FSB Report on Structural Banking Reforms
On 27 October 2014, the Financial Stability Board (FSB) produced a report to G20 Leaders on structural banking reforms and the effect that inconsistencies in cross-border implementation are having on global financial stability.
The report noted that major structural banking changes that have been implemented in a number of jurisdictions (including in those jurisdictions in which most of the globally systemically important banks (G-SIBs) are currently hosted and operating). These changes, brought about in light of the lessons learned from the 2008 financial crisis, have been designed to separate ‘core’ banking activities (including retail and payment activities) with ‘riskier’ capital market and investment banking activities, in order to reduce the risk burden on depositors and the individual governments who may be tasked with bailing them out; and the risks posed to the stability of the broader financial system. Most of these changes have been implemented through functional separation of retail and investment banking divisions, through regulatory mechanisms including prohibition, ring-fencing, subsidiarisation or geographic separation.
The report findings state that banking reform in the US, UK, EU and other places has been generally justified by authorities on the basis of reducing systemic risk and ending implicit guarantees for ‘Too Big To Fail’ institutions. The intention has been to provide greater clarity and certainty in the event of troubled G-SIBs requiring resolution. Although generally supported by other jurisdictions, there have been concerns highlighted in a number of areas, including complications in crossborder resolution; decreased liquidity in financial markets; reduced capital market flows; and regulatory arbitrage (where firms shop to pick and choose their regulatory jurisdictions to suit business objectives).
The report noted that whilst there have not been any observed cases of materially adverse impacts resulting from the changes, the new regulations and rules have yet to be fully adopted and implemented, and the effects on global financial stability will only become apparent once many of the regulatory changes have been published and come into effect.
As a result of this, the FSB has indicated it will continue to monitor the situation. The FSB, together with the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD), will present an update on structural banking reforms and associated cross-border implications in 2016. To supplement this update, the report notes that the Basel Committee on Banking Supervision (BCBS) will be reporting in late 2015 on the range of mechanisms used by national governments for dealing with cross-border branches and subsidiaries; which will also coincide with the OECD assessment of the cross-jurisdictional consistency of capital and liquidity requirements.
Benchmarks Under Close Regulatory Scrutiny
In the wake of recent scandals, there has been a renewed regulatory focus on benchmarks and their regulation. The international response to the various benchmark scandals and the concerns arising out of them has been driven by the International Organisation of Securities Commissions (IOSCO)’s publication of the Principles for Financial Benchmarks in 2013. In summary, these principles were designed to improve the reliability of benchmarks by addressing:
- The governance of benchmark administrators;
- The quality of the data submitted; and
- Accountability mechanisms for benchmark administrators and submitters.
The FSB published its final report on foreign exchange benchmarks on 30 September 2014, which highlighted a number of recommendations for reforming key FX benchmarks, particularly focussing on the WM/Reuters 4pm London Fix (WM/R 4pm London Fix). The focus of the paper was to improve not only the structure of the fixes, but also measures to improve the conduct of participants within the market.
The recommendations centred on a number of key aspects of the benchmark process, including calculation methodologies; banks’ risk and conflict management infrastructure; and greater regulatory and market scrutiny of participants before, during and after a fix. The paper also endorsed the recommendations of the September 2014 IOSCO review specifically of the WM/R 4pm London Fix.
The FSB report noted that “based on discussions with the relevant market sectors, the [FSB] believes that all the recommendations above can and will be accepted and implemented by the market groups concerned”.
Europe has also responded to the global benchmark regulatory push. In December, the Commission issued its latest compromise proposal for its Regulation on the indices and benchmarks in financial instruments and financial contracts. The proposed regulation is still working its way through the European Parliament and the Council of the EU, and is not expected to be in force until 2016.
The regulation proposes regulating a significantly wider array of benchmarks than had previously been considered. ‘Critical benchmarks’ which would require supervision and regular viability assessments, would be defined as those indices used to reference the amount payable under a financial instrument, which are used as a reference for at least €500 billion of financial instruments, and for whom the majority of the contributors to the benchmark are supervised entities.
There will be requirements on national competent authorities to notify ESMA of the use of benchmarks; requirements for benchmark administrators to be authorised and have strict policies on governance, oversight and accountability; and requirements for contributors to comply with a legally binding code of conduct.
The UK, which has direct supervision over a number of the major benchmarks, including LIBOR and the WM/R 4pm London Fix, has also proposed introducing domestic legislation to ensure transparency and restore integrity to the fixes. The Fair and Efficient Markets Review (FEMR), set up by the Chancellor George Osbourne in June 2014, produced its preliminary findings into the additional financial benchmarks to be brought under regulatory scope.
The report recommended bringing seven new benchmarks under UK regulation, on top of LIBOR, which is already regulated. These were:
- SONIA – Sterling Overnight Index Average;
- RONIA – Repurchase Overnight Index Average;
- WM/Reuters 4pm London Fix;
- ISDAFIX – a benchmark for annual swap rates for swap transactions;
- London Gold Fixing;
- LBMA Silver Price; and
- ICE Brent – the benchmark for crude oil.
In December 2014, the UK Government accepted the findings of FEMR’s review, and has committed to implementing regulation on the seven named financial benchmarks. Alongside its response paper, the government also produced an impact assessment and draft statutory instrument.
It is expected that further regulatory developments will be seen over the course of the next year, as regulators both nationally and internationally strive to rebuild the integrity of benchmark indices.