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International Association of Risk and Compliance Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com

Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's agenda, and what is next

Dear Member, We will start with the Archbishop of Canterbury.

(Don‘t worry, you are not reading the wrong top 10 list, this is the risk management list)
―Let me gently remind them of the benchmark for this kind of mis-reporting set by a cub-reporter covering the visit of the Archbishop of Canterbury to the US, landing in New York. The Archbishop had been advised to be cautious with the scandal mongering press.

―Be discreet: be very discreet; but with a smile‖.
On arrival he was hijacked by a bevy of press men clamouring for a story.
One reporter asked ―What do you think of the night clubs in New York?‖ Remembering to be discreet, with a smile, the Archbishop ironically responded ―Are there any night clubs in New York?‖ Headlines next day: Archbishop‘s first question on landing in New York ―Are there any night clubs here?‖

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The speaker continued, but you must be careful… although he said ―I have sanitised the story considerably for sensitive ears‖… I am not sure about that.
Read more at N umber 9 of our list – the speech by Mr Rundheersing Bheenick, Governor of the Bank of Mauritius, at the Annual Dinner in honour of Economic Operators, Pailles. Not to forget… I love the logo of the Bank of Mauritius! N o lions, no eagles … Also…

―Regulation is all about balance.
If regulation is too lax, excessive risk-taking may result with devastating effects. If regulation is too tight, it may suppress beneficial financial activity and reduce growth.‖ Who said that? Karen Kemp, Executive Director (Banking Policy), Hong Kong Monetary Authority. He started with a really excellent remark: ―Last month the United States (US) regulatory authorities announced that they did not expect their rules implementing Basel 3 would become effective on 1 January 2013, although they are working as ―expeditiously as possible‖ to complete their rulemaking process. Similarly in the European Union (EU), the trilogue between the European Commission, the European Parliament and the Council of Ministers to agree the text of Capital Requirements Directive IV (CRD IV, the EU version of Basel 3 is still ongoing and, even if a political
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agreement can be reached by year-end (which still appears to be the intention), it is recognised in the EU that there will not be sufficient time for CRD I V to be codified as legislation and put into effect on 1 January 2013.‖

His best question:
―But notwithstanding the intrinsic benefits of Basel 3, should we nevertheless be swayed by the argument put to us that Asia is taking the ―medicine‖ designed for the countries worst affected by the crisis, whilst the intended ―patients‖ defer and thereby give their banks significant ―competitive advantages‖ over our own? ‖ Read more at N umber 1 below. Also, host country supervisors worry after the Basel iii framework, but what if the host country is the United States? As Daniel Tarullo said (member of the Board of Governors of the Federal Reserve Board since January 28th, 2009): ―The Basel I I I capital and liquidity frameworks are big improvements, and the proposed capital surcharges for systemically important firms will be another important step forward. But these reforms are primarily directed at the consolidated level, with little attention to vulnerabilities posed by internationally active banks in host markets. The risks associated with large intra-group funding flows have remained largely unaddressed.‖ Read more at N umber 2 below. Welcome to the Top 10 list.

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Karen Kemp Executive Director (Banking Policy)

Basel 3 – The Timing Dilemma
Last month the United States (US) regulatory authorities announced that they did not expect their rules implementing Basel 3 would become effective on 1 January 2013, although they are working as ―expeditiously as possible‖ to complete their rulemaking process. Similarly in the European Union (EU), the trilogue between the European Commission, the European Parliament and the Council of Ministers to agree the text of Capital Requirements Directive IV (CRD IV, the EU version of Basel 3 is still ongoing…

Governor Daniel K. Tarullo At the Yale School of Management Leaders Forum, New Haven, Connecticut

Regulation of Foreign Banking Organizations
In the aftermath of the financial crisis, regulators around the world continue to implement reforms designed to limit the incidence and severity of future crises.

PCAOB Publishes Staff Audit Practice Alert on Maintaining and Applying Professional Skepticism in Audits

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James R. Doty, Chairman

Keynote Address
AICPA National Conference on Current SEC and PCAOB Developments

Economic and Monetary Affairs Committee

EU bank supervision system must be strong, accountable and inclusive
Banking supervision powers transferred to the EU level must be matched by measures that subject them to democratic scrutiny, said Economic and Monetary Affairs Committee MEPs on Thursday.

Opportunities facing Islamic finance and challenges in managing capital flows in Asia
Outline of special address by Mr Tharman Shanmugaratnam, Chairman of the Monetary Authority of Singapore, at the 8th World I slamic Economic Forum, Johor Bahru, Malaysia

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Resolving Globally Active, Systemically Important, Financial I nstitutions
A joint paper by the Federal Deposit Insurance Corporation and the Bank of England Resolving Globally Active, Systemically I mportant, Financial I nstitutions Federal Deposit I nsurance Corporation and the Bank of England

784 pages - Publication of the Credit institutions Register

EBA Register of Credit Institutions
provided for in Article 14 of Directive 2006 /48/ EC Article 14 of Directive 2006/ 48/ EC as amended by Art. 9 (3) of Directive 2010/78/EU requires the EBA to publish on its website a list of credit institutions to which authorisation has been granted in the Member States , and to keep that list updated.

Past I mperfect, Present Tense and Future Conditional
Speech by Mr Rundheersing Bheenick, Governor of the Bank of Mauritius, at the Annual Dinner in honour of Economic Operators, Pailles.

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Understanding macroprudential regulation
Introductory remarks by Mr Jan F Qvigstad, Deputy Governor of Norges Bank (Central Bank of Norway), at the workshop on ―Understanding macroprudential regulation‖, organised by Norges Bank, Oslo.

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Basel 3 – The Timing Dilemma
Last month the United States (US) regulatory authorities announced that they did not expect their rules implementing Basel 3 would become effective on 1 January 2013, although they are working as ―expeditiously as possible‖ to complete their rulemaking process. Similarly in the European Union (EU), the trilogue between the European Commission, the European Parliament and the Council of Ministers to agree the text of Capital Requirements Directive I V (CRD IV, the EU version of Basel 3 is still ongoing and, even if a political agreement can be reached by year-end (which still appears to be the intention), it is recognised in the EU that there will not be sufficient time for CRD I V to be codified as legislation and put into effect on 1 January 2013. So, does it necessarily follow that we should delay Basel 3 implementation in H ong Kong because the US and the EU cannot meet the internationally agreed timeline? Or should we follow the timeline set by the Basel Committee on Banking Supervision and begin the first phase of Basel 3 implementation from 1 January 2013? Our Basel 3 rules (the Banking (Capital) (Amendment) Rules 2012) are currently tabled at LegCo and notwithstanding the expected delays in the US and the EU, the Basel Committee‘s timeline remains unchanged.

Its gradual phase-in of the new capital standards over six years begins from January 2013 and extends until 2019.
In resolving the timing dilemma, it might first be instructive to remind ourselves that Basel 3 is being introduced to rectify weaknesses made all too starkly apparent in the recent global financial crisis.

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Or, put another way, Basel 3 is considered good for financial stability. The Basel 3 capital standards are designed to strengthen banks‘ resilience by requiring more and better quality capital and by addressing and capturing risks not adequately recognised previously. The aim is to ensure that banks can weather future financial storms without disruption to their lending. This should in turn make them less likely to create or amplify problems in other areas of the economy and facilitate their contribution to long-term sustainable economic growth. The roller-coaster of excessive leverage pre-crisis and excessive deleveraging post-crisis is not conducive to sustainable growth.

Regulation is all about balance.
If regulation is too lax, excessive risk-taking may result with devastating effects. If regulation is too tight, it may suppress beneficial financial activity and reduce growth. In our view, Basel 3 represents an appropriate balance in bolstering resilience whilst at the same time (with its extended phase-in) not unduly hampering lending to business and households today and ensuring banks can continue to lend in any downturn tomorrow. For this reason we propose to begin implementing Basel 3 from 1 January 2013.

We are not alone in this.
Our regional peers, Mainland China, Japan, Singapore and Australia have all published their final rules for Basel 3 implementation next year. As has Switzerland, another important financial centre.
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But notwithstanding the intrinsic benefits of Basel 3, should we nevertheless be swayed by the argument put to us that Asia is taking the ―medicine‖ designed for the countries worst affected by the crisis, whilst the intended ―patients‖ defer and thereby give their banks significant ―competitive advantages‖ over our own?
This competitive advantage argument would seem to be based on two assumptions. First that US and EU global banks (i.e. those banks that could realistically compete with our own) are currently holding much lower levels of capital than required by Basel 3 (and hence will have a genuine cost advantage); and second that our banks will, come 1 January 2013, have to hold more capital than they currently hold (and hence will incur additional cost). Are these assumptions correct? Well even though adoption of Basel 3 is delayed in the US and the EU, this certainly does not mean that banks in these regions remain at their pre-crisis capital levels. There has been significant re-capitalisation. The Dodd Frank Wall Street Reform and Consumer Protection Act in the US already requires the regulatory agencies to conduct stress-testing programmes to ensure banks and other systemically important financial institutions have enough capital to weather severe financial conditions and, even before the passage of the Dodd Frank Act, the US Federal Reserve Board put some of the largest US bank holding companies through stress-tests, the results of which have led to significant increases in capital. By 2012, the 19 bank holding companies subject to the Fed‘s Comprehensive Capital Analysis and Review had increased their aggregate tier 1 common capital to US$803 billion in the second quarter of the year from US$420 billion in the first quarter of 2009, with their tier 1 common capital ratio (which compares high quality capital to assets
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weighted according to their riskiness) doubling to a weighted average of 10.9% from 5.4%.
In the EU, under a recapitalisation exercise in 2011 that covered 71 of the EU‘s major banks, the European Banking Authority (EBA) required most to attain a ―core tier 1 ratio‖ of not less than 9% by the end of June 2012. In October 2012, the EBA indicated that it will focus on capital conservation to ―support a smooth convergence to the CRD I V….. regulatory requirements‖ and require the banks to maintain an absolute amount of core tier 1 capital corresponding to the level of the 9% core tier 1 ratio. So even absent formal adoption of Basel 3, the capital levels of the largest banks in the US and the EU have increased significantly post-crisis to levels comparable with, or even in excess of, those required under Basel 3 and so the prospect of such banks ―competing‖ by being allowed to maintain much lower capital levels than Basel 3 banks would seem more apparent than real. Turning to the second ―competitive‖ assumption, will the first phase of Basel 3, which starts next year, require local banks to hold significantly more capital than they do at present, to the extent that they may become constrained in their ability to lend and compelled to pass on the costs of the extra capital to borrowers? Well, the results of the HK MA‘s quantitative impact studies tell us that our local banks are already very well-placed to meet the new Basel 3 capital ratios. Their capital levels are already in excess of the standard taking effect on 1 January 2013 and the issuance of ordinary shares (common equity) already accounts for a very significant proportion of their capital base, positioning them well for Basel 3‘s new focus on common equity as the highest quality capital for the purpose of loss absorption.

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In summary then, irrespective of any delay in formal implementation of Basel 3, major banks in the US and EU are inexorably moving to higher levels of capital.
This, together with the benefits offered by Basel 3 and the relative ease with which local banks can comply, serves to underpin our view that we should proceed to implement the first phase of Basel 3 in line with the Basel Committee‘s timeline. Generally speaking, jurisdictions in Asia have in the past tended to adopt regulations that are in some respects higher than the Basel Committee‘s minimum standards. This may have helped Asia weather the global financial crisis relatively unscathed when compared with the jurisdictions worst affected. There would, therefore, seem little to be gained from seeking to engage in, or indeed prompt, a ―race-to-the-bottom‖ in regulatory terms by deliberately delaying the introduction of Basel 3 at this point in time. In implementing on 1 January 2013, we will be fulfilling our commitment both as an international financial centre which customarily adopts best international standards and as a member of the Basel Committee on Banking Supervision. Karen Kemp Executive Director (Banking Policy)

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Governor Daniel K. Tarullo At the Yale School of Management Leaders Forum, New Haven, Connecticut

Regulation of Foreign Banking Organizations
In the aftermath of the financial crisis, regulators around the world continue to implement reforms designed to limit the incidence and severity of future crises. My subject today pertains to an area in which reforms have yet to be made--the regulation of the U.S. operations of large foreign banks. Applicable regulation has changed relatively little in the last decade, despite a significant and rapid transformation of those operations, as foreign banks moved beyond their traditional lending activities to engage in substantial, and often complex, capital market activities. The crisis revealed the resulting risks to U.S. financial stability. In taking a fresh look at regulation of foreign banks in the United States, I by no means want to imply that the United States should revoke its welcome to foreign banks. On the contrary, this reconsideration reflects the important role foreign banks have played. The presence of foreign banks can bring particular competitive and countercyclical benefits because foreign banks often expand lending in the United States when U.S. banking firms labor under common domestic strains. But just as we are adapting our regulatory approach to U.S. banks, so we need to incorporate important lessons learned from the crisis into our oversight program for foreign banks. The question of how best to regulate foreign banks is hardly a new one, either here or in other countries.
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Debates over the relative merits of territorial versus global or mutual recognition approaches, the difficulties in achieving strictly equal terms of competition between banks with different home regulatory systems, and the degree to which harmonization of international standards and supervisory consultations can mitigate the resulting inconsistencies and frictions are all familiar topics to academics, banking lawyers, and supervisory authorities.
While I do not aim to resolve this afternoon the complicated interaction among these perspectives and considerations, I will try to outline a practical and reasonable way forward. To be effective, a new approach must address the vulnerabilities that have been created by the shift in foreign bank activities, in keeping with sound prudential policy and congressional mandates in the Dodd-Frank Wall Street Reform and Consumer Protection Act. At the same time, a modified regulatory system should maintain the principle of national treatment and allow foreign banks to continue to operate here on an equal competitive footing, to the benefit of the U.S. banking system and the U.S. economy generally.

Foreign Bank Regulation in the United States
Regulating the U.S. operations of foreign banks presents unique challenges. Although U.S. supervisors have full authority over the local operations of foreign banks, we see only a portion of a foreign bank's worldwide activities, and regular access to information on its global activities can be limited. Foreign banks operate under a wide variety of business models and structures that reflect the legal, regulatory, and business climates in the home and host jurisdictions in which they operate. Despite these difficulties, the United States has traditionally accorded foreign banks the same national treatment as domestic banks, and U.S. regulators generally have allowed foreign banks to choose among structures that they believe promote maximum efficiency at the consolidated level.
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Under the statutory scheme established by Congress, permissible U.S. structures include cross-border branching and direct and indirect subsidiaries, provided that they operate in a safe and sound manner.
U.S. law also allows well-managed and well-capitalized foreign banks to conduct a wide range of bank and nonbank activities in the United States under conditions comparable to those applied to U.S. banking organizations. Still, it is worth noting that even as there has been continuity in this basic policy, U.S. regulation of foreign banks has evolved over the years in response to changes in the extent and nature of foreign bank activities. Let me mention two examples. Before 1978, foreign bank branches in the United States were licensed and regulated by individual states, with little in the way of federal regulation or restrictions. They were not subject to the full panoply of limitations on interstate banking, equity investments, or affiliations with securities firms that were applicable to domestic banks. The rapid growth of foreign banking in the 1970s, particularly branching, prompted an end to this lighter regulatory regime. The International Banking Act of 1978 gave the Federal Reserve Board regulatory authority over the domestic operations of foreign banks and significantly equalized regulatory treatment of foreign and domestic firms. Congress maintained this approach of basic competitive equality in the 1999 Gramm-Leach-Bliley Act. That law substantially removed restrictions on affiliations between commercial banks and other kinds of financial firms for both domestic and foreign institutions operating in the United States. Moreover, in light of provisions in Gramm-Leach-Bliley that permitted a foreign bank to be a financial holding company (FHC), the Federal Reserve announced in 2001 that a bank holding company (BHC) in the United States that was owned and controlled by a well-capitalized and
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well-managed foreign bank generally would not be required to meet the Board's capital requirements normally applicable to BHCs.
My second example relates to the massive fraud uncovered at the Bank of Credit and Commerce International (BCCI) and its subsequent collapse in 1991, which highlighted the need for more effective supervision of banks operating in multiple countries. The Foreign Bank Supervision Enhancement Act of 1991 (FBSEA) required foreign banks to receive approval from the Board before establishing a branch or agency in the United States.

The law required the Federal Reserve, in turn, to determine that the foreign bank is subject to "comprehensive supervision or regulation on a consolidated basis" in its home country before approving an application either to open a branch or to acquire a U.S. subsidiary bank.
It is further worth noting that changes in U.S. law and regulatory practice affecting foreign banking organizations have often corresponded to changes in international regulatory agreements. For example, FBSEA was enacted at the same time as the Basel Committee on Banking Supervision was working to address the problems revealed by BCCI--an effort that bore fruit the next year in changes to the so-called Basel Concordat, which established minimum standards for the supervision of international banking groups. Another instance was the substantial reduction or removal of remaining asset-pledge and asset-maintenance requirements for most U.S. branches of foreign banks, prompted in part by implementation of the new international capital standards included in the 1988 Basel Accord.

The Shift in Foreign Bank Activities
Although foreign banks expanded steadily in the United States during the 1970s, 1980s, and 1990s, their activities here posed limited risks to overall U.S. financial stability. Throughout this period, the U.S. operations of foreign banks were largely net recipients of funding from their parents and generally engaged in traditional lending to home-country and U.S. clients.
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U.S. branches and agencies of foreign banks held large amounts of cash during the 1980s and '90s, in part to meet asset-maintenance and asset-pledge requirements put in place by regulators.
Their cash-to-third-party liability ratio from the mid-1980s through the late 1990s generally ranged between 25 percent and 30 percent. The U.S. branches and agencies of foreign banks that borrowed from their parents and lent those funds in the United States ("lending branches") held roughly 60 percent of all foreign bank branch and agency assets in the United States during the 1980s and '90s.

Commercial and industrial lending continued to account for a large part of foreign bank branch and agency balance sheets through the 1990s.
This profile of foreign bank operations in the United States changed in the run-up to the financial crisis. Reliance on less stable, short-term wholesale funding increased significantly. Many foreign banks shifted from the "lending branch" model to a "funding branch" model, in which U.S. branches of foreign banks were borrowing large amounts of U.S. dollars to upstream to their parents. These "funding branches" went from holding 40 percent of foreign bank branch assets in the mid-1990s to holding 75 percent of foreign bank branch assets by 2009. Foreign banks as a group moved from a position of receiving funding from their parents on a net basis in 1999 to providing significant funding to non-U.S. affiliates by the mid-2000s--more than $700 billion on a net basis by 2008. A good bit of this short-term funding was used to finance long-term, U.S. dollar-denominated project and trade finance around the world. There is also evidence that a significant portion of the dollars raised by European banks in the pre-crisis period ultimately returned to the United States in the form of investments in U.S. securities.

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Indeed, the amount of U.S. dollar-denominated asset-backed securities and other securities held by Europeans increased significantly between 2003 and 2007, much of it financed by the short-term, dollar-denominated liabilities of European banks.
Meanwhile, commercial and industrial lending originated by U.S. branches and agencies as a share of their third-party liabilities fell significantly after 2003. In contrast, U.S. broker-dealer assets of the top-10 foreign banks increased rapidly during the past 15 years, rising from 13 percent of all foreign bank third-party assets in 1995 to 50 percent in 2011.

Lessons from the Recent Financial Crisis
The 2007–2008 financial crisis and the continuing financial stress in Europe have revealed financial stability risks associated with the foreign banking model as it has evolved in the United States. To some extent the concerns associated with foreign banking operations track the more general shortcomings of pre-crisis financial regulation. Internationally agreed minimum capital levels were too low, the quality standards for required capital were too weak, the risk weights assigned to certain asset classes did not reflect their actual risk, and the potential for liquidity strains was seriously underappreciated. But some risks are more closely tied to the specifically international character of certain global banks, both here and in some other parts of the world. The location of capital and liquidity proved critical in the resolution of some firms that failed during the financial crisis. Capital and liquidity were in some cases trapped at the home entity, as in the case of the Icelandic banks and, in our own country, Lehman Brothers. Actions by home-country authorities during this period showed that while a foreign bank regulatory regime designed to accommodate centralized management of capital and liquidity can promote efficiency during good times, it also increases the chances of ring-fencing by home and host
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jurisdictions at the moment of a crisis, as local operations come under severe strain and repayment of local creditors is called into question.
Resolution regimes and powers remain nationally based, complicating the resolution of firms with large cross-border operations. The large intra-firm, cross-border flows that grew rapidly in the years leading up to the crisis also created vulnerabilities. To be fair, the ability to move liquidity freely throughout a banking group may have provided some financial stability benefits during the crisis by enabling banks to respond to localized balance-sheet shocks and dysfunctional markets in some areas (such as the interbank and foreign exchange swap markets) and by transferring resources from healthier parts of the group. Nevertheless, this model also created a degree of cross-currency funding risk and heavy reliance on swap markets that proved destabilizing. Moreover, foreign banks that relied heavily on short-term, U.S. dollar liabilities were forced to sell U.S. dollar assets and reduce lending rapidly when that funding source evaporated, thereby compounding risks to U.S. financial stability. Although the United States did not suffer a destabilizing failure of foreign banks, many rode out the crisis only with the help of extraordinary support from home- and host-country regulators. Following national treatment practice, the Federal Reserve itself provided substantial discount window access to U.S. branches and the opportunity to participate in the Primary Dealer Credit Facility to U.S. primary-dealer subsidiaries of foreign banks. Moreover, the potential for funding disruptions did not disappear with the waning of the global financial crisis. In 2011, for example, as concerns about the euro zone rose, U.S. money market funds suddenly pulled back their lending to large euro area banks, reducing lending to these firms by roughly $200 billion over just four months.

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While there has been some reduction in operations and some change in funding patterns by foreign banking organizations in the United States since the crisis, particularly by European firms reacting to euro zone financial stress, the basic circumstances have not changed.
The proportion of foreign banking assets to total U.S. banking assets has remained at about one-fifth since the end of the 1990s. But the concentration and complexity of those assets have changed noticeably from earlier decades, and have not reversed in recent years despite the global financial crisis and subsequent events.

Ten foreign banks now account for more than two-thirds of foreign bank third-party assets held in the United States, up from 40 percent in 1995.
And while the largest U.S. operations of foreign banks do not approach the size of our largest domestic financial institutions, it is striking that there are 23 foreign banks with at least $50 billion in assets in the United States--the threshold established by the Dodd-Frank Act for special prudential measures for domestic firms--compared with 25 U.S. firms. Most notably, perhaps, five of the top-10 U.S. broker-dealers are owned by foreign banks. Like their U.S.-owned counterparts, large foreign-owned U.S. broker-dealers were highly leveraged in the years leading up to the crisis. Their reliance on short-term funding also increased, with much of the expansion of both U.S.-owned and foreign-owned U.S. broker-dealer activities attributable to the growth in secured funding markets during the past 15 years. Finally, we should note that one of the fundamental elements of the current approach--our ability, as host supervisors, to rely on the foreign bank to act as a source of strength to its U.S. operations--has come into question in the wake of the crisis. The likelihood that some home-country governments of significant international firms will backstop their banks' foreign operations in a crisis appears to have diminished.

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It also appears that constraints have been placed on the ability of the home offices of some large international banks to provide support to their foreign operations.
The motivations behind these actions are not hard to understand and appreciate, but they do affect the supervisory terrain for host countries such as the United States.

International and Domestic Regulatory Response
Since the crisis, important changes have been made to strengthen international regulatory standards. The Basel I I I capital and liquidity frameworks are big improvements, and the proposed capital surcharges for systemically important firms will be another important step forward. But these reforms are primarily directed at the consolidated level, with little attention to vulnerabilities posed by internationally active banks in host markets. The risks associated with large intra-group funding flows have remained largely unaddressed.

Managing international regulatory initiatives also has become more difficult, as the number of complex items on the agenda has increased.
And despite continued work by the Financial Stability Board, challenges to cross-border resolution are likely to remain significant. For the foreseeable future, then, our regulatory system must recognize that while internationally active banks live globally, they may well die locally. Quite apart from the need to act pragmatically under the circumstances, it is not clear that we should aim toward extensive harmonization of national regulatory practices related to foreign banking organizations. The nature and extent of foreign banking activities vary substantially across national markets, suggesting that regulatory responses might best vary as well.
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For instance, the importance of the U.S. dollar in many international transactions can motivate foreign banks to use their U.S. operations to raise dollar funding for their international operations, potentially creating vulnerabilities.
Such a model is unlikely to prevail in most other host financial markets around the world. Indeed, in response to financial stability risks highlighted during the crisis, ongoing challenges associated with the resolution of large cross-border firms, and the limitations of the international reform agenda, several national authorities have already introduced their own policies to fortify the resources of internationally active banks within their geographic boundaries. Regulators in the United Kingdom, for example, have recently increased requirements for liquidity to cover local operations of domestic and foreign banks, set stricter rules around intra-group exposures of U.K. banks to foreign subsidiaries, and moved to ring-fence home-country retail operations. Meanwhile, Swiss authorities have explicitly prioritized the domestic systemically important operations of their large, internationally active firms in resolution. Here in the United States, Congress included in the Dodd-Frank Act a number of changes directed at the financial stability risk posed by foreign banks. Sections 165 and 166 instruct the Federal Reserve to implement enhanced prudential standards for large foreign banks as well as for large domestic BHCs and nonbank systemically important financial institutions. Dodd-Frank also bolstered capital requirements for FHCs, including foreign FHCs, by extending the well-capitalized and well-managed requirements beyond U.S. bank subsidiaries to the top-tier holding company. In addition, the so-called Collins Amendment in Dodd-Frank removed the exemption from BHC capital requirements granted by the Federal Reserve's Supervision and Regulation Letter 01-01.
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The required phase-out of SR 01-01 was clearly intended to strengthen the capital regime applied to the U.S. operations of foreign banks; however, the organizational flexibility that the amendment gave to foreign banks in the United States has allowed some large foreign banks to restructure their U.S. operations to minimize the impact of this regulatory change.
As a result, in the absence of additional structural requirements for foreign banks in the United States, the effectiveness of our capital regime for large foreign banks with both bank and nonbank operations in the United States depends on the foreign bank's own organizational choices.

A Rebalanced Approach to Foreign Bank Regulation
As has been the case in the past, we need to adjust the regulatory requirements for foreign banks in response to changes in the nature of their activities in the United States, the risks attendant to those changes, and instructions from Congress in new statutory provisions. The modified regime should counteract the risks posed to U.S. financial stability by the activities of foreign banking organizations, as manifested in the years leading up to, and through, the financial crisis. Special attention must be paid to the risk of runs associated with significant reliance on short-term funding. In addition, the regime should reduce the difficulties in resolution of cross-border firms. Finally, it should take steps to diminish the potential need for ex-post ring-fencing when losses mount or runs develop during a crisis, since such actions may well be unhelpfully procyclical. At the same time, in modifying our regulatory regime for foreign banking organizations, we must remain mindful of the benefits that foreign banks can bring to our economy and of the important policies of national treatment and comparable competitive opportunity. Thus, we should chart a middle course, not moving to a fully territorial model of foreign bank regulation, but instead making targeted adjustments to address the risks I have identified. In basic terms, three such adjustments are desirable.
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First, a more uniform structure should be required for the largest U.S. operations of foreign banks--specifically, that these firms establish a top-tier U.S. intermediate holding company (IH C) over all U.S. bank and nonbank subsidiaries.
An I HC would make application of enhanced prudential supervision more consistent across foreign banks and reduce the ability of foreign banks to avoid U.S. consolidated-capital regulations. Because U.S. branches and agencies are part of the foreign parent bank, they would not be included in the I HC.

However, they would be subject to the activity restrictions applicable to branches and agencies today as well as to certain additional measures discussed below.

Second, the same capital rules applicable to U.S. BHCs should also apply to U.S. I HCs.
These rules have been reshaped to counteract the risks to the U.S. financial system revealed by the crisis and should be implemented consistently across all firms that engage in similar activities. Similarly, other enhanced prudential standards required by the Dodd-Frank Act--including stress testing requirements, risk management requirements, single counterparty credit limits, and early remediation requirements--should be applied to the U.S. operations of large foreign banks in a manner consistent with the Board's domestic proposal.

Third, there should be liquidity standards for large U.S. operations of foreign banks.
Standards are needed to increase the liquidity resiliency of these operations during times of stress and to reduce the threat of destabilizing runs as dollar funding channels dry up and short-term debt cannot be rolled over. For IH Cs, the standards should be broadly consistent with the standards the Federal Reserve has proposed for large domestic BHCs, pending final

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adoption and phase-in of quantitative liquidity requirements by the Basel Committee.
That is, they should be designed to ensure that, in stressed circumstances, the U.S. operations have enough high-quality liquid assets to meet expected net outflows in the short term. There should also be liquidity standards for foreign bank branch and agency networks in the United States, although they may be less stringent, in recognition of the integration of branches and agencies into the global bank as a whole.

By imposing a more standardized regulatory structure on the U.S. operations of foreign banks, we can ensure that enhanced prudential standards are applied consistently across foreign banks and in comparable ways between U.S. banking organizations and foreign banking organizations.
As with domestic firms subject to enhanced prudential standards, the Federal Reserve would work to ensure that the new regime is minimally disruptive, through transition periods and other means. An I HC structure would also provide the Federal Reserve, as umbrella supervisor of the U.S. operations of foreign banks, with a uniform platform to implement a consistent supervisory program across large foreign banks. In the case of foreign banks with the largest U.S. operations, the I H C would also help mitigate resolution difficulties by providing U.S. regulators with one consolidated U.S. legal entity to place into receivership under title I I of the Dodd-Frank Act if the failure of the foreign bank would threaten U.S. financial stability. Branches and agencies would remain separate, but all other entities would be included. Further, an I HC structure would facilitate a consistent U.S. capital regime for bank and nonbank activities of foreign banks under the I HC, similar to the approach taken in other jurisdictions, such as the United Kingdom and some continental European countries.

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Some observers will, I am sure, ask if it is necessary to depart from the prevailing firm-by-firm approach to foreign banking regulation and to adopt generally applicable requirements in implementing the Dodd-Frank enhanced prudential standards for foreign banks.
It is difficult to see how reliance on this approach can be effective in addressing risks to U.S. financial stability, at least in the absence of extraterritorial application of our own standards and supervision, and perhaps not even then. We would, at a minimum, need to make regular and detailed assessments of each firm's home-country regulatory and resolution regimes, the financial stability risk posed by each firm in the United States, and the financial condition of the consolidated banking organization. In fact, such an approach might result in the worst of both worlds--an ongoing intrusiveness into the consolidated supervision of foreign banks by their home-country regulators without the ultimate ability to evaluate those banks comprehensively or to direct changes in a parent bank's practices necessary to mitigate risks in the United States. Although the Federal Reserve will continue to cooperate with its foreign counterparts in overseeing large, multinational banking operations, that supervisory tool cannot provide complete protection against risks engendered by U.S operations as extensive as those of many large U.S. institutions. It is also important to note that while the reforms I have described today contain some elements that are more territorial than our current approach, including requiring some additional capital and liquidity buffers to be held in the United States, they do not represent a complete departure from prior practice. This enhanced approach would allow foreign banks to continue to operate branches in the United States and would generally allow branches to meet comparable capital requirements at the consolidated level. Similarly, this approach would not impose a cap on intra-group flows, thereby allowing foreign banks in sound financial condition to continue to obtain U.S. dollar funding for their global operations through their U.S. entities.
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It would instead provide an incentive to term out at least some of this funding in a way that reduces the risk of runs.
Requiring additional local capital and liquidity buffers, like any prudential regulation, may incrementally increase cost and reduce flexibility of internationally active banks that manage their capital and liquidity on a centralized basis. However, managing liquidity and capital on a local basis can have benefits not just for financial stability generally, but also for firms themselves.

During the crisis, the more decentralized global banks relied somewhat less on cross-currency funding and were less exposed to disruptions in international wholesale funding and foreign exchange swap markets than the more centralized banks.
Indeed, as noted earlier, in the wake of the crisis and of subsequent stresses, many foreign banks have modified their funding practices and business models. In revamping our approach, we will both be guarding against a return to pre-crisis practices and, more generally, ensuring that foreign banking operations in the United States that pose potential risks to U.S. financial stability are regulated similarly to domestic banking operations posing similar risks.

Conclusion
The imperative for change in our foreign bank regulation is clear and, indeed, mandated by Dodd-Frank. Of course, I have provided only an outline of the three key measures that will best navigate the middle course I have suggested.

The all-important details are under discussion at the Board.
I anticipate that in the coming weeks we will complete our work and issue a notice of proposed rulemaking that will elaborate the basic approach I have foreshadowed.

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I look forward to hearing your general reactions today and more specific feedback after the Board has adopted a proposed rule.

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PCAOB Publishes Staff Audit Practice Alert on Maintaining and Applying Professional Skepticism in Audits
The Public Company Accounting Oversight Board published a Staff Audit Practice Alert to remind auditors of their requirement to exercise professional skepticism throughout their audits. "Investors depend on independent audits to provide a meaningful check on the financial statements prepared by company management," said PCAOB Chairman James R. Doty. "Without professional skepticism, the audit cannot serve that essential function." The PCAOB continues to observe instances in which circumstances suggest that auditors did not appropriately apply professional skepticism in their audits.

Staff Audit Practice Alert No. 10: Maintaining and Applying Professional Skepticism in Audits focuses on the importance of professional skepticism, the appropriate application of professional skepticism in audits, and certain important considerations for audit firms' quality control systems.
PCAOB standards define professional skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence, and it is essential to the performance of effective audits under Board standards.

"This Alert discusses factors that impair an auditor's skepticism, and steps that firms and auditors can take to enhance their application of professional skepticism," said Martin F. Baumann, PCAOB Chief Auditor and Director of Professional Standards.
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"PCAOB standards require every individual auditor to exercise professional skepticism throughout their audits."
The timing of the release of Staff Audit Practice Alert No. 10 is intended to assist audit firms' emphasis in upcoming calendar year-end audits on the importance of the appropriate use of professional skepticism. Due to the fundamental importance of the appropriate application of professional skepticism in performing an audit in accordance with PCAOB standards, the Board is also continuing to explore whether additional actions might meaningfully enhance auditors' professional skepticism. The PCAOB publishes Staff Audit Practice Alerts to highlight new, emerging, or otherwise noteworthy circumstances that may affect how auditors conduct audits under the existing requirements of PCAOB standards and relevant laws. Auditors should determine whether and how to respond to these circumstances based on the specific facts presented. The statements contained in Staff Audit Practice Alerts do not establish rules of the Board and do not reflect any Board determination or judgment about the conduct of any particular firm, auditor, or any other person.

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STAFF AUDIT PRACTICE ALERT NO. 10
MAINTAINING AND APPLYING PROFESSI ONAL SKEPTI CISM I N AUDITS
Staff Audit Practice Alerts highlight new, emerging, or otherwise noteworthy circumstances that may affect how auditors conduct audits under the existing requirements of the standards and rules of the PCAOB and relevant laws. Auditors should determine whether and how to respond to these circumstances based on the specific facts presented. The statements contained in Staff Audit Practice Alerts do not establish rules of the Board and do not reflect any Board determination or judgment about the conduct of any particular firm, auditor, or any other person.

Executive Summary
Professional skepticism is essential to the performance of effective audits under Public Company Accounting Oversight Board ("PCAOB" or "Board") standards. Those standards require that professional skepticism be applied throughout the audit by each individual auditor on the engagement team. PCAOB standards define professional skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence.

The standards also state that professional skepticism should be exercised throughout the audit process.
While professional skepticism is important in all aspects of the audit, it is particularly important in those areas of the audit that involve significant management judgments or transactions outside the normal course of business.
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Professional skepticism also is important as it relates to the auditor's consideration of fraud in an audit.
When auditors do not appropriately apply professional skepticism, they may not obtain sufficient appropriate evidence to support their opinions or may not identify or address situations in which the financial statements are materially misstated. Observations from the PCAOB's oversight activities continue to raise concerns about whether auditors consistently and diligently apply professional skepticism. Certain circumstances can impede the appropriate application of professional skepticism and allow unconscious biases to prevail, including incentives and pressures resulting from certain conditions inherent in the audit environment, scheduling and workload demands, or an inappropriate level of confidence or trust in management. Audit firms and individual auditors should be alert for these impediments and take appropriate measures to assure that professional skepticism is applied appropriately throughout all audits performed under PCAOB standards. Firms' quality control systems can help engagement teams improve the application of professional skepticism in a number of ways, including setting a proper tone at the top that emphasizes the need for professional skepticism; implementing and maintaining appraisal, promotion, and compensation processes that enhance rather than discourage the application of professional skepticism; assigning personnel with the necessary competencies to engagement teams; establishing policies and procedures to assure appropriate audit documentation, especially in areas involving significant judgments; and appropriately monitoring the quality control system and taking necessary corrective actions to address deficiencies, such as, instances in which engagement teams do not apply professional skepticism. The engagement partner is responsible for, among other things, setting an appropriate tone that emphasizes the need to maintain a questioning mind throughout the audit and to exercise professional skepticism in
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gathering and evaluating evidence, so that, for example, engagement team members have the confidence to challenge management representations.
It is also important for the engagement partner and other senior engagement team members to be actively involved in planning, directing, and reviewing the work of other engagement team members so that matters requiring audit attention, such as unusual matters or inconsistencies in audit evidence, are identified and addressed appropriately.

It is the responsibility of each individual auditor to appropriately apply professional skepticism throughout the audit, including in identifying and assessing the risks of material misstatement, performing tests of controls and substantive procedures to respond to the risks, and evaluating the results of the audit.
This involves, among other things, considering what can go wrong with the financial statements, performing audit procedures to obtain sufficient appropriate audit evidence rather than merely obtaining the most readily available evidence to corroborate management's assertions, and critically evaluating all audit evidence regardless of whether it corroborates or contradicts management's assertions. The Office of the Chief Auditor is issuing this practice alert to remind auditors of the requirement to appropriately apply professional skepticism throughout their audits. The timing of this release is intended to facilitate firms' emphasis in upcoming calendar year-end audits, as well as in future audits, on the importance of the appropriate use of professional skepticism.

Due to the fundamental importance of the appropriate application of professional skepticism in performing an audit in accordance with PCAOB standards, the PCAOB also is continuing to explore whether additional actions might meaningfully enhance auditors' professional skepticism.

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Professional Skepticism and Due Professional Care
Professional skepticism, an attitude that includes a questioning mind and a critical assessment of audit evidence, is essential to the performance of effective audits under PCAOB standards. The audit is intended to provide investors with an opinion on whether the financial statements prepared by company management are presented fairly, in all material respects, in conformity with the applicable financial reporting framework.

If the audit is conducted without professional skepticism, the value of the audit is impaired.
The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. This responsibility includes obtaining sufficient appropriate evidence to determine whether the financial statements are materially misstated rather than merely looking for evidence that supports management's assertions. PCAOB standards require the auditor to exercise due professional care in planning and performing the audit and in preparing the audit report. Due professional care requires the auditor to exercise professional skepticism. PCAOB standards define professional skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence. PCAOB standards require the auditor to exercise professional skepticism throughout the audit. While professional skepticism is important in all aspects of the audit, it is particularly important in those areas of the audit that involve significant management judgments or transactions outside the normal course of business, such as nonrecurring reserves, financing transactions, and
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related party transactions that might be motivated solely, or in large measure, by an expected or desired accounting outcome.
Effective auditing involves diligent pursuit of sufficient appropriate audit evidence, particularly if contrary evidence exists, and critical assessment of all the evidence obtained. Professional skepticism is also important as it relates to the auditor's consideration of fraud in the audit. Company management has a unique ability to perpetrate fraud because it frequently is in a position to directly or indirectly manipulate accounting records and present fraudulent financial information. Company personnel who intentionally misstate the financial statements often seek to conceal the misstatement by attempting to deceive the auditor. Because of this incentive, applying professional skepticism is integral to planning and performing audit procedures to address fraud risks. In exercising professional skepticism, the auditor should not be satisfied with less than persuasive evidence because of a belief that management is honest. Examples of the application of professional skepticism in response to the assessed fraud risks are (a)Modifying the planned audit procedures to obtain more reliable evidence regarding relevant assertions and (b)Obtaining sufficient appropriate evidence to corroborate management's explanations or representations concerning important matters, such as through third-party confirmation, use of a specialist engaged or employed by the auditor, or examination of documentation from independent sources. PCAOB inspectors continue to observe instances in which the circumstances suggest that auditors did not appropriately apply professional skepticism in their audits.
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As examples, audit deficiencies like the following raise concerns that a lack of professional skepticism was at least a contributing factor:
•For certain hard-to-value Level 2 financial instruments, the engagement team did not obtain an understanding of the specific methods and/ or assumptions underlying the fair value estimates that were obtained from pricing services or other third parties and used in the engagement team‘s testing related to these financial instruments. Further, the firm used the price closest to the issuer‘s recorded price in testing the fair value measurements, without evaluating the significance of differences between the other prices obtained and the issuer‘s prices. •The issuer discontinued production of a significant product line during the prior year and introduced a new product line to replace it. There were no sales of the discontinued product line during the last nine months of the year under audit. The engagement team did not test, beyond inquiry, the significant assumptions management used to calculate its separate inventory reserve for this product line.

•The engagement team did not evaluate the effects on the financial statements of management's determination not to test a significant portion of its property and equipment for impairment, despite indicators that the carrying amount may not have been recoverable.
These indicators in this situation included operating losses for the relevant segment for the last three years, substantial charges for the impairment of goodwill and other intangible assets during the year, a projected loss for the segment for the upcoming year, and reduced and delayed customer orders.

•After the date of the issuer's balance sheet, but before the release of the firm's opinion, the issuer reported that it anticipated that comparable store sales for the first quarter of the year would be significantly lower than those for the first quarter of the year under audit.

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The engagement team had performed sensitivity analyses as part of its assessment on the issuer's evaluation of its compliance with its debt covenants, the issuer's ability to continue as a going concern, and the possibility of the impairment of the issuer's long-lived assets.
The engagement team did not consider the implications of the anticipated decline in sales on its sensitivity analyses and its conclusions with respect to compliance with debt covenants, the issuer's ability to continue as a going concern, and impairment of long-lived assets. The PCAOB's enforcement activities also have identified instances in which auditors did not appropriately apply professional skepticism. For example, in one recent disciplinary order, the Board found, among other things, that certain of a firm's audit partners accepted a company's reliance on an exception to generally accepted accounting principles ("GAAP") requirements for reserving for expected future product returns even though doing so conflicted with the plain language of the exception and the firm's internal accounting literature. The partners were aware of, but did not appropriately consider, contradictory audit evidence indicating that the returns were not eligible for the exception. This illustration of a lack of professional skepticism reappeared in the firm's response when the issue was questioned by the firm's internal audit quality reviewers. Although certain of the partners involved determined that the company's reliance on the exception to GAAP did not support the company's accounting, they, along with other firm personnel, formulated another equally deficient rationale that supported the company's existing accounting result.

Impediments to the Application of Professional Skepticism
Although PCAOB standards require auditors to appropriately apply professional skepticism throughout the audit, observations from the PCAOB's oversight activities indicate that, as a practical matter, auditors are often challenged in meeting this fundamental audit requirement.
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In maintaining an attitude that includes a questioning mind and a critical assessment of audit evidence, it is important for auditors to be alert to 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.
Certain conditions inherent in the audit environment can create incentives and pressures that can serve to impede the appropriate application of professional skepticism and allow unconscious bias to prevail. For example, incentives and pressures to build or maintain a long-term audit engagement, avoid significant conflicts with management, provide an unqualified audit opinion prior to the issuer's filing deadline, achieve high client satisfaction ratings, keep audit costs low, or cross-sell other services can all serve to inhibit professional skepticism. In addition, over time, auditors may sometimes develop an inappropriate level of trust or confidence in management, which may lead auditors to accede to inappropriate accounting.

In some situations, auditors may feel pressure to avoid potential negative interactions with, or consequences to, individuals they know (that is, management) instead of representing the interests of the investors they are charged to protect.
Other circumstances also can impede the appropriate application of professional skepticism. For example, scheduling and workload demands can put pressure on partners and other engagement team members to complete their assignments too quickly, which might lead auditors to seek audit evidence that is easier to obtain rather than evidence that is more relevant and reliable, to obtain less evidence than is necessary, or to give undue weight to confirming evidence without adequately considering contrary evidence. Although powerful incentives and pressures exist that can impede professional skepticism, the importance of professional skepticism to an
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effective audit cannot be overstated, particularly given the increasing judgment and complexity in financial reporting and issues posed by the current economic environment.
Auditors and audit firms must remember that their overriding duty is to put the interests of investors first. Appropriate application of professional skepticism is key to fulfilling the auditor's duty to investors. In the words of the U.S. Supreme Court: By certifying the public reports that collectively depict a corporation's financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public. This "public watchdog" function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust. However, inadequate performance of audit procedures may be caused by factors other than the lack of skepticism, or in combination with a lack of skepticism. As discussed further below, firms should take appropriate steps to understand the various factors that influence audit quality, including those circumstances and pressures that can impede the application of professional skepticism.

Promoting Professional Skepticism via an Appropriate System of Quality Control
PCAOB standards require firms to establish a system of quality control to provide the firm with reasonable assurance that its personnel comply with applicable professional standards and the firm's standards of quality.
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This includes designing and implementing policies and procedures that lead engagement teams to appropriately apply professional skepticism in their audits.
Firms' quality control systems can help engagement teams improve the application of professional skepticism in a number of ways, including the following: •"Tone-at-the-Top" Messaging. The PCAOB's inspection findings have identified instances in which the firm's culture allows or tolerates audit approaches that do not consistently emphasize the need for professional skepticism. Consistent communication from firm leadership that professional skepticism is integral to performing a high quality audit, backed up by a culture that supports it, could improve the quality of work performed by audit partners and staff. On the other hand, messages from firm leadership that are excessively focused on revenue or profit growth over achieving audit quality, can undermine the application of professional skepticism. • Performance Appraisal, Promotion, and Compensation Processes. An audit firm's performance appraisal, promotion, and compensation processes can enhance or detract from the application of professional skepticism in its audit practice, depending on how they are designed and executed. For example, if a firm's promotion process emphasizes selling non-audit services or places an undue focus on reducing audit costs, or retaining and acquiring audit clients over achieving high audit quality, the firm's personnel may perceive those goals as being more important to their own compensation, job security, and advancement within the firm than the appropriate application of professional skepticism. •Professional Competence and Assigning Personnel to Engagement Teams.
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A firm's quality control system depends heavily on the proficiency of its personnel, which includes their ability to exercise professional skepticism.
To perform the audit with professional skepticism, it is important that personnel assigned to engagement teams have the necessary knowledge, skill, and ability required in the circumstances, which includes appropriate technical training and experience. Professional skepticism is interrelated with an auditor's training and experience, as auditors need an appropriate level of competence in order to appropriately apply professional skepticism throughout the audit. In addition, it is important for the firm's culture to continually reinforce the appropriate application of professional skepticism throughout the audit. • Documentation. It is important for a firm's quality control system to establish policies and procedures that cover documenting the results of each engagement. Although documentation should support the basis for the auditor's conclusions concerning every relevant financial statement assertion, areas that require greater judgment generally need more extensive documentation of the procedures performed, evidence obtained, and rationale for the conclusions reached. In addition to the documentation necessary to support the auditor's final conclusions, audit documentation must include information the auditor has identified relating to significant findings or issues that is inconsistent with or contradicts the auditor's final conclusions. • Monitoring. Under PCAOB standards, a firm's quality control policies and procedures should include an element of monitoring to ensure that quality control policies and procedures are suitably designed and being effectively applied.
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If the firm identifies deficiencies, the firm should evaluate the reasons for the deficiencies and determine the necessary corrective actions or improvements to the quality control system.
Accordingly, if a firm identifies deficiencies that include failures to appropriately apply professional skepticism as a contributing factor, the firm should take appropriate corrective actions.

Importance of Supervision to the Application of Professional Skepticism
The supervisory activities performed by the engagement partner and other senior engagement team members are important to the application of professional skepticism. The engagement partner is responsible for the proper supervision of the work of engagement team members. Accordingly, the engagement partner is responsible for setting an appropriate tone that emphasizes the need to maintain a questioning mind throughout the audit and to exercise professional skepticism in gathering and evaluating evidence, so that, for example, engagement team members have the confidence to challenge management representations. It is also important for the engagement partner and other senior engagement team members to be actively involved in planning, directing, and reviewing the work of other engagement team members so that matters requiring audit attention are identified and addressed appropriately. In directing the work of others, senior engagement team members, including the engagement partner, may have knowledge and experience that may assist less experienced engagement team members in applying professional skepticism. For example, senior engagement team members might help more junior auditors identify matters that are unusual or inconsistent with other evidence.
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In addition, senior members of the engagement team might be better able to challenge the assertions of senior levels of management, when necessary.

Appropriate Application of Professional Skepticism
Although a firm's quality control systems and the actions of the engagement partner and other senior engagement team members can contribute to an environment that supports professional skepticism, it is ultimately the responsibility of each individual auditor to appropriately apply professional skepticism throughout the audit, including the following areas among others: •I dentifying and assessing risks of material misstatement; • Performing tests of controls and substantive procedures; and •Evaluating audit results to form the opinion to be expressed in the auditor's report.

Identifying and Assessing Risks of Material Misstatement
By its nature, risk assessment involves looking at internal and external factors to determine what can go wrong with the financial statements, whether due to error or fraud. When properly applied, the risk assessment approach set forth in PCAOB standards should focus auditors' attention on those areas of the financial statements that are higher risk and thus most susceptible to misstatement. This includes considering events and conditions that create incentives or pressures on management or create opportunities for management to manipulate the financial statements. The evidence obtained from the required risk assessment procedures should provide a reasonable basis for the auditor's risk assessments, which, in turn, should drive the auditor's tests of accounts and disclosures in the financial statements.
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The risk assessment procedures required by PCAOB standards also should provide the auditor with a thorough understanding of the company and its environment as a basis for identifying unusual transactions or matters that warrant further investigation.
They also provide a basis for the auditor to evaluate and challenge management's assertions. It is important to note that the auditor's understanding should be based on actual information obtained from the risk assessment procedures.

It is not sufficient for auditors merely to rely on their perceived knowledge of the industry or information obtained from prior audits or other engagements for the company.

Performing Tests of Controls and Substantive Procedures
Appropriately applying professional skepticism is critical to obtaining sufficient appropriate audit evidence to determine whether the financial statements are free of material misstatement and, in an integrated audit, whether internal controls over financial reporting are operating effectively. Application of professional skepticism is not merely obtaining the most readily available evidence to corroborate management's assertion. The need for auditors to appropriately apply professional skepticism is echoed throughout PCAOB standards. For example, PCAOB standards caution that representations from management are not a substitute for the application of those auditing procedures necessary to afford a reasonable basis for an opinion regarding the financial statements under audit. Also, the standards warn that inquiry alone does not provide sufficient appropriate evidence to support a conclusion about a relevant assertion. In addition, PCAOB standards require auditors to design and perform audit procedures in a manner that addresses the assessed risks of material
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misstatement and to obtain more persuasive evidence the higher the assessment of risk.
The auditor is required to apply professional skepticism, which includes a critical assessment of the audit evidence. Substantive procedures generally provide persuasive evidence when they are designed and performed to obtain evidence that is relevant and reliable. When discussing the characteristics of reliable audit evidence, PCAOB standards observe that generally, among other things, evidence obtained from a knowledgeable source independent of the company is more reliable than evidence obtained only from internal company sources and evidence obtained directly by the auditor is more reliable than evidence obtained indirectly. Taken together, this means that in higher risk areas, the auditor's appropriate application of professional skepticism should result in procedures that are focused on obtaining evidence that is more relevant and reliable, such as evidence obtained directly and evidence obtained from independent, knowledgeable sources. Further, if audit evidence obtained from one source is inconsistent with that obtained from another, the auditor should perform the audit procedures necessary to resolve the matter and should determine the effect, if any, on other aspects of the audit. The following are examples of audit procedures in PCAOB standards that reflect the need for professional skepticism: •Resolving inconsistencies in or doubts about the reliability of confirmations; •Examining journal entries and other adjustments for evidence of possible material misstatement due to fraud; •Reviewing accounting estimates for biases that could result in material misstatement due to fraud;
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•Evaluating the business rationale for significant unusual transactions; and
•Evaluating whether there is substantial doubt about an entity's ability to continue as a going concern.

Evaluating Audit Results to Form the Opinion to be Expressed in the Audit Report
When professional skepticism is applied appropriately, the auditor does not presume that the financial statements are presented fairly in conformity with the applicable financial reporting framework. Instead, the auditor employs an attitude that includes a questioning mind in making critical assessments of the evidence obtained to determine whether the financial statements are materially misstated. PCAOB standards indicate that the auditor should take into account all relevant audit evidence, regardless of whether the evidence corroborates or contradicts the assertions in the financial statements. Examples of areas in the evaluation that reflect the need for the auditor to apply professional skepticism, include, but are not limited to, the following: • Evaluating uncorrected misstatements. This includes evaluating whether the uncorrected misstatements identified during the audit result in material misstatement of the financial statements, individually or in combination, considering both qualitative and quantitative factors. • Evaluating management bias. This includes evaluating potential bias in accounting estimates, bias in the selection and application of accounting principles, the selective correction of misstatements identified during the audit, and identification by management of additional adjusting entries that offset misstatements accumulated by the auditor.
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When evaluating bias, it is important for auditors to consider the incentives and pressures on management to manipulate the financial statements.
• Evaluating the presentation of the financial statements. This includes evaluating whether the financial statements contain the information essential for a fair presentation of the financial statements in conformity with the applicable financial reporting framework. When evaluating misstatements, bias, or presentation and disclosures, it is important for auditors to appropriately apply professional skepticism and avoid dismissing matters as immaterial without adequate consideration.

Conclusion
The Office of the Chief Auditor is issuing this practice alert to remind auditors of the requirement to appropriately apply professional skepticism throughout their audits, which includes an attitude of a questioning mind and a critical assessment of audit evidence.

The timing of this release is intended to facilitate firms' emphasis in upcoming calendar year-end audits, as well as in future audits, on the importance of the appropriate use of professional skepticism.
Due to the fundamental importance of the appropriate application of professional skepticism in performing an audit in accordance with PCAOB standards, the PCAOB also is continuing to explore whether additional actions might meaningfully enhance auditors' professional skepticism.

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James R. Doty, Chairman

Keynote Address

EVENT: LOCATION:

AICPA National Conference on Current SEC and PCAOB Developments Washington, DC

Thank you for inviting me to speak today. It is a pleasure to participate in the 40th occasion for this conference. It is my second year here, and I am honored to be back. I was also honored to participate in the AICPA's 125th Anniversary in May. I congratulate you again on what you have put forth for the public interest in those years, and I have high expectations for the years to come.

Let me begin by saying that the views I express are my own and should not be attributed to the PCAOB as a whole or any other members or staff.
You have an excellent conference program, offering valuable insights on current technical questions and quandaries as well as an opportunity to discuss important policy issues. I am especially pleased that the conference devotes more attention to auditing each year.

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I. High Quality, I ndependent Auditing is Critical to Our Economic Success.
As I have learned in this job, getting the accounting right is indeed not the same thing as getting the auditing right. My sense from accountants I talk to is that auditing is receiving well-deserved attention in its own right. Our economic success depends on the confidence of the users of capital and the providers of capital alike. Corporate managers hire internal accountants — many of you here today — to ensure they have accurate and detailed information on which to base management decisions. Managers ignore opportunities to glean trends and insights from this data at their peril. Mistakes in this information can send a company into a business line or market that squanders resources. We now know that the true cost of financial misstatement is much greater than stock market fallout, concomitant lawsuits and insurance claims. Researchers from Rutgers and NYU reported in 2009 on the costs of misstatements by companies known to have been managing earnings between 1997 and 2000. In their words, "the essential point that emerges" is that if management wants to maintain appearances, then hiring and investment must be consistent with reported profits. Therefore, they found, during the years of earnings management the companies increased hiring by 25 percent. Competitors increased hiring, on average, by only seven percent.
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As soon as the companies came clean, the unneeded employees were fired.
The researchers estimated that the restating companies fired between 250,000 and 600,000 workers between 2000 and 2002, slashing payrolls by more than 25 percent, while other companies cut them by just 1.5 percent. Investors and employees of misreporting companies are not the only ones hurt.

Columbia Business School Professor Gil Sadka did his PhD dissertation at the University of Chicago on the effects of fraudulent reporting on competitor companies.
He found that false reporting leads both companies who misreport and their competitors to overinvest in new technology and engage in misguided price wars. He did a case study on WorldCom to test the point. WorldCom's major competitors were Sprint and AT&T, which together made up 60 percent of the telecommunications market. The price war prompted by WorldCom during the period of fraud drove industry pricing down in key product lines. The artificially low prices took a toll on margins at WorldCom's competitors. Both Sprint and AT&T experienced a decline in their operating margins during the period.

This is the kind of information we can, of course, only know with hindsight.
What it teaches us is that the unanticipated cost of misreporting can be both general in impact and great. Fudging the financials misleads investors and other companies alike
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into inefficient allocation of capital.
Economists warn that this, in turn, leads workers to train up, and sometimes move families, for jobs in industries that don't need them. Years later, when they lose those jobs, their potential productivity is yet again wasted in unemployment. These are social costs of financial misreporting in economic terms. When they occur, they imply a market failure: efficient market allocations have been diverted by bad numbers. That's where the auditing profession comes in. High quality auditing is critical to our economic success because it allows us to allocate capital efficiently. Indeed, it has done so since our country was formed. If it weren't for auditing, our country would likely not have moved forward from frontier land speculation and canal projects to an industrial economy that would employ sophisticated financing through global capital markets. Accounting standard-setters have rightly spent much of the last ten years exploring ways to close loopholes wedged open by companies that issued fraudulent financial reports at the turn of this century. But it would be a mistake to conclude that, until standard-setters close loopholes, our system permits or tolerates fraudulent exploitation of them. Both Bernie Ebbers of WorldCom and the Rigas father-and-son team that headed Adelphia learned that lesson the hard way when the Second Circuit Court of Appeals, in separate cases, affirmed their convictions, rejecting their arguments that Generally Accepted Accounting Principles allowed the fraudulent reporting treatments. In both cases, the Second Circuit Court of Appeals affirmed the
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convictions.
In Ebbers's case, the Court held — If the government proves that a defendant was responsible for financial reports that intentionally and materially misled investors, the [securities fraud] statute is satisfied. The government is not required in addition to prevail in a battle of expert witnesses over the application of individual GAAP rules. In Judge Wesley's opinion in the Rigas case, "Even if Defendants complied with GAAP, a jury could have found, as the jury did here, that Defendants intentionally misled investors." Securities lawyers know that the cases since Enron broke no new ground. They were founded on the long-standing principle articulated in the 1969 case, United States v. Simon. There, three auditors were convicted for their role in the Continental Vending fraud.

On appeal, the court rejected the auditors' argument that they could not be found guilty if the company's disclosures complied with accounting standards.
In a thoughtful opinion by Judge Henry Friendly, one of the most respected jurists in U.S. history, the Second Circuit Court of Appeals affirmed the trial court's decision that proof of compliance with GAAP was "not necessarily conclusive that [the auditors] acted in good faith, and that the facts as certified were not materially false or misleading." Many accounting firms devote inestimable time and attention to the study of the fine points of the applicable accounting regimes. But with this history , it is high time that we focus on auditing as its own discipline, to be studied, nurtured and trained. All auditors should be versed in the case studies on fraud. I t is simply
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not the case that frauds do not repeat; although there may be new twists, familiar elements reappear.
The economic literature also provides important insights and is worth more than mere browsing. Just last month, David Larcker of Stanford University and other researchers revealed thought-provoking new evidence of the linkage between certain kinds of equity incentives and misreporting. The work of academics and other thought leaders has refocused on the importance of the audit profession. Their new look at the archives of the last decade may lead you to new insights of your own. It could make you a better auditor, and better equip you to recognize and confront a bad situation.

I I . Audit Firm Culture Must Support Auditors' Work.
I acknowledge that auditors are in a tough spot. With rare exception, they are an ethical breed. One does not go into, or stay in, auditing just for the tangible benefits. As in all professions, fair compensation is critical to the vitality of the profession. I never met an auditor who wasn't proud of finding a fraud, avoiding the company's demise, and sparing investors' ruin. Yet firms are, by design, profit enterprises. The public is the intended beneficiary of the audit. But the public doesn't pay the auditor's bills. Auditees do, and, in the United States, the audit fees that those
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engagements pay are a decreasing portion of audit firms' revenues. Large audit firms' revenues from consulting are growing rapidly, at some firms more than 15 percent a year. Audit fees have stagnated at, basically, the inflation rate. Thus audit practices have shrunk in comparison to audit firms' other client service lines — not all of which are schooled in, or depend upon, the fundamental exercise of skepticism.

This threatens to weaken the strength of the audit practice in the firm overall.
After nearly ten years of inspecting the audits of issuers, the PCAOB has identified hundreds of engagements that did not meet PCAOB standards in significant respects. These are serious audit deficiencies in procedures and actions that mean, essentially, that the audit opinions involved were not adequately supported.

Moreover, inspection findings have increased at many firms over the last several years.
This is a hard message. It is to be expected that the inspection findings are a disappointment to a profession proud of its reputation for technical excellence. Some firms have seen even more findings this year. Yet I say with confidence that I have seen dramatic improvements in audit quality in response to the findings. When a firm accepts the findings, and undertakes a rigorous root cause analysis, it can design actions to reduce and eliminate recurrence. The audit firm takes a significant step on the road to excellence when
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it acknowledges that the number and vector of our findings indicate root cause, systemic issues, and not merely episodic failures in execution.
That involves self-monitoring and testing — not just waiting to see if the PCAOB finds the problem in other audits. Inspectors have seen it done. This requires, when a firm is grappling with evidence of a lack of skepticism in certain past audits, the firm demands — through its words, actions and subsequent testing — pervasive and explicit evidence of skepticism in the work papers. It means the firm issues meaningful, believable and consistent messages internally that quality is not one of many goals, but the firm's number one priority. It means these communications go to — and are honored by — all professionals, because the firm engages all professionals in the remediation efforts.

I hope you are seeing these actions and improvements in your firm. Not all firms have gone to these lengths. But this is what quality means.

I I I. The PCAOB's Initiatives are Aimed at Enhancing the Relevance, Credibility and Transparency of Audits.
The PCAOB too is deeply engaged in examining ways to enhance the relevance, credibility and transparency of the audit to better serve investors.

In November 201 1, the PCAOB adopted a major new strategic plan to focus its programs and initiatives on ways to do so.
It built on the work of the founding board but brought that work forward to address current challenges and expectations for the

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organization.
The Board reaffirmed that strategic plan last week, in connection with adopting the PCAOB's 2013 Budget. The new plan reflects modest updates and adjustments as well. In particular, it includes a new strategy to underscore the continuing development of the PCAOB's Global N etwork Firm Inspection Program, as well as a new strategy related to standard-setting for audits of emerging growth companies, in light of recent legislative developments. Since last November, we have brought on a new director for our Office of Research and Analysis, Greg Jonas. We have also adopted a new I T governance framework. Therefore, the plan also includes an updated strategy related to managing knowledge and leveraging I T, reflecting enhancements to our IT governance and our vision for research and analysis under Greg's leadership. In my message accompanying the plan, I set forth certain near-term priorities. They afford some insight into initiatives that our inspections, research and standards-setting programs have undertaken to improve audit quality in the interest of the investing public.

A. Inspection Initiatives Will Focus on Deepening Inspection Analysis and Improving Reporting.
Our inspections initiatives will focus on further deepening our inspection analysis and improving our reporting — both for inspections and remediation.
This past year our inspections program, under the leadership of Helen Munter, has been very active — issuing around 200 reports and
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completing approximately 265 inspections thus far.
While inspection findings for the 2012 inspection cycle are still preliminary, the deficiencies continue to be high relative to prior years and H elen will speak about that on Wednesday. Helen's group has devoted considerable attention to further develop the infrastructure necessary to reduce the time it takes to produce reports. That effort will continue into 2013 and is one of the near-term priorities of the Board. Our reports do take time to produce. While we aim to issue reports within 12 months of the inspections fieldwork, and many now beat that target, some reports take longer. The period from the end of the fieldwork to the time a report is produced is an important time period. We issue comments on potential findings, give firms time to respond and then evaluate their responses to develop the draft report. Once drafted, reports go through several reviews to ensure consistency of approach across firms and findings. Inspectors take care to ensure that findings are appropriate, and that if they criticize conduct, they criticize it consistently wherever they find it. Importantly, inspectors give time throughout the process for dialogue with firm personnel and leadership. We continue, however, to improve our processes to reduce the time it takes to issue our domestic large firm inspection reports and to improve the content of our other reports. A note about form: An essential ingredient of the inspection process is candor with firms about the points on which we see a need for
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improvement.
That emphasis may often result in inspection reports that appear to be laden with criticism of a firm's policies, practices, and audit performance, and less concerned with a recitation of a firm's strengths. Grounded in the vision of the Sarbanes-Oxley Act, the inspection reports are not intended to serve as balanced report cards, rating tools, or potential marketing aids for any firm. The reports are intended principally to focus our inspection-related dialogue with a firm on those areas where improvement is either required for compliance with relevant standards and rules, or is likely to enhance the quality of the firm's audit practice. That purpose should not be lost. But in light of these goals, the inspections division will also consider ways to deepen our own analysis of inspection findings, over time and across firms, so that we see more and miss less when we encounter what may be only the tip of a problem.

I anticipate more summary reports on insights from inspections, on more topics.
We will prepare these reports always with an eye on, among other things, getting useful information to audit committees. This will build on the release the Board issued in August on how audit committees can learn more from the results and implications of the PCAOB's inspection findings. Armed with more and better information, audit committees should be in a better position to champion audit quality. PCAOB outreach to audit committees is naturally an important component. An observation here, about outreach to and interaction with audit
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committees — one of our near-term priorities: Our outreach and interaction should help audit committees promote audit quality.
Audit committees have a role in fostering not just integrity in management's reporting, but the vitality and viability of the independent audit. In my experience, when an audit committee meets with internal audit or compliance staff, the first question they ask is, "do you have enough resources?"

Do the audit committees you interact with ask the same of the external auditor? They should, and the good ones do.
The audit is the linchpin of the investing public's confidence in the company; it is not something to be procured from the lowest cost supplier.

B. The PCAOB's Office of Research and Analysis Will Initiate a Project to Identify Audit Quality Measures.
I've mentioned our new Director of Research and Analysis. We've served Greg a full plate. His office works closely with the inspections division on inspection planning. As in past years, the office is responsible for delivering detailed risk analysis to the inspection division in the Fall, to assist with planning for the next year. This is in addition to the year-round work the office does to spot audit and accounting risks, run them down as far as they can based on public information and their own analysis, and work with others internally to determine the best resource to address the risk. In 2013, the Office of Research and Analysis will also initiate a project to identify audit quality measures, with a longer-term goal of tracking such measures over time and across firms and networks of firms, and
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back-testing them for their predictive value.
The fruits of this data analysis could also enable us not only to better inform our own processes, but to provide meaningful analysis to auditors, audit committees, and the investing public. We are at the earliest stages of this endeavor, but I have high hopes.

C. Evaluating the PCAOB's Standard-Setting Framework.
The PCAOB's standards-setting staff are also hard at work finding ways to make our standards-setting process as effective as possible, including through greater use of economic analysis. All but fifteen of the audit standards were adopted by the profession itself. The PCAOB adopted those standards as its own in 2003 and called them the "interim standards." We don't rewrite standards just for the sake of change. Since its earliest days, the PCAOB has endeavored to develop instructive standards that comprise the real intellectual content of what auditors do. The standards ought to be a living set of principles that a learned profession can believe in and resort to for support. At the same time, they must be sufficiently clear and concrete to be enforceable fairly, for enforcing them is an important element of what we do — a subject that our enforcement director, Claudius Modesti, will talk about later. To these ends, under Chief Auditor Marty Baumann's leadership, the PCAOB's standards-setting staff have devoted renewed attention to developing a new framework by which to organize and integrate the interim standards with the PCAOB's new standards. I don't envision that this exercise should result in an immutable set of

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standards for all time.
Each generation will have to evaluate new needs for change, for example as the interim related parties standard is today receiving renewed attention in light of new information about the relationship between executive compensation and audit risk. To my mind, the standards — even the reorganization of them — ought to reflect a contemporary review of the challenges that auditors face, which we alone among standards-setters can see through our inspections.

We should also take good ideas from wherever else they come. For
example, under Arnold Schilder's leadership, the I nternational Auditing and Assurance Standards Board is moving forward with its paper on using the auditor's reporting model to communicate useful information from the audit to investors. PCAOB staff and board members have had numerous discussions with Arnold and his team, and our own project on the Auditor's Reporting Model has benefitted greatly from our interaction. But there should be no presumption for simply adopting, off-the-shelf, other standards-setters' work in order to trade out an interim standard expeditiously. Above all, emphasis should be placed on identifying and reacting appropriately to risk, and on establishing counterweights to circumstances that could detract from the ultimate goal of obtaining a high level of assurance that the financial statements are free of material misstatement.

This is why I believe it is so important to reexamine how we protect the auditor's independence, including by considering term limits.
Economic analysis can help us in this review of the PCAOB's standards-setting framework.

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Economic analysis prompts us to ask critical questions:
What is the problem? What are our alternatives, both to rulemaking and by rulemaking?What is the most cost-effective solution for society? Indeed, economic analysis may tell us that if we can drive audit quality improvements through certain kinds of structural changes — such as by enhancing independence, introducing more transparency , or infusing the audit report with more insight, turning the auditor's focus more squarely toward communication with the investing public — we may be able to avoid the incremental cost of requiring additional audit procedures. Economic analysis may also help us help the profession overcome market obstacles and realign incentives to promote sustainable excellence. I want to see the audit profession compete on quality more than price. I imagine you wish for that as well, but wishing isn't doing.

Standards that give audit committees and the public tools to distinguish on the basis of quality may help you get there.
*** Historians remind us that each generation is, in a sense, the custodian of and fiduciary for the best ideas the past has given us. The enduring lesson of the past is that men and women do change their worlds.

Through this annual conference, the profession comes together each year to discuss and debate the work you do to serve the public.
This conference is not about business development, or client service. It's about serving the public interest. I commend you for showing such
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initiative, year in and year out, to find new and better ways to do so. You have been a gracious audience and I thank you very much for your attention.

Martin Baumann, Chief Auditor Remarks
AICPA Conference on Current SEC and PCAOB Developments Washington, DC Good afternoon. I'm delighted once again to be a part of this AICPA conference. I congratulate the AICPA for this annually successful conference that benefits thousands of professionals and congratulate all of you for attending. The Office of the Chief Auditor is responsible for advising the Board on the establishment of auditing and related professional standards to strengthen the reliability of audits. As Chief Auditor I'm fortunate to lead an extraordinary group of professionals at the PCAOB who are dedicated to audit quality — and to the development of standards and related guidance to continually improve audit quality. This afternoon I want to touch on, first, our most recently adopted standard — AS 16, Communications with Audit Committees- and then briefly comment on two standard-setting projects — the Auditor's Reporting Model and Going Concern.

Then I want to focus my remarks on a most critical aspect of auditing — Professional Skepticism.
AS 16 was adopted by the PCAOB in August. Subject to SEC approval, it is intended to be effective for audits beginning on or after December 15, 2012.
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Through appropriate and timely communications with audit committees, this standard can significantly improve audit quality.
It also benefits the audit committee in fulfilling the role it was charged with under the Sarbanes-Oxley Act. Among other things, the standard improves auditor communications regarding the audit strategy, significant risks, information about other firms and specialists participating in the audit, the company's most complex accounting estimates, significant unusual transactions, complaints about accounting matters, and the auditor's evaluation of the company's ability to continue as a going concern. AS 16 went through an extensive exposure process and generally received strong support for its improvements in audit quality. Some firms are planning to adopt its communications principals early, in this year's audits. The Auditor's Reporting Model has been referenced a number of times in this conference, including the many commissions or committees that have recommended the need for the audit report to change, the extensive outreach we have made in considering changes to the Auditor's Report, as well as related global initiatives by the IAASB and the European Commission. We have received significant and valuable input to help in our deliberations. We are being extremely thoughtful and careful in our approach — making changes to the auditor's report has significant support, but making such changes needs the deliberative approach we are taking.

Our plan at this stage, as noted in our current standard-setting agenda, is to issue a proposal for public comment in the first-half of 2013.
We expect many comment letters on such an important proposal but we also plan further Roundtables and discussions with our Advisory

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groups.
Economic Analysis is also an important ingredient in considering any new audit report — so we will be soliciting views there as well. So a lot has been done, but much more is yet to be done as we address this most important matter of revising the Standard Auditor's Report. We have a very busy standard-setting agenda, but I want to mention just one more item — that is, revising the standard on the auditor's consideration of a company's ability to continue as a going concern. The financial crisis evidenced a need for improvements in this standard, but just as importantly evidenced the need for improved reporting by I ssuers. The FASB has recently approved a project to require periodic evaluations by management and disclosures under certain circumstances about doubts regarding the company's ability to continue as a going concern. They plan an Exposure Draft in early 2013 and we will plan to propose our revised auditing standard shortly thereafter. This is the holistic approach to this problem that investors, preparers and auditors have asked for. Now, let me turn away from current standard-setting and comment on a very important existing audit requirement — Professional Skepticism. In August, 2011, the PCAOB issued a Concept Release entitled "Auditor Independence and Audit Firm Rotation". Auditors have long recognized that Independence is critical to an audit and critical to the viability of auditing itself. The Concept Release noted, however, that the Board continues to find instances in which auditors did not approach some aspect of the audit
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with the required I ndependence, Objectivity and Professional Skepticism.
Sometimes it's interesting to go back to basics - so let me do that. On independence, the second general standard on auditing (written before most of you were born) says that - "In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor." Let me highlight some words again — "I N ALL MATTERS" pertaining to the audit, " INDEPENDENCE I N MENTAL ATTIT UDE" is required of the auditor. There are a plethora of independence rules, as you know — generally they focus on financial interests and services that are deemed to impair independence. But remember at its core — Independence is a matter of maintaining an independent mental attitude in all matters pertaining to the audit. The third general standard of auditing requires that "Due professional care" is to be exercised throughout the audit and in preparing the audit report. And that standard goes on to say that "Due Professional Care requires the auditor to exercise professional skepticism." I want to pause for a moment to make sure I'm engaging not only the auditors here, but also so many of you who are the preparers of the financial statements — the controllers, those in accounting policy or operations or other Corporate executives.

This message is also important for you.
When your auditor questions your assertions, he or she is not being difficult. They're just doing their job.
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They're acting like an auditor is required to.
And when I talk about the risks of management fraud today, please don't think I'm being difficult. That's just the job of an audit standard-setter. Under PCAOB standards, the auditor neither assumes management is dishonest nor assumes unquestioned honesty. In exercising professional skepticism, the auditor should not be satisfied with less than persuasive evidence because of a belief that management is honest. "Professional Skepticism!" Just two words. But so fundamental to the performance of an audit. Observations about the lack of professional skepticism in some audits was at the heart of the Concept Release to which I referred earlier. And the PCAOB is not alone in identifying concerns regarding professional skepticism in audits. Regulators in many other countries such as Australia, Canada, Germany, The Netherlands, Singapore, Switzerland and the United Kingdom have each cited concerns in public reports about the lack of professional skepticism in audits they have inspected. So, I want to focus the remainder of my remarks on this topic so essential to the ongoing relevance and quality of audits. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence. It is essential to the performance of effective audits. Professional skepticism is required in every aspect of every audit by every auditor working on the audit. Audits are performed to provide investors with assurance on the fair
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presentation of the financial statements prepared by management.
If the audit is conducted without professional skepticism, the value of the audit to investors and others is seriously impaired. While professional skepticism is important in all aspects of the audit, it is particularly important in those areas of the audit that involve significant management judgments , including judgments in areas with great measurement uncertainty, or transactions outside the normal course of business, such as nonrecurring transactions, financing activities, and related party transactions that might be motivated solely, or in large measure, by an expected or desired accounting outcome. Effective auditing involves diligent pursuit of sufficient appropriate audit evidence, particularly if contrary evidence exists. Professional skepticism is also critical as it relates to the auditor's consideration of fraud in the audit. Company management has a unique ability to perpetrate fraud because it frequently is in a position to directly or indirectly manipulate accounting records and present fraudulent financial information. Company personnel who intentionally misstate the financial statements often seek to conceal the misstatement by attempting to deceive the auditor. Because of this incentive, applying professional skepticism is integral to planning and performing audit procedures to address fraud risks. PCAOB inspectors continue to observe instances in which the circumstances suggest that auditors did not appropriately apply professional skepticism in their audits. As examples, audit deficiencies like the following, observed in our inspections, raise concerns that a lack of professional skepticism was

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at least a contributing factor:
- For certain hard-to-value Level 2 financial instruments, the engagement team failed to obtain an understanding of the specific methods and assumptions underlying the prices that were obtained from pricing services and other third parties and used in the engagement team's testing related to these financial instruments. Further, the firm used the price closest to the issuer's recorded price in testing the fair value measurements, without evaluating the significance of differences between the other prices obtained and the issuer's prices. - The issuer discontinued production of a significant product line during the prior year and introduced a new product line to replace it. There were no sales of the discontinued product line during the last nine months of the year under audit. The engagement team did not test, beyond inquiry of management, the significant assumptions management used to calculate its separate inventory reserve for this product line. - The engagement team did not evaluate the effects on the financial statements of management's determination not to test a significant portion of its property and equipment for impairment, despite indicators that the carrying amount may not have been recoverable. These indicators in this situation included operating losses for the relevant segment for the last three years, substantial charges for the impairment of goodwill and other intangible assets during the year, a projected loss for the segment for the upcoming year, and reduced and delayed customer orders.

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The PCAOB's enforcement activities also have identified instances in which auditors did not appropriately apply professional skepticism.
For example, in one recent disciplinary order, the Board found that certain of a firm's audit partners accepted a company's reliance on an exception to GAAP for reserving for expected future product returns even though doing so conflicted with the plain language of the exception and the firm's internal accounting literature. The partners were aware of, but did not appropriately consider, contradictory audit evidence indicating that the returns were not eligible for the exception. Although auditing standards require auditors to appropriately apply professional skepticism throughout the audit, observations from our oversight activities indicate that, as a practical matter, auditors are often challenged in meeting this fundamental audit requirement. In maintaining an attitude that includes a questioning mind and a critical assessment of audit evidence, it is important for auditors to be alert to 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 investors. Certain conditions inherent in the audit environment can create incentives and pressures that can serve to impede the appropriate application of professional skepticism and allow unconscious bias to prevail. For example, incentives and pressures to build or maintain a long-term audit engagement, avoid significant conflicts with management, provide an unqualified audit opinion prior to the issuer's filing deadline, achieve high client satisfaction ratings, keep audit costs low, or cross-sell other services can all serve to inhibit professional skepticism. I think audit staff too often hear from their leaders about the
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importance of delivering high quality "client service."
That expression, "client service", can have confusing overtones to the audit team — like, keeping the client happy. How about deleting "client service" from the language and have leaders say instead — "audit teams, be focused on delivering the highest audit quality possible." Focus on extraordinary "audit quality", not extraordinary "client service." Another factor possibly impeding skepticism is that, over time, auditors may sometimes develop an inappropriate level of trust or confidence in management, which may lead auditors to accede to inappropriate accounting. In some situations, auditors may feel pressure to avoid potential negative interactions with individuals they know (that is, management) instead of representing the interests of the unseen investors they are charged to protect.

By the way, that's a good lead-in to some other phrases I think we should re-consider.
They are "Relationship Partner" and "maintaining strong client relationships." The term "relationship" can also have confusing overtones to an audit team , like "kinship" or "closeness". Does that feeling support skepticism? As far as I know, Federal Bank Regulators, State I nsurance Departments, and Securities Regulators all perform their examinations, getting everything they need to complete their work, without a focus on "relationships". I'd substitute "professional courtesy" for "client relationships." Let's

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create the right tone from the top.
Other circumstances also can impede the appropriate application of professional skepticism. For example, scheduling and workload demands can put pressure on partners and other engagement team members to complete their assignments too quickly, which might lead auditors to seek audit evidence that is easier to obtain rather than evidence that is more relevant and reliable, to obtain less evidence than is necessary, or to give undue weight to confirming evidence without adequately considering contrary evidence. Although powerful incentives and pressures exist that can impede professional skepticism, the importance of professional skepticism to an effective audit cannot be overstated, particularly given the increasing judgment and complexity in financial reporting, and issues posed by the current economic environment. Auditors and audit firms must remember that their overriding duty is to put the interests of investors first. Appropriate application of professional skepticism is key to fulfilling the auditor's duty to investors. In the words of the U.S. Supreme Court: "By certifying the public reports that collectively depict a corporation's financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public. This 'public watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust".

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Firms' quality control systems can help engagement teams improve the application of professional skepticism in a number of ways.
They include setting a proper tone at the top that emphasizes the need for professional skepticism; implementing and maintaining appraisal, promotion, and compensation processes that enhance rather than discourage the application of professional skepticism; assigning personnel with the necessary competencies to engagement teams; and appropriately monitoring the quality control system to take necessary corrective actions to address audit engagements lacking professional skepticism. When professional skepticism is applied appropriately, the auditor does not presume that the financial statements are presented fairly. Instead, the auditor employs an attitude that includes a questioning mind in making critical assessments of the evidence obtained to determine whether the financial statements are materially misstated. PCAOB standards indicate that the auditor should take into account all relevant audit evidence, regardless of whether the evidence corroborates or contradicts the assertions in the financial statements. Examples of areas in the auditor's evaluation that reflect the need for the auditor to apply professional skepticism, include, among many others, the following: - Evaluating uncorrected misstatements. This includes evaluating whether the uncorrected misstatements identified during the audit result in material misstatement of the financial statements, individually or in combination, considering both qualitative and quantitative factors. - Evaluating management bias. This includes evaluating potential bias in accounting estimates, bias in the selection and application of
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accounting principles, the selective correction of misstatements identified during the audit, and identification by management of additional adjusting entries that offset misstatements accumulated by the auditor.
When evaluating bias, it is important for auditors to consider the incentives and pressures on management regarding financial results. - Evaluating the presentation of the financial statements. This includes evaluating whether the financial statements contain the information essential for a fair presentation of the financial statements in conformity with the applicable financial reporting framework. Do the financial statements really tell the complete story? When evaluating misstatements, bias, or presentation and disclosures, it is important for auditors to appropriately apply professional skepticism and avoid dismissing matters as immaterial without adequate consideration. In summary, it was my intent here to remind auditors of the importance of appropriately applying professional skepticism throughout their audits. In upcoming year-end audits, and in all audits, it is essential that every auditor be professionally skeptical in all aspects of their audit work, to maintain a questioning mind and make a critical assessment of audit evidence. I must respectfully disagree with the notion mentioned by a speaker yesterday that professional skepticism calls for a "trust but verify" approach. I hope my comments have made clear that it is the responsibility of each individual auditor to have a questioning mind throughout the

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audit.
That means to be mindful of the risks of fraud or material misstatements, to obtain sufficient appropriate audit evidence rather than merely available evidence that corroborates assertions, and critically evaluate all evidence — especially when it contradicts those assertions. The Office of the Chief Auditor has issued an Audit Practice Alert today on "Maintaining and Applying Professional Skepticism in Audits." I consider it essential reading for all auditors. I believe it will also be useful for audit committee members and others in understanding the responsibilities of auditors to maintain an attitude of professional skepticism throughout the audit. Due to the fundamental importance of the appropriate application of professional skepticism in performing an audit, the PCAOB is also continuing to explore whether additional actions might meaningfully enhance auditors' professional skepticism. Thank you so much for your attention as I addressed this critically important subject, and other standard-setting matters.

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Economic and Monetary Affairs Committee

EU bank supervision system must be strong, accountable and inclusive
Banking supervision powers transferred to the EU level must be matched by measures that subject them to democratic scrutiny, said Economic and Monetary Affairs Committee MEPs on Thursday. They voted on plans to confer banking supervision powers on the ECB and ways to better integrate non-Eurozone countries into the new banking supervision system. The committee kept to its pledge to vote its position on EU banking supervision rules on time. The vote gives its negotiating team a strong mandate to hammer out a deal with the Council, which is expected to adopt its negotiating position at the 4 December ECOFIN meeting. "We have adopted a constructive position today: banks in trouble will be able to access funds, non-Eurozone countries will have equal rights, and we have kept to our deal by delivering our position on time", said rapporteur on ECB supervisory powers Marianne Thyssen (EPP, BE) after the vote. "Our package sends clear signals. We want a more inclusive system, a strong supervisor, recognition that there are different types of banks, and democratic accountability", said rapporteur on changes to the European Banking Authority (EBA) Sven Giegold (Greens, DE), adding that the ball was now in the Council's court.

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Which banks?
The Commission proposal would make the ECB supervisor responsible for all the Eurozone's 6,000 or so banks, with help from national supervisors. The committee position stipulates that the ECB would be most directly involved with banks receiving public assistance and those posing a systemic risk, whereas other banks would be supervised by national authorities monitored by the ECB. Draft supervisory decisions by national authorities would be deemed adopted by the ECB unless it rejected them. However the ECB would always have the power to undertake direct supervision of a bank if it felt the need to.

New supervisor, new accountability
The legislation as proposed by the Commission would give sweeping supervisory powers to the ECB, at least over banks in the Eurozone. The committee voted to balance these powers by strengthening the accountability provisions so as to impose strong controls on the ECB's supervisory arm. Most importantly, the position voted today would allow MEPs to hold inquiries into alleged failures of the ECB supervisor. It would also require that the Chair of the supervisory board be approved by the European Parliament. National parliaments and the European
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Parliament would moreover be entitled to hold hearings with representatives of the Supervisory Board.
The text also provides for the setting up of a Board of Appeal to hear complaints by parties with grievances arising out of ECB supervisor decisions.

An inclusive system
As the Commission's original proposal prompted fears that the single market could be fractured and that non-Eurozone countries would have no say, the text adopted today places non-Eurozone countries and their banks in a stronger position to take part in the proposed single supervisory mechanism (SSM).
Today's position would also give all countries taking part in the system equal voting rights in the ECB Supervisory Board. Moreover, the ECB Governing Council, the only body where non-Euro countries cannot participate, would not have the power to change proposed Board decisions. Instead, it could only ask the Board to submit a new decision. This would allow non-Eurozone countries to retain influence over decision making at all times. The position also provides for various degrees of involvement of non-Euro countries with the ECB supervisor, ranging from "close cooperation", through signing memoranda of understanding, to remaining outside the SSM but still interacting with it.

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Finally, MEPs changed the proposed voting arrangements within the EBA so as to reduce inequalities between countries within the SSM and those outside.

Next steps
Parliament is now ready to start negotiations with member states to hammer out a deal on the two texts.

Talks could begin next week, if the Council gives the Cyprus Presidency its negotiating mandate in time.

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Opportunities facing Islamic finance and challenges in managing capital flows in Asia
Outline of special address by Mr Tharman Shanmugaratnam, Chairman of the Monetary Authority of Singapore, at the 8th World I slamic Economic Forum, Johor Bahru, Malaysia The Prime Minister of Malaysia, H is Excellency Dato‘ Sri Najib Tun Razak, The President of Comoros, His Excellency Ikililou Dhoinine, The President of the Islamic Development Bank, H is Excellency Ahmad Mohamed Ali, Chairman of the World I slamic Economic Forum Foundation Tun Musa Hitam Ministers and distinguished guests, Ladies and gentlemen

I ntroduction
It is my pleasure to be here today and have the opportunity to share some thoughts. Let me first congratulate the WIEF on the progress it has made in establishing itself as a leading international forum for economic leaders and opinion shapers from a broad range of countries to discuss issues of interest in Islamic Finance and related themes in global finance. The theme of the Forum, ―Changing Trends, New Opportunities‖ is particularly relevant. Allow me to first offer a brief perspective on opportunities facing I slamic finance.

I will then go on to talk about the challenges we face in Asia in managing capital flows in the aftermath of the Global Financial Crisis.

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I slamic finance: opportunities for growth
The Islamic finance industry is estimated to have grown by some 19% per year since 2006 – to record nearly US$1.3 trillion of total shariah compliant assets in 2012. But there is still considerable scope for its development: •I slamic finance presently forms less than 1% the global financial industry. •For a large number of countries, even in jurisdictions with substantial Muslim populations, Islamic finance currently constitutes less than 5% of their financial sector. •And despite a record level of sukuk issuance in 2012, the industry as a whole is still largely concentrated on the banking sector. There is much ahead in the journey to develop I slamic capital markets and the takaful (Islamic insurance) industry.

I believe the next 10–15 years offer significant opportunities for the growth and diversification of Islamic finance.
Let me highlight the reasons to be optimistic about its prospects: •First, Islamic financial institutions have in the main escaped significant damage in the global financial crisis. They are well-placed to grow, at a time when many of the global banks, especially the European banks, are deleveraging or focusing on consolidating their balance sheets. •Second, Islamic finance has much potential to diversify into new growth areas such as trade and infrastructure financing in Asia and the emerging markets.

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These new areas will allow I slamic banks to reduce their exposure to the real estate sector, and to take advantage of the stronger growth potential of the emerging market economies.
There are gaps to be filled in structured trade finance and in funding for infrastructural projects as the emerging markets grow, and as global finance consolidates. •Third, Islamic finance can also seek to meet the increased demand for simpler and more transparent products and ‗back-to-basics‘ finance.

Investors are now much more circumspect about complex products and their risks.
The crisis taught investors worldwide not only about the damage they can face from the risks that are known and unsurprising, but of the risks of ‗what we do not know‘. Islamic finance, with its focus on transparency, price certainty and risk-sharing, can ride this wave of demand for simpler and more basic investments. However, Islamic finance will have to overcome a few important challenges in order to grow its share in global finance and contribute to cross-border finance. These include the need to reduce fragmentation in I slamic finance markets due to differences in accepted standards of Shariah compliance between regions, jurisdictions, and in some cases even domestically within jurisdictions. This has hampered the flow of liquidity between jurisdictions, and is in part why there is yet no I slamic equivalents to the international money and bond markets. There is considerable progress being made to address these challenges.

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Bodies such as AAOIFI, ID B‘s I slamic Research & Training I nstitute, and Malaysia‘s International Shariah Research Academy (ISRA) have made significant efforts to narrow the differences in acceptability of Shariah compliance.
The Islamic Financial Services Board (IFSB), in conjunction with international standards setting bodies such as the Bank of International Settlements (BIS), I OSCO and I AIS and various regulators from I slamic and conventional jurisdictions, are also formulating international standards and best practices for the industry.

Islamic finance is also seeing increasing interest in Asia.
We are seeing financial institutions leveraging on the strengths and expertise that have been developed in both I slamic and conventional financial markets. This is expanding the range of Shariah-compliant products and allowing the I slamic finance industry to tap on broad and deep investor pools globally and in Asia. •Malaysia is widely recognised as a leader in I slamic finance, in particular for the issuance of sukuks. •I slamic finance is also seeing growing interest in other Asian financial centres such as Singapore, H ong Kong and Tokyo. •Just recently in mid-November 2012, institutional and private investors in Singapore and H K were the largest investors in the US$15.5 billion global sukuk issued by the Abu Dhabi I slamic Bank (ADIB). •Between our two countries, we are seeing Malaysian banks collaborating with Singapore corporates and financial players to structure S$ denominated corporate sukuk programmes. And Singapore-listed companies are venturing out to tap the Ringgit sukuk market in Malaysia.

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These are trends that we are keen to encourage.
To repeat therefore, I am optimistic that we can realise the significant growth potential for Islamic finance in the next 10–15 years.

Managing the challenge of capital flows in the post-crisis era
Let me move on now to say a few things about the challenges that many in the emerging world face in managing capital flows, particularly in the face of the extremely low interest rates being set in the advanced economies (AEs). We are in an unprecedented situation. Interest rates are expected to stay extremely low in the US and much of the advanced world for a few years, reflecting decisions by their central banks to keep monetary conditions highly accommodative until their economies resume normal growth. There is debate among economists on how effective these activist monetary policies, such as the US Fed‘s QE3 strategy, will be in reviving entrepreneurial spirits and rivate investments. If the strategy succeeds and the US economy recovers, it will be a plus for Asia as well. In the meantime, however, there are significant implications for emerging market economies, as global investors search for better returns – better than the near-zero rates they get on cash and treasury bills. With large amounts of liquidity now moving between markets, short-term shifts in investor sentiment leads to volatility in capital flows. We have seen how a shock in the European periphery can send money that was invested in emerging markets rushing back to the US or other safe havens.

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To be clear about it, there is a lot that is good about capital flows, including even short term flows.
They add liquidity to markets, by bringing more buyers and sellers together. However, we know too that capital inflows can also be too much of a good thing. They can lead to asset prices, or exchange rates, becoming disconnected from fundamentals. And the sudden withdrawal of capital from emerging economies when investors switch from ‗risk on‘ to ‗risk off‘ in their portfolios can be destabilising. As I mentioned, the current global condition is unprecedented. The policy responses in the advanced countries too are without precedent.

Globally therefore, we need some humility in understanding the benefits and costs of QE3 and easy monetary policies in the advanced countries.
But it will be wise to strengthen our policy toolkits in Asia, so that we can deal with unpredictable and often excessive capital flows. There are some lessons that come out of our experiences in Asia and elsewhere, and policy responses that we can learn from each other. I will mention three sets of policy responses that will inevitably have to figure in our toolkits. First, there is much sense in curtailing volatility in the exchange rate over the short-term. The costs of volatile and uncertain exchange rates are high in small open economies especially – which is what most of our ASEAN economies are.
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Accordingly, Malaysia, Singapore and several other Asian countries have not felt comfortable leaving their exchange rates entirely to market forces.
Their central banks, within each of their monetary policy frameworks, have sought to instil a focus on longer term fundamentals. There is merit in allowing exchange rates in Asia‘s emerging economies to appreciate gradually over the long term, reflecting their more rapid growth. If we resist these long term trends, we are likely to see more inflation in our economies. But some stability in the short term is wise. Second, macro-prudential policies are now an important part of the policy tool kit. Many Asian countries have introduced new macro-prudential measures to try and avoid bubbles in their property markets over the last two years.

Malaysia brought in stricter limits on loan-to-value ratios on housing loans.
Singapore and H ong Kong have done similarly, and have introduced additional stamp duties or transaction taxes to discourage speculative demand for residential properties. These targeted administrative and prudential measures are not conventional macro-economic tools. But they are likely to remain part of our policy toolkit, at least for the foreseeable future, given the real risks to macro-economic stability that an environment of very low global interest rates poses. A third and more fundamental strategy has to focus on building greater depth in Asia‘s capital markets, while ensuring that our banking systems remain sound.
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A good example of this strategy is in fact in Malaysia.
Bank Negara‘s Financial Sector Blueprint I I (2012–2020), released as part of the government‘s Economic Transformation Programme (ETP), will build on the solid foundations of Malaysia‘s financial system, including developing a deep and vibrant bond market. The banks in several leading Asian countries, including Malaysia and Singapore, are generally well-managed and well-capitalised. They were a source of strength for us during the global financial crisis. However, Asia‘s capital markets, and especially the corporate bond markets, need much more depth. Broader and deeper capital markets will allow investors to invest for the long term while hedging against risks. They will help us meet the growing infrastructural and other long term investment needs of the region.

This is therefore a very important priority in the region, and there is in fact significant scope for future development of Asian capital markets.
Regulators are working to harmonise rules and market practices across the region, such as issuance procedures and settlement standards. We also need to develop the securitisation markets, with appropriate safeguards, so that banks can recycle their capital. More too is being done to boost linkages between our markets and economies. We have to pool liquidity across our markets, so as to add depth to the Asian capital market.

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An example is how the Malaysian stock exchange, Bursa Malaysia, the Singapore Exchange and the Stock Exchange of Thailand recently launched an ASEAN Trading Link.
We are also cooperating to encourage financing for infrastructure projects in the region. The ASEAN Infrastructure Fund (AIF), an initiative that was led by Malaysia, is a good example. It will pool resources, knowledge and experience among ASEAN governments and the Asian Development Bank (ADB) for loans to sovereign or sovereign-guaranteed infrastructure projects. The Fund will also issue bonds, so as to bring in private sector and institutional investors. Another example of such cooperation in the region is the Credit Guarantee and I nvestment Facility (CGIF) amongst the ASEAN+3 countries, which aims to help companies in ASEAN+3 countries raise long term financing for infrastructure investment by providing the governments‘ guarantees on their corporate bonds, thereby reducing risk for bond-holders. Projects such as Iskandar Malaysia are also a prime example of how intra-regional investments can be encouraged, and how countries in our region can develop competitive strengths jointly. •Iskandar Malaysia‘s performance has been impressive – poised to exceed its targeted RM100 billion investment mark by the end of this year. •I am glad there is good progress on the joint venture by Temasek Holdings and Khazanah Nasional, Pulau I ndah Ventures Sdn Bhd to co-develop two separate sites in Medini. •Other significant projects include a S$1.5 billion integrated eco-friendly tech-park by Ascendas and Malaysia‘s UEM Land Berhad in Nusajaya (one of the five flagship zones in I skandar).
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Once completed, the park will accommodate a range of industries including electronics and precision engineering.
•Just in the last month, we have seen other significant investment commitments in Iskandar reported by Singapore companies. Iskandar Malaysia will enhance the complementary space between our two economies. It is a win-win.

To ensure continued progress in I skandar, Singapore and Malaysia will continue to take steps to improve connectivity, cross-border trade facilitation, and immigration processes.

Conclusion
I would like to conclude by emphasising once again that I am basically optimistic about the prospects in our bilateral and regional cooperation. We face many challenges in this post-Global Financial Crisis era. But the opportunities for us in Asia are intact, and our ability to cooperate with each other to achieve our full potential as a region is an asset for all our countries.

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Resolving Globally Active, Systemically Important, Financial Institutions
A joint paper by the Federal Deposit Insurance Corporation and the Bank of England Resolving Globally Active, Systemically I mportant, Financial I nstitutions Federal Deposit I nsurance Corporation and the Bank of England

Executive summary
The financial crisis that began in 2007 has driven home the importance of an orderly resolution process for globally active, systemically important, financial institutions (G-SIFIs). Given that challenge, the authorities in the United States (U.S.) and the United Kingdom (U.K.) have been working together to develop resolution strategies that could be applied to their largest financial institutions. These strategies have been designed to enable large and complex crossborder firms to be resolved without threatening financial stability and without putting public funds at risk. This work has taken place in connection with the implementation of the G20 Financial Stability Board‘s Key Attributes of Effective Resolution Regimes for Financial I nstitutions. The joint planning has been productive and effective.

It has enhanced the resolution planning process in both jurisdictions, tackled key issues in relation to cross-border coordination, and identified potential challenges that will be addressed through further work.

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This paper focuses on the application of ―top-down‖ resolution strategies that involve a single resolution authority applying its powers to the top of a financial group, that is, at the parent company level.
The paper discusses how such a top-down strategy could be implemented for a U.S. or a U.K. financial group in a cross-border context. In the U.S., the strategy has been developed in the context of the powers provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Such a strategy would apply a single receivership at the top-tier holding company, assign losses to shareholders and unsecured creditors of the holding company, and transfer sound operating subsidiaries to a new solvent entity or entities.
In the U.K., the strategy has been developed on the basis of the powers provided by the U.K. Banking Act 2009 and in anticipation of the further powers that will be provided by the European Union Recovery and Resolution Directive and the domestic reforms that implement the recommendations of the U.K. Independent Commission on Banking. Such a strategy would involve the bail-in (write-down or conversion) of creditors at the top of the group in order to restore the whole group to solvency. Both the U.S. and U.K. approaches ensure continuity of all critical services performed by the operating firm(s), thereby reducing risks to financial stability. Both approaches ensure activities of the firm in the foreign jurisdictions in which it operates are unaffected, thereby minimizing risks to cross-border implementation. The unsecured debt holders can expect that their claims would be written down to reflect any losses that shareholders cannot cover, with some converted partly into equity in order to provide sufficient capital to return the sound businesses of the G-SIFI to private sector operation.
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Sound subsidiaries (domestic and foreign) would be kept open and operating, thereby limiting contagion effects and cross-border complications.
In both countries, whether during execution of the resolution or thereafter, restructuring measures may be taken, especially in the parts of the business causing the distress, including shrinking those businesses, breaking them into smaller entities, and/ or liquidating or closing certain operations. Both approaches would be accompanied by the replacement of culpable senior management. This paper outlines several common considerations that affect these particular approaches to resolution in the U.S. and the U.K., including the need to ensure sufficient loss absorbency at the top of the group. The Federal Deposit Insurance Corporation and the Bank of England will continue to work together on these resolution strategies.

Resolving Globally Active, Systemically Important, Financial Institutions, Federal Deposit Insurance Corporation and the Bank of England Introduction
1 The Federal Deposit I nsurance Corporation (FDIC) and the Bank of England—together with the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, and the Financial Services Authority—have been working to develop resolution strategies for the failure of globally active, systemically important, financial institutions (SIFIs or G-SIFIs) with significant operations on both sides of the Atlantic. This work has taken place in connection with the implementation of the Financial Stability Board‘s (FSB) Key Attributes of Effective Resolution Regimes for Financial I nstitutions (Key Attributes), as well as in
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connection with the reforms to the legal arrangements for handling the failure of financial institutions that were instituted in the United States (U.S.) and the United Kingdom (U.K.) in response to the recent financial crisis.
2The goal is to produce resolution strategies that could be implemented for the failure of one or more of the largest financial institutions with extensive activities in our respective jurisdictions. These resolution strategies should maintain systemically important operations and contain threats to financial stability. They should also assign losses to shareholders and unsecured creditors in the group, thereby avoiding the need for a bailout by taxpayers. These strategies should be sufficiently robust to manage the challenges of cross-border implementation and to the operational challenges of execution. 3As highlighted in the FSB‘s recently published draft Guidance on Recovery and Resolution Planning, strategies for resolution may broadly be categorized as either applying resolution powers to the top of a group by a single national resolution authority (single point of entry), or applying resolution tools to different parts of the group by two or more resolution authorities acting in a coordinated way (multiple points of entry). Which strategy is most suitable to resolving the group will depend upon a range of factors. For example, a single point of entry strategy may offer the simplest and most effective choice if the debt issued at the top of the group is sufficient to absorb the group‘s losses. Where this is not the case, a multiple points of entry strategy will be more suitable, particularly if different parts of the group can continue on a standalone basis.

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4The focus of this paper is on a single point of entry resolution approach.
It is hoped that the detail it provides on the single point of entry approach, when combined with the published FSB Guidance on Recovery and Resolution Planning, will give greater predictability for market participants about how resolution authorities may approach a resolution. This predictability cannot, however, be absolute, as the resolution authorities must not be constrained in exercising discretion in pursuit of their statutory objectives in how best to resolve a firm.

Post-crisis resolution strategy
5The financial crisis that began in late 2007 highlighted the shortcomings of the arrangements for handling the failure of large financial institutions that were in place on either side of the Atlantic. Large banking organizations in both the U.S. and the U.K. had become highly leveraged and complex, with numerous and dispersed financial operations, extensive off-balance-sheet activities, and opaque financial statements. These institutions were managed as single entities, despite their subsidiaries being structured as separate and distinct legal entities. They were highly interconnected through their capital markets activities, interbank lending, payments, and off-balance-sheet arrangements. 6The legislative frameworks and resolution regimes at the time were ill-suited to dealing with financial institution failures of this scale and interconnectedness. In the U.S., the FDI C only had the power to place an insured depository institution into receivership; it could not resolve failed or failing bank holding companies or other nonbank financial companies that posed a systemic risk.
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In the U.K., until 2009 there was no special resolution regime available for banks or other financial companies, whatever their size or complexity, and as a result the U.K. was reliant on standard insolvency procedures such as administration.
7As demonstrated by the Title I requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), the U.S. would prefer that large financial organizations be resolvable through ordinary bankruptcy. However, the U.S. bankruptcy process may not be able to handle the failure of a systemic financial institution without significant disruption to the financial system. 8Similarly, the U.K. administration process often takes time and involves significant uncertainty regarding the outcome. Forcing large financial organizations through administration can create significant and systemic risks for the real economy by interrupting critical services, disrupting key financial relationships, and freezing financial markets. In addition, it can destroy value, harming the real economy. 9 Given these problems with the bankruptcy process, the U.S. and the U.K. authorities resorted to providing large scale public support to failing financial companies during the 2007-09 crisis to prevent further systemic disruption. This public support has exposed taxpayers to loss and resulted in the bailout of multiple financial institutions and their creditors. 10 Following the crisis, an overhaul of the framework for dealing with large and complex financial institution failures was required. While it may be useful to strengthen the current bankruptcy code or administration rules to improve the handling of financial failures, systemic considerations warrant having an alternative resolution strategy.

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11A resolution strategy for a failed or failing G-SIFI should assign losses to shareholders and unsecured creditors, and hold management responsible for the failure of the firm.
The strategy should provide continuity of the critical services that the institution provides within the financial system and to the real economy, thereby minimizing systemic risk. The strategy should also enable a prompt transition of the firm‘s ongoing operations to full private ownership and control without taxpayer support.

Given the cross-border nature of G-SIFIs, the resolution strategy should ensure financial stability concerns are addressed across all jurisdictions in which the firm operates.
To be successful, such an approach will require close cooperation between home and foreign authorities. 12Under the strategies currently being developed by the U.S. and the U.K., the resolution authority could intervene at the top of the group.

Culpable senior management of the parent and operating businesses would be removed, and losses would be apportioned to shareholders and unsecured creditors.
In all likelihood, shareholders would lose all value and unsecured creditors should thus expect that their claims would be written down to reflect any losses that shareholders did not cover. Under both the U.S. and U.K. approaches, legal safeguards ensure that creditors recover no less than they would under insolvency.

13An efficient path for returning the sound operations of the G-SIFI to the private sector would be provided by exchanging or converting a sufficient amount of the unsecured debt from the original creditors of the failed company into equity.

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In the U.S., the new equity would become capital in one or more newly formed operating entities.
In the U.K., the same approach could be used, or the equity could be used to recapitalize the failing financial company itself—thus, the highest layer of surviving bailed-in creditors would become the owners of the resolved firm. In either country, the new equity holders would take on the corresponding risk of being shareholders in a financial institution.

Throughout, subsidiaries (domestic and foreign) carrying out critical activities would be kept open and operating, thereby limiting contagion effects.
Such a resolution strategy would ensure market discipline and maintain financial stability without cost to taxpayers.

Legislative frameworks for implementing the strategy
14 It should be stressed that the application of such a strategy can be achieved only within a legislative framework that provides authorities with key resolution powers. The FSB Key Attributes have established a crucial framework for the implementation of an effective set of resolution powers and practices into national regimes. In the U.S., these powers had already become available under the Dodd-Frank Act. In the U.K., the additional powers needed to enhance the existing resolution framework established under the Banking Act 2009 (the Banking Act) are expected to be fully provided by the European Commission‘s proposals for a European Union Recovery and Resolution Directive (RRD) and through the domestic reforms that implement the recommendations of the U.K. I ndependent Commission on Banking
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(ICB), enhancing the existing resolution framework established under the Banking Act.
The development of effective resolution strategies is being carried out in anticipation of such legislation.

U.S. regime
15The framework provided by the Dodd-Frank Act in the U.S. greatly enhances the ability of regulators to address the problems of large, complex financial institutions in any future crisis. Title I of the Dodd-Frank Act requires each G-SIFI to periodically submit to the FDIC and the Federal Reserve a resolution plan that must address the company‘s plans for its rapid and orderly resolution under the U.S. Bankruptcy Code. The FDIC and the Federal Reserve are required to review the plans to determine jointly whether a company‘s plan is credible. If a plan is found to be deficient and adequate revisions are not made, the FDIC and the Federal Reserve may jointly impose more stringent capital, leverage, or liquidity requirements, or restrictions on growth, activities, or operations of the company, including its subsidiaries. Ultimately, the company could be ordered to divest assets or operations to facilitate an orderly resolution under bankruptcy in the event of failure. Once submitted and accepted, the SIFIs‘ plans for resolution under bankruptcy will support the FDIC ‘s planning for the exercise of its resolution powers by providing the FDIC with an understanding of each SIFI‘s structure, complexity, and processes. 16Title I I of the Dodd-Frank Act provides the FDIC with new powers to resolve SIFIs by establishing the orderly liquidation authority (OLA). Under the OLA, the FDIC may be appointed receiver for any U.S. financial company that meets specified criteria, including being in default
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or in danger of default, and whose resolution under the U.S. Bankruptcy Code (or other relevant insolvency process) would likely create systemic instability.
Title I I requires that the losses of any financial company placed into receivership will not be borne by taxpayers, but by common and preferred stockholders, debt holders, and other unsecured creditors, and that management responsible for the condition of the financial company will be replaced. Once appointed receiver for a failed financial company, the FDIC would be required to carry out a resolution of the company in a manner that mitigates risk to financial stability and minimizes moral hazard. Any costs borne by the U.S. authorities in resolving the institution not paid from proceeds of the resolution will be recovered from the industry.

U.K. regime
17In the U.K., the Banking Act provides the Bank of England with tools for resolving failing deposit-taking banks and building societies. Powers similar to those of the FDIC are available, including powers to transfer all or part of a failed bank‘s business to a private sector purchaser or to a bridge bank until a private purchaser can be found. The Banking Act also provides the U.K. authorities with a bespoke bank insolvency procedure that fully protects insured depositors while liquidating a failed bank‘s assets. These powers have proved valuable; for example, during the crisis they allowed the authorities to transfer the retail and wholesale deposits, branches, and a significant proportion of the residential mortgage portfolio of a failed building society to another building society. 18The Banking Act powers do not, however, provide a wholly effective solution to the failure of a large, complex, and international financial firm.
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The critical economic functions of a G-SIFI are currently intertwined legally, operationally, and financially across jurisdictions and legal entities.
For U.K. firms, these functions frequently reside in the same entities as the firms‘ core unsecured liabilities. Using the existing statutory transfer powers would involve separating and transferring large and complex businesses from within operating entities to a purchaser or bridge bank, while leaving behind the remaining liabilities and bad assets in the failed firm to be wound up through insolvency. These operating companies may have several thousand counterparties, customers, and contracts. Such a transfer would be almost impossible to achieve over a resolution weekend without destroying value and causing financial stability concerns in multiple jurisdictions. 19The introduction of a statutory bail-in resolution tool (the power to write down or convert into equity the liabilities of a failing firm) under the RRD is critical to implementing a whole group resolution of U.K. firms in a way that reduces the risks to financial stability. A bail-in tool would enable the U.K. authorities to recapitalize an institution by allocating losses to its shareholders and unsecured creditors, thereby avoiding the need to split or transfer operating entities. The provisions in the RRD that enable the resolution authority to impose a temporary stay on the exercise of termination rights by counterparties in the event of a firm‘s entry into resolution (in other words, preventing counterparties from terminating their contractual arrangements with a firm solely as a result of the firm‘s entry into resolution) will be needed to ensure the bail-in is executed in an orderly manner. 20The existing Banking Act does not cover nondeposit-taking financial firms, notably investment banks and financial market infrastructures
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(clearing houses in particular), the failure of which, in many cases, would also have significant financial stability consequences.
The Banking Act also has limitations with regard to the application of resolution tools to financial holding companies. The U.K. is in the process of expanding the scope of the Banking Act to include these firms. This is expected to be achieved through the introduction of the U.K. Financial Services Bill, which is due to complete its passage through Parliament by the end of this year. 21In addition to expanding the U.K. resolution regime, the Financial Services Bill will significantly enhance the U.K.‘s approach to banking supervision. Going forward, the framework for prudential supervision in the U.K. will emphasize supervisory judgment, rather than supervision based solely on rules. Under this framework, considerations of resolvability or ease of resolution would become a core part of the supervisory process. 22In conjunction with the Financial Services Bill, the adoption of the recommendations of the I CB will also significantly improve the resolvability of the U.K. domestic retail bank by ringfencing it from the rest of the group. This will help to preserve core domestic intermediation services if a group-wide resolution is not feasible for some reason.

23To ensure that banks are resolvable, the Financial Services Authority (and in the future, the Prudential Regulation Authority (PRA)) will require firms under the Financial Services Act 2010 to produce Recovery and Resolution Plans (RRPs).

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Firms will submit the information that the authorities will need to prepare resolution plans and to assess resolvability.
Where barriers to resolution are identified, firms will be required to remove them through changes to their structure and operations. The proposed RRD provides authorities with the necessary powers to achieve this, including the ability to require changes to the legal or operational structures of institutions, and to require firms to cease specific activities.

Description of the resolution strategies U.S. approach to single point of entry resolution strategy
24Under the U.S. approach, the FDIC will be appointed receiver of the top-tier parent holding company of the financial group following the company‘s failure and the completion of the appointment process set forth under the Dodd-Frank Act. Immediately after the parent holding company is placed into receivership, the FDIC will transfer assets (primarily the equity and investments in subsidiaries) from the receivership estate to a bridge financial holding company. By taking control of the SIFI at the top of the group, subsidiaries (domestic and foreign) carrying out critical services can remain open and operating, limiting the need for destabilizing insolvency proceedings at the subsidiary level. Equity claims of the shareholders and the claims of the subordinated and unsecured debt holders will likely remain in the receivership. 25Initially, the bridge holding company will be controlled by the FDIC as receiver. The next stage in the resolution is to transfer ownership and control of the surviving operations to private hands.
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Before this happens, the FDIC must ensure that the bridge has a strong capital base and must address whatever liquidity concerns remain.
The FDIC would also likely require the restructuring of the firm— potentially into one or more smaller, non-systemic firms that could be resolved under bankruptcy. 26By leaving behind substantial unsecured liabilities and stockholder equity in the receivership, assets transferred to the bridge holding company will significantly exceed its liabilities, resulting in a well-capitalized holding company. After the creation of the bridge financial company, but before any transition to the private sector, a valuation process would be undertaken to estimate the extent of losses in the receivership and apportion these losses to the equity holders and subordinated and unsecured creditors according to their order of priority. In all likelihood, the equity holders would be wiped out and their claims would have little or no value.

27To capitalize the new operations—one or more new private entities— the FDIC expects that it will have to look to subordinated debt or even senior unsecured debt claims as the immediate source of capital.
The original debt holders can thus expect that their claims will be written down to reflect any losses in the receivership of the parent that the shareholders cannot cover and that, like those of the shareholders, these claims will be left in the receivership. 28At this point, the remaining claims of the debt holders will be converted, in part, into equity claims that will serve to capitalize the new operations. The debt holders may also receive convertible subordinated debt in the new operations.

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This debt would provide a cushion against further losses in the firm, as it can be converted into equity if needed.
Any remaining claims of the debt holders could be transferred to the new operations in the form of new unsecured debt. 29 The transfer of equity and investments in operating subsidiaries to the bridge holding company should do much to alleviate liquidity pressures. Ongoing operations and their attendant liabilities also will be supported by assurances from the FDIC, as receiver. As demonstrated by past bridge-bank operations, the assurance of performance should encourage market funding and stabilize the bridge financial company. However, in the case where credit markets are impaired and market funding is not available in the short term, the Dodd-Frank Act provides for FDIC access to the Orderly Liquidation Fund (OLF), a fund within the U.S. Treasury.

In addition to providing a back-up source of funding, the OLF may also be used to provide guarantees, within limits, on the debt of the new operations.
An expected goal of the strategy is to minimize or avoid use of the OLF. To the extent that the OLF is used, it must either be repaid from recoveries on the assets of the failed financial company or from assessments against the largest, most complex financial companies. The Dodd-Frank Act prohibits the loss of any taxpayer money in the orderly liquidation process.

U.K. approach to single point of entry resolution strategy
30 The U.K.‘s planned approach to single point of entry also involves a top-down resolution.
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On the basis that the RRD will introduce a broad bail-in power, the U.K. authorities would seek to recapitalize the financial group through the imposition of losses on shareholders and, as appropriate, creditors of the firm via the exercise of a statutory bail-in power.
This U.K. group resolution approach need not employ a bridge bank and administration, although such powers are available in the U.K. and may be appropriate under certain circumstances. 31Current proposals for implementing such a strategy incorporate a period in which equity and debt securities would be transferred from the shareholders and debt holders to an appointed trustee. The trustee would hold the securities during a valuation period in which the extent of the losses expected to be incurred by the firm would be established and, in turn, the recapitalization requirement determined. During this period, listing of the company‘s equity securities (and potentially debt securities) would be suspended. Once the recapitalization requirement has been determined, an announcement of the final terms of the bail-in would be made to the previous security holders. This announcement would include full details of the write-down and/ or conversion. 32Debt securities would be cancelled or written down in order to return the firm to solvency by reducing the level of outstanding liabilities. The losses would be applied up the firm‘s capital structure in a process that respects the existing creditor hierarchy under insolvency law. The value of any loans from the parent to its operating subsidiaries would be written down in a manner that ensures that the subsidiaries remain solvent and viable.

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33Completion of the exchange would see the trustee transfer the equity (and potentially some of the existing debt securities written down accordingly) back to the original creditors of the firm.
Those creditors unable to hold equity securities (for example, for reasons of investment mandate restrictions) would be able to request that the trustee sell the equity securities on their behalf. The trust would then be dissolved and the equity securities (and potentially debt securities) of the firm would resume trading.

The firm would now be recapitalized and primarily owned by the (appropriate layer of) original creditors of the institution.
As described later, the process would be accompanied by restructuring measures to address the causes of the firm‘s failure and to restore the business to viability. 34The U.K. has also given consideration to the recapitalization process in a scenario in which a G-SIFI‘s liabilities do not include much debt issuance at the holding company or parent bank level but instead comprise insured retail deposits held in the operating subsidiaries. Under such a scenario, deposit guarantee schemes may be required to contribute to the recapitalization of the firm, as they may do under the Banking Act in the use of other resolution tools. The proposed RRD also permits such an approach because it allows deposit guarantee scheme funds to be used to support the use of resolution tools, including bail-in, provided that the amount contributed does not exceed what the deposit guarantee scheme would have as a claimant in liquidation if it had made a payout to the insured depositors. That is consistent with the contribution requirement that is already imposed on the Financial Services Compensation Scheme in the U.K. in the exercise of resolution powers and simulates the losses that would have been incurred by those deposit guarantee schemes during bank insolvency.
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But insofar as a bail-in provides for continuity in operations and preserves value, losses to a deposit guarantee scheme in a bail-in should be much lower than in liquidation.
Insured depositors themselves would remain unaffected. Uninsured deposits would be treated in line with other similarly ranked liabilities in the resolution process, with the expectation that they might be written down. 35Following the recapitalization process, the firm would be restructured to address the causes of its failure. It should then be solvent and viable, and as a result in a position to access market funding. In recognition of the fact that it will take time for losses to be assessed for purposes of recapitalization, and that it will take time to execute the restructuring plan that will underpin the firm‘s viability, immediate access may prove difficult.

In certain circumstances, to reduce the immediate funding need and so facilitate market access, illiquid assets might be removed from the balance sheet of the firm and transferred into an asset management company to be worked out over a longer period.
36If market funding were not immediately available, temporary funding may need to be provided by the authorities to meet the firms‘ liquidity needs. The funding would only be provided on a fully collateralized basis with appropriate haircuts applied to the collateral to reduce further the risk of loss. In the unlikely event that losses were associated with the provision of temporary public sector support, such losses would be recovered from the financial sector.

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37It is important to note that the strategy described above would not necessarily be appropriate for all U.K. G-SIFIs in all circumstances.
Other strategies may be more appropriate depending on the structure of a group, the nature of its business, and the size and location of the group‘s losses. For example, in cases where the losses on assets in a particular operating subsidiary were potentially so great that they could not be absorbed by bailing in at group level or where the business had incurred such significant losses and was so weighed down by toxic assets that the capital needs in resolution were too difficult to estimate credibly, resolution at the level of one or more operating subsidiaries may be more appropriate. In this situation, the application of resolution tools to operating subsidiaries would be easier if the subsidiaries providing critical economic services were operationally and financially ringfenced from the rest of the group. 38This is one of the advantages of the ringfence which is being introduced in the U.K. I t will provide flexibility in the event of fatal problems elsewhere in the group to transfer the ringfenced entity to a bridge bank or purchaser in its entirety. If losses were concentrated in the ringfenced entity and capital in the ringfenced entity was insufficient to absorb them, then losses could be borne by creditors of the ringfenced bank (including debt holders where the ringfenced bank had issued debt into the market). This could be achieved either by bail-in or by transferring the operations of the ringfenced bank to a bridge bank, leaving uninsured creditors behind in administration. Draft legislation to establish this ringfence of the largest retail deposit-takers is due to be introduced into Parliament early in 2013 and if passed will provide valuable additional flexibility in implementing

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resolution strategies to preserve the provision of core services in the U.K. business of U.K. G-SIFIs.

Key common considerations for U.S. and U.K. approaches
39As outlined above, high-level transaction structures have been developed for each jurisdiction. As discussed in the FSB Guidance on Recovery and Resolution Planning, for any resolution to be effective, consideration needs to be given in advance to various preconditions and operational requirements. Several of these considerations in relation to a top-down resolution strategy are discussed in more detail below.

Resolution and restructuring measures
40A top-down resolution by definition focuses on assigning losses and establishing new capital structures at the top of the group. This approach keeps the rest of the group, potentially comprised of hundreds or thousands of legal entities, intact. However, a top-down resolution would need to be accompanied, or shortly followed, by significant restructuring measures to address the causes of the firm‘s failure and to underpin the firm‘s viability . Such a restructuring may include shrinking the G-SIFI‘s balance sheet, breaking the company up into smaller entities, and/ or selling or closing certain operations. The newly restructured companies will all need to have strong corporate governance and management oversight, which would likely necessitate significant changes to management and board personnel and processes. In both countries, it is likely that supervisory actions will continue after the return to private ownership to ensure that the firm is on a stable and
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sustainable footing and the problems that caused the firm to fail in the first place have been properly dealt with.
41In the U.S., effective governance will be an important issue for both the transitional bridge financial company and the newly capitalized entity or entities into which the bridge will transition. The FDIC, as receiver, will control the bridge financial company and would immediately appoint a temporary board of directors and Chief Executive Officer (CEO) to run the bridge. The claims of the failed G-SIFI‘s unsecured creditors will be converted into equity and, as a result, the former creditors will become owners of the new private sector operations. They will thereafter be responsible for electing a new board of directors, which will in turn appoint a new CEO. 42During the period in which the FDIC controls the bridge financial company, decisions will be made on how to on simplify and shrink the institution. It also would likely require restructuring of the firm—perhaps into one or more smaller, non-systemic firms. Consideration will also be given to how to create a more stable, less systemically important institution. Required changes, including divestiture, may be influenced by the failed firm‘s Title I resolution plan. Once determined, the required actions and relevant time frames for their execution will be specified in formal supervisory agreements with the new owners of the private sector operations. 43The required actions would be executed in private markets by the new owners.

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For example, the new owners might be required to sell a portion of their branch structure to reduce their footprint, divest their foreign operations, or separate their commercial and investment banking operations.
The resulting new private sector operations would be smaller, more manageable—and perhaps more profitable. They would also be easier to examine and supervise. Importantly, all new operations must be resolvable under bankruptcy without public support. 44 In the U.K., similar considerations would enter into decisions on the restructuring process. Depending on the specific timeline for resolution, the restructuring may occur primarily either during the trustee stage (before the delivery of equity securities to the creditors) or during the stage following the dissolution of the trust. The extent of the restructuring measures required would depend on the cause of failure, and the extent to which losses were contained within a particular pool of assets or legal entity. If losses at the firm were localized, the restructuring measures required may be limited. These would likely require a sale or wind-down of relevant business lines and withdrawal from loss-making activities. The senior management that were responsible for bringing the firm into distress would also be replaced. On the other hand, if losses at the firm were pervasive and spread across multiple business lines, a more fundamental restructuring of the firm‘s business would be required. This would likely include a complete governance overhaul and a thorough reorganization of the activities of the institution.

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In the extreme case, much of the institution may enter managed wind-down over a prolonged period of time.
In such a scenario, it is likely that a legal and operational ringfencing of a banking group‘s retail banking activities from the group‘s investment banking activities would prove particularly valuable in facilitating such a restructuring.

Maintaining financial stability
45 Both the U.S. and U.K. resolution proposals are designed to maintain financial stability by ensuring that critical business functions continue to be performed. Critical business functions are generally performed at the level of the operating subsidiaries—assets of the holding companies of U.S. and U.K. G-SIFIs tend to comprise little more than the equity stakes in the operating subsidiaries. The newly resolved group would be solvent and viable, and should be in a position therefore to access market funding or, if necessary, funding from the authorities as discussed above. Liquidity will be downstreamed in a ―business as usual‖ manner to the operating subsidiaries immediately following the resolution weekend. As described above, the balance sheets of the operating subsidiaries should be broadly unaffected by the resolution action at the top of the group. To recapitalize the operating subsidiaries that had incurred losses, the equity or debt held by the parent in those subsidiaries would need to be written down. The parent and, indirectly, the subsidiary operating companies may also be subject to change of control procedures arising from a switch of ownership from the existing shareholders to creditors.

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Provision of critical shared services across the group should be unaffected.
46 Given minimal disruption to the balance sheet of the operating companies, and given that the group should be recapitalized following the assignment of losses to shareholders and creditors, counterparties should not have strong incentives to cease trading with the operating companies during and following the resolution. The contingency plans are designed to minimize the triggering of cross-defaults or closeout of netting arrangements at the operating companies. In certain cases, a stay on termination rights may be applied to ensure that termination of counterparty relationships cannot be triggered solely as a result of entry into resolution. A stay may assist in promoting the continuity of a variety of critical economic functions that are dependent on maintaining counterparty relationships (for example, those functions relating to wholesale market activities) and also avoiding the rapid, disorderly, and potentially value-destructive closeout of financial contracts and liquidation of securities. The stay could also minimize the closeout risk that may result from cross-default clauses within financial contracts. In the scenario in which the holding company is placed into receivership, the stay would extend to certain subsidiary counterparties subject to financial contracts that reference the holding company. Given cross-border considerations, it is important that stays on termination apply to both domestic and foreign operations of G-SIFIs. In certain cases, authorities cannot currently extend stays on termination to foreign operations.

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Supporting actions by host authorities may be required (as included in the Key Attributes), or it may be necessary to introduce clauses that recognize foreign resolution actions, including stays on termination, into counterparty documentation.
47Similarly, because the group remains solvent, retail or corporate depositors should not have an incentive to ―run‖ from the firm under resolution insofar as their banking arrangements, transacted at the operating company level, remain unaffected. In order to achieve this, the authorities recognize the need for effective communication to depositors, making it clear that their deposits will be protected. 48If continuity of critical functions is to be achieved, the firm will need continuing access to core services provided by the financial market infrastructures (for example, payment systems and central counterparties) during and following resolution. To achieve this, authorities in both the U.S. and U.K. have begun a process of engaging with such infrastructures to develop effective procedures relating to the treatment of members who have entered resolution.

Minimization of cross-border coordination risk
49It should be stressed that a key advantage of a whole group, single point of entry approach is that it avoids the need to commence separate territorial and entity-focused insolvency proceedings, which could be disruptive, difficult to coordinate, and would depend on the satisfaction of a large number of pre-conditions in terms of structure and operations of the group for successful execution. Because the whole group resolution strategies maintain continuity of business at the subsidiary level, foreign subsidiaries and branches should be broadly unaffected by the resolution action taken at the home holding company level.

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The strategies remove the need to commence foreign insolvency proceedings or enforce legal powers over foreign assets (although, as discussed later, it may be necessary to write down or convert debt at the top of the group that are subject to foreign law).
Liquidity should continue to be downstreamed from the holding company to foreign subsidiaries and branches. Given minimal disruption to operating entities, resolution authorities, directors, and creditors of foreign subsidiaries and branches should have little incentive to take action other than to cooperate with the implementation of the group resolution. In particular, host stakeholders should not have an incentive to ringfence assets or petition for a preemptive insolvency—preemptive actions that would otherwise destroy value and may disrupt markets at home and abroad. 50A key part of the work undertaken by the U.S. and the U.K. has been to identify the regulatory obligations of foreign authorities in response to a resolution originated by a home authority. Where any impediments to effective whole group resolution have been identified, authorities are in the process of exploring methods to overcome them. 51The Key Attributes stress the importance of a globally coordinated approach to resolution, and emphasize that resolution authorities should consider the potential impact of their resolution actions on the financial stability of foreign jurisdictions. The Key Attributes propose a framework that would facilitate cross-border cooperation between resolution authorities. This framework would help to ensure that local resolution authorities support a resolution carried out by a foreign authority.

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52A central element of the cross-border cooperation process set out in the Key Attributes is the establishment of Crisis Management Groups (CMGs)—groups composed of supervisors, central banks, and resolution authorities of the key jurisdictions in which a G-SIFI operates.
Members of these groups are expected to enter into firm-specific cross-border cooperation agreements that detail the proposed means by which a particular resolution should be coordinated between authorities. To provide a platform for such cooperation agreements, authorities in the home jurisdiction are required to submit firm-specific resolution strategies to members of the CMG for consultation by the end of 2012. 53These resolution strategies set out at a high level the key elements of the approach to resolution and outline the use of key resolution powers. The strategies will be translated into detailed resolution plans for each firm during the first half of 2013. These resolution plans will provide specific detail on implementing the proposed resolution strategy, including consideration of entities to which resolution powers may be applied and the possible roles of relevant national resolution authorities. Subsequently, firm-specific resolvability assessments will be developed by the end of 2013. The resolvability assessments will identify barriers to implementation of the resolution plans, and will be key to demonstrating the extent to which the resolution plan for each G-SIFI is feasible and credible without severe systemic disruption and without exposing taxpayers to loss.

In addition, certain U.S. and U.K. G-SIFIs have been required to make their first full RRP submissions in 2012 to support the development of viable resolution plans by the authorities.
These submissions will help to expose, among other things, actions that firms will need to take to improve their resolvability.
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Write-down of liabilities and conversion of debt into equity
54Under a top-down resolution, shareholders and certain creditors at the top of the group absorb losses and recapitalize the group as whole. For a top-down approach to work, there must be sufficient loss-absorbing capacity available at the top of the group to absorb losses sustained within operational subsidiaries. 55In the U.S., the capital structures of large financial holding companies are characterized by equity and large amounts of unsecured debt of various maturities. This debt is structurally subordinated within the group, and limited external unsecured debt tends to be raised at entities below the financial holding company. Regulation may be adopted to ensure that sufficient debt is held at the top-tier holding company level. 56In the U.K., on the other hand, financial holding companies at the top of the group often do not account for a significant proportion of the group‘s unsecured debt raised by groups externally. Looking ahead, either the groups could restructure so that more debt is issued out of the holding company or the U.K. authorities could look to bail-in the liabilities of the top operating companies within each group. The latter course would require careful planning given that senior unsecured bonds typically rank alongside other unsecured liabilities that are unlikely to be bailed-in.

Detailed consideration of this part of the resolution strategy for individual banking groups will need to take account of the precise provisions of the RRD as eventually passed into law.
Also, both the draft RRD and the U.K. government‘s plans for implementing the I CB report include requirements aimed at ensuring
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that banks have sufficient capital and debt in issue to make them resolvable using bail-in or other resolution tools.
The U.K. authorities will in due course consider how the final versions of those requirements should be applied to U.K. G-SIFIs given their group structures and resolvability. 57Consideration also needs to be given to ensuring that debt issued at the top of the group that is subject to foreign law can be written down or converted alongside liabilities subject to the law of the home jurisdiction. This may be crucial to ensuring that the firm‘s recapitalization needs can be met and that creditors are treated fairly. Ensuring that foreign law securities can be written down or converted into equity alongside securities issued under the law of the home jurisdiction may require the inclusion of contractual recognition of foreign resolution proceedings within debt contracts.

Valuation
58During resolution, a valuation process will need to be undertaken to assess the losses on assets that the firm has incurred and the capital needed under stress assumptions to restore confidence in the firm, which will determine the extent to which creditor claims should be written down and converted.
The valuation will determine how far up the capital structure the write down or conversion of debt may need to apply (that is, whether shareholders and subordinated debt holders can fully absorb losses in order to recapitalize the firm, or whether senior unsecured creditors would also need to be included). The valuation process will in turn determine what financial instruments if any—for example, common equity in the new firm or warrants—the different classes of original creditors of the firm should receive.

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59Given the differences in the U.S. and U.K. resolution processes, the precise valuation requirements and timelines are unlikely to be the same for the two jurisdictions.
Consideration is being given in both jurisdictions as to how much of the valuation process can be prepared in advance of resolution (for example, as part of enhanced preparation under the U.K. Proactive I ntervention Framework). Consideration is also being given as to whether new financial statements would be required, and whether the firm‘s external auditors would need to be replaced for the valuation process to provide sufficient comfort to the market that the ongoing operations were fully (re)capitalized and solvent. An effective valuation process should facilitate the issuance of new securities and other financial instruments, and would likely be required by rating agencies in order to make a judgment on the creditworthiness of the resolved institution. The U.S. and U.K. authorities are considering how a credible valuation could be carried out quickly and effectively, and with flexibility to respond to the characteristics of particular institutions and the nature of their failures.

Listing requirements post-resolution
60To return the firm to the market effectively, the public listing of its equity and debt securities would need to resume. Insofar as new debt or equity instruments are issued, listing rules may require that a prospectus or other offering documentation be provided to investors. This would likely include audited financial statements for the firm, and may therefore take a significant amount of time to achieve. 61Under the U.S. approach, a new parent entity is established during resolution.
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Therefore, new securities would need to be issued in satisfaction of creditor claims.
Such securities would either need to be issued pursuant to effective registration statements, or may, in certain instances, be listed pursuant to an exemption from registration. 62In the case of a U.K. resolution, new equity and debt securities would not necessarily need to be issued following resolution. Under certain circumstances, it is possible, subject to a number of conditions, that existing equity and debt securities could resume trading without the need for a prospectus. 63In both jurisdictions, engagement with securities regulators well in advance of, and also during, resolution will be key to ensuring that public listing can be achieved in a timely manner following resolution.

Conclusion
64In both the U.S. and the U.K., legislative reforms already made or planned in response to the financial crisis provide new powers for resolving failed or failing G-SIFIs. The FDIC and the Bank of England have developed resolution strategies that take control of the failed company at the top of the group, impose losses on shareholders and unsecured creditors—not on taxpayers—and remove top management and hold them accountable for their actions. These strategies provide an efficient path for returning the systemically important parts of the G-SIFI to the private sector by exchanging or converting a sufficient amount of creditor claims from the failed company into capital in the newly resolved entities. Because the resolution action is taken at the top of the group and by the home authorities, continuity of all critical services would be maintained and subsidiaries (foreign and domestic) would remain open and operating with access to sufficient liquidity.
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As a result, the strategy achieves the important goals of imposing market accountability and maintaining financial stability in all jurisdictions in which the firm operates.
65 The FDIC and the Bank of England continue to work to ensure that their respective resolution strategies will be fully operational. Importantly, the process of cross-border dialogue that has facilitated the above strategies reflects a shared public interest in developing the capacity to resolve a G-SIFI in a credible and effective manner, and offers a model for multilateral resolution planning more broadly.

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784 pages - Publication of the Credit institutions Register

EBA Register of Credit Institutions
provided for in Article 14 of Directive 2006 /48/ EC Article 14 of Directive 2006/ 48/ EC as amended by Art. 9 (3) of Directive 2010/78/EU requires the EBA to publish on its website a list of credit institutions to which authorisation has been granted in the Member States , and to keep that list updated. This list (the "EBA Register of Credit I nstitutions") replaces the former list of authorized credit institutions published by the European Commission in the Official Journal of the European Union. The EBA Register of Credit I nstitutions was first published on 29. November 2012 and shall be updated twice a year, with competent authorities of the Member States reporting as of the 30. June and 31. December of each year. The EBA Register of Credit Institutions is to improve transparency in the context of the single financial market, and the EBA is to ensure that information on registered financial institutions is easily accessible to the public. Therefore, the EBA Register of Credit I nstitutions strives to provide a complete and transparent picture of all entities legitimately providing the services of credit institutions within the Member States. The EBA Register of Credit I nstitutions is drawn up by the EBA on the basis of information supplied by the Member States. Unlike the registers of banks kept in some Member States, the EBA Register of Credit I nstitutions has no legal significance and confers no rights in law.

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If an unauthorised institution is inadvertently included in the list, its legal status is in no way altered; similarly, if an institution has inadvertently been omitted from the list, the validity of its authorisation will not be affected.
The EBA is responsible only for the accurate reproduction of information received, while responsibility for the respective data submitted, especially the name and location of the institutions and their classification, lies with the Member States in question. It is recommended to users of the EBA Register of Credit I nstitutions to also consult national registers, and to doublecheck their search results with those national registers.

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List of reporting competent authorities

To download the document:
http:/ / eba.europa.eu/ News--Communications/ Year/2012/Publicationof-the-Credit-institutions-Register.aspx
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Past I mperfect, Present Tense and Future Conditional
Speech by Mr Rundheersing Bheenick, Governor of the Bank of Mauritius, at the Annual Dinner in honour of Economic Operators, Pailles.

Taking stock
I have been here nearly six years and I thought it opportune tonight to look back, take stock before the past is truly past, and then try to peer into our hazy economic future as we continue to battle through what certainly looks like an extended period of economic uncertainty.

The past six years
The most obvious change at the Bank in these past six years has been the new and, some might say, sumptuous building. I inherited that, and since moving in, I have been conscious of the necessity for the Bank to deliver even better value for money than in the past. For as Lord Kelvin has said:

Large increases in cost with questionable increases in performance can be tolerated only in race horses and fancy women.
We had to pay greater attention to our performance. The Bank plays a supportive role in the economy.

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But the global financial crisis – which happened to coincide with my assuming the role of Governor;
I trust not a case of post hoc ergo propter hoc – encouraged me to look a little beyond our traditional role to embrace that of promoting socio-development by giving new life to some of the little-used statutory powers of the Bank.

So I set out to improve governance by putting in place the Monetary Policy Committee (MPC).
I called upon external talents and developed clear lines of communication with economic agents. The MPC has been worth its salt and I pressed for statutory changes to make it more transparent and accountable by publishing the minutes of its meetings and the individual voting pattern of MPC members. I also embraced an open-door policy responding to the concerns of the various economic stakeholders going well beyond the banking industry, to include real sector operators, academia, opinion leaders, and consumer associations. We have regular public consultations through press conferences and public addresses. I initiated, amongst others, MERI − the Mauritius Exchange Rate I ndex − , PLIBOR – the Port Louis I nterbank Offered Rate − and the I nflation Expectations Survey to focus more sharply on expectations to help us track changing market sentiment. We initiated two new regular reports, one on Financial Stability and the other on I nflation.

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In addition, we have brought in some internal reorganisation endowing the institution with a flatter structure enabling more delegation, faster response, and greater flexibility in decisionmaking.
New operating units were created to address new issues, such as financial stability and I slamic finance, or to give sharper focus to specific work areas such as financial markets and compliance. Banking supervision and regulation were strengthened; the payments system was modernised allowing for cheque truncation and bulk clearing; financial market infrastructure was spruced up with single-maturity auctions of Treasuries; financial literacy programmes were initiated. All these required strong emphasis on capacity-building and training, and continuous interaction with regional and global networks to keep up to the mark. Above all, I have been steering affairs, guided by Rabindranath Tagore‘s great prayer,

Give me the strength never to disown the poor, nor bend my knees before insolent might.
We continue to prize our independence and we defend it in the best interests of the country. Often we remind the most powerful in the land that our concerns extend not least to pensioners and those constrained to live off their savings; for our task at the Central Bank extends to promoting a stable and growing economy for all. It is vital for the Bank to respond to the interests of all sectors, not just the most powerful, the best-connected, or the most vociferous. Now if Paul Getty‘s formula for success was …rise early, work late and strike oil I have had to adapt that to the circumstances of Mauritius where there is no black gold.
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Not finding oil here, the Bank has taken to buying gold; we bought two metric tonnes of it from the I MF in November 2009 for 2 billion rupees: that gold is now worth nearly 3½ billion rupees.
The profit from this should pay for a few tower blocks or even a few new botanical gardens. And to ensure all Mauritians have easy access to a similar deal, we now offer for sale to the public solid gold bars; so do come by and make a mint while the stocks last.

This offer comes during the course of our 45th anniversary year as the central bank in Mauritius and we have had a series of international events in celebration.
As a more lasting commemoration, we shall be issuing a souvenir book on central banking, the economy and Mauritian society.

Riding the storm
Now, many theorists have speculated on the causes of the continuing international financial crisis − perhaps as many as those whose speculation promoted it! Some here have contributed to this mountain of analysis. On these occasions, I usually offer a new Law to illuminate the issue of concern. We‘ve had Maradona‘s law of interest rates; Einstein‘s law of success; Newton‘s laws on physical response; and now I offer you Poul Andersen‘s law. This is the obverse of the law of Occam‘s razor for simplicity of explanatory hypotheses. So I offer you tonight Andersen‘s law of the shaving brush, in which he declared:
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I have yet to see any problem, however complicated, which, when looked at in the right way, did not become still more complicated.
This law underpins much of the writing about the recent crisis. But for my own part I prefer to go straight to the point, as Liaquat Ahmed has done in his brilliant analysis of the Great Depression, when he wrote:

More than anything else…the Great Depression (1929–31) was caused by the failure of intellectual will and a lack of understanding about how the economy operated.
Similarly, I put down the lingering crisis to the dual impact of market failure in the capital market and supervisory and policy failure at the level of financial boards and the regulators. Incredibly, other banking Boards did not see the demise of Barings as prime evidence of a fatal flaw that could engulf the banking world and much beyond, as it did. To correct this flaw required just a little imagination and courage.

Unfortunately, this turned out to be beyond the grasp of every western bank board, every regulator and supervising agency, every Minister of Finance and every Government.
Thus the poor tax payer has had to pick up the tab for the gross failure of top financial management, leaving the banksters‘ bonuses and golden parachutes largely intact. Those in charge just lacked the courage to ensure that if banks went bust so must the bankers. Which rather reminds me of Lord Salisbury‘s observation on the political scene:

You will find as you grow older that courage is the rarest of qualities to be found in public life.
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So, where are we now in Mauritius in the lingering crisis?
We‘ve done rather well in fact. In the last six years the total assets of banks have expanded by 70 per cent; our 21 banks have almost 35,000 shareholders and employ over 7,000 staff. I have granted five new banking licences, the public now has access to 216 branches with 2.5 million accounts – or 2 accounts per head of population.

More than half of the bankable population are internet-banking users.
The footprints of our banks stretch from the I ndian Ocean islands, to Malawi, Mozambique and Zimbabwe on the continent, and across to Maldives and I ndia.
The list of the Top 80 Banks in Africa in terms of assets includes three of our banks. We have consistently logged positive economic growth, and enjoyed social peace with low inflation and moderate unemployment.

Despite the lingering global economic crisis, our banking and financial system has remained robust, resilient and well-managed.
Strong supervision and prudent management have earned us a coveted place on the short list of countries that actually had a rating upgrade this year when the likes of the United States, France and, more recently, the European Stability Mechanism, have been stripped of their coveted triple-A ratings. Banks in Mauritius have continued to make extraordinary profits, beyond those of even our top six companies in the real economy! Let‘s hope our top bankers will share this wealth judiciously with all stakeholders to the benefit of all the people of this land. A fair deal for bank customers is very much at the top of our agenda.

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It is not exactly a secret although it may not be very widely known in financial circles but we do have very fishy banks in Mauritius – and large ones too.
It is also an area where there are many sharks. Worse, these fishy banks are all under water. Now, before you look suspiciously at the banker sitting at your table, let me give you the names of these fishy banks. Do I feel a chill running through our bankers? Out with the names then! They are Sudan bank, Nazareth bank, and Saya de Malha bank. These banks, which do not require a bank licence, are within our territorial waters of 2 million km2 and are very fishy indeed. They provide us with our white fish for the dinner table and occasionally, like now, with a fishy tale for dinner table chat as well. We have here a clear case of fishy banks without fishy bankers. If any of our scoop-hungry press is ruminating over a catchy headline: ―Very Fishy Banks in Mauritius, Governor says‖. Let me gently remind them of the benchmark for this kind of mis-reporting set by a cub-reporter covering the visit of the Archbishop of Canterbury to the US, landing in New York. The Archbishop had been advised to be cautious with the scandal mongering press.

―Be discreet: be very discreet; but with a smile‖.
On arrival he was hijacked by a bevy of press men clamouring for a story.

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One reporter asked ―What do you think of the night clubs in New York?‖ Remembering to be discreet, with a smile, the Archbishop ironically responded ―Are there any night clubs in New York?‖ Headlines next day: Archbishop‘s first question on landing in New York ―Are there any night clubs here?‖ Some people have continued to express dismay that we are not continuing to achieve the 5% growth that they had come to feel was our birth-right. May I say, this is just unrealistic. It arises from a failure to understand the dynamics of economic growth. These dynamics change as you emerge from the developing to the developed stage. To move into the higher income bracket, escaping the middle-income trap is a long haul. It requires quite different capacities and is not done at the sprint of 5% but more at the pace of a long-distance runner. It is good to remind ourselves − especially if we are inclined to agonise over the estimated 3.4% GDP growth rate this year − that 1% on our national income now is far greater than 5% was twenty years ago. Why? Simply because the national cake is much bigger! Just the annual incremental output in 2012 – at an estimated nominal Rs21 billion – is greater than the entire GDP of the country was as recently as 1987. ―Growth at any cost‖ has never been our credo.
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Equitable growth, inclusive growth, sustainable growth is what we have been pursuing with, as even the most carping critic must concede, impressive results in terms of rising national income, a stable multi-ethnic society, and a democratic polity.
Our track record may not be perfect; our present may be tense; and our future may look conditional – that may in fact well serve as an apt diagnosis of our predicament at any point in our recent history. What we should avoid is the risk of blowing it all by pursuing an unrealistic agenda of higher growth by monetary fixes. Instead of growing at a brisk sprint, galoping inflation is the more likely outcome if we rush down this route. We must adapt to the ―new normal‖ of reduced growth in the western economies on whose coattails our export-driven economy has been riding. What we need to power future growth is not cheap labour but increasing productivity, greater competitiveness, more innovation and a more agile, cerebral management in both the public and the private sectors. But if we have indeed weathered the storm, some of our sails are looking rather shabby, and badly in need of a refit. But what sort of refit do we need? And what sort of strategy must we devise to continue to face up to the turbulent world?

Lessons we have learned
We should be wise to acknowledge another of oilman Paul Getty‘s maxims, this time on banking:

If you owe the bank $100, that is your problem. If you owe the bank $100 million, that‘s the bank‘s problem.
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Which reminds me of the story of the very distinguished banker, if there are any left standing.
Our banker was attending a grand international conference of bankers. The sessions that day had been long, with detailed workshops and breakout sessions. After a formal dinner he paused for a night-cap in a quiet bar in the hotel. As he was relaxing over a screwdriver, his favourite cocktail, a fashionably-dressed lady, slid into the seat beside him, flashed a smile and engaged him in conversation. He could not remember her in the conference sessions, so he explained he was a banker at the conference of international bankers taking place at the hotel. She took up his offer of a drink and settled down with a screwdriver, too. ―Much obliged‖, she said, sipping appreciatively, and giving him her best come-hither look. As our banker just looked into his glass, wondering who he was dealing with, she added, ―I also oblige – for a fee of course.‖ ―I oblige my clients anytime‖, she went on. Our banker was trying to puzzle this out. She vaguely reminded him of a Churchillian wartime speech as she continued: ―I oblige them in the train; I oblige in the car; I oblige in the office, I oblige in the lift, I oblige on the golf course…‖

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―Oh, blow me!‖ interrupted our banker, as the penny finally dropped, ―why − you are a banker, like the rest of us! Tell me, which bank are you with?‖
Now, I have sanitised the story considerably for sensitive ears, but you get the gist of it! So, be on your guard when you come across an obliging banker! If there is one thing we must learn, it is how to bring banking and accountancy back in from the righteous wind of public anger, for a refit with refreshed ethics, a new sense of corporate probity and a bolder capacity for corporate governance. That is exactly what we seek to achieve by the new Guidelines on Corporate Governance that we introduced in August this year. Not to be outdone, the Banker‘s Association has announced that it is coming up with a new Code of Ethics and Banking Practice. Not a minute too soon, one might be tempted to say! So I must say that I am very pleased to hear that after the Diamond era of super bonuses and the alleged massaging of the figures in rampant rate-rigging, one of the largest banks concerned is to refocus on the retail trade. Good news indeed! For here we are initiating the separation of domestic banking from international banking business, as a sound precaution against any further global infection. Let‘s just hope that bankers everywhere remember whose money they are speculating on − not their own money but yours! So what can we learn from the past few years?

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To be sure, we should be more vigilant in identifying the first tell-tale signs of bubbles.
We should be wary of unsustainable credit levels and fat profit margins. Banks must again pursue the function of promoting the optimum allocation of capital, and not just sit on it. We must also remember that real estate is just houses, buildings and land that have fundamental economic, social and environmental functions, only some of whose value appears in the accountants‘ books. We need to account for all these functions more clearly. We may also draw lessons for the future as we approach key decisions on advancing the regional integration agenda with Common Market for Eastern and Southern Africa, Southern Africa Development Community, Association of African Central Banks and the rest. For we need forms of management in business and political governance that rise above the self-interest of the nation-state. When 90% of the people of the south western I ndian Ocean are living in poverty − I speak principally of Madagascar and the Comoros − we might ask ourselves, not how we can continue to be in the lead at the top of the Mo Ibrahim I ndex for Africa, but what have we done with that leadership to secure development in our region to relieve poverty, and to promote growth. What we lack now is a clear vision for our future, a long-term picture of where we want to be in 2030 based on greater intra-regional cooperation and reinvigorated trade, amongst others. To turn round the famous Clinton adage on political priorities, it seems to me that on the regional integration issue:

It‘s all about trade, stupid!

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A future prospectus
We have been promoting greater financial integration and facilitating regional banking initiatives. The I OC is promoting new regional ventures in air and sea transport and in communications; many businesses are extending their regional links. But we would do well to think ahead about combining regional fiscal and monetary management and the development of regional governance through some sharing of sovereignty. But if intra-regional trade is where the EU, and indeed the USA, began, we have yet to reach the starting blocks. We need free movement of capital and labour; we need social union with common frameworks for labour law, portable pensions and social security; we must foster greater international competitiveness and probity; we need fewer cartels and more competition. We need to nurture greater savings and investment with a regional fund for development and less reliance on external aid programmes. Banking union is a very distant prospect; and dare I even mention that far-off dream of a common currency? For our dreams need to keep in touch with reality and not turn into debilitating daydreams. If our dreams are to be, then as Tagore has declared:

We have no time to lose, and having no time we must Scramble for our chances. We are too poor to be late…
Or as Ovid remarked, for those who still have some Latin:

Tempus edax rerum.
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And for those who don‘t have the Latin, I might broadly translate that as

Time [is] the devourer of all things.
That is why I have put so much effort in recent years into the tasks of getting banking ready for regional lift-off. For I am doing nothing less than banking on the future of Mauritius as a regional leader in this field. We must avoid the pitfalls that are testing the EU, seeing the task not to enrich ourselves but to enrich all the peoples of these beautiful African lands. As I close, let me say that last year some of you were kind enough to say they liked my speech. Others suffered a mild bout of indigestion and were less kind. A few are still smarting from the mere recollection. But words, whether meant in earnest, or spoken half in jest, are just precursors of greater things. I trust that, over my six years as Governor, I have adequately demonstrated that I go well beyond word-smithing. In these matters, I am a disciple of the Athenian Statesman, still celebrated for his rhetorical prowess, Demosthenes, who declared (and here I will save you from the original Attic Greek): First in oratory is action; second is action; and again third is action!

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Understanding macroprudential regulation
Introductory remarks by Mr Jan F Qvigstad, Deputy Governor of Norges Bank (Central Bank of Norway), at the workshop on ―Understanding macroprudential regulation‖, organised by Norges Bank, Oslo. Dear all, It is a pleasure to welcome you to Norges Bank for this workshop on Understanding Macroprudential Regulation. The topic of the workshop is timely; Authorities in all parts of the world are now actively debating macroprudential policy. Academic research provides a necessary foundation, both for the design and the implementation of such regulations. During my years of service here at the central bank, and also some years at the Treasury, I have had my fair share of dealings with banking and financial crises in N orway. In the 1990s, N orway was hit by a severe banking crisis.

Three of the four largest banks failed.
Required capital injections were more than three and a half per cent of GDP.

This is substantially more than the percentage share that euro area banks currently need to recapitalise.

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Ever since the Norwegian banking crisis in the early 1990s, our banking industry has been regulated more strictly than banks in comparable countries.
For instance, bank capital definitions have been tighter, while packaging loans into complex instruments was in practice not permitted until 2007. Financial supervision has also been rather strict. As a result, the Norwegian financial system only had limited exposure to the subprime mortgage market – notwithstanding some municipalities in the northern part of Norway that got involved, with a less than full understanding of inherent risks. Our banks were therefore relatively unaffected by the recent crisis when it comes to credit risk. The downturn that our economy experienced in 2009 was modest in relation to other countries – but this is of course also due to the composition of our production and exports, with oil accounting for a large share. More than two decades ago, in the early stages of the Norwegian banking crisis, N orges Bank provided a large liquidity loan to a savings bank. The bank, however, soon became insolvent. We learnt how fast illiquidity can turn into insolvency. At the time, the bank was rescued partly by Norges Bank writing off its loan.

This incident showed that it was important to clarify the division of responsibilities between the central bank and the fiscal authorities.
The Government Bank Insurance Fund was established, which would be able to extend loans and inject capital into distressed banks in the future.

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The aim was to make sure Norges Bank avoided intruding into the arena of the fiscal authorities.
It is not up to an independent central bank to spend taxpayers‘ money. When N orwegian banks‘ funding dried up in the aftermath of the Lehman Brothers collapse, government bonds were swapped for covered bonds issued by banks. That is, the Ministry of Finance became the banks‘ counterparty in the swap arrangement. We thereby avoided an expansion of the central bank‘s balance sheet while improving the liquidity and funding situation of our banks. The most recent global financial crisis has taught us that it is vital to focus on the financial system as a whole, and not only on its components. Many of the risks that played a role in the recent crisis were identified by central banks and international financial institutions.

However, not enough attention was paid to the ways in which these risks were interconnected and how they reinforced each other.
System-wide risk amplified the financial crisis and its global repercussions. An international response to the management of systemic risk has been to introduce macroprudential regulation. However, incorporating systemic oversight in the financial stability framework poses considerable analytical and operational challenges for most countries. Indeed, we as economists have relatively limited understanding of the design and effectiveness of macroprudential policies.

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But, even when inflation targeting was introduced, not much was known about how to go about implementing it.
Practice and research developed in parallel, interacting. We hope to see similar developments regarding macroprudential policies. To this end, Norges Bank, like many other national and international monetary authorities, is actively working to further develop the conceptual and analytical foundations for macroprudential policy.

Several analytical approaches for the identification of the factors contributing to the building up of systemic risk may be used and different policy tools may be employed to address them.
One policy instrument introduced by Basel I I I is the countercyclical capital buffer. In line with our past experience of dividing responsibilities, the Ministry of Finance will implement countercyclical capital requirements from 2013. Norges Bank will make recommendations for its buffer decisions. We therefore need to strengthen our understanding of macroprudential regulation and develop relevant analytical tools for our recommendations. The financial crisis called renewed attention to the fact that developments in the real economy and the financial sector are closely linked. In response, Norges Bank has decided to provide monetary policy and financial analyses in a joint report published quarterly as from 2013. The reports will form the basis for both monetary policy decisions and for our advice on the buffer. The primary objective of monetary policy is low and stable inflation over time.
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We operate a flexible inflation targeting regime, which also aims at stabilising economic activity.
Furthermore, Norges Bank gives weight to the risk that a prolonged period of low interest rates could lead to elevated risk-taking and excessive debt accumulation in the household and business sectors. There is always room for improvement. We will seek to improve systemic risk indicators and macro-stress testing approaches, keeping them at the research frontier. We will also work to better incorporate the financial sector in our macroeconomic models. Economic research can contribute significantly to this, and in this context, some fundamental questions need to be addressed. –First, what is the macroeconomic impact of financial regulations? A greater understanding of how financial regulations act at the aggregate level is needed, both in containing systemic risk and in affecting the growth potential of economies. This would enable us to make more informed policy recommendations. –Second, how should systemic risk for banks, non-bank financial institutions and markets be identified and measured? Economists have proposed several methods of measuring systemic risk. But more research is needed in order to understand systemic risk arising from banks and non-bank financial institutions and their interaction. –Third, how should monetary policy be conducted in the context of macroprudential policy?

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And there are many more questions, some of which will be discussed during this workshop.
We are eager to learn from the expertise and the experience of other countries. N orges Bank is committed to investing in research and supporting cooperation with other central bankers and foreign academics. This workshop is one product of this commitment.

We are fortunate to have such prominent speakers contributing to the program.
I wish you fruitful and stimulating discussions, and I hope you enjoy your stay in Oslo. Fortunately, the weather is on our side, motivating us to stay focused on our work. It would have been more difficult on a sunny day in June.

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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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