Bart Joosen August 26 2011 The development of liquidity risk management FMLA Financial Markets Lawyers | Banking & Financial Services - Netherlands Bart Joosen Banking & Financial Services Background Recent developmentsOutlookBackground From July 1 2004, the following entities became subject to the Liquidity Regulation 2004: banks licensed by the Dutch Central Bank (De Nederlandsche Bank); and Dutch branches of European Economic Area banks which are subject to home state supervision as regards solvency and whose Dutch operations are subject to liquidity supervision by the Dutch Central Bank.The regulation contained a comprehensive set of rules for banks on the maintenance of sufficient liquid assets to meet short-term payment obligations without the need to incur considerable losses. The regulation was intended to ensure that solvent banks could address temporary liquidity constraints.In 2006 the regulation was replaced by the Liquidity Regulation 2006, as part of a process undertaken by the Dutch Central Bank to introduce a new regulatory framework pursuant to the Act on Financial Supervision of 2006, which entered into force on January 1 2007. The 2006 regulation was not revised substantially until 2011.Recent developments The adoption of Directive 2009/111/EC(1) introduced Europe-wide changes to the liquidity framework for banks. In October 2010 the Regulation of the Dutch Central Bank Liquidity Act on Financial Supervision 2011 was published. The new regulation replaced the 2006 regulation and was adopted to: meet the requirements under Directive 2009/111/EC; and introduce certain revised definitions of eligible collateral under the monetary instruments framework of the European Central Bank. The 2011 regulation, which entered into force on May 1 2011, represented a significant step forward in shaping comprehensive regulations for liquidity risk management in the Netherlands.On June 30 2011 the Dutch Central Bank Policy Liquidity Act on Financial Supervision 2011 also entered into force; this was quickly followed on July 1 2011 by the Dutch Central Bank publishing comprehensive regulators guidance, entitled "The Foundations for the Internal Liquidity Adequacy Assessment Process".The 2011 regulation implemented the new criteria on liquidity risk management set out in Annex V of Directive 2009/111/EC, and the liquidity management evaluation provisions in the supervisory review and evaluation process also set out in Annex XI of that directive. According to the Dutch Central Bank, the changes were required to address the fact that although certain assets were appraised as sufficiently liquid, the banks did not actually have the requisite liquidity when markets collapsed (which became apparent from the summer of 2007 onwards). In 2008, in response to new guidance(2) from the Committee of European Banking Supervisors (CEBS) (now the European Banking Authority), the European Commission proposed that the relevant provisions of the Banking Directive (2006/48/EC) be enhanced by implementing changes to Annexes V and XI by way of Directive 2009/111/EC. As a result, stress testing was introduced as an important element of banks' risk management procedures. Further CEBS guidelines issued in 2009(3) revised the European framework for liquidity risk management by introducing a requirement for banks to measure adequacy of liquidity over two timeframes ('survival periods'): one week and one month. Since January 1 2007, banks and (in limited circumstances) investment firms in the Netherlands have been obliged to implement an internal liquidity adequacy assessment process as a part of their internal capital adequacy assessment process. Until the recent publication of the Dutch Central Bank policy and regulators guidance, it was unclear how standalone institutions and/or groups of regulated banks should approach this. The new documents set out comprehensive guidance on the process and how it fits in with the regulations on minimum liquidity requirements. The outcome of a bank's internal liquidity adequacy assessment process calculations is reported in the annual internal capital adequacy assessment process report which each bank must submit to the Dutch Central Bank. The Dutch Central Bank then performs the supervisory review and evaluation process and, in discussion with the bank, will consider the adequacy of the measures taken by the bank. The outcome of this supervisory review and evaluation process may be a requirement for additional capital or additional liquidity, if the Dutch Central Bank is not satisfied with the outcome of the bank's own assessment as set out in its internal capital adequacy assessment process.The Dutch Central Bank policy and regulatory guidance specify criteria that will be applied at the time the supervisory review and evaluation process is performed. They further confirm the adoption by the Dutch Central Bank of the European and international guidelines contained in the following documents: the CEBS 2008 and CEBS 2009 guidelines; the CEBS Guidelines on the Management of Concentration Risk under the Supervisory Review Process of September 2010; the CEBS Revised Guidelines on Stress Testing of August 2010; the CEBS Guidelines on Liquidity Cost Benefit Allocation of October 2010; the Basel Committee for Banking Supervision (BCBS) Principles for Sound Liquidity Risk Management of September 2008; the BCBS Guidelines on the Application of the Supervisory Review Process under Pillar 2 of January 2006; the CEBS Liquidity Identity Card of June 2009; and the BCBS International Framework for Liquidity Measurement, Standards and Monitoring of December 2010. As regards liquidity requirements and liquidity risk management, the Dutch Central Bank has explained in its policy that if the supervisory review and evaluation process indicates that a bank's situation must be improved, it may require that the bank take the following measures (based on Article 126 of Directive 2006/48/EC, implemented in the Netherlands through Article 3:111a of the Act on Financial Supervision): maintain higher liquidity than the minimum standards as prescribed for all banks; mitigate its risks - for instance, by reducing the amount and composition of loans taken and the maturities of such loans; improve its risk management strategies; and/or reduce its business activities and transactions. OutlookThe Dutch Central Bank considers that its recent policies and guidance are interim measures, and that more significant changes in the area of liquidity risk management will be implemented as a result of the Basel III and Capital Requirements Directive IV proposals.For further information on this topic please contact Bart PM Joosen at FMLA Financial Markets Lawyers by telephone (+31 20 348 52 00), fax (+31 20 348 5201) or email ([email protected]).Endnotes(1) OJ EU L 302.(2) Second part of CEBS's technical advice to the European Commission on liquidity risk management, CEBS 147/2008.(3) Guidelines on liquidity buffers and survival periods.