Global Risk Regulator - May 2021
- Archegos fallout raises troubling questions over bank risk controls
- Will climate stress tests boost financial services resilience?
- UK regulators looking to make ‘quick fixes’ to MiFID II
- ESMA calls for more effort to improve EMIR and SFTR data quality
- 'Black swan' event possible if tough Libor legacy contracts not tackled
- US carbon commitments to have big impact on banks
Central banks plot pivot towards net-zero: Central banks have signalled a new phase in tackling climate change by placing a net-zero carbon strategy at the core of their monetary policy and oversight of financial institutions.
'On prudential regulation, they say that supervisors should make net-zero a core element of supervisory practice at both micro and macro levels, aligning supervisory expectations and prudential instruments with net-zero. According to the report: “One way of implementing a net-zero approach through supervisory policy would be to require all regulated financial institutions (banks, insurance firms, pension funds and asset managers) to submit net-zero transition plans… As well as setting out long-term targets, net-zero transition plans from financial institutions would need to include shorter-term outlooks on the positioning of firms over five-year periods, including steps to reduce fossil fuel exposure and increase green assets.” The authors add: “In effect, supervisors would be focusing on the risk of not achieving net-zero and the consequences that this will have for both micro- and macro-financial stability. Ultimately, a net-zero approach would require prudential policy to put a higher risk weight on assets that are not compatible with net-zero for prudential reasons.” Disclosure frameworks, such as the Financial Stability Board’s Task Force on Climate-related Financial Disclosures rules, would need to be revised to incorporate net-zero, while forward-looking scenarios would need to become more consistent with net-zero pathways. “Central banks and supervisors need to signal clearly that they are not indifferent to whether net-zero is achieved or not and complement long-terms scenarios with short-term outlooks,” the report states.'
FRTB implementation continues, but many banks still undecided over IMA: Despite the complications posed by the COVID-19 pandemic, banks are mostly pressing ahead with implementing FRTB. There are open questions over how many will use the internal models approach, however.
'Responding to a UK Treasury consultation about Basel III standards on April 1, the International Swaps and Derivatives Association and the Association for Financial Markets in Europe highlighted numerous concerns. They said FRTB will “materially” increase minimum capital requirements for market making banks in the UK. In particular, they are concerned that FRTB will create greater divergence between liquid and less liquid instruments and amplify the capital requirements for particular asset classes when market liquidity deteriorates. This is a concern, they wrote, despite there being some mitigating factors due to the way UK authorities interpret certain aspects of VAR and Pillar 2 (supervisory review). The two bodies expressed concern over the UK’s timelines and the authorisation process under the SA. They said guidance is needed, with UK reporting on FRTB SA anticipated to start in the first quarter of 2022. They called for the UK to follow some of the alterations the EU announced in February to its interpretation of FRTB, but wrote that where possible the UK should follow the Basel III standards as faithfully as possible for the sake of global consistency. The two associations also highlighted concerns over the SA capital treatment of equity investments in funds as being too punitive, calling for the UK to address the issue pragmatically.'
Eurozone NPLs held in check by ‘paradox of strengthening’: Predictions that euro-area COVID NPL numbers would eclipse 2007-9 global financial crisis levels look premature, but the final figure and the correct policy response are still unclear.
“We would refer to the sensitivity analysis we conducted during early summer 2020 showing that stage three ratios for loans could go up from 4.2% to as high as 7.7%, so it’s not a doubling but it is an increase,” he says. This time banks have strong risk buffers to deal with the impact of COVID-19. The EBA’s latest figures show that CET capital stood at a new all-time high of 15.5%, a 40 basis points increase relative to the previous quarter and significantly higher than the 9% average posted in 2012 at the height of the European sovereign debt crisis. Despite these strong capital levels the ECB is not complacent. In a speech to an industry conference in March, ECB supervisory board member Elizabeth McCaul demanded a systemic response to deal with COVID-related NPLs, including the creation of a European asset management company, or a European network of national asset management companies (AMCs). There are numerous well-known issues with an EU bad bank, including the heterogeneous nature of NPL portfolios, different rules on restructuring, insolvency and collateral enforcement across countries, as well as high-profile resistance to the concept of debt mutualisation from several member states.'
US inter-agency co-operation deepens to provide fintech guidance to banks: US supervisors at federal and state level are looking to work closer together to provide greater clarity to the banking community on fintech issues and the adoption of new innovative technologies.
“A lot of it is about engagement, but also it includes some states partnering with local fintech accelerators,” said Margaret Liu, senior vice president and deputy general counsel at the Conference of State Bank Supervisors (CSBS), which represents state bank supervisors. State regulators oversee 79% of US banks. Ms Liu explains that several state supervisors have created innovation offices or functions, and have named chief innovation individuals dedicated to identifying emerging trends, seeing how they impact banks and interact with the institutions they oversee. She cites the example of the Independent Community Bankers of America (ICBA) ThinkTech Accelerator programme, which supports collaboration between community banks and fintechs. ICBA is an advocacy group representing the interests of US community banks. “We’ve had states do tech sprints around different issues, including regulatory reporting, and finally there is a lot of work in all the states. The CSBS tries to support it and enable innovation and supervision, leveraging data and analytics technology tools to continue to evolve supervision,” says Ms Liu, adding that this work is also being aimed at larger institutions.'
Banks told to beef up operational resilience as threats proliferate: Banks around the world are being called on by the BCBS to beef up their operational resilience in light of the pandemic and other disruptive threats and work is already afoot.
'The BCBS has drawn on work already carried out by jurisdictions that are furthest ahead on developing policy in this area, namely the UK and the EU. The BCBS published its principles shortly after the UK’s policy statements in March which, despite different language in places, share much common ground. Both adopt a principle-based framework aimed at limiting the impact of potential disruptions. For example, the BCBS has followed the approach taken by UK regulators when defining key concepts such as operational resilience, critical operations and tolerance for disruption. Kuangyi Wei, director in the risk and regulatory practice at Accenture, says: “Impact tolerance and scenario analysis – centrepieces of the UK framework – are reinforced in the Basel principles. Particularly with the committee broadening its definition for ‘critical operations’ – the basis for tolerance setting and scenario analysis – to include ‘activities, processes, services and their relevant supporting assets’, the steer for an end-to-end view of vulnerability is clear.” Meanwhile, the BCBS’s Principle 7 – which recommends firms have an ICT policy – is closely aligned to the rules the EU proposes to require financial entities to have an ICT risk management framework in place. Perhaps the biggest change is a shift in the regulatory mindset from focusing on trying to avoid disruptions to accepting they will happen and rising to the challenge, say operational risk experts.'