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International Association of Risk and Compliance Professionals (IARCP)
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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, Do you know what is contagiousness? “We distinguish between contagiousness (the share of total banking assets represented by those banks that a specific bank brings down by contagion) and vulnerability (the number of banks by which a bank is brought down by cascading failures).” “The purpose of this paper is to analyze (hypothetical) contagious bank defaults, i.e. defaults not caused by the fundamental weakness of a given bank but triggered by failures in the banking system.” But this is superb!!! Who wrote that? At number 10 of our list, (Financial Stability Report, Oesterreichische Nationalbank, page 64) Claus Puhr, Reinhardt Seliger and Michael Sigmund, from the Oesterreichische Nationalbank, Financial Markets Analysis and Surveillance Division, at the paper “Contagiousness and Vulnerability in the Austrian Interbank Market” Are you good in mathematics? If the answer is yes, you will enjoy Number 10. I started my career as a mathematician, but it took me 4 hours to read the paper. It is absolutely brilliant.
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I have a long flight tomorrow, and guess what… I have printed it and I will take it with me, to read it again. I know… it looks strange… I told it to one of my friends, an attorney, and he sent me a paper entitled: “The impact of fluctuating workloads on well-being and the mediating role of work−nonwork interference in this relationship.” Oh, no, he believes that my problem is called occupational psychosis … he is wrong … Ok, when I sleep I do dream of SIFIs and regulatory arbitrage opportunities, but it is quite normal I believe. Of course I sometimes experience the oppressive feeling of guilt, the sense of not having lived up to Basel iii framework’s expectations (Basel iii is against regulatory arbitrage), but I cannot resist. After this analysis, I have decided what to read during the flight: The paper “Contagiousness and Vulnerability in the Austrian Interbank Market” Did I tell you that “we distinguish between contagiousness (the share of total banking assets represented by those banks that a specific bank brings down by contagion) and vulnerability (the number of banks by which a bank is brought down by cascading failures).”? Yes, I did, I remember now.

Read more at Number 10 below.
Welcome to the Top 10 list.

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

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Governor Daniel K. Tarullo At the Cornell International Law Journal Symposium: The Changing Politics of Central Banks, New York, New York

International Cooperation in Financial Regulation
Next month marks the fifth anniversary of the failure of Bear Stearns--in retrospect, the beginning of the most acute phase of the financial crisis.

Gabriel Bernardino, Chairman of EIOPA

IMD2 and Solvency II – The road to better policyholder protection and financial stability
Workshop organised by the European Federation of Insurance Intermediaries (BIPAR) Brussels

Submitting a Suspicious Activity Report (SAR) within the Regulated Sector
This is a United Kingdom Financial Intelligence Unit (UKFIU) communications product, produced in line with the Serious Organised Crime Agency's (SOCA) commitment to sharing perspectives on the Suspicious Activity Reports (SARs) Regime.
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This document seeks to provide advice and relay best practice when making a Suspicious Activity Report (SAR), a piece of information that alerts Law Enforcement Agencies (LEAs) that certain client/customer activity is in some way suspicious and might indicate money laundering or terrorist financing.

Financial Stability Board reports to G20 on progress of financial regulatory reforms
The Chairman of the Financial Stability Board (FSB) reported to the G20 Finance Ministers and Central Bank Governors on progress in the financial regulatory reform programme.

Financial regulatory factors affecting the availability of long-term investment finance
Report to G20 Finance Ministers and Central Bank Governors The most important contribution of financial regulatory reforms to LT investment finance is to promote a safer, sounder and therefore more resilient financial system. If implemented in timely and consistent manner, these reforms will help rebuild confidence in the global financial system, which will enhance its ability to intermediate financial flows through the cycle and for different investment horizons.

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Keynote

James R. Doty, Chairman Florida Bar Association 31st Annual Federal Securities Institute, Miami Beach, FL “Today, I would like to talk to you about some of the PCAOB's initiatives to enhance the relevance, credibility and transparency of the audit to promote high quality financial reporting. We meet in the midst of a robust and wide-ranging global debate on how to promote audit quality. Whatever the outcome, it is clear that the audit is indeed a valued, critical feature of the U.S. financial system, and it enjoys an important position in the eyes of people around the world.”

Strategic Goals 2013 to 2016
The Swiss Financial Market Supervisory Authority FINMA is an institution under public law with its own legal personality. It is responsible for implementing the Financial Market Supervision Act and financial market legislation. As an independent supervisory authority, FINMA acts to protect the interests of creditors, investors and insured persons, and to ensure the proper functioning of the financial markets .
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Manuel Sánchez: Mexico’s economic outlook and challenges
Remarks by Mr Manuel Sánchez, Deputy Governor of the Bank of Mexico, at the Conference “Regulatory reform, the global economic outlook, and the implications for Mexico’s financial sector”, organized by the Institute of International Finance and Banorte, Mexico City

“The SEC Speaks in 2013”
Commissioner Daniel M. Gallagher U.S. Securities and Exchange Commission Washington, D.C.

Contagiousness and Vulnerability in the Austrian Interbank Market
Claus Puhr, Reinhardt Seliger, Michael Sigmund, Oesterreichische Nationalbank, Financial Markets Analysis and Surveillance Division The purpose of this paper is to analyze (hypothetical) contagious bank defaults, i.e. defaults not caused by the fundamental weakness of a given bank but triggered by failures in the banking system. As failing banks become unable to honor their commitments on the interbank market, they may cause other banks to default, which may in turn push even more banks over the edge in so-called default cascades.
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Governor Daniel K. Tarullo At the Cornell International Law Journal Symposium: The Changing Politics of Central Banks, New York, New York

International Cooperation in Financial Regulation
Next month marks the fifth anniversary of the failure of Bear Stearns--in retrospect, the beginning of the most acute phase of the financial crisis. The cross-border dimensions of the crisis itself and the global effects of the Great Recession that followed provoked a major effort to strengthen international cooperation in financial regulation. While a good deal has already been accomplished, this evening I will suggest the next steps that would be most useful in advancing global financial stability. Of course, the fashioning of an international agenda requires a clear understanding of the overall regulatory aims of participating national authorities. Here is where international regulatory cooperation links to the subject of this conference--if not quite the changing politics of central banks, then at least their changing policy goals in the wake of the financial crisis.
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Almost by definition, systemic crises reveal failures across the financial system, from breakdowns in risk management at many financial firms to serious deficiencies in government regulation of financial institutions and markets. While the recent crisis was no exception, it has presented particular challenges to the policy foundations of central banks, especially those like the Federal Reserve that carry out regulatory mandates alongside their monetary policy missions. So I begin with some remarks on the nature of those challenges, before turning to a discussion of how changes in approach should inform international cooperation in financial regulation.

Central Banks and the Financial Crisis
In surveying the failings of financial authorities, both here and abroad, one can certainly identify some specific characteristics of pre-crisis regulation that look today to have been significantly misguided, rather than the advances they were formerly thought to be. So, for example, regulators became prone to place too much confidence in the capacity of firms to measure and manage their risks. Indeed, the decade or so prior to the crisis had seen an acceleration of the shift from a dominantly regulatory approach to achieving prudential aims--one that rests on activities and affiliation restrictions, and other reasonably transparent rules--toward greater emphasis on a supervisory approach, which relies on a more opaque, firm-specific process of watching over banks' own risk-management and compliance systems. Yet the breadth and depth of the financial breakdown suggest that it has much deeper roots. In many respects, this crisis was the culmination of fundamental shifts in both the organization and regulation of financial markets that began in the 1970s.
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The New Deal reforms of financial regulation, themselves spawned by a systemic crisis, had separated commercial banking from investment banking, cured the problem of commercial bank runs by providing federal deposit insurance, and brought transparency and investor protections to trading and other capital markets activities. This regulatory approach fostered a commercial banking system that was, for the better part of 40 years, quite stable and reasonably profitable, though not particularly innovative in meeting the needs of depositors and borrowers. In the 1970s, however, turbulent macroeconomic developments combined with technological and business innovations to produce an increasingly tight squeeze on the traditional commercial banking business model. The squeeze came from both the liability side of banks' balance sheets, in the form of more attractive savings vehicles such as money market funds, and from the asset side, with the growth of public capital markets and international competition. The large commercial banking industry that saw both its funding and its customer bases under attack sought removal or relaxation of the regulations that confined bank activities, affiliations, and geographic reach. While supervisors differed with banks on some important particulars, they were sympathetic to this industry request, in part because of the potential threat to the viability of the traditional commercial banking system. The period of relative legal and industry stability that had followed the New Deal thus gave way in the 1970s to a nearly 30-year period during which many prevailing restrictions on banks were relaxed. A good number were loosened through administrative action by the banking agencies, but important statutory measures headed in the same direction.
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This legislative trend culminated in the Gramm-Leach-Bliley Act of 1999, which consolidated and extended the administrative changes that had allowed more extensive affiliations of commercial banks with investment banks, broker-dealers, private equity firms, and other financial entities. But in sweeping away the remnants of one key element of the New Deal regulatory system, neither Gramm-Leach-Bliley nor financial regulators substituted new regulatory mechanisms to match the wholesale changes in the structure of the financial services industry and the dramatic growth of novel financial instruments. In fact, I would generalize this last observation to say that the need to address the consequences of the progressive integration of traditional lending, trading activities, and capital markets lies at the heart of three post-crisis challenges to the policy foundations of the Federal Reserve and, to a greater or lesser degree, many other central banks.

Microprudential Regulation
The first challenge posed by the crisis was to traditional, microprudential regulation, which focuses on the safety and soundness of each prudentially regulated firm. Not all central banks have microprudential regulatory authority, of course, and--as in the United States--those that do sometimes share it with other agencies. But the shortcomings of pre-crisis regulatory regimes have been of concern to all central banks. Most notably, capital requirements for banking organizations, particularly the large ones that might be regarded as too-big-to-fail, simply were not strong enough. Risk-weights were too low for certain traded assets that had proliferated as credit and capital markets integrated more thoroughly.

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In some cases, the arbitrage opportunities presented by existing capital requirements were an incentive for securitization and other capital markets activities. The exposures created by off-balance-sheet activities such as structured investment vehicles (SIVs) were badly underweighted. Minimum capital ratios were not high enough and, in meeting even those inadequate requirements, firms were allowed to count liabilities that did not really provide the ability to absorb losses and still maintain the firms as viable, functioning intermediaries. There has already been a substantial response to this challenge. With the support of the Federal Reserve and other U.S. bank regulators, the Basel Committee on Banking Supervision has strengthened capital requirements by raising risk-weightings for traded assets and improved the quality of loss-absorbing capital through a new minimum common equity ratio. The committee also has created a capital conservation buffer and introduced an international leverage ratio. These Basel 2.5 and Basel III reforms either have been, or soon will be, implemented in the United States and most other countries that are home to internationally active banking firms. Also, the Basel Committee has just recently adopted the Liquidity Coverage Ratio (LCR), a first step in addressing liquidity problems. In the United States, some important additional steps have been taken. Beginning at the peak of the crisis, the Federal Reserve has conducted stress tests of large banking organizations, making capital requirements more forward-looking by estimating the effect of an adverse economic scenario on firm capital levels in a manner less dependent on firms' internal risk-measurement infrastructure.

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And the provision of the Dodd-Frank Act popularly known as the Collins Amendment ensures that banking organizations cannot use models-based approaches to reduce their minimum capital below generally applicable, more standardized risk-based ratios.

Macroprudential Regulation
A second challenge for central banks is that the crisis revealed the need for a much more active set of macroprudential monitoring and regulatory policies--that is, a reorientation toward safeguarding financial stability through the containment of systemic risk. The failure to attend to, or even recognize, financial stability risks was perhaps the most glaring public sector deficiency in the pre-crisis period. This was a fault by no means limited to central banks. On the contrary, systemic risk had also come to seem more theoretical than real to many academics and financial market participants. Even most of those inside and outside the official sector who argued for stronger capital or other prudential standards did not appreciate the degree to which the secondary mortgage market had turned into a house of cards. Still, regardless of formal mandates, central banks are better positioned than most other government agencies to see and evaluate the emergence of asset bubbles, excessive leverage, and other signs of potential systemic vulnerability. In some respects this second challenge is an extension of the first, since the safety and soundness of large institutions must take account of the relative correlation of their asset holdings, interconnectedness, common liquidity constraints, and other characteristics of large banking organizations as a group. Similarly, systemic risks and too-big-to-fail problems can increase if large, highly leveraged firms may operate outside the perimeter of
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statutory microprudential oversight, as was the case prior to 2008 with the large, free-standing investment banks in the United States. And market discipline will be badly compromised if financial market participants believe that an insolvent counterparty cannot be resolved in an orderly fashion and thus is likely to receive government assistance under stress. Here again, domestic and international efforts have already produced significant reform programs, though implementation of some of these programs is less advanced than Basel 2.5 and Basel III. Domestically, the Federal Reserve's annual stress tests examine the effects of unexpected macroeconomic shocks on asset classes held within all major regulated firms. The Dodd-Frank Act gave the Financial Stability Oversight Council (FSOC) authority to bring systemically important firms that are not already bank holding companies within the perimeter of Federal Reserve regulation and supervision. The FSOC is actively considering several firms for possible designation. Finally, the Dodd-Frank Act gave the Federal Deposit Insurance Corporation orderly liquidation authority for systemically important financial firms, thereby creating an alternative to the Hobson's choice of bailout or bankruptcy that authorities faced in 2008. Internationally, the Basel Committee has agreed to a regime of capital surcharges for large banks based on their systemic importance. There is also an initiative to parallel U.S. efforts to identify non-bank systemically important firms. The Basel Committee and the Financial Stability Board have developed international principles for resolution authority, though most of the rest of the world is behind the United States in actually implementing those principles.
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But meeting the macroprudential challenge will require measures beyond a more comprehensive, cross-firm approach to microprudential regulation. Much academic and policy work of the past several years has revived and elaborated the previously somewhat heterodox view that financial instability is endogenous to the financial system, or at least the kind of financial system we now have. Consider, for example, how the intertwining of traditional lending and capital markets gave rise to what has become known as the shadow banking system. Shadow banking, which refers to credit intermediation partly or wholly outside the limits of the traditional banking system, involves not only sizeable commercial and investment banks, but many firms of varying sizes across a range of markets. While some of the more notorious pre-crisis components of the shadow banking system are probably gone forever, current examples include money market funds, the triparty repo market, and securities lending. From the perspective of financial stability, the parts of the shadow banking system of most concern are those that create assets thought to be safe, short-term, and liquid--in effect, cash equivalents. For a variety of reasons, demand for such assets has grown steadily in recent years, and is not likely to reverse direction in the foreseeable future. Yet these are the assets whose funding is most likely to run in periods of stress, as investors realize that their resemblance to cash or insured deposits in normal times has disappeared in the face of uncertainty about their underlying value. And, as was graphically illustrated during the crisis, the resulting forced sales of assets whose values are already under pressure can accelerate an adverse feedback loop, in which all firms with similar assets suffer mark-to-market losses, which, in turn, can lead to more fire sales.
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This kind of contagion lay at the heart of the financial stresses of 2007 and 2008. As already noted, pre-crisis shortcomings at the intersection of microprudential and macroprudential regulation have motivated a variety of reforms, many explicitly directed at the problem of too-big-to-fail institutions. While some of these reforms remain unfinished, and some additional measures are needed, there has been considerable progress. Unfortunately, the same cannot be said with respect to shadow banking and, more generally, the vulnerabilities associated with wholesale short-term funding. These vulnerabilities involve both large, prudentially regulated institutions, and thus too-big-to-fail concerns, and the broader financial system. Except for the liquidity requirements agreed to in the Basel Committee, however, the liability side of the balance sheets of financial firms has barely been addressed in the reform agenda. Yet here is where the systemic problems of interconnectedness and contagion are most apparent. And, as evidenced by the funding stresses experienced by a number of European banks prior to the stabilizing measures taken by the European Central Bank, these problems are still very much with us. Within the United States, reform efforts are underway in some discrete, but important, areas. The provisions of Dodd-Frank requiring more central clearing of derivatives and minimum margins for those that remain uncleared are designed to provide more systemic stability.

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As to shadow banking itself, the FSOC recently proposed options to address the structural vulnerabilities in money market mutual funds, with an eye toward recommending action by the Securities and Exchange Commission. And the Federal Reserve has begun using its supervisory authority to press for a reduction in intraday credit risk in the triparty repo market. But these measures are incomplete, and do not extend to all forms of short-term funding that can pose run risks, a universe that is likely to expand as prudential constraints begin to apply to large existing shadow banking channels.

Monetary Policy
While the first two policy challenges are shared among regulatory and financial agencies, the third lies solely with central banks. In the wake of the crisis, we need to consider carefully the view that central banks should assess the effect of monetary policy on financial stability and, in some instances, adjust their policy decisions to take account of these effects. The dramatic rise in housing prices, and the associated high amounts of leverage taken on by both households and investors, occurred during an extended period of low inflation. Some have suggested that, by not raising rates because inflation remained subdued, monetary policy in the United States and elsewhere may have contributed to the magnitude of the housing bubble. Whatever the merits of that much-contested point, it seems wise to address this issue as we face what could well be another extended period of low inflation and low interest rates. It is important to note that incorporating financial stability considerations into monetary policy decisions need not imply the creation of an additional mandate for monetary policy.
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The potentially huge effect on price stability and employment associated with bouts of serious financial instability gives ample justification. Here I want to mention some comments by my colleague Jeremy Stein a couple of weeks ago. After reviewing the traditional arguments against using monetary policy in response to financial stability concerns and relying instead on supervisory policies, Governor Stein offered several reasons for keeping a more open mind on the subject. First, regulation has its own limits, not the least of which is the opportunity for arbitrage outside the regulated sector. Second, whatever its bluntness, monetary policy has the advantage of being able to "get in all the cracks" of the financial system, an attribute that is especially useful if imbalances are building across the financial sector and not just in a particular area. Finally, by altering the composition of its balance sheet, central banks may have a second policy instrument in addition to changing the targeted interest rate. So, for example, it is possible that a central bank might under some conditions want to use a combination of the two instruments to respond to concurrent concerns about macroeconomic sluggishness and excessive maturity transformation by lowering the target (short-term) interest rate and simultaneously flattening the yield curve through swapping shorter duration assets for longer-term ones. To be clear, I do not think that we are at present confronted with a situation that would warrant these kinds of monetary policy action. But for that very reason, it seems that now is a good time to discuss these issues more actively, so that if and when we do face financial stability concerns associated with asset bubbles backed by excessive leverage, we will have a well-considered view of the role monetary policy might play in mitigating those concerns.
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Advancing the International Reform Agenda
Let me turn now to the way in which our shifts in policy approach should inform the agenda for international cooperation in financial regulation. For obvious reasons, the monetary policy issues are not directly related to this agenda, though our understanding of these issues may profit from discussions with our central bank colleagues from around the world. It is equally obvious that the other two sets of policy changes are quite closely related to the international agenda. More than in most other areas, the financial sphere suffers from a basic lack of congruence between the authority to regulate and the object of regulation. Thus we have a significantly internationalized financial system, in which shocks are quickly transmitted across borders, but a nationally-based structure of regulation. Within countries, responsibilities may be divided between prudential regulators and market regulators, among regulators with similar mandates, or both. Central banks may have exclusive prudential authority, share it with other agencies, or have none at all. International arrangements both reflect, and try to compensate for, this web of divided and overlapping domestic authority. Thus there are sectoral standards setters like the Basel Committee, the International Organization of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors (IAIS) on the one hand, but also broader groupings such as the Group of Twenty, the Financial Stability Board (FSB), and the International Monetary Fund on the other.

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In addition, under the umbrella of the international home of central bankers, the Bank for International Settlements, numerous other committees work across fields also covered by one or more of the groups I have just mentioned. There are some obvious weaknesses with such an assortment of international arrangements, notably the difficulty of coordinating initiatives where more than one group is working on an issue. This kind of coordination challenge can be further complicated by the participation in international discussions of various national officials without domestic authority in a particular area. The sheer proliferation of international arrangements, each with its own staff, has at times also led to a proliferation of studies and initiatives that become burdensome to the national regulators and supervisors who have been overtaxed at home since the onset of the crisis and ensuing domestic reform efforts. Yet there are also some strengths derived from the crowded international field of organizations and committees. One such virtue is that issues not falling squarely within the remit of a particular kind of standards setter can nonetheless be dealt with internationally. This, in fact, has been the experience with the ongoing international effort to agree on minimum margin requirements for derivatives that are not centrally cleared. Another is that different perspectives are frequently brought to bear on a single set of problems. At some point, it likely will be beneficial to rationalize somewhat the overlapping, sometimes competing efforts of these various international arrangements.

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For the near to medium term, though, it is important to have some principles for deciding upon the international agenda that should govern the efforts of these arrangements as a whole. First, initiatives should be prioritized. One point of emphasis should be completing, and ensuring implementation of, the internationally agreed-upon framework for containing the too-big-to-fail risks associated with systemically important firms. Another should be distilling the various ideas relating to short-term funding vulnerabilities into a few that have promise as discrete, relatively near-term initiatives, while continuing study of other, more comprehensive measures. A second, related principle is that initiatives should be focused and manageable, reflecting not only the limited capacity of participating national authorities, but also the desirability of reaching at least a temporary equilibrium at which firms can get on with the business of planning their strategies in a clearer regulatory environment, and regulators can begin to take stock of the cumulative effects and effectiveness of the changes that have taken place in that environment. A third principle is that, in most instances at least, international efforts to develop new regulatory mechanisms or approaches should build on experience derived from national practice in one or more jurisdictions. The challenges encountered during the initial effort to devise an LCR in the Basel Committee, with little or no precedent of national quantitative liquidity requirements from which to learn, should counsel caution in trying to construct new regulatory mechanisms from scratch at the international level. There will doubtless be exceptions to this general principle, such as where the transnational arbitrage incentives of a regulatory measure are so strong as to make national efforts difficult to initiate and sustain without substantial loss of financial activity to other countries.
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And, in the immediate aftermath of the crisis, there was a need to harness the broad-based demands for reform and move forward on some priority reforms without benefit of learning from national initiatives. On the other hand, there may also be areas where, notwithstanding the importance of a particular regulatory objective for international financial stability, it may be preferable to maintain a variety of approaches to achieving that objective. Bearing in mind both these principles and the key areas for policy change at central banks and other financial regulators, let me now suggest some specific subjects for near-term emphasis. As to the framework for systemically important financial institutions (SIFIs), I would urge that two ongoing initiatives be completed over the next year and two ideas that have been in the discussion stage be developed into concrete proposals. First, the proposal for a capital surcharge for systemically important banking organizations is nearing completion. The Basel Committee continues to refine the methodology to be used in identifying the firms and calibrating the surcharge amount--perhaps a byproduct of the fact that this methodology had to be developed in the Basel Committee without benefit of prior precedent. But I have confidence that this work will be successfully completed. The second ongoing initiative--work on designating non-bank SIFIs--has to date been pursued mostly in the IAIS and thus has concentrated on insurance companies. It is important to take the time to evaluate carefully the actual systemic risk associated with these companies, and to understand the amount of such risk relative to other financial firms, before fixing on a list of firms and surcharges.
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But this seems to me a realistic goal over the next six months. Third, we should build on the very good analytic work in the Basel Committee, both on simplifying capital requirements for credit risk and on fashioning standardized capital requirements for market risk, to apply standardized credit and market risk capital measures to all internationally active banking firms. As I mentioned earlier, the United States has already adopted such a requirement for capital requirements on credit risk. These standardized measures serve as a floor to guard against the potential for models-based capital measures to understate capital needs under some circumstances. They are also substantially less opaque than, for example, the advanced internal ratings-based approach of Basel II, and thus would provide more comparable measures that are also more amenable to international monitoring. Fourth, I would hope to see a requirement proposed for large internationally active financial institutions to have minimum amounts of long-term unsecured debt, which would be available to absorb losses in the event of insolvency. As I mentioned earlier, work on resolution continues, albeit at different paces in different jurisdictions. Given the complexities arising from the independent, often differing national bankruptcy and insolvency laws, the goal of achieving a fully integrated resolution regime for internationally active financial firms may take a good deal of time. But a minimum long-term debt requirement would at least provide national authorities with sufficient equity and long-term debt in these firms to bear all losses in the event of insolvency, and thereby counteract the moral hazard associated with taxpayer bailouts without risking disorderly failure.
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This requirement would not break brand new regulatory ground, since it would really be a modification of existing Tier 2 gone-concern capital concepts, and would complement the requirement for minimum equity levels included in Basel III. As implied in my identification of short-term funding vulnerabilities as a priority area, the best way forward here is considerably less easy to specify. Short-term initiatives on money market funds and triparty repo are both possible and desirable. In truth, though, because money market funds are largely American and, to a somewhat lesser extent, European, the United States and the European Union together have the ability to address the global run risks associated with these products. I think we also have the responsibility to do so, but not necessarily in identical ways. Accordingly, I would hope that both the United States and the European Union would each take effective action to counter the run risk, tailored as appropriate to their regulatory environments, and then explain those actions at IOSCO and the FSB, where their efficacy can be reviewed. Similarly, since the settlement process for triparty repo that remains of concern is centered at two institutions, both of which are regulated American banks, the United States can take effective action without need of an international agreement As to broader initiatives, proposals to require minimum haircuts for all securities financing transactions have been tentatively discussed in the FSB. This is certainly a ripe subject for discussion, insofar as securities financing transactions facilitate leverage, enable maturity transformation, and produce the kind of interconnectedness that can spawn runs and contagion.
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At present, no set of generally applicable prudential standards governs these activities. Even within regulated firms, microprudential risk-weighted capital standards have little effect, since they are calibrated against credit risk and most such transactions are short-term and fully (or over) collateralized. Thus requirements that would attach to instruments and transactions, as opposed to firms that happen to be prudentially regulated for other reasons, have considerable attraction. On the other hand, universal haircut requirements are the type of regulatory innovation that I suggested earlier was best developed internationally following some experience within financially significant countries. One may, for example, have significant concern about some of the unintended consequences that would ensue. My instinct, then, is that the analysis of this idea should continue within the FSB and, one hopes, in other venues both in and out of the official sector. There should also be concerted efforts internationally to gather relevant data, some of which is at present uncollected. But we are not going to be in a position to establish an international securities transaction financing regime in the near term. However, one proposal already on the international agenda might be reconsidered, so as to address more directly the short-term funding problem. Following completion of the LCR earlier this year, the Basel Committee is turning its attention back to the Net Stable Funding Ratio (NSFR), a proposal that was intended to complement the LCR by regulating liquidity levels beyond the 30-day LCR horizon.
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Like the LCR, the NSFR proposal raised many questions even among those favoring robust measures to deal with the liability side of firm balance sheets. There is some appeal to moving forward with this complementary measure fairly quickly by simply making some incremental changes to the NSFR while keeping its current structure. But I think we may be better advised to take the opportunity of this review to examine whether there are approaches that might address more directly the vulnerabilities for the financial system created by large non-deposit, short-term funding dependence at major financial institutions. I do not mean to prejudge the outcome of such an examination, or the degree to which we might build on measures being considered in various jurisdictions to address these vulnerabilities. But I do think it worth the effort.

Conclusion
Responses to what I have described as the three challenges to pre-crisis central bank policies will continue to evolve. So will the reenergized international agenda for cooperation in international financial regulation. My aim tonight has not been to lay out a comprehensive program for either, but to suggest that these changing agendas are neither completely correlated nor completely independent. In suggesting some concrete next steps, I have tried to define some useful and important points of intersection between the two.

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

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Gabriel Bernardino, Chairman of EIOPA

IMD2 and Solvency II – The road to better policyholder protection and financial stability

Workshop organised by the European Federation of Insurance Intermediaries (BIPAR) Brussels Good evening ladies and gentlemen, I would like to start by thanking BIPAR for the invitation to speak to you today and for the opportunity to meet again with the representatives of EU intermediaries. In my speech, I will bring forward some personal reflections about the current challenges in revising the regulatory framework in the insurance area, namely IMD2 and Solvency II and will finish by pointing out some strategic reflections on the way to achieve further consistency of EU regulation and supervision.

Let me start with IMD2.
The review of the Insurance Mediation Directive is very relevant for EIOPA, because this directive affects almost all our stakeholders. Intermediaries are, and will continue to be, a key link in the retail distribution chain. We recognise that at EIOPA, in the same way that we see protection of consumers as a fundamental goal for us and an area where we are required to take a “leading role”. For us, intermediaries are an essential part of the insurance market and play a crucial role in consumer protection. Therefore, we welcome the publication of the Commission’s proposal to recast the existing IMD (“IMD2”) in July 2012.
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I must say that it has certainly been a long time in the making ever since the review of IMD1 was first introduced into the Recitals of Solvency II by the European Parliament and then our predecessor, CEIOPS subsequently provided advice to the Commission on the Directive in 2010 with 39 different recommendations. We support the Commission’s objectives of making retail insurance markets work better and promoting a more level playing field by, for example, extending the scope of the Directive to include direct sales. Indeed, preventing regulatory arbitrage and promoting equal conditions of competition are key objectives for EIOPA too. From EIOPA’s perspective, it is important that the final legislative text creates a regulatory regime in the retail insurance market that can be effectively supervised both from a national and a European perspective, bearing in mind the wide variety of existing structures at national level for supervising insurance distribution. IMD2 also needs to adopt a proportionate approach as regards the objectives to be achieved. There needs to be proper consideration of existing market specificities such as a very diverse range of distribution channels at national level, from high street brokers to multinationals. As I say, I welcome the Commission’s proposal. Nevertheless, there are a number of points where I would personally recommend further reflection:

Transparency of remuneration
• The proposal introduces a mandatory disclosure of the full amount of remuneration for life insurance products and a 5 year transitional period allowing for an “on request” disclosure regime for non-life products; at the end of the 5 year period, mandatory disclosure would apply.
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• Furthermore, insurance undertakings are only required to inform the customer about the nature and the basis of the calculation of any variable remuneration received by any employee of theirs i.e. not disclosure of the full amount. For non-life insurance, I consider an “on request” regime as a better way to move further at an EU level, while maintaining the possibility for Member States to impose stricter requirements. In my view, this would be the best possible and balanced solution to improve the transparency of remuneration. Furthermore, both insurance undertakings and insurance intermediaries should have to comply with the same high-level principles as regards information requirements and conflicts of interest provisions. I also believe that disclosure is not a panacea to managing conflicts of interest. The introduction of a general “duty of care” would help as would the implementation of proportionate and robust administrative and organisational arrangements to help systematically identify and manage conflicts of interest.

Scope – Comparison Websites
• Comparison websites are caught under the Recitals, but not under the definition of “insurance mediation”, creating legal uncertainty. In my opinion, it is important that new forms of on-line distribution such as comparison web sites, are properly caught under the scope of the Directive to ensure a level playing field and adequate protection for consumers. Some would argue that they are already caught by IMD1, but we need more clarity on this issue.

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Indeed, we are currently working on a Report on Good Practices regarding supervisory standards relating to comparison websites which we hope to publish before the summer. It would also be useful if EIOPA could clarify by means of Guidelines the application of the Directive to aggregators or price comparison websites. Advice • “Advice” is defined under the proposal as “the provision of a recommendation to a customer, either upon their request, or at the initiative of the insurance undertaking or the insurance intermediary”.

I am surprised that the definition of “advice” was not personalised as at
present it captures generic advice as well. We think a clearer definition of advice is required where advice is provided on the basis of a “personal recommendation….”

Freedom to provide services/ Freedom of establishment
• The proposal deletes the provision providing for a European passport based on a single registration and is not re-stated in the new Chapter IV regarding freedom to provide services and freedom of establishment I am surprised that the provision was deleted as it was the foundation of IMD1 so as to encourage the cross-border activities of insurance intermediaries. In my view, this needs to be reinstated to send out the right message.

Cross-selling
• The proposal recognises the practice and risks of bundling products and requires certain information disclosure on sale of bundled products. Tying is outlawed Tying and bundling is an issue that has regularly cropped up in discussions in EIOPA (with regard to sales of PPI or linking life insurance to sales of mortgages).
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Several of our Members have taken action already at national level to combat this practice. I support action on tying but a blanket ban on all tying has important implications, as there are an enormous amount of tied products on the market in the EU. We need also to consider that a complete ban might also prevent consumers from getting cheaper deals. It is important to have the same approach in IMD2, MiFID II and Mortgage Credit Directive to ensure consistency on this issue. This is an area we have foreseen work under the Joint Committee of the ESAs.

Insurance PRIPs
• The proposal introduces special requirements for insurance PRIPs e.g. requirement to identify, prevent, manage and disclose conflicts of interest when selling insurance investment products. I believe that these provisions should be kept within IMD2 and we should avoid a simple “cut and paste” as the distribution channels involved are very diverse so a “one size fits all” approach could have major impact on the market. Furthermore, I would definitely include in IMD2, the organisational requirements needed by distributors in order to manage conflicts of interest. At EIOPA, we are following closely the negotiations in the Council and Parliament. It is very interesting to see the wide range of different opinions coming to the fore on this issue.

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This is not surprising because IMD2 seeks to perform a very tricky “balancing act”: enhancing the possibilities for cross-border retail trade, but at the same time, raising the bar in terms of adequate safeguards for consumers. This balancing act is even more difficult in the aftermath of the financial crisis. EIOPA stands ready to support the EU political institutions in the negotiation process.

Let me know turn to Solvency II.
The EU is faced with an outdated and fragmented regulatory regime in insurance. Solvency II has been developed during the last 13 years to answer to concrete needs. It increases policyholder protection by using the latest developments in risk-based supervision, actuarial science and risk management. We should be proud that Solvency II is based on sound core principles. Obviously, the financial crisis had a number of consequences on Solvency II. Some lessons were incorporated early on in the regime, but other challenges are still creating uncertainties on the final design and calibration. The huge market volatility proved to be a challenge in a market-consistent regime, especially for long-term guarantees. The sovereign crisis led to questions on the concept of the risk-free rate. The changes in banking regulation create pressure on the role of insurers as providers of long-term bank funding.
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The low interest rate environment is threatening some insurance business models, especially in life insurance. This year will be a crucial year for Solvency II. So, what are we doing? Following the agreement by the EU political institutions, EIOPA have launched the long-term guarantee assessment that aims to test various measures that have been discussed in the Omnibus II negotiations. We are encouraged by the level of participation in the different member states, covering big, medium and smaller players. EIOPA will present its final report in June. It is essential for policyholder protection and financial stability that Solvency II appropriately reflects the long-term financial position and risk exposure of undertakings carrying out insurance business of a long-term nature. We need a robust framework that would price correctly any options embedded in the contracts. We need to recognise that guarantees have a price; there is no “free lunch”. On top of the long-term guarantee assessment, EIOPA sees it as of key importance that there will be a consistent and convergent approach with respect to the preparation of Solvency II. That is why, in December 2012, we issued our Opinion on interim measures regarding Solvency II. Our plan is to develop Guidelines that will ensure that national supervisory authorities will start in 2014 to put in place certain important aspects of the new prospective and risk based supervisory approach.
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These Guidelines will cover the system of governance, including risk management and the process of developing an own risk and solvency assessment, pre-application of internal models, and reporting to supervisors. We are not anticipating Solvency II, but preparing supervisors and undertakings for the new regime in a consistent way. The guidelines are addressed to national supervisory authorities and will be subject to comply or explain procedure. We are working in close cooperation with the European Commission and maintaining an informal dialogue with EIOPA’s Insurance and Reinsurance Stakeholder Group and the different stakeholders. We plan to have a public consultation on the Guidelines in April/May 2013 and they will be tabled to EIOPA Board of Supervisors in the autumn. Going forward, one of the most critical challenges in the EU supervisory landscape is to ensure consistency of supervisory practices. I believe that the convergence of supervisory practices is as important as the single rule book. By assuring that day-to-day supervisory oversight of financial institutions is done within a consistent framework, we can effectively contribute to an increased level of protection of policyholders and beneficiaries in the European Union. The single market requires it and EIOPA is committed to deliver it. A first step should be the development of a Supervisory Handbook that would work as a guidebook for supervision in Solvency II, setting out good practices in all the relevant areas of supervision. This handbook will foster the implementation of a more consistent framework for the conduct of supervision.
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EIOPA is starting to work in this area. I believe that it is fundamental to build on the experience of what has been achieved by EIOPA under the current Regulation and start a reflection on the further steps (tasks and powers) needed to deliver a truly consistent supervisory process and, in particular, to assure the consistent oversight of cross-border insurance groups. Furthermore, EIOPA needs to have resources to play its challenging oversight role according to the Regulation, by conducting inquiries into a particular type of financial institution, or type of product, or type of conduct in order to assess potential threats to the stability of the financial system and make appropriate recommendations for action to the competent authorities concerned. In order to perform this independent assessment in a transparent, efficient and risk based way, EIOPA needs to reinforce its human resources, should have access to the relevant individual information available to the national supervisors and also have direct access to the individual institutions. Another strategic challenge is the level of regulatory consistency in the financial sector. I believe it is very relevant to achieve an appropriate level of convergence of the rules protecting retail consumers in the different areas of the financial sector. Nevertheless, proportionality and good sense should prevail. By covering the different angles of disclosure and selling practices in the insurance market, IMD2 should avoid the tendency to apply a one-size-fits-all approach. Insurance business and insurance products have their own specificities that need to be carefully considered.

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Some may argue that these specificities are a sufficient argument to maintain the status quo. I don’t believe that this is the case. We need to recognize that an evolution is also needed in the way consumer protection is ensured in the different distribution channels. We need to learn from the mis-selling events that occurred in certain markets involving products like PPI, unit-linked products and pensions. Consumer’s attitudes and needs are changing, and that should be viewed positively. The insurance market cannot and will not be out of this evolution. Insurance intermediaries should support this trend and should view IMD2 as a good opportunity to improve consumer protection, preserve the relevant insurance specificities and increase consumer confidence. Thank you for your attention.

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Submitting a Suspicious Activity Report (SAR) within the Regulated Sector
This is a United Kingdom Financial Intelligence Unit (UKFIU) communications product, produced in line with the Serious Organised Crime Agency's (SOCA) commitment to sharing perspectives on the Suspicious Activity Reports (SARs) Regime. This document seeks to provide advice and relay best practice when making a Suspicious Activity Report (SAR), a piece of information that alerts Law Enforcement Agencies (LEAs) that certain client/customer activity is in some way suspicious and might indicate money laundering or terrorist financing. Persons in the regulated sector are required under Part 7 of the Proceeds of Crime Act 2002 (POCA) and the Terrorism Act 2000 (TACT) to submit a SAR in respect of information that comes to them in the course of their business, if they know, or suspect or have reasonable grounds for knowing or suspecting, that a person is engaged in, or attempting, money laundering or terrorist financing. A SAR must be submitted as soon as is practicable. This document seeks to complement the Money Laundering Regulations and HM Treasury approved guidance in this regard. It is important that when submitting a SAR to SOCA that reporters refer to the published guidance from their own regulatory body and their own internal guidance.
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By submitting a SAR to the Serious Organised Crime Agency (SOCA) you will be providing LEAs with valuable information of potential criminality whilst ensuring appropriate compliance with your legal obligations to report under POCA and TACT. You are able to submit SARs in any format including by post, fax or via the SOCA website (www.soca.gov.uk) through the SAR Online system. Once you have submitted your SAR you should remember your obligations not to make any disclosures which might constitute an offence of tipping off under section 333A of POCA or section 21D of TACT 2000. SOCA does not provide or approve standard wording for you to use in such circumstances. It is therefore recommended that you give careful consideration to how you will handle your relationship with the subject once you have submitted the SAR, particularly if the subject is a client or customer of your business. You may wish to discuss with your supervisor or professional body if you are unsure. SAR Online is a secure web based system by which you can submit SARs to SOCA. Registering with SAR Online is a very simple process and ensures SARs are delivered directly to SOCA, including an activation process to create the account for the submission of SARs.

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SAR Online is SOCA's preferred means of SARs submission and provides a standardised approach to structuring SARs that reporters may find useful. It is important to provide as much comprehensive detail as possible when registering. In order to register for SAR Online, new users require an active email account as this is used as your user identification. The registration is unique to the user so the email address needs to be designated to the appropriate person. It is recommended that the Money Laundering Reporting Officer (MLRO), Nominated Officer or designated officer responsible for the Anti-Money Laundering (AML) compliance within the organisation is the registered user. Use of SAR Online is recommended as:  it will provide you with an automated acknowledgement of receipt  it will help you structure your SAR in the most helpful way, thereby improving processing time in SOCA  it will give you the opportunity to flag the SAR as a consent issue. Reporters that submit SARs via SAR Online will also receive an acknowledgement email containing a unique reference once the report has been submitted. The submission of consent SARs is particularly valuable to ensure a prompt response. There is a dedicated support team available during office hours to deal with any SAR Online enquiries. The SAR Online Helpdesk can be contacted on 020 7238 8282, option 3.
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Further support is available on the SOCA website (www.soca.gov.uk) or through your supervisor or professional body. You should note that SAR Online does not retain a file copy for your future use and therefore you should ensure that you retain your own record of your submission. SAR Online has an automatic timeout session of 20 minutes for each page. You should save your work at regular intervals to re-set the timeout clock before the session expires. However if you are not reporting electronically please use the SOCA Preferred Forms for manual reporting which can be downloaded from the SOCA website.

Reason for suspicion
Making a quality report, structured in a logical format and including all relevant information, will significantly enhance LEAs' abilities to extract greater value from submitted SARs and speed up the process. Often a seemingly minor piece of information to you can become a valuable piece of intelligence to LEAs. It is helpful to write a brief summary to explain your suspicion and then also provide a chronological sequence of events. It helps if you try to keep the content clear, concise and simple. For example, describe the events, activities or transactions that led you to be suspicious, how and why you became suspicious, and where appropriate, the nature of the business activity you were engaged in and details of dates of any activities or transactions etc. The SAR Glossary of Terms (available on the SOCA website www.soca.gov.uk) is used to identify specific categories of suspicious
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activity and is widely used by law enforcement enabling them to identify SARs in which they have a specific interest. The inclusion of the appropriate Glossary Term can be useful in ensuring the distribution of the SAR to a law enforcement or government agency which may be best placed to utilise or act on the information provided. However, use of the SAR Glossary of Terms is not mandatory. If the reported subject (for example client/customer) has been the subject of a previous SAR submitted by your organisation, it is valuable to include the previous SAR reference number, and, if appropriate to do so, the glossary code XXS2XX. However, please also remember that under POCA and TACT, each SAR you submit on the same individual must contain a suspicion and all the relevant details; even if you have included the reference number for a previously submitted SAR. As a basic guide, wherever you can, try to answer the following six basic questions to make the SAR as useful as possible: Who? What? Where? When? Why? How? Remember to include the date of activity, the type of product or service, and how the activity will take place or has taken place, when documenting the reason for suspicion. If you are suspicious because the activity deviates from the normal activity for that customer/business sector, it would be helpful to briefly explain how the activity that gave rise to your suspicion differs. Avoid the use of acronyms or jargon within SARs as they may not be understood by the recipient and may be open to misinterpretation. If you are describing a service provided or a technical aspect of your work, it would be beneficial to provide a brief synopsis in your SAR to aid the financial investigator.
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We recommend you do not send attachments with your SAR – all the relevant information should be within the SAR. If further information is available which you are willing to share with an LEA then reference to this and who to contact may be recorded in the SAR.

Subject information
The amount of information a reporter holds on the reported subject may be dependent on the nature of the relationship with the subject which may frequently be a client or customer, but may also for example be a prospective client, someone connected with or trading with a client/customer or other subject seen in the ordinary course of business. Accordingly, the information may be derived from Customer Due Diligence (CDD) obtained in line with guidance published by its firm and supervisory body or other information gathered in the ordinary course of business. It is helpful to those who will use your SAR to be as comprehensive as possible; however you are only required to provide information obtained within the ordinary course of your business. Where known, the information listed below should be provided, and in the case of addresses, wherever possible the status of the address (e.g. current, business, residential etc) should be provided together with postcodes or equivalent for overseas addresses. The inclusion of postcode allows the SAR to be automatically allocated to law enforcement. Please note: If you are submitting a SAR using SAR Online you are requested to fill in the subject information within the fixed fields provided for the purpose.

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Individuals
Please provide all relevant details known about the individual reported. The amount of information you will have may well depend on the relationship to the reported subject. Please provide all identifying information. This should include, as far as possible: full name/s, date of birth, nationality and address. It is important that the status of the address/es can be fully understood i.e. current, previous, home, business, and other known property, ensuring that postcodes are included. If further information is held about the individual – for example:  identification document details (including relevant reference or document numbers) e.g. passport, driving licence, National Insurance number  car details (registration number)  telephone numbers (clearly marked home, business, mobile etc)  full details of bank accounts or other financial details (including account numbers etc)  occupation then the information can be provided in context with your suspicion.

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Businesses, trusts and other entities, incorporated and unincorporated 1) Incorporated
Please provide all relevant details known about the incorporated entity. The amount of information you will have may depend on the relationship to the reported subject. Please provide all identifying information such as:  full name  designation e.g. Limited, SA, GmbH  trading name  registered number  VAT and/or tax reference number  country of incorporation  business/trading address  registered office address. Additionally if relevant to your suspicion, please provide details of the individuals or entities that are the directors (or equivalent) and details of the individuals who own or control or exercise control over the management of the entity.

2) Unincorporated
Please provide all relevant details known about the unincorporated entity. The amount of information you will have may depend on the relationship to the reported subject.
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Please provide all identifying information such as:  full name  business/trading address  VAT and/or tax reference number. Additionally, if relevant to your suspicion, please provide details of all partners/principals who own or control or exercise control over the management of the entity.

3) Trusts
Please provide all relevant details known about the trust. The amount of information you will have may depend on the relationship to the reported subject. Please provide all identifying information such as:  full name of the trust  address  nature and type of the trust. Additionally, if relevant to your suspicion, please provide details of all trustees, settlors, protectors and known beneficiaries as appropriate.

Description of criminal property and its whereabouts
When the suspicion being reported relates to a financial transaction, the report should include the relevant details of the beneficiary/remitter of the funds and, if known, the destination/originating bank details e.g. sort code, correspondent bank details.
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It is important to accurately record the date on which the transaction has occurred or will occur. It is also useful to understand the type of transaction – for example online payment/receipt, debit or credit card, ATM withdrawal, cheque, electronic transfer (BACS/CHAPS), or cash. If the beneficiary/remitter of the transaction is believed to be complicit in the suspicious activity then consideration should be given to providing their details as an associate subject. An associated subject is a person or entity that is linked to the main person/entity in some direct way and is involved in the suspicious activity. If the activity does not involve a financial transaction then an explanation of the suspicious activity that has occurred or will occur should be given. When submitting a SAR using SAR Online there are fields for documenting specific financial transactions. Equally, transactions or activity can be documented within the ‘reason for suspicion’ field provided.

Appropriate consent
Obtaining consent provides a defence against the principal money laundering offences. Should you wish to avail yourself of this you should refer to a separate document which has also been published on the SOCA website (www.soca.gov.uk) entitled ‘Obtaining consent from SOCA’. This provides specific guidance on the process to be followed and what to expect if you wish to apply to SOCA for a consent decision. If you are using SAR Online you are reminded to ensure you tick the appropriate Consent Box when completing your SAR.
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In all cases it is important to specify clearly the activity for which consent is required.

Threshold Requests
Section 339A of POCA makes provision for a threshold in the case of deposit-taking institutions in operating an account if it is £250 or less without the need to seek consent. If the proposed activity exceeds £250, permission to vary the ‘threshold’ payment is required from SOCA before the activity may be conducted. The reporter should still make a disclosure in respect of the initial opening of an account or, if different, the time when the deposit-taking body first suspects that the property is criminal property. If you are submitting a SAR with a Threshold Request, please submit the SAR in the normal way and specify the threshold amount sought, the account it relates to, and details of the frequency, nature and value of the activity to which the threshold will relate. If a threshold is already in place and you wish to seek a variation, then the reasons for the variation will need to be set out in an additional SAR and submitted to SOCA.

Please note:
A threshold request is not the same thing as a consent request and there are no statutory timescales for dealing with them. However to facilitate threshold requests, SOCA uses the consent desk to progress the responses and it is helpful if the consent box is ticked on the SAR to enable the desk to identify the requests quickly.

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Court orders and law enforcement enquiries
In some instances, you may be served with or have notice of a court order such as a production order, made in respect of a particular individual or entity. This may act as a catalyst for you to review the activity which you conduct or have conducted in relation to that individual or entity. If, following such a review, you feel that there is an obligation to submit a SAR or seek consent, then the SAR/consent request should reflect your suspicions in the context of your engagement with the subject.

Acquisitive or fraud related crime
When you have knowledge or suspicion of an acquisitive or fraud related crime, you will be faced with a parallel decision making process. Firstly, you will have to decide whether or not you wish the offence to be investigated. In cases of all fraud (confirmed fraud, attempted fraud or where information relating to fraud can be provided), reports should be made to Action Fraud via www.actionfraud.police.uk or telephone 0300 123 2040. SOCA does not take crime reports. Also, regardless of whether or not a crime has been reported, you will wish to consider your legal obligations under the Proceeds of Crime Act 2002 (POCA). If you have knowledge or suspicion that a money laundering offence has taken place then you must submit a SAR to SOCA. SOCA’s advice from its police partners is that where a reporter wishes the content of a SAR to be formally recorded as a crime report they should report this directly to their local police force.
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Where the reporter has reported a crime and, in addition, has submitted a SAR, it would be helpful if the crime reference number could be included in the top line of the text in the SAR so that it can immediately be cross-referenced by law enforcement.

Alerts and keywords
The Alerts process is a recognised and established way by which SOCA communicates with the UK's private sector. These are written communications that warn of a specific risk, threat or problem. All Alerts contain a keyword or a glossary code. If you submit a SAR as a result of the information contained in an Alert please include the keyword within the free text field.

SAR confidentiality
The confidentiality of SARs is the cornerstone of the reporting regime. SARs are held on a secure central database within SOCA and access to the database by law enforcement is strictly controlled by SOCA. The use of SARs is governed by Home Office Circular No. 53/2005 (Money Laundering: The Confidentiality And Sensitivity of Suspicious Activity Reports [SARs] And The Identity Of Those Who Make Them). All law enforcement agencies using SARs are required to follow the guidance outlined If reporters have concerns about the inappropriate use of SARs by Law Enforcement Agencies (LEAs), or breaches of SAR confidentiality, they should call the SAR Confidentiality Breach Line on freephone 0800 234 6657 (9am-5pm, UK time, Monday to Friday). This number is for reporting breaches of confidentiality only.
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Contacting SOCA UK Financial Intelligence Unit (UKFIU)
SARs should not be used as a communication channel e.g. as a means of gaining advice. SARs are only for the reporting of suspicious activity to SOCA. If you need to seek general guidance relating to money laundering or the SARs Regime in particular, you are advised to contact your designated Money Laundering Reporting Officer (MLRO) or your regulatory body. For information or assistance with submitting SARs, SAR Online enquiries and consent, please visit www.soca.gov.uk or contact the UKFIU as follows: Tel: 020 7238 8282 Press '2' - General SAR enquiries Press '3' - SAR Online helpdesk Press '4' - Consent SAR enquiries When contacting the UKFIU please have available your SAR reference number if applicable. General UKFIU matters may be emailed to ukfiusars@soca.x.gsi.gov.uk If you wish to make a SAR by post you should address your SAR to UKFIU, PO Box 8000, London, SE11 5EN or by fax on 0207 283 8286. You are reminded that post and fax are slower than SAR Online and therefore it will take longer for your SAR to be processed. You will not receive an acknowledgement if you use post or fax.

Disclaimer
While every effort is made to ensure the accuracy of any information or other material contained in or associated with this document, it is provided on the basis that SOCA and its staff, either individually or collectively, accept no responsibility for any loss, damage, cost or expense of whatever kind arising directly or indirectly from or in connection with the use by any person, whomsoever, of any such information or material.
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Any use by you or by any third party of information or other material contained in or associated with this document signifies agreement by you or them to these conditions.

Dialogue Team
The aim of the Dialogue Team is to drive the UK Financial Intelligence Unit (UKFIU) agenda on interfacing with stakeholders on Suspicious Activity Reports (SARs) activity. The team strives to improve communication and understanding between the SARs regime participants, to increase the value extracted from the SARs regime, to provide, facilitate and contribute to various forums to share perspectives on the operation of the regime as a whole. In essence the Dialogue Team seeks to improve the quality of SARs intelligence, and promote the value and greater use of this intelligence in mainstream law enforcement activity.

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What is SOCA?
“We work to put serious criminals behind bars, and use many other tactics to fight crime and keep you safe. In particular, we want to ensure crime doesn’t pay and that it’s harder to commit. The power to counter criminals SOCA officers can have the combined powers of police, customs and immigration officers. We also have a substantial range of tools and legislation to target criminals with – everything from the ability to recover assets through to Serious Crime Prevention Orders. We work with agencies and officials across the UK and all over the world to help us do our job and to help them do theirs.

New ways of fighting crime
We use traditional law enforcement methods – investigating, and arresting criminals. We also draw on innovative new approaches to prevent crimes from happening in the first place. Here are some examples: First class intelligence - we use all kinds of ways to gather the knowledge we need to know where, when and how to strike to best effect. Monitoring serious career criminals - in some cases we watch them for life, to prevent them from continuing their criminal activities in prison or after release. Hitting them where it hurts - by taking criminals’ cash and property. For many serious criminals, this worries them more than the prospect of going to prison.

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Working in partnership - serious organised crime is a major problem that affects everyone every day, so we co-operate with law enforcement, public and private sector partners to counter it. Worldwide operations - we go anywhere we need to when tackling criminal activity. For instance, a street drug dealer is just the last link in a chain that probably stretches to the other side of the world. So our activities aren’t limited by borders. Making it harder to commit crime - for example, passing on details of suspicious financial activities or forged identities to banks before frauds can take place.”

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Financial Stability Board reports to G20 on progress of financial regulatory reforms
The Chairman of the Financial Stability Board (FSB) reported to the G20 Finance Ministers and Central Bank Governors on progress in the financial regulatory reform programme. In connection with this, the FSB is publishing: • a letter by the FSB Chair to the G20, sent ahead of their meeting, reporting on the good progress being made in financial reforms, including in the following priority areas: o creating continuous core markets by completing OTC derivatives and related reforms; o strengthening the oversight and regulation of shadow banking; o building resilient financial institutions; and o ending “too big to fail”. The letter also summarises the FSB’s recent work and plans to monitor the implementation of reforms. • An assessment of the effect of the G20 financial reform programme on the availability of long-term finance. This assessment has been contributed by the FSB as part of a broader diagnostic report prepared by international organisations to assess factors affecting long-term financing. The FSB assessment concludes that, while there may be short-term adjustment effects, the most important contribution of the financial reform programme to long-term investment finance is to rebuild confidence and resilience in the global financial system.
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• a joint update by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board on the status and timeline of their remaining projects on converging their standards. At today’s meeting the G20 Finance Ministers and Central Bank Governors reaffirmed their commitment to the full, timely and consistent implementation of internationally agreed financial sector reforms, and looked forward to a comprehensive report on progress in implementing all reforms at the St Petersburg G20 Summit in September. G20 Ministers and Governors also welcomed the establishment of the FSB in January as a legal entity with greater financial autonomy and enhanced capacity to coordinate the development and implementation of financial regulatory policies, while maintaining strong links with the Bank for International Settlements.

Progress of Financial Regulatory Reforms
Financial market conditions have improved over recent months. Nonetheless, medium-term downside risks remain, given weak growth prospects and high levels of public and private sector debt in many economies. The recent improvement in financial market conditions owes much to central bank actions, in particular, the accommodative monetary policy aimed at stimulating the economic recovery. As a consequence, market participants’ appetite for risk has increased, but this has not yet translated into a robust recovery in real investment. The beginning of the return of risk appetite to financial markets – while intended and welcome – raises a number of issues. First, market participants and authorities need to be on guard against mispricing of risk and valuations of assets.

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Second, the importance of timely completion of the reforms to over-the-counter (OTC) derivatives markets and the shadow banking system has increased. Third, historically low interest rates in many countries pose challenges for institutional investors with long-dated liabilities and may leave market participants more vulnerable to unanticipated movements in the yield curve. Financial institutions and supervisors should continue to assess the resilience of the financial system through regular stress testing, notably of credit and interest rate risk, and complete the process of balance-sheet repair.

1. Reports submitted for this meeting a. Regulatory factors affecting the availability of long-term finance
As part of the diagnostic work you requested of the international organisations, the FSB has prepared an assessment of the effect of the G20 financial reform programme on the availability of long-term investment finance. The reforms include Basel III, OTC derivatives market reforms, and changes affecting the regulatory and accounting framework for institutional investors. The general conclusion is that, while there may be some short-term adjustment effects, the most important contribution of the financial reform programme to long-term investment finance is to rebuild confidence and resilience in the global financial system. As a result, these reforms should substantially enhance the financial system’s capacity to intermediate investment flows through the cycle at all investment horizons.
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Hence, the G20 regulatory reforms are unambiguously supportive of long-term investment and economic growth. The submissions of FSB members found little evidence that the regulatory reforms have had a notable impact on long-term financing to this point. This is not surprising given the fact that the reform process is still at an early stage. Several features of the reforms are designed to avoid major unintended consequences: the long phase-in period for reforms; the ongoing implementation monitoring; and, in certain cases, the flexibility to adjust rules during the observation period. The financial reform programme is not specific to the regulation of long-term finance. Nevertheless, the reforms will change the incentives of some financial institutions and the costs of certain transactions, which may affect the composition of long-term finance. In particular, institutional and other long-horizon investors are expected to assume a greater role in funding long-term assets and more of this investment may be intermediated via capital markets rather than the banking system. There are three areas for specific follow-up by the FSB. First, there should be ongoing monitoring to identify any regulatory factors that may disproportionately affect the provision of long-term finance so that they can be addressed. Second, the FSB could work with others to examine whether regulatory factors may constrain the ability of non-banks to expand their provision of long-term finance.

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Third, the FSB can contribute to the work of other international organisations to help promote the development of longer-term domestic savings and the capacity of domestic financial systems to intermediate them, particularly in emerging market and developing economies (EMDEs).

b. Update on accounting convergence
The Chairs of the International Accounting Standards Board and the US Financial Accounting Standards Board have written you on their work on convergence of accounting standards. The two Boards expect to make progress on the two key outstanding issues of impairment of loans, where they expect to complete their deliberations in 2013, and insurance contracts, where both Boards will be holding public consultations this year. Of these two outstanding issues, the need for convergence on a new forward-looking expected loss approach to provisioning is of most immediate concern for end-users and from a financial stability perspective. We note with concern the delays in convergence to date. We therefore recommend that the G20 ask the IASB and FASB to prepare by end-2013 a roadmap for converging to a common approach for impairment and for achieving the G20 objective of a single set of high quality accounting standards.

2. Priorities and work plans a. Creating continuous markets
The FSB remains fully committed to the rapid completion of the G20’s agreed reforms to OTC derivatives markets.

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As you are aware, these complex reforms are taking somewhat longer than originally planned. The FSB will submit for your April meeting its latest progress report on implementation, including a comprehensive stock-take of reforms as of end-2012, estimates of the extent to which transactions are being centrally cleared and reported to trade repositories, and an overview of the remaining issues to be resolved. It is important that all jurisdictions promptly complete the necessary changes to legislative and regulatory frameworks to put these reforms into practice. To maintain momentum, I have asked FSB member jurisdictions to confirm before the September Summit that the legislation and regulation for reporting to trade repositories are in place, and also the steps they are taking to complete the implementation of other OTC derivatives reforms. Ministers may wish to take a particular interest in progress in their jurisdictions to ensure timely compliance with these important reforms. The FSB has previously identified regulatory uncertainty as the most significant impediment to full and timely implementation of the OTC derivatives reforms. To reduce this uncertainty, regulators are working together to identify and address conflicts, duplication and gaps in the cross-border application of rules. They will provide an update in April on their progress and next steps, and a report to the Summit on how the identified cross-border issues have been resolved. International policies in remaining important areas will also be published by the Summit. These include capital requirements for exposures to central counterparties, margining standards for non-centrally cleared transactions and guidance on resolution of central counterparties.
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Standard setters are undertaking an assessment of the incentives to centrally clear transactions that these standards create and will adjust them as necessary to ensure a robust system. The FSB will also report at the Summit the findings of a new macroeconomic impact assessment of the OTC derivatives regulatory reforms. Standard setters are also developing international guidance on authorities’ access to trade repository data, including in such a way that it can be aggregated across trade repositories. This guidance, which will be issued for consultation shortly and finalised by the Summit, will be important for ensuring that authorities can use information from trade repositories in their oversight of OTC derivatives markets and assessment of systemic risk. Ministers and Governors will wish to ensure there is effective cross-border access to this information, which is vital to the monitoring of emerging financial vulnerabilities. The global Legal Entity Identifier (LEI) system will enhance the usability of the data; the Regulatory Oversight Committee as the governance body of the global LEI system was established in January 2013. Establishing the Global LEI Foundation is the key next step to launch the system in March 2013. The FSB continues to offer strong support to the LEI initiative and the FSB Secretariat will serve as ROC LEI Secretariat for the initial period.

b. Strengthening the oversight and regulation of shadow banking
As you will recall, the FSB delivered to you last November an initial set of recommendations to strengthen the oversight and regulation of shadow banking.
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We have received useful feedback through a public consultation on the initial recommendations. The FSB is refining the recommendations relating to securities lending and repos, and those relating to the policy measures for shadow banking entities other than money market funds. The recommendations will address bank-like risks to financial stability emerging from outside the regular banking system while not inhibiting sustainable non-bank financing models that do not pose such risks. The approach is designed to be proportionate to financial stability risks by focusing on those activities that are material to the system, using as a starting point those that were a source of systemic risk during the crisis. We will deliver certain recommendations to the St Petersburg Summit. These measures should be viewed as the start of a broader process since they address the specific risks that arose during the crisis and we all recognise the ability of the shadow banking sector to innovate.

c. Building resilient financial institutions
In January, agreement was reached by the Group of Governors and Heads of Supervision on the Liquidity Coverage Ratio (LCR) to be applied to banks. The agreement expands the range of high-quality liquid assets that can be included in the LCR and incorporates evidence-based assumptions about liquidity outflows in times of stress. The LCR will be introduced in 2015 as planned, with the minimum requirements beginning at 60% and reaching 100% by 2019 to allow the global banking system sufficient time to adjust.

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d. Ending “too-big-to-fail”
Progress is being made by the IAIS in developing and testing a methodology for identification of global systemically important insurers (G-SIIs), and in developing appropriate policy measures. This work should be completed in the second quarter of 2013. An identification methodology for non-bank G-SIFIs will be issued for consultation in the second half of 2013. Although implementation of the G-SIFI framework has much farther to go, we will deliver an assessment to the St. Petersburg Summit of the progress made in developing credible policies for ending too-big-to-fail (TBTF).

3. Implementation of reforms Basel III
Consistent implementation of Basel III is fundamental to strengthening the resilience of the global banking system, maintaining market confidence in the regulatory reforms and providing a level playing field for internationally active banks. The 27 member jurisdictions of the Basel Committee on Banking Supervision (BCBS) continue to make progress toward implementation; 11 had issued final regulations by 12 February 2013 and the remaining 16 jurisdictions have tabled draft regulations. The European Union and the United States published draft regulations in 2012 and intend to finalise them over the course of 2013. The FSB and BCBS will prepare a full update on countries’ adoption of Basel III in domestic regulation for your April meeting.

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The countries that have missed the January 2013 start date are working to finalise their regulations and are expected to meet the 2019 timeline for full implementation. Several more members will undergo a consistency assessment of their final regulations by the BCBS in 2013. By end-2013, all jurisdictions that are the home regulator to global systemically important banks (G-SIBs) will have been subject to an assessment of their Basel III implementation. Other jurisdictions will be subject to regulatory consistency assessments shortly thereafter. The BCBS has concluded an initial examination of the international consistency in the application of the Basel III risk weighting scheme for trading book assets. A similar review is underway regarding the banking book. The analysis for banks’ trading books indicates that supervisory decisions and variations in banks’ models contribute to the substantial differences in banks’ calculations of market risk. (The average risk weighting of trading assets for most banks in the study varied between 15% and 45%.) The study also shows that banks’ public disclosures are insufficient for understanding how much of these variations in banks’ reported risk weightings of assets are owing to differing levels of actual risk versus that owing to other factors. This situation is unacceptable, and the study highlights three policy options which are being addressed in the Basel Committee’s ongoing work: (i) Improving banks’ public disclosures, building on the recommendations of the Enhanced Disclosure Task Force;
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(ii) Narrowing down modelling choices for banks; and (iii) Further harmonising supervisory practices over approval of models.

Resolution regimes and G-SIFI resolution plans
An effective and credible resolution regime for SIFIs is a critical component of the policy framework for ending TBTF. Full implementation of the FSB Key Attributes of Effective Resolution Regimes will provide authorities with the powers and tools necessary for this purpose. We will shortly conclude the first peer review of FSB members’ implementation of the Key Attributes. The work under the review confirms that reforms are underway in many jurisdictions to align national statutory regimes with the FSB Key Attributes, but that significant work remains. We are developing an assessment methodology to assist countries with their implementation, and to provide a basis for future peer reviews and IMF and World Bank assessments. The methodology will be tested in pilot assessments by the IMF and World Bank later this year and published in the second half of 2013. The FSB and its members will also this year address the specific aspects of resolution of insurers and financial market infrastructures and the protection of client assets in resolution. By June 2013, resolution strategies and plans should be in place for all G-SIFIs designated in November 2011. To assist this process the FSB has publicly consulted on specific aspects of recovery and resolution planning and is now finalising its guidance.
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Progress in ending TBTF is contingent on the feasibility and credibility of putting these resolution plans into operation. We will launch in the second half of 2013 a first round of assessments under the G-SIFI Resolvability Assessment Process to evaluate the progress made.

Reducing the reliance on Credit Rating Agency (CRA) ratings
The FSB has recently launched a thematic peer review to assist its members to fulfil their commitments under the roadmap for implementing the FSB principles for reducing reliance on CRA ratings. This will include a stock-take of references to CRA ratings in national authorities’ laws and regulations and of actions being taken to remove or replace these references. The findings will feed into the progress report on CRAs for the Summit, while the peer review will be completed by early 2014.

Monitoring the impact of reforms on EMDEs
The FSB will organise a workshop for EMDEs in the first half of 2013 to share lessons and experiences on implementing agreed financial reforms and on undertaking ex ante assessments of their impact. FSB members with significant experience in undertaking such assessments will be asked to present their methodologies. The FSB will report the findings of the workshop and other relevant monitoring processes at the St. Petersburg Summit.

4. FSB resources, capacity and governance
Finally, I am pleased to report that the FSB has now been established with a legal personality.
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Alongside this, a rolling five-year agreement under which the BIS will host and provide resources for the FSB has been activated, and an institutional mechanism for the FSB’s financial and resource governance established. The FSB has also adopted Procedural Guidelines for its operational and administrative activities and practices. These are important steps towards implementation of the G20 recommendations at Cannes and Los Cabos to place the FSB on an enduring organisational footing, with strengthened governance, greater autonomy in resource use and enhanced capacity to coordinate the development and implementation of financial regulatory policies, while maintaining strong links with the BIS. The FSB will next elect new chairs for three of its Standing Committees and begin a review of the composition of their memberships. Following the St. Petersburg Summit, the FSB will set in train a review of the structure of its representation, which we envisage to be completed under the Australian Presidency of the G20.

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Financial regulatory factors affecting the availability of long-term investment finance
Report to G20 Finance Ministers and Central Bank Governors

Executive Summary
The most important contribution of financial regulatory reforms to LT investment finance is to promote a safer, sounder and therefore more resilient financial system. If implemented in timely and consistent manner, these reforms will help rebuild confidence in the global financial system, which will enhance its ability to intermediate financial flows through the cycle and for different investment horizons. For this reason, the G20 regulatory reform programme is supportive of LT investment and economic growth. FSB members have identified a number of regulatory reforms that may affect LT finance. These include Basel III, over-the-counter (OTC) derivatives market reforms, and the regulatory and accounting framework for different types of institutional investors. Many of these reforms are still in the process of policy development or at an early stage of implementation. The regulatory community is vigilant to avoid material unintended consequences and to analyse potential impacts prior to finalisation of the reforms. The reforms do not specifically target LT finance.
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For example, Basel III neither introduces higher risk weights nor requires matched funding on bank exposures with maturities of over one year. However, the reforms do alter the incentives of different types of financial institutions to participate in this market as well as the costs of different types of transactions. As the balance of incentives changes, institutional investors – which are the most natural providers of LT finance in the financial system – will need to assume a greater role in this market. Anecdotal evidence suggests that this process is underway, but it can take time and is not uniform across different financial market segments or regions. An important issue going forward is whether the regulatory framework enables non-bank providers of LT finance, particularly institutional investors, to step up their involvement in this market. The FSB can contribute to future G20 work on LT investment finance by: • Monitoring the effect of financial reforms on an on-going basis to identify any factors that may disproportionally impact the provision of LT finance so that they can be addressed; • Working with relevant parties to identify regulatory factors that may impede the effectiveness and efficiency of financial markets and non-bank institutions in the provision of LT finance, without compromising financial stability objectives; and • Working with other relevant international organisations to promote the development of domestic contractual savings and the capacity of financial systems to intermediate them, particularly in emerging market and developing economies (EMDEs).

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1. Introduction
At the meeting of the G20 Ministers and Governors in November 2012, the FSB was asked to undertake diagnostic work, together with other relevant international organisations (IOs), to assess factors affecting long-term (LT) investment financing in order to provide a sound basis for any future G20 work in this area. In the division of labour amongst the IOs, the FSB is focusing on financial regulatory factors affecting the availability, cost, time horizon and other terms of LT finance; other IOs are covering different dimensions of this topic.1 For the purpose of this note and to be consistent with the definition used by other IOs involved in this project, LT finance is defined as maturities of financing in excess of five years, including sources of financing that have no specific maturity (e.g. equities). LT investment finance is commonly defined as resources that support LT investment in the productive capacity of an economy. This includes: (i) public and private infrastructure; (ii) equipment and software; (iii) education and research and development (R&D); (iv) new housing and real estate development; and (v) construction of oil, gas and energy facilities. These investments tend to be less liquid, have maturities that extend beyond the business cycle, and are more exposed to changes in credit quality and inflation expectations rather than short-term market volatility.

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The G20 request is motivated by concerns about inadequate resources being channelled to growth-enhancing LT financing projects in the post-crisis environment. The drivers of these concerns include the strains on government budgets and the weakened banking system, which make both sectors less able to support LT investment finance at a time when, in the face of weak global demand, LT investment is likely to be more critical for sustaining long term growth. Some of the stylized facts cited in support of these concerns are the reduced fiscal space available to support investment projects; the reduction in the amount and tenor of corporate lending by some (mostly European) banks; the retreat of some banks from cross-border lending, including from certain specialized LT finance segments (e.g. aircraft, shipping and energy lending); and the existence of large corporate cash surpluses in some jurisdictions that are not being invested. However, this picture is not uniform as there have been large volumes of LT non-financial corporate debt issuance globally; the share of outstanding LT bank loans to firms and households in the euro area has not declined since 2007; and LT finance does not seem to have been affected in some regions or markets. This note is based on the input provided by FSB members (including IOs and standard-setting bodies), interviews with market participants, and the review of recent literature. The financial regulatory factors that are covered include both internationally agreed reforms and other national/regional policy measures in FSB member jurisdictions. In most cases, the reforms are at a relatively early phase of implementation and their impact at this stage is overshadowed by broader post-crisis developments affecting the provision of overall finance, so the findings and conclusions in this note are tentative. The note is structured as follows.
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The second section describes the role of the financial system in LT finance provision, including the way that financial regulation may influence this role. The third section focuses on those reforms identified by FSB members as potentially affecting LT finance. The final section summarises the main findings and suggests possible future areas of work to address the issues identified in the note.

2. Role of the financial system in LT finance
The financial system intermediates savings to, and facilitates the management of risks that arise in, the financing of LT investment. Funds originate from various internal and external sources (domestic and foreign households, corporations, and governments) and financial system participants (banks, institutional investors etc.) help to intermediate some of those flows to end users via a variety of instruments (loans, bonds, equities etc.) and services (origination, structuring, underwriting etc.). Investment finance can take place both by providing funds to specific projects and by providing general purpose financing. The other main role of the financial system is to provide risk management services that, by hedging specific types of risk, allow LT investments to take place. Within the financial system, banks have generally been the primary providers of LT finance, with capital markets being another important intermediation mechanism. LT investments stem from a mix of self-financing (through current earnings and savings) and capital raised through the financial system. Banks have typically provided a substantial portion of external finance by drawing on their informational advantages, expertise in credit origination, experience in monitoring loans and investments, and (at least before the crisis) low-cost access to wholesale funding.

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Bond and equity financing by institutional and other investors (see below) via capital markets is another important form of financial intermediation in many countries; debt market instruments often have a longer tenor than bank loans. The ability of the financial system in a given jurisdiction to provide LT finance is influenced by a variety of structural factors. These include the model of economic development that has been adopted (state-led vs. market/private-sector led), the institutional mix of financial market participants (such as the existence of dedicated development financial institutions or other types of non-bank financial institutions), the state of development of domestic capital markets etc. Other factors – such as macroeconomic performance, property rights and the rule of law, the extent to which the jurisdiction is commodity-rich or domestic savings-poor, demographics etc. – are also important determinants of domestic and foreign investors’ willingness and ability to provide LT finance in that jurisdiction. Conjunctural or cyclical factors have an important bearing on the demand for, and supply of, LT investment finance. In the current environment, strained fiscal positions limit government financing of LT investment, while uncertainty associated with weak global growth and the longer term macroeconomic policy outlook is discouraging corporate investment in spite of sizeable corporate cash holdings and the low interest rate environment. In the euro area, sovereign debt and currency concerns have adversely affected the capacity of the financial system to intermediate LT investment flows, particularly on a cross-border basis. Meanwhile, the on-going financial sector deleveraging process, the shrinkage of the wholesale dollar funding market, and the retreat of some major European banks from certain global financial market segments, have impacted cross-border bank lending, particularly in EMDEs.

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3. Financial regulatory factors affecting LT finance
The global regulatory reform programme aims to create a safer, sounder and thus more resilient financial system. If implemented in timely and consistent manner, these reforms will help rebuild confidence in the global financial system. Confidence has a large bearing on the financial system’s capacity to intermediate financial flows through the cycle and for different investment horizons. For this reason, the G20 regulatory reform programme is supportive of LT investment and economic growth. Financial regulation (and its reform) influences both the level and distribution of LT finance provided by the financial system. For example, prudential regulation seeks to ensure that the maturity mismatch and leverage risks that accumulate on bank balance sheets as part of the financial intermediation process are adequately covered by capital and liquidity buffers. The buffers increase the resiliency of these institutions and contribute to the internalisation of the risks they pose to the broader financial system (which were not properly priced or regulated prior to the crisis), but may also increase the costs of intermediation for users of their services, thereby affecting the quantity of loans demanded. Ideally, financial regulation should not distort incentives in favour of certain types of market participants or sectors, but rather seek to better align providers and users of finance in accordance with their respective investment horizons and risk-bearing capacity. FSB members have identified a number of internationally agreed post-crisis regulatory reforms and other national or regional policy measures that may affect LT finance.
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These cover a broad range of topics at different stages of policy development and implementation. They include Basel III; OTC derivatives market reforms; and the regulatory and accounting framework for different types of institutional investors. Some other internationally agreed reforms – accounting rules for banks, policy measures for globally systemically important financial institutions (G-SIFIs), and policy recommendations to strengthen the oversight and regulation of the shadow banking system – have also been noted in this context even though they are still in the policy development stage. In considering the impact of these reforms on LT finance, it is important to distinguish between transitional and permanent effects as well as the type of market or region that may be affected. In particular, the short term adjustment costs are generally easier to identify but often rely on a static, partial equilibrium framework that does not take account of the dynamic general equilibrium process of market adjustment. In contrast to these potential transition costs, the long-term benefits of reforms tend to be understated because, being dependent on a counterfactual, they are more difficult to quantify. Moreover, the effects of reforms will differ across markets and regions given the different starting positions as well as the scope for substitution of financial providers and instruments. Finally, it is important to recognise that pre-crisis models and levels of financing were unsustainable and should not be the appropriate benchmark for assessing the impact of reforms on the availability and cost of LT finance.

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3.1 Basel III
Basel III is a comprehensive set of policy measures designed to strengthen the regulation, supervision and risk management of the banking sector in response to the financial crisis. The main objective of the reforms is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, thus reducing the risk of spillover from the financial sector to the real economy. The key elements of Basel III are: (1) the strengthening of the regulatory capital framework by raising the quantity and quality of the capital base, enhancing risk coverage, supplementing the risk-based capital requirement with a leverage ratio backstop, and promoting the conservation of capital and reducing procyclicality via additional capital buffers; and (2) the introduction of two minimum global liquidity standards. The Basel III reform package does not specifically target long-term bank finance, although it may affect it. Basel III neither introduces higher risk weights nor requires matched funding on bank exposures with maturities of over one year. However, the combined effect of the reforms will be to increase the amount of regulatory capital for such transactions and to dampen the scale of maturity transformation risks they carry on their balance sheet (Box 1). In response to these regulatory requirements, the cost of LT bank lending may increase or its supply (and tenor) may decrease. In addition, if the bank uses OTC derivatives to hedge the risks associated with the LT exposure, then those transactions will be subject
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to additional capital and possibly margining requirements under Basel III (see section below). The overall effect will vary depending on a number of factors, such as the specific characteristics and location of the transaction as well as the presence of alternative funding sources in different market segments.

Box 1. Example of the Impact of Basel III on a LT Corporate Loan
The capital treatment of a LT corporate loan under pillar 1 of Basel II depends on a number of parameters reflecting the credit risk measurement approach used by the bank: • standardised approach – external credit rating of borrower and use of any credit risk mitigants in the transaction (e.g. development bank or export credit agency guarantees); or • internal ratings based (IRB) approach – bank estimates of risk parameters (i.e. PD, LGD, EAD, effective maturity) using different formulae depending on the asset class (i.e. standard corporate vs. SME vs. so-called “specialized lending”6 etc.) The risk weights and formulae under Basel III for this type of banking book transaction remain unchanged. However, there will be an increase in both the quality (definition) and level of minimum regulatory capital requirements, which will raise the amount of regulatory capital that a bank needs to allocate for loans. These transactions will also be subject to a leverage ratio that will supplement and act as a backstop to the risk-based capital requirements. These changes affect the required regulatory capital for all types of bank lending, including LT corporate loans. In addition, two new minimum funding liquidity standards are introduced under Basel III:
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• Liquidity Coverage Ratio (LCR) – Its objective is to promote short-term resilience of a bank’s liquidity risk profile by ensuring that it has sufficient unencumbered high quality liquid assets (HQLA) to survive an acute stress scenario of cash outflows lasting for one month. In the LCR formula, 50% of all corporate loans maturing within 30 calendar days are included in the cash inflow, i.e. banks are assumed to roll over 50% of those loans in a stress period. • Net Stable Funding Ratio (NSFR) – Its objective is to promote resilience over a one year time horizon by creating additional incentives for a bank to fund its activities with more stable sources of funding on an on-going structural basis. In the NSFR formula, loans (excluding mortgages) with a maturity greater than 1 year are assigned a 100% required stable funding factor, implying that they require stable funding (i.e. bank equity and liabilities such as deposits and wholesale borrowing) greater than 1 year. There is no direct effect on the LT corporate loan from the introduction of the LCR (unless the loan is close to repayment). However, the bank may be incentivized to hold other types of more liquid assets that are treated more favourably under the HQLA definition (e.g. sovereign bonds) in order to meet the LCR requirement. In the case of the NSFR, if the LT corporate loan is funded via short-term deposits or other liabilities (that are regularly rolled over), there is a maturity mismatch that will need to be covered by lengthening the term of funding and/or by reducing the maturity of the loan. However, the NSFR allows for considerable maturity transformation since a LT loan can be fully funded with bank liabilities of 1 year or greater. At this stage, it is too early to assess the actual impact of Basel III on the availability of bank-provided LT investment financing; implementation of the overall package has just begun and will not be completed before end-2018.
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In addition, the calibration of some of the elements of Basel III – such as the NSFR and the leverage ratio – has not yet been finalised. The long phase-in period, the on-going implementation monitoring and, in certain cases, the flexibility to adjust rules during the observation period are intended to address concerns about major unintended consequences from the introduction of Basel III. However, a number of studies have shown that the net long-term benefits of Basel III significantly outweigh the costs.8 The main benefits stem from a lower probability of banking crises (and associated output losses) and from a reduction in the amplitude of fluctuations in output during non-crisis periods.

3.2 OTC derivatives market reforms
Hedging of major risks (commodity, interest rate, exchange rate and credit) through OTC derivatives contracts as well as other financial instruments can support the viability of LT investment finance. This is because the existence of these instruments allows the ‘parcelling’ of different types of risk to those parties that are better positioned to manage them, thereby facilitating the execution of a LT finance transactions. OTC derivatives reforms will likely affect the ability of ‘sponsors’ or capital providers to hedge the various components of risk associated with providing long-term loans and investments, and thus influence the supply (cost and availability) of LT finance for commercial end-users. G20 jurisdictions have committed to a package of reforms to OTC derivatives markets in order to improve transparency, mitigate systemic risk and protect against market abuse. Under this package, all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties; OTC derivative contracts should be reported to trade repositories; and non-centrally cleared
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contracts should be subject to higher capital requirements.9 To assist in meeting the central clearing objectives, the G20 has also called for the development of standards on margining for non-centrally cleared OTC derivatives. To implement this package, international policy recommendations and national measures are being developed. The timing of implementation varies across jurisdictions. In particular, some jurisdictions have already begun imposing mandatory obligations, while others are still establishing their broad regulatory frameworks. Reporting to trade repositories applies to all OTC derivatives transactions, while central clearing requirements apply, for the most part, to financial institutions that are active in OTC derivatives markets, with non-financial participants (at least below a certain size) generally excluded from central clearing obligations. Certain aspects of Basel III will also directly affect banks operating in OTC derivatives markets. In particular, a new ‘credit valuation adjustment’ (CVA) capital charge has been introduced for bilateral derivatives exposures. This reflects the experience of the crisis that counterparty risks arising from bilateral derivatives exposures were being undercapitalised. While this capital charge will increase the costs to banks of undertaking bilateral derivatives transactions, it is intended to ensure that potential losses are appropriately capitalised. For centrally cleared transactions, there is no CVA capital requirement. There is likely to be a much smaller counterparty credit risk charge for exposures to the default of the central counterparty (CCP) than for a bilaterally cleared transaction.
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Reforms to capital requirements therefore strengthen the incentive for banks to centrally clear OTC derivatives transactions, where possible. The effects of these reforms on the provision of LT finance are difficult to quantify at this stage as some of the relevant standards are still under development. The reforms imply additional costs through new capital and margining requirements, particularly for non-centrally cleared transactions, as well as compliance costs (Box 2). These directly measurable costs need to be set against the broader reductions in costs and increased robustness of markets through the targeted improvement in market functioning. However, the reforms have not yet been finalised, so their full effect will take some time to be felt across global OTC derivatives markets. A particular example is international standards for bilateral margining requirements: once the standards are finalised later this year, there will be more information on the magnitude and scope of the requirements (including a potential threshold for the size of exposures before collateralisation applies) from which to evaluate the potential impact on LT finance. While the largest impact of the reforms will be on the financial institutions most active in OTC derivatives markets, non-financial users are likely to be directly and indirectly affected. Finance providers who are lenders or derivatives counterparties to end-users are likely to be affected by the reforms to the extent that they use derivatives to hedge their own exposures, though the likely effect of this on the provision of LT finance is unclear. Where risks associated with providing funding or hedging can be hedged through standardised contracts that are centrally cleared, the capital and margin requirements will be lower than for bilaterally cleared transactions.
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In addition, greater standardisation, central clearing and use of organised trading platforms should help improve the depth, liquidity and price efficiency of OTC derivatives markets. But for portions of the market that are not standardised and for which central clearing is not available (which may be the case for customised long-term hedges of investment financing transactions), the additional capital and margin requirements faced by intermediaries are likely to raise the cost and may reduce the availability of derivatives contracts. In such cases, intermediaries and end-users may instead resort to more standardised contracts for hedging purposes, which have greater liquidity but may be less exact and of a shorter-duration. Some costs relating to additional reporting and other compliance requirements may also be passed through to end-users. Work is currently taking place to analyse the incentives for central clearing associated with proposed capital and margining requirements. The FSB is also considering a broader macroeconomic assessment of the collective impact of the various regulatory reforms that directly impact OTC derivatives markets. This should include an analysis of the impact on end-users of OTC derivatives for hedging risks related to financing of the real economy.

Box 2. Example of the Impact of the Reforms on an OTC Derivatives Transaction
A firm proposes to build a power plant in country X, receiving revenue denominated in the local currency. To finance the construction, the firm arranges a 10-year loan denominated in USD from a syndicate group of lenders. The firm is exposed to a number of risks, which it may hedge using derivatives markets.
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The firm’s swap counterparties and lenders may also employ derivatives to hedge associated risks. • The firm may be exposed to long-term fluctuations in the energy price, which could be hedged through a long-term commodity (electricity price) derivative. • The firm is exposed to currency and interest rate risk from the USD funding source, which it may hedge through a long-term cross-currency interest rate swap. • For each of these transactions, the firm’s derivative counterparties may look to offset the resultant exposure by hedging with other counterparties. • Lenders to the firm may wish to hedge the credit risk of the loan by using credit derivatives. If the firm is subject to margining or central clearing requirements (for instance, because it is a derivatives market participant on a scale above a threshold set for exemption of non-financial firms), it will face the need to post initial and variation margin (for which purpose it must have eligible collateral available) or the need to arrange direct or indirect participation in a CCP. If the firm is exempt from central clearing or margin requirements, the only direct requirement under the OTC derivatives reforms may be for the derivatives transactions to be reported to a trade repository; this will likely be undertaken by the dealer it uses as its derivatives counterparty. There will be impacts on the firm’s swap counterparties and lenders as a result of the various OTC derivatives reforms, with the potential that some of the additional costs may be passed on to the firm. • If the firm’s derivatives are not centrally cleared, the swap counterparty will face a higher capital charge (under Basel III) for that derivative.

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In addition, if the derivative counterparty chooses to hedge the resulting exposure through additional OTC derivatives transactions, there will either be centrally cleared or face additional costs for bilateral clearing. • To the extent that the combined effect of Basel III and other international and national derivatives market reforms improve the transparency, liquidity and resilience of markets, this would lead to reductions in transaction costs for hedging transactions to offset the direct transactions costs mentioned above.

3.3 Regulatory and accounting framework for institutional investors
Institutional investors – such as insurance companies, mutual funds, endowments and pension funds – are suitable providers of LT investment capital and funding in the financial system. Their long investment horizons allow them to take advantage of long-term risk and illiquidity premia. They are also able to behave in a patient, counter-cyclical manner, making the most of low valuations to seek attractive investment opportunities. The need for diversification and the search for yield given the low interest rate environment have driven their expansion into alternative investments in recent years, including certain types of LT finance. Other types of institutional investors – such as private equity, sovereign wealth funds, and dedicated infrastructure funds – have also emerged as providers of LT capital (see below). Institutional investors are obliged to meet a variety of prudential regulations and to comply with accounting standards. On the regulatory side, investment choices may be constrained by the need to meet prudential limits. For example, ceilings on certain types of investments (such as equity or non-liquid/marketable debt) apply to pension funds in some European
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countries, and are relatively common in emerging and developing market economies. Solvency rules for insurers and pension funds are not uniform globally, but recent reforms have generally moved such investors to apply fair (market) value to their balance sheet. Some European countries have moved towards a system of risk-based solvency regulation, where funding requirements are linked to the risk faced by the institution, while accounting rules for valuing assets and liabilities have also affected these investors (Box 3). While these regulations strive to ensure that institutional investors are able to meet their obligations, they may have influenced investment behaviour and constrained the long-term outlook of those investors. On the one hand, the measures have been associated with investors matching assets and liabilities more closely, and moving to lower-risk, fixed-term assets (e.g. sovereign bonds) that provide a long-term return that better matches the expected cash flows of the insurance contract or pension liability. In addition, there has been an on-going movement away from defined benefit to defined contribution pension funds as greater transparency and better data on longevity have clarified the costs of providing the benefit. These changes were already underway before the financial crisis, and are in some ways a reaction to better understanding of risk and greater transparency of reporting. On the other hand, to the extent that the regulations use short horizons for assessing solvency or apply different methods of fair valuing the assets and liabilities, thereby creating excessive volatility in financial statements, they may promote myopic behaviour and impinge on the ability of those investors to participate in certain LT asset classes. The standard-setters are continuing to work on this issue, both in the context of the development of these standards and as part of the wider reassessment of the conceptual framework for financial reporting.
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However, it is important to note that other financial market developments – such as the increasing use of short-term benchmarks for performance measurement, risk management, reporting and compensation – may also have contributed to an excessive focus on short-term returns.15

Box 3. Examples of specific regulations affecting institutional investors Accounting rules for insurers
Insurance companies that use IFRS for their consolidated accounts are required to apply IAS39/IFRS9 to their financial assets and IFRS4 to their insurance contracts; the latter is a temporary transitional standard and the final version will not come into force until 1 January 2018 at the earliest (US GAAP has similar standards). Both standards will require market consistent valuations techniques to be applied, where appropriate, to reach a form of fair value or (in the case of insurance contracts) current value, which is felt to provide a better measure of the risks of the contract and the future cash flows of the assets than amortised cost (although some financial assets that have fixed cash flows may still be at amortised cost). These techniques, which are intended to foster consistency and transparency in the accounting treatment of insurers, may also introduce volatility to their financial statements (income statement and/or balance sheet) – for example, due to the differing valuation of assets and liabilities – and may therefore influence investment behaviour.

Accounting rules for pension liabilities of companies
Pension funds per se are outside the scope of IFRS/US GAAP and so accounting issues are not relevant. However, companies that offer defined benefit pensions schemes are obliged to calculate the present value of the future pension obligations (discounted using the rate of return on a AA-rated corporate bond) and subtract it from the current fair value of the scheme’s assets to determine a net asset or (more often) liability that is recognised on the company’s balance sheet.
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There are two relevant issues here: (1) as the liabilities are discounted using a AA-rated corporate bond, there is a tendency to match the risk by investing in bonds rather than equities; and (2) the standard’s requirement to offset current asset values against long-term liability values can cause volatility that companies may seek to mitigate by investing in lower-risk, less volatile assets. This is not a new issue – the standard has been in operation for about eight years – and it has, together with other factors (e.g. updated mortality tables), prompted many companies to move away from defined benefit schemes.

Solvency II
At the European Union (EU) level, the new prudential rules of the Solvency II Directive will require insurers to hold assets to cover the nature and duration of their liabilities. Its aim is to ensure the financial soundness of insurance undertakings, and in particular to ensure that they can survive difficult periods. Solvency II will introduce an economic risk-based solvency standard under which insurers will be charged with capital requirements proportional to the creditworthiness and duration mismatch of instruments held on their balance sheet. The European Commission has requested the European Insurance and Occupational Pensions Authority (EIOPA) to examine whether the detailed calibration of capital requirements for investments in certain assets under the Solvency II regime (particularly for infrastructure financing, project bonds and SME financing) should be adjusted to ensure there are no undue obstacles to long-term financing.

3.4 Other reforms Accounting reforms for banks
The most relevant accounting reform for banks will be on the impairment of loans and receivables.
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Both the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) are proposing a forward-looking model whereby expected losses are recognised on a loan or other financial asset measured at amortised cost (as opposed to solely after a loss event has been identified), although their approaches differ. The two Boards will be consulting on their proposals during 2013. Both models will give rise to bank loan loss provisions that are larger and recognised more quickly than the current incurred loss model, but this is an intended effect that has been requested by G20 Leaders and the regulatory community in response to the crisis. While the standards are still under development, it is likely that there will be higher levels than currently of so-called “day 1” loan loss provisions under both proposals. This treatment is consistent with the April 2009 call by the G20 Leaders to “strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information”, and it is expected to increase the transparency and comparability of banks’ financial reporting for stakeholders. The earlier recognition of losses may increase the interest rate charged for certain types of higher-risk loans, but it will reduce incentives for banks to take excessive risks and to overstate the value of their assets, thereby mitigating procyclicality.

Policy measures for G-SIFIs
Policy measures for G-SIFIs intend to address the “too-big-to-fail” problem, although they may affect the provision of LT finance by these firms. The G20 Leaders in the Cannes Summit endorsed a set of policy measures designed to address the systemic and moral hazard risks associated with SIFIs.

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These measures include a new international standard for national resolution regimes, resolution planning and higher loss absorbency requirements for G-SIFIs, and more intensive supervision of all SIFIs. The requirements for globally systemically important banks (G-SIBs) will be phased in by 2019, while the policy framework for non-bank G-SIFIs is still under development. The effect of higher loss absorbency requirements on the provision of LT finance by G-SIBs (and potentially by globally systemically important insurers) is qualitatively similar to Basel III. More effective resolution tools to address TBTF, notably the ‘bailing-in’ of debt holders of failing banks under enhanced national resolution regimes, are expected to increase these banks’ cost of funding as previously socialised risk is transferred back to bank creditors. As in the case of Basel III, the G-SIFI reforms do not specifically target LT finance. Their implementation is expected to address incentive distortions by reducing the implicit subsidy on the cost of capital and thereby lessen the need for public bail-outs to prevent disorderly failure of firms that, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity.

Shadow banking
The shadow banking system can broadly be defined as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system”. It is conducted through (for example) securitisation or securities lending activities and involves various types of institutions, including investment and money market funds, structured finance vehicles, finance and trust companies etc.

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The shadow banking system represents an important provider of financing in several FSB member jurisdictions. Such intermediation was highly volatile in the past but, if appropriately conducted, it can provide a valuable alternative to bank funding, including by filling some gaps left by the potential retrenchment of bank lending in certain regions or business lines. The on-going shadow banking reforms aim to promote prudent financial intermediation and thereby contribute to more sustainable non-bank financing, including for LT investments. In particular, the objective of strengthening the oversight and regulation of this sector is to address, in a proportionate manner, bank-like liquidity and maturity transformation risks to financial stability, while not inhibiting sustainable non-bank financing models that do not pose such risks. Since policy development is on-going in this area, it is too early to assess the effects of these reforms, including on LT financing.

4. Conclusion and next steps
It is still early days in the global regulatory reform process. Many of the reforms are in the process of policy development or at an early stage of implementation. However, the regulatory community has analysed potential impacts prior to finalisation of the reforms and is vigilant to avoid material unintended consequences. The long observation and implementation periods are designed to adjust the policy frameworks, if needed, in the face of material unintended consequences. There is little tangible evidence to suggest that global financial regulatory reforms have significantly contributed to current LT financing concerns, although on-going monitoring is needed.
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It is difficult to separate the effects of regulatory reforms on LT finance from broader post-crisis developments affecting the financial system, but conjunctural factors other than financial regulation are particularly important given the current market environment. The effects will also differ significantly across jurisdictions and market segments depending on their particular characteristics, such as the origin and circumstances of the banks providing cross-border lending. Nonetheless, there is concern by some EMDEs that the reforms may exacerbate deleveraging and increase the costs for global banks operating in host jurisdictions, thereby reducing domestic credit (including for LT finance) and financial market liquidity; some of these jurisdictions may lack private sector options to replace this financing gap, at least in the short term. Monitoring the effect of regulatory reforms on an on-going basis will facilitate the identification of any factors that may disproportionally impact the provision of LT finance so that they can be addressed. While the reform process is still at an early stage, the direction is unambiguous and intended. The most important contribution of financial reforms to LT investment finance is to promote a more resilient and stable financial system. The reforms are intended to be proportionate to risks and are not designed to encourage particular types of finance at the expense of financial stability. Many financial institutions were over-leveraged and had engaged in excessive maturity mismatching prior to the crisis, and are currently working to strengthen their balance sheets and adjust their business models. These are intended changes that aim to return to more prudent business practices and smooth the provision of LT finance over economic and
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financial cycles, even if they may result in, for example, lower access to credit or higher loan spreads during boom times. Although the reforms are not specifically targeting LT investment finance, they do alter the incentives of different types of financial institutions to participate in this market. As previously mentioned, the reforms introduce stricter prudential requirements for all types of lending and not solely for LT finance. However, to the extent that new regulation reduces the incentives for funding long-term assets with short-term liabilities by banks, some change to the structure and composition of such financing might be expected. Greater reliance on equity finance may also be a desirable effect of this change as there has arguably been excessive use of debt to finance LT projects whose payoff and risk characteristics are more equity-like. As the balance of incentives changes, long-term institutional investors will need to assume a greater role in funding long-term assets. This would be desirable from a financial stability perspective as the financial system would become inherently less fragile. An important issue going forward is whether non-bank providers of LT finance, particularly institutional investors, can step up their involvement in this market. Anecdotal evidence suggests that this process is underway in some market segments (e.g. infrastructure finance), but it can take time and is not uniform across different segments or regions. As noted in the preceding section, the regulation of these types of investors may need closer study to ensure their effectiveness and efficiency in playing this role prudently, without compromising financial stability objectives.
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The FSB and its member institutions are already contributing to this effort via inter alia enhancing risk disclosures by financial institutions, undertaking measures to reduce undue reliance on credit rating agency ratings, encouraging the adoption of international financial standards and continuing work to achieve a single set of high-quality accounting standards, promoting cross-border supervisory cooperation, and supporting prudent financial intermediation by non-bank financial institutions. However, more can potentially be done to assess the impact of changes in financial market structures and trading practices on LT capital raising, to overcome existing information asymmetries and improve the contractual environment for investors in LT transactions, to promote LT investment horizons by institutional investors, to identify ways to expand access to capital markets for non-financial firms, to avoid the inconsistent implementation of internationally agreed reforms that may give rise to uncertainty by market participants, and to promote greater use of sound and sustainable securitisation structures as a tool for LT financing. An FSB workshop, bringing together relevant parties (national authorities, standard-setters, IOs, institutional investors), may be a helpful first step to identify regulatory initiatives to foster LT investment finance. From a longer-term perspective, promoting the development of domestic contractual savings and the capacity of domestic financial systems to intermediate them will foster more and less volatile LT finance, particularly in EMDEs. The presence of market participants with different horizons and risk preferences is an important contributor to financial stability and it also helps promote efficient resource allocation by reducing over-reliance on the banking sector or on foreign sources of finance for the mobilisation of savings and financial intermediation. However, developing domestic non-bank financial institutions and capital markets is a long-term process that requires proper planning and commitment as well as appropriate prioritization and sequencing.
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The development of capital markets requires a number of important building blocks, such as strengthening the legal and regulatory framework; developing short-term money and government securities markets and instruments to hedge exchange rate risk; expanding the domestic investor base; strengthening market infrastructure; and promoting local currency corporate bond markets. The FSB, working through its Regional Consultative Groups and in collaboration with relevant IOs (e.g. IMF, World Bank, OECD), can contribute to the on-going work on this topic. There is little tangible evidence to suggest that global financial regulatory reforms have significantly contributed to current LT financing concerns, although on-going monitoring is needed. It is difficult to separate the effects of regulatory reforms on LT

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Keynote

James R. Doty, Chairman Florida Bar Association 31st Annual Federal Securities Institute, Miami Beach, FL Thank you for inviting me to this conference. Let me begin by saying that the views I express are my own and should not be attributed to the Public Company Accounting Oversight Board as a whole or any other members or staff. Today, I would like to talk to you about some of the PCAOB's initiatives to enhance the relevance, credibility and transparency of the audit to promote high quality financial reporting. We meet in the midst of a robust and wide-ranging global debate on how to promote audit quality. Whatever the outcome, it is clear that the audit is indeed a valued, critical feature of the U.S. financial system, and it enjoys an important position in the eyes of people around the world.

I. High-Quality Audits Are Critical to Capital Formation and Economic Growth.
High-quality audits are critical to capital formation and economic growth. This has been so since the earliest days of our organized securities markets. Our colleague Bernard Black, on the faculty at Northwestern, may have put investors' predicament best. He once wrote — [C]reating strong public securities markets is hard. That securities markets exist at all is magical, in a way.
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Investors pay enormous amounts of money to strangers for completely intangible rights, whose value depends entirely on the quality of information that the investors receive and on the sellers' honesty. It is to the credit of the securities bar that we have been able to fashion a system of securities regulation that gives millions of disorganized investors a basis to trust the information they receive, to trust that their capital will be applied to the purpose intended. One of the best features of our system is that it is not immutable. We have been able to improve it over time, as we develop new forms of capital accumulation and allocation to meet new needs of investors and new uses for public funds. Through your efforts, among others, the U.S. has become a clearinghouse for the fair allocation and use of capital. Professional, skilled and independent auditors are key to helping investors separate the credible managers from the charlatans. By building a basis for confidence, auditors reduce financing costs, and contribute to an efficient allocation of capital to fuel economic growth. But conferences like this do not exist to congratulate ourselves. The bar has reconvened each of the 31 years in the history of this conference to prepare for and channel new developments and evolution. As with the Holmesian view of the law — not logic but experience — so also with the audit. We learn and improve from experience. One principle that continues to stand, upon examination and re-examination, is that, as Bernie Black said, the value of the investor's intangible right — the value of the share — depends entirely on the quality of information the investor receives and on the seller's honesty.

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In recognition of Black's insight, I believe we are in a high risk period that merits more attention to the audit, not less. Although we have never needed it more, the audit has, in the minds of some, become a commodity to be contained with other compliance costs. Academic research confirms that the harm of fraudulent reporting extends beyond the injury to direct stakeholders and reaches whole industries and competitors. When trust in financial reporting is lost, the markets question competitors' business strategies too. Unwinding ill-conceived investments may be costly and impractical. Moreover, confidence in new, valid proposals for capital committment can be affected. As a former securities law practitioner and counsel to boards, I believe the audit is the most cost-effective way to avoid being surprised by errors or malfeasance that have quietly grown to approach a material level. While not foolproof, the audit confirms legitimacy. But an audit that does not serve the needs of users is false comfort and, over time, loses its relevance to market participants. To be relevant, the auditor must speak to and for the users of the financial statements. For the audit to be relevant, the public must be confident in the auditor's ability to apply both technical expertise and skepticism to management's assertions. Fair or not, that is in question today. And this is where the PCAOB's initiatives come in.
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I want to see a vibrant audit profession that competes on quality more than price. I want to see a profession that is revered for insight and clarity, not box-checking. I want to see a profession that attracts and retains top graduates who are and remain committed to excellence in public service. I doubt I need to impress upon you the bar's interest in these goals as well. Audit regulators around the world are engaged in confronting these challenges. The PCAOB is deeply engaged with its counterparts, both through inspection coordination and multi-lateral meetings in venues such as the International Federation of Independent Audit Regulators. I will share some of what we are learning from other regulators.

II. International Audit Oversight Coordination and Results
With that in mind, let me briefly describe our approach to coordinating with our counterparts around the world. To date, the PCAOB has conducted inspections in 40 foreign jurisdictions. Last year, one-fourth of our inspections took place outside the United States. Overall, there are around 240 non-U.S. audit firms in over 50 foreign jurisdictions that have issued audit opinions on U.S. issuers and are required to be inspected at least every three years.

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A. Audit Regulators Around the World Are Developing a New Paradigm for Working Together.
Gradually, together with our counterparts, we are creating a network of regulators to match the networks of firms. The aim is to work seamlessly together to meet our respective inspection mandates. We now jointly inspect with local regulators in Australia, Canada, Germany, Korea, the Netherlands, Norway, Singapore, South Africa, Switzerland, Chinese Taipei and the United Kingdom. Two weeks ago, the PCAOB entered protocols on cooperation and information-sharing with the audit regulators in France and Finland. These agreements will allow the PCAOB to begin conducting joint inspections of PCAOB-registered firms in France and Finland with the local regulators. Our non-U.S. inspections are important, not only because of the foreign private issuers that sell securities in U.S. markets. Many of the non-U.S. audit firms that have registered with the PCAOB also perform significant audit work for U.S. companies that have operations abroad. This is the nature of the global audit. The principal auditor — that is, the auditor that signs the audit report — refers a portion of the audit to local auditors in a country or countries where the company has subsidiaries or significant operations. The local auditor may perform specified procedures that the principal auditor asked it to perform. Or it may perform for the principal auditor a complete audit, with audit report, on the local operation.
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In either case, generally speaking, the principal auditor uses the work of other audit firms to form an opinion on the financial statements as a whole.

B. Regulators Around the World Have Expressed Shared Concerns About Disappointing Inspection Results.
Let me turn to results. What benefit does coordination yield? As we deepen our relationships with fellow independent regulators, we deepen our understanding of audit risks. We have identified significant audit failures after issues identified jointly with another regulator in an inspection of the principal auditor led us to review a subsidiary audit in a third country. Our inspectors have also found situations where a U.S. firm has used the work of another audit firm that turned out to be unreliable. Sometimes the work requested by the principal auditor was never performed. Both in this joint work and independently, regulators around the world have expressed concerns about disappointing inspection results. In Australia, Greg Medcraft, the Chairman of the Australian Securities and Investment Commission recently commented in the Australian Financial Review about ASIC's review of inspections conducted in the 18 months up to June 30, 2012. He said it "showed an increase in auditors failing to obtain reasonable assurance the audited financial statement was not materially misstated." In particular, he called for improvement in three key areas — the sufficiency and appropriateness of audit evidence, auditors' professional skepticism, and auditors' use of other auditors and experts. Similar results have been reported across Europe and in Canada.
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According to a compilation of inspection results from Canada, the U.S., the U.K. and Australia, prepared by the Canadian Public Accountability Board's Chairman, Brian Hunt, "Insufficient Professional Skepticism . . . is undoubtedly the most common finding — that auditors are too often accepting or attempting to validate management evidence and representations without sufficient challenge and independent corroboration." Since it began operations in 2003, the PCAOB has tackled progressively more of the vexing issues with which the audit profession has struggled for decades — such as the failure to apply professional skepticism in difficult audit areas, including management estimates and valuations. The PCAOB also performs increasingly refined and sophisticated risk assessments to identify where the most significant challenges to audit quality exist. This contributes to the increase in inspection findings over time. Tackling these tough issues has also contributed to an improvement in audit quality, I believe. Nevertheless, as other audit regulators around the world have concluded too, the rate of failure is unacceptably high.

III. The PCAOB's Initiatives Aim to Help the Profession Realize Its Potential by Enhancing the Relevance, Credibility and Transparency of the Audit.
There is a lot going on at the PCAOB to examine these issues and find ways to improve auditor performance. We have an active standards-setting agenda developed through extensive outreach, including with the PCAOB's Standing Advisory Group as well as other standard-setters.

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In this outreach, we hear from numerous stakeholders, including auditors themselves, as well as preparers and their representatives, experienced members of the bar, investors, and others. We don't rewrite standards just for the sake of change. But through our consultation process we identify areas of auditing that deserve improvement or updating in light of developments in practice. We consider alternatives to achieve our intended outcome. We consider potential costs, as well as potential unintended consequences. We are adding resources to involve economists more deeply in our work. Our agenda is available on our website and is updated periodically. Today, I will highlight a handful of projects that may be of particular interest to the bar.

A. Facilitating the Work of Audit Committees.
The first two such initiatives focus on arming audit committees with more and better information about the audit, as well as more and better information about the auditor's strengths and weaknesses. According to a January 2013 Global Audit Committee Survey, released by KPMG's Audit Committee Institute, only 38% of audit committees claimed to have a formal and comprehensive annual external auditor evaluation process in place. Audit committees cannot make decisions about hiring and compensating auditors on the basis of quality without transparency and insight about quality. Our audit committee initiatives aim to help audit committees obtain that information.
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1. Auditing Standard No. 16 Improves Auditor Communication with Audit Committees.
The PCAOB has recently adopted a new auditing standard — Auditing Standard No. 16 — on what the auditor should communicate to audit committees in order to protect the public's interest in keeping audit committees informed of important audit matters. I know you'll have a panel on the Jumpstart Our Business Start-ups Act of 2012 tomorrow. So it may be of interest that this standard is the first promulgated after the JOBS Act was enacted. Consistent with Section 104 of the JOBS Act, when the PCAOB submitted the final standard for approval by the SEC, we included a discussion of efficiency, competition and capital formation. The SEC approved the standard on December 17, 2012. It is effective for audits of fiscal years beginning on or after December 15, 2012. AS 16 is intended to foster a more robust discussion between the auditor and the audit committee. It is intended to focus the audit committee on the importance of probing and understanding challenging audit issues and significant auditor judgments, and championing the auditor's independence and professional skepticism in resolving those issues and making those judgments. I would expect the best audit committees to demand this kind of dialogue already. Yet we see situations where this was not the case. AS 16 is an attempt to change that.

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2. The PCAOB Has Issued Guidance on What Audit Committees Can Learn from PCAOB Inspections.
The PCAOB has also recently issued guidance about how audit committees can learn more from their auditors about the results and implications of the PCAOB's inspection findings. Description in the public portion of the inspection report of failure to obtain sufficient evidence to support the firm's opinion means that the inspection staff has determined that the firm failed to fulfill its fundamental responsibility in the audit: the firm failed to obtain reasonable assurance about whether the financial statements are free of material misstatement. Firms' characterizations of inspection results can sometimes distort them. How an auditor approaches inspection results can tell an audit committee a lot about the firm's commitment to excellence. Your role as corporate counsel makes a difference: how an audit committee addresses inspection results can affect the tone of the audit. An audit committee that is impatient with the technicalities of an audit, or accepts weak arguments to dismiss the findings in an inspection report, may inadvertently signal to the audit firm and audit team that the audit committee is not concerned with quality. An audit committee that, on the other hand, expresses explicit concern for how the auditor has resolved noted deficiencies tells the auditor that quality matters. And then, there is the fallacy of elevating the fee above the quality of the auditor. As counsel for corporate boards, you will want to be attuned to these nuances.
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B. The PCAOB Has Proposed New Standards on Related Party Transactions and Audit Transparency.
The PCAOB has also proposed two new standards. The first would enhance the public's understanding of the audit by requiring disclosure about participating firms as well as the name of the engagement partner who supervises them. Today, only the principal audit firm's name goes on the audit report that the public sees. We are reminded, from time to time, that even sophisticated business people and government officials who use audit reports do not realize that audits for large companies are often performed by consortiums of separate audit firms. For companies, and their counsel, concerned about the risk of override of controls and material misstatements in far-flung locations, it is the work of these undisclosed subsidiary auditors, and the rigor of the principal auditor's oversight of their work, that provides the company (and investors) with assurance that the necessary controls are in place and working effectively. Depending on where a company's operations and accounting are, the underlying source of half or more of this assurance work may be performed by a firm or firms other than the firm whose name is on the audit report. But even those who are aware that multiple firms may be involved in an audit generally don't know the extent of work performed by other audit firms. The PCAOB has proposed to address this. The second proposal is a new auditing standard on related party transactions, describes basic tools that good auditors have used for years to identify financial reporting risks.
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For example, it requires auditors to understand management's compensation as a way to understand management's motivations. To be clear, nothing about the standard would put the auditor in the role of setting or passing on management compensation. Some commenters have expressed concerns in this regard, but as the standard itself makes clear it's simply not the case. I doubt I need to tell you, though, that changes in performance metrics provide important information about management's incentives that may not otherwise be understood. They offer the auditor — and audit committee — insights about where management's financial story could be weak. We are currently evaluating comments on both the related party proposal and the transparency proposal.

C. The PCAOB Has Issued Concept Releases to Commence Debate on More Broad-Ranging Topics.
The PCAOB standards-setting work also includes two rather more broad-ranging projects, commenced not with concrete proposals but with concept releases.

1. The Auditor's Reporting Model
One involves consideration of changes to the form and content of the standard audit report. The current model is essentially three boilerplate paragraphs. For a long while, investors have called for more insights from the auditor's work.

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This project is intended to develop a better, more transparent reporting model, one that will impart the auditors' insights about key aspects of the financial statements and other matters to emphasize. The project is not about changing the nature or scope of the auditor's work. It's about making the results of that work more relevant.

2. Auditor Independence
The second concept release goes to the issue of auditor independence, objectivity and professional skepticism. In August 2011, the Board issued a Concept Release on Auditor Independence and Audit Firm Rotation. The concept release notes the importance of auditor independence to the viability of auditing as a profession. It asked for comment on ways to enhance auditor independence, objectivity and professional skepticism, including through auditor term limits, which are being debated around the world today. As a concept release, it made no specific proposal. Rather, the vehicle of the concept release is designed to pose questions to solicit public input before any proposal is considered or formulated. Independence and skepticism are complex issues that warrant deep study. The PCAOB has embarked on a series of public meetings to engage prominent and thoughtful commenters with various, often conflicting, viewpoints. One outgrowth of the meetings so far has been a PCAOB staff audit practice alert on Maintaining and Applying Professional Skepticism in Audits issued in December 2012.
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The Alert reminds auditors of the critical importance of professional skepticism to effective audits. The Alert also describes a number of impediments to professional skepticism — including, for example, unconscious human biases and other circumstances that can cause auditors to gather, evaluate, rationalize, and recall information in a way that is consistent with client preferences rather than the interests of external users. Finally, the Alert describes steps that firms and auditors can take to enhance professional skepticism in audits. We must also watch and evaluate the implications of international developments. The Dutch Parliament recently adopted audit firm rotation. It appears likely that some companies plan to implement auditor switches ahead of the 2016 deadline. The European Commission, Parliament and Member States are engaged in their own inquiry. Their legislative deliberations indicate a real likelihood that some form of term limits could be adopted this year. Firms in Europe have had to factor the possibility into their strategic business planning. This is not a new issue: concerns over independence and the role of anticipated or established auditor tenure predate the Sarbanes-Oxley Act. It is now, however, a broad international debate. People disagree on what the best reforms will be, how to implement them, and indeed whether reform is necessary. Costs and any potential unintended consequences will have to be considered.
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We should not rush to decision. I don't have the view that independence and skepticism can only be achieved through term limits. Through the responses to the August 2011 concept release and the substance of our public meetings, we have elucidated many of the questions asked by the concept release. Our job at the PCAOB is to be alert to the changes that are afoot: to understand them, to analyze their effects on the audit, and to consider what it all implies for the future of the audit. *** You have been a gracious audience and I thank you very much for your interest in the PCAOB's work.

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Strategic Goals 2013 to 2016
Note: The Swiss Financial Market Supervisory Authority FINMA is an institution under public law with its own legal personality. It is responsible for implementing the Financial Market Supervision Act and financial market legislation. As an independent supervisory authority, FINMA acts to protect the interests of creditors, investors and insured persons, and to ensure the proper functioning of the financial markets . Their protection lies at the heart of FINMA’s mandate.

Consistent, risk-oriented supervision
In its supervisory role, FINMA focuses on the prudential supervision of banks, insurers, collective investment schemes and other financial intermediaries. Prudential supervision is an ongoing activity in which FINMA scrutinises the supervised institutions and the market with a focus on the future. Its aim is to maintain the financial soundness of these institutions, primarily by ensuring that they are solvent, have adequate risk controls and provide assurance of proper business conduct. In order to set the right priorities in prudential supervision, FINMA consistently pursues a risk-oriented approach. FINMA cannot provide full-spectrum monitoring of all the supervised institutions. It must therefore concentrate on the key risks for creditors, investors and the system as a whole.
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Supervision of large, interconnected institutions and segments with greater inherent risk is necessarily more intense than for smaller market participants with lower risk profiles. The risk-oriented approach is reinforced by continuous monitoring of the financial market and, more recently, targeted spot checks. In line with international trends, FINMA has substantially increased its activities to identify system-wide and systemic risks at an early stage. The focus here is on large, interconnected financial institutions and market participants that perform non-substitutable functions. FINMA aims to ensure that Switzerland’s financial institutions meet international norms in terms of capital, liquidity and resolvability. Systemically important institutions must exceed the international norms. In the event of the insolvency or bankruptcy of a supervised institution, it is FINMA’s task to protect financial market clients from the consequences. If an institution gets into difficulties, FINMA reacts rapidly and professionally to take the necessary measures. If there is no prospect of successful restructuring, an orderly market exit must be possible. FINMA analyses the conduct of financial market participants. However, in order to effectively protect financial market clients from abuses, clear rules of conduct for financial services providers are imperative, as are better product documentation and increased transparency.

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FINMA’s strategic goals

Prudential supervision Strengthening financial stability and crisis resistance through prudential supervision
The interest rate situation, the changed environment in cross-border business and the pressure on margins and prices are presenting banks and insurers with major financial and organisational challenges in their core business. Significant structural change in the Swiss financial centre can be expected in the medium term. Historically low interest rates are depressing the earnings of almost all supervised institutions. Banks and insurers, especially life insurers, are being forced to find investments that generate higher returns. This means, however, that they are also taking greater risks. Low interest rates also pose a danger to supervised institutions in the Swiss real estate market.
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The legal and reputational risks associated with cross-border financial services continue to be of major importance. The companies in question must recognise the need for strategic reorientation and deal appropriately with legacy issues.

Strategic goal 1
The stability and crisis resistance of the Swiss financial centre are strengthened through internationally recognised prudential standards and consistent compliance with them. If market exits take place, they do so in a way that is orderly and quick, and result in the least possible damage to financial market clients.

Business conduct Promoting integrity, transparency and client protection in business conduct
Current legislation does not guarantee adequate client protection as far as the business conduct of financial intermediaries is concerned. In this respect, Switzerland lags behind international regulatory standards. In the first place, Swiss clients are at a disadvantage compared with non-Swiss clients because they are often not adequately and transparently informed. Secondly, there is a risk that the Swiss financial centre could attract undesired market participants. Thirdly, client protection that is not fully equivalent can have an adverse impact on the ability of Swiss financial service providers to gain access to other markets.

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Regulations that do not meet appropriate, internationally recognised minimum standards weaken the reputation of a quality-oriented financial centre. The patchy client protection regulations at point of sale are one example of this. The supervisory legislation provides for a variety of authorised institutions with differing licensing requirements. Not every licence leads to ongoing monitoring by the authorities. As far as the quality and intensity of licensing and supervision by FINMA are concerned, there is a transparency deficit for financial market clients.

Strategic goal 2
In order to enhance the reputation of the financial centre and promote fair business conduct and integrity on the part of financial market participants, FINMA consistently implements licensing procedures, creates transparency regarding the varying degrees of supervisory intensity, and promotes internationally recognised regulations on client and investor protection.

National and international cooperation Joining forces at the international level and working together efficiently at the national level
The scope and intensity of international activities have increased markedly. This trend will persist into the near future. FINMA must prioritise the deployment of its resources on international initiatives effectively. Against this backdrop, cooperation at the national level with other institutions and authorities must be streamlined so that Switzerland’s interests can be more effectively represented at the international level.
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Because of the different mandates of the authorities involved, their responsibilities have to be prioritised differently depending on the situation: • The Federal Department of Finance promotes Switzerland as a place to do business. The State Secretariat for International Financial Matters works to strengthen the international position of Switzerland in the field of finance and tax. It represents the interests of Switzerland vis-à-vis other countries in international finance and tax matters and is leading the international negotiations in these areas. • FINMA fulfils its international remit from the point of view of a financial market supervisor. In the field of financial stability, FINMA works closely with the Swiss National Bank. Responsibility for supervising the individual financial institutions lies with FINMA. It is crucially important that the differing statutory responsibilities and decision-making powers are preserved.

Strategic goal 3
In its international activities, FINMA concentrates its resources and uses them to address important core issues. In the context of national cooperation, the information flow is efficient and the decision-making scope of the authorities is clear.

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Regulation Engaging expertise and regulating in light of its supervisory goals
Financial market supervisory law defines FINMA’s competences in financial market regulation. FINMA generally regulates by way of circulars which explain how financial market regulation is to be applied. It also regulates by way of ordinances where this is enshrined in the law. Financial market legislation, on the other hand, is a political responsibility. The legislature defines the regulatory framework binding on FINMA. The financial market laws are therefore the result of a political process and hence the subject of political discussions and compromises. In accordance with its supervisory mandate, FINMA is guided by its supervisory goals, explaining its position early and transparently, but without taking part in political debates.

Strategic goal 4
FINMA analyses existing regulations and legal trends from the perspective of financial market supervision, proposes relevant amendments, uses its specialist expertise to support the proposed regulations that are important and highlights its own concerns early and transparently. Within its area of responsibility, FINMA regulates only in so far as this is necessary in light of its supervisory goals.

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Manuel Sánchez: Mexico’s economic outlook and challenges
Remarks by Mr Manuel Sánchez, Deputy Governor of the Bank of Mexico, at the Conference “Regulatory reform, the global economic outlook, and the implications for Mexico’s financial sector”, organized by the Institute of International Finance and Banorte, Mexico City
***

It is a privilege to speak at the close of this conference devoted to the implications for Mexico of recent regulatory reforms and the global economic outlook. I would like to thank the organizers of this seminar, the Institute of International Finance and Banorte, for the opportunity to share some thoughts with you on Mexico’s economic conditions and prospects. I would like first to review the recent developments in the Mexican economy and its outlook in today’s weak world economic environment. Then, I will analyze the implications of currently benign financial conditions. And finally, I will discuss some of the present challenges for monetary policy in Mexico. As usual, my remarks are entirely my own responsibility and do not necessarily reflect the views of the Bank of Mexico or its Governing Board.

The Mexican economy in a weak global environment
The performance of the Mexican economy last year continued to be constrained by a weak global environment.
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The world economy expanded at a slower pace than the average observed in the two decades before the big financial crisis. In the United States, GDP grew moderately, and for a fifth consecutive year, output remained below its secular trend. Signs of improvement in several variables in the United States are encouraging, including those suggesting the beginning of a turnaround in the housing market and the gradual recovery of bank lending to the private sector. However, the level and characteristics of unemployment as well as the sluggishness of private investment remain sources of concern. Additionally, U.S. industrial production, which exerts substantial influence on Mexico’s production and trade, has lately exhibited a deceleration. The rebound in U.S. output after the crisis has been disappointing, especially in light of significant stimulus provided through previous fiscal packages and the ongoing extraordinarily expansionary stance of monetary policy. Subpar economic performance may be partly explained by uncertainty regarding the speed and distribution of costs in the pursuit of fiscal consolidation. Recent fiscal accords may have reduced the risk of a GDP contraction. On the other hand, during 2012, the euro area fell into recession with unemployment rates at record highs. To a large extent, the problems in the region stem from institutional limitations of the design of the monetary union that have complicated dealing with the aftermath of national financial crises. Progress in revamping the EMU architecture, bailout programs for troubled economies and, especially, decisive measures undertaken by the
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ECB have lowered perceived risk for sovereign and bank debt, especially in the peripheral countries. Although further meaningful structural measures will be required to attain a full economic recovery, the financial stabilization achieved may suggest that the worst of the crisis is over in the euro area. Consistently, the most recent consensus estimates for 2013 and 2014 posit a gradual recovery for the world economy, moderate deceleration followed by higher growth in the United States, and a slight contraction and later an expansion in the Eurozone. In spite of this challenging environment, last year Mexican economic activity continued to exhibit a positive trend, with a firmer expansion in services than in industry. In the fourth quarter, annual growth was the same as in the previous quarter, although both figures were not as high as in the first half of the year. Annual GDP growth for the full year was 3.9 percent, virtually the same as in 2011; this growth is noteworthy, especially in the present world context, as it is almost one percentage point higher than Mexico’s average growth rate during the twenty years prior to the crisis. On the back of this progress, external demand, as reflected prominently in manufacturing exports, has shown some moderation in growth in the past several months, with a recovery in the most recent quarter. By far, the main source of deceleration came from countries other than the United States, and in particular in automotive exports. This slowdown is partly explained by restrictions imposed by Brazil and Argentina on auto imports from Mexico. At the same time, domestic demand continued expanding.

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Private consumption, the largest component of domestic spending, maintained its momentum, as indicated by available data on retail sales up to November. The strength of consumption has been supported by a sustained increase in formal employment, a moderate decline in unemployment, and a significant expansion in consumer lending. Gross fixed investment kept rising, with machinery and equipment showing higher growth rates than construction. Additionally, measures of business confidence up to January 2013, such as the Manufacturing Orders Indicator (IPM), reveal that business managers foresee that the economy will maintain its expansion. Given the expected slowdown in the U.S. economy largely due to fiscal consolidation, analysts predict that Mexico’s economic growth in 2013 will be slightly lower than that of the previous year, with a recovery occurring in 2014. There are both downside as well as upside risks to this scenario. A fiscal adjustment in the United States applied in a disorderly way or lacking credibility, or a complication in policy implementation in the Eurozone that augments financial uncertainty, stand out as possible negative external factors. However, the recovery in the United States may be faster than forecast, and investor confidence in Mexico could increase as a result of progress on structural reforms favoring long-term growth.

Capital inflows and benign financial conditions
During the last four years, the yield curve in Mexico has successively shifted downward, a process that has continued so far this year, leaving current interest rates for all terms close to or at their all-time lows.

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Aside from variations due to changes in risk aversion, the main driving force for these shifts has been almost synchronic shifts in the U.S. yield curve, resulting from the different stages of monetary easing there. The main transmission mechanism for lower interest rates has come from persistent capital inflows. As in other emerging economies, Mexico has received substantial capital flows from foreign investors seeking higher yields in both equity and bond markets. Also, foreign investors may feel more confident about the Mexican economy because of its sound macroeconomic and financial fundamentals, the openness of its capital account, the flexibility and depth of its foreign exchange market, and higher expectations for structural reforms, among other factors. As a result, from 2009 to 2012, the proportion of non-equity financial assets held by foreigners relative to the broadest monetary aggregate, M4, increased from five to seventeen percent. There are indications that inflows have speeded up during the current year in many emerging economies, including Mexico. The abundance of foreign savings was supportive of Mexico’s recent economic growth. However, the possibility of a change in the perceived conditions that gave rise to the inflows makes it likely for those flows to stop and even revert. Such reversals have occurred on innumerable occasions in many countries, including Mexico, for reasons not necessarily related to the recipient country, causing substantial financial disturbances. The obvious case at present could be the expectation that the Federal Reserve will start unwinding its expansionary monetary policy.

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Before such an eventuality occurs, for whatever reason, and about which only the timing and magnitude are uncertain, it is absolutely necessary for savers and borrowers as well as financial intermediaries to take into account that interest rates will eventually rise. The real danger is to believe that this time will be different and that somehow present favorable conditions will last forever. Such myopic behavior has often led to excessive risk-taking, overleveraging and the formation of bubbles in credit and real estate markets, frequently the prelude to financial crises and painful massive redistributions of wealth. Fortunately, Mexico’s banks have been operating cautiously, thereby maintaining strong balance sheets and healthy loan portfolios. Also, no lending bubble is apparent. However, authorities will have to continue monitoring threats to stability in any part of the financial system, in order to act in a timely way if they emerge.

The challenges to monetary policy
In 2012 annual inflation exhibited a rising trend to a maximum of 4.8 percent in September. During seven months it surpassed the upper limit of the variability interval of plus or minus one percentage point around the permanent target of 3 percent established by the Bank of Mexico. Factors exerting pressure on inflation included the international draught and the domestic bird flu epidemic that resulted in significant agricultural price increases, and some pass-through from peso depreciation to merchandise prices.

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In December 2012 and January 2013, inflation fell to below 4 percent, a welcome development in light of the previous considerable deviation from the target. Nevertheless, the recent decline in inflation should be seen with caution. This is because, first, it is based only on two observations, which cannot yet be proven to be the beginning of a new trend. Second, the drop in inflation depended significantly on sharp declines in telecom prices and moderating agricultural price increases. If one were to exclude the effect of telecom prices on inflation in December and January, inflation would have been above and practically on the upper limit of the variability interval, respectively. Also, as occurs with negative disturbances, positive shocks like the recent ones sooner or later die out and could be followed in their own turn by adverse shocks. Third, the proportion of the components of the National Consumer Price Index (INPC) basket with annual increments higher than 4 percent is still substantial. Fourth, the two most recent inflation prints exceed the target and do not even correspond to the lowest inflation rates observed in Mexico during recent years. These caveats are all the more important as the target has not been achieved in the past, in the sense that inflation has not been fluctuating around 3 percent. In fact, since the end of 2003 when this objective became effective, inflation has varied around a mean of 4.3 percent. Moreover, during the nine years after the establishment of the target, inflation has not exhibited any clear path of convergence towards it.
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This lack of convergence may partially explain why inflation expectations for the short and medium terms, as reflected in analysts’ surveys, have long remained stubbornly above the target. These considerations call for vigilance in monetary policy. The target is the principal guide and has not been attained. Furthermore, negative shocks could easily complicate convergence. Risks include the following: weather and animal health problems could fuel agricultural price rises; new episodes of heightened risk aversion could trigger currency depreciation with some effects on inflation; public-sector prices could be higher than anticipated; and finally, some aggregate demand pressures may arise in light of conventional measures suggesting that slack in the economy has disappeared.

Concluding remarks
In spite of a weak global environment, Mexico’s GDP kept growing at rates surpassing historical records. Analysts’ outlook for the Mexican economy posits a slight deceleration in 2013 and a recovery the following year. There are both downside and upside risks to this scenario, including on the positive side, further progress on structural reforms. Substantial capital inflows resulting in unusually favorable financial conditions in Mexico have been supportive of economic activity. However, economic agents should remain prudent as these flows, for many reasons, could stop and even revert.
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Finally, the short period of recent improvement in inflation, the extraordinary factors that explain it, and the absence of convergence toward the inflation target, require a vigilant monetary policy. Convergence of inflation to the permanent target demands more than a few months of good results.

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“The SEC Speaks in 2013”
Commissioner Daniel M. Gallagher U.S. Securities and Exchange Commission Washington, D.C. Thank you, Craig [Lewis], for your kind introduction. This is my second year addressing this conference as a Commissioner. Last year, I spoke as one of five Commissioners, while this year, as you well know, we’re temporarily down one member. And so, I understand that the organizers are

offering a 20% discount which you can collect after my remarks. Just kidding.
The truth is that they asked all of us to give longer speeches, and since I am still the junior Commissioner, the others dumped their extra time on me. So, I hope you are ready for an hour long adventure. Before I begin, let me remind you that as usual, my remarks today are my own and do not necessarily reflect the views of the Commission or my fellow Commissioners. On a number of occasions since returning to the SEC as a Commissioner, I’ve spoken about the Commission’s priorities, both in terms of what the Commission is doing and what it should be doing in order effectively to
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carry out its mandate to protect investors, ensure fair and efficient markets, and facilitate capital formation. Needless to say, the Commission does not operate in a vacuum, and for various reasons, it’s not always easy to execute those priorities as we see fit. The constant stream of external influences on the Commission’s work serves as a significant impediment to its ability to focus on the core mission, including the vital, basic “blocking and tackling” of securities regulation. Today, therefore, I’d like to talk about the Commission’s origin and role as an expert, independent agency — as well as the challenges to that independence — in what has become in recent years a difficult environment for independent agencies. As I’m sure all of you know, Congress created the SEC in the Securities Exchange Act of 1934. What some of you may not know, however, is that the Securities Act of 1933 originally tasked the Federal Trade Commission with administering the new federal securities laws. Indeed, the FTC was the initial choice of many, including President Franklin Roosevelt, to administer the Exchange Act as well. Ultimately, however, a consensus emerged that the difficult task of administering the federal securities laws required the creation of a new independent, bipartisan agency with a high level of technical expertise in securities matters that could focus exclusively on the nation’s capital markets. For example, during consideration of the House version of the legislation that would ultimately become the Exchange Act, Representative Charles Wolverton cited the “high degree of technical skill and knowledge,” that would be necessary to administer the new federal securities laws in his
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support for the creation of a five-member, expert Commission to take over the administration of those new laws. Similarly, during consideration of the corresponding Senate bill, Senator Duncan Fletcher explained the belief among “[m]any people, Members of Congress and others . . . that a special commission ought to be provided to administer the measure because the provisions are largely technical, and we ought to have men experienced in business of the kind involved.” The final version of the Exchange Act that emerged from Congress in the summer of 1934 provided the newly-established Commission with a broad mix of regulatory and quasi-judicial authority to carry out the legislative policies set forth in the Securities Act and the Exchange Act. The movement toward the establishment of expert, independent agencies represented a major shift in the regulatory paradigm, and it wasn’t long before this model was challenged. A year after Congress created the SEC, the Supreme Court took up the issue of independent agencies in the case of Humphrey’s Executor v. United States, which arose from President Roosevelt’s attempt to remove William Humphrey from his position as an FTC Commissioner. Much to the chagrin of the President, the Court ruled that as “an administrative body created by Congress to carry into effect legislative policies,” an independent agency such as the FTC “cannot in any proper sense be characterized as an arm or an eye of the executive. Its duties are performed without executive leave and, in the contemplation of the statute, must be free from executive control.” Most recently, in its 2010 decision in Free Enterprise Fund v. PCAOB, the Supreme Court implicitly referenced the Commission’s independence, proceeding on the understanding that SEC Commissioners “cannot themselves be removed by the President except under the Humphrey’s Executor standard of inefficiency, neglect of duty, or malfeasance in office.”
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This stands in contrast to, for example, Cabinet secretaries, who, while subject to Senate confirmation, serve at the pleasure of the President. Having established the SEC as an expert, independent agency with the authority to administer the federal securities laws, Congress has traditionally provided the Commission with considerable flexibility to exercise that expertise and authority. Historically, Congress has avoided imposing minutely detailed mandates on the Commission. Instead, Congress has, in conjunction with past grants of authority to the SEC, largely left it to the Commission to study issues and formulate rules which the Commission deemed in its discretion to be “in the public interest or for the protection of investors,” a phrase that appears time and again in our securities laws. As President Roosevelt himself remarked upon signing the Investment Company Act and Investment Advisers Act into law in 1940, “[E]fficient regulation in technical fields such as this requires an administering agency which has been given flexible powers[.]” For nearly eighty years, the Commission, like other independent agencies, has brought its expertise and judgment to bear in fulfilling the legislative mandates established by Congress in the federal securities laws. Yet, in today’s post-financial crisis, post-Dodd-Frank regulatory environment, the Commission is faced with a variety of challenges that carry with them the potential to erode its independence. The Commission must remain alert to these challenges and must respond when appropriate in order to preserve its ability to act independently in fulfilling its core mission. My concerns here do not derive from ideology or a desire to perpetuate seemingly age old agency turf wars.
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Instead, this is about the need to preserve a long-standing regulatory model that eschews a one-size-fits-all approach in favor of allowing expert, independent agencies to craft rules that, when necessary, are appropriately tailored to the specific entities and products they regulate. And then came Dodd-Frank. I worry about the limits placed on the Commission’s ability independently to apply its expertise and judgment under the paradigm established by the Dodd-Frank Act. The Act contains approximately 400 specific mandates to be implemented through agency rulemaking, around 100 of which apply directly to the SEC. Many of these mandates are highly prescriptive, and instead of directing the Commission to regulate in an area after studying the relevant issues, compiling data, and determining what, if any, regulatory action may be appropriate, they require the Commission to issue strictly prescribed and often highly technical rules under short deadlines. Unfortunately, although the Commission always has some degree of discretion when implementing a Congressional mandate, these more prescriptive rules limit the Commission’s flexibility in the rulemaking process while occupying time and resources that could be better spent fulfilling the Commission’s other important responsibilities. If one of the duties of an independent agency is to work proactively with Congress to ensure that statutes do not impose unnecessary or inappropriate mandates, then on that front the Commission unfortunately came up short with respect to many Dodd-Frank mandates. Ideally, when Congress provides the SEC with statutory authority to draft and implement rules in a new area, it will allow the Commission the time and flexibility necessary to study the issues involved and formulate smart regulation that reflects a complete understanding of the underlying data, including the costs and benefits associated with regulatory action.
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This is, after all, how the Commission was intended to operate when it was established nearly eighty years ago. In fact, I believe it is the Commission’s duty as an expert, independent agency to continue to employ this data-driven approach as best it can even in the face of prescriptive mandates from Congress. Although the Commission continues to stare down an overflowing plate of Dodd-Frank mandates in addition to its other responsibilities, as an expert, independent agency, the Commission must not allow itself to assume a secondary role in the regulation of matters squarely within its jurisdiction and core competencies. This, I’m afraid, is exactly the role that the Commission has taken thus far with respect to critical initiatives, including the Volcker Rule. Pursuant to Section 619 of Dodd-Frank, the three Federal banking agencies, the SEC, and the CFTC must together adopt regulations to implement the Volcker Rule’s two prohibitions on banking entities and their affiliates: its prohibition on engaging in proprietary trading and its prohibition on sponsoring or investing in “covered funds” such as hedge funds or private equity funds. Unfortunately, there is little doubt that notwithstanding the valiant efforts of the SEC staff, the Commission for too long has taken a back seat to the banking regulators in this rulemaking process. As I have said in the past, despite the Rule’s ostensible application to banking entities, the Rule is actually focused on the conduct to be regulated, not the entities that engage in this activity. There is no question that the specific trading, hedging, and investing activities to be regulated under the Rule fall firmly within the Commission’s core competencies, as they deal directly with SEC registrants and registration requirements. It makes little sense, therefore, for the Commission to defer to the banking regulators in this area when for decades it has regulated
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securities market-making in order to facilitate liquidity and promote the efficient allocation of capital. The implementing rulemaking for the Volcker Rule was proposed in October 2011. Almost a year and a half — and over 18,000 comment letters — later, the Volcker Rule remains at the proposal stage. Indeed, it appears that the proposal’s broad definitions of statutory terms have taken a bad situation and made it worse. Commission staff continue to engage in discussions with the bank regulators and the CFTC regarding the many concerns raised in those 18,000-plus comment letters. For this rule to get done and get done properly, the SEC must take a leadership role. In fact, I believe it is our duty as the independent financial regulator with primary authority over, and expertise in, the activities to be regulated to ensure that the final Rule meets the aims of Congress without destroying critically important market activity that the Rule explicitly intends not to eliminate. Moreover, in accordance with its core mission, it is the Commission’s responsibility to balance the bank regulators’ focus on safety and soundness and Dodd-Frank’s overarching focus on managing systemic risk with legitimate considerations of investor protection and the maintenance of vibrant markets. This brings me to the elephant in the room: FSOC. FSOC was created, in part, to respond to the realization during the financial crisis that regulatory balkanization had resulted in a lack of communication and information-sharing among financial services regulators, which undoubtedly led to poor policy decisions during the crisis.
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None of us who lived through the crisis on the ground floor would argue against improvements to the regulatory structure that would facilitate coordination and information-sharing among regulators. However, with FSOC the threats to the Commission’s independence move from the theoretical to the immediate, for already in its short existence, this new body has directly challenged the Commission’s regulatory independence. It is also where just one member of the Commission, the Chairman, can defend that independence. Pursuant to the provisions of Dodd-Frank establishing FSOC, the group is composed not of agencies, but the individual heads of agencies, acting ex officio. As I have said in the past, the structure of FSOC is particularly troubling for an independent agency like the SEC. While the Secretary of the Treasury and the heads of the FHFA and the CFPB may speak on behalf of their agencies — not to mention the President that appointed them — the same cannot be said of the Chairman of the SEC. To preserve its independence, Congress created the SEC as a bipartisan, five-member Commission and gave each Commissioner — including the Chairman — only one vote. This means that the Chairman has no statutory authority to represent or bind the Commission through his or her participation on FSOC. Yet as a voting member of FSOC, the Chairman of the SEC does have a say in authorizing FSOC to take certain actions that may affect — and indeed have already affected — markets or entities that the Commission regulates. While one might expect that the Chairman of the SEC would always represent the views of the Commission as a whole, there is no formal
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oversight mechanism available to the Commission to check the Chairman’s participation on FSOC. Moreover, although the Commission’s bipartisan structure insulates it from undue political influence, FSOC’s structure does not. On the contrary, FSOC is composed of individuals who are heads of their agencies — typically making them members of the President’s political party — and led by a Cabinet official who is removable by the President at will. These factors, among others, make FSOC particularly susceptible to political influence which, in turn, can be — and has been — exerted on the agencies led by FSOC’s members. To further complicate matters, FSOC operates under a different mandate than the SEC, having been established by Congress with a broad mandate to identify systemic risks and emerging threats to the country’s financial stability. Putting aside the fact that FSOC’s designation of certain firms as “systemically important” likely institutionalizes the idea of “too big to fail,” FSOC’s core mission is to ensure the safety and soundness of the U.S. financial system — not surprising given that a significant plurality of FSOC is composed of the heads of bank regulators. While this mission is of unquestionable importance, so, too is the distinct mission of the SEC. To be sure, proper oversight of our capital markets should positively impact the safety and soundness of our financial system. Nevertheless, the SEC is not by statute a safety and soundness regulator. In fact, the markets we regulate are inherently risky, and with good reason.

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By putting money at risk, investors allocate capital in a manner that spurs economic growth in the hopes of a much higher return on their investments than they could obtain from lower-risk, lower-return investments, such as bank accounts. The SEC seeks to protect these investors from fraud and to ensure that the markets in which they put their capital to work are fair and efficient. Our mission is not, and should not be, to make these markets risk-free, nor is it to preserve the existence of any particular firm or firms. Capital markets regulators and bank regulators have drastically different missions and oversee fundamentally different markets and market participants. And, importantly for me and all of those who appreciate and advocate for free markets, we must keep a healthy distance between capital markets regulation, which rightfully assumes no taxpayer safety nets, and bank regulation. It is not difficult to see the potential tension between the SEC and FSOC missions and the resulting threat to the Commission’s ability to function independently. As the old adage goes: “No one can serve two masters.” When the Chairman of the SEC faces this tension, which of these two potentially competing mandates does he or she honor? Nor is FSOC merely an advisory body without teeth. To carry out its mandate, Congress provided FSOC with extraordinary powers for an inter-agency council. For example, FSOC has the authority to designate a nonbank financial company as “systemically important,” and to subject these companies to prudential supervision by the Fed.
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FSOC may also designate a financial market utility or a payment, clearing, or settlement activity as “systemically important,” and direct the Fed, in consultation with the relevant supervisory agencies and FSOC itself, to prescribe risk management standards. To the extent that these “systemically important” utilities or activities are conducted by firms for which the SEC or CFTC is the primary regulator, Dodd-Frank provides “special procedures” pursuant to which the Fed may, if it determines that the risk management standards set by the SEC or the CFTC are “insufficient,” impose its own standards. That authority is not simply a threat to the Commission’s independence — if exercised, it would be an outright annexation. FSOC also has the authority to recommend that a primary financial regulator, such as the SEC, apply new or heightened standards and safeguards for systemically significant financial activities or practices. In this regard, FSOC has been busy in recent months prodding the Commission on money market fund reforms, including through the release of proposed reform recommendations last November. I won’t recount the history that led to FSOC’s involvement in the regulation of money market funds, an area which unquestionably falls within the core expertise and regulatory jurisdiction of the SEC. But I will emphasize that my colleagues and I have made it clear that, having now been provided with the rigorous study and economic analysis on money market funds that a bipartisan majority of the Commission asked for from the start, we fully expect the Commission to move forward with a rule proposal shortly. Why, then, is FSOC still involved in the process? FSOC was established in part to promote coordination, collaboration, and information-sharing among its member agencies.

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It is immensely troubling then to think of the FSOC as an institutionalized mechanism for one set of regulators to pressure another in the latter agency’s field of expertise — yet that is exactly what is happening. Moving on from the threats posed to the Commission’s independence by Congressional mandates and FSOC intervention, there are other, more mainstream, jurisdictional incursions the Commission must monitor and manage. For example, in December 2012, the Fed, acting pursuant to Dodd-Frank authority, issued proposed regulations to apply U.S. capital, liquidity, and other prudential standards to the U.S. operations of foreign bank organizations with total global consolidated assets of at least $50 billion. These rules, if adopted in their current form, would require such organizations to create an intermediate holding company that would house all of their U.S. bank and nonbank subsidiaries. The Fed proposal would affect SEC registrants as the new holding company capital rules would treat assets held by broker-dealer subsidiaries differently than they are treated in the SEC capital rules because of the proposed leverage standard that would apply to foreign bank organizations. Specifically, a U.S. broker-dealer subsidiary of a foreign bank organization could be required indirectly to hold more capital than would be necessary to satisfy the SEC’s net capital rule to maintain the same positions. The regulation of broker-dealers is at the heart of the Exchange Act and, as such, has been under the Commission’s regulatory purview for nearly eight decades. Using the expertise it has developed over this period, the Commission has designed capital requirements under Rule 15c3-1 that are tailored to the operations of broker-dealers and the industry in which they operate.
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Here, it is crucial to understand the differing theories that underlie broker-dealer and bank capital requirements. The Commission’s capital rules are meant to deal with failure, in that they are designed to ensure that when a broker-dealer fails, it has net liquid assets in excess of all non-subordinated liabilities so that the firm can be self-liquidated in an orderly manner and satisfy all creditors, particularly its customers. On the other hand, bank capital standards are not designed to require a bank to maintain sufficient net liquid assets to satisfy all creditors. Instead, banks have access to federal liquidity facilities that can be used as a funding source in the event that the bank cannot find private funding. These facilities allow the bank to be liquidated in a more orderly manner in the case of a failure. And, if the bank is “too big to fail,” the facilities can operate as a tax payer-funded life support system. Accordingly, it will be very important for the Fed and the Commission to coordinate carefully as this rule proposal is considered to ensure that legitimate goals can be advanced without undermining SEC oversight. This Fed rulemaking comes on the heels of the misguided repeal in Dodd-Frank of the Commission’s Supervised Investment Bank Holding Company, or SIBHC, program. This little-known program, which the Commission implemented under the authority of Exchange Act Section 17(i), should have been expanded in Dodd-Frank to allow the SEC to better oversee non-systemically important broker-dealer holding companies. Instead, Dodd-Frank eliminated Exchange Act Section 17(i), and replaced it with a new Fed program. On a final note, the Commission must also be mindful of the effect that international regulatory bodies, even those like IOSCO and the FSB in
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which the Commission is a participant, can have on the Commission’s prerogatives as an expert, independent agency. Many of these organizations were formed in large part to foster cooperation, information-sharing, and coordination among financial regulators in different jurisdictions. However, we now often see from these groups one-size-fits-all “recommendations,” some of which run contrary to the Commission’s existing regulations or address the substance of specific issues pending before the Commission. I believe that the Commission must remain an active, productive member of these groups, but we must ensure that policymaking remains in the hands of domestic regulators acting with the requisite independence. Thank you all for coming to this year’s SEC Speaks, and I look forward to seeing you again next February.

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Contagiousness and Vulnerability in the Austrian Interbank Market
Claus Puhr, Reinhardt Seliger, Michael Sigmund, Oesterreichische Nationalbank, Financial Markets Analysis and Surveillance Division The purpose of this paper is to analyze (hypothetical) contagious bank defaults, i.e. defaults not caused by the fundamental weakness of a given bank but triggered by failures in the banking system. As failing banks become unable to honor their commitments on the interbank market, they may cause other banks to default, which may in turn push even more banks over the edge in so-called default cascades. In our paper we distinguish between contagiousness (the share of total banking assets represented by those banks that a specific bank brings down by contagion) and vulnerability (the number of banks by which a bank is brought down by cascading failures). Our analysis consists of three steps: first, we analyze the structure of the Austrian interbank market from end-2008 to end-2011. Second, we run (hypothetical) default simulations based on Eisenberg and Noe (2001) for the same set of banks. Finally, we estimate a panel data model to explain the (hypothetical) defaults generated by these simulations with the underlying structure of the network using network indicators that reflect (i) the network as a whole, (ii) a subnetwork or cluster, and (iii) the node level based on banks’ interbank lending relationships.
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As a result we find strong correlations between a bank’s position in the Austrian interbank market and its likelihood of either causing contagion or being affected by contagion. Although our analysis is based on a dataset constrained to the interbank market of unconsolidated Austrian banks, we believe our findings could be verified by analyzing other banking systems (albeit with a different model calibration). Given the importance of identifying systemically important banks for the formulation of macroprudential policy, we believe that our analysis has the potential to improve our assessment with regard to second-round effects and default cascades in the interbank market.

1 Introduction 1.1 Motivation
The financial crisis has revealed the danger of systemic risk due to contagion effects given the interconnectedness of modern banking systems. Identifying systemically important banks has since become one of the key objectives of systemic risk assessment and a necessary precondition for the formulation of macroprudential policy. Systemically important banks can be identified in many different ways. We would like to contribute to this important discussion by applying techniques from network economics. In general, network analysis requires two input arguments. First, it takes a network, which could either be given or derived through a network formation process. Second, each network analysis needs an objective.
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In our paper we consider the interbank lending network as given and leave the theory on network formation aside, since the Austrian interbank lending relationships are the very network we supervise. We view the interbank lending market as a network where each participating bank is a node and each credit a link. The objective of our paper is analyzing one important contagion mechanism within this network, namely counterparty credit risk associated with interbank lending. Ex ante it is unknown whether difficulties at even a relatively small (but interconnected) institution might trigger problems at another bank. In the context of macroprudential analysis such an institution could be considered as a systemically important bank (also known as a key player in network economics). Specifically, we analyze two variants of (hypothetical) contagious default for the Austrian network of interbank lending relationships. First, we study a bank’s contagiousness in terms of the share of total banking assets represented by other banks that it will cause to default given its own default. Second we study a bank’s vulnerability in terms of the number of banks by which it is brought down if defaults cascade through the banking sector. In the remainder of the paper we try to identify key network properties that influence our two variants of contagious default. Our main motivation is finding out whether simulated contagiousness and vulnerability is driven by (i) banks’ idiosyncratic characteristics (i.e. a thin capital buffer) or (ii) network effects/positions, or (iii) by both.
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To this end we estimate panel data models that exploit network indicators to predict potential default cascades following individual bank failures while we control for idiosyncratic variables (i.e. the traditional measures of riskbearing capacity like capitalization ratios etc.). If supervisors are able to identify network indicators that add significantly to the analysis of these models, macroprudential policy will be able to (i) analyze the characteristics/drivers of individual indicators to get a better understanding of default dynamics and (ii) potentially target selected variables to address contagiousness and vulnerability in the interbank market “indirectly.” Our results should therefore provide potential novel means for policymakers to design and/or complement macroprudential tools. If you are good in mathematics, you can read it: Financial Stability Report 24 at http://www.oenb.at/en/welcome_to_the_oenb.jsp

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P a g e | 142 Disclaimer The Association tries to enhance public access to information about risk and compliance management. Our goal is to keep this information timely and accurate. If errors are brought to our attention, we will try to correct them. This information: is of a general nature only and is not intended to address the specific circumstances of any particular individual or entity; should not be relied on in the particular context of enforcement or similar regulatory action; is not necessarily comprehensive, complete, or up to date;

is sometimes linked to external sites over which the Association has no control and for which the Association assumes no responsibility; is not professional or legal advice (if you need specific advice, you should always consult a suitably qualified professional); is in no way constitutive of an interpretative document;

does not prejudge the position that the relevant authorities might decide to take on the same matters if developments, including Court rulings, were to lead it to revise some of the views expressed here; does not prejudge the interpretation that the Courts might place on the matters at issue. Please note that it cannot be guaranteed that these information and documents exactly reproduce officially adopted texts. It is our goal to minimize disruption caused by technical errors. However some data or information may have been created or structured in files or formats that are not error-free and we cannot guarantee that our service will not be interrupted or otherwise affected by such problems. The Association accepts no responsibility with regard to such problems incurred as a result of using this site or any linked external sites. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Certified Risk and Compliance Management Professional (CRCMP) distance learning and online certification program.
Companies like IBM, Accenture etc. consider the CRCMP a preferred certificate. You may find more if you search (CRCMP preferred certificate) using any search engine. The all-inclusive cost is $297. What is included in the price:

A. The official presentations we use in our instructor-led classes (3285 slides)
The 2309 slides are needed for the exam, as all the questions are based on these slides. The remaining 976 slides are for reference. You can find the course synopsis at: www.risk-compliance-association.com/Certified_Risk_Compliance_ Training.htm

B. Up to 3 Online Exams
You have to pass one exam. If you fail, you must study the official presentations and try again, but you do not need to spend money. Up to 3 exams are included in the price. To learn more you may visit: www.risk-compliance-association.com/Questions_About_The_Certif ication_And_The_Exams_1.pdf www.risk-compliance-association.com/CRCMP_Certification_Steps_ 1.pdf

C. Personalized Certificate printed in full color
Processing, printing, packing and posting to your office or home.

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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_Cert ification.htm

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