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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,
Oscar Wilde has said something strange but
interesting: "Between men and women there
is no friendship possible. There is passion,
enmity, worship, love, but no friendship."
Commissioner Kara M. Stein said "I care
passionately about the success of the Legal
Entity Identifier (or LEI)."
I am sure that Oscar Wilde did not have
supervisors like Kara M. Stein in mind.
Kara joined the SEC after serving as Legal
Counsel and Senior Policy Advisor for
securities and banking matters.
What? You cannot understand how somebody cares passionately about
the success of the Legal Entity Identifier?
I cannot help. As T. S. Eliot has said: "It is obvious that we can no more
explain a passion to a person who has never experienced it than we can
explain light to the blind."
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Kara M. Stein also said: "Despite living in the age of “big data”, what
became abundantly clear during the financial crisis was that we were
unable to interpret the information we did have."
It looks like the SEC and the intelligence communities have exactly the
same problem.
Kara M. Stein continues: "Certainly, there were data gaps. But, more
importantly, we couldn’t use the information that was there.
Neither regulators nor market participants could fully evaluate risk
exposures or interconnectedness.
Opacity fueled uncertainty, and that uncertainty sparked fears that
ultimately froze the credit markets and shook the financial system."
Read more at Number 5 below.
At number 4 we have another really interesting speech about change.
Gabriel Bernardino, Chairman of EIOPA closes it with a quote:
Albert Einstein had said: “The measure of intelligence is the ability to
change”.
When you ask for help from Einstein, you try to do something really tough.
Gabriel Bernardino said about insurance distribution in a challenging
environment:
“Another important point I would like to raise is the necessity to have
proper regulation and supervision of conduct risk.
Failures in business conduct can pose a threat to the stability of the
financial sector, while miss-selling can pose the risk of serious detriment to
individual consumers and create a lack of trust in the sector.
Overall, there are four main lines of action that are paramount:
• Strengthening corporate governance, i.e. to better integrate conduct of
business concerns in the institutional governance arrangements and
ensuring that Boards of financial institutions take full responsibility for
ensuring that consumer interests are take into account throughout the
product lifecycle.
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• Reinforcing the regulation of product oversight and governance and sales
incentives. Certain changes should be done in the companies’ processes
related to the manufacturing and distribution of products.
For example, when designing products, manufacturers have to identify the
target market of the product, analyse its characteristics and ensure that the
product meets the identified objectives and interests of that target market.
• Enhancing conduct of risk supervision by putting in place, systematic
monitoring to identify conduct risks. Supervisors should perform off-site
analysis as well as on-site and „mystery shopping” activities.
Such practices could be particularly effective in reaction to the mis-selling
of products.
We are also currently developing certain tools such as Thematic Reviews,
Retail Risk Indicators and deep and effective market monitoring, which will
enable us to identify emerging consumer risks and act early before the
horse has bolted!
• Putting in place credible and dissuasive enforcement. This will only work,
however, if national authorities have the requisite powers and tools to
enforce conduct of business rules.
Sadly, there is still a huge level of diversity on this at the national level”
Read more at Number 4 below. Welcome to the Top 10 list.
Best Regards,
George Lekatis
President of the IARCP
General Manager, Compliance LLC
1200 G Street NW Suite 800,
Washington DC 20005, USA
Tel: (202) 449-9750
Email: [email protected]
Web: www.risk-compliance-association.com
HQ: 1220 N. Market Street Suite 804,
Wilmington DE 19801, USA
Tel: (302) 342-8828
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International Association of Risk and Compliance Professionals (IARCP)
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Interest rate risk in the banking book
Issued for comment by 11 September 2015
Interest rate risk in the banking book (IRRBB) is currently
part of the Basel capital framework’s Pillar 2 (Supervisory
Review Process).
“The Committee is proposing changes to the regulatory capital treatment
and supervision of IRRBB for two reasons.
First, to help ensure that banks have appropriate capital to cover potential
losses from exposures to changes in interest rates. This is particularly
important in the light of the current exceptionally low interest rates.
Second, to limit incentives for capital arbitrage between the trading book
and the banking book, as well as between banking book portfolios that are
subject to different accounting treatments.”
The 2015 National Money Laundering Risk Assessment
(NMLRA)
The 2015 National Money Laundering Risk Assessment (NMLRA)
identifies the money laundering risks that are of priority concern to the
United States.
The purpose of the NMLRA is to explain the money laundering methods
used in the United States, the safeguards in place to address the threats and
vulnerabilities that create money laundering opportunities, and the
residual risk to the financial system and national security.
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National Terrorist Financing Risk Assessment
After the September 11, 2001 terrorist attacks, the United States adopted a
preventive approach to combating all forms of terrorist activity.
Efforts to combat the financing of terrorism (CFT) are a central pillar of this
approach. Cutting off financial support to terrorists and terrorist
organizations is essential to disrupting their operations and preventing
attacks.
Insurance distribution in a challenging
environment
Gabriel Bernardino, Chairman of EIOPA
“Of course, you are defending your activity and your main goal is to
promote a European regulatory environment in which intermediaries can
prosper.”
Quality Data and the Power of Prevention:
Remarks at Meet the Market, North America
Commissioner Kara M. Stein, New York, NY
“With the financial crisis in the rear view mirror, it is
sometimes easy to forget the forces that converged in
2007 and harmed both our financial markets and our
economy.”
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Rule-making and Implementation – EMIR and
MiFID II
Verena Ross, Executive Director
European Securities and Markets Authority
Keynote speech at IDX 2015, London
“ESMA is dealing with the two main European legislative projects affecting
derivatives regulation – EMIR and MiFID II – for a number of years now.
While EMIR has already entered the review stage, MiFID II still has 1.5
years to go before it applies in practice and during which ESMA will have to
finalise its legislative implementing measures and work towards practical
implementation along with the European national supervisors.”
Building real markets for the good of the
people
Speech by Mr Mark Carney, Governor of the Bank of
England and Chairman of the Financial Stability
Board, at the Lord Mayor's Banquet for Bankers and
Merchants of the City of London at the Mansion
House, London
“Almost 350 years ago, the Great Fire destroyed the City of London and
rendered 100,000 people homeless.
It took half a century to rebuild.
The legacy of the Great Fire endures, including such Wren masterpieces as
St Paul's and his twenty-five other steeples that survive today within the
City's precincts.
But the Fire's legacy is not limited to how the City looks, it extends to what
the City does.
The blaze led Nicholas Barbon to establish the first insurance company, an
innovation to fulfil a social need: the sharing of risk.”
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Office of Inspector General
Report on CIA Accountability
The CIA has released a nearly 500-page inspector
general report outlining systemic problems in the spy
agencies ahead of the terror attacks on September 11, 2001.
Central banking - the next 50 years
Introductory remarks by Mr Alexandre Antonio
Tombini, Governor of the Central Bank of Brazil, at a
panel discussion to celebrate the 50th anniversary of
the Central Bank of Brazil, Rio de Janeiro, 10 June
2015.
“Today we'd like to take advantage of the collective
wisdom and experience of our distinguished guests to look forward: what
can we expect in the next 50 years of central banking?”
Basel Committee announces Chile as host of the
2016 International Conference of Banking
Supervisors
The Basel Committee announced that Chile will host the
19th International Conference of Banking Supervisors
(ICBS) that will take place in 2016.
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International Association of Risk and Compliance Professionals (IARCP)
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Interest rate risk in the banking book
Issued for comment by 11 September 2015
Executive summary
Interest rate risk in the banking book (IRRBB) is currently
part of the Basel capital framework’s Pillar 2 (Supervisory Review Process).
Most jurisdictions follow this approach, which is based on the Committee’s
guidance set out in the 2004 Principles for the management and
supervision of interest rate risk (henceforth the IRR Principles).
The IRR Principles lay out the Committee’s expectations for banks’
identification, measurement, monitoring and control of IRRBB as well as
its supervision.
The Committee is proposing changes to the regulatory capital treatment
and supervision of IRRBB for two reasons.
First, to help ensure that banks have appropriate capital to cover potential
losses from exposures to changes in interest rates.
This is particularly important in the light of the current exceptionally low
interest rates.
Second, to limit incentives for capital arbitrage between the trading book
and the banking book, as well as between banking book portfolios that are
subject to different accounting treatments.
This is particularly important given the enhancements to the capital
treatment of positions in the trading book, including the Committee’s
ongoing Fundamental Review of the Trading Book (FRTB).
This consultative document presents two options for the regulatory
treatments of IRRBB:
A standardised Pillar 1 (Minimum Capital Requirements) approach and
An enhanced Pillar 2 approach (which also includes elements of Pillar 3 –
Market Discipline).
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By adopting a uniformly applied Pillar 1 measure for calculating minimum
IRRBB capital requirements, the framework would have the benefit of
promoting greater consistency, transparency and comparability.
This would have the advantage of promoting market confidence in banks’
capital adequacy and a level playing field internationally.
Conversely, an advantage of a Pillar 2 approach is that it can better
accommodate differing market conditions and risk management practices
across jurisdictions.
Moreover, the required calculation of a standardised framework, embedded
in a Pillar 2 approach, represents a new hybrid intersection between a
capital requirement (Pillar 1) and a supervisory review process (Pillar 2)
and would have served to promote greater consistency, transparency and
comparability.
Given the motivations behind this new proposal, the Committee is of the
view that a strengthened framework for IRRBB is necessary.
Consistent with Part I (Scope of Application) of the Basel II framework, the
proposed framework would be applied to large internationally active banks
on a consolidated basis.
Supervisors would have the national discretion to apply the IRRBB
framework to other non-internationally active institutions.
The Committee is seeking comments on the proposed approaches, which
share a number of common features.
The Committee will carefully review the comments received with the aim of
narrowing down its policy options.
In doing so, the Committee will also take into account progress made by
other areas on the Committee’s efforts to balancing risk sensitivity,
simplicity and comparability.
This consultation paper is structured as follows.
Section I provides an introduction to IRRBB, reviews the lessons from the
crisis and summarises past and new policy aspects and challenges related to
IRRBB.
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Section II presents the proposal for a standardised Pillar 1 capital
framework for IRRBB.
Using an economic value of equity (EVE) measure, interest rate risk
exposure is measured against several interest rate shock scenarios (ie
parallel up and downwards shifts in the yield curve, steepening,
flattening, as well as short-term up and down interest rate shocks).
These scenarios are designed to be sensitive to local economic conditions
and also reflective of measures of global interest rate volatility.
The proposal recognises that not all banking book positions are easily
amenable to standardisation, given uncertainty about the timing of cash
flows due to behavioural aspects and embedded options (eg non-maturity
deposits, loan prepayment).
The proposal provides flexibility to allow banks to use internal parameter
estimates for certain products – subject to constraints as well as
supervisory review and approval.
The Committee acknowledges the risk of unintended consequences if an
IRRBB framework were to create incentives to exclusively mitigate possible
declines in EVE.
There is a trade-off between optimal duration of equity and earnings
stability.
To address this issue, the Committee is proposing overlaying the EVE
measure with an earnings-based metrics in the Pillar 1 framework.
Section III presents revised principles, which would apply as an alternative
to the Pillar 1 framework and are intended to replace the IRR Principles for
defining supervisory expectations on the management of IRRBB (including
credit spread risk in the banking book (CSRBB)).
The nine principles addressed to banks set out expectations on the
corporate and risk governance framework, as well as on the disclosure of
banks’ IRRBB exposures and capital as well as earnings measures, and
include an expectation that a bank will allocate adequate internal capital to
cover the risk.
The three principles addressed to supervisors cover supervisory reporting,
data-gathering, assessment and capital review.
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Section III also expands on the enhanced Pillar 2 approach.
Under this approach, banks would be allowed to use their internal
measurement systems (IMS) for assessing their capital adequacy subject to
supervisory approval.
The standardised approach outlined in Section II of this consultative
document would serve as a fallback to a bank’s IMS.
The Pillar 2 approach includes standardised disclosure of a bank’s IRRBB
risk profile, key measurement assumptions, qualitative and quantitative
assessment of IRRBB levels and quantitative disclosure of IRRBB metrics,
including the standardised calculation framework.
The proposal also includes guidance for supervisory responses with a
strong presumption for capital consequences for banks with high levels of
IRRBB relative to their level of capital and sophistication of risk
management.
The Committee is seeking comments specifically on:
(i)
technical aspects, particularly regarding the approaches for
behavioural options, the earnings overlay and basis risk;
(ii) specification and values of the standardised risk parameters (eg
pass-through rate, stability rate, maturity cap, conditional prepayment rate,
pull-through rate, term deposit redemption rate, time horizon of the
earnings measure, basis risk parameters) as well as constraints on the own
estimate risk parameters (eg stability cap, pass-through floor, maturity
cap);
(iii) specification, selection and calibration of the prescribed interest rate
shock scenarios;
(iv) specification of the candidate minimum capital requirements
calculations, in particular on a possible earnings-based overlay to the EVE
measure, the scenario-consistency principle and currency aggregation rule;
(v)
the mandatory disclosure of the standardised framework under the
Pillar 2 alternative; and
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(vi) information as to how the standardised framework measure
compares to banks’ internal interest rate risk in the banking book
measures.
To read more:
http://www.bis.org/bcbs/publ/d319.pdf
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The 2015 National Money Laundering Risk Assessment
(NMLRA)
The 2015 National Money Laundering Risk Assessment (NMLRA)
identifies the money laundering risks that are of priority concern to the
United States.
The purpose of the NMLRA is to explain the money laundering methods
used in the United States, the safeguards in place to address the threats and
vulnerabilities that create money laundering opportunities, and the
residual risk to the financial system and national security.
The terminology and methodology of the NMLRA is based on the guidance
of the Financial Action Task Force (FATF), the international standard setting body for anti-money laundering and counter-terrorist financing
safeguards.
The underlying concepts for the risk assessment are threats (the predicate
crimes associated with money laundering), vulnerabilities (the
opportunities that facilitate money laundering), consequence (the impact of
a vulnerability), and risk (the synthesis of threat, vulnerability and
consequence).
Threats
Money laundering is a necessary consequence of almost all profit
generating crimes and can occur almost anywhere in the world.
It is difficult to estimate with any accuracy how much money is laundered
in the United States.
However, while recognizing the limitations of the data sets utilized, this
assessment estimates that about $300 billion is generated annually in illicit
proceeds.
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Fraud and drug trafficking offenses generate most of those proceeds.
Fraud encompasses a number of distinct crimes, which together generate
the largest volume of illicit proceeds in the United States.
Fraud perpetrated against federal government programs, including false
claims for federal tax refunds, Medicare and Medicaid reimbursement, and
food and nutrition subsidies, represent only one category of fraud but one
that is estimated to generate at least twice the volume of illicit proceeds
earned from drug trafficking.
Healthcare fraud involves the submission of false claims for
reimbursement, sometimes with the participation of medical professionals,
support staff, and even patients.
Federal government payments received illegally by check can be cashed
through check cashing services, some of which have been found to be
complicit in the fraud.
Use of the Internet to commit identity theft has expanded the scope and
impact of financial fraud schemes.
Personal identifying information and the information used for account
access can be stolen through hacking or social exploits in which the victim
is tricked into revealing data or providing access to a computer system in
which the data is stored.
A stolen identity can be used to facilitate fraud and launder the proceeds.
Stolen identity information can be used remotely to open a bank or
brokerage account, register for a prepaid card, and apply for a credit card.
Drug trafficking is a cash business generating an estimated $64 billion
annually from U.S. sales.
Mexico is the primary source of supply for some drugs and a transit point
for others.
Although there are no reliable estimates of how much money Mexican drug
trafficking organizations earn overall (estimates range from $6 billion to
$39 billion), for cocaine, Mexican suppliers are estimated to earn about 14
cents of every dollar spent by retail buyers in the United States. It is the
thousands of low level drug dealers and distributors throughout the country
who receive most of the drug proceeds.
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The severing by U.S. banks of customer relationships with Mexican money
exchangers (casas de cambio) as a result of U.S. enforcement actions
against U.S. banks between 2007 and 2013, combined with the U.S.
currency deposit restrictions imposed by Mexico in 2010, are believed to
have led to an increase in holding and using drug cash in the United States
and abroad, because of placement challenges in both countries.
This shifted some money laundering activity from Mexico to the United
States.
International organized crime groups target U.S. interests both
domestically and abroad.
The criminal activity associated with these groups includes alien smuggling,
drug trafficking, extortion, financial fraud, illegal gambling, kidnapping,
loan sharking, prostitution, racketeering, and money laundering.
Some groups engage in white-collar crimes and co-mingle illegal activities
with legitimate business ventures.
To read more:
http://www.treasury.gov/resource-center/terrorist-illicit-finance/Docume
nts/National%20Money%20Laundering%20Risk%20Assessment%20%E2
%80%93%2006-12-2015.pdf
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National Terrorist Financing Risk Assessment
After the September 11, 2001 terrorist attacks, the United States adopted a
preventive approach to combating all forms of terrorist activity.
Efforts to combat the financing of terrorism (CFT) are a central pillar of this
approach.
Cutting off financial support to terrorists and terrorist organizations is
essential to disrupting their operations and preventing attacks.
To that end, the U.S. government has sought to identify and disrupt
ongoing terrorist financing (TF) and to prevent future TF.
The law enforcement community, including various components of the U.S.
Departments of Justice, Homeland Security, and the Treasury, along with
the intelligence community and the federal functional regulators, applies
robust authorities to identify, investigate, and combat specific TF threats,
enforce compliance with applicable laws and regulations, and prosecute
supporters in order to deter would-be terrorist financiers.
The U.S. Department of the Treasury (Treasury), which leads financial and
regulatory CFT efforts for the U.S. government, employs targeted financial
sanctions, formulates systemic safeguards, and seeks to increase financial
transparency to make accessing the U.S. financial system more difficult and
risky for terrorists and their facilitators.
All of these efforts involve extensive international engagement to try to
prevent any form of TF, particularly financing that does not necessarily
originate in the United States, from accessing the U.S. financial system.
These efforts have succeeded in making it significantly more difficult for
terrorists and their facilitators to access and abuse the regulated U.S. and
international financial systems.
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At the time of the September 11, 2001 attacks, Al-Qaida (AQ) was relying on
both a web of wealthy supporters that practically operated in the open and a
financial system that let money for terrorists flow with minimal scrutiny.
Operating such a financial network would be substantially more difficult
today in the United States because of robust anti-money laundering
(AML)/CFT standards.
Additionally, several of the most significant sources of TF—such as the
ability of terrorists to derive financial benefit through the control of
territory—result from weak governance that the United States does not
experience.
However, the threat from terrorism and terrorist financing is constantly
evolving and requires adaptation by law enforcement, financial regulators,
intelligence services, and policy makers.
When examined over time, several fundamental lessons emerge: first, a
wide range of terrorist organizations have sought to draw upon the wealth
and resources of the United States to finance their organizations and
activities; second, just as there is no one type of terrorist, there is no one
type of terrorist financier or facilitator; and third, terrorist financiers and
facilitators are creative and will seek to exploit vulnerabilities in our society
and financial system to further their unlawful aims.
Thus, even with the safeguards described above, the U.S. financial system
continues to face residual TF risk.
The central role of the U.S. financial system within the international
financial system and the sheer volume and diversity of international
financial transactions that in some way pass through U.S. financial
institutions expose the U.S. financial system to TF risks that other financial
systems may not face.
As Treasury Secretary Jacob Lew has observed, “The dollar is the world’s
reserve currency and, for over 200 years, we have established ourselves as
the backbone of the global financial system.”
While U.S. counterterrorism (CT)/CFT efforts have resulted in better
identification and faster action than prior to September 11, 2001,
information obtained from financial institution reporting, TF-related
prosecutions, and enforcement actions against financial institutions in the
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United States are powerful reminders of the TF risk that remains in the
United States.
As described in detail in Section III, multiple terrorist organizations and
radicalized individuals seek to exploit several vulnerabilities in the United
States and in the U.S. financial system to raise and move funds, that despite
ongoing efforts by the U.S. government to mitigate, still pose a residual risk
of TF.
Terrorist financiers use various criminal schemes to raise funds in the
United States, and they continue to attempt to exploit the generosity of
American citizens.
Although coordinated law enforcement and regulatory efforts by the U.S.
government, working with charitable organizations, has improved the
resiliency of the charitable sector to abuse by TF facilitators, the large size
and diversity of the U.S. charitable sector and its global reach means the
sector remains vulnerable to abuse.
A notable trend identified in the charitable sector involves individuals
supporting various terrorist groups seeking to raise funds in the United
States under the auspices of charitable giving, but outside of any charitable
organization recognized by the U.S. government.
Additionally, the growth of online communication networks, including
social media, has opened up new avenues for terrorists and their supporters
to solicit directly, and receive funds from, U.S. residents.
In terms of moving and placing funds, while the United States has reduced
the ability of terrorist groups to use regulated financial institutions to move
funds through the U.S. financial system through effective regulation,
supervision, investigations and enforcement, some residual risks remain,
due to correspondent banking relationships with foreign financial
institutions and the acts of complicit money services business (MSB)
employees in the United States.
Unlicensed money transmitters may also be used to send funds abroad, and
there are aggressive investigation, prosecution, and regulatory efforts
underway to detect and disrupt such activity.
Because other more effective funds transmission routes are disrupted, the
use of cash smuggling to move funds across U.S. borders — while slower,
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less efficient, and more expensive than regulated or unregulated financial
institutions — continues to be employed by a variety of terrorist groups.
The U.S. government is also closely monitoring several emerging TF threats
and vulnerabilities, including the use of cybercrime and identity theft
schemes by terrorist groups and individuals to raise funds, as well as the
use of new payment systems to move and place funds.
To read more:
http://www.treasury.gov/resource-center/terrorist-illicit-finance/Docume
nts/National%20Terrorist%20Financing%20Risk%20Assessment%20%E2
%80%93%2006-12-2015.pdf
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Insurance distribution in a
challenging environment
Gabriel Bernardino
Chairman of EIOPA
Good afternoon Ladies and Gentleman,
Dear Chairman of the Management Committee, Mr. Alessandro De Besi,
Dear Director, Nic De Maesschalck; and Dear Paul Carty, Member of the
EIOPA Insurance and Reinsurance Stakeholder Group, I would like to
thank you for the invitation to speak again at the BIPAR Annual General
Meeting.
You know that I always enjoy engaging directly with BIPAR members, to
understand your concerns and messages and to be open and transparent on
our strategies and positions.
I have a long standing history of dialogue, discussions and engagement with
BIPAR. And I must say that I always appreciated your approach.
Of course, you are defending your activity and your main goal is to promote
a European regulatory environment in which intermediaries can prosper.
Nevertheless, you have always been capable to point to other important
elements such as ensuring fair competition, an adequate level of consumer
protection and a sound insurance market.
That makes you a credible stakeholder and I believe you should continue to
follow that approach.
So, I am happy to be here today to update you on some key topics for
EIOPA.
In particular, I would like to touch upon the following three issues:
1. How the Insurance Distribution Directive (IDD) is shaping up and some
of our key strategic views (a topic, which I know is very close to your heart!).
As insurance intermediaries, you play a key role in selling insurance
products to consumers.
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You are the main interface in the market. That is why your conduct needs to
appropriately match the interests and needs of customers.
2. The work on the Key Information Documents (KID) for Packaged Retail
and Insurance-based Investment Products (PRIIPs) to enhance product
disclosure for consumers by reducing complexity and enhancing
comparability; as well as
3. EIOPA’s vision on Conduct of Business Supervision; I will end by making
reference to the upcoming challenges posed by the digital era.
How the Insurance Distribution Directive is shaping up
As you know, negotiations are currently on-going in the trilogues with the
aim of trying to reach a political compromise by the end of this month
under the Latvian Presidency.
We are confident that a good outcome can be achieved in terms of the final
text, but, as is the case with politics, there will be inevitably some
compromises.
We support the general goals of the IDD, namely ensuring retail insurance
markets work better and strengthening consumer protection.
At the same time, we are of the view that the IDD can only really achieve
these goals if it can be effectively supervised by creating a common
supervisory culture across the EU.
There are a very wide variety of structures, which currently exist at national
level for supervising insurance intermediaries, which makes supervisory
convergence more challenging.
In addition, in a cross-border context, effective supervision can only take
place if there is a very clear demarcation of home/host competences.
Thus, it’s important to have harmonized EU rules on insurance
distribution, whilst, at the same time, avoiding the predominance of
national law.
In addition, it is important that the IDD is proportionate as regards the
objectives to be achieved and full consideration is given to existing market
specificities such as the very fragmented national markets and a diverse
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range of distribution channels (large numbers of natural persons) at
national level.
I often hear the phrase “MiFID-isation of the insurance sector” being
bandied about!
We fully support the general objectives of enhancing cross-sectoral
consistency and ensuring a level playing field for financial institutions by
having in the IDD the provisions that are similar to those in the MiFID II.
The reason is that if supervisors from different financial sectors treat the
same issues differently, it will not mean a “consistent level of protection” for
consumers, which is our final aim.
However, at the same time, we also think it is important to take account of
the specificities of the insurance sector - in particular, the diversity of
distribution channels I have mentioned. In more concrete terms, we
consider the following elements to be fundamental in the revised Directive:
 It is important that the IDD addresses conflicts of interest that arise when
distributors sell insurance products. Please note: I am not saying that all
conflicts of interest pose a problem to consumers.
Conflicts of interest are indeed a fact of day-to-day business.
What we are talking about here are conflicts of interest that actually or
potentially harm the best interests of customers.
To prevent this from happening, we consider it of utmost importance that
relevant organisational measures and procedures are introduced to
appropriately address conflicts of interest.
It is about good business practices, not more bureaucracy.
At the beginning of the year, we provided technical advice to the
Commission on conflicts of interest in the direct and intermediated sale of
insurance-based investment products.
We believe that distributors should have an effective conflicts of interest
policy set out in writing.
Only with this approach, will consumers always be confident that they are
offered a fair deal.
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We also considered the issue of third party payments (or "inducements"),
which have the potential to be a key source of conflicts of interest entailing
the risk of consumer detriment.
We did not say that commission-based distribution models should be
eliminated.
Instead, such models should demonstrate in a transparent way that
inducements are used for the benefit of consumers.
In addition, conflicts of interest also arise with regard to internal payments
paid by insurers to staff involved in distribution.
We think that further analysis is required on how best to coordinate
national approaches to the mitigation of these conflicts.
 We support the current provision in the IDD stating the need for a
standardised Product Information Document (or PID) for
non-investment-based insurance products.
I believe that EIOPA can be instrumental in developing such a PID in order
to materially reduce information asymmetry for consumers.
 Insurance distributors should fully understand the products (their costs,
risks etc.) that they are selling to consumers. Therefore, EIOPA supports
the provision in the IDD foreseeing a specific number of hours of
continuous professional development (or CPD) to be completed by
distributors.
This is the reality: the number of innovative insurance products is growing
and before selling them, the distributors first need to study them to be
prepared to give the best advice. They should have time for this.
The work with regard to the market monitoring and product
intervention powers in the PRIIPs Regulation
The Regulation on key information documents for PRIIPs (PRIIPs
Regulation) is an important tool for consumer and investor protection.
Its central focus is product disclosure: establishing new rules for short,
consumerfriendly and comparable Key Information Documents, or KIDs.
EIOPA is currently working on the regulatory technical standards (RTS)
that will define the design and content of the KID.
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The focus is on more transparent and comparable cost, risk and
performance disclosures in the KID.
This includes developing detailed methods that PRIIP manufacturers will
need to follow in preparing these disclosures.
I am convinced that better, shorter and more easily compared disclosures
will in practice be an aid to BIPAR members in providing quality advice and
transparency to customers.
I would also underline that it is not the aim of the KID to usurp the role of
the advisor or distributor, but to better aid the advisor or distributor.
In view of the consumer focus of the KID, we are also using consumer
testing as an integral part of our work on the RTS: 10000 consumers from
10 EU Member States will see different versions of the KID and we will
collect their feedback through a questionnaire on their impressions of the
KID, its clarity and usefulness of the content etc.
We are also using this research to see how well the different versions are
able to inform consumers in practice, through some testing questions to see
how well specific messages are picked up by the consumers.
The RTS will be submitted to the European Commission by March 2016
and as of January 2017 the new KID will be introduced across the EU.
This work is jointly done by all the three European Supervisory Authorities
under the leadership of EIOPA.
Under the PRIIPs Regulation we are also currently working on product
intervention powers in relation to insurance-based investment products.
The PRIIPs Regulation complements EIOPA’s and NCAs’ existing powers
with an explicit mechanism for temporarily prohibiting or restricting the
marketing, distribution and sale of insurance-based investment products.
We believe that there is a clear need for a more consumer-centric culture in
firms.
However, product intervention powers should not imply any requirement
to introduce or apply, product approval or licensing by the national
supervisors or by EIOPA.
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At the same time, product intervention powers do not relieve the
manufacturer of an insurance-based investment product of his
responsibility to comply with all relevant requirements of the PRIIPs
Regulation.
EIOPA’s work on product intervention is twofold:
 Firstly, we are finalising our technical advice to the Commission on the
criteria to be taken into account in determining when there is a significant
investor protection concern or a threat to the orderly functioning and
integrity of financial markets.
These criteria are high-level and flexible and, at the same time, sufficiently
specific and clear.
We are planning to submit the advice to the Commission in July 2015.
 Secondly, EIOPA is further strengthening its market monitoring, also with
a view towards product intervention. Exploring issues that go beyond
purely one national market where those issues have a cross-border element
to them or where they arise in several national markets, helps to build a
coordinated understanding across those markets and is thereby beneficial
for European consumers.
In the same vein, it would not only help national authorities to comply with
a new market monitoring obligation, but also to establish state-ofthe art
conduct supervision regimes where this is not already the case.
Some of the key tools to be implemented will be Thematic Reviews of
market conduct, Retail Risk Indicators, deep and effective market
monitoring both for general and product intervention purposes and
Consumer Trends Reports.
Conduct Risk regulation and supervision
Another important point I would like to raise is the necessity to have proper
regulation and supervision of conduct risk.
Failures in business conduct can pose a threat to the stability of the
financial sector, while miss-selling can pose the risk of serious detriment to
individual consumers and create a lack of trust in the sector.
Overall, there are four main lines of action that are paramount:
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 Strengthening corporate governance, i.e. to better integrate conduct of
business concerns in the institutional governance arrangements and
ensuring that Boards of financial institutions take full responsibility for
ensuring that consumer interests are take into account throughout the
product lifecycle.
 Reinforcing the regulation of product oversight and governance and sales
incentives. Certain changes should be done in the companies’ processes
related to the manufacturing and distribution of products.
For example, when designing products, manufacturers have to identify the
target market of the product, analyse its characteristics and ensure that the
product meets the identified objectives and interests of that target market.
 Enhancing conduct of risk supervision by putting in place, systematic
monitoring to identify conduct risks. Supervisors should perform off-site
analysis as well as on-site and „mystery shopping” activities.
Such practices could be particularly effective in reaction to the mis-selling
of products.
We are also currently developing certain tools such as Thematic Reviews,
Retail Risk Indicators and deep and effective market monitoring, which will
enable us to identify emerging consumer risks and act early before the
horse has bolted!
 Putting in place credible and dissuasive enforcement. This will only work,
however, if national authorities have the requisite powers and tools to
enforce conduct of business rules.
Sadly, there is still a huge level of diversity on this at the national level;
The challenge of the digital era
The digital revolution is transforming completely the way we interact and
do business.
The insurance world is not going to be out of this process. Some will say
that we have always been facing change and that this is just another step.
That’s true, but the change coming from the digital era is potentially
different: it is not incremental; it can be disruptive.
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The entire insurance value chain will be impacted, from insurers to
intermediaries and distributors and service providers.
We will see some business models threatened and new entrants in
insurance markets implementing business models that will dramatically
reduce the traditional frictional costs.
This will happen because of one fundamental element: customer behaviour.
However, as always, change brings risks, but also opportunities.
The digital era comes with the growing use of big data and telematics,
comparison websites and automated advice tools.
This has the potential to produce better outcomes for customers, but also
raises several issues in terms of access to financial services for those
digitally excluded.
What kind of personalised advice is going to be given?
How to ensure data and cyber security?
Conclusion
Distribution of insurance products is a very complicated topic.
We should not forget that certain markets have their own long-term
culture, traditions and specificities.
There are also a wide variety of structures at the national level for
supervising insurance intermediaries.
But the EU has a single European market, which should be promoted in the
field of regulation and supervision.
We need to have harmonized rules that, at the same time, consider the
existing market specificities, as well as effective supervision.
Only if we put at the centre of regulation and at the heart of the business,
the interests of customers, we will be able to ensure the appropriate level of
consumer protection and, in general, enhance consumers’ confidence in
financial markets.
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Finally, all market participants need to embrace the changes coming from
the digital era and use them to provide customers a better experience and
service.
As Albert Einstein said: “The measure of intelligence is the ability to
change”.
Thank you.
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Quality Data and the Power of Prevention:
Remarks at Meet the Market, North
America
Commissioner Kara M. Stein
New York, NY
June 10, 2015
Thank you, David [Strongin, Executive Director, Global Financial Markets
Association] for that kind introduction. It is an absolute pleasure to be with
you today at the Meet the Market Symposium.
Before I begin my remarks, I need to remind you that the views I express
this afternoon are my own, and do not necessarily reflect the views of my
fellow Commissioners or the staff of the Commission.
As many of you know, I care passionately about the success of the Legal
Entity Identifier (or LEI).
With the financial crisis in the rear view mirror, it is sometimes easy to
forget the forces that converged in 2007 and harmed both our financial
markets and our economy.
The events of 2008 are indelibly etched into my memory.
I remember when many of our country’s economic leaders began
closed-door briefings with members of Congress.
Concerned about the unfolding financial crisis, the Chair of the Federal
Reserve and the Secretary of Treasury plead for help and for an
unprecedented financial intervention to stave off another Great Depression.
They wanted tools to protect our nation from powerful forces that were
pulling the financial system deeper and deeper into distress and potential
chaos.
At the edge of the abyss, our economic and policy leaders developed a
strategy to stabilize our financial system and unlock the halting credit
markets.
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Those were scary days, with millions of American jobs, and billions of
dollars, on the line.
Huge policy choices had to be made quickly and with imperfect
information.
And the consequences of those decisions continue to affect the world
economy.
There was a sentiment that the financial storm that began in the U.S. and
engulfed economies around the globe was unforeseen — that the storm had
seemingly come from nowhere.
That simply is not true.
There were signs.
But, the signs went unseen and didn’t seem to be connected. And, as a
result, even when the storm was upon us, no one knew exactly what action
to take.
Despite living in the age of “big data”, what became abundantly clear during
the financial crisis was that we were unable to interpret the information we
did have.
Certainly, there were data gaps. But, more importantly, we couldn’t use the
information that was there.
Neither regulators nor market participants could fully evaluate risk
exposures or interconnectedness.
Opacity fueled uncertainty, and that uncertainty sparked fears that
ultimately froze the credit markets and shook the financial system.
As I mentioned, the U.S. was at the epicenter of the financial crisis, but it
grew and enveloped economies around the world, requiring extraordinary
market interventions from the United States to Europe to Asia.
Globalization and digitalization had begun their transformation of our
securities markets long before the first symptoms of the looming financial
crisis.
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Some believe this transformation can be contained by regulatory walls or
geographic borders.
But, changes in technology and communications cannot be turned back.
There is perhaps no greater lesson from the financial crisis than the
fundamental lesson of how technology connects everyone in the global
marketplace.
Risks are no longer contained by borders or walls, and they now can travel
at light speed around the globe.
As globalization and digitalization increased in our securities markets,
private industry was working to develop standardized identifiers for both
financial instruments and firms.
The paperwork crisis of the late 1960s spurred private firms and
associations to seek out identification standards that could be used to
identify and aggregate data.
The CUSIP numbers emerged from the work of the Committee on Uniform
Securities Identification Procedures.
Other identifiers emerged and gained acceptance, such as SWIFT codes or
Dun and Bradstreet numbers.
However, a single standard for entity identification that could be
consistently applied for universal coverage remained elusive.
As a result of the vulnerabilities revealed by the financial crisis, Congress
stepped in and decided that financial data quality needed to be improved.
Accordingly, Congress created the Office of Financial Research (OFR) to
improve the quality of financial data for all regulators.
In 2010, OFR issued a policy directive announcing its intention to adopt a
universal standard to identify legal entities.
Other regulators around the globe discussed and announced similar
initiatives.
Shortly after OFR’s announcement, regulators, industry, private firms, and
others began working together hand-in-hand in a global coalition to
hammer out a global standard.
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And that private-public partnership has been a resounding success — a
model that demonstrates the power of teamwork between regulators and
industry.
I hope that this cooperative approach can be a harbinger of things to come.
This model can benefit both intermediaries and investors as our securities
markets continue to evolve rapidly and in response to continuous waves of
disruption and innovation.
For example, I believe this model of teamwork and cooperation can be
emulated as efforts continue to reduce the settlement cycle for securities
transactions.
So why do I care so passionately about a 20-digit alphanumeric character,
similar to a bar code that appears on grocery and other consumer products?
This small but mighty tool has the power to help us prevent another
financial crisis.
It serves as a Rosetta Stone to clearly and uniquely identify firms and
entities participating in the global financial markets.
Simply put, there has been no single pre-existing globally accepted
standard for identifying market participants.
Consequently, no one can readily begin to compile the most basic
information necessary to comprehend the connections, exposures, and
distribution of risks across the financial system.
But the global LEI system will help change this paradigm.
While concerns have been raised about the system being monopolistic, I
believe this private-public partnership has worked hard to implement
appropriate safeguards, such as the creation of an oversight foundation that
has a fiduciary duty to the public.
Moreover, competition has been built into the system through the LEI
governance structure.
The local operating units that issue the LEIs are subject to controls and
standards but have incentives to be fiercely competitive.
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The local operating units need to adhere to the high standards promulgated
by the Regulatory Oversight Committee (ROC), but the LEI is portable from
one local operating unit to another.
So, in effect, the units that administer the LEIs can compete on cost and
service, but they can’t compromise on quality.
This strikes the right balance between developing a common standard that
can be broadly implemented, while learning from the issues and problems
that have arisen when other standards have emerged without appropriate
checks and balances.
All financial regulators could learn a few lessons from the success of this
partnership.
Four years after OFR had issued its policy mandate, LEIs were being issued.
The rules had been worked out.
The governance and oversight of the issuance of LEIs had been resolved. In
four short years, legal entity identifiers went from an idea to a reality.
Now, over 360,000 LEIs have been issued in 191 countries, and it is time for
industry to help accelerate the growth of the standard and take up of LEIs.
The regulators have provided the initial momentum and have mandated
LEI in a number of rules; however, it’s now time to pass the baton to the
industry to accelerate the incorporation and acceptance of LEI in financial
transactions around the world.
You must not rest on your laurels, which are indeed laudable achievements,
but instead, work to invest in the future and integrate LEIs into standard
industry practice — including risk systems and reporting systems.
Greater usage of LEI has the potential to reduce both costs and burdens for
participants, including reducing compliance costs and targeting risk
management activities as a result of widespread usage of LEI.
Essentially, greater use of LEI could increase profits while mitigating
market risks. Everybody wins.
Just for the record, I’m not just challenging you; I will be doing my part
throughout my tenure at the Commission.
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I will work to ensure that LEI is appropriately included in every SEC rule
where a legal entity needs to be identified.
Recently, the Commission released rules that mandate the use of LEI when
associated with security-based swap transactions.
The LEI is now a component of mandatory swaps transaction reporting in
the U.S., Europe and Canada. Europe has mandated future LEI usage
widely, including in payment and settlement activities as well as structured
finance.
Just a few weeks ago, the Commission proposed rules that would
modernize reporting for registered investment companies, such as mutual
funds and exchange traded funds (ETFs) and bring them into the 21st
century.
LEI was part of this proposal as well.
The full benefits of LEI have yet to be realized. As some companies may
have hundreds or thousands of subsidiaries or affiliates operating around
the world, more benefits lie ahead as the LEI becomes increasingly used.
While the first phase, or “Level 1” data, serves as a corporate business card,
greater incorporation of so-called “Level 2” data will allow more
transparency regarding hierarchies and relationship mapping.
This will support better analysis of risks as they aggregate and potentially
become systemic.
The Commission needs your help in other areas.
The next financial crisis will come from a new direction.
We will likely have access to more data than ever before.
However, the failure in 2008 also was a failure to properly interpret the
data we did have.
Developing a comprehensive approach to standardizing and interpreting
data is critical to prevention and remediation in advance of other financial
headwinds.
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As a result of the crisis, the Commission is taking on more and more data
projects, such as the Swap Data Repositories.
The Commission also now has access to new, rich data sets through filings
on Form PF and Form N-MFP that need to be analyzed.
Over the last five to ten years, data management and analysis have become
more complex and require a strategic approach.
I have been advocating for the creation of an Office of Data Strategy at the
SEC overseen by a Chief Data Officer.
This new office would ensure a thoughtful and holistic approach to data
collection, business analysis, data governance, and data standards.
Other regulators have proactively moved forward on forming similar
offices.
I believe that the Commission needs to act now to develop a group of
employees solely focused on data, including building an in-house
infrastructure to facilitate the use of data throughout the agency.
One of the most important focuses of this new office would be promoting
data standards and taxonomies.
Data standards and taxonomies play a vital role in both the quality and
utility of data.
It is critical that we approach data standards as a community and not in
isolation and an Office of Data Strategy could help facilitate and lead such
efforts.
A key role of such an office would be identifying data gaps and refining
existing data collections.
This should be an evergreen process whereby the Commission — through
the Office of Data Strategy — is constantly seeking to improve upon its data
quality and filling gaps.
We should be testing our forms and data sets continuously, and searching
for better ways to obtain clear, usable data.
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As we analyze data and receive feedback from market participants, we can
tweak and refine how we collect and ask for data to produce better, more
reliable results.
It is also important for the Commission to think globally about standards
and data.
For example, the International Organization of Securities Commissions
(IOSCO), in conjunction with the Committee on Payments and Settlement
Systems (CPSS), has been working to develop a framework for derivatives
data reporting and aggregation requirements.
This work parallels and supports the important work already being done at
the Commission in our efforts to establish a taxonomy for swaps reporting.
The next challenge is to bring to life additional coding schema that will
enable a new depth of data aggregation.
The development and use of a unique product identifier (UPI) and a unique
trade identifier (UTI) will empower global risk analysis across all market
participants and the products they trade.
These are challenging initiatives, and we will need a private-public
partnership to get them done.
In fact, you may be in the best position to do the heavy lifting.
I hope that we can all build on our relationships and past work to advance
UPI and UTI
Again, as I’ve stressed throughout my remarks, it is critical that we work
together as a community, rather than independently.
In conclusion, I’m proud of the work that regulators and industry have done
together on LEI.
I think it’s a model for how we can improve data aggregation and usability,
and help prevent and respond to future financial system issues and
problems.
Thank you for inviting me to join you today, and I hope you enjoy the rest of
this Meet the Market event.
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Keynote speech at IDX 2015
London
Verena Ross, Executive Director
European Securities and Markets Authority
Rule-making and Implementation – EMIR and MiFID II
 ESMA is dealing with the two main European legislative projects affecting
derivatives regulation – EMIR and MiFID II – for a number of years now.
While EMIR has already entered the review stage, MiFID II still has 1.5
years to go before it applies in practice and during which ESMA will have to
finalise its legislative implementing measures and work towards practical
implementation along with the European national supervisors.
These two projects show the different phases of ESMA regulatory work and
I will talk about aspects of both of them today.
 For EMIR, ESMA is very much in the implementation stage.
The initial work on technical standards has been completed and we are now
working to ensure stringent implementation of the legislation.
For example, we are working on the review of reporting to Trade
Repositories building on the experience of the start of TR reporting in
February 2014.
We expect to submit draft technical standards to the European Commission
after this summer.
The revised ESMA standards should become applicable in the second half
of 2016.
I will elaborate on this a bit later.
 In addition, under EMIR, ESMA continues working on the clearing
obligation for derivatives and again I will say a bit more about the current
work on this implementation topic a little later on.
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 At the same time, EMIR is already undergoing a review.
Like for most legislative measures, a review clause was included in EMIR
and the Commission has launched a public consultation recently.
ESMA will be actively contributing to the review, building on its experience
in implementing EMIR.
 For MiFID II, the decisive date for application remains 3 January 2017.
ESMA is therefore very much still in the rule-making stage with regards to
this project.
The initial date for ESMA to deliver its main set of technical standards to
the European Commission is 3 July 2015.
While ESMA is in full flow trying to finalise its package of standards, the
timetable has recently been slightly amended due to ESMA and the
European Commission agreeing on an early legal review.
 Under the European set of rules, any technical standard proposed by
ESMA has to be adopted by the European Commission and one prerequisite
for such adoption is the standard passing the review by the Commission
Legal Services.
 Given that MiFID II is of a size unprecedented in terms of number and
volume of technical standards, ESMA and the European Commission
considered it important for the standards to be legally reviewed before final
and formal submission of draft standards from ESMA to the European
Commission.
That way, the risk of having potentially a number of standards rejected for
legal drafting reasons which would render the subsequent implementation
timetable for MiFID II unworkable should be diminished.
 The early legal review will take place over the course of the summer and
ESMA expects to submit its draft technical standards for formal adoption
by the European Commission at the end of September 2015.
At that point in time there will be clarity for stakeholders as to the exact
content of ESMA’s proposals relevant for the regulation of derivatives
trading. 2 MiFID II –
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Transparency regime for derivatives
 Transparency is a central element of MiFID II and will be extended in the
new world to equity-like instruments and non-equity instruments.
As you know, MiFID II mandates ESMA with calibrating the details of the
transparency regime.
 I am aware that many of you are concerned that the new transparency
regime, and in particular the calibrations of the waivers and deferrals
available to orders and transactions may undermine liquidity.
I can assure you that ESMA’s approach is not solely to maximise
transparency for its own sake.
Our approach is to determine appropriate amount of transparency that
benefits market functioning, while at the same time respecting
co-legislators’ intention to increase transparency.
We therefore conducted an extensive data analysis and are considering
carefully the feedback from three public consultations, the DP last May and
the CPs in December and February.
 I cannot provide you at this stage with details regarding our final drafts,
but I’d like to react to some of the key concerns in the area of derivatives
that ESMA received and which are and remain also our main focus points
when finalising our RTS following the consultation.
In particular, I would like to highlight four areas:
-
Data issues, in particular the use of data from trade repositories (TRs)
-
The concept of a “liquid market”;
-
Calibration of thresholds for orders or transactions that are large in
scale (LIS) or of a size specific to the instrument (SSTI); and
-
The treatment of package transactions.
 1) Data issues: Many respondents raised concerns in this area and
considered that three months of data was too short a period and that the
analysis often didn’t sufficiently distinguish between OTC derivatives and
exchange traded derivatives (ETDs).
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One particular concern related to the use of TR data which was considered
to be of too low a quality and not granular enough.
 We have put an enormous effort on evidence-based regulation in this
project. No other EU rule that I know has been subject in the last few years
to such an extensive test, against real market data.
However, we acknowledge that TR data, also after performing intense
cleaning, suffers currently from deficiencies.
We have worked with stakeholders on some specific cases, like on Forex or
Commodities, where data shortcomings were particularly problematic.
We are aware that we need to find an acceptable solution for today’s
situation, where only TRs have comprehensive information on OTC
transactions but the quality of reporting by firms is still poor.
 Looking forward, these problems should not affect the calibration of the
liquidity regime in future, because:
1) ESMA is constantly working on improving the quality of TR data
(including important reviews of the reporting rules that I will explain later);
and
2) once MiFID II applies more data sources will be available, such as
transaction data from Approved Publication Mechanisms (APAs) for OTC
transactions.
 2) The concept of a liquid market: MiFIR provides for waivers and
deferrals for instruments or classes of instruments not having a liquid
market.
In the CP, ESMA proposed determining liquidity on the basis of a static
COFIA approach and determining which classes are liquid or illiquid in the
RTS.
Any reclassification would, under this approach, require an amendment of
the RTS. Feedback focussed on two elements.
First, stakeholders supported generally the COFIA approach for derivatives
but asked for more granularity and higher liquidity thresholds to avoid the
problems of false positives, i.e. illiquid derivatives wrongly classified as
being liquid.
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Second, stakeholders argued the static approach should be replaced by a
periodic liquidity assessment to reflect the dynamic market environment
for derivatives.
 3) SSTI and LIS thresholds: ESMA proposed, in the CP, to set identical
thresholds for both pre- and post-trade transparency purposes and to set
the size specific to the instrument (SSTI) threshold equal to 50% of the
large in scale threshold.
Furthermore, ESMA suggested determining the thresholds annually, based
on a methodology specified in the RTS which would kick-in in the second
year of application.
Overall, respondents supported the periodic determination of thresholds,
but considered it necessary to set different thresholds for pre- and
post-trade purposes, and in particular to improve the methodology for
setting the SSTIthreshold.
 4) Package transactions: Finally, a number of stakeholders asked for a
specific treatment for package transactions, i.e. transactions that are
composed of a number of interlinked and contingent trades.
In particular, it was considered important to exempt those transactions
from the transparency regime.
ESMA understands these concerns, but recognises at the same time that
co-legislators did not provide for a tailored regime for package transactions
and that the possibilities of introducing such a regime at Level 2 are limited.
 As I said before, I can’t give you more information on the final draft RTS
at this stage but I can say at least that your feedback triggered significant
changes.
MiFID II - Position limits for Commodity Derivatives.
 Another key area of our current MiFID II work is the regime for position
limits for commodity derivatives.
 We are, in the EU, on the verge of implementing the world’s most
ambitious and comprehensive position limits regime to date.
 Spot month and other months position limits will apply to all commodity
derivative contracts traded on an EU trading venue – Regulated Market,
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MTFs, OTFs – and to contracts traded OTC which are deemed to be
economically equivalent to the contracts traded on a trading venue.
Because of some unknowns such as the new category of OTFs, the number
of contracts captured is not known but we do know that we are talking
about thousands of contracts.
 It’s worth turning to probably the most well-known position limits regime
today which is that of the US and has been in place for several decades.
The CFTC intends to expand its existing position limits regime, applying to
9 agricultural contracts, to 28 core physical commodity contracts - the most
liquid contracts - and to contracts which are economically equivalent to
them.
The scope of the new EU regime compared to even the new, beefed-up, US
regime is vast.
 The comparison to the US regime is important because it shows that in
the EU we are putting in place something on a scale which has not been
done before and are doing so in record time (a couple of years).
ESMA is charged with the herculean task of crafting a methodology which
has to bring a number of contradictory elements together:
o it has to apply to, and work for, both very liquid and very illiquid
contracts;
o it has to provide for a consistent approach to avoid arbitrage
opportunities whilst allowing sufficient flexibility to deal with a wide range
of contracts;
o it has to ensure limits are low enough to avoid squeezes without killing off
contracts with only two or three participants.
 All these elements mean that this is one of the most controversial areas of
MiFID II and one of the most scrutinised parts of ESMA’s work.
 ESMA’s approach is what we call, informally, the snake in the tunnel
approach: the methodology needs to allow enough flexibility or wriggle
room for the competent authorities to set limits on a vast array of contacts
but within constraints – the tunnel – so that the competent authorities do
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apply limits in a consistent way and reach similar levels for similar
contracts.
 ESMA outlined this approach in the December CP: limits would be based
on 25% of deliverable supply with competent authorities being able to
adjust this baseline by 15% either way depending on a number of factors,
listed in level 1, such as maturity, number and size of market participants
etc. F
eedback was generally supportive with main comments being: the other
months’ limits should be based on open interest (not deliverable supply)
and for new contracts and illiquid contracts, a maximum of 40% limit may
still be insufficient.
 In the interim, ESMA has gathered further data for a cost benefit analysis
and some competent authorities have further analysed their own markets to
inform the final approach and quantitative limits in its draft RTS.
EMIR - Clearing Obligation.
 Before coming back to MiFID II in a minute, let me briefly talk about the
Clearing Obligation – one of the key areas of ESMA’s current work in the
implementation of EMIR.
 The clearing obligation is one of the pillars of EMIR and constitutes the
European response to the G20 commitment to “clear all standardised OTC
derivatives with central counterparties”.
 ESMA started to work on the clearing obligation in March 2014, following
the authorisation of the first European CCP under the new framework
introduced by EMIR .
Since that date, ESMA has analysed most of the contracts that are currently
offered for clearing by European CCPs, to determine whether they meet the
criteria defined in EMIR to be subject to the clearing obligation.
Those criteria relate to standardization, liquidity, and availability of pricing
information.
 This work, which has been increasingly supported by data retrieved from
European Trade Repositories, led to several proposals for mandatory
clearing.
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The proposals have reached various stages now and they can be
summarised per asset classes (interest rate rates, credit and foreign
exchange).
 Starting with interest rate derivatives, which concentrate approximately
80% of the total volumes of OTC derivatives, we launched a public
consultation in July 20142 and in October 2014 we submitted to the
European Commission our final proposal to impose a clearing obligation on
several classes of interest rate swaps denominated in the G4 currencies
(EUR, GBP, JPY and USD).
 The European Commission is expected to endorse this proposal shortly,
although there has been some delay mainly due to the need to amend the
timeline of entry into force and introduce a special carve-out for intragroup
transactions concluded with non-EU counterparties .
 Continuing the work on interest rate derivatives, we have launched a
public consultation in May 20155 with a proposal to extend the scope of IRS
to 6 other currencies, namely the Czech Koruna (CZK), Danish Krone
(DKK), Hungarian Forint (HUF), Norwegian Krone (NOK), Polish Zloty
(PLN) Swedish Krona (SEK).
The consultation is running until 15 July 2015.
 Turning to the other asset classes, we have also consulted stakeholders in
July 2014 on a proposal for mandatory clearing on certain CDS indices.
Although the feedback received to this consultation was broadly positive,
we are holding the delivery of the final proposal to the European
Commission until the first rules on the clearing obligation for IRS are
finalised.
 Finally, we have issued a consultation paper in October 2014 which
detailed a proposal of mandatory clearing for certain FX products, namely
non-deliverable forwards, or NDFs.
This segment of the market is significantly smaller than the IRS market and
participants have less experience with clearing those contracts.
Based on the feedback received, ESMA has concluded that more time would
be needed to address the concerns raised in the responses, and has decided
not to propose a clearing obligation on those classes at this stage.
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 To sum this up, we expect the clearing obligation to be implemented in
Europe in the coming months, first with IRS denominated in the G4
currencies and then with index CDS, ensuring an important level of
international convergence.
We believe this scope could expand in the future, to other currencies but
also possibly to other classes as CCPs gradually develop their clearing offer.
MiFID II - Trading Obligation.
 The trading obligation for derivatives is closely linked to the clearing
obligation.
Just like MiFID II is behind EMIR in the legislative timetable also ESMA is
dealing with the trading obligation as a second step - only after it has
developed significant parts of the clearing obligation.
 The implementation of the trading obligation will be a technically
complex and data intensive challenge which will become an on-going task
for ESMA.
This task has been rendered even more challenging by the timelines set in
MiFID II.
 The general design of the trading obligation in MiFID II can be found in
the directly applicable regulation part – commonly referred to as MiFIR –
and the standard process will be that ESMA looks at the classes of
derivatives declared subject to the clearing obligation, checks whether those
classes are already traded on-venue and then performs a liquidity test.
 If the respective class of derivatives is considered sufficiently liquid,
ESMA would draft a technical standard declaring the class subject to the
trading obligation which would have to be adopted by the European
Commission.
 While Europe is undoubtedly late in implementing the trading obligation
for derivatives as per the Pittsburgh Accord, the timetable envisaged in
MiFIR is nonetheless problematic.
 The trading obligation will not apply until 3 January 2017, which is the
date for all MiFID II obligations to go live. However, ESMA shall
nonetheless be obliged to develop technical standards already within 6
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months of the European Commission adopting a clearing obligation
standard.
As I mentioned a few minutes ago, for interest rate derivatives such an
adoption is expected soon, and thus ESMA would be required to conduct a
liquidity assessment on such derivatives, to conduct a public consultation
and to draft technical standards in the second half of 2015.
 However, ESMA will not have data available to check how liquid the
relevant derivative classes are post-imposition of the clearing obligation
and will not be able to assess the arrival of the new organised trading
facilities (OTFs).
This means an important piece of the puzzle is missing at a time when
ESMA has to make its first assessments.
 This is problematic and, given the fact that any technical standard drafted
by ESMA in 2015 or 16 would in any case not apply any earlier than 3
January 2017, we consider it necessary to find a different timing solution
for dealing with the trading obligation.
EMIR - Reporting Review.
 EMIR reporting requirements have been in effect since February 2014.
The six TRs are now processing over 300 million trade reports on a weekly
basis with more than 16,5 billion reports (relating to 4,3 billion new trades)
since the reporting start date of end-May 2015 being stored in TRs systems.
The reporting system is up and running.
And overall, I would say, no major hiccups have occurred in terms of
reporting flows and connections with TRs and regulators.
 However, 15 months after the introduction of any major data reporting
system (think of MIFID I or other jurisdiction’s reporting on derivatives) it
is rare to see data quality at an acceptable level.
The practical experience acquired so far together with valuable feedback
provided by the reporting community and trade repositories during the
implementation phase, allows us to identify a number of shortcomings and
limitations that need to be addressed so that EMIR reports better fulfil their
objective.
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 There are three main areas on which the ongoing review of the reporting
rules by ESMA is focused:
o Clarifying the description and purpose of certain reportable fields;
o Aligning existing fields to the reporting logic prescribed in the Q&As
document or to reflect specific ways of populating them; and
o Introducing a number of new fields and values to reflect market practice
of trading in specific derivative contracts or accommodate specific
regulatory requirements.
 The review also aims at achieving a more consistent and harmonised
population of fields and reporting of complex derivatives.
 But let me be clear: beyond clarifying and improving the rules, reporting
parties need to comply with those that are actually in force, like assigning a
mutually agreed code to the report (UTI) which is not always the case.
We have agreed with the national competent authorities to increase the
supervision efforts on this important obligation.
International derivatives convergence
 Let me finally conclude by mentioning how much international progress
we have made since the Pittsburgh declaration.
We have worked closely with other regulators in multiple fora to achieve a
consistent and robust regulation of the derivatives markets and, in that
collective effort, we especially value the cooperation with the US authorities
and especially the regulator of the largest part of that market, the CFTC.
 As is well known, we also have some sticking points of international
consistency that need to be tackled in a market as globalised as this one.
CCP margins for futures is the most obvious of those issues. This has
prevented full equivalence and thus has not yet opened doors (as we all
desire) across the Atlantic for the clearing of venuetraded derivatives.
 We can each talk about how we believe our respective rules are ‘better’
than those in other jurisdictions, but I don’t think that is a very productive
way to proceed.
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What we need is full understanding of where the differences are, what the
impact of those differences might be to the entities subject to the respective
rules and how we can – in that environment – ensure we create as level a
playing field as we can and the conditions for a global derivatives markets
to operate in a way that supports financial stability – as our political
masters in Pittsburgh desired.
 Allow me to explain briefly from my perspective what we know already
and what we learnt also from the US experience.
 First, there is an essential difference between margins collected to protect
the clearing members’ own account positions and the one collected to
protect clients’ positions, since client margins cannot be used to protect the
CCP from the clearing member’s default.
This difference is key because if the margins collected by the CCP for house
accounts are not sufficient, the CCP and the non-defaulting clearing
members are at risk.
 Second, during the Lehman default, as evidenced by the Valukas report,
the margins collected by CME on the Lehman’s own account position were
insufficient to close the positions without losses in 3 asset classes out of 5.
So it was a pure (lucky) coincidence that the default fund was not impacted.
 In our view it is not prudent to assume that the portfolio composition of a
clearing member will ensure that, if the margins collected in one asset class
are insufficient, the margins collected in other asset classes will be
sufficient to compensate that.
 This episode is in our view truly educational on why 1 day MPOR for
clearing member own account is not sufficient.
We are open to recognising that we can learn from each other’s experience,
for instance on the benefits of gross collection of margins (as done in the
US) for the protection of clients.
I would hope however that also the CFTC will want to reflect further on the
benefit of 2-days MPOR on house accounts for the protection of the CCP
and the non-defaulting clearing members.
 I remain confident that we will be able to disentangle this in a reasonable
timeframe.
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 We have plenty of other issues to work on with our fellow regulators from
the US and the rest of the world (on very important topics like
implementation of bilateral margins, aggregation of data, evolution of LEI
or recovery of CCPs, to name but a few) and we are looking forward to
continued close cooperation in addressing those issues.
Conclusion
I hope my short review today of some of the key work streams and topical
issues in the rule making under MiFID II and the implementation of EMIR
has been useful.
As you can see, there are plenty of important reforms in our plate that are
essential for the orderly functioning and the safety of derivatives markets.
We look forward to working with our fellow international regulators and
also expect to count on your input and cooperation from the market user
and participant perspective to make them successful. Thank you very much
for your attention.
Wish you a good rest of the day!
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Building real markets for the good of the
people
Speech by Mr Mark Carney, Governor of the Bank of
England and Chairman of the Financial Stability
Board, at the Lord Mayor's Banquet for Bankers and
Merchants of the City of London at the Mansion
House, London
I am grateful to Ben Nelson, Iain de Weymarn, Nicola Anderson, Alex
Brazier, Andrew Hauser, Chris Salmon and Tim Taylor for their assistance
in preparing this speech and accompanying Open Forum document.
My Lord Mayor, Lady Mayoress, Chancellor, Ladies and Gentlemen.
Almost 350 years ago, the Great Fire destroyed the City of London and
rendered 100,000 people homeless.
It took half a century to rebuild.
The legacy of the Great Fire endures, including such Wren masterpieces as
St Paul's and his twenty-five other steeples that survive today within the
City's precincts.
But the Fire's legacy is not limited to how the City looks, it extends to what
the City does.
The blaze led Nicholas Barbon to establish the first insurance company, an
innovation to fulfil a social need: the sharing of risk.
Public authorities complemented private initiative.
There was a Royal Proclamation that set standards for wider roads and
houses built from brick and stone instead of timber.
And Parliament passed the Parish Pump Act to prevent "mischiefs that may
happen by fire" by establishing fire brigades and improving water supply.
So that spark in Pudding Lane ignited much more besides the Great Fire
itself:
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- the provision of liquidity to limit contagion;
- a recognition that clear, well-understood codes contribute to the greater
good; and
- a belief that financial markets can solve real world problems.
From the coffee houses that served as meeting places for entrepreneurs and
merchants; to the exchanges that supported the trading of financial claims;
to a central bank that acted as lender of last resort: a rich infrastructure
developed to support markets that served the UK and the world.
As it grew into the world's leading economic and trading power, the UK also
became its centre of financial capitalism.
By the early 20th century, though no longer the world's largest economy,
the UK was still its hub of international finance.
It held close to a half of the world's stock of overseas investments and
traded one third of all negotiable instruments.
The City has retained its pre-eminence through market innovation. From
eurobonds to emerging market debt, credit derivatives and centralised
clearing; the City has continually created new financial products and
markets to serve the real economy.
Today the City remains the leading global financial centre.
The UK is the venue for 40% of foreign exchange trading volume, half of all
trades in OTC interest rate derivatives, and more than two-thirds of trading
in international bonds.
More international banking activity is booked in London than anywhere
else, and the UK is host to the world's third largest insurance sector as well
as its second largest asset management industry.
UK markets matter for global commerce. But above all, our markets matter
for our prosperity.
Markets are a major part of the UK economy. 350,000 people are employed
in financial services in London alone, and 1 million across the UK as a
whole.
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Across the country, their enterprise contributes £130 billion to our national
income and £70 billion to our exports.
On current trends, the UK-based non-bank financial system would increase
from around six times UK GDP to nearly fifteen times by 2050.
Most fundamentally, our markets serve our real economy.
By financing firms to hire, invest and expand, our markets help drive UK
growth.
By opening up cross-border trade and investment, our markets create new
opportunities for UK businesses and savers.
By transferring risks to those most willing and able to bear them, our
markets help UK households and businesses insure against the unexpected.
Much of this activity depends on fixed income, currency and commodity
markets.
These FICC markets establish the borrowing costs of households,
companies and governments.
They set the exchange rates we use when we travel or buy goods from
abroad.
They determine the costs of our food and raw materials.
And they help our companies manage the financial risks they incur when
investing, producing and trading.
Markets have become ever more important to people as they bear
increasing responsibility for financing their retirements and insuring
against risks.
The suitability of those decisions will depend heavily on FICC markets. It is
therefore vital that they work well. And are seen to do so.
The failures of FICC markets
Though markets can be powerful drivers of prosperity, markets can go
wrong.
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Left unattended, they are prone to instability, excess and abuse.
Markets without the right standards or infrastructure are like cities without
building codes, fire brigades or insurance.
Poor infrastructure allowed the spark of the US subprime crisis to light a
powder keg under UK markets, triggering the worst recession in our
lifetimes.
- Poor "soft" infrastructure such as codes of conduct that too few read and
too many ignored.
- Faulty "hard" infrastructure like interest rate and foreign exchange
benchmarks that were quite literally fixed; and
- Weak banks whose light capital and heavy reliance on short-term funding
created a tinder box.
Central banks shared in these failings, operating a system of fire insurance
whose ambiguity was anything but constructive when global markets were
engulfed in flames.
The Bank of England's general approach was consistent with the attitude of
FICC markets, which historically relied heavily on informal codes and
understandings.
That informality was well suited to an earlier age. But as markets innovated
and grew, it proved wanting.
Most troubling have been the numerous incidents of misconduct that
exploited such informality, undercutting public trust and threatening
systemic stability.
This has had direct economic consequences.
Mistrust between market participants has raised borrowing costs and
reduced credit availability. Falling confidence in market resilience has
meant companies have held back productive investments.
And uncertainty has meant people have hesitated to move job or home.
These effects are not trivial, and they have reduced the dynamism of our
economy in the post-crisis years.
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Widespread mistrust has also had deeper, indirect costs.
Markets are not ends in themselves, but powerful means for prosperity and
security for all.
As such they need to retain the consent of society - a social licence - to be
allowed to operate, innovate and grow.
Repeated episodes of misconduct have called that social licence into
question.
We have all been let down by these developments. And we all share
responsibility for fixing them.
Real markets
I believe everyone in this room would agree: we need real markets for
sustainable prosperity.
Not markets that collapse when there is a shock from abroad. Not markets
where transactions occur in chat rooms. Not markets where no one appears
accountable for anything.
Real markets are professional and open, not informal and clubby.
Participants in real markets compete on merit rather than collude online.
Real markets are resilient, fair and effective. They maintain their social
licence.
Real markets don't just happen; they depend on the quality of market
infrastructure.
Robust market infrastructure is a public good, one in constant danger of
under-provision because the best markets innovate continually.
This inherent risk can only be managed if all market actors, public and
private, recognise their responsibilities for the system as a whole.
The City has a special responsibility given London's pre-eminent position in
global markets, which is why it has already brought so many ideas and such
energy to advance financial reform.
Financial reform is re-building real markets
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Reform is strengthening the resilience of major banks. Their capital
requirements have increased ten-fold and their liquid assets are up
four-fold.
These banks' trading assets are down by a third and intra-bank exposures
by two-thirds.
Reform is ending the scourge of Too Big To Fail.
The combination of eliminating the implicit public subsidy and increased
capitalisation will correct the distortions caused by the structural
under-pricing of risk on banks' balance sheets.
And by making a further shift to market-based finance inevitable, it is
increasing choice and competition - real market forces.
Reform is also improving risk transfer by untangling the complex web of
derivatives that meant failures like Lehman triggered chaos; and by
creating simple, transparent and comparable securitisation markets.
This reform agenda has increased the effectiveness of FICC markets and
reinforced their social licence.
It is frustrating for us all that such major progress risks being
overshadowed by misconduct problems.
The fair and effective markets review
We must break the back of these issues, and the Fair and Effective Markets
Review shows the way forward.
With its publication today, all the main building blocks are now in place for
the real markets we need.
I want to pay tribute to my colleagues Charles Roxburgh, Minouche Shafik
and Martin Wheatley, who so ably led the Review.
And to salute Elizabeth Corley, who so expertly chaired the Review's
independent Market Practitioner panel, canvassing and coalescing views
from across the industry.
The importance and complexity of their task is illustrated by the multiple
root causes of the misconduct in FICC markets.
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Specifically, the Review identifies:
- Market structures which presented specific opportunities for abuse, such
as poor benchmark design, and which more generally were vulnerable to
conflicts of interest, collusion, and thin markets;
- Standards of acceptable market practice that were usually poorly
understood, often ignored and always lacked teeth;
- Firms' systems of internal governance and control that were incapable of
asserting the interests of firms - let alone the wider market - over those of
close-knit trading staff;
- Individual incentives that were skewed, with pay packages stressing
short-term returns overlong-term value and good conduct;
- And personal accountability that was lacking, with a culture of impunity
developing in parts of the market.
All these factors contributed to an ethical drift.
Unethical behaviour went unchecked, proliferated and eventually became
the norm.
Too many participants neither felt responsible for the system nor
recognised the full impact of their actions.
For too many, the City stopped at its gates, though its influence extended
far beyond.
A good start has been made in addressing these deficiencies.
The design and regulation of key FICC benchmarks has been overhauled
and transparency in FICC markets is being enhanced. Compensation rules
have, in the main, been transformed to align better risk and reward.
From next year, senior managers of banks and insurers will be held directly
accountable for failures in their areas of responsibility.
And the best firms are improving the "tone from the top", launching
conduct training and revamping control structures.
But major gaps remain.
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These are evidenced by enforcement actions which continue to appear with
depressing frequency.
These sanctions, while necessary, aren't the solution, not least since the
$150 billion of fines levied on global banks translates into more than $3
trillion of reduced lending capacity to the real economy.
We need a better balance between individual and firm accountability.
But who should be accountable? Against which standards? And with what
consequences?
In these regards, I welcome the Review's recommendations that:
First, individuals must be held to account. Doing so requires new, common
standards, cast in clear language; better training and qualifications for
FICC personnel; and mechanisms to ensure that when individuals are fired,
their history will be known to those who consider hiring them.
Second, firms must take greater responsibility for the system by improving
the quality, clarity and market-wide understanding of FICC trading
practices.
I welcome the industry's leadership in drawing up plans for a new FICC
Market Standards Board.
The Board's mandate will be to establish readily understandable standards,
keep them up-to-date with market developments, and promote adherence
to them.
Crucially, the Board will be dynamic, and will monitor and address areas of
uncertainty in specific trading practices.
This is a major opportunity for the industry to establish common standards
of market practice that are well understood, widely followed and, crucially,
that keep pace with markets.
If firms and their staff fail to take this opportunity, more restrictive
regulation is inevitable.
To give these measures teeth, key elements of the Senior Managers Regime
should be extended to all firms active in wholesale FICC markets, including
dealers and asset managers.
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That means all senior managers would have clearly defined responsibilities
and would be answerable for training, certifying and monitoring the
material risk takers they supervise.
The FCA should oversee compliance, redeploying resources to focus on
Senior Persons. In turn, these individuals would be on the hook for
promoting compliance within their organisations.
Incentives will be aligned.
For the best in the industry, this won't be new.
This is just how you run your business. But for others, who free ride on your
reputations: the Age of Irresponsibility is over.
Third, regulators should extend the coverage of market abuse regulation to
include every major fixed income and currency market. And criminal
sanctions should be updated, with market abuse rules similarly extended
and maximum prison terms lengthened.
Finally we need global standards for global markets. I welcome the FICC
Markets Standards Board's intent to be as global as possible in its
membership and influence.
All major Central Banks and market participants have begun working on
developing a new single Global Code for FX.
I would encourage IOSCO to consider complementing these efforts with a
similar initiative to cover FICC markets as a whole when they meet in
London next week.
The FSB will engage with these processes and work to improve the
alignment between remuneration and conduct risk across the globe.
The Bank of England's role
All must play a role in building real markets, including the Bank of England.
Although the Bank does not regulate conduct or markets per se, it has
responsibilities for, and powers over, the stability of the UK's financial
system as a whole.
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In the run-up to the crisis, the Bank's contribution to the effectiveness of
markets fell short in three respects.
In all cases, the Bank is now responding.
First, the Bank's framework for providing liquidity was shown to have
lagged behind market developments.
Once under pressure, the Bank could neither stabilise overnight rates nor
support the banking system.
Fortunately, in the jaws of the crisis, the Bank innovated rapidly and
admirably to avoid a collapse of the system.
Those lessons are now embedded in a new, comprehensive framework for
the Bank's sterling market operations.
We have expanded the range of eligible collateral, and will lend to many
more counterparties, at much longer maturities. The Bank also stands
ready to act as a market maker of last resort.
Constructive Ambiguity has been replaced by Open for Business.
Second, like many others, the Bank neither identified the scale of risks in
the system nor spotted the gaps in the regulatory architecture.
Following the Chancellor's reforms in the last Parliament, the Bank now
has statutory responsibility to protect and enhance the stability of the UK's
financial system, and is working as One Bank to do so.
The FPC and the PRA have catalysed a series of actions that influence
market resilience including stress tests of banks and hedge funds,
system-wide capital actions, and new tools like the leverage ratio and
minimum repo haircuts.
Third, the Bank's arcane governance blurred the Bank's accountability and,
by extension, weakened the social licence of markets.
Before my arrival, the Bank's governance was reshaped.
The Bank's board of directors, Court, has been strengthened.
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Its external members now have formal powers to observe the meetings of
the Bank's policy committees and to commission reviews into the Bank's
performance.
I welcome the Government's intention to introduce legislation further
strengthening the governance and accountability of the Bank.
The Bank will continue to modernise its operations. Following the Grabiner
report, the Bank has focused its Market Intelligence programme,
strengthened procedures, improved training and overhauled compliance.
And the Bank is introducing today a new code of conduct.
The Bank expects its senior management to meet the highest standards of
professional conduct.
As one example, the Bank will apply the core principles of the Senior
Managers Regimes to its own senior staff, including the Governor.
This is in addition to existing obligations and scrutiny from Court,
Parliament, the media and the general public.
And the Bank will continue to reinforce its commitment to openness and
transparency.
Minutes of Court meetings are now published with minimal delay.
The Monetary Policy Committee will publish transcripts of its deliberations
with an appropriate lag.
Whenever there are difficult issues, outside reviews of the Bank's
performance will be conducted, publicly released and acted upon.
Looking ahead
The Bank welcomes such scrutiny of our activities, including open debate
about the cumulative impact of reform on the functioning of markets.
In particular, while the core of the system has been made more resilient, the
combination of new prudential requirements on dealers and structural
changes in markets has reduced market depth and increased potential
volatility.
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This process likely has further to run, particularly as the normalisation of
global monetary conditions edges closer.
Firms and regulators should be alert to these developments, including their
consequences for investment funds that offer daily liquidity while investing
in securities that only appear liquid.
To be clear, more expensive liquidity is a price well worth paying for making
the core of the system more robust.
Removing public subsidies is absolutely necessary for real markets to exist.
Volatility characterises such real markets and much of the pre-crisis market
making capacity among dealers was ephemeral.
However, the possibility of sharp, unpredictable changes in market
liquidity poses a clear risk to financial stability, particularly when some
market participants take liquidity for granted and crowd into trades in
anticipation of central bank action.
The Bank is keenly alert to such risks.
The FPC and the FSB are currently analysing these issues and welcome
perspectives on whether the market, regulation or both should adjust for
the good of the system.
Conclusion
With the main building blocks of reform in place, now is the time to take
stock.
It's vital that we - public authorities and private market participants - work
together to reverse the tide of ethical drift.
This cannot be a one-off exercise. We need continuous engagement so that
market infrastructure keeps pace with market innovation.
That's why the Bank is announcing that it will hold an Open Forum this
Autumn which will bring together all stakeholders in FICC markets.
Our goal is to discuss the prospects for market functioning, where
regulations might overlap or conflict, and whether enough has been done to
build the real markets the UK deserves.
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To prompt an open discussion, we are publishing a detailed paper which
reviews these issues and draws out such questions.
Everyone has an interest in the future of financial markets, so I would
strongly encourage you to engage with our Open Forum process online and
at the conference itself.
An Open and Accountable Bank welcomes your input.
Our response to recent failings should be as ambitious as those of our
predecessors to the Great Fire: renewed prosperity built on private markets
and public market infrastructure.
Let our legacy be the earthly equivalent of Wren's ethereal genius, real
markets so that the City can do what it does best: transact and innovate for
the good of the people of the United Kingdom and the world.
Thank you.
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Office of Inspector General
Report on CIA Accountability
The CIA has released a nearly 500-page inspector
general report outlining systemic problems in the
spy agencies ahead of the terror attacks on
September 11, 2001.
“The events of 9/11 will be forever seared into the memories of all
Americans who bore witness to the single greatest tragedy to befall our
homeland in recent history,” the CIA said. “The documents released today
reflect differing views formed roughly a decade ago within CIA about the
Agency’s performance prior to 9/11.”
To learn more:
http://www.foia.cia.gov/sites/default/files/DOC_0006184107.pdf
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Central banking - the next 50 years
Introductory remarks by Mr Alexandre Antonio
Tombini, Governor of the Central Bank of Brazil, at
a panel discussion to celebrate the 50th anniversary
of the Central Bank of Brazil, Rio de Janeiro, 10
June 2015.
Today's panel discussion is part of a series of events to celebrate the 50th
anniversary of the Banco Central do Brasil. Other events in the series have
looked backward.
Today we'd like to take advantage of the collective wisdom and experience
of our distinguished guests to look forward: what can we expect in the next
50 years of central banking?
This is an ambitious question, but an appropriate one as the art and science
of central banking is currently in flux, and the outcomes of today's policy
debates and institutional innovations will shape central banking for many
years to come.
The global financial crisis has had a major impact on how we think about
central banking.
Before the crisis, there were, naturally, a number of unanswered questions
and challenging issues for central banking, but the prevalent view was that
the major pillars of the field were largely settled.
In a growing number of countries, the operational regime for monetary
policy was inflation targeting; monetary and financial stability objectives
could be safely addressed separately; and floating exchange rates, coupled
with robust international reserves and access to multilateral funding
facilities, were often seen as sufficient to protect financial stability from
excessive international capital flow volatility.
Naturally, macroeconomic stability was and still is a necessary condition for
the framework to operate properly.
The crisis has led to a reexamination of some issues we thought were settled
and to the emergence of some new questions.
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Even though Brazil was not at the epicenter of the crisis, we were affected
by the crisis itself and by the policies that were put in place in its wake.
Furthermore, we have been actively participating in the international
central banking debate in order to offer our views and to learn from the
experience of others.
*
*
*
In my opening remarks, I will focus on three topics that have provoked
particularly intense debate and that I believe will shape central banking for
some time to come.
In each of these topics, the global financial crisis prompted a rethinking
that is still underway, although some initial conclusions can already be
drawn.
First, maintaining financial stability was reemphasized as a core function
of central banks.
Central banks have always been concerned with financial stability,
particularly through their lender-of-last-resort role.
But in many jurisdictions, central banks progressively downgraded the
importance of the financial stability goal in the post-war period.
The supervision of banks was progressively split off from central banking,
and a gap emerged in that, in some jurisdictions, nobody was tasked with
looking at the vulnerabilities in the system as a whole.
This is less true for emerging markets, including Brazil, where central banks
tended to keep a strong focus on financial stability even before the global
financial crisis.
In part, this reflects the fact that financial crises were relatively more
common in emerging markets in the late 20th century.
There was also an old and important academic and monetary policy debate
in the decade leading up to the crisis on whether we should lean against a
financial bubble or clean up after it has burst.
However, the lack of consensus on this issue resulted, in practice, in a
mostly laissez-faire policy stance.
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Today, I think it is safe to say that there is general agreement that
proactively maintaining financial stability, by taking appropriate action
against the buildup of vulnerabilities, is a proper goal for central banks.
The high cost of "cleaning up" after the global financial crisis will serve as a
reminder against excessive complacency for some time to come.
The current debate is about the policy tools for the goal of maintaining
financial stability.
Macroprudential policy is widely seen as the first line of defense against
systemic risk, but there is still uncertainty about its effectiveness.
There is also disagreement on whether monetary policy should take
financial stability considerations into account at all.
On this latter issue - the use of monetary policy to deflate potential financial
bubbles - there are two views.
One is that monetary policy is likely to be particularly effective because it
affects all financial markets.
Another view, that has been stated most forcefully by Lars Svensson, is that
monetary policy is an inefficient and potentially even harmful tool for
financial stability, since it is too unfocused and may have counterproductive
macroeconomic effects.
This is far from a theoretical matter: there is currently a lively debate on
whether the current low interest rates in major jurisdictions are leading to
"search-for-yield" behavior in certain financial market segments,
potentially threatening financial stability, and whether this provides an
additional motivation for normalizing monetary policy sooner rather than
later.
The view that seems to be gaining strength, and to which I subscribe, is to
use macroprudential policy to maintain financial stability and allow
monetary policy to focus on price stability.
However, the definitive answer to this question will depend on the progress
in the development of macroprudential policy tools and frameworks.
Despite some positive experiences, including in Brazil, macroprudential
tools are still insufficiently tested and the theoretical literature is in its
infancy.
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The degree of success in using these tools will help determine whether there
is a role for monetary policy in helping to achieve the financial stability
goal.
A second issue that has been the subject of considerable debate is the
nature of monetary policy regimes.
Before the crisis, there was a strong consensus on inflation targeting (or IT)
as the most adequate monetary policy regime, due to its flexibility and
transparency.
After the crisis began, major central banks were soon forced to lower
interest rates to the effective zero lower bound.
Or so we thought at the time: some central banks are now testing the bound
by bringing interest rates further and further below zero.
Even so, it is clear that there must be some effective lower bound on
interest rates.
Furthermore, negative rates, if maintained over a significant period of time,
may result in financial market distortions; for example by causing lasting
damage to the money market fund business model.
Central banks responded to this new challenge through a variety of
unconventional measures which included what is known now as
quantitative easing (or QE).
However, there is still no full agreement about the effectiveness and the
collateral effects of these unconventional policies. (I will speak about some
of its side-effects a bit later).
Even before the debate about the limits of IT frameworks at a zero-lower
bound, many economists, particularly in academia, proposed innovative
monetary policy regimes such as price-level or even nominal GDP targeting.
These regimes were seen as more powerful in the zero lower bound because
they would effectively require central banks to make up for periods of
below-target inflation or nominal GDP growth by keeping rates lower than
required under IT after the economy recovers.
Since monetary policy primarily affects the economy through long-term
real interest rates, and therefore through agents' expectations for the future
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paths of the policy rate and of inflation, the end result would be more
accommodative policy during the downturn than recommended under the
IT regime.
A more modest proposal was to keep the IT regime, but increase the
targeted level of inflation.
The crisis and the bubbly period that preceded it convinced many that the
modern macroeconomy is more prone to shocks that previously believed,
and therefore the 2% target level that prevailed in mature economies before
the crisis was perhaps too low to keep the economy from repeatedly hitting
the zero lower bound.
My take on this debate is that, at the end of the day, inflation targeting
emerged even stronger from the crisis. No major central banks abandoned
inflation targeting, and some central banks that were not inflation-targeters
adopted elements of the framework.
There are several reasons for the resilience of the IT regime:
Central banks found that inflation targets were actually helpful in
explaining the need and the room for unconventional policy measures to
the general public.
Furthermore, inflation targets helped anchor inflation expectations,
keeping deflation at bay despite the large output gaps prevalent at the
height of the crisis.
The proposed new monetary policy regimes suffer from a number of
practical deficiencies.
They are too complex for the general public to understand and follow. And
nominal GDP targeting relies too heavily on an unobserved variable,
potential GDP growth.
Finally, changing the regime, or even just raising the inflation target, in the
middle of a crisis risked damaging the credibility that central banks have
gained under the IT regime.
However, if the secular stagnation hypothesis that has been revived by
Larry Summers and Paul Krugman is to be believed, this debate may be far
from over.
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The argument is that there may be a tendency for a chronic excess of
savings relative to investment, for various reasons including slower
population growth and a less capital-intensive economy.
If so, real equilibrium interest rates will be lower than in the past and the
zero-lower-bound will be a recurrently binding constraint.
I am still unconvinced by this hypothesis, however.
As has been pointed out by Ben Bernanke, the secular stagnation
arguments tend to ignore the global nature of today's economy.
As long as there are profitable investment opportunities somewhere in the
world, capital will tend to flow from economies with excessive savings to
those with excessive investment demand.
The resulting exchange rate depreciation would increase aggregate demand
and therefore neutral interest rates in the economies with excessive savings.
And indeed, there are abundant high-return, capital-intensive investment
opportunities in many emerging economies including Brazil, particularly in
infrastructure.
However, if the hypothesis does turn out to be realistic, the zero lower
bound will recur, and the shortcomings of the inflation targeting regime
under those conditions may lead to a renewed search for alternatives.
The third and final issue I will address today is how to deal with capital
flows.
Of course, the potential for destabilizing capital flows was well understood
even before the crisis.
In fact, after the various financial crises of the 1990's, emerging markets
began to accumulate international reserves in order to build a buffer of
foreign exchange liquidity.
The combination of floating exchange rates and robust foreign reserves, it
was hoped, would be sufficient to protect economies and financial systems
from destabilizing capital flows.
The resort to unconventional monetary policies in the wake of the global
financial crisis resulted in an unprecedented level of global liquidity.
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Emerging markets were buffeted by unusually intense and volatile capital
flows.
Exchange rate appreciation and FX market intervention were insufficient to
maintain financial stability.
The policy response in many emerging markets included macroprudential
policies to dampen the effects of capital inflows on domestic credit and
capital markets.
These policies included both measures that aimed at domestic markets and
measures that directly targeted capital inflows.
There is currently widespread agreement that a multipronged approach,
including macroeconomic, structural, and macroprudential policies may be
necessary in order to deal with capital flow surges.
More recently, academia, central bank researchers and the IMF have
endorsed a judicious combination of capital flow management measures
with strong macroeconomic policies, including using exchange rate
flexibility as the first shock absorber.
However, these measures have costs, including market distortions,
administrative burden, and negative market reactions.
Furthermore, there are still a number of open questions.
-
What combination of policy instruments should recipient countries use
in order to minimize costs?
-
To what extent should the burden of adjustment also be on source
countries?
-
Is it possible to improve on the decentralized outcome through
international policy cooperation?
I am still unconvinced that there is room for much greater international
policy coordination - central banks have domestic, not global mandates.
However, it seems to me that there is some scope for cooperation at least in
identifying potential cross-border and financial stability risks and adopting,
when necessary, targeted macroprudential policies - either in recipient or in
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source countries - in order to prevent capital flows from fueling
unsustainable financial bubbles.
*
*
*
I've raised a number of open issues in central banking that I believe will
shape central banking for some time to come:
Financial stability is once again a core function of central banks, but
macroprudential policies and frameworks are still in their infancy, and a
proper role of monetary policy in ensuring financial stability is still under
discussion.
Inflation targeting remains the dominant monetary policy regime, but if
growth skeptics are correct and the zero-lower-bound recurs, there will be
renewed calls for moving to innovative regimes or at least higher inflation
targets in mature economies.
A laissez-faire approach to capital flows is off the table.
There is still disagreement, however, on how to deal with flows, on who
bears the burden of adjustment, and on the scope for global policy
cooperation.
However, there is perhaps a deeper lesson to be drawn from the global
financial crisis.
The crisis came largely as a surprise; not because we did not see the bubbles
forming, but rather because the central banking community as a whole
failed to fully take into account the vulnerabilities resulting from the growth
of the shadow banking sector, the opacity of the novel financial instruments
that helped fuel the bubble, and the complex domestic and international
linkages between different financial sector intermediaries.
A fundamental lesson to be drawn from the global financial crisis is the
need to develop an integrated, forward-looking approach to central banking
that brings together:
-
Comprehensive, granular (and perhaps "real time") financial sector
surveillance that focuses on identifying systemic risk and develops
adequate market infrastructure and reporting systems;
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-
Market intelligence that captures short, medium and long-term trends
in the financial system, including, for example, the potential impacts of
the rapid evolution of electronic trading platforms and algorithmic
investment strategies; and
-
Research and analysis that spans monetary, exchange rate, and
macroprudential policies.
We have made some progress in this direction here at the Central Bank of
Brazil, but we expect to continue to develop this integrated approach to
central banking for some years to come.
Hosting discussions like this one we are having today is part of this process,
so I'm looking forward to hear from our panelists, which do not require any
introduction.
But nevertheless let me say a few words to introduce them to you.
Our first panelist is Jacob Frenkel. Dr. Frenkel taught international
economics at the University of Chicago before serving as Governor of the
Bank of Israel between 1991 and 2000.
He then moved to the private sector, where he is currently the Chairman of
JPMorgan Chase International and he also serves as Chairman of the Board
of Trustees for the Group of Thirty.
I'd also like to introduce Jean Claude Trichet. Mr. Trichet had a long and
successful career in the public sector where he was assigned to various
posts in the French government, including Governor of the Banque de
France.
In 2003 he was appointed President of the European Central Bank, in
which capacity he served for eight years. He is currently the Chairman and
CEO of the Group of Thirty.
Our third panelist is Axel Weber. After a distinguished career in academia,
Dr. Weber was president of the Deutsche Bundesbank between 2004 and
2011.
After leaving the Bundesbank, he was a Visiting Professor at the Booth
School of Business at the University of Chicago. He is currently Chairman of
the Board at UBS.
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I have enjoyed throughout these many years, in a variety of forums and
debates their always-to-the-point sharp remarks and so I hope that we can
today benefit from their thoughts, thank you for being here Jacob,
Jean-Claude and Axel.
Ms. Adriana Arai will moderate the discussion. Ms. Arai joined Bloomberg
News in 2004, and currently is executive editor for local language content
and chair of the Bloomberg São Paulo Office Committee.
Previously, she worked for Dow Jones Newswires in São Paulo, Brasília and
London.
Adriana, the floor is yours.
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Basel Committee announces Chile as host of the
2016 International Conference of Banking
Supervisors
The Basel Committee announced that Chile will host the
19th International Conference of Banking Supervisors
(ICBS) that will take place in 2016.
The ICBS, which has been held every two years since 1979, brings together
senior bank supervisors and central bankers from more than 100 countries
as well as representatives of international financial institutions.
The conference promotes discussion of key supervisory issues and fosters
continuing cooperation in the oversight of international banking.
With its wide membership of senior supervisors and policymakers, the
ICBS presents a unique opportunity for a broad-based discussion on issues
that are timely and relevant to supervisors in advanced and emerging
market jurisdictions alike.
Mr Stefan Ingves, Chairman of the Basel Committee on Banking
Supervision and Governor of Sveriges Riksbank, noted that "this is a
significant undertaking on the part of the Chilean authorities.
It is a reflection of their commitment to be an active participant on the
Basel Committee and to continue their adoption of global regulatory
standards".
Notes
The Basel Committee is the primary global standard setter for the
prudential regulation of banks and provides a forum for cooperation on
banking supervisory matters.
Its mandate is to strengthen the regulation, supervision and practices of
banks worldwide with the purpose of enhancing financial stability. Chile
joined the Basel Committee in 2014 as an observer.
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The International Association of Risk and Compliance
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