From a risk and regulation perspective, the biggest regulatory change for the UK financial services industry in 2010 was the imposition of the Financial Services Authority’s (FSA) new liquidity regime. In one move the FSA implemented the vast majority of liquidity policy initiatives that were previously suggested by the Basel Committee on Banking Supervision (BCBS) and others. By outlining such a coherent regime, the FSA ensured that the UK was the first country to manage and identify strict risk requirement metrics for liquidity in a way that is very distinct from the requirements of capital, since the 2008 financial crisis.
This move also had a global effect. Lessons learnt from the UK regime and its implementation clearly had an influence on the detail within the BCBS’s Basel III regime announced earlier in the year. This new framework has the potential to impact many financial business models. The requirement that firms have a global view of their liquidity at all times, and that they are able to stress test for liquidity within the whole firm, will also lead to very significant reappraisals of how information within larger financial organisations is managed.
Another important change has been the switch from the FSA’s principles-based supervisory method to an outcomes-based model with a more intrusive brand of supervision. This is exemplified by the record levels of fines that were levied on firms last year – particularly for systems and controls breaches. But it is not only in this area that the policy has had an effect. Firms are now generally much more mindful of the FSA and their pronouncements than in previous years.
The fact that the governing body now has more accountability, the increased vetting of senior hires and the imposition of a tougher liquidity and capital regime has significantly changed the financial services industry.
Going forward, Basel III will have the biggest impact on financial organisations’ risk management and regulatory compliance. Specifically, concerns over capital buffers, the redefinition of regulatory capital and the introduction of the liquidity regime will all have a significant impact. That is not to say Basel III will be implemented next year, but there is a tendency at present for firms to want to demonstrate that they are ‘Basel III ready’. As a result Basel III projects and announcements will play a major role in shaping 2011.
Many enterprises will have noted the increasing requirement for governing body accountability and for an accurate and responsive reporting infrastructure. They will also have observed the requirement to stress test the business in its entirety – not just the trading book, credit or another silo. As a result, one can expect firms to increasingly consider how to create a holistic infrastructure that combines risk and regulation in a way that satisfies both management and regulators’ needs.
Alongside the detail about risk buffers within Basel III is the concept of reverse stress testing. Currently it is not clear how firms will define the point at which they cease to be a viable business proposition. We can also expect some interesting discussions and the evolving of new risk management practice to tackle the problems reverse stress testing will produce.
In Europe the financial sector will move towards Basel III through the implementation of CRD2 and CRD3, while in the US the Dodd-Frank bill will shape much of 2011.
The issue of firms that are ‘too large to fail’ and the introduction of living wills are likely to dominate much of the policy discussions during next year. As larger enterprises become clearer on what the final regime will look like, they may conclude that there is not enough time for a successful implementation, and will attempt to start to restructure their businesses early.
There was a large focus around the challenges of Solvency II last year. While most of that focus has been on the capital calculation elements of pillar one of Solvency II, we are also seeing many financial firms looking ahead at the governance and enterprise risk management framework requirements around pillar two of Solvency II and starting projects to address it.
Source: FRSGlobal Survey November 2010
In an online poll conducted during an FRSGlobal webinar held in November 2010, over 50% of participants said that data and IT systems are the biggest challenges in the run-up to full Solvency II compliance. Data management and IT systems are essential to achieving compliance. More time and effort therefore needs to be dedicated to these areas in 2011.
There is a clear need for senior management to change their strategy from ensuring good compliance at a ‘budgeted’ cost to a more proactive approach that analyses the strategic implications of Solvency II in order to derive the maximum competitive advantage.
In many ways, 2011 will be a year of consolidation and implementation of the policy initiatives that have been developing since the 2008 crisis.
Senior managers and board members will increasingly understand that the new regulatory environment is much more demanding of them. They will be required to have a consistent and detailed view of the activities of their entire organisation. This development is on top of the FSA’s more intrusive regulatory stance and its insistence on board member approval.
Even though a lot of the policies are coming to the final form, there will still be manoeuvring between regulators, industry and other participants on exactly how they are to be implemented. With costs very much still an issue, the industry is in for an interesting time in 2011.
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