monday november 5 2012 - top 10 risk management news

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_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)

www.risk-compliance-association.com

International Association of Risk and Compliance Professionals (IARCP)

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

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

week's agenda, and what is next

Dear Member, Year after year, new laws and regulations require firms to undertake a forward-looking self-assessment of risks, corresponding capital requirements, and adequacy of capital resources. Year after year, it becomes critical to look into the future, to understand what is next. Which is the new law, regulation or development? Which are the challenges and the opportunities for firms and organizations? How will these changes affect the competitive position of existing and new capital warriors in the markets? There is a great window to look into the future: The excellent forward-looking papers of the Group of Thirty.

The Group of Thirty The Group of Thirty is a private, nonprofit, international body composed of very senior representatives of the private and public sectors and academia. The Group aims to deepen understanding of international economic and financial issues, to explore the international repercussions of decisions taken in the public and private sectors, and to examine the choices available to market practitioners and policymakers.

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

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Members

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Emeritus Members

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Welcome to the Top 10 list.

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Toward Effective Governance of Financial Institutions Weak and ineffective governance of systemically important financial institutions (SIFIs) has been widely cited as an important contributory factor in the massive failure of financial sector decision making that led to the global financial crisis.

Statement on Public Meeting On Auditor Independence and Audit Firm Rotation SPEAKER: James R. Doty, Chairman EVENT: PCAOB Public Meeting LOCATION: Houston, TX

BIS, A framework for dealing with domestic systemically important banks

The Basel Committee on Banking Supervision (the Committee) issued the rules text on the assessment methodology for global systemically important banks (G-SIBs) and their additional loss absorbency requirements in November 2011.

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Mario Draghi: Opening statement at Deutscher Bundestag Speech by Mr Mario Draghi, President of the European Central Bank, at the discussion on ECB policies with Members of Parliament, Berlin

Andreas Dombret: As goes Ireland, so goes Europe?

Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, at the Institute of International and European Affairs, Dublin

CIMA Hosts Risk Management and Internal Controls Seminar The Cayman Islands Monetary Authority (CIMA) hosts a seminar on Risk Management and Internal Controls. The event, which is scheduled for 29 October to 2 November at the Grand Cayman Marriott Beach Resort

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Goldman Sachs Group Interesting numbers before the Basel III deadlines The Goldman Sachs Group, Inc. (NYSE: GS) reported net revenues of $8.35 billion and net earnings of $1.51 billion for the third quarter ended September 30, 2012.

Bermuda’s Insurance Solvency Framework The Roadmap to Regulatory Equivalence Planned 2012/2013 Developments

Mervyn King: Monetary policy developments Speech by Mr Mervyn King, Governor of the Bank of England, to the South Wales Chamber of Commerce, Cardiff, 23 October 2012.

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Erkki Liikanen: On the structural reforms of banking after the crisis

Speech by Mr Erkki Liikanen, Governor of the Bank of Finland and Chairman of the Highlevel Expert Group on reforming the structure of the EU banking sector, at the Centre for European Policy Studies, Brussels, 23 October 2012.

Progress note on the Global LEI Initiative This is the third of a series of notes on the implementation of the legal entity identifier (LEI) initiative. Following endorsement of the FSB report and recommendations by the G-20, the FSB LEI Implementation Group (IG) has been tasked with taking forward the planning and development work to launch the global LEI system by March 2013.

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Toward Effective Governance of Financial Institutions Important Parts Weak and ineffective governance of systemically important financial institutions (SIFIs) has been widely cited as an important contributory factor in the massive failure of financial sector decision making that led to the global financial crisis. In the wake of the crisis, financial institution (FI) governance was too often revealed as a set of arrangements that approved risky strategies (which often produced unprecedented short-term profits and remuneration), was blind to the looming dangers on the balance sheet and in the global economy, and therefore failed to safeguard the FI, its customers and shareholders, and society at large. Management teams, boards of directors, regulators and supervisors, and shareholders all failed, in their respective roles, to prudently govern and oversee. On the subject of governance as it applies to FIs, much has been written and said in the past few years. Notable among these statements are the 2009 Walker report (A Review of Corporate Governance in UK Banks and other Financial Industry Entities) and the Basel Committee’s Principles for Enhancing Corporate Governance (2010). Many domestic regulators and stock exchanges have also weighed in with new requirements and guidelines for governance. The Group of Thirty (G30) applauds these prior initiatives and supports not only the spirit of their conclusions but also many of the detailed recommendations they contain.

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The combination of these reports, self scrutiny by the firms themselves, and pressure from regulatory overseers has already yielded substantial changes in governance practice across the financial services industry and around the globe. Why would the G30 wish to add its own voice to the body of work already available, in light of progress being made? First, no one should presume that FI governance is now fixed. It is true that boards are working harder; supervisors are asking tough questions and preparing for more intensive oversight; management has become much more attuned to risk management and to supporting the oversight responsibilities of the board; and shareholders, to some degree, are taking a deeper look into their role in promoting effective governance. Nevertheless, as this report highlights, highly functional governance systems take significant time and sustained effort to establish and hone, and the G30’s input can help with that effort. Second, in a modern economy, business leadership represents a large concentration of power. The social externalities associated with the business of significant financial institutions give that power a major additional dimension and underscore the critical importance of good corporate governance of such entities. Third, we note that the prior reports and guidance almost always come from a national or regional perspective (the Basel Committee report being a notable exception), which is understandable as a practical matter, but curious given the distinctly global nature of the SIFIs, which are appropriately the focus of attention. Accordingly, in late spring of 2011, the G30 launched a project on the governance of major financial institutions.

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The project was led by a Steering Committee chaired by Roger W. Ferguson, Jr., with John G. Heimann, William R. Rhodes, and Sir David Walker as its vice-chairmen. They were supported by 11 other G30 members, who participated in an informal working group. Requests for interviews went out from the G30 to the chairs of 41 of the world’s largest, most complex financial institutions— banks, insurance companies, and securities firms. In an extraordinary response, especially in light of the pressures on each of these companies, 36 institutions shared their perspectives and experiences through detailed discussions with board leaders, CEOs, and selected senior management leaders. In addition, the project team held discussions with a global cross section of FI regulators and supervisors. The majority of these interviews were conducted in person, all under the Chatham House Rule,which encourages candor. The report is the responsibility of the G30 Steering Committee and Working Group and reflects broad areas of agreement among the participating G30 members, who took part in their individual capacities. All G30 members (aside from those with current national official responsibilities) have had the opportunity to review and discuss preliminary drafts. The report does not reflect the official views of those in policy-making positions or leadership roles in the private sector. The report is wide-ranging in its coverage of the composition and functioning of FI boards and the roles of regulators, supervisors, and shareholders.

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The focus is on potentially universal core themes but acknowledges differences in customs and practice in different parts of the world. As regards approaches to total compensation, we do not address this subject in detail in this report; the G30 commends the Financial Stability Board’s Principles for Sound Compensation Practices and fully supports their implementation. The G30 undertook its initiative on effective FI governance in the hope and expectation that FI board and senior management leaders could share actionable wisdom on the essence of effective governance and what it takes to build and nurture governance systems that work. We hope this report provides a measure of insight and sustenance to those with policymaking and operational responsibilities for effective governance in the world’s great financial institutions.

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Executive Summary What is meant by “governance” in the context of a financial institution (FI)? Corporate governance is traditionally defined as the system by which companies are directed and controlled. The OECD Principles of Corporate Governance (2004) defines corporate governance as involving “a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” In the case of financial institutions, chief among the other stakeholders are supervisors and regulators charged with ensuring safety, soundness, and ethical operation of the financial system for the public good. They have a major stake in, and can make an important contribution to, effective governance. Good corporate governance requires checks and balances on the power and rights accorded to shareholders, stakeholders, and society overall. Without checks, we see the behaviors that lead to disaster. But governance is not a fixed set of guidelines and procedures; rather, it is an ongoing process by which the choices and decisions of FIs are scrutinized, management and oversight are strengthened and streamlined, appropriate cultures are established and reinforced, and FI leaders are supported and assessed.

Why governance matters The global economic crisis, with the financial services sector at its center, wreaked economic chaos and imposed enormous costs on society.

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The depth, breadth, speed, and impact of the crisis caught many FI management teams and boards of directors by surprise and stunned central banks, FI regulators, supervisors, and shareholders. [Note: We attempt throughout the report to distinguish the regulatory function from the supervisory function. The regulator sets the rules and regulations within which FIs are obliged to operate, while the supervisor oversees the actions of the board and management to ensure compliance with those rules and regulations. Confusion arises because both functions are often performed within the same institution (for example, the U.S. Federal Reserve and the UK Financial Services Authority).] Enormous thought and debate has gone into discovering what caused the global financial crisis and how to avoid another. In his much-quoted 2009 report on the causes of the crisis, Lord Adair Turner, chair of the UK’s Financial Services Authority (FSA), cited seven proximate causes: (1) Large, global macroeconomic imbalances; (2) An increase in commercial banks’ involvement in risky trading activities; (3) Growth in securitized credit; (4) Increased leverage; (5) Failure of banks to manage financial risks; (6) Inadequate capital buffers; and (7) A misplaced reliance on complex math and credit ratings in assessing risk.

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A critical subtext to these seven causes is a pervasive failure of governance at all levels. More generally, most observers have agreed that a combination of “light touch” supervision, which relied too heavily on self-governance in financial firms, and weak corporate governance and risk management at many systemically important financial institutions (SIFIs) contributed to the 2008 meltdown in the United States. In several key markets, deregulation and market-based supervision were the political order of the day as countries vied for global capital flows, corporate headquarters, and exchange listings. Regulators also missed the potential systemic impact of entire classes of financial products, such as subprime mortgages, and in general failed to spot the large systemic risks that had been growing during the previous two decades. In this context, boards of directors failed to grasp the risks their institutions had taken on. They did not understand their vulnerability to major shocks, or they failed to act with appropriate prudence. Management, whose decisions and actions determine the organization’s risk status, clearly failed to understand and control risks. In many cases, spurred on by shareholders, both management and the board focused on performance to the detriment of prudence. Effective governance is a necessary complement to rules-based regulation. The system needs both. Carefully crafted rules-based regulations concerning capital, liquidity, permitted business activities, and so forth are essential safeguards for the

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financial system, while effective governance shapes, monitors, and controls what actually happens in FIs. Ineffective governance at financial institutions was not the sole contributor to the global financial crisis, but it was often an accomplice in the context of massive macroeconomic vulnerability. Effective governance can make a significant positive difference by helping to prevent future crises or by mitigating their deleterious impact. In other words, the rewards for investment in effective governance are great.

A call to action Each of the four participants in the governance system—boards of directors, management, supervisors, and (to an extent) long-term shareholders— needs to reassess their approach to FI governance and take meaningful steps to make governance stronger. This report offers a comprehensive set of concrete insights and recommendations for what each participant needs to do to make FI governance function more effectively. The G30 is acutely aware that the agendas of FI boards and supervisors are crowded, yet we urge them to continue to give effective governance one of their highest priorities. ‹. The financial sector needs better methods of assessing governance and of cultivating the behaviors and approaches that make governance systems work well. Board self-evaluation, especially when facilitated or led by an outside expert, can yield important insight, but it is sobering to consider that in 2007, most boards would likely have given themselves passing grades. ‹. Supervisors now aspire to understand governance effectiveness and vulnerabilities, but admit to having much to learn.

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‹. Governance experts often describe what good governance looks like, but give little thought to how to measure or achieve high-performance results. Given the role that inadequate governance played in the massive failure of financial sector decision making that led to the global financial crisis, it is natural that supervisors and stock exchanges are now paying great attention to governance arrangements. This attention, as a practical matter, often focuses on explicit rules, structures, and processes—best practices—that governance experts often believe are indicative of effective governance. Consequently, compliance with best practice guidelines has become very important to boards and to overseers charged with monitoring and encouraging good governance. The G30 hopes this report will contribute meaningfully to the body of knowledge on governance and will be a useful tool for those tasked with shaping governance systems.

The board Boards of directors play the pivotal role in FI governance through their control of the three factors that ultimately determine the success of the FI: the choice of strategy; the assessment of risk taking; and the assurance that the necessary talent is in place, starting with the CEO, to implement the agreed strategy. The 2008–2009 financial crisis revealed that management at certain FIs, with the knowledge and approval of their boards, took decisions and actions that led to terrible outcomes for employees, customers, shareholders, and the wider economy. What should the boards have done differently? To answer that question, it is helpful to consider the mandate of boards.

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Boards control the three key factors that ultimately determine the success of an FI: 1. The choice of business model (strategy) 2. The risk profile, and 3. The choice of CEO—and by extension the quality of the top-management team. Boards that permit their time and attention to be diverted disproportionately into compliance and advisory activities at the expense of strategy, risk, and talent issues are making a critical mistake. Above all else, boards must take every step possible to protect against potentially fatal risks. FI boards in every country must take a long-term view that encourages long-term value creation in the shareholders’ interests, elevates prudence without diminishing the importance of innovation, reduces short-term self-interest as a motivator, brings into the foreground the firm’s dependence on its pool of talent, and demands the firm play a palpably positive role in society. The importance of mature, open leadership by a skillful board chair cannot be overemphasized. Effective chairs capitalize on the wisdom and advice of board members and management leaders and on the board’s interactions with supervisors and shareholders, individually and collectively. Good chairs respect each of these vital constituents, preside, encourage debate, and do not manage toward a predetermined outcome.

Risk governance Those accountable for key risk policies in FIs, on the board and within management, have to be sufficiently empowered to put the brakes on the firm’s risk taking, but they also play a critical role in enabling the firm to

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conduct well-measured, profitable risk-taking activities that support the firm’s long-term sustainable success. In the financial services sector more than in other industries, risk governance is of paramount importance to the stability and profitability of the enterprise. Without an ability to properly understand, measure, manage, price, and mitigate risk, FIs are destined to underperform or fail. Effective risk governance requires a dedicated set of risk leaders in the boardroom and executive suite, as well as robust and appropriate risk frameworks, systems, and processes. The history of financial crises, including the 2008–2009 crisis, is littered with firms that collapsed or were taken to the brink by a failure of risk governance. The most recent financial crisis demonstrated the inability of many FIs to accurately gauge, understand, and manage their risks. Firms greatly understated their inherent risks, particularly correlations across their businesses, and were woefully unprepared for the exogenous risks that unfolded during the crisis and afterward.

Management Management needs to play a continuous proactive role in the overall governance process, upward to the board and downward through the organization. The vast majority of governance and control processes are embedded in the organizational fabric, which is woven and maintained by management. The board is dependent on management for information and for translating sometimes highly technical information into issues and choices requiring business judgment.

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Governance cannot be effective without major continuing input from management in identifying the big issues and presenting them for discussion with the board. Management needs to strengthen the fabric of checks and balances in the organization. It must deepen its respect for the vital roles of the board and supervisors and help them to do their jobs well. It must reinforce the values that drive good behavior through the organization and build a culture that respects risk while encouraging innovation.

Supervisors Supervisors that more fully comprehend FI strategies, risk appetite and profile, culture, and governance effectiveness will be better able to make the key judgments their mandate requires. Supervisors have legally defined responsibilities relating to risk control; fraud control; and conformance to laws, regulations, and standards of conduct. Supervisors now seek a deeper and more nuanced understanding of how the board works, how key decisions are reached, and the nature of the debate around them, all of which reveal much about the firm’s governance. Most FI boards applaud this expansion in the supervisors’ focus from control process details to include a broader grasp of issues and context. To be effective, however, this expansion requires regular interaction among senior people in supervisory agencies and boards and board members. Supervisors need to broaden their perspectives to include FI strategy, people, and culture.

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They should focus their discussions with senior management and the board on the real issues—through both formal and informal communications. But they must also maintain their independence and accept that they will at best have an incomplete picture. Similarly, supervisors must not try to do the board’s job or so overwhelm the board and management that they cannot guide the FI. Supervisors have a unique perspective on emerging systemic, macroprudential risks and can compare and contrast one FI with others. This is vital information to develop and share. Unfortunately, in the policy-making debate, the qualitative aspect of supervision is sometimes overshadowed by quantitative, rules-based regulatory requirements. Clearly, new capital, liquidity, and related standards are essential to a more stable global financial architecture, but enhanced oversight of the performance and decision-making processes of major FIs is also essential.

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Statement on Public Meeting On Auditor Independence and Audit Firm Rotation SPEAKER: James R. Doty, Chairman EVENT: PCAOB Public Meeting LOCATION: Houston, TX Welcome everyone to the Public Company Accounting Oversight Board's third public meeting on the Board's concept release on ways to enhance auditor independence. I want to thank Rice University and Dean Bill Glick for providing such an inspiring venue for this meeting. We have assembled an august set of panelists today to assist the Board in an in-depth examination of an issue that continues to trouble many of the most thoughtful supporters of the audit profession — the subtle (and not so subtle) influences on the auditor's mindset, and the implication for the integrity of the audit. Enhancing auditor independence was one of the main goals of the Sarbanes-Oxley Act of 2002. We have one of the draftsmen of that Act seated to my left at the table. In the weeks and months leading up to the enactment of Sarbanes-Oxley, Congress considered requiring audit firm rotation to improve auditor independence. But the final statute as enacted stepped back. Instead, it provided for partner rotation on public company audits. In addition, it asked for further study of firm rotation. Shortly thereafter, in 2003, the Government Accountability Office embarked on a review of the arguments for and against audit firm

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rotation. The review was preliminary in light of other Sarbanes-Oxley reforms that were only beginning to be implemented. Thus it concluded that the SEC and the Board would need several years to evaluate whether the Sarbanes-Oxley reforms, including audit partner rotation, were sufficient, or whether further independence measures are necessary to protect investors. We are fortunate to have on the PCAOB board one of the drafters of the GAO report to help us put it in context. Since then, the financial crisis of 2008 has caused us as a nation to reflect on how dependent our financial system is on high quality, unbiased audits. It has prompted us to look again at auditor independence, objectivity and professional skepticism, and to ask whether features of our financial system have allowed companies to become too close to their auditors. And to consider whether there are ways we can improve the reliability and usefulness of audit reports to the public. We are not alone in this inquiry. Many other countries have commenced their own reviews of audit practices. We are fortunate to be able to hear from a representative of the European Commission later today about potential reforms that are currently under consideration in Europe. Just last month, the United Kingdom published a regulation that would entail mandatory retendering every ten years for FTSE 350 companies, with corresponding disclosure requirements. I don't mean to exclude other important actions in other countries. There are many. The U.K.'s is just the most recent. Given the breadth of the international debate, it is not surprising that people disagree on what the best reforms will be, or how to implement

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them, or indeed whether reform is necessary. Or whether the costs to those who would incur them outweigh the benefits to those who would receive them. I hear no doubt in any corner, however, about the importance of independent audits. Let me say that I believe it is the rare case in which an auditor knowingly compromises his or her integrity. But well-intentioned auditors, as with other people, sometimes fail to recognize and guard against their own unconscious biases. We are nearly ten years from the adoption of Sarbanes-Oxley, during which we have had time to observe whether its reforms were sufficient. Against this historical background, in August 2011, the PCAOB issued a concept release, seeking public comment on a variety of questions about how to improve auditor independence, objectivity and professional skepticism. The concept release notes the importance of auditor independence to the viability of auditing as a profession and highlights the risk to independence arising from the "client-pays" model. As noted in the concept release, the PCAOB inspectors continue to find what is to me an unacceptable level of deficient audits. In addition, inspectors continue to find troubling suggestions of firms showing willingness to put management's short-term interest ahead of investors'. The concept release seeks public comment on ways that auditor independence, objectivity and professional skepticism can be enhanced. In this regard, the release notes that there may be risks to professional skepticism in both the relatively new audit that the auditor may hope to turn into a long-term engagement, as well as the very long engagement that no partner wants to be the one to lose.

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We have received more than 600 comment letters, primarily from auditors and their clients. On the whole, they counsel for more time and study, and more modest reforms. To be sure, I want to be cautious in making any decisions, and that is why I have asked for meetings like this and two previous meetings in Washington, D.C., and San Francisco. We have the benefit of the record of our first two meetings. Therefore, although today's panelists have been invited to provide views on any of the issues raised in the Board's concept release, they have also been asked to comment specifically on certain themes, issues and suggestions from the prior public meetings. I want to thank the panelists, my fellow board members, the SEC's Deputy Chief Accountant Brian Croteau who has joined us today, and the PCAOB staff who have made the meeting possible. I look forward to a thoughtful discussion that will help the Board advance its inquiry.

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Statement on Public Meeting On Auditor Independence and Audit Firm Rotation SPEAKER: Jeanette M. Franzel, Board Member EVENT: PCAOB Public Meeting LOCATION: Houston, TX Thank you, Chairman Doty, for calling this public meeting to further explore some of the principal themes that have emerged in the feedback that the Board has received in response to the PCAOB Concept Release on Auditor Independence and Audit Firm Rotation issued in August of last year. The Board has received more than 670 comment letters and heard from 77 speakers on this topic to date. Throughout this process, the Board has received rich feedback on the complex issues that impact auditor independence and audit quality, as well as a range of suggestions for potential actions that could be taken. Commenters have acknowledged the fundamental importance of auditor independence as the underpinning of confidence in the auditing profession. They also expressed support for the Board's efforts to ensure or enhance the auditor's independence, objectivity, and professional skepticism, although suggestions for how this might be achieved varied widely. The concept release and our related public meetings are creating a substantive debate among the full range of stakeholders. It is certainly public knowledge that the majority of the commenters on this issuer were opposed to a requirement for mandatory audit firm rotation for a variety of reasons. We are currently conducting analyses of the feedback we have received, as well as additional research by the PCAOB and others.

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Today we will explore a number of major themes in the comment letters and panelist feedback, including the following suggestions: - strengthening audit committees, including enhancing their financial

expertise, increasing their independence from management, and enhancing and increasing interaction and communications with investors, auditors, and the PCAOB;

- increasing emphasis on professional skepticism in standards and

education for auditors, as well as in the firms' culture and systems of quality control.

- increasing the transparency surrounding PCAOB inspection results,

as well as making public the PCAOB's enforcement investigations and proceedings;

- expanding PCAOB inspections in certain circumstances;

- increasing the root cause analyses by the PCAOB and the firms on the

causes of audit deficiencies; - using mandatory "retendering" of the audit and/or a formal

re-evaluation of the auditor's tenure at given intervals; - exploring variations on the possible use of firm rotation, including

limiting any potential rotation requirement to certain audits and certain circumstances; and

- potentially further restricting the provision of non-audit services by

the auditor. I am personally committed to exploring the broad range of themes and issues that influence auditor independence, objectivity, and professional skepticism, as well as audit quality, and advancing the Board's efforts to protect investors and the public interest through high quality, independent audits.

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Any methods for improving auditor independence and audit quality won't be simple, and there will not be a "silver bullet." Today, we will be hearing from a new group of highly qualified panelists. I am interested in their views on the different challenges to achieving independence, objectivity, and professional skepticism and the variety of potential actions that could be taken to help improve auditor independence and audit quality. I believe that we need concerted and sustained action from the full range of parties who have responsibility for these issues, including those responsible for accounting education, audit firm recruitment and training, audit firm culture and tone at the top, audit committee and board oversight, as well as PCAOB inspections and other regulatory activities. It is paramount, of course, that all of the parties with responsibility throughout the process keep the interests of investors front and center. One of the major themes that has emerged during the Board's efforts on auditor independence is a consensus on the importance of audit committees in overseeing the auditor and the audit process. PCAOB does not have regulatory jurisdiction over audit committees. But we should not overlook the tremendous value in coordinating and leveraging our efforts; avoiding duplication and/or fragmentation; and providing for a seamless system of effective governance and audit oversight. During our outreach, PCAOB received feedback on ways that audit committee performance can be enhanced. I'm pleased that we have a number of audit committee members and corporate governance experts here today to explore these issues. Another theme emerging from the input that the Board has received is that professional skepticism should be emphasized more in the

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education, training, and standard-setting for auditors, as well as in the firms' cultures, tone at the top, and systems of quality control. I'm pleased that we have a number of academicians and practitioners here today to further explore these issues with us. I am also very interested in the views of the investors and others here today on these and other issues impacting auditor independence, audit quality, and investor protection. I believe investors will be well-served if the various organizations and groups charged with protecting investors, the public interest, and the integrity of the U.S. capital markets work together effectively to achieve these goals. The bottom line here is that we must come up with a package of actions that will be solid and effective in protecting investors and the public interest through independent, high quality financial audits. We also need to carefully consider and analyze the potential costs and benefits of various actions, as well as the risks associated with unintended consequences, so that we are effective in protecting the interests of investors and furthering the public interest in the preparation of informative, accurate, and independent audit reports. I want to thank all of the panelists, their staff, and their constituencies, for taking the time and effort to assist us in exploring these very important issues.

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Statement on Public Meeting On Auditor Independence and Audit Firm Rotation SPEAKER: Jay D. Hanson, Board Member EVENT: PCAOB Public Meeting LOCATION: Houston, TX Good morning, I would like to join Chairman Doty and my fellow Board members in welcoming today's panelists and to thank the Rice University community for their warm welcome. I would also like to thank the PCAOB staff for their hard work in getting all of us into this room together to discuss auditor independence, objectivity and skepticism, which, without a doubt, is one of the most fundamental elements in the performance of robust audits and key to serving the needs of investors. Fourteen months ago, we issued a concept release with the goal of gathering information and framing a discussion about whether the Board should take any steps to enhance auditor independence, objectivity and skepticism. Since then, we have received almost 700 comment letters and have heard from dozens of panelists. Commenters overwhelmingly support the Board's efforts to enhance auditor independence, objectivity and skepticism, but there are widely varying views on how to accomplish that goal. Most commenters oppose mandatory rotation and express concern that auditor rotation will actually decrease audit quality. From this group, we have heard some suggestions for ways to enhance auditor rotation, including an enhanced focus by audit committees, joint audits, mandatory re-tendering, tenure protection for auditors, non-audit service restrictions, increased PCAOB inspections and/or transparency about our inspections, and several others.

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Some commenters, on the other hand, believe that auditor rotation is the only way to overcome what some describe as an inherent conflict between independence and the fact that auditors are paid by the companies they audit. Thus, we have received a lot of input, and we have much to think about. There are a few areas, however, where I believe we would benefit from more information, and I would like to encourage today's panelists, and any other potential commenters, to consider whether they can help us fill in these gaps. For example, it has proven difficult to establish a clear correlation between audit quality and auditor tenure. I know some of you may address that issue today, and I look forward to hearing your views on this subject. I look forward to hearing views on how panelists define audit quality. To date, we also have not delved deeply into the details and implications of all the potential ways to enhance auditor independence that have been suggested. In order to fully understand all possible approaches, and to determine how to evaluate various alternatives, I believe it is important that we do so. I look forward to hearing from those of you who plan to share with us views on approaches other than rotation that could enhance both auditor independence and audit quality. To the extent companies, auditors or audit committees have tried any approaches to enhance auditor independence, I encourage you to share your experiences with us, both in terms of benefits and costs. Finally, I have spoken a number of times on the key role played by audit committees.

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In my experience as an auditor, I saw a transformation in audit committee behavior and focus after implementation of the requirements of the Sarbanes-Oxley Act. We have heard from many audit committee members who described in great detail their extensive efforts to evaluate and ensure their auditor's independence. Yet, some believe that even the most diligent audit committees cannot sufficiently monitor auditor independence. One question I frequently ask myself is what we can do to help audit committees do a better job in this regard. In August, the Board issued a new auditing standard on communications with audit committees. It is my hope that by arming audit committees with more information about the audit, including audit risks, significant or difficult accounting issues, significant unusual transactions, and other important matters, those committees can provide better oversight over the entirety of the audit process, including evaluating whether the auditor is approaching difficult issues with an appropriate degree of skepticism. Likewise, we recently issued a release to provide audit committees with more information about PCAOB inspections and related topics that audit committees may wish to discuss with their auditor. This too, I trust, will assist audit committees in better evaluating their auditors in a variety of important areas, including competence, diligence and independence. Although the Board does not have the authority to regulate audit committees, we are willing to help them however we can. I am particularly interested in your views — and those of other commenters who may not yet have participated in this dialog — as to what else this Board can do to enhance the ability of audit committees to

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ensure that their auditors are appropriately meeting all of their obligations. Thank you again for taking time out of your busy schedules to be with us today, and I look forward to your comments.

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BIS, A framework for dealing with domestic systemically important banks

I. Introduction 1. The Basel Committee on Banking Supervision (the Committee) issued the rules text on the assessment methodology for global systemically important banks (G-SIBs) and their additional loss absorbency requirements in November 2011. The G-SIB rules text was endorsed by the G20 Leaders at their November 2011 meeting. The G20 Leaders also asked the Committee and the Financial Stability Board to work on modalities to extend expeditiously the G-SIFI framework to domestic systemically important banks (D-SIBs). 2. The rationale for adopting additional policy measures for G-SIBs was based on the “negative externalities” (ie adverse side effects) created by systemically important banks which current regulatory policies do not fully address. In maximising their private benefits, individual financial institutions may rationally choose outcomes that, from a system-wide level, are sub-optimal because they do not take into account these externalities. These negative externalities include the impact of the failure or impairment of large, interconnected global financial institutions that can send shocks through the financial system which, in turn, can harm the real economy.

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Moreover, the moral hazard costs associated with direct support and implicit government guarantees may amplify risk-taking, reduce market discipline, create competitive distortions, and further increase the probability of distress in the future. As a result, the costs associated with moral hazard add to any direct costs of support that may be borne by taxpayers. 3. The additional requirement applied to G-SIBs, which applies over and above the Basel III requirements that are being introduced for all internationally-active banks, is intended to limit these cross-border negative externalities on the global financial system and economy associated with the most globally systemic banking institutions. But similar externalities can apply at a domestic level. There are many banks that are not significant from an international perspective, but nevertheless could have an important impact on their domestic financial system and economy compared to non-systemic institutions. Some of these banks may have cross-border externalities, even if the effects are not global in nature. Similar to the case of G-SIBs, it was considered appropriate to review ways to address the externalities posed by D-SIBs. 4. A D-SIB framework is best understood as taking the complementary perspective to the G-SIB regime by focusing on the impact that the distress or failure of banks (including by international banks) will have on the domestic economy. As such, it is based on the assessment conducted by the local authorities, who are best placed to evaluate the impact of failure on the local financial system and the local economy. 5. This point has two implications.

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The first is that in order to accommodate the structural characteristics of individual jurisdictions, the assessment and application of policy tools should allow for an appropriate degree of national discretion. This contrasts with the prescriptive approach in the G-SIB framework. The second implication is that because a D-SIB framework is still relevant for reducing cross-border externalities due to spillovers at regional or bilateral level, the effectiveness of local authorities in addressing risks posed by individual banks is of interest to a wider group of countries. A framework, therefore, should establish a minimum set of principles, which ensures that it is complementary with the G-SIB framework, addresses adequately cross-border externalities and promotes a level-playing field. 6. The principles developed by the Committee for D-SIBs would allow for appropriate national discretion to accommodate structural characteristics of the domestic financial system, including the possibility for countries to go beyond the minimum D-SIB framework and impose additional requirements based on the specific features of the country and its domestic banking sector. 7. The principles set out in the document focus on the higher loss absorbency (HLA) requirement for D-SIBs. The Committee would like to emphasise that other policy tools, particularly more intensive supervision, can also play an important role in dealing with D-SIBs. 8. The principles were developed to be applied to consolidated groups and subsidiaries. However, national authorities may apply them to branches in their jurisdictions in accordance with their legal and regulatory frameworks. 9. The implementation of the principles will be combined with a strong peer review process introduced by the Committee.

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The Committee intends to add the D-SIB framework to the scope of the Basel III regulatory consistency assessment programme. This will help ensure that appropriate and effective frameworks for D-SIBs are in place across different jurisdictions. 10. Given that the D-SIB framework complements the G-SIB framework, the Committee considers that it would be appropriate if banks identified as D-SIBs by their national authorities are required by those authorities to comply with the principles in line with the phase-in arrangements for the G-SIB framework, ie from January 2016.

II. The principles 11. The Committee has developed a set of principles that constitutes the D-SIB framework. The 12 principles can be broadly categorised into two groups: The first group (Principles 1 to 7) focuses mainly on the assessment methodology for D-SIBs while the second group (Principles 8 to 12) focuses on HLA for D-SIBs. 12. The 12 principles are set out below:

Assessment methodology

Principle 1:

National authorities should establish a methodology for assessing the degree to which banks are systemically important in a domestic context.

Principle 2:

The assessment methodology for a D-SIB should reflect the potential impact of, or externality imposed by, a bank’s failure.

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Principle 3:

The reference system for assessing the impact of failure of a D-SIB should be the domestic economy.

Principle 4:

Home authorities should assess banks for their degree of systemic importance at the consolidated group level, while host authorities should assess subsidiaries in their jurisdictions, consolidated to include any of their own downstream subsidiaries, for their degree of systemic importance.

Principle 5:

The impact of a D-SIB’s failure on the domestic economy should, in principle, be assessed having regard to bank-specific factors: (a) Size (b) Interconnectedness (c) Substitutability/financial institution infrastructure (including considerations related to the concentrated nature of the banking sector) (d) Complexity (including the additional complexities from cross-border activity). In addition, national authorities can consider other measures/data that would inform these bank-specific indicators within each of the above factors, such as size of the domestic economy.

Principle 6:

National authorities should undertake regular assessments of the systemic importance of the banks in their jurisdictions to ensure that their assessment reflects the current state of the relevant financial systems and that the interval between D-SIB assessments not be significantly longer than the G-SIB assessment frequency.

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Principle 7:

National authorities should publicly disclose information that provides an outline of the methodology employed to assess the systemic importance of banks in their domestic economy.

Higher loss absorbency

Principle 8:

National authorities should document the methodologies and considerations used to calibrate the level of HLA that the framework would require for D-SIBs in their jurisdiction. The level of HLA calibrated for D-SIBs should be informed by quantitative methodologies (where available) and country-specific factors without prejudice to the use of supervisory judgement.

Principle 9: The HLA requirement imposed on a bank should be commensurate with the degree of systemic importance, as identified under Principle 5.

Principle 10:

National authorities should ensure that the application of the G-SIB and D-SIB frameworks is compatible within their jurisdictions. Home authorities should impose HLA requirements that they calibrate at the parent and/or consolidated level, and host authorities should impose HLA requirements that they calibrate at the sub-consolidated/subsidiary level. The home authority should test that the parent bank is adequately capitalised on a stand-alone basis, including cases in which a D-SIB HLA requirement is applied at the subsidiary level.

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Home authorities should impose the higher of either the D-SIB or G-SIB HLA requirements in the case where the banking group has been identified as a D-SIB in the home jurisdiction as well as a G-SIB.

Principle 11:

In cases where the subsidiary of a bank is considered to be a D-SIB by a host authority, home and host authorities should make arrangements to coordinate and cooperate on the appropriate HLA requirement, within the constraints imposed by relevant laws in the host jurisdiction.

Principle 12:

The HLA requirement should be met fully by Common Equity Tier 1 (CET1). In addition, national authorities should put in place any additional requirements and other policy measures they consider to be appropriate to address the risks posed by a D-SIB.

Assessment methodology

Principle 1: National authorities should establish a methodology for assessing the degree to which banks are systemically important in a domestic context. Principle 2: The assessment methodology for a D-SIB should reflect the potential impact of, or externality imposed by, a bank’s failure.

13. A starting point for the development of principles for the assessment of D-SIBs is a requirement that all national authorities should undertake an assessment of the degree to which banks are systemically important in a domestic context. The rationale for focusing on the domestic context is outlined in paragraph 17 below. 14. Paragraph 14 of the G-SIB rules text states that “global systemic importance should be measured in terms of the impact that a failure of a bank can have on the global financial system and wider economy rather than the risk that a failure can occur.

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This can be thought of as a global, system-wide, loss-given-default (LGD) concept rather than a probability of default (PD) concept.” Consistent with the G-SIB methodology, the Committee is of the view that D-SIBs should also be assessed in terms of the potential impact of their failure on the relevant reference system. One implication of this is that to the extent that D-SIB indicators are included in any methodology, they should primarily relate to “impact of failure” measures and not “risk of failure” measures.

Principle 3: The reference system for assessing the impact of failure of a D-SIB should be the domestic economy. Principle 4: Home authorities should assess banks for their degree of systemic importance at the consolidated group level, while host authorities should assess subsidiaries in their jurisdictions, consolidated to include any of their own downstream subsidiaries, for their degree of systemic importance.

15. Two key aspects that shape the D-SIB framework and define its relationship to the G-SIB framework relate to how it deals with two conceptual issues with important practical implications: • What is the reference system for the assessment of systemic impact • What is the appropriate unit of analysis (ie the entity which is being assessed)? 16. For the G-SIB framework, the appropriate reference system is the global economy, given the focus on cross-border spillovers and the negative global externalities that arise from the failure of a globally active bank. As such this allowed for an assessment of the banks that are systemically important in a global context.

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The unit of analysis was naturally set at the globally consolidated level of a banking group (paragraph 89 of the G-SIB rules text states that “(t)he assessment of the systemic importance of G-SIBs is made using data that relate to the consolidated group”). 17. Correspondingly, a process for assessing systemic importance in a domestic context should focus on addressing the externalities that a bank’s failure generates at a domestic level. Thus, the Committee is of the view that the appropriate reference system should be the domestic economy, ie that banks would be assessed by the national authorities for their systemic importance to that specific jurisdiction. The outcome would be an assessment of banks active in the domestic economy in terms of their systemic importance. 18. In terms of the unit of analysis, the Committee is of the view that home authorities should consider banks from a (globally) consolidated perspective. This is because the activities of a bank outside the home jurisdiction can, when the bank fails, have potential significant spillovers to the domestic (home) economy. Jurisdictions that are home to banking groups that engage in cross-border activity could be impacted by the failure of the whole banking group and not just the part of the group that undertakes domestic activity in the home economy. This is particularly important given the possibility that the home government may have to fund/resolve the foreign operations in the absence of relevant cross-border agreements. This is in line with the concept of the G-SIB framework. 19. When it comes to the host authorities, the Committee is of the view that they should assess foreign subsidiaries in their jurisdictions, also

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consolidated to include any of their own downstream subsidiaries, some of which may be in other jurisdictions. For example, for a cross-border financial group headquartered in country X, the authorities in country Y would only consider subsidiaries of the group in country Y plus the downstream subsidiaries, some of which may be in country Z, and their impact on the economy Y. Thus, subsidiaries of foreign banking groups would be considered from a local or sub-consolidated basis from the level starting in country Y. The scope should be based on regulatory consolidation as in the case of the G-SIB framework. Therefore, for the purposes of assessing D-SIBs, insurance or other non-banking activities should only be included insofar as they are included in the regulatory consolidation. 20. The assessment of foreign subsidiaries at the local consolidated level also acknowledges the fact that the failure of global banking groups could impose outsized externalities at the local (host) level when these subsidiaries are significant elements in the local (host) banking system. This is important since there exist several jurisdictions that are dominated by foreign subsidiaries of internationally active banking groups.

Principle 5: The impact of a D-SIB’s failure on the domestic economy should, in principle, be assessed having regard to bank-specific factors: (a) Size; (b) Interconnectedness; (c) Substitutability/financial institution infrastructure (including considerations related to the concentrated nature of the banking sector); and (d) Complexity (including the additional complexities from cross-border activity).

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In addition, national authorities can consider other measures/data that would inform these bank-specific indicators within each of the above factors, such as size of the domestic economy.

21. The G-SIB methodology identifies five broad categories of factors that influence global systemic importance: size, cross-jurisdictional activity, interconnectedness, substitutability/financial institution infrastructure and complexity. The indicator-based approach and weighting system in the G-SIB methodology was developed to ensure a consistent international ranking of G-SIBs. The Committee is of the view that this degree of detail is not warranted for D-SIBs, given the focus is on the domestic impact of failure of a bank and the wide ranging differences in each jurisdiction’s financial structure hinder such international comparisons being made. This is one of the reasons why the D-SIB framework has been developed as a principles-based approach. 22. Consistent with this view, it is appropriate to list, at a high level, the broad category of factors (eg size) that jurisdictions should have regard to in assessing the impact of a D-SIB’s failure. Among the five categories in the G-SIB framework, size, interconnectedness, substitutability/financial institution infrastructure and complexity are all relevant for D-SIBs as well. Cross-jurisdictional activity, the remaining category, may not be as directly relevant, since it measures the degree of global (cross-jurisdictional) activity of a bank which is not the focus of the D-SIB framework. 23. In addition, national authorities may choose to also include some country-specific factors. A good example is the size of a bank relative to domestic GDP.

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If the size of a bank is relatively large compared to the domestic GDP, it would make sense for the national authority of the jurisdiction to identify it as a D-SIB whereas a same-sized bank in another jurisdiction, which is smaller relative to the GDP of that jurisdiction, may not be identified as a D-SIB. 24. National authorities should have national discretion as to the appropriate relative weights they place on these factors depending on national circumstances.

Principle 6: National authorities should undertake regular assessments of the systemic importance of the banks in their jurisdictions to ensure that their assessment reflects the current state of the relevant financial systems and that the interval between D-SIB assessments not be significantly longer than the G-SIB assessment frequency.

25. The list of G-SIBs (including their scores) is assessed annually, based on updated data submitted by each participating bank, but measured against a global sample that is largely unchanged for three years. It is expected that the names and buckets of G-SIBs and the data used to produce the scores will be disclosed. 26. The Committee believes it is good practice for national authorities to undertake a regular assessment as to the systemic importance of the banks in their financial systems. The assessment should also be conducted if there are important structural changes to the banking system such as, for example, a merger of major banks. A national authority’s assessment process and methodology will be reviewed by the Committee’s implementation monitoring process. 27. It is also desirable that the interval of the assessments not be significantly longer than that for G-SIBs (ie one year).

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For example, a SIB could be identified as a G-SIB but also a D-SIB in the same jurisdiction or in other host jurisdictions. Alternatively, a G-SIB could drop from the G-SIB list and become/continue to be a D-SIB. In order to keep a consistent approach in these cases, it would be sensible to have a similar frequency of assessments for the two frameworks.

Principle 7: National authorities should publicly disclose information that provides an outline of the methodology employed to assess the systemic importance of banks in their domestic economy.

28. The assessment process used needs to be clearly articulated and made public so as to set up the appropriate incentives for banks to seek to reduce the systemic risk they pose to the reference system. This was the key aspect of the G-SIB framework where the assessment methodology and the disclosure requirements of the Committee and the banks were set out in the G-SIB rules text. By taking these measures, the Committee sought to ensure that banks, regulators and market participants would be able to understand how the actions of banks could affect their systemic importance score and thereby the required magnitude of additional loss absorbency. The Committee believes that transparency of the assessment process for the D-SIB framework is also important, even if it is likely to vary across jurisdictions given differences in frameworks and policy tools used to address the systemic importance of banks.

Higher loss absorbency

Principle 8: National authorities should document the methodologies and considerations used to calibrate the level of HLA that the framework would require for D-SIBs in their jurisdiction. The level of HLA calibrated for D-SIBs should be informed by

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quantitative methodologies (where available) and country-specific factors without prejudice to the use of supervisory judgement.

29. The purpose of an HLA requirement for D-SIBs is to reduce further the probability of failure compared to non-systemic institutions, reflecting the greater impact a D-SIB failure is expected to have on the domestic financial system and economy. 30. The Committee intends to assess the implementation of the framework by the home and host authorities for its degree of cross-jurisdictional consistency, having regard to the differences in national circumstances. In order to increase the consistency in the implementation of the D-SIB framework and to avoid situations where banks similar in terms of the level of domestic systemic importance they pose in the same or different jurisdictions have substantially different D-SIB frameworks applied to them, it is important that there is sufficient documentation provided by home and host authorities for the Committee to conduct an effective implementation review assessment. It is important for the application of a D-SIB HLA, at both the parent and subsidiary level, to be based on a transparent and well articulated assessment framework to ensure the implications of the requirements are well understood by both the home and the host authorities. 31. The level of HLA for D-SIBs should be subject to policy judgement by national authorities. That said, there needs to be some form of analytical framework that would inform policy judgements. This was the case for the policy judgement made by the Committee on the level of the additional loss absorbency requirement for G-SIBs. 32. The policy judgement on the level of HLA requirements should also be guided by country-specific factors which could include the degree of

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concentration in the banking sector or the size of the banking sector relative to GDP. Specifically, countries that have a larger banking sector relative to GDP are more likely to suffer larger direct economic impacts of the failure of a D-SIB than those with smaller banking sectors. While size-to-GDP is easy to calculate, the concentration of the banking sector could also be considered (as a failure in a medium-sized highly concentrated banking sector would likely create more of an impact on the domestic economy than if it were to occur in a larger, more widely dispersed banking sector). 33. The use of these factors in calibrating the HLA requirement would provide justification for different intensities of policy responses across countries for banks that are otherwise similar across the four key bank-specific factors outlined in Principle 5.

Principle 9: The HLA requirement imposed on a bank should be commensurate with the degree of systemic importance, as identified under Principle 5.

34. In the G-SIB framework, G-SIBs are grouped into different categories of systemic importance based on the score produced by the indicator-based measurement approach. Different additional loss absorbency requirements are applied to the different buckets (G-SIB rules text paragraphs 52 and 73). 35. Although the D-SIB framework does not produce scores based on a prescribed methodology as in the case of the G-SIB framework, the Committee is of the view that the HLA requirements for D-SIBs should also be decided based on the degree of domestic systemic importance. This is to provide the appropriate incentives to banks which are subject to the HLA requirements to reduce (or at least not increase) their systemic importance over time. In the case where there are multiple D-SIB buckets

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in a jurisdiction, this could imply differentiated levels of HLA between D-SIB buckets.

Principle 10: National authorities should ensure that the application of the G-SIB and D-SIB frameworks is compatible within their jurisdictions. Home authorities should impose HLA requirements that they calibrate at the parent and/or consolidated level, and host authorities should impose HLA requirements that they calibrate at the sub-consolidated/subsidiary level. The home authority should test that the parent bank is adequately capitalised on a stand-alone basis, including cases in which a D-SIB HLA requirement is applied at the subsidiary level. Home authorities should impose the higher of either the D-SIB or G-SIB HLA requirements in the case where the banking group has been identified as a D-SIB in the home jurisdiction as well as a G-SIB.

36. National authorities, including host authorities, currently have the capacity to set and impose capital requirements they consider appropriate to banks within their jurisdictions. The G-SIB rules text states that host authorities of G-SIB subsidiaries may apply an additional loss absorbency requirement at the individual legal entity or consolidated level within their jurisdiction. The Committee has no intention to change this aspect of the status quo when introducing the D-SIB framework. An imposition of a D-SIB HLA by a host authority is no different (except for additional transparency) from their current capacity to impose a Pillar 1 or 2 capital charge. Therefore, the ability of the host authorities to implement a D-SIB HLA on local subsidiaries does not raise any new home-host issues. 37. National authorities should ensure that banks with the same degree of systemic importance in their jurisdiction, regardless of whether they are domestic banks, subsidiaries of foreign banking groups, or subsidiaries of G-SIBs, are subject to the same HLA requirements, ceteris paribus.

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Banks in a jurisdiction should be subject to a consistent, coherent and non-discriminatory treatment regardless of the ownership. The objective of the host authorities’ power to impose HLA on subsidiaries is to bolster capital to mitigate the potential heightened impact of the subsidiaries’ failure on the domestic economy due to their systemic nature. This should be maintained in cases where a bank might not be (or might be less) systemic at home, but its subsidiary is (more) systemic in the host jurisdiction. 38. An action by the host authorities to impose a D-SIB HLA requirement leads to increases in capital at the subsidiary level which can be viewed as a shift in capital from the parent bank to the subsidiary, unless it already holds an adequate capital buffer in the host jurisdiction or the additional capital raised by the subsidiary is from outside investors. This could, in the case of substantial or large subsidiaries, materially decrease the level of capital protecting the parent bank. Under such cases, it is important that the home authority continues to ensure there are sufficient financial resources at the parent level, for example through a solo capital requirement. Indeed, paragraph 23 of the Basel II rules text states “(f)urther, as one of the principal objectives of supervision is the protection of depositors, it is essential to ensure that capital recognised in capital adequacy measures is readily available for those depositors. Accordingly, supervisors should test that individual banks are adequately capitalised on a stand-alone basis.” 39. Within a jurisdiction, applying the D-SIB framework to both G-SIBs and non-G-SIBs will help ensure a level playing field within the national context.

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For example, in a jurisdiction with two banks that are roughly identical in terms of their assessed systemic nature at the domestic level, but where one is a G-SIB and the other is not, national authorities would have the capacity to apply the same D-SIB HLA requirement to both. In such cases, the home authorities could face a situation where the HLA requirement on the consolidated group will be the higher of those prescribed by the G-SIB and D-SIB frameworks (ie the higher of either the D-SIB or G-SIB requirement). 40. This approach is also consistent with the Committee’s standards, which are minima rather than maxima. It is also consistent with the G-SIB rules text that is explicit in stating that home authorities can impose higher requirements than the G-SIB additional loss absorbency requirement (G-SIB rules text paragraph 74). 41. The Committee is of the view that any form of double-counting should be avoided and that the HLA requirements derived from the G-SIB and D-SIB frameworks should not be additive. This will ensure the overall consistency between the two frameworks and allows the D-SIB framework to take the complementary perspective to the G-SIB framework.

Principle 11: In cases where the subsidiary of a bank is considered to be a D-SIB by a host authority, home and host authorities should make arrangements to coordinate and cooperate on the appropriate HLA requirement, within the constraints imposed by relevant laws in the host jurisdiction.

42. The Committee recognises that there could be some concern that host authorities tend not to have a group-wide perspective when applying HLA requirements to subsidiaries of foreign banking groups in their jurisdiction. The home authorities, on the other hand, clearly need to know D-SIB HLA requirements on significant subsidiaries since there could be

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implications for the allocation of financial resources within the banking group. 43. In these circumstances, it is important that arrangements to coordinate and cooperate on the appropriate HLA requirement between home and host authorities are established and maintained, within the constraints imposed by relevant laws in the host jurisdiction, when formulating HLA requirements. This is particularly important to make it possible for the home authority to test the capital position of a parent on a stand-alone basis as mentioned in paragraph 38 and to prevent a situation where the home authorities are surprised by the action of the host authorities. Home and host authorities should coordinate and cooperate with each other on any plan to impose an HLA requirement on a subsidiary bank, and the amount of the requirement, before taking any action. The host authority should provide a rationale for their decision, and an indication of the steps the bank would need to take to avoid/reduce such a requirement. The home and host authorities should also discuss (i) The resolution regimes (including recovery and resolution plans) in both jurisdictions, (ii) Available resolution strategies and any specific resolution plan in place for the firm, and (iii) The extent to which such arrangements should influence HLA requirements.

Principle 12: The HLA requirement should be met fully by Common Equity Tier 1 (CET1). In addition, national authorities should put in place any additional requirements and other policy measures they consider to be appropriate to address the risks posed by a D-SIB.

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44. The additional loss absorbency requirement for G-SIBs is to be met by CET1, as stated in the G-SIBs rules text (paragraph 87). The Committee considered the use of CET1 to be the simplest and most effective way to increase the going concern loss-absorbing capacity of a bank. HLA requirements for D-SIBs should also be fully met with CET1 to ensure a maximum degree of consistency in terms of effective loss absorbing capacity. This has the benefit of facilitating direct and transparent comparability of the application of requirements across jurisdictions, an element that is considered desirable given the fact that most of these banks will have cross-border operations being in direct competition with each other. In addition, national authorities should put in place any additional requirements and other policy measures they consider to be appropriate to address the risks posed by a D-SIB. 45. National authorities should implement the HLA requirement through an extension of the capital conservation buffer, maintaining the division of the buffer into four bands of equal size (as described in paragraph 147 of the Basel III rules text). This is in line with the treatment of the additional loss absorbency requirement for G-SIBs. The HLA requirement for D-SIBs is essentially a requirement that sits on top of the capital buffers and minimum capital requirement, with a pre-determined set of consequences for banks that do not meet this requirement. 46. In some jurisdictions, it is possible that Pillar 2 may need to adapt to accommodate the existence of the HLA requirements for D-SIBs. Specifically, it would make sense for authorities to ensure that a bank’s Pillar 2 requirements do not require capital to be held twice for issues that

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relate to the externalities associated with distress or failure of D-SIBs if they are captured by the HLA requirement. However, Pillar 2 will normally capture other risks that are not directly related to these externalities of D-SIBs (eg interest rate and concentration risks) and so capital meeting the HLA requirement should not be permitted to be simultaneously used to meet Pillar 2 requirement that relate to these other risks.

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Mario Draghi: Opening statement at Deutscher Bundestag Speech by Mr Mario Draghi, President of the European Central Bank, at the discussion on ECB policies with Members of Parliament, Berlin * * * Dear President Lammert, Honourable Committee Chairs, Honourable Members of the Bundestag, I am deeply honoured to be here today. As President of the European Central Bank (ECB), it is a privilege for me to come to the heart of German democracy to present our policy responses to the challenges facing the euro area economy. I know that central bank actions are often a topic of debate among politicians, the media and the general public in Germany. So I would like to thank President Lammert and all Committee Chairs most warmly for this kind invitation – and the opportunity it gives me to participate in that discussion. It is rare for the ECB President to speak in a national parliament. The ECB is accountable to the European Parliament, where we have scheduled hearings every three months and occasional hearings on topical matters.

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We take these duties of accountability to the citizens of Europe and their elected representatives very seriously. But I am here today not only to explain the ECB’s policies. I am also here to listen. I am here to listen to your views on the ECB, on the euro area economy and on the longer-term vision for Europe. To lay the ground for our discussion, I would like to explain our view of the current situation and the rationale for our recent monetary policy decisions. I will focus in particular on the Outright Monetary Transactions (OMTs) that we formally announced in September.

Financial markets and the disruptions of monetary policy transmission Let me begin with the challenges facing the euro area. We expect the economy to remain weak in the near term, also reflecting the adjustment that many countries are undergoing in order to lay the foundations for sustainable future prosperity. For next year, we expect a very gradual recovery. Euro area unemployment remains deplorably high. In this environment, the ECB has responded by lowering its key interest rates. In normal times, such reductions would be passed on relatively evenly to firms and households across the euro area. But this is not what we have seen. In some countries, the reductions were fully passed on.

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In others, the rates charged on bank loans to the real economy declined only a little, if at all. And in a few countries, some lending rates have actually risen. Why did this divergence happen? Let me explain this in detail because it is so important for understanding our policies. A fundamental concept in central banking is what is known as “monetary policy transmission”. This is the way that changes in a central bank’s main interest rate are passed via the financial system to the real economy. In a well-functioning financial system, there is a stable relationship between changes to central bank rates and the cost of bank loans to firms and households. This allows central banks to influence overall economic conditions and maintain price stability. But the euro area financial system has become increasingly disturbed. There has been a severe fragmentation in the single financial market. Bank funding costs have diverged significantly across countries. The euro area interbank market has been effectively closed to a large number of banks and some countries’ entire banking systems. Interest rates on government bonds in some countries have risen steeply, hurting the funding costs of domestic banks and limiting their access to funding markets. This has been a key factor why banks have passed on interest rates very differently to firms and households across the euro area.

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Interest rates do not have to be identical across the euro area, but it is unacceptable if major differences arise from broken capital markets or the perception of a euro area break-up. The fragmentation of the single financial market has led to a fragmentation of the single monetary policy. And in an economy like the euro area where about three quarters of firms’ financing comes from banks, this has very severe consequences for the real economy, investment and employment. It meant that countries in economic difficulties could not benefit from our low interest rates and return to health. Instead, they were experiencing a vicious circle. Economic growth was falling. Public finances were deteriorating. Banks and governments were being forced to pay even higher interest rates. And credit and economic growth were falling further, leading to rising unemployment and reduced consumption and investment. A number of economies could have seen risks of deflation. All of this meant that the outlook for the euro area economy as a whole was increasingly fragile. There were potentially negative consequences for Europe’s single market, as access to finance was increasingly influenced by location rather than creditworthiness and the quality of the project. The disruption of the monetary policy transmission is something deeply profound. It threatens the single monetary policy and the ECB’s ability to ensure price stability.

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This was why the ECB decided that action was essential.

Restoring the proper transmission of monetary policy So let me now turn directly to our recent policy announcements. To decide what type of action was appropriate, we had to make two key assessments. First, we had to diagnose precisely why the transmission was disrupted. And second, we had to identify the most effective policy tool to repair those disruptions, while remaining within our mandate to preserve price stability. In our analysis, a main cause of disruptions in the transmission was unfounded fears about the future of the euro area. Some investors had become excessively influenced by imagined scenarios of disaster. They were therefore charging interest rates to countries they perceived to be most vulnerable that went beyond levels warranted by economic fundamentals and justifiable risk premia. Clearly, it was not by chance that some countries found themselves in a more difficult situation than others. It was mainly those countries that had implemented inappropriate economic policies in the past. This is also why the first responsibility in this situation is for countries to make determined reforms and convince markets that they are credible. But many were already doing this, only for interest rates to rise even higher.

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There was an element of fear in markets’ assessments that governments, acting alone, could not remove. Markets were not prepared to wait for the positive effects of reforms to emerge. In our view, to restore the proper transmission of monetary policy, those unfounded fears about the future of the euro area had to be removed. And the only way to do so was to establish a fully credible backstop against disaster scenarios. We designed the OMTs exactly to fulfil this role and restore monetary policy transmission in two key ways. First, it provides for ex ante unlimited interventions in government bond markets, focusing on bonds with a remaining maturity of up to three years. A lot of comments have been made about this commitment. But we have to understand how markets work. Interventions are designed to send a clear signal to investors that their fears about the euro area are baseless. Second, as a pre-requisite for OMTs, countries must have negotiated with the other euro area governments a European Stability Mechanism (ESM) programme with strict and effective conditionality. This ensures that governments continue to correct economic weaknesses while the ECB is active. The involvement of the IMF, with its unparalleled track record in monitoring adjustment programmes would be an additional safeguard.

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The consequences of the ECB’s actions So what are the likely consequences of the ECB’s actions? Before announcing the OMT programme, we considered very carefully the possible risks – and we designed our operations to minimise them. But I am aware that some observers in this country remain concerned about the potential impact of this policy. I would therefore like to use this opportunity to go through those concerns – one by one – and explain our views. First, OMTs will not lead to disguised financing of governments. We have specifically designed our interventions to avoid this. They will take place solely on secondary markets, where bonds that have already been issued are traded. If interventions take place, they will involve buying government debt from investors, not from governments. All this is fully consistent with the Treaty’s prohibition on monetary financing. Moreover, they will focus on shorter maturities and leave room for market discipline. Second, OMTs will not compromise the independence of the ECB. The ECB will continue to take all decisions related to OMTs in full independence. It will decide whether to intervene based on its own assessment of monetary policy transmission and with the aim of safeguarding price stability.

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The fact that governments have to comply with conditionality will actually protect our independence. The ECB will not be forced to step in for a lack of policy implementation. Third, OMTs will not create excessive risks for euro area taxpayers. Such risks would only materialise if a country were to run unsound policies. This is explicitly prevented by the ESM programme. And we have been very clear that each time a programme starts being reviewed, we will routinely suspend operations and resume them only if the review has been concluded positively. This will ensure that the ECB intervenes only in countries where the economy and public finances are on a sustainable path. Fourth, OMTs will not lead to inflation. We have designed our operations so that their effect on monetary conditions will be neutral. For every euro we inject, we will withdraw a euro. In our assessment, the greater risk to price stability is currently falling prices in some euro area countries. In this sense, OMTs are not in contradiction to our mandate: in fact, they are essential for ensuring we can continue to achieve it. Moreover, we see no signs that our announcement has affected inflation expectations. They continue to be firmly anchored.

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This is testament to our track record on price stability over the last decade and our credible commitment to maintaining price stability. The citizens of the euro area can be confident that we will remain permanently alert to risks to price stability. We have all the necessary tools at our disposal to maintain it and to withdraw any excess liquidity in case of upward risks to price stability.

Conclusion Let me conclude these opening remarks. Three elements are essential for understanding the policies of the ECB: immutable focus on price stability; acting within our mandate; and being fully independent. The ECB’s new measures help to ensure price stability across the euro area. They also contribute to improving the economic environment. But completing that task of economic renewal demands continuing action by the governments of the euro area. It is governments that must set right their public finances. It is governments that must reform their economies. And it is governments that must work together effectively to establish an institutional architecture for the euro area that best serves its citizens. We are already moving in the right direction. Across the euro area, deficits are being cut. Competitiveness is being improved. Imbalances are closing.

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And governments are working seriously to complete economic and monetary union. It is important that Europe’s leaders stay on course. In doing so, they will be able to unlock fully the enormous potential of the euro to improve living standards and carry forward the project of European integration. Thank you for your attention – and I look forward to our discussion.

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Andreas Dombret: As goes Ireland, so goes Europe?

Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, at the Institute of International and European Affairs, Dublin, 25 October 2012. * * *

1. Introduction Ladies and Gentlemen, Many thanks for inviting me to speak to you. I am delighted to have the opportunity to be with you here in Dublin today. One of the issues which the Institute of International and European Affairs features on its website is “The Future of Europe”. And, indeed, the future of Europe is at the centre of the current public debate. After nearly ten very successful years, the European Monetary Union has encountered a serious crisis. Over the past few months, we have seen some progress in this regard: a fiscal compact has been agreed, the ESM has come to life, there is preliminary agreement on a European Single Supervisory Mechanism, and – most importantly – more member states of the euro area have embarked on broader economic reforms. But the crisis is still not over, and progress is still too often painfully slow. When talking about the euro, the successes, the setbacks and the way forward, Ireland plays an important role.

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As an open and flexible economy with a highly skilled work force, Ireland has seized the opportunities presented by global and especially by European economic integration. When Ireland joined the EU in 1973, it was one of the poorer member states. Since then, your real per capita income has increased more than twofold and is today among the highest in the euro area. Ireland has benefited from several factors: low barriers in terms of language and culture vis à vis the US and the UK have certainly helped, but Ireland also has done a lot to raise its growth potential by improving the skills of its labour force, lowering corporate taxes and maintaining flexible labour and product markets. As a result, you attracted a lot of Foreign Direct Investment and became a remarkably open economy. As we all know, this remarkable success story has suffered a number of setbacks. In the light of the crisis, some economic developments have proved unsustainable. The Irish real estate boom – as so many others – provided a temporary boost at the time, but raised private debt to worrying levels – to 215 % of GDP in 2007 – and diverted capital away from potentially more productive uses. Exploding unit labour costs have eroded the competitiveness of the Irish economy, undermining the very core of its growth model so far. But even though the last few years have been challenging, many signs point to a silver lining.

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There has been significant progress in reforms with the results to show for it: on-track deficit reduction, falling unit labour costs, a positive current account and last but not least a return to positive growth. To sum it up: I am very much confident with regard to the Irish case. And I am more and more convinced that we are witnessing a resurgence that is instructive for the euro area as a whole. The problems experienced by Ireland are by no means confined to the “Green Island”, but are typical of what went wrong in the run-up to the crisis. Thus, the reforms undertaken in Ireland hold valuable lessons for the wider monetary union. But what exactly did go wrong at the onset of EMU?

2. The origins of the crisis For many euro-area member states, the introduction of the euro ushered in a new era of abundant capital. In the case of Ireland, for instance, capital inflows amounted to about two trillion euro between 1999 and 2008. In principle, this is exactly what standard economic reasoning predicts: capital was flowing from capital-rich to capital-poor economies, where returns should be higher. Such flows complemented limited domestic saving in capital-poor countries and reduced their cost of capital, boosting investment and growth. As we all know, it did not always work that way. Overblown financial sectors channeled the capital flows into unproductive investments.

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Ireland is certainly a case in point as light-touch regulation and tax incentives encouraged the financial sector to balloon. Overinvestment in real estate as well as in public and private consumption failed to boost productivity. Unit labour costs soared, competitiveness declined, and rigid labour and product markets meant that this process gained additional momentum. When the financial crisis broke out in 2007, the vulnerabilities became apparent in Ireland. Growth imploded, deficits – which were often already too high before the crisis – exploded, and cracks in the Irish banking system started to show. As an aside, you may recall that these cracks extended right into Germany, where Irish subsidiaries or special investment vehicles got their German parent companies into trouble. Not surprisingly, investor sentiment began to shift, and also interest rates in your country started to rise sharply, triggering a major crisis that is still far from being resolved. How could it all go so wrong? Key to understanding the crisis is the euro area’s unique institutional set-up, a set-up that easily leads to simple, but faulty analogies with other economies. As you are well aware the euro area pairs a common monetary policy with 17 national fiscal policies. Firstly, this combination gives rise to a deficit bias, as it allows costs to be shifted partially on to others. If a worsening fiscal position in one country has repercussions for our monetary union as a whole, others may step in and bail out.

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And, secondly, central banks’ balance sheets can serve as a conduit for shifting risks among national taxpayers, even if there are no explicit fiscal transfers. The founding fathers of the euro foresaw this risk. Precautions were taken in the form of the prohibition of monetary financing of government deficits, price stability as the primary objective, the no-bail-out clause and the Stability and Growth Pact that was to give teeth to the rules on sound public finances enshrined in the Maastricht Treaty. However, the fiscal rules were breached numerous times, not least by Germany and France. In addition, investors made hardly any distinction between the bonds of individual member states – I leave it to you to decide whether this was because they neglected the growing differences in the economic fundamentals or because they never really believed that the no-bail-out clause would hold once the going got tough. While the provisions against unstable fiscal positions proved to be insufficient, the institutional framework took no account of other macroeconomic imbalances. Risks stemming from divergences in competitiveness or exaggerations in national real estate sectors were not considered in the design of the European Monetary Union. Hence, even countries that had impressive fiscal data before the crisis ran into deep trouble once the enormous implicit liabilities in their banking sectors became apparent. Ireland, unfortunately, was one of those countries. Assessing the Irish economy in 2007 the IMF – which I quote for convenience, not to blame it – wrote: “Fiscal policy has been prudent,

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with a medium-term fiscal objective of close to balance or surplus, in line with Fund advice. In the past couple [of] years, windfall property-related revenues were saved and the fiscal stance was not procyclical, in line with Fund advice”. However, once the risks in the financial sector materialised and the government had to step in, Irelands fiscal position deteriorated very quickly.

3. The way forward To overcome the current crisis, and to prevent future crises, we have to address these problems I have just described. And this has to happen both nationally and at the European level. So far, a number of steps have been taken. At the beginning of my speech I mentioned the ESM, to which I might add the fiscal compact and the new excessive imbalance procedure that has been established to prevent macroeconomic developments from diverging too much in the future. Nevertheless, the painful task of correcting past mistakes lies mainly with the member states. In this context I wish to point to Ireland as a good example of what has to be done and what can be achieved. In this regard I view Ireland as a “role model of the periphery”. I have already mentioned the decline in competitiveness that occurred prior to the crisis. In this respect Ireland certainly had a steep mountain to climb.

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In 2008, Irish unit labour costs, as an indicator of competitiveness, were more than 40% higher than at the launch of EMU. Still, not least thanks to flexible labour markets, the necessary adjustment has been swifter in Ireland than in other member states. There was a similar experience with the bubble in the Irish real estate market. Your problems became apparent earlier than in other member states, with property prices starting to fall in the last quarter of 2007. Hence, Ireland responded earlier than other countries, and in a determined manner, to a shock which, as of today, has cut property prices in half. As a result, the restructuring of the banking sector is more advanced and costs for bank loans to firms are now lower than in countries such as Italy or Spain. This highlights the fact that it is sometimes better to take a big bath rather than just a shower. And it is better to take it as soon as possible because the water typically gets colder as time passes by. But the situation in your country also highlights something else: the dangerous link between banks and sovereigns. Looking to the future, this link has to be broken, or at least to be weakened considerably, to prevent history from repeating itself. Let me first step back and take a look at why the close link between banks and sovereigns has proven to be so problematic and so dangerous in this crisis. If many banks run into trouble at the same time, possibly on account of a large asset bubble bursting, financial stability as a whole is threatened.

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The government then often has no option but to step in if it wants to prevent a meltdown of the real economy. But such a rescue can place a huge burden on government finances – and no country knows that better than Ireland, where support for the financial sector was a major factor why the debt ratio soared from 25% of GDP in 2007 to 108% in 2011. Conversely, weak government finances can destabilise banks – directly through their exposure to sovereign bonds, and, indirectly, through worsening macroeconomic conditions. That is what we are also witnessing at this very moment. Thus, breaking the link between banks and sovereigns is vital for making the euro area more stable. A banking union can very well be a major step in that direction – but by harnessing the disciplinary forces of the market, not by doing away with them. Core elements of a banking union therefore have to be: First, a comprehensive bail-in of bank creditors, and second, an appropriate risk-weighting of sovereign bonds. In order to minimise the risk that bank rescues pose to government finances, creditors have to be the first in line when it comes to bearing banks’ losses. Implicit guarantees have to be removed as taxpayers’ money can only be the last resort. By the same token, sovereign bonds need to be risk-weighted appropriately when it comes to the adequacy of capital buffers. Riskier bonds have to become more expensive in terms of the amount of equity that they tie down, as is already the case for non-sovereign bonds.

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This serves two purposes: On the one hand, surcharges of this kind should translate into lower demand and, hence, into larger spreads, which gives a disciplining signal to the respective sovereign. And, on the other hand, banks would become more resilient in the event of market turmoil. Adequate risk-weighting of sovereign bonds helps to prevent fiscal difficulties from translating directly into financial instability. If fiscal autonomy remains with national member states, which is still the status quo in the EU Treaties, this is crucial. Banks have to internalise the fiscal position of sovereigns in a similar manner as they take into account the risk of corporate bonds or loans. Otherwise, the envisaged recapitalisation of banks via European funds could turn out to be a backdoor for mutualising sovereign solvency risks. I therefore believe that these two regulatory reforms – a comprehensive bail-in of creditors as well as an adequate risk-weighting of sovereign bonds – need to complement the envisaged European supervisory mechanism. In principle, this single European supervisor can help prevent future crises by enforcing the same high standards irrespective of the banks’ country of origin and by taking transnational interdependencies into account. At the moment, it looks as though this task shall be carried out by the European Central Bank. This is, first of all, an expression of confidence in the competence of central banks in general and in the ECB in particular. But conducting monetary policy and financial supervision does not come without risks.

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If the institution responsible for ensuring the financial soundness of banks simultaneously influences banks’ financing conditions via its monetary policy, conflicts of interest may arise. Besides, the resolution of banks implies intervening in property rights, which requires democratic accountability. If the ECB is to be tasked with supervising European banks, there will have to be a strict separation of monetary policy and supervision. Such a separation will be difficult from both a legal and an organisational point of view. In this respect, there still are questions that need to be resolved. A banking union will contribute to financial stability, if its design preserves sound incentives for all actors involved. This holds true not only for future risks, but also for risks that have already materialised. Economically speaking, a banking union is basically an insurance mechanism. And, as with any insurance, only future losses or damages that are unknown ex ante can be covered. No doubt, the banking union is an important building block for a more stable monetary union. But, as such, it is meant to mitigate future risks and not to cover past sins. In this context, I fully understand that Ireland is closely following the conditions under which euro-area member states will provide financial assistance to Spain for the recapitalisation of its financial institutions. One specific point is the degree of bondholders’ participation in the

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Spanish restructuring process. The Eurogroup stated in July with respect to Ireland: “Similar cases will be treated equally, taking into account changed circumstances.” However, as this issue is currently under discussion I prefer abstaining from public comments. Instead I like to share my view with you on the issue of legacy assets in general. Legacy assets are those risks which evolved under the responsibility of national supervisors. From what I have already said, it follows that these assets have to be dealt with by the respective member states. Anything else would amount to a fiscal transfer. It may be that such fiscal transfers are desired or even deemed necessary. But then, they should be conducted via national budgets and subject to approval of national parliaments, rather than under the guise of a banking union, which would then have to start under a heavy burden. And, in the event of such transfers the proper sequencing of events is the key. We should not end up in a world where risks from bank balance sheets are rapidly mutualised, while an effective single supervisory mechanism would be slow in coming. A banking union will therefore not be a quick fix. But it can be an important milestone towards a more stable and prosper monetary union and hence instrumental in regaining confidence in the euro area.

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Ireland has already come a long way in this regard, as your successful return to the capital markets in July has shown. Trust has been regained because Ireland has walked the talk. And I am sure you agree: Any deviation from this climb when the mountaintop is already in sight would be both short-sighted and costly. More precisely, when listening to the discussion on more leniency for Greece, I can understand that demanding similar adjustments to the Irish programme seem tempting at first glance. But as we have learned the hard way over the last years, trust is as easily lost as it is hard to regain. Ireland has made enormous progress in the process of regaining trust and confidence. Important financial market indicators are an expression of this fact. CDS premia for the Irish sovereign have fallen continuously in 2012. In the meantime Irish CDS premia are below those of Spain and even Italy. The same development can be observed for the spread over German bunds. All of these developments are the result of “leading by example” with structural reforms. Hence, I see no reason for Irish CDS changing the course, and I doubt that this would truly be in Ireland’s best interest. I suggest not to jeopardise what has been achieved so far.

4. Conclusion Ladies and gentlemen,

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When we talk about Europe, Ireland is such an interesting example for a number of reasons. First, it highlights the benefits of a unified Europe which still leaves its member states enough room to establish their own model of success – Ireland has certainly seized that opportunity. But the Irish experience at the same time also illustrates some of the things that have gone wrong in Europe over the past decade, and I have mentioned many of them in my speech. Nevertheless, and even more importantly, the Irish experience holds valuable lessons on how to overcome the current crisis. Of course, Ireland has not yet overcome all of its problems – every country is different and challenges are never exactly the same. But I believe we all can learn a great deal from the Irish way of handling the crisis: As goes Ireland, so goes Europe. Let me conclude my speech with the single most important and most encouraging lesson we can draw from the Irish experience: “Yes, it can be done”. Thank you for your attention.

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CIMA Hosts Risk Management and Internal Controls Seminar The Cayman Islands Monetary Authority (CIMA) hosts a seminar on Risk Management and Internal Controls. The event, which is scheduled for 29 October to 2 November at the Grand Cayman Marriott Beach Resort, is sponsored by the Association of Supervisors of Banks of the Americas (ASBA) and the Caribbean Group of Banking Supervisors (CGBS) and facilitated by the Federal Reserve of the United States. Intended for examiners with more than six months of field experience who have participated in examinations of banks, this seminar is designed to provide examiners with an understanding of the importance of internal controls and risk management in banks, and how the review of internal controls and risk management fits into the overall bank rating assessment. The seminar is also intended to give examiners guidance on assessing the risk management and internal control environment in key functions such as credit administration and investments, including trading operations, deposits, and payments systems risk. Notable speakers and presenters include Sarkis Yoghourtdjian and Rosanne Farley from the Federal Reserve Bank of New York and Yareny Valdes from the Federal Reserve Bank of Atlanta. Commenting on CIMA’s role in this event, Head of the Banking Division, Mrs. Reina Ebanks said, “The Cayman Islands Monetary Authority is delighted to host the Risk Management and Internal Controls Seminar.

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Our staff are our greatest resource and our investment in their training and development goes a long way in facilitating a safe and sound financial services industry”. Established in 1999, the Association of Supervisors of Banks of the Americas (ASBA) is a non-profit, civil association formed to develop programs for cooperation between different bank supervisory and regulatory organisations. The main activities of ASBA are to promote and maintain close communications between bank supervisory and regulation institutions in the Americas aimed at facilitating cooperation among them for efficient performance of their functions. ASBA also provides a high-level forum for the discussion and exchange of ideas, technology, techniques, experiences and know-how on the matter of its Associate Members’ competence. The Caribbean Group of Banking Supervisors (CGBS) was established in 1983 under the aegis of the CARICOM Central Bank Governors, with the specific mandate to enhance and coordinate the harmonization of bank supervisory practices in the English speaking Caribbean and bring them in line with internationally accepted practices. The CGBS was later expanded to include non-CARICOM territories and has been formally accepted as a regional grouping under the Basel Committee for Banking Supervision. The CGBS membership presently comprises banking supervisors from sixteen regional jurisdictions, including CARICOM and non-CARICOM countries.

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Goldman Sachs Group Interesting numbers before the Basel III deadlines The Goldman Sachs Group, Inc. (NYSE: GS) reported net revenues of $8.35 billion and net earnings of $1.51 billion for the third quarter ended September 30, 2012. Diluted earnings per common share were $2.85 compared with a diluted loss per common share of $0.84 for the third quarter of 2011 and diluted earnings per common share of $1.78 for the second quarter of 2012. Annualized return on average common shareholders’ equity (ROE) was 8.6% for the third quarter of 2012 and 8.8% for the first nine months of 2012. The firm’s global core excess liquidity was $170 billion as of September 30, 2012. In addition, the firm’s Tier 1 capital ratio under Basel 1 was 15.0% and the firm’s Tier 1 common ratio under Basel 1 was 13.1% as of September 30, 2012.

Capital As of September 30, 2012, total capital was $241.57 billion, consisting of $73.69 billion in total shareholders’ equity (common shareholders’ equity of $68.34 billion and preferred stock of $5.35 billion) and $167.88 billion in unsecured long-term borrowings. Book value per common share was $140.58 and tangible book value per common share was $129.69, both approximately 3% higher compared with the end of the second quarter of 2012.

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Book value and tangible book value per common share are based on common shares outstanding, including restricted stock units granted to employees with no future service requirements, of 486.1 million at period end. On September 4, 2012, The Goldman Sachs Group, Inc. (Group Inc.) issued 5,000 shares of Perpetual Non-Cumulative Preferred Stock, Series F (Series F Preferred Stock), for aggregate proceeds of $500 million. During the quarter, the firm repurchased 11.8 million shares of its common stock at an average cost per share of $106.17, for a total cost of $1.25 billion. The remaining share authorization under the firm’s existing repurchase program is 34.2 million shares. Under the regulatory capital guidelines currently applicable to bank holding companies (Basel 1), the firm’s Tier 1 capital ratio was 15.0% and the firm’s Tier 1 common ratio was 13.1% as of September 30, 2012, both unchanged compared with June 30, 2012.

Other Balance Sheet and Liquidity Metrics

The firm’s global core excess liquidity was $170 billion as of September

30, 2012 and averaged $175 billion for the third quarter of 2012, compared with an average of $174 billion for the second quarter of 2012.

Total assets were $949 billion as of September 30, 2012, unchanged compared with June 30, 2012.

Level 3 assets were $48 billion as of September 30, 2012, compared with $47 billion as of June 30, 2012 and represented 5.0% of total assets.

Basel 3 In addition, the U.S. federal bank regulatory agencies issued revised proposals to modify their market risk regulatory capital requirements for

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banking organizations in the United States that have significant trading activities. The modifications are designed to address the adjustments to the market risk framework that were announced by the Basel Committee in June 2010 (Basel 2.5), as well as the prohibition on the use of credit ratings, as required by the Dodd-Frank Act. We expect the federal banking agencies to propose further modifications to their capital adequacy regulations to address both Basel 3 and other aspects of the Dodd-Frank Act, including requirements for global systemically important banks. Once implemented, it is likely that these changes will result in increased capital requirements, although their full impact will not be known until the U.S. federal bank regulatory agencies publish their final rules. The Dodd-Frank Act also establishes a Bureau of Consumer Financial Protection having broad authority to regulate providers of credit, payment and other consumer financial products and services, and this Bureau has oversight over certain of our products and services.

Management’s Discussion and Analysis We are currently working to implement the requirements set out in the Federal Reserve Board’s Risk-Based Capital Standards: Advanced Capital Adequacy Framework — Basel 2, as applicable to us as a bank holding company (Basel 2), which are based on the advanced approaches under the Revised Framework for the International Convergence of Capital Measurement and Capital Standards issued by the Basel Committee. U.S. banking regulators have incorporated the Basel 2 framework into the existing risk-based capital requirements by requiring that internationally active banking organizations, such as us, adopt Basel 2, once approved to do so by regulators. As required by the Dodd-Frank Act, U.S. banking regulators have adopted a rule that requires large banking organizations, upon adoption

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of Basel 2, to continue to calculate risk-based capital ratios under both Basel 1 and Basel 2. For each of the Tier 1 and Total capital ratios, the lower of the Basel 1 and Basel 2 ratios calculated will be used to determine whether the bank meets its minimum risk-based capital requirements. The U.S. federal bank regulatory agencies have issued revised proposals to modify their market risk regulatory capital requirements for banking organizations in the United States that have significant trading activities. These modifications are designed to address the adjustments to Basel 2.5, as well as the prohibition on the use of credit ratings, as required by the Dodd-Frank Act. Once implemented, it is likely that these changes will result in increased capital requirements for market risk. Additionally, the guidelines issued by the Basel Committee in December 2010 (Basel 3) revise the definition of Tier 1 capital, introduce Tier 1 common equity as a regulatory metric, set new minimum capital ratios (including a new “capital conservation buffer,” which must be composed exclusively of Tier 1 common equity and will be in addition to the minimum capital ratios), introduce a Tier 1 leverage ratio within international guidelines for the first time, and make substantial revisions to the computation of RWAs for credit exposures. Implementation of the new requirements is expected to take place over the next several years. Although the U.S. federal banking agencies have now issued proposed rules that are intended to implement certain aspects of the Basel 2.5 guidelines, they have not yet addressed all aspects of those guidelines or the Basel 3 changes. The Basel Committee has published its final provisions for assessing the global systemic importance of banking institutions and the range of

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additional Tier 1 common equity that should be maintained by banking institutions deemed to be globally systemically important. The additional capital for these institutions would initially range from 1%to 2.5% of Tier 1 common equity and could be as much as 3.5% for a bank that increases its systemic footprint (e.g., by increasing total assets). The firm was one of 29 institutions identified by the Financial Stability Board (established at the direction of the leaders of the Group of 20) as globally systemically important under the Basel Committee’s methodology. Therefore, depending upon the manner and timing of the U.S. banking regulators’ implementation of the Basel Committee’s methodology, we expect that the minimum Tier 1 common ratio requirement applicable to us will include this additional capital assessment. The final determination of whether an institution is classified as globally systemically important and the calculation of the required additional capital amount is expected to be disclosed by the Basel Committee no later than November 2014 based on data through the end of 2013. The Dodd-Frank Act will subject us at a firmwide level to the same leverage and risk-based capital requirements that apply to depository institutions and directs banking regulators to impose additional capital requirements as disclosed above. The Federal Reserve Board is expected to adopt the new leverage and risk-based capital regulations in 2012. As a consequence of these changes, Tier 1 capital treatment for our junior subordinated debt issued to trusts will be phased out over a three-year period beginning on January 1, 2013. The interaction among the Dodd-Frank Act, the Basel Committee’s proposed changes and other proposed or announced changes from other governmental entities and regulators adds further uncertainty to our future capital requirements.

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Internal Capital Adequacy Assessment Process We perform an ICAAP with the objective of ensuring that the firm is appropriately capitalized relative to the risks in our business. As part of our ICAAP, we perform an internal risk-based capital assessment. This assessment incorporates market risk, credit risk and operational risk. Market risk is calculated by using Value-at-Risk (VaR) calculations supplemented by risk-based add-ons which include risks related to rare events (tail risks). Credit risk utilizes assumptions about our counterparties’ probability of default, the size of our losses in the event of a default and the maturity of our counterparties’ contractual obligations to us. Operational risk is calculated based on scenarios incorporating multiple types of operational failures. Backtesting is used to gauge the effectiveness of models at capturing and measuring relevant risks. We evaluate capital adequacy based on the result of our internal risk-based capital assessment, supplemented with the results of stress tests which measure the firm’s performance under various market conditions. Our goal is to hold sufficient capital, under our internal risk-based capital framework, to ensure we remain adequately capitalized after experiencing a severe stress event. Our assessment of capital adequacy is viewed in tandem with our assessment of liquidity adequacy and integrated into the overall risk management structure, governance and policy framework of the firm.

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We attribute capital usage to each of our businesses based upon our internal risk-based capital and regulatory frameworks and manage the levels of usage based upon the balance sheet and risk limits established.

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Bermuda’s Insurance Solvency Framework The Roadmap to Regulatory Equivalence Planned 2012/2013 Developments • Full implementation of the groups rules for Class 4 and Class 3B groups, including group solvency and financial reporting requirements, effective 1st January 2013 • Continued phased implementation of Bermuda Solvency Capital Requirement (BSCR - standard capital model) for the Long-Term sector, i.e. Class E insurers, and also refined BSCR for small commercial insurers, i.e. Class 3A, for year-end 2011 filings • Extending the optional use of approved internal capital models to Long-Term insurers; preparation for group ICM reviews for the Long-Term sector • Revised eligible capital rules effective 1st January 2013 • Complete (Long-Term Prudential Standard Rules), effective 1st January 2013 for Class C and Class D insurers • Review of Commercial Insurers Solvency Self-Assessment submissions in 2012 for year-end 2011 filings from Class 4, 3B, 3A and Class E firms • Introduction of the Quarterly Financial Return for Class 4 and Class 3B insurers, which will comprise unaudited financial statements, intra-group transactions and risk concentrations and will be filed in May, August and November 2012

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Completed Framework Developments • Substantially completed the policy and legislative infrastructure for group supervision, which included issuing the Insurance (Group Supervision) Rules 2011 as well as the Insurance (Prudential Standards) (Insurance Groups Solvency Requirement) Rules 2011.

Also identified over 20 insurance groups for which the BMA will be the Group-Wide Supervisor (GWS)

• Completed pilots and pre-application procedures with selected insurers for the internal capital models (ICM) evaluation process

• Established the Commercial Insurers’ Solvency Self-Assessment (CISSA) requirement, our Bermuda-specific ORSA (Own Risk and Solvency Assessment)

• Advanced work to establish an Economic Balance Sheet policy and framework

• Developed a refined Bermuda Solvency Capital Requirement standard capital adequacy model as a core element of our enhanced supervisory framework for the Long-Term (life) insurance sector

• Implemented evaluations of an enhanced Schedule of Risk Management and new Catastrophe Return submissions by insurers as part of solvency assessments

• Extended our disclosure and transparency requirements to Class 3A and Class E Long-Term insurers by requiring submission of GAAP financial statements that the Authority will make publicly available.

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Mervyn King: Monetary policy developments Speech by Mr Mervyn King, Governor of the Bank of England, to the South Wales Chamber of Commerce, Cardiff * * * Of the many memorable moments in an eventful summer, recall that balmy night in late July when attention was diverted from the economy by the Opening Ceremony of the Olympic Games. The sound of Welsh children singing Cwm Rhondda on that beautiful beach in Rhossili filled the Olympic stadium. Inside the stadium, we saw not manna descending from heaven, but thousands of athletes and volunteers rising to their challenge. If the Olympics aimed to inspire a generation, the challenge for economic policymakers is to give that same generation the opportunities to make the best possible use of their talents in a vibrant economy. After a period of lopsided expansion, with growing trade deficits and debt levels, and a collapse of their banking systems, advanced economies across the world are facing a huge adjustment. Such is the scale of the global adjustment required that the generation we hope to inspire may live under its shadow for a long time to come. During the course of this year, the challenge has grown as the economic sky has darkened. The storm clouds coming from the Euro area have not yet lifted, and in other parts of the sky new clouds have drifted over.

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China, India and Brazil, the three largest emerging market economies, are all slowing. According to the latest IMF projections output will fall this year in no fewer than 10 European economies. And the IMF recently lowered its forecast for growth in the advanced economies next year. Ours may be a sceptred isle, with its own currency and control of monetary policy, but we cannot insulate ourselves from these events. So this precious stone set in the silver sea seems more like a storm-tossed vessel. Despite the probable rise in output in the third quarter, the big picture is that GDP is barely higher than two years ago, and remains some 15% below where steady growth since 2007 would have taken us. Total exports have risen sharply in the wake of sterling’s depreciation, but manufactured exports to Europe are falling. Recovery and rebalancing of our economy remain the main challenges for economic policy. Here in Wales, despite impressive improvements to the infrastructure – not least the remarkable regeneration of Cardiff Bay and the magnificent monument to Welsh culture in this Millennium Centre – your economy too is suffering with total production well below its peak in 2007. In combating the downturn, monetary policy has played its part. Bank Rate has been cut to its lowest level ever and the Bank has purchased £375 billion of assets in order to inject money into the economy.

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Although this unprecedented degree of monetary loosening has prevented a depression, it has caused pain to those dependent on interest income. And we have not been able to avoid a sharp rise in youth unemployment. In the long run, we will need to rebalance our economy away from domestic spending and towards exports, to reduce our trade deficit, to repay our debts, and to raise the rate of national saving and investment. So you are probably puzzled by the fact that we seem to be doing exactly the opposite of that today. Almost four years ago now, I called this the “paradox of policy” – policy measures that are desirable in the short term appear diametrically opposite to those needed in the long term. Although we cannot avoid the long-term adjustment to our economy, we can try to slow the pace of the adjustment in order to limit the immediate damage to output and employment. Loose monetary policy today will eventually give way to a tighter stance of policy as the economy recovers. In confronting the paradox of policy, the Bank has had to show some of the same fleetness of foot and ability to feint as my Cambridge contemporary, Gerald Davies. So let me try to explain this evening what monetary policy can do and what it can’t. In doing this I am not going to pretend that I shall be entertaining. But these are serious times and you deserve a serious explanation of what we at the Bank can do and what we can’t, or shouldn’t. Let me start with what monetary policy can do.

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When banks extend loans to their customers, they create money by crediting their customers’ accounts. The usual role of a central bank is to limit this rate of money creation, so that an excessive expansion of money spending does not lead to inflation. But a damaged banking system means that today banks aren’t creating enough money. We have to do it for them. And as private sector balance sheets contract, public sector (government and central bank) balance sheets have to take the strain. The way in which the Bank of England expands the money supply is to purchase government gilts from the non-bank private sector and credit the bank accounts of people from whom the gilts are purchased. Please note that we are not giving money away. What is the effect of these purchases? They push up the price of gilts thus lowering yields. As the sellers of gilts use the proceeds to buy other assets, the price of those assets also tends to rise. Increases in asset prices boost wealth, and at the same time reduce the cost of borrowing for companies and households, which helps to stimulate spending and hence output. The size of these effects is of course uncertain. But there can be no doubt that our economy would have followed an even more painful path over the past few years in the absence of asset purchases. Some question the scope for further purchases, or their likely effectiveness.

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I do not have any concerns on the first point. The quantity of gilts in private hands is higher now than when we began our asset purchases, and the government continues to issue new gilts at a rapid rate. As far as the effectiveness of gilt purchases is concerned, it is of course true that as gilt yields have declined the room for further falls is reduced. But it is not the sole objective of asset purchases to push down on government bond yields. Raising the price and reducing the risk premium on a much wider class of assets is equally important. Although monetary policy can play a crucial role in supporting the economy in these difficult times, there are limits to its ability to stimulate private sector spending. Those limits are inherent in any form of monetary easing, not only asset purchases. Two limits are important. First, monetary policy supports demand and output by encouraging households and businesses to switch demand from tomorrow to today. But when tomorrow becomes today, an even larger stimulus is required to bring forward more spending from the future. Since the paradox of policy has been evident for almost four years, tomorrow has become not just today but yesterday. When the factors leading to a downturn are long – lasting, only continual injections of stimulus will suffice to sustain the level of real activity. Obviously, this cannot continue indefinitely.

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Policy can only smooth, not prevent, the ultimate adjustment. At some point the paradox of policy must be resolved. Second, the scale of the underlying adjustment is large, and monetary policy cannot put off for long the necessary change in the pattern of demand and output. A downward correction of expectations about future incomes and wealth has rendered unprofitable some of the investments made before the crisis. A good example is the investment made in shopping centres which is now either proving less valuable than anticipated, or making redundant some of the other pre-existing stock of retail space. Almost 1,000 high street chain stores closed in the first half of the year. Lower asset values have left debt levels looking too high.Households, businesses and, especially, banks are all deleveraging. Nowhere is the overhang of debt more obvious than in the banking sector where deleveraging is holding back the flow of new lending. During the crisis central banks have provided liquidity to banks on a truly extraordinary scale, so much so that there were no takers for additional liquidity in our latest auction. It is still useful to keep that auction facility as an insurance policy. But banks are now overflowing with liquid assets. Their problem remains insufficient capital. Just as in 2008, there is a deep reluctance to admit the extent of the undercapitalisation of the banking system in many parts of the industrialised world. The verdict of the market is clear – without central bank support banks still find it expensive to borrow.

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So the Bank of England, together with the Government, has set up the Funding for Lending Scheme (FLS) which provides banks with access to finance for up to four years at below prevailing market rates for term funding. Crucially, the more banks lend to UK households and businesses, the more they can borrow from the Scheme and the cheaper is that funding. That provides a powerful financial incentive for banks to supply more credit. More than 20 banking groups, including the five largest lenders to the UK real economy and covering nearly 80% of all such lending, have so far signed up. Since the Scheme was announced bank funding costs have fallen by around 100 basis points (see Chart 1).

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Not all of this is attributable to the FLS – the announcement by the ECB of Outright Monetary Transactions has also played an important role. But it is noteworthy that UK bank funding costs have fallen by more since June than have European bank funding costs (see Chart 2).

The effect of the FLS will be seen in the lending data only after some months because of the time it takes for banks to change their lending strategies and for data to be collected and published. The FLS can be only a temporary scheme. The window of opportunity which it provides must be used to restore the capital position of the UK banking system. I am not sure that advanced economies in general will find it easy to get out of their current predicament without creditors acknowledging further likely losses, a significant writing down of asset values and recapitalisation of their financial systems.

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Only then will it be possible to return to a more normal provision of the vital banking services so crucial to an economic recovery. In the 1930s, faced with problems of sovereign and other debt similar to those of today, the pretence that debts could be repaid was maintained for far too long. We must not repeat that mistake. Over the past three years, the Bank of England has bought £375 billion of government bonds – gilts – from the private sector to create a lot of new money. Many – perhaps some of you – are understandably concerned about the use of such an unusual and unfamiliar policy. Some people talk about the dangers of money creation. I want to explain why it is important to distinguish between “good” and “bad” money creation. In essence, the argument is very simple. “Good” money creation is where an independent central bank creates enough money in the economy to achieve price stability. “Bad” money creation is where the government chooses the amount of money that is created in order to finance its expenditure. Insufficient money creation can lead to a contraction of the money supply and a depression. We saw that in the United States during the Great Depression and we see it today in Greece. Excessive money creation leads to accelerating inflation and ultimately the collapse of the currency.

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The role of the Bank of England is to create the right amount of money, neither too much, nor too little, to support sustainable growth at the target rate of inflation. We are not doing it at the behest of the Government to help finance its spending. It is the independence of the Bank that allows us to create money without raising doubts about our motives. But just as it is crucial that governments do not control the printing of money, so too the unelected central bank must not determine the levels of taxes and public spending. Fiscal policy is a matter for elected governments. There has been some talk about the possibility that money created by the Bank could be used directly to finance additional government spending, or even that money could be given away. Abstracting from the colourful metaphor of “helicopter money”, such operations would combine monetary and fiscal policies. There is no need to combine them because, as now, once the Bank has decided how much money should be created to meet the inflation target, the case for the Government to increase spending or cut taxes to counter a downturn stands or falls on its own merits. What determines the interest rate at which the government can borrow, however, is the path for the amount of government debt held by the private sector, rather than the total amount of gilts in issue. That is true when the Bank purchases gilts and will be true later when the Bank comes to sell the gilts. Not only is combining monetary and fiscal policies unnecessary, it is also dangerous.

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Either the government controls the process – which is “bad” money creation – or the Bank controls it and enters the forbidden territory of fiscal policy. It is peculiar, to say the least, that some of the same people who believe that the Governor of the Bank is too powerful also believe that he should stand on the steps of Threadneedle Street distributing £50 notes – a policy which you will appreciate is rather hard to reverse. For the same reason, the Bank could not countenance any suggestion that we cancel our holdings of gilts. The Bank must have the ability to reverse its policy – to sell gilts and withdraw money from the economy – when that becomes necessary. Otherwise, we run the risk of losing control over monetary conditions. Giving money either to the government or to households directly, or indeed cancelling our holding of gilts, means that the Bank of England has no assets to sell when the time comes to tighten monetary policy. And when Bank Rate eventually starts to return to a more normal level, as one day it will, the Bank would then have no income, in the form of coupon payments on gilts, to cover the payments of interest on reserves at the Bank of England that we had created. The Bank would become insolvent unless it created even more money to finance those interest payments, and that would lead ultimately to uncontrolled inflation. That is a road down which the Bank will not go, and does not need to go. I suspect that the advocates of “helicopter money” and related ideas are really talking about a relaxation of fiscal policy. It would be better to be open about that. Enough of what the Bank of England should not be doing.

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So what should we be doing? Since the Monetary Policy Committee last published an assessment of the economic outlook, other central banks have been active. The European Central Bank announced its plans for Outright Monetary Transactions, the Bank of Japan expanded the scale of its asset purchases, and the Federal Reserve committed to continue with its asset purchases until the outlook for the labour market improves substantially. Our current programme of asset purchases will be complete by next month. What happens after that will depend upon the outlook, beginning with an appraisal of where we are today. Judging the present state of the UK economy is far from easy. On the one hand, over the past two years total output, or GDP, has been much weaker than expected. In fact, output has been broadly flat over that period. And the zig-zag pattern of quarterly growth rates of GDP that we have seen this year is likely to continue, as we may see on Thursday when figures for the third quarter are released. On the other hand, there are other more encouraging signs. First, the labour market gives a very different picture to that conveyed by the output data. In the private sector, more new jobs have been created than over any other two-year period since the mid-1990s. And in the past year, unemployment has been falling, and falling faster in Wales than in the United Kingdom as a whole.

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Second, inflation has now fallen back to 2.2%, close to our 2% target. Although recent increases in domestic energy and food prices are likely to leave it a little above target well into next year, the fall in inflation means that the squeeze on real take home pay, which accounted for much of the weakness in consumer spending over the past two years, has eased somewhat. And retail sales figures are consistent with a pickup in consumer spending. The disparity between weak output growth and a buoyant labour market is not easy to explain. It is not the product of a switch from full-time to part-time jobs because total hours worked have risen at the same rate as employment. Productivity per head is 4% below its level of five years ago. No-one really understands why. Perhaps the output data are understating the true picture. Perhaps the black cloud of uncertainty moving towards us from the euro area means that businesses are choosing to meet demand by expanding employment, which can if necessary be adjusted downwards relatively easily, rather than investing in new capital equipment which cannot. Perhaps flexible wages have encouraged employers to hold on to labour. Or perhaps forbearance by banks has allowed inefficient firms that might otherwise have had to contract to continue with more labour than can be employed in the long run. One thing we can see clearly is that the recovery and rebalancing of the UK economy are proceeding at a slow and uncertain pace. At this stage, it is difficult to know whether some of the recent more positive signs will persist.

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The Monetary Policy Committee will think long and hard before it decides whether or not to make further asset purchases. But should those signs fade, the MPC does stand ready to inject more money into the economy. Printing money is not, however, simply manna from heaven. There are no shortcuts to the necessary adjustment in our economy. The problems in the world economy mean that we shall have to be patient. Over the past twenty years, during regular visits to Wales, I have seen several waves of restructuring of the Welsh economy. And the rebalancing of the UK, towards manufacturing, offers opportunities for Wales. As for the MPC, you can be sure we shall be looking for as much guidance as we can find, divine or otherwise. What better inspiration than the memory of those children on Rhossili beach singing Cwm Rhondda.

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Erkki Liikanen: On the structural reforms of banking after the crisis Speech by Mr Erkki Liikanen, Governor of the Bank of Finland and Chairman of the Highlevel Expert Group on reforming the structure of the EU banking sector, at the Centre for European Policy Studies, Brussels * * *

Changes in banking in the run-up to the crisis The new landscape In the years preceding the global financial crisis that started in 2007, the landscape of banking had gone through major changes. Global financial institutions had grown ever bigger in size and scope and their organizational complexity had increased, adding to their opacity. They had become strongly interconnected via increasingly long chains of claims as well as correlated risk exposures, arising from increasingly similar investment strategies. Their leverage had strongly increased and the average maturity of their own funding had shortened.

Driving forces Behind these trends were forces that intensified competition in banking; technological development and deregulation. Advances in information technology as well as in investment theory and practice meant that commercial banks faced increasing competition both on their liability side and asset side.

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New savings alternatives to bank deposits, such as money market mutual funds, proliferated and new opportunities for borrowing, in addition to bank loans, emerged. In fact, an entire shadow banking sector developed, comprising a chain of non-bank institutions which were able to provide similar financial intermediary services as traditional banks. In this environment, deregulation was partly a response to this and allowed banks to cope with the increasing pressure from non-bank competitors. In the US, the gradual unwinding and the ultimate repeal of the Glass-Steagall Act in the late 1990s made it possible to reunite investment banking and commercial banking which had been separated since the crisis of the 1930s. In Europe, the universal banking model already had a longer history of combining commercial banking and investment banking under the same roof. However, there was a trend before the crisis, among the biggest European banking institutions, to strengthen their focus on investment banking, including trading operations, and to increase wholesale funding to the point of excess. Part of this trend was driven by the growing demand by non-financial firms for risk management services. With more freedom to choose their business models, banks sought for economies of scale and scope and strived to take advantage of diversification benefits from multiple sources of income. Commercial banking moved increasingly away from customer relationship-based banking where loans are granted and then held until maturity to the “originate and distribute” model where granted loans are pooled, then securitized and sold to investors.

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This shift in the business model increased traditional banks’ connections to the shadow banking sector and they became part of the long intermediation chains characteristic of shadow banking. The increasing influence of investment banking oriented management culture also spurred the focus on short-term profits in commercial banking, reinforced by managerial compensation schemes that were based on short-term performance. Investment banks in turn transformed themselves from partnerships to public corporations. This helped them grow but also provided them with incentives to take risks that partners would not have taken with their own money.

Contributing macroeconomic factors The expansion of banks’ balance sheets in the run-up to the crisis was fuelled by several macroeconomic factors. First, global imbalances especially between the leading emerging economies and the United States developed as globalization continued. Accumulating surpluses in the emerging economies increased their demand for (seemingly) safe assets. Partly as a response to this growing demand, the advanced western financial markets offered financial innovations that increasingly utilized securitization of previously illiquid assets such as (subprime) mortgages. In Europe, imbalances started to develop within the euro area, with many countries experiencing overheating of their property markets. Another important macroeconomic factor was that, in the aftermath of the slower economic growth of the early 2000, the monetary policy stance both in the US and Europe was relatively light.

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Finally, the wide-spread consensus of “the great moderation” fostered expectations of declining macroeconomic risks. This was based on growing evidence that business cycle fluctuations were getting smaller and inflation rates were getting lower and steadier.

Lack of restraints from regulation, supervision and market discipline Problems with capital requirements

The Basel capital requirements on banks proved ineffective in restraining the strong growth in banks’ leverage and balance sheet size. Most importantly, the Basel I and II rules required very little common equity. Much of the eligible capital had poor loss absorbing capacity, which helped trigger the crisis. Secondly, what was important for the global reach of the financial crisis was that much of the asset and mortgage backed securities, originating from the US, ended up on European banks’ balance sheets. This was partly spurred by differences in American and European banks’ capital requirements as the EU moved ahead to implement the Basel II reform in full while the US largely stayed in Basel I and maintained a separate leverage ratio requirement. In effect, capital requirements on perceived low-risk assets, such as mortgage backed securities, were lower in Europe than in the US. The third set of regulatory problems concerned the Basel capital requirements on banks’ trading book positions. The Basel rules allowed banks to lower their capital requirements by securitizing loans from the banking book and taking corresponding risks onto their trading books.

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For instance, banks provided short-term loan commitments, which had very low Basel capital requirements, to off-balance sheet special-purpose investment vehicles (SIVs) which in turn funded mortgage-backed securities. This is an important example of how and why banks were strongly connected with the shadow banking sector. It has been suggested that many of the loan securitizations were motivated by such regulatory arbitrage rather than credit risk transfer which would aim at a better diversification of credit risks among banks and other financial institutions and insurance companies. The role of overly optimistic agency ratings used to market the securitized assets, and used as a basis for capital requirements, should not be dismissed either. Fourth, many risk-weights used in the Basel framework to determine the effective capital requirements were simply too low, as was revealed by the crisis. Lack of market discipline and the too-big-to-fail problem The increasing complexity of structures and products, and the financial sector’s increasing interconnectedness, along with growing size, led to reduced transparency of bank balance sheets. This should logically have rung alarm bells among investors, especially among banks’ uninsured debt holders, at some point. However, the opposite seems to have happened: the markets rewarded size by charging lower debt margins from the biggest institutions. This suggests that there was a perception among market participants that the biggest financial institutions enjoyed an implicit public guarantee. These institutions could not be allowed to fail; in other words, they had become too big to fail.

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In a market environment where the price of a bank’s own debt funding is insensitive to the risks the bank takes and decreases with the bank’s size, the bank has a strong incentive to further increase its leverage by taking on even more debt and continue to grow in size. Another way for banks to benefit from cheap funding is deposits which are explicitly insured and whose interest rates are consequently insensitive to banks’ risk taking. To sum up, neither banks’ debt holders nor depositors had proper incentives to react to banks’ increasing opacity, leverage and risk-taking. Lack of a systemic aspect There was clearly the lack of a sufficient, systemic (macro-prudential) aspect to banking supervision and regulation prior to the crisis. The fundamental problem is that banks themselves do not have an incentive to fully internalize the social cost stemming from their own contribution to system wide risks into their business decisions. In the absence of substitutive regulatory and supervisory measures, systemic risks built up in the form of ever larger, more complex and more leveraged financial institutions. Three main weaknesses ought to be mentioned. First, the Basel minimum capital requirements were based on stand-alone risks of a bank. For instance, the Basel rules entail no direct measure of an asset’s exposure to systemic risk, such as home and real estate loans’ exposure to the business cycle. Second, liquidity risks resulting from short-term money market funding were not part of the Basel minimum capital requirements.

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This was a problem because excessive short-term money market funding increases interconnectedness and thereby systemic risk in the financial system. Moreover, if a rapid growth of lending, for example to a booming property market, can only be financed from the short-term markets, it is often an indication of growing risks on a bank’s asset side. Third, the existing supervisory structures focused on risks facing institutions rather than the financial system as a whole.

Public reaction to the crisis and need to rebuild trust The huge cost of the financial crisis, both in terms of direct public support to banks and lost economic output has sadly fallen to tax payers. This has caused an understandable and justified public outcry. Trust needs to be rebuilt between banks and the general public, and the coordinative role of the regulatory reform is central in this process. But management teams and boards of banks also play a crucial role in rebuilding trust. In order to succeed in this, we must make sure that also in banking not only gains but also losses, incurred from private risk-taking fall on the risk-takers. Our perspective has to be long enough, well beyond the current troubles. But it is also of vital importance to carefully plan the implementation of reforms in order to ensure the continuation of smooth provision of lending and other vital banking services in the current challenging environment.

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Regulatory response to the crisis Summary of problems The problems in banking, revealed by the crisis, can be summarized as follows. There has been excessive risk-taking, excessive leverage, excessive complexity and inadequate capital. An important form of risk-taking has been the growing maturity mismatch between assets and liabilities as funding from the market has increasingly shortened. Excessive real estate lending increased banks’ exposure to macroeconomic and hence systematic risks. All these factors have increased the likelihood of bank failures. Secondly, there have been extensive interconnectedness and very limited possibilities to resolve failed banks, including possibilities to shift the burden to banks’ creditors. Both these factors increase the impact of bank failures or, alternatively, the cost to tax payers. Interconnectedness also increases the risk of bank failure because it increases banks’ opacity which can lead to the loss of investors’ trust thereby making banks more prone to runs. Thirdly, there have been competitive distortions via explicit and implicit subsidies, which reduce both internal market efficiency and the level playing field. For instance, the availability of insured deposits to fund other, more risky, banking activities has skewed incentives and competition. Banks’ incentives to sound long-run risk management have also weakened.

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National measures to implement regulatory reforms and the lack (until recently) of sufficient EU wide frameworks in supervision and resolution are a concern to the well functioning of the internal market in the area of banking. Common rules and institutions would also facilitate the much needed undoing of the bank-sovereign loop.

What has already been done? In response to the crisis, international and EU wide regulatory reforms have been focused on two crucial areas, capital adequacy and liquidity requirements (Basel III) and recovery and resolution (e.g. the Commission’s proposal). If effective, the new and still evolving capital adequacy requirements of Basel III can go a long way to reducing incentives to take excessive risks and the use of excessive leverage. Most obviously, Basel III addresses the issue of inadequate capital. Basel III liquidity requirements can also reduce banks’ interconnectedness by restricting the use of short-term market funding. They will also be helpful in reducing excessive leverage and building liquidity buffers. Basel III also reduces complexity and interconnectedness by blocking opportunities for regulatory arbitrage which under Basel II was possible via complex securitisation structures. Recovery and resolution regimes for systemically important financial institutions aim at creating a framework which did not exist at EU level prior to the crisis. If successful, such plans can greatly reduce the social costs of bank failures and reduce the need for the implicit public guarantees.

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This means that recovery and resolution plans can reduce the distortive risk-taking incentives created by public bail out expectations. Moreover, a number of initiatives have been launched with the aim of reducing contagion and complexity in the financial market. In order to improve transparency, accounting standards are in the process of being reviewed. Banks are urged to improve risk management and corporate governance practices and new macro-prudential tools will be given to international and national authorities to better tackle asset price bubbles and procyclicality in lending.

Proposals of the High-level Expert Group The High-level Expert Group on reforming the structure of the EU banking sector has presented a structural proposal to be implemented at the EU level. In the process of reaching the final outcome, the Group considered two avenues as a possible way forward. In the first avenue, additional, non-risk-weighted capital requirements on trading activities and banks’ credible recovery and resolution plans, subject to supervisory approval, were the main instruments. Such measures would be in line with the ideas of academic researchers who have suggested that a review of capital requirements is the best way to tackle risks in trading and who have emphasized the need to develop bank resolution and recovery mechanisms. However, if the bank were not able to prove that its required recovery and resolution plan was credible, separation of certain banking activities could be imposed. In the second avenue, separation of retail and investment banking would be imposed.

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Separation would be consistent with research which emphasizes that capital requirements are not sufficient to limit excessive risk-taking incentives induced by deposit insurance if risks are difficult to measure and risk profiles can be changed rapidly. Sufficiently wide separation of investment banking activities would also avoid definitional problems which arise, for example, when the dividing line is pursued between proprietary trading and market making. Eventually, the Group converged to the following five proposals to be implemented at the EU level.

1. Proposal for mandatory separation The Group proposes a mandatory separation of certain trading related activities according to the following three principles. First, if the share of proprietary trading, market making and certain other securities-related businesses in the balance sheet exceeds a given threshold, banking groups must organize these businesses to a separate legal entity (“trading entity”). Second, the trading entity must be separately capitalized and must not be funded by insured deposits. And third, the deposit-taking part of the banking group (“deposit bank”) is not allowed under any circumstances to support the trading entity either directly or indirectly by making transfers or commitments to the extent that its capital adequacy including capital buffer requirements would be endangered or that the general limits on large exposures would be violated. The threshold above which separation is required must be low enough so that the volume of activities below the threshold can be considered insignificant from the viewpoint of financial stability. The other businesses that must be separated are loans, loan commitments, or unsecured credit exposures to hedge funds (including

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prime brokerage), SIVs and other such entities of comparable nature. Private equity investments must also be separated. The client-driven trading positions against which the bank has hedged itself do not have to be separated. Also, securities underwriting does not have to be separated but it is important that risks in long-term positions possibly arising from underwriting are carefully monitored by supervisors. All other banking businesses are allowed to the deposit bank unless firm-specific recovery and resolution plans require otherwise. Only the deposit bank is allowed to provide retail payment services. The trading entity can engage in all banking activities which are not specifically mandated to the deposit bank. For instance, the trading entity is allowed to make loans and loan commitments to its customers. The rationale for separation as a regulatory measure can be summarized in the following four points. First, separation is a way of prohibiting banks with insured deposits from engaging in activities whose risks are potentially high and difficult to measure precisely, and which are not essential to deposit banking. Second, separation of activities is the most direct instrument for tackling banks’ complexity and interconnectedness. As banks become simpler in structure, recovery and resolution will be easier. Third, simpler structures can make it easier for the management and board to understand and manage and for outsiders to monitor and supervise banking institutions.

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This can enhance the effectiveness of market discipline and financial supervision. Fourth, separating deposit banking and trading entities can also reduce the mixing of the two different management cultures. The separation of activities is complementary to, rather than a substitute for, other areas of bank regulations. The disadvantage of separating banking activities may be that the benefits of scale and scope and diversification of revenue streams are reduced. However, evidence on the economies of scale and scope in banking as well as the benefits from diversification seems to be mixed. Most importantly, when separation is allowed to be carried out within the banking group, thebanks’ ability to efficiently provide a wide range of financial services to their customers is maintained.

2. Additional separation conditional on the recovery and resolution plan A credible recovery and resolution plan implies that the bank stakeholders bear the costs of a possible bank failure and that there is no significant harm to the real economy, even in a crisis situation when many banks are in trouble at the same time. This would imply that no tax payer money is under threat of being used in a bail out. Therefore it is essential to strive for good recovery and resolution plans. A solid plan will also enhance the bank’s own risk management and potentially increase transparency of the bank to outsiders.

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The European Commission’s plan that banks need to draw up and maintain effective and realistic recovery and resolution plans (RRP) is of utmost importance. Banks should be able to demonstrate the ability to isolate retail banking activities from trading activities and to wind down significant trading risk positions in a crisis situation, in a manner that does not jeopardize the bank’s financial health nor does significantly contribute to systemic risk. A credible recovery and resolution plan is a challenging goal to achieve, so the criteria on passing the credibility “test” must be set high. The European Banking Authority (EBA) plays a central role as a standard setter in ensuring that the RRPs and their supervisory assessments are applied uniformly across the Member States. The Group suggests that if a bank’s recovery and resolution plan, assessed by the supervisor, is not acceptable, a more comprehensive separation of activities can be required than under the proposed mandatory separation. For example, a wider separation might have to cover all trading related assets.

3. Facilitating the use of bail-in instruments The Group strongly promotes the proposal to use bail-in instruments to further increase the loss absorbing capability of banks. In order to limit interconnectedness within the banking system, it is preferable that the bail-in instruments should not be held by investors within the banking sector. In order to create a liquid market for the bail-in instruments, it would be essential to carefully define their contractual properties in order to reduce uncertainty and ambiguity and hence facilitate their efficient market pricing.

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Therefore the Group is of the opinion that the bail-in instruments should be applied only to particular debt instruments and to make sure that investors know the eventual treatment of the respective instruments in a crisis situation.

4. A review of capital requirements on trading assets and real estate related instruments The measurement of risks inherent in trading assets is prone to a significant “model risk”; the risk that the model itself, used in the risk measurement is inaccurate. The severity of model risk stems largely from the presence of “tail risks” in trading assets. These are risks which cause catastrophic losses but which materialize with a very low probability. Moreover, tail risks are intertwined with severe liquidity shortages which materialize in systemic crises. Hence, almost by definition, tail risks are difficult to model and measure. Separation of the riskiest trading activities from deposit banking is a key to limiting the impact of these risks. Other measures available are robust capital requirements which do not heavily rely on models, and limits on risk concentrations and counterparty exposures. In this respect, the Group acknowledges the important work in reviewing the trading book capital requirements conducted by the Basel Committee on Banking Supervision. The Group recommends that the Commission should carry out an evaluation of whether the resultant amendments, in terms of robust capital requirements and limits on risk concentrations and counterparty exposures, would be sufficient at the EU level.

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The Group recommends that the Commission should also evaluate the sufficiency of the current capital requirements on real estate related lending which has been the major source of losses in many financial crises, including the most recent one.

5. Need to reinforce corporate governance reforms Finally, the Group strongly promotes the strengthening of corporate governance and control of banks. In particular the Group considers that it is necessary to augment existing corporate governance reforms by specific measures to 1) strengthen boards and management; 2) promote the risk management function; 3) rein in compensation for bank management and staff; 4) improve risk disclosure and 5) strengthen sanctioning powers.

Comparison with other proposals An important objective of the mandatory separation, proposed by the Group, is simplicity and unambiguity. These facilitate implementation at the EU level. Furthermore, banking activities which naturally belong together should be conducted within the same legal entity. To promote these aims the proposed mandatory separation includes both proprietary trading and market making as differentiating these from one another would be challenging and, if placed in different legal entities within the same banking group, some natural synergies might be lost.

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In this respect, the proposal makes deposit banks somewhat narrower than the definition under the Volcker Rule in the United States. However, an important difference is that the proposed mandatory separation in the EU can take place within a banking group whereas the Volcker Rule prohibits proprietary trading from the entire banking group. Further, all corporate loans are allowed in deposit banks because differentiating among loans according to the customer size would be equally challenging at the EU level and important scale economies in corporate lending might be lost. This suggests that, as regards corporate lending, deposit banks would be somewhat broader than under the UK’s Independent Commission on Banking (ICB) proposal.

Conclusions Remaining concerns Many observers have noted that major systemic risks can remain in the various parts of the banking system, even if these are separated from one another. This is a valid concern even though separation by definition reduces interconnectedness as a key source of systemic risk. The possibility to further review capital requirements and limits on risk concentrations and counterparty exposures in trading activities, as discussed in the other recommendations, are the means to further containing systemic risks. It is also important that the development of capital surcharges for systemically important institutions as well as macro-prudential tools such as caps on loan to value ratios (LTVs) is continued. An obvious danger lies in the possibility that structural measures, together with higher capital and liquidity requirements, may drive an increasing part of banking to the shadow banking sector.

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If this implies that market expectations of implicit public guarantees shift to the less regulated shadow banking sector, then the fundamental problem has not been solved. This is a matter that needs further consideration and needs to be constantly monitored. Proactive measures may need to be taken.

The role of banks in financing the European economy Banks play an important role in the society. Banks have a pivotal role in providing finance to households and firms. It is particularly so in Europe where the banks’ role in corporate finance has traditionally been large. The banks’ role in corporate finance is central especially for small and medium sized enterprises (SMEs). The continuous and smooth supply of banking services to SMEs is also essential to large corporations because SMEs are often subcontractors to them. It is of utmost importance that regulatory reforms as a whole support and strengthen the banking sector’s ability to continue to provide these socially vital financial services efficiently and in a stable manner. The reputation of banks and the public trust that they rely on has been severely dented during the latest financial crisis. This has hurt not only banks themselves but also the economies and societies of Europe and the whole Western world. Trust and public acceptance must now be restored, and the proposals which the High-level Expert Group has submitted for the consideration of the EU Commission will contribute to this end.

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Achieving this important aim will benefit the banking industry and our societies at large.

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Progress note on the Global LEI Initiative This is the third of a series of notes on the implementation of the legal entity identifier (LEI) initiative. Following endorsement of the FSB report and recommendations by the G-20, the FSB LEI Implementation Group (IG) has been tasked with taking forward the planning and development work to launch the global LEI system by March 2013. The IG is collaborating closely with private sector experts through a Private Sector Preparatory Group (PSPG) of some 300 members from 25 jurisdictions across the globe.

Charter for the Regulatory Oversight Committee (ROC):

The IG has prepared a draft Charter for the Regulatory Oversight Committee for review and endorsement by the FSB and G20. The draft was supported by the FSB at its recent meeting in Tokyo for submission to the early November G20 Finance Ministers and Central Bank Governors meeting for final endorsement. Approval of the Charter will initiate the process for the ROC to be formed. ROC membership will be open to public authorities from across the globe that assent to the Charter. Authorities will also be able to apply for Observer status. The objective is to launch the ROC as the permanent governance body for the global LEI system in January 2013.

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Location and legal form of the global LEI foundation: Formation of the ROC is a necessary step for the creation of the global LEI foundation which is the legal form for the Central Operating Unit. The location and exact legal form of the global LEI foundation will have a bearing on the overall governance framework for the Global LEI System. The IG and PSPG have analysed potential locations for the foundation and have now initiated a detailed assessment of a narrow set of potential candidates. The results of the assessment will facilitate the drafting of the necessary legal documentation to establish the foundation and will be presented at the first meeting of the ROC.

Board of Directors of the LEI foundation:

One of the first tasks for the ROC will be the appointment of the initial Board of Directors. PSPG members are working closely with the IG to develop criteria for fitness, experience, regional and sectoral balance, term of office etcetera that will support the process for nomination and selection of the first Board and deliver a governance framework for the global LEI foundation to help sustain the public good nature of the system. The PSPG presented a number of initial recommendations and options related to these criteria for the Board of Directors on 16 October; the proposals are currently being reviewed by the IG and the final version of the recommendations will be presented at the first meeting of the ROC.

Operational Solutions Demonstration Day:

The FSB hosted a Global LEI System Operational Solution Demonstration Day in Basel on 15 October.

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Thirteen presentations from across the globe were made that contained proposals and solutions covering all or part of the proposed global LEI system as set out in the FSB report.

Business Processes and Use Cases:

PSPG members presented an initial set of deliverables containing business processes and use cases for the operational elements of the global LEI system at the joint PSPG and IG meeting on 16 October. PSPG members have already undertaken detailed work in some areas and will expand on a strong base. The next phase of the operational work is to build on these specification documents, focusing on how the system can best address a number of key issues in relation to areas such as data quality, addressing local languages, as well as how to draw most effectively on local infrastructure to deliver a truly global federated LEI system. The PSPG are requested to prepare clear proposals and recommendations by the end of the year, in order to support a successful and speedy launch of the global LEI system.

Number allocation scheme for the global LEI system: On 12 September, the IG requested an ‘engineering study’ from PSPG experts to determine which scheme for the management of the issue of identifiers best serves the purposes of the global LEI system. Following receipt of response and discussion with private sector experts at the 16 October PSPG meeting, the IG prepared a recommendation for the technical specification of the LEI code structure which has been endorsed by the FSB Plenary. Annex sets out the FSB decision to adopt a ‘structured’ approach to the number allocation scheme, whereby LOUs are assigned a unique prefix.

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The FSB decision is provided now to deliver clarity and certainty to the private sector on the approach to be taken by potential pre-LEI systems that will facilitate the integration of such local precursor solutions into the global LEI system.

Ownership and hierarchy data: Addition of information on ownership and corporate hierarchies is essential to support effective risk aggregation, which is a key objective for the global LEI system. The IG is developing proposals for additional reference data on the direct and ultimate parent(s) of legal entities and on relationship (including ownership) data more generally and will prepare initial recommendations by the end of 2012. The IG is working closely with the PSPG to develop the proposals.

Annex: Number Allocation Scheme for the Global LEI System - implications for local pre-LEI Issuers and other early movers

In response to requests for early clarity and guidance on the determination of the number allocation scheme for the management of identifiers for the Global LEI System, the FSB Implementation Group requested an ‘engineering study’ from the FSB LEI Private Sector Preparatory Group (PSPG) experts to explore the advantages and disadvantages of different schemes. The FSB is very grateful for all of the responses and for the contributions of members of the PSPG. While there are a range of different schemes to manage the issue of identifiers that fit the characteristics of the 20 digit code (including two check digits) approach outlined in the ISO 17442 standard, for simplicity those schemes can be categorised into two general groups: - An unstructured numbering system – one where an 18 character

unique identifier fills the whole numbering spectrum;

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- A structured numbering system – one where subsets of the spectrum

of possible codes are partitioned for efficient allocation according to a structural guideline; for instance, an N digit prefix could be assigned to each Local Operating Unit (LOU) for its exclusive use.

On the basis of the arguments presented, the FSB has concluded that a structured number offers the best approach for the Global LEI System. The following method is to be used: - Characters 1-4: A four character prefix allocated uniquely to each

LOU. - Characters 5-6: Two reserved characters set to zero.

- Characters 7-18: Entity-specific part of the code generated and

assigned by LOUs according to transparent, sound and robust allocation policies.

- Characters 19-20: Two check digits as described in the ISO 17442

standard. Public authorities wishing to sponsor local pre-LEI issuance that would transition to the LEI system should ensure that new numbers are allocated according to the above guideline. Pre-LEI solutions wishing to transition into the Global LEI System upon its launch shall be required to adopt the numbering scheme outlined above no later than 30 November 2012. This approach does not affect ISO 17442 compliant numbers issued prior to that date. Once the global LEI system is in place, pre-LEI codes issued according to the ISO 17442 standard (and if issued after November 30, complying with the above guideline and thus embodying an appropriate 4 digit prefix) will be transitioned into LEIs, subject to meeting the agreed

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global LEI standards, including survival rules adopted by the ROC or the COU in the exceptional cases where entities have multiple ISO 17442 compliant pre-LEI identifiers. The LEI will be portable within the global LEI system, implying that the LEI code may be transferred from one LOU to another. Each LOU should immediately transfer an LEI to a different LOU following the request of the LEI registrant or an LOU acting on its behalf without any financial or operational hindrance. Each LOU must consequently have the capability to take over responsibility for LEIs issued by other LOUs. Given the importance to the system of ensuring high data quality, recommendation 18 of the FSB LEI report highlighted that the LEI system should promote the provision of accurate LEI reference data at the local level from LEI registrants, and that self-registration should be encouraged as a best practice for the global LEI system. To provide force to this recommendation, the FSB has agreed that pre-LEI services should henceforth be based on self-registration. From November 9, all pre-LEI systems will allow self-registration only. Authorities sponsoring pre-LEI issuers are expected to sign the ROC Charter once it is approved by the G20.

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

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monday november 5 2012 - top 10 risk management news

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