me: I do not believe that macroprudential instruments are useless. Quite the contrary is true. What I want to highlight is that we cannot expect to prevent all future crises from happening. It is an illusion to believe that we can finetune our instruments such that they have exactly the effect we want them to have. Recently, Otmar Issing wrote in the Frankfurter Allgemeine Zeitung: “The attempt to prevent each kind of crisis is just as hopeless as harmful. … The guiding principle of the market paradigm of action and liability for the consequences (of these actions) should be valid without exemption.” _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 38. P a g e | 38 Taking this into consideration, the effects and the interdependence of macroprudential instruments may turn out to be a very fruitful research area. To sum up, every intervention in the market needs to be justified by market failures, something that, unfortunately, is not hard to find in many areas of the financial system. There is no guarantee, however, that governments can do a better job. But at least the state has an incentive taking into account the negative externalities of banks’ decisions and thus to minimise tax payers’ losses. When the state is aware of its own limitations there is a good chance that the outcome will be better than one in which the financial system is left to its own devices. Newton’s “annus mirabilis” There was one famous scientist for whom 1666 was indeed an “annus mirabilis”. Isaac Newton made revolutionary inventions and discoveries in calculus, motion, optics and gravitation. As such, 1666 was later referred to Isaac Newton's “annus mirabilis”. It is the year when Isaac Newton was said to have observed an apple falling from a tree and hit upon gravitation. He afforded the time to work on his theories due to the closure of Cambridge University. In his own words: “All this was in the two years 1665 and 1666, for in those days I was in the prime of my age of invention, and minded mathematics and philosophy more than at any time since.” Nowadays, Newton’s experience might inspire you to invent and discover macroprudential mechanisms which policy makers could put to appropriate use in practice. Then the year 2012 might, in hindsight, turn out to have been a genuine “annus mirabilis”. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 39. P a g e | 39 I wish you all a very successful conference. Thank you for your attention. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 40. P a g e | 40 Preserving the safety and security of Malaysia’s banking system Speech by Mr Encik Abu Hassan Alshari Yahaya, Assistant Governor of the Central Bank of Malaysia, at the launch of the e-Banking Fraud Awareness Campaign, Kuala Lumpur It is my pleasure and honour to be invited to launch this joint e-Banking fraud awareness campaign. I would like to thank the Association of Banks in Malaysia for this invitation and the coordinated efforts in undertaking this important awareness campaign. A significant initiative This campaign is indeed a very important initiative for the banking industry in Malaysia. This is the first time that all banks have come together in a concerted effort to help create greater awareness of online fraud with the cooperation of CyberSecurity and the Police Force. This is to be lauded as all stakeholders have a role to play in preserving the safety and security of the banking system. Maintaining confidence in online banking services Online transactions have been growing at a rapid pace over the years. Over the last decade, the use of electronic payments has increased at an average annual growth of 23.4%. In 2012, Malaysian households and businesses performed more than 300 million financial transactions with a value close to RM15 trillion via _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 41. P a g e | 41 electronic channels comprising mainly funds transfers, bill payments, top-up for prepaid cards, purchases of phone cards and payments for investments in the capital market. Among the electronic channels, internet banking is the most popular. Fundamental to the growth of internet banking over the years is the confidence which the public has in its convenience and security. This is something that we cannot take for granted and must be continuously preserved. Advancement in technology and innovation has resulted in greater consumer convenience and enhanced efficiency. However, the same technology and innovation have also created new methods of perpetrating fraud that could be executed faster and with greater reach. Cyber criminals have been active ever since the advent of the internet, and are constantly finding new ways to defraud innocent victims. Safety and security of transactions in the banking system is fundamental in ensuring consumer confidence. Hence, an important function and responsibility of the Central Bank is to ensure online transactions can be made in a safe and efficient manner in the economy, in the pursuit of monetary and financial stability objectives. The need for constant vigilance & cooperation This fight that the banks are launching today is something that requires the support of all parties. We are aware of the creative ways in which criminals have attempted to deceive customers over the years and measures were required to be taken by the banks to protect the customers. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 42. P a g e | 42 While it is good to know that banks have played their roles in investing in robust security systems, they must also ensure that customers play their part in protecting their own assets and savings. The reminder and greater awareness from the Banks through this campaign is timely. It will not only reinforce the need for constant vigilance from all parties, but also help create an environment where everyone is risk conscious and responsible in protecting the interests of each other. These initiatives would not achieve the desired outcomes without effective communication, and the media has a critical role to play in conveying the message from the banks. We have always acknowledged the importance of the media and I would like to record Bank Negara Malaysia’s appreciation for the assistance rendered by the media in creating awareness of this issue in the past. We hope that with the support of the media on this occasion too, this campaign will be a success, and the public will have heightened levels of understanding and vigilance over this issue. On behalf of Bank Negara Malaysia, I would like to thank all the banks for taking this initiative to undertake this joint e-banking awareness campaign. Our thanks also to Cyber Security and the Police Force for your ongoing efforts to collaborate with the banking industry. I wish all of you the best and assure you that Bank Negara Malaysia will continuously support you in this noble effort. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 43. P a g e | 43 Comments received on the consultative report "Recovery and resolution of financial market infrastructures South Africa, Financial Services Board (FSB) has requested the SAFEX Clearing Company (Pty) Limited (SAFCOM) and Strate Limited to provide feedback. Introduction On the 31st of July 2012, a consultative report on the Recovery and Resolution of Financial Market Infrastructures was issued by the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO). Subsequently the Financial Services Board (FSB) has requested the SAFEX Clearing Company (Pty) Limited (SAFCOM) and Strate Limited to provide feedback and commentary on the report. This report serves as a consolidation of Strate Limited’s and SAFCOM’s views on the contents of the document. Background Strate Limited is a licensed Central Securities Depository (CSD) for the electronic settlement of financial instruments in South Africa. Strate handles the settlement of a number of securities including equities and bonds for the Johannesburg Stock Exchange (JSE) as well as a range of derivative products such as warrants, Exchange Traded Funds (ETFs), retail notes and tracker funds. It is also responsible for the settlement of money market securities to its portfolio of services. It provides services to issuers for their investors in terms of the Companies Act and Securities Services Act (SSA), 2004. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 44. P a g e | 44 SAFEX Clearing Company (Pty) Limited operates as a clearing house for the Johannesburg Stock Exchange derivatives markets. It was incorporated in 1987 and is based in South Africa. As of October 2008, SAFEX Clearing Company (Pty) Limited operates as a subsidiary of the JSE. General Comment In compiling a response to the request for comment by CPSS-IOSCO, Strate has reviewed the Consultative Report, the Key Attributes of Effective Resolution Regimes for Financial Institutions (issued by the Financial Stability Board) as well as the Principles for Financial Market Infrastructure and the associated recommendations for Regulators. Strate believes that the Consultative Report has been generally well thought out and represents a comprehensive assessment of the likely impacts in the event of FMI default or failure as well as an effective guideline to assist individual FMI’s in the development of an appropriate and effective Recovery and Resolution plan. The broad differentiation between those FMI’s that assume credit risk and those that do not is also considered most appropriate to take into account the different roles and responsibilities of individual FMI’s. It is, however, very clear from this exercise that a comprehensive review of the Resolution Regimes contained in current and proposed future legislation will need to be undertaken to ensure that the ideals contained in the referenced documents are suitably entrenched and understood. Specific responses to questions raised: The following responses and comments have been put forward for each of the specific questions raised in the Recovery and Resolution of Financial Market Infrastructures report. 1. In what circumstances, and for what types of FMI, can a statutory management, administration or conservatorship offer an appropriate process within which to ensure a continuity of critical services? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 45. P a g e | 45 The consideration as to whether statutory management, administration or conservatorship would offer the most appropriate process within which to ensure the continuity of critical services is, in our opinion, directly linked to the speed with which such an arrangement could be effectively implemented within the framework provided in local legislation rather than the type of FMI. This does, however, also link to question 2 below. 2. Are there powers beyond those of a standard insolvency practitioner that a statutory manager, administrator or conservator would require in these circumstances? Potentially, yes. This assessment can, however, only be completed with a full legislative review in the particular jurisdiction to ensure that the appointed authority has the necessary authorities already outlined in the Consultative Paper. Key to this assessment will be the ability to ensure the speedy assumption of control by the appointed authority. 3. Is tear-up an appropriate loss allocation arrangement prior to resolution of a CCP? If so, in what circumstances? Unable to comment – not applicable to Strate 4. To what extent should the possibility of a tear-up in recovery be articulated in ex ante rules? Unable to comment – not applicable to Strate. 5. Should there be a limit to the number of contracts that are eligible for tear-up? Unable to comment – not applicable to Strate. 6. How should the appropriate haircuts be determined? Unable to comment – not applicable to Strate. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 46. P a g e | 46 7. What qualitative or quantitative indicators of non-viability should be used in determining the trigger for resolution for different types of FMI? Key to this decision is the role of the particular FMI. In the case of non-credit risk bearing FMI’s the indicators would tend to be qualitative rather than quantitative once the primary measurement of adequate reserves has been addressed. In the case of Strate, this would include many elements assessed by its lead regulator in terms of the annual licence renewal process (including such things as competencies, quality of service delivery, operational capacities, robustness of existing technology etc.). 8. What loss allocation methods must be available to a resolution authority, and for which types of FMI? Could or should these resolution powers include tear-up, cash calls or a mandatory replenishment of default fund contributions by an FMI’s direct participants? Does it make a difference if the losses are from a defaulting member or are made up of other losses (e.g. losses in investments made by the FMI)? In what circumstances, and by what methods, should losses be passed on beyond the direct participants – e.g. to the clients or FMI shareholders – in resolution? To the extend applicable to Strate, losses in investments made by the FMI would be allocated directly to its shareholders rather than to its participants in any way. 9. What, if any, special considerations or methods should be applied when allocating losses whose maximum value cannot be capped (e.g. when allocating potential losses that might arise from open and uncapped positions at a CCP)? Unable to comment – not applicable to Strate. 10. How should equity in FMIs be treated in resolution scenarios: should it be written down in all circumstances? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 47. P a g e | 47 From a Strate perspective, and given the nature of the risks borne by the CSD, no need for differentiation in the treatment of equity write-downs could be identified. 11. Are there circumstances in which loss allocation in resolution should result in a different distribution of losses to losses borne in insolvency? Does it make a difference if the losses stem from a defaulting member or are made up of other losses (e.g. losses in investments made by the FMI or resulting from operational risks)? Given the profile of Strate it is not envisaged that there should be any difference in the loss allocation regardless of whether by resolution or insolvency. 12. Should an FMI’s rules for addressing uncovered losses be taken into account when calculating whether creditors are no worse off in resolution than in liquidation? Unable to comment – not applicable to Strate. 13. Are there any circumstances in which the ability to exercise termination rights as a result of the use of resolution powers should outweigh the objective of ensuring continuity? Given the profile of Strate this would only apply to contracts for services from third parties and to the extent that the ability to exercise termination rights relates to non-core services, this may assist in minimizing the immediate negative financial impacts on the FMI. It is unlikely that one would wish to invoke the early termination of core services as part of a resolution process. 14. Are there any circumstances in which a temporary stay on exercising termination rights should apply for any event of default and not just where triggered by the resolution measures? As with 13. above, the profile of Strate reduces the need to exercise, or indeed temporarily stay, termination rights whether as a result of default or resolution. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 48. P a g e | 48 15. Are there any circumstances in which a moratorium with a suspension of payments to unsecured creditors may be appropriate when resolving an FMI? Should this be limited to certain types of FMI and/or certain types of payment? The benefit of introducing a suspension of payments to unsecured creditors to assist in the resolution of an FMI such as Strate would be minimal and, given the specific nature of the role that Strate plays in the market, is unlikely to affect (either positively or negatively) its ability to continue settling or processing transactions which are processed directly between counterparties through the Central Bank payment system or, as is the case with Corporate Events processing, through Trust accounts which could effectively be ring-fenced from the FMI itself. 16. If so, should resolution authorities retain the discretion to apply a moratorium and, if so, what restrictions (if any) on its use would be appropriate (e.g. scope, duration or purpose)? Given the response to 15 above, this is not considered relevant to Strate other than to the extent that the Resolution Authority may wish to defer payment on non-core services in terms of existing powers. No special powers are considered necessary. 17. Should the bail-in tool be available to collateral, margin (including initial margin) and other sources of funds if they would bear losses in insolvency? Unable to comment – not applicable to Strate. 18. In what circumstances and for what types of FMI should wider loss recovery arrangements exist beyond the FMI’s own rules and the resolution powers of the resolution authority? Not applicable to Strate as it does not assume principal risk in any of the transactions it processes. The CSD Rules already cover the CSD adequately in this respect. 19. In conducting a resolvability assessment of an FMI, what factors should authorities pay particular attention to? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 49. P a g e | 49 The assessments outlined in Annexure II of the Key Attributes of Effective Resolution Regimes for Financial Institutions issued by the Financial Stability Board are considered sufficiently comprehensive to conduct a resolvability assessment. 20. In addition, is the summary of the application of the Key Attributes to FMIs provided in the annex sufficiently detailed to support the development of recovery and resolution regimes for FMIs? Are there specific areas where more detail could be provided? If so, which areas and what additional detail should be provided? Are any of the key attributes not applicable to a particular type of FMI? If so, which key attribute(s) and why not? Other than those areas already identified in the Annex as being not applicable to an FMI like Strate, no additional areas could be identified and no additional detail is considered necessary to assist Strate, in consultation with its Lead Regulator, in the development of an appropriate Resolution Plan. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 50. P a g e | 50 Opening Remarks at Investor Advisory Committee Meeting By Chairman Elisse Walter U.S. Securities and Exchange Commission Washington, D.C. January 18, 2013 Good morning. It is a pleasure to be with you today, and to make my first public appearance as SEC Chairman with you, a group who has chosen to dedicate yourselves to looking at the issues we face through the eyes of the investors we are dedicated to protect. As you know, although I am new to the role of Chairman, I am proud to have worked at the SEC both as a staff member and a Commissioner for a total of more than two decades. I have made the SEC the cornerstone, and the heart, of my career because I strongly believe that the SEC’s mission of investor protection and market stability is critical to the function of and confidence in the financial system as a whole…and especially because I believe that investors need and deserve an effective advocate within the Federal government. Today, thanks to our exceptional staff and strong leadership team, I believe that we are executing our role as the investor’s advocate boldly and effectively, at a time when our role has become more important than ever. This is a challenging and exciting time for the Commission. Commissioners and the staff are considering a number of complex and important issues and working hard on rules that will have a profound and positive impact on investors and our markets for years to come. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 51. P a g e | 51 I am currently working with the other Commissioners to prioritize the many agenda items before us and to set a realistic timetable for executing on those priorities. With these discussions still under way, I can’t yet give you too many details. I will say, though, that I am confident that completing the remaining rulemakings and other projects mandated by the Dodd-Frank Act and the JOBS Act will be at the top of the list. And despite the often-mentioned 2-2 divide, I find that my fellow commissioners — as well as Commission staff — are eager to find common ground and move forward in a practical and effective manner. I’m also on something of a listening tour -- clarifying my own thoughts and keeping an appropriate perspective by listening to ideas, questions and complaints from people in and out of the agency. And, that is why I am here today — to listen to you. The Investor Advisory Committee is the right idea, and particularly at this critical juncture in the history of our markets. Over the last decade, the retail investing landscape has become increasingly complex, populated by products, strategies, technologies, opportunities, and risks that simply didn’t exist just a short time ago. And, on top of the changes that arise more or less organically from in the marketplace, important new legislation is reshaping the terrain, as well. Just 21 months after Dodd Frank, the most significant financial reform bill in decades, was enacted — and created this committee — the JOBS Act brought another seismic shift in the way companies, particularly small and emerging ones, raise capital and how individual investors participate in that process. Against this backdrop, the decisions confronted by individual investors — decisions that are absolutely critical to the course of their lives and the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 52. P a g e | 52 lives of their families — and the information and advice they receive when they make these decisions, are becoming more complex even as the stakes grow higher. As some of you may know, when I think about the SEC’s role at a time like this, I like to think of my very dear — if completely imaginary — Aunt Millie, a retail investor with a modest portfolio, looking towards a secure retirement — hopefully in the near term — and some fun with her family during her golden years. Now, as dear to me as she is, Aunt Millie is no hedge fund manager. So when she sits down with her financial professional, and the talk turns to ETFs and target date funds, crowdfunding or her professional’s fees, I want the SEC’s presence to be felt there in that office — whether or not she even knows anything about the SEC (although MY Aunt Millie is, of course, qvelling at her niece’s recent promotion), I want the SEC to be there looking out for her, helping her make sense of the environment in which she is investing her future security. Aunt Millie and her fellow retail investors are unique among the major stakeholders in the financial system: they aren’t members of a trade association, and they don’t exactly spend a lot of time (or any time for that matter) following the Federal Register, monitoring the SEC, or — although I am trying to improve this — submitting substantive comments on proposed rules and concept releases. Like most retail investors, Aunt Millie is under-informed and underrepresented in the regulatory process. That is why, in the midst of continuing and significant changes in the markets, your work is so important. You help represent these retail investors with a visibility and sophistication that ensures that their needs and interests are carefully considered. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 53. P a g e | 53 You help us keep the playing field level for all investors, including and especially investors like Aunt Millie and her compatriots. Your first set of recommendations to the Commission, on proposed rules that would lift the restriction on general solicitation in certain private placements, reflects your commitment to that task. I deeply appreciate the effort and thoughtfulness that went into crafting the recommendations. In addition, your ability to work together and provide recommendations that were unanimously supported by the Committee is heartening to me and serves as an example to us all. In a short time, you have established yourselves as an effective organization and a critical component of the ongoing regulatory dialogue that affects every American investor. I look forward to our continuing collaboration as you address other matters of critical importance in a relentlessly evolving financial world. Thank you for what you have accomplished already and for what I know you will continue to do. I said earlier that we were still sorting out all of our priorities for the days ahead, but one of them is certainly this: continuing the close relationship that I believe we already have. And, since I’m here as part of my listening tour and not my talking tour, it’s probably time for me to stop talking and start listening to any questions and comments you may have. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 54. P a g e | 54 Fulfilling the Commission’s Statutory Responsibility to Respond to IAC’s Recommendations By Commissioner Luis A. Aguilar, U.S. Securities and Exchange Commission, Investor Advisory Committee Meeting Washington, D.C., January 18, 2013 I want to welcome the members of the Investor Advisory Committee to the Committee’s third in-person meeting. I also want to thank you for your continuing focus on the many issues confronting investors. Your input to the Commission is vital to highlight the initiatives that serve to benefit and protect investors, as well as to deter the Commission from undertaking initiatives that undercut or dismantle existing investor protections. It is critical that initiatives undertaken by the Commission fulfill its mission of protecting investors. As the Investor Advisory Committee, you are the Committee focused on the needs of investors and your recommendations are critical to facilitating that the Commission is operating to fulfill its mission. Congress clearly had this in mind when it codified this Committee in Section 911 of the Dodd-Frank Act and mandated how the Committee would operate. This Committee has already demonstrated that it takes its responsibilities seriously. For example, on October 12, 2012, the Committee sent the Commission seven unanimous recommendations regarding the SEC Rulemaking to Lift the Ban on General Solicitation and Advertising in Rule 506 Offerings. I commend you for the hard work that you have undertaken, as reflected in the recommendations we received and which are available on the SEC website. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 55. P a g e | 55 It is now incumbent on the Commission to act. As required by Section 911 of the Dodd-Frank Act, the Commission is required to “review the findings and recommendations of the Committee.” In particular, the statute specifies that, “each time the Committee submits a finding or recommendation to the Commission,” the Commission is required to “… promptly issue a public statement – (A) assessing the finding or recommendation of the Committee; and (B) disclosing the action, if any, the Commission intends to take with respect to the finding or recommendation.” The importance of this obligation is underscored by the fact that the law requires that the Commission itself assess the Committee’s recommendations and determine how best to respond to them. This is a responsibility of the Commission – not one that has been delegated to the staff. To that end, I look forward to the Commission issuing the required response assessing your October 2012 recommendations. It is imperative that this Committee’s recommendations be treated with the serious consideration that the law mandates. I look forward to the Committee’s on-going efforts and to what the Committee has to say. Thank you. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 56. P a g e | 56 Tougher credit rating rules confirmed by European Parliament's vote New rules on when and how credit rating agencies may rate state debts and private firms' financial health were approved by Parliament on Wednesday. They will allow agencies to issue unsolicited sovereign debt ratings only on set dates, and enable private investors to sue them for negligence. Agencies' shareholdings in rated firms will be capped, to reduce conflicts of interest. MEPs also ensured that the ratings are clearer by requiring agencies to explain the key factors underlying them. Ratings must not seek to influence state policies, and agencies themselves must not advocate any policy changes, adds the text. The rules have already been provisionally agreed with the Council. "We are taking some steps forward with this new regulation, fully in line with its basic spirit, which is to enable firms to do their own internal ratings. These should provide viable, comparable and reliable alternatives to those of the rating oligopoly", said lead MEP Leonardo Domenici (S&D, IT). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 57. P a g e | 57 Set dates for sovereign debt ratings Unsolicited sovereign ratings could be published at least two but no more than three times a year, on dates published by the rating agency at the end of the previous year. Furthermore, these ratings could be published only after markets in the EU have closed and at least one hour before they reopen. Agencies to be liable for ratings Investors who rely on a credit rating could sue the agency that issued it for damages if it breaches the rules set out in this legislation either intentionally or by gross negligence, regardless whether there is any contractual relationship between the parties. Such breaches would include, for example, issuing a rating compromised by a conflict of interests or outside the published calendar. Reducing over-reliance on ratings To reduce over-reliance on ratings, MEPs urge credit institutions and investment firms to develop their own rating capacities, to enable them to prepare their own risk assessments. The European Commission should also consider developing a European creditworthiness assessment, adds the text. By 2020 no EU legislation should directly refer to external ratings, and financial institutions must not be any more obliged to automatically sell assets in the event of a downgrade. Capping shareholdings A credit rating agency will have to refrain from issuing ratings, or disclose that its ratings may be affected, if a shareholder or member holding 10 % of the voting rights in that agency has invested in the rated entity. The new rules will also bar anyone from simultaneously holding stakes of more than 5% in more than one credit rating agency, unless the agencies concerned belong to the same group. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 58. P a g e | 58 The Domenici report on the regulation was adopted by 579 votes to 58, with 60 abstentions and that on the directive by 599 votes to 27, with 68 abstentions. Article 1 Subject matter This Regulation introduces a common regulatory approach in order to enhance the integrity, transparency, responsibility, good governance and independence of credit rating activities, contributing to the quality of credit ratings issued in the Union, thereby contributing to the smooth functioning of the internal market while achieving a high level of consumer and investor protection. It lays down conditions for the issuing of credit ratings and rules on the organisation and conduct of credit rating agencies, including their shareholders and members, to promote credit rating agencies' independence, the avoidance of conflicts of interest and the enhancement of consumer and investor protection. This Regulation also lays down obligations for issuers, originators and sponsors established in the Union regarding structured finance instruments. Article 5ba Over-reliance on credit ratings in Union law Without prejudice to its right of initiative, the Commission shall continue to review references to credit ratings in Union law which trigger or have the potential to trigger sole or mechanistic reliance on credit ratings by competent authorities or financial market participants, with a view to eliminating all references to ratings in Union law by 1 January 2020, provided that appropriate alternatives to credit risk assessment have been identified and implemented. Article 6a Conflicts of interest concerning investments in credit rating agencies 1. A shareholder or a member of a credit rating agency holding at least 5 % of the capital or the voting rights in a credit rating agency or in a company _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 59. P a g e | 59 which has the power to exercise dominant influence or control over the registered credit rating agency, shall be prohibited from: (a) holding 5 % or more of the capital of any other credit rating agency; (b) having the right or the power to exercise 5 % or more of the voting rights in any other credit rating agency; (c) having the right or the power to appoint or remove members of the administrative, management or supervisory body of any other credit rating agency; (d) being member of the administrative, management or supervisory body of any other credit rating agency; (e) exercising or having the power to exercise dominant influence or control over any other credit rating agency. The prohibition referred to in point (a) of the first subparagraph does not apply to holdings in diversified collective investment schemes, including managed funds such as pension funds or life insurance, provided that the holdings in diversified collective investment schemes do not put him or her in a position to exercise significant influence on the business activities of those schemes. Article -8a Sovereign debt ratings 1. Sovereign debt ratings shall be issued in a manner, which ensures that the individual specificity of a particular Member State has been analysed. A statement announcing revision of a given group of countries shall be prohibited, if not accompanied by individual country reports. Those reports shall be made publicly available. 2. Public communications other than credit ratings, rating outlooks or accompanying press releases, as referred to in point 5 of Part I of Section D of Annex I, which relate to potential changes of sovereign ratings shall not be based on information stemming from the sphere of the rated entity, where such information has been released without the consent of the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 60. P a g e | 60 rated entity, unless it is available from generally accessible sources or unless there are no legitimate reasons for the rated entity not to give its consent to the release of the information. 3. A credit rating agency shall, taking into consideration the provisions in second subparagraph of Article 8(5), publish on its website and send to ESMA on an annual basis, in accordance with point 3 of Part III of Section D of Annex I, a calendar at the end of the month of December for the next 12 months, setting a maximum of three dates for the publication of unsolicited sovereign ratings and related outlooks and setting the dates for the publication of solicited sovereign ratings and related outlooks. Such dates shall be set on a Friday. 4. Deviation of the publication of sovereign rating or related rating outlooks from the calendar shall only be possible in as much as this is necessary for the credit rating agency to comply with its obligations under Article 8(2), Article 10(1) and Article 11(1) and shall be accompanied by a detailed explanation of the reasons for the deviation from the announced calendar. Article 8c Use of multiple credit rating agencies 1. Where an issuer or a related third party intends to mandate at least two credit rating agencies for the credit rating of the same issuance or entity, the issuer shall consider the possibility to mandate at least one credit rating agency which does not have more than 10 % of the total market share and which can be evaluated by the issuer as capable for rating the relevant issuance or entity, provided that, based on the list of ESMA mentioned in paragraph 2, there is a credit rating agency available for rating the specific issuance or entity. Where the issuer does not mandate at least one credit rating agency which does not have more than 10 % of the total market share, this shall be recorded. 2. With a view to facilitating the evaluation by the issuer under paragraph 1, ESMA shall annually publish on its website a list of registered credit rating agencies, indicating their total market share and the types of ratings issued, which can be used by the issuer as a starting point for its evaluation. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 61. P a g e | 61 3. For the purposes of this Article, the total market share shall be measured by annual turnover generated from credit rating activities and ancillary services, at group level. Article 35a Civil liability 1. Where a credit rating agency has committed intentionally or with gross negligence any of the infringements listed in Annex III having an impact on a credit rating, an investor or issuer may claim damages from that credit rating agency for damage caused to them due to that infringement. An investor may claim damages under this Article where it establishes that it has reasonably relied, in accordance with Article 5a or otherwise with due care, on a credit rating for a decision to invest into, hold onto or divest from a financial instrument covered by that credit rating. An issuer may claim damages under this Article where it establishes that it or its financial instruments are covered by that credit rating and the infringement was not caused by misleading and inaccurate information provided by the issuer to the credit rating agency, directly or through information publicly available. 5. Civil liability as referred to in paragraph 1 may be limited in advance only where all of the following conditions are complied with: (a) the limitation is reasonable and proportionate; and (b) the limitation is allowed by the relevant national law as determined in accordance with paragraph 5a. Where a limitation of civil liability does not comply with the conditions referred to in the first subparagraph it shall have no legal effect. 5a. The terms “damage”, “intention”, “gross negligence”, “reasonably relied”, “due care”, “impact”, “reasonable” and “proportionate” which are referred to in this Article but are not defined in this Regulation, shall be interpreted and applied in accordance with the applicable national law as determined by the relevant rules of private international law. Matters concerning the civil liability of a credit rating agency and which are not at all covered by this Regulation shall be governed by the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  • 62. P a g e | 62 applicable national law as determined by the relevant rules of private international law. The competent court to decide on a claim for civil liability brought by an investor shall be determined by the relevant rules of private international law. 5b. This Article does not exclude further civil liability claims in accordance with national law. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com