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Timestamp: 2018-02-19 07:10:03
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Matched Legal Cases: ['Art. 1', 'Art. 1', 'Art. 1', 'Art. 1', 'Art. 1', 'Art. 1']

Monday December 31 2012 Top 10 Risk Compliance News Events | Capital Requirement | Banks
Monday December 31 2012 Top 10 Risk Compliance News Events
Description: International Association of Risk and Compliance Professionals (IARCP) http://www.risk-compliance-association.com Every Monday Top 10 risk and compliance management related news stories and wo...
Dear Member, I wish you every success for 2013. Success defined by what you achieve in the workplace, measured in financial terms, and of course success in your family life. I hope your longs will keep going up and your shorts will keep coming down 
We are in 1013… we have the Basel iii deadline… or not?
The 11 jurisdictions that will be implementing Basel III from January 1 are: Australia, Canada, China, Hong Kong, India, Japan, Mexico, Saudi Arabia, Singapore, South Africa and Switzerland. The 7 jurisdictions that have issued draft regulations and are working towards final versions are: Argentina, Brazil, the European Union,
Indonesia, Korea, Russia and the United States. Turkey will issue its draft regulation early next year. Read more at Number 6 below. Welcome to the Top 10 list.
With themes like, "Joy to All", "Shine, Give, Share" and "Simple Gifts", the holiday customs celebrated by the Obama family in the White House.
Opinion of the European Banking Authority
The recommendations of the High-level Expert Group on reforming the structure of the EU banking sector
Opinion of the European Insurance and Occupational Pensions Authority
Interim measures regarding Solvency II
Prudential Supervision Department, Document BS2A Issued: December 2012 Interesting pictures from the Basel iii implementation in New Zealand
How can financial institutions achieve the goal of early and effective internal triggers, while avoiding negative market reaction to recovery actions taken?
Comments received on the FSB consultative document on Recovery and Resolution Planning.
At its meeting on 13-14 December, the Basel Committee on Banking Supervision discussed the progress of its members in implementing the capital adequacy reforms within Basel III. The Basel Committee has been actively monitoring on a continuing basis the progress of members in implementing the Basel III package of regulatory reforms, as well as the implementation of Basel II and Basel 2.5.
Governor Jeremy C. Stein At the Global Research Forum, International Finance and Macroecomomics, Sponsored by the European Central Bank, Frankfurt am Main, Germany
Effective for Fiscal Years Beginning On or After Dec. 15, 2012 Washington, D.C., Dec. 20, 2012
As Required by Section 939F of the Dodd-Frank Wall Street Reform and Consumer Protection Act Interesting Parts
New DARPA challenge is looking for innovative approaches to adaptive, software-based radio communications Radios are used for a wide range of tasks, from the most mundane to the most critical of communications, from garage door openers to military operations.
With themes like, "Joy to All", "Shine, Give, Share" and "Simple Gifts", the holiday customs celebrated by the Obama family in the White House. Visitors during the holiday season have been enchanted by the representations of the First Dog, Bo, who has been recreated using pipe cleaners, trash bags, buttons, pompoms and even chocolate.
THE PRESIDENT: Good afternoon, everybody. Over the last few weeks I've been working with leaders of both parties on a proposal to get our deficit under control, avoid tax cuts -- or avoid tax hikes on the middle class, and to make sure that we can spur jobs and economic growth -- a balanced proposal that cuts spending but also asks
the wealthiest Americans to pay more; a proposal that will strengthen the middle class over the long haul and grow our economy over the long haul. During the course of these negotiations, I offered to compromise with Republicans in Congress. I met them halfway on taxes, and I met them more than halfway on spending. And in terms of actual dollar amounts, we're not that far apart. As of today, I am still ready and willing to get a comprehensive package done. I still believe that reducing our deficit is the right thing to do for the long-term health of our economy and the confidence of our businesses. I remain committed to working towards that goal, whether it happens all at once or whether it happens in several different steps. But in 10 days, we face a deadline. In 10 days, under current law, tax rates are scheduled to rise on most Americans. And even though Democrats and Republicans are arguing about whether those rates should go up for the wealthiest individuals, all of us -- every single one of us -- agrees that tax rates shouldn’t go up for the other 98 percent of Americans, which includes 97 percent of small businesses. Every member of Congress believes that. Every Democrat, every Republican. So there is absolutely no reason -- none -- not to protect these Americans from a tax hike. At the very least, let’s agree right now on what we already agree on. Let’s get that done.
I just spoke to Speaker Boehner and I also met with Senator Reid. In the next few days, I've asked leaders of Congress to work towards a package that prevents a tax hike on middle-class Americans, protects unemployment insurance for 2 million Americans, and lays the groundwork for further work on both growth and deficit reduction. That's an achievable goal. That can get done in 10 days. Once this legislation is agreed to, I expect Democrats and Republicans to get back to Washington and have it pass both chambers. And I will immediately sign that legislation into law, before January 1st of next year. It’s that simple. Averting this middle-class tax hike is not a Democratic responsibility or a Republican responsibility. With their votes, the American people have determined that governing is a shared responsibility between both parties. In this Congress, laws can only pass with support from Democrats and Republicans. And that means nobody gets 100 percent of what they want. Everybody has got to give a little bit, in a sensible way. We move forward together, or we don't move forward at all. So, as we leave town for a few days to be with our families for the holidays, I hope it gives everybody some perspective. Everybody can cool off; everybody can drink some eggnog, have some Christmas cookies, sing some Christmas carols, enjoy the company of loved ones.
And then I'd ask every member of Congress while they’re back home to think about that. Think about the obligations we have to the people who sent us here. Think about the hardship that so many Americans will endure if Congress does nothing at all. Just as our economy is really starting to recover and we're starting to see optimistic signs, and we've seen actually some upside statistics from a whole range of areas including housing, now is not the time for more self-inflicted wounds -- certainly not those coming from Washington. And there’s so much more work to be done in this country -- on jobs and on incomes, education and energy. We're a week away from one of the worst tragedies in memory, so we’ve got work to do on gun safety, a host of other issues. These are all challenges that we can meet. They’re all challenges that we have to meet if we want our kids to grow up in an America that’s full of opportunity and possibility, as much opportunity and possibility as the America that our parents and our grandparents left for us. But we’re only going to be able to do it together. We’re going to have to find some common ground. And the challenge that we’ve got right now is that the American people are a lot more sensible and a lot more thoughtful and much more willing to compromise, and give, and sacrifice, and act responsibly than their elected representatives are. And that’s a problem. There’s a mismatch right now between how everybody else is thinking about these problems-- Democrats and Republicans outside of this town -- and how folks are operating here.
And we’ve just got to get that aligned. But we’ve only got 10 days to do it. So I hope that every member of Congress is thinking about that. Nobody can get 100 percent of what they want. And this is not simply a contest between parties in terms of who looks good and who doesn’t. There are real-world consequences to what we do here. And I want next year to be a year of strong economic growth. I want next year to be a year in which more jobs are created, and more businesses are started, and we’re making progress on all the challenges that we have out there -- some of which, by the way, we don’t have as much control over as we have in terms of just shaping a sensible budget. This is something within our capacity to solve. It doesn’t take that much work. We just have to do the right thing. So call me a hopeless optimist, but I actually still think we can get it done. And with that, I want to wish every American a merry Christmas. And because we didn’t get this done, I will see you next week.
“This year’s theme is ‘Joy to All.’ It celebrates the many joys of the holiday seasons: the joy of giving and service to others; the joy of sharing our blessings with one another; and, of course, the joy of welcoming our friends and families as guests into our homes over these next several weeks.” First Lady Michelle Obama
Opinion of the European Banking Authority on the recommendations of the High-level Expert Group on reforming the structure of the EU banking sector Introduction and legal basis
1. The High-level Group on reforming the structure of the EU banking sector was set up by the European Commission in February 2012 with a mandate to determine whether, in addition to ongoing regulatory reforms, structural reforms of EU banks would strengthen financial stability and improve efficiency and consumer protection, and if that is the case, to make recommendations as appropriate. 2. On 2 October 2012, the Group published its final report (“the Report”) which recommends actions in the five following areas: a. Mandatory separation of proprietary trading and other high-risk trading activities when these activities are material within a group b. Possible additional separation of activities conditional on the recovery and resolution plan c. Possible amendments to the use of the bail-in instruments as a resolution tool d. Review of the capital requirements on trading assets and real estate related loans e. Strengthening banks’ governance and controls 3. The EBA competence to deliver an opinion is based on Article 34(1) of Regulation No 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority) amending Decision No 716/2009/EC and
repealing Commission Decision 2009/78/EC1. In accordance with Article 14(5) of the Rules of procedure of the EBA, the Board of Supervisors has adopted this opinion.
4. The EBA welcomes the contribution of the Report to the discussion on possible initiatives to strengthen the regulatory framework of the EU. The introduction of structural measures to complement the existing and forthcoming regulatory reform is being considered in several Members States. The EBA emphasises the need to ensure consistency across the Single Market in order to foster level playing field and to avoid regulatory arbitrage. Otherwise, there is a risk that the development of structural measures at the national level ends up supporting a ring fencing of national establishments and contributes to a segmentation of the Single Market. The EBA stands ready to contribute to the design of an EU framework and to monitor possible flexibility left to national authorities. 5. The EBA emphasises the need to strike an appropriate balance in the trade off between preserving the core features of the traditional European model of universal banking and strengthening the resilience of the financial sector by segregating riskier capital market business into a separate legal entity. The proposals put forward by the High Level Group are mindful of balancing these two objectives by preserving the benefits of universal banking thanks to a separate legal entities approach within a single banking group rather than by adopting a complete separation of activities.
However, only a thorough impact assessment could provide an evaluation of the potential benefits of such measures on the European banking sector and on the real economy and to compare them with their costs. In conducting this impact assessment, the EBA suggests that particular attention should be devoted to the impact of the increase in the cost of capital and funding for trading firms to assess whether this would be commensurate to the objectives of the reform and would not create unintended adverse consequences. The possible consequences on the structure of the market for investment banking services in the EU should also be assessed. 6. The EBA would also like to stress the need to maintain full consistency between the legislation on bank recovery and resolution and any additional structural measures. As the draft Directive on Bank Recovery and Resolution already provides strong incentives to modify business models away from complex firm structures, which would not allow for a smooth management of a crisis, the assessment of additional structural measures should focus on the incremental net benefit of a legal obligation to segregate trading activities. Within this framework, it will be appropriate to consider that in the absence of a legal segregation, as proposed by the High Level Group, it might be extremely difficult for a supervisory authority to exercise its discretionary judgment and impose a break up of a universal bank, especially if other competent authorities are not responding with similarly harsh measures in comparable cases. Some common, EU-wide legal constraints could be helpful in supporting the supervisory work on bank resolvability. This consideration, however, also points to the need to maintain an appropriate sequencing and coordination of the different legislative measures.
7. Implementation of any structural measures, such as a legal separation of risky financial activities from deposit-taking within a group, would need to be reasonably enforceable by competent authorities. Clear and fair criteria must be established in order to determine situations where this separation is mandatory, bearing in mind that the purpose of this breakdown is to protect the socially most vital parts of the banking group and to limit the taxpayers’ stake in the trading parts of the group. 8. Any structural measure should not be viewed as a substitute for adequate supervision. The crisis showed that any form of banking business carries a high potential for systemic risk. This is true for liquidity and maturity transformation in traditional banking as well as for complex derivatives transactions conducted on banks’ accounts in the trading book. All types of activities generating systemic concerns should be subject to intensive supervision. The fact that certain business is done on wholesale markets, between parties who should be able to properly assess the risks stemming from the transactions, and does not entail an immediate impact on retail business and payment activities is not a sufficient reason to reduce supervisory coverage. During the past 20 years, major operational losses faced by individual institutions occurred from activities considered non-risky, where risk management was inadequate. 9. These measures should be accompanied by review clauses and macro-prudential monitoring. Since structural measures are easily eroded via financial innovations, they should be accompanied by arrangements for swift review, while macro-prudential authorities should be requested to closely monitor the
migration of risks to non regulated financial intermediaries and the overall effect on the build up of risks in the financial system as a whole. One should avoid that such structural breakdown unintentionally feeds the development of the shadow banking system. 10. Beyond such structural measures, the Report also “strongly supports the use of designated bail-in instruments within the scope of the BRR Directive, as it improves the loss-absorbency of the bank”. It calls for a clear definition of the position of bail-in instruments in the hierarchy of commitments, which would facilitate the pricing and trading of such instruments and the resulting market discipline and monitoring. 11. The EBA also considers that there is a need to further develop the bail-in framework in the BRR Directive in order to improve its predictability. As already expressed in the 3 March 2011 Opinion on “Technical Details of a Possible EU Framework for Bank Recovery and Resolution”, the EBA would rather support a two tier regime where bail-in requirements would be applied explicitly first to a certain category of debt instruments (targeted approach) and, if this proved insufficient, only in a second stage and within a proper administrative procedure for resolution to the remaining classes of debtors (comprehensive approach). Bail-in needs to be carefully designed in order to ensure legal and operational certainty and prevent the risk that its implementation impair the pricing mechanism of banks’ liabilities and cause unintended consequences, triggering destabilising effects on other financial institutions and the financial stability as a whole. In the absence of a targeted approach, there is a risk that a wide ex ante scope of bail-in instruments turns out to be limited once the resolution occurs. 12. As noted in the abovementioned EBA Opinion, requiring credit institutions to issue and hold a minimum percentage of their liabilities as
“bail-inable” debt instruments, besides ensuring a minimum loss-absorbing capacity, has also the advantage to create large market volumes, which in turn will provide market participants with an incentive to standardise contracts, and rating agencies to focus properly on rating such debt instruments. 13. The EBA believes that clear requirements for a minimum amount of loss-absorbing liabilities, calibrated according to a thorough impact assessment and combined with a comprehensive statutory approach to bail-in would ensure strict adherence to creditors’ hierarchy and would be appropriately targeted, while preserving the essential features of a comprehensive statutory approach.
14. On the mandatory separation of proprietary trading activities and other significant trading activities’ proposal of the Report, significant work on the calibration of the trigger for mandatory separation will need to be carried out before any translation into the EU regulatory framework. The Report adopts a two-stage approach based firstly on trading book and available for sale-related quantitative indicators to set a preliminary view on which banks can be subject to separation and secondly, a supervisors’ assessment based on more complex criteria which would eventually determine the need for separation. The EBA stands ready to contribute to possible Commission’s work on the calibration of the threshold to be applied by National supervisors in order to ensure a clear identification of the banks for which a ring-fence of trading activities is relevant. As a preliminary remark, it should be underlined that some of the assets which are referred to for the first threshold may be similar to the assets required for the Liquidity Coverage Ratio, which may not be satisfactory, if one wants to avoid conflicting regulations. Therefore, the EBA suggests that available for sale components of liquidity portfolios are excluded from the first threshold calculation.
To ensure a consistent application of these thresholds in the Single Market, there should be a need for technical standards to adopt a common definition and accounting framework. Moreover, the EBA could provide some mediation at the EU level to ensure consistent application across the EU. 15. Regarding the activities to be ring-fenced, the Report introduces some exceptions by stating that “the provision of hedging services to non-banking clients which fall within narrow position risk limits in relation to own funds, to be defined in regulation, and securities underwriting and related activities do not have to be separated”. To ensure a consistent application of such exceptions across the EU, the EBA stands ready to contribute to the definition of these hedging services. 16. According to the Report, “transfer of risks or funds between the deposit bank and the trading entity within the same group would be on market-based terms and restricted according to the normal large exposures rules on interbank exposures”. In such organisation, there will be a need for clear rules on the transfer of risks between the “deposit bank” and the “trading entity” in a bank holding company. However, the abovementioned restriction according to the normal large exposures rules on interbank exposures is not applicable in the current framework since the treatment of credit institutions’ intra-group exposures is not harmonised. Article 113 (4)(c) of the 2006/48 Directive offers Member States the possibility to “fully or partially exempt exposures, including participations or other kinds of holdings, incurred by a credit institution to its parent undertaking, to other subsidiaries of that parent undertaking or to its own subsidiaries, in so far as those undertakings are covered by the supervision on a consolidated basis to which the credit institution itself is subject”.
An update of the large exposures regulation – which is foreseen in the Report – will therefore be necessary to implement these rules on risk transfer between a deposit bank and a trading entity within a group. 17. Moreover, any financial support between the deposit bank and the trading entity will have to be ruled by clear and transparent principles that would go beyond simple reference to market price. The EBA stands ready to provide its expertise in setting up such standards and monitor their correct application throughout the EU. 18. The EBA also underlines that the draft Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (“BRR” Directive) introduces measures on intra-group financial support. Thus, Institutions operating within the same group should be able to enter into agreements to provide financial support to other entities within the group experiencing financial difficulties. Such release of the legal restrictions for intra-group financial support within a group would have to be implemented consistently with intra-group financing restrictions between “deposit” and “trading” institutions. 19. Regarding additional functional separation of activities in the context of recovery and resolution plans, the EBA stands ready to promote a consistent application of recovery and resolution plans’ content and assessment across the EU. To fulfil this objective, the EBA should set binding technical standards to be applied by national supervisors (including the ECB) and resolution authorities. The EBA should then have a mandate to conduct a rigorous review to check that consistency has been achieved.
To ensure a consistent application of these standards on recovery and resolution, such ex post review will be a crucial component. 20. As already mentioned in the general comments, the Report suggests possible amendments to the use of the bail-in instrument as a resolution tool. The EBA agrees that “such debt should be held outside the banking system” which would require appropriate mechanisms in order to prevent the acquisition of such securities by the banking sector (e.g. introducing a particular risk-weight for such debt). Moreover, the EBA welcomes the suggestion to use bail-in instruments (i) In remuneration schemes for top management and (ii) By introducing a mandatory share of variable remuneration into bail-in bonds. Such measures could be adopted in a swift manner and may efficiently contribute to the overall efforts to reduce moral hazard and restore confidence between the public and the banking system. 21. As regards the recommendations to improve the robustness of the trading book capital requirement by i) Setting an extra, non-risk based, capital buffer requirement for all trading book assets; and/or by ii) Introducing a strict floor risk-based requirement, the EBA understands that the Group’s initiative is brought to the general review of the capital requirements in the trading book conducted under the aegis of the Basel Committee which would bring a global answer to this particular issue. The EBA considers that such extra capital buffer may be justified with reference to market risk and operational risk, but one should underline that a major driver for bringing down banks during the crisis (or at least
generating systemic risk that justified public bail-outs) has been counterparty risk, especially in derivatives transactions. Any additional capital requirement related to trading assets should, therefore, also refer to counterparty risk and explicitly mention derivatives transaction together with trading operations in order to capture the underlying risk generated by these activities. 22. Finally, the Report calls for a consistent application of loan-to-value and loan-to-income ratio in all member states, which is strongly supported by the EBA. To ensure this consistency, ex post monitoring should be conducted by microprudential and/or macroprudential authorities across the EU. This opinion will be published on the EBA’s website. Andrea Enria Chairperson For the Board of Supervisors
Opinion of the European Insurance and Occupational Pensions Authority of on interim measures regarding Solvency II Legal Basis
1. This opinion is issued under the provisions of Article 29(1) (a) of Regulation (EU) No 1094/2010 of the European Parliament and of the Council of 24 November 2010 (hereafter the ‘Regulation’) in conjunction with Directive 2009/138/EC of the European Parliament and the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (hereafter Solvency II Directive). 2. As established in Article 29(1) (a) of the Regulation, EIOPA shall play an active role in building a common Union supervisory culture and consistent supervisory practices, as well as in ensuring uniform procedures and consistent approaches throughout the Union. 3. As established under Article 1 (6) of the Regulation EIOPA shall contribute to improving the functioning of the internal market, including in particular a sound, effective and consistent level of regulation and supervision, (Art. 1(6)(a)) preventing regulatory arbitrage and promoting equal conditions of competition (Art. 1(6)(d)). EIOPA shall also contribute to enhancing consumer protection (Art. 1(6)(f)). 4. As established under Article 8 (1) of the Regulation EIOPA’s task is to contribute to the establishment of high quality common regulatory and supervisory standards and practices (Art. 1(6)(a)) and to contribute to the consistent application of legally binding Union acts ensuring consistent, efficient and effective application of the acts referred to in Art. 1 (2) of the Regulation (Art. 1(6)(b)). The fact that the Solvency II Directive has entered into force, means that it is considered “Union law”, but it will not have legally binding effect until after the date of its application, which is currently set to 1
January 2014 in accordance with the ("Quick Fix") Directive 2012/23/EU of 12 September 2012. 5. This opinion is addressed to the national competent authorities represented in EIOPA’s Board of Supervisors.
6. During the Board of Supervisors (BoS) meeting of September 2012, Members expressed their strong concerns with respect to the current status of the OMNIBUS II negotiations which might further delay the application of the Solvency II Directive. 7. In its explanatory memorandum to the Proposal for the Solvency II Directive the European Commission states: “The present solvency rules are outdated. They are not risk sensitive, they leave too much scope to Member States for national variations, they do not properly deal with group supervision and they have meanwhile been superseded by industry, international and cross-sectoral developments. This is the reason why a new solvency regime, called Solvency II, which fully reflects the latest developments in prudential supervision, actuarial science and risk management and which allows for updates in the future is necessary.” 8. In addition, in the absence of a final agreement on Solvency II, European supervisors may be forced to develop national solutions in order to ensure sound risk sensitive supervision. Instead of reaching consistent and convergent supervision in the EU, different national solutions may emerge to the detriment of a good functioning internal market. 9. The BoS mandated the Chair of EIOPA to write to the OMNIBUS II trialogue parties setting out its concerns.
In his letter, dated 4 October 2012, the Chair not only expressed the need for a stable and reliable time plan but also the need to reflect on an earlier implementation of some Solvency II elements.
{Note: Do you remember the letter?}
Undertakings which are well-governed and which, in particular, measure correctly, mitigate and report the risks which they face will be more likely to be prepared for the new regulatory framework and act in the interests of policyholders. 10. In that regard it is of key importance that there will be a consistent and convergent approach with respect to the preparation of Solvency II.
In the run-up to the new system the following key areas of Solvency II need to be addressed in order to ensure proper management of undertakings and to ensure that supervisors have sufficient information at hand. These are the system of governance, including risk management system and a forward looking assessment of the undertaking's own risks (based on the ORSA principles), pre-application of internal models, and reporting to supervisors. 11. EIOPA sets out below its expectations for the national competent authorities. These actions are consistent with EIOPA’s obligation to foster supervisory convergence. 12. EIOPA will, taking into account its objective under Article 1 Para 6 and its tasks and powers under Article 8 of the Regulation, contribute to the consistent efficient and effective preparation of supervisors and insurance and reinsurance undertakings for the application of the Solvency II Directive. 13. As a follow-up to the opinion, and by making use of its powers under Article 16 of the Regulation, EIOPA will publish guidelines addressed to national competent authorities on how to proceed in the interim phase leading up to Solvency II. 14. Within 2 months of the issuance of the guidelines, each national competent authority shall confirm whether it complies or intends to comply with the guidelines. In the event that a national competent authority does not comply or does not intend to comply, it shall inform EIOPA, stating its reasons. 15. EIOPA will publish the fact that a national competent authority does not comply or does not intend to comply with that guideline.
Proposed actions by national competent authorities
16. As part of the preparation for Solvency II, national competent authorities should put in place, starting on 1 January 2014 certain important aspects of the prospective and risk based supervisory approach to be introduced in order to address the concerns set out above. 17. National competent authorities are expected to ensure that insurance and reinsurance undertakings have in place an effective system of governance which provides for sound and prudent management of the undertaking and an effective risk management system including a forward looking assessment of the undertaking's own risks (based on the ORSA principles). 18. National competent authorities are expected to ensure that insurance and reinsurance undertakings have in place an effective risk-management system comprising strategies, processes and reporting procedures necessary to identify, measure, monitor, manage and report, on a continuous basis the risks, at an individual and at an aggregated level, to which they are or could be exposed, and their interdependencies. 19. National competent authorities are expected to review and evaluate with respect to the undertakings concerned the system of governance, the assessment of the risks which those undertakings face or may face and the assessment of the ability of those undertakings to assess those risks taking into account the environment in which the undertakings are operating. 20. Through internal model pre-application processes, national competent authorities engaged in pre-application of internal models should continue to work with undertakings to form a view on undertakings’ degree of readiness for internal model applications, and should also follow subsequent evolutions to the internal model framework. 21. National competent authorities are encouraged to request all the information necessary for applying a prospective and risk based supervisory approach.
22. National competent authorities are expected to ensure that the requirements mentioned above are applied in a manner which is proportionate to the nature, scale and complexity inherent in the business of the insurance and reinsurance undertaking.
Capital Adequacy Framework (Standardised Approach)
Prudential Supervision Department, Document BS2A, Issued: December 2012 Interesting pictures from the Basel iii implementation in New Zealand
This document sets out the methodology to be used by locally incorporated registered banks that have adopted the standardised approach for calculating capital requirements. This methodology is to be used for the purposes of determining these banks’ compliance with conditions of registration relating to capital and for disclosing information about capital.
Starting from reciprocal cross holdings…
SPVs…
Only 3 credit rating agencies…
Securitization…
Capital Adequacy Framework (Internal Models Based Approach)
Prudential Supervision Department, Document BS2B Issued: December 2012
This document sets out the methodology to be used by locally incorporated registered banks that have been accredited to use the internal models based approaches to calculating capital ratio requirements. This methodology is to be used for the purposes of determining these banks’ compliance with conditions of registration relating to capital and for disclosing information about capital.
Comments received on the FSB consultative document on Recovery and Resolution Planning On 2 November 2012, the Financial Stability Board (FSB) published its consultative document on Recovery and Resolution Planning. Interested parties were invited to provide written comments by 7 December 2012. Some of these comments to the question: How can financial institutions achieve the goal of early and effective internal triggers, while avoiding negative market reaction to recovery actions taken? are available below.
As part of regular risk management, firms should have early warning signals which, when breached, could trigger the initiation of preventive actions. These early warning indicators serve to monitor disruptions (minimum to severe) and ensure appropriate management attention and action before going in a recovery situation. The use of early warning signals will allow firms to respond to threats prior to them becoming so severe as to trigger a formal recovery response. With respect to recovery measures, senior management of firms and regulators need to ensure that communication is sufficiently forthcoming, factual, clear and transparent to avoid unwarranted reactions by market participants.
It is essential that triggers are viewed as 'soft' triggers, i.e. trigger breaches lead to predetermined escalation and information process up to senior management level within the firm. Recovery triggers should not lead to automatic, compulsory reactions as this may jeopardize flexibility to develop a discretionary response in accordance with the specifics of the situation and is counter- productive in a stress scenario. We also agree that this can also help avoid awkward situations where an ill-timed public disclosure might be forced by the existence of hard triggers, which could exacerbate distress.
It is important that the recovery plan and its trigger framework enable the G-SIFI to identify the need to take action before the market does. The metric escalation governance and escalation process must also be supported by a realistic communication plan that seeks to avoid unhelpful reputational impacts in the markets that may exacerbate the situation, and that remedial action is implemented fully and without delay. It is absolutely vital however that the recovery programme and its associated metrics should be treated as highly confidential by all those party to the information therein and that neither the bank nor any of the authorities with access to it should disclose it in any way.
The question should be focused on the execution of recovery actions rather than triggers. Internal triggers documented within an institution’s recovery plan – whether they are early warning indicators or triggers as to invoke recovery governance procedures – should be subject to strict confidentiality. Confidentiality provisions should apply to the preparation and implementation of any aspect of the recovery planning process. There should be no expectation that the process of recovery planning affects the criteria or level of expectation used to apply listing and market disclosure rules.
Interesting parts from Deutsche Bank’s Response to FSB Consultative Document on Recovery and Resolution Planning: Making the Key Attributes Requirements Operational Triggers vs. early warning indicators:
It should be very clear that there is a difference between recovery triggers and early warning indicators. We contend that some of the quantitative triggers listed on page 8 should be considered to be early warning indicators rather than recovery triggers since they don’t reflect the financial health of an institution. Examples include GDP forecasts and three-month LIBOR. When considering the appropriateness of triggers, on page 9 the FSB has pointed out that some firms do not have specific recovery triggers and also mentions that between three and seven triggers are the norm.
It is not necessarily the case that there will be an ideal number of triggers which can be identified for the industry as a whole and therefore trying to determine this may be counterproductive.
Triggers and the link to risk management:
The proposed guidance mentions that triggers should be aligned but shouldn’t be limited to existing triggers, which we take to mean those already embedded within the bank’s risk management framework - for example those linked to the bank’s risk appetite and regulatory requirements. We recommend that instead the guidelines should refer to situations “where existing triggers are not sufficient” in order to reflect the work that has already been done and to avoid the assumption that there must be a suite of separate triggers. Assuming authorities have reviewed the arrangements and consider that the firm is able to take into account the various warning signs and indicators, the firm should not automatically be expected to have a certain number of supplementary triggers over and above those already being used. The focus of the assessment should be to understand how triggers are combined and supported by high quality management information.
Group-level planning:
We recommend the FSB include in the guidance the explicit expectation that recovery planning is done at group level and that there should not be a proliferation of local level requirements. In the proposed guidance there is no clear statement about the appropriateness of local frameworks. If these are ultimately implemented, there is a need for guidance about how authorities and firms should coordinate.
We support the approach taken by the FSB and consider the elements listed on page 9 to be comprehensive. We agree that conceptually the practice of reverse stress-testing may provide a helpful perspective and is good practice within risk management. Any requirements for reverse stress-testing should be in this context and used to support recovery planning, but should not be a mandatory part of the framework.
We believe trigger definition should be at the discretion of the institution and that supervisors should work with them to identify the right metrics for each bank. This is highly dependent on the risk management framework and risk profile of the institution and so should be considered on a firm-specific basis. Recovery triggers should reflect the institution’s financial health in terms of sufficient liquidity and capitalisation in order to prevent a near-default or default situation of the firm. Examples of such recovery triggers are the Common Equity Tier 1 ratio, the stressed net liquidity position as well as the firm’s economic capital adequacy. These universally apply to all types of financial institutions irrespective of their portfolio composition. To identify triggers, we have employed guiding principles and this type of approach may be helpful to reflect in the guidance. We believe that appropriate triggers should be:
- integrated into standard risk management practices; - transparent, with unambiguous definitions and good internal understanding; - related to the bank’s stress-testing processes with metrics embedded in that process; and - relevant to the Recovery Plan and viability of the firm.
Quantitative triggers:
Referring to the potential quantitative triggers listed we would make the following observations: - The proposed guidance refers to the renewal of wholesale funding and withdrawal of deposits and other funding. We recommend considering these risk types separately. For example, in the case of liquidity risk, rather than looking purely at renewal of wholesale funding or deposit activity (which would be very bank-specific in terms of relevance) supervisors should be encouraged to ensure that a bank’s recovery trigger is aligned with its approved Liquidity Risk Management framework. Where possible a stressed net liquidity position should be used as the recovery trigger (therefore incorporating inflows and outflows, including deposits and wholesale funding) until such time as the Liquidity Coverage Ratio (LCR) is implemented. The LCR should subsequently become the trigger. - Some of the suggested triggers are based on external factors such as LIBOR, GDP, etc. These may be considered more appropriate for scenario planning or as early warning indicators.
A firm-specific approach should also be encouraged for early warning indicators which need to be portfolio - and therefore institution - specific, in order to ensure an effective monitoring and default prevention process.
At its meeting on 13-14 December, the Basel Committee on Banking Supervision discussed the progress of its members in implementing the capital adequacy reforms within Basel III. The Basel Committee has been actively monitoring on a continuing basis the progress of members in implementing the Basel III package of regulatory reforms, as well as the implementation of Basel II and Basel 2.5. To date, it has published three progress reports and two reports to the G20. The number of member jurisdictions that have published the final set of Basel III regulations effective from the start date of 1 January 2013 is 11. These include Australia, Canada, China, Hong Kong SAR, India, Japan, Mexico, Saudi Arabia, Singapore, South Africa and Switzerland. Seven other jurisdictions - Argentina, Brazil, the European Union, Indonesia, Korea, Russia and the United States - have issued draft regulations, and have indicated they are working towards issuing final versions as quickly as possible. Turkey will issue draft regulations early in 2013. Stefan Ingves, Chairman of the Basel Committee and Governor of the Sveriges Riksbank, said "While some jurisdictions have not been able to meet the planned start date, a large number will be ready to begin introducing the new capital requirements as planned on 1 January 2013." Mr Ingves also said, "The globally agreed timeline includes a number of milestones from 2013 to 2019, designed to provide for a gradual phasing in of the new capital requirements.
It is expected that as remaining jurisdictions finalise their domestic regulations during 2013, they will incorporate all the remaining transitional deadlines in line with the original global agreement, even where they have not been able to meet the 1 January 2013 start date. Hence, by the end of 2013, almost all Basel Committee jurisdictions will be implementing Basel III in accordance with the agreed timetable. This is an absolutely critical step towards strengthening the resilience of the global banking system." "Furthermore", Mr Ingves added, "even though there are delays in implementing the regulations, national supervisors are ensuring that internationally active banks are, where necessary, making steady progress in strengthening their capital base in accordance with the Basel III framework." All Basel Committee members have reiterated their commitment to implement the globally-agreed reforms, and several members are due to undergo a peer review of the consistency of their final regulations during 2013. At the conclusion of this set of peer reviews, all jurisdictions that are the home regulator for global systemically important banks (G-SIBs) will have been subject to a peer review of their Basel III implementation. Other jurisdictions will be subject to peer reviews shortly thereafter.
Dollar Funding and Global Banks Thanks very much. It's a pleasure to be part of this panel on the future of financial globalization. I will focus my remarks on one important aspect of this issue--namely, the growing use of wholesale dollar funding by global financial institutions. I'll begin by briefly discussing research I've been doing, along with my coauthors Victoria Ivashina and David Scharfstein, which examines some of the consequences of this funding model during times of market stress. I'll then touch on the policy implications of this and related work. But first, the usual disclaimer: The views that follow are my own and do not necessarily reflect the thinking of my colleagues on the Federal Open Market Committee. By way of background, the dollar liabilities of foreign banks have grown rapidly in the past two decades and now stand at about $8 trillion, roughly on par with those of U.S. banks. A significant proportion of foreign banks' dollar liabilities are raised via U.S. branches, most of which are legally precluded from raising deposits insured by the Federal Deposit Insurance Corporation. The main source of funding for these branches, therefore, comes from uninsured wholesale claims such as large time deposits, making the cost
and availability of such dollar funding highly sensitive to changing perceptions of these banks' creditworthiness. In our work, we asked how shocks to the ability of foreign banks to raise dollar funding might lead to changes in their lending. We began with a simple conceptual model: Imagine a European bank that lends in euros to European firms and in dollars to U.S. firms. To finance its euro-denominated lending, it funds itself by issuing insured euro deposits to its local retail deposit base. By contrast, to finance its dollar-denominated lending, it raises funds in the wholesale dollar market. Because the bank's dollar liabilities are uninsured, an adverse shock to the bank's perceived creditworthiness will result in a spike in its dollar funding costs. At the same time, the cost to the bank of funding in euros is unchanged to the extent that its euro deposits are insured. So we might expect such a shock to induce the bank to shift its funding away from the U.S. wholesale market and toward the European deposit market. But what are the consequences of this adjustment, both for the geographic distribution of its lending and for the functioning of foreign exchange (FX) swap markets? Note that if the bank wants to maintain the volume of its dollar-based lending, it will have to tap its insured deposit base to raise more euros and then swap these euros into dollars using the FX swap market. However, if the induced funding realignment is big enough, and if arbitrageurs have limited capacity to take the other side of the trade, this large swap demand can cause a breakdown in the usual
overed-interest-parity (CIP) relationship--a breakdown of the sort that we have seen during times of extreme market stress. In this case, the direction of the deviation would be such that the cost of synthetic dollar borrowing--in other words, euro borrowing combined with an FX swap--would go up and would approach that of the now-elevated cost of funding directly in the wholesale dollar market. And given that any method of dollar funding--direct or synthetic--has become more expensive relative to euro funding, it then follows that an adverse shock to a global bank's perceived creditworthiness leads to a decline in its dollar-denominated lending relative to its euro-denominated lending. So, two principal effects of the dollar funding shock are intimately connected: a widening of the so-called CIP basis in the FX swap market, and a reduction in credit supply to firms that borrow in dollars. To test the model's implications, my coauthors and I focused on events in the second half of 2011, when the credit quality of a number of large euro-area banks became a concern and U.S. prime money market funds sharply reduced their lending to those banks. In a span of four months, the exposure of money funds to euro-area banks fell by half, from about $400 billion in May to about $200 billion in September. Coincident with this contraction in dollar funding, the CIP basis widened in the direction predicted by our model, increasing the cost of obtaining synthetic dollars via the FX swap market. We used data from the international syndicated loan market to test the model's predictions about the reaction of lending to this type of funding stress. We found that dollar-denominated lending by euro-area banks fell relative to their euro-denominated lending, while this result did not hold for U.S. banks.
We also found that, even holding fixed the identity of the borrowing firm, a syndicate formed to make a dollar-denominated loan during this period was less likely to include euro-area banks, while the same was not true of syndicates making euro-denominated loans. Finally, euro-area banks that relied most on funding from U.S. money market funds also cut back most sharply on their dollar-denominated lending. This last result is similar to one in recent work by my Fed colleagues Ricardo Correa, Horacio Sapriza, and Andrei Zlate. They documented that the U.S. branches of foreign banks that experienced the most shrinkage in their dollar-denominated large time deposits--funding that had been mostly provided by money market funds prior to mid-2011--cut their U.S.-based commercial and industrial lending by more than banks that fared better on this score. Taken together, these findings have two types of policy implications: one for central bank responses to dollar funding pressures and another for measures to regulate foreign banking firms that rely heavily on short-term wholesale funding. This analysis underscores that the Federal Reserve's temporary dollar liquidity swap lines with the European Central Bank and other central banks are an effective response to stresses in dollar funding markets. Last week, the FOMC approved the extension of these swap lines through February 1, 2014. These lines have helped avert fire sales of dollar assets and maintain the flow of credit to U.S. households and firms. Although we documented cutbacks in dollar lending in the latter half of 2011 by foreign banks reliant on wholesale dollar funding, those cutbacks likely would have been more pronounced in the absence of the swap lines I will now turn to regulation.
It is useful to bear in mind that our current regulatory regime evolved during a period when the U.S. operations of foreign banks were largely net recipients of funding from their parents. However, their reliance on less stable, short-term wholesale funding increased significantly in the decade leading up to the financial crisis, when U.S. branches of foreign banks began borrowing large volumes of dollars to send to their foreign parents. Such activity increases the vulnerabilities I described earlier. And it may not only pose the risk of a cutback in lending, but could also threaten the safety and soundness of the foreign banks themselves--and of the U.S. entities exposed to those banks. The regulation of U.S. branches of foreign banks has changed little over the past decade, even in the face of these significant changes in the global banking landscape. However, last week, the Federal Reserve Board proposed new rules for foreign banking organizations that would address some of the concerns that I've discussed and thereby mitigate the attendant risks to U.S. financial stability. These proposed rules apply enhanced prudential standards to foreign banking organizations and are designed to increase their resiliency. Importantly, the rules will not disadvantage foreign banks relative to domestic U.S. banking firms, but rather the rules seek to maintain a level playing field. To avoid or mitigate potential disruptions in wholesale dollar funding markets, the proposed rules require foreign banking organizations to hold sufficient high-quality liquid assets to meet expected near-term net outflows in a stress scenario.
These rules should reduce the pressure on foreign banks that rely heavily on short-term dollar funding to either sell illiquid dollar assets or cut back on dollar lending in times of financial stress. By helping to alleviate disruptions in dollar funding markets the rules should also reduce the reliance on swap lines in a future stress episode. Finally, the central role played by money market funds in the 2011 episode is a reminder of the fragility of these funds themselves--and of the risk created by their combination of risky asset holdings, stable-value demandable liabilities, and zero-capital buffers. The events following the Lehman Brothers bankruptcy in 2008 provide even starker evidence of the risks that money market funds pose for the broader financial system. In light of these vulnerabilities, I welcome the recent proposed recommendations by the Financial Stability Oversight Council for further money market fund reforms. To conclude: Financial globalization undoubtedly brings with it substantial benefits. At the same time, it creates important challenges for financial stability and for the appropriate design of regulation. The research discussed in conferences such as this one will help us better understand and respond to these challenges. Thank you, and I look forward to your questions.
Effective for Fiscal Years Beginning On or After Dec. 15, 2012 Washington, D.C., Dec. 20, 2012 The Public Company Accounting Oversight Board announced that the Securities and Exchange Commission approved Auditing Standard No. 16, Communications with Audit Committees, and amendments to other PCAOB standards. The new standard and related amendments are effective for public company audits of fiscal periods beginning on or after Dec. 15, 2012. Additionally, the SEC determined that the standard and related amendments will apply to audits of "emerging growth companies" under the Jumpstart Our Business Startups Act of 2012. "AS 16 supports the critical role of auditors and audit committees in financial reporting," said PCAOB Chairman James R. Doty. "The standard moves the auditor's communication with the audit committee away from compliance checklists, and decisively in the direction of meaningful, effective interchange." The standard establishes requirements that enhance the relevance and timeliness of the communications between the auditor and the audit committee, and is intended to foster constructive dialogue between the two on significant audit and financial statement matters. The standard supersedes the Board's interim auditing standards AU sec. 310, Appointment of the Independent Auditor, and AU sec. 380,
Communication with Audit Committees, and amends other PCAOB standards. The PCAOB adopted the new standard on Aug. 15, 2012. The SEC approved the standard on Dec. 17, 2012.
Auditing Standard No. 16 Communications with Audit Committees Introduction
1. This standard requires the auditor to communicate with the company's audit committee regarding certain matters related to the conduct of an audit and to obtain certain information from the audit committee relevant to the audit. This standard also requires the auditor to establish an understanding of the terms of the audit engagement with the audit committee and to record that understanding in an engagement letter. 2. Other Public Company Accounting Oversight Board ("PCAOB") rules and standards identify additional matters to be communicated to a company's audit committee. Various laws or regulations also require the auditor to communicate certain matters to the audit committee. The communication requirements of this standard do not modify or replace communications to the audit committee required by such other PCAOB rules and standards, and other laws or regulations. Nothing in this standard precludes the auditor from communicating other matters to the audit committee.
3. The objectives of the auditor are to:
- Communicate to the audit committee the responsibilities of the auditor in relation to the audit and establish an understanding of the terms of the audit engagement with the audit committee; - Obtain information from the audit committee relevant to the audit; - Communicate to the audit committee an overview of the overall audit strategy and timing of the audit; and - Provide the audit committee with timely observations arising from the audit that are significant to the financial reporting process. Note: "Communicate to," as used in this standard, is meant to encourage effective two-way communication between the auditor and the audit committee throughout the audit to assist in understanding matters relevant to the audit.
Appointment and Retention - Significant Issues Discussed with Management in Connection with the Auditor's Appointment or Retention
4. The auditor should discuss with the audit committee any significant issues that the auditor discussed with management in connection with the appointment or retention of the auditor, including significant discussions regarding the application of accounting principles and auditing standards.
Establish an Understanding of the Terms of the Audit
5. The auditor should establish an understanding of the terms of the audit engagement with the audit committee.
This understanding includes communicating to the audit committee the following: - The objective of the audit; - The responsibilities of the auditor; and - The responsibilities of management. 6. The auditor should record the understanding of the terms of the audit engagement in an engagement letter and provide the engagement letter to the audit committee annually. The auditor should have the engagement letter executed by the appropriate party or parties on behalf of the company. If the appropriate party or parties are other than the audit committee, or its chair on behalf of the audit committee, the auditor should determine that the audit committee has acknowledged and agreed to the terms of the engagement. 7. If the auditor cannot establish an understanding of the terms of the audit engagement with the audit committee, the auditor should decline to accept, continue, or perform the engagement.
Obtaining Information and Communicating the Audit Strategy Obtaining Information Relevant to the Audit
8. The auditor should inquire of the audit committee about whether it is aware of matters relevant to the audit, including, but not limited to, violations or possible violations of laws or regulations.
Overall Audit Strategy, Timing of the Audit, and Significant Risks
9. The auditor should communicate to the audit committee an overview of the overall audit strategy, including the timing of the audit,7/ and
discuss with the audit committee the significant risks identified during the auditor's risk assessment procedures. Note: This overview is intended to provide information about the audit, but not specific details that would compromise the effectiveness of the audit procedures. 10. As part of communicating the overall audit strategy, the auditor should communicate the following matters to the audit committee, if applicable: - The nature and extent of specialized skill or knowledge needed to perform the planned audit procedures or evaluate the audit results related to significant risks; - The extent to which the auditor plans to use the work of the company's internal auditors in an audit of financial statements; - The extent to which the auditor plans to use the work of internal auditors, company personnel (in addition to internal auditors), and third parties working under the direction of management or the audit committee when performing an audit of internal control over financial reporting; - The names, locations, and planned responsibilities of other independent public accounting firms or other persons, who are not employed by the auditor, that perform audit procedures in the current period audit; and Note: The term "other independent public accounting firms" in the context of this communication includes firms that perform audit procedures in the current period audit regardless of whether they otherwise have any relationship with the auditor. The basis for the auditor's determination that the auditor can serve as principal auditor, if significant parts of the audit are to be performed by other auditors.
11. The auditor should communicate to the audit committee significant changes to the planned audit strategy or the significant risks initially identified and the reasons for such changes.
Results of the Audit - Accounting Policies and Practices, Estimates, and Significant Unusual Transactions
(1) Management's initial selection of, or changes in, significant accounting policies or the application of such policies in the current period; and (2) The effect on financial statements or disclosures of significant accounting policies in (i) controversial areas or (ii) areas for which there is a lack of authoritative guidance or consensus, or diversity in practice.
All critical accounting policies and practices to be used, including: (1) The reasons certain policies and practices are considered critical; and (2) How current and anticipated future events might affect the determination of whether certain policies and practices are considered critical.
(1) A description of the process management used to develop critical accounting estimates; (2) Management's significant assumptions used in critical accounting estimates that have a high degree of subjectivity; and (3) Any significant changes management made to the processes used to develop critical accounting estimates or significant assumptions, a description of management's reasons for the changes, and the effects of the changes on the financial statements.
(1) Significant transactions that are outside the normal course of business for the company or that otherwise appear to be unusual due to their timing, size, or nature; and (2) The policies and practices management used to account for significant unusual transactions. Note: If management communicates any of these matters, the auditor does not need to communicate them at the same level of detail as management, as long as the auditor: (1) Participated in management's discussion with the audit committee, (2) Affirmatively confirmed to the audit committee that management has adequately communicated these matters, and (3) With respect to critical accounting policies and practices, identified for the audit committee those accounting policies and practices that the auditor considers critical. The auditor should communicate any omitted or inadequately described matters to the audit committee.
Auditor's Evaluation of the Quality of the Company's Financial Reporting
13. The auditor should communicate to the audit committee the following matters:
Qualitative aspects of significant accounting policies and practices.
(1) The results of the auditor's evaluation of, and conclusions about, the qualitative aspects of the company's significant accounting policies and practices, including situations in which the auditor identified bias in management's judgments about the amounts and disclosures in the financial statements; and (2) The results of the auditor's evaluation of the differences between
(i) estimates best supported by the audit evidence and (ii) estimates included in the financial statements, which are individually reasonable, that indicate a possible bias on the part of the company's management.
Assessment of critical accounting policies and practices.
The auditor's assessment of management's disclosures related to the critical accounting policies and practices, along with any significant modifications to the disclosure of those policies and practices proposed by the auditor that management did not make.
Conclusions regarding critical accounting estimates.
The basis for the auditor's conclusions regarding the reasonableness of the critical accounting estimates.
The auditor's understanding of the business rationale for significant unusual transactions.
The results of the auditor's evaluation of whether the presentation of the financial statements and the related disclosures are in conformity with the applicable financial reporting framework, including the auditor's consideration of the form, arrangement, and content of the financial statements (including the accompanying notes), encompassing matters such as the terminology used, the amount of detail given, the classification of items, and the bases of amounts set forth.
Situations in which, as a result of the auditor's procedures, the auditor identified a concern regarding management's anticipated application of accounting pronouncements that have been issued but are not yet effective and might have a significant effect on future financial reporting. Alternative accounting treatments. All alternative treatments permissible under the applicable financial reporting framework for policies and practices related to material items that have been discussed with management, including the ramifications of the use of such alternative disclosures and treatments and the treatment preferred by the auditor.
14. When other information is presented in documents containing audited financial statements, the auditor should communicate to the audit committee the auditor's responsibility under PCAOB rules and standards for such information, any related procedures performed, and the results of such procedures.
Difficult or Contentious Matters for which the Auditor Consulted
15. The auditor should communicate to the audit committee matters that are difficult or contentious for which the auditor consulted outside the engagement team and that the auditor reasonably determined are relevant to the audit committee's oversight of the financial reporting process.
Management Consultation with Other Accountants
16. When the auditor is aware that management consulted with other accountants about significant auditing or accounting matters and the auditor has identified a concern regarding such matters, the auditor should communicate to the audit committee his or her views about such matters that were the subject of such consultation.
17. The auditor should communicate to the audit committee, when applicable, the following matters relating to the auditor's evaluation of the company's ability to continue as a going concern: If the auditor believes there is substantial doubt about the company's ability to continue as a going concern for a reasonable period of time, the conditions and events that the auditor identified that, when considered in the aggregate, indicate that there is substantial doubt; If the auditor concludes, after consideration of management's plans, that substantial doubt about the company's ability to continue as a going concern is alleviated, the basis for the auditor's conclusion, including elements the auditor identified within management's plans that are significant to overcoming the adverse effects of the conditions and events; If the auditor concludes, after consideration of management's plans, that substantial doubt about the company's ability to continue as a going concern for a reasonable period of time remains:
(1) The effects, if any, on the financial statements and the adequacy of the related disclosure; and (2) The effects on the auditor's report.
18. The auditor should provide the audit committee with the schedule of uncorrected misstatements related to accounts and disclosures that the auditor presented to management. The auditor should discuss with the audit committee, or determine that management has adequately discussed with the audit committee, the basis for the determination that the uncorrected misstatements were immaterial, including the qualitative factors considered. The auditor also should communicate that uncorrected misstatements or matters underlying those uncorrected misstatements could potentially cause future-period financial statements to be materially misstated, even if the auditor has concluded that the uncorrected misstatements are immaterial to the financial statements under audit. 19. The auditor should communicate to the audit committee those corrected misstatements, other than those that are clearly trivial, related to accounts and disclosures that might not have been detected except through the auditing procedures performed, and discuss with the audit committee the implications that such corrected misstatements might have on the company's financial reporting process.
Departure from the Auditor's Standard Report
21. The auditor should communicate to the audit committee the following matters related to the auditor's report:
When the auditor expects to modify the opinion in the auditor's report, the reasons for the modification, and the wording of the report; and When the auditor expects to include explanatory language or an explanatory paragraph in the auditor's report, the reasons for the explanatory language or paragraph, and the wording of the explanatory language or paragraph.
22. The auditor should communicate to the audit committee any disagreements with management about matters, whether or not satisfactorily resolved, that individually or in the aggregate could be significant to the company's financial statements or the auditor's report. Disagreements with management do not include differences of opinion based on incomplete facts or preliminary information that are later resolved by the auditor obtaining additional relevant facts or information prior to the issuance of the auditor's report.
23. The auditor should communicate to the audit committee any significant difficulties encountered during the audit. Significant difficulties encountered during the audit include, but are not limited to: - Significant delays by management, the unavailability of company personnel, or an unwillingness by management to provide information needed for the auditor to perform his or her audit procedures; - An unreasonably brief time within which to complete the audit; - Unexpected extensive effort required by the auditor to obtain sufficient appropriate audit evidence;
- Unreasonable management restrictions encountered by the auditor on the conduct of the audit; and - Management's unwillingness to make or extend its assessment of the company's ability to continue as a going concern when requested by the auditor. Note: Difficulties encountered by the auditor during the audit could represent a scope limitation, which may result in the auditor modifying the auditor's opinion or withdrawing from the engagement.
24. The auditor should communicate to the audit committee other matters arising from the audit that are significant to the oversight of the company's financial reporting process. This communication includes, among other matters, complaints or concerns regarding accounting or auditing matters that have come to the auditor's attention during the audit and the results of the auditor's procedures regarding such matters.
25. The auditor should communicate to the audit committee the matters in this standard, either orally or in writing, unless otherwise specified in this standard. The auditor must document the communications in the work papers, whether such communications took place orally or in writing.
26. All audit committee communications required by this standard should be made in a timely manner and prior to the issuance of the auditor's report.
The appropriate timing of a particular communication to the audit committee depends on factors such as the significance of the matters to be communicated and corrective or follow-up action needed, unless other timing requirements are specified by PCAOB rules or standards or the securities laws. Note: An auditor may communicate to only the audit committee chair if done in order to communicate matters in a timely manner during the audit. The auditor, however, should communicate such matters to the audit committee prior to the issuance of the auditor's report.
This is a study by the Staff of the Division of Trading and Markets of the U.S. Securities and Exchange Commission. The Commission has expressed no view regarding the analysis, findings or conclusions contained herein. December 2012 On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. Title IX, Subtitle C of the Dodd-Frank Act (“Title IX, Subtitle C”), “Improvements to the Regulation of Credit Rating Agencies,” among other things, established new self-executing requirements applicable to nationally recognized statistical rating organizations (“NRSROs”), required certain studies, and required that the Commission adopt rules applicable to NRSROs in a number of areas. Under section 939F of Title IX, Subtitle C (“section 939F”), the U.S. Securities and Exchange Commission (“Commission”) must submit to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives, not later than 24 months after the date of enactment of the Dodd-Frank Act, a report containing: (1) the findings of a study on matters related to assigning credit ratings for structured finance products; and
(2) any recommendations for regulatory or statutory changes that the Commission determines should be made to implement the findings of the study. In particular, section 939F provides that the Commission shall carry out a study of the following: (1) The credit rating process for structured finance products and the conflicts of interest associated with the issuer-pay and the subscriber-pay models; (2) The feasibility of establishing a system in which a public or private utility or a self regulatory organization (“SRO”) assigns NRSROs to determine the credit ratings for structured finance products, including: (a) An assessment of potential mechanisms for determining fees for NRSROs for rating structured finance products; (b) Appropriate methods for paying fees to NRSROs to rate structured finance products; (c) The extent to which the creation of such a system would be viewed as the creation of moral hazard by the Federal Government; and (d) Any constitutional or other issues concerning the establishment of such a system; (3) The range of metrics that could be used to determine the accuracy of credit ratings for structured finance products; and (4) Alternative means for compensating NRSROs that would create incentives for accurate credit ratings for structured finance products. Section 939F also provides that, after submission of the report to Congress containing the findings of the study, the Commission shall, by rule, as the Commission determines is necessary or appropriate in the public interest or for the protection of investors, establish a system for the
assignment of NRSROs to determine the initial credit ratings of structured finance products, in a manner that prevents the issuer, sponsor, or underwriter of the structured finance product from selecting the NRSRO that will determine the initial credit ratings and monitor such credit ratings. In issuing any rule pursuant to section 939F, the Commission is directed to give thorough consideration to the provisions of section 15E(w) of the Exchange Act, as that provision would have been added by section 939D of H.R. 4173 (111th Congress), as passed by the Senate on May 20, 2010 (the “Section 15E(w) Provisions”), and shall implement the system described in section 939D of H.R. 4173 (the “Section 15E(w) System”) unless the Commission determines that an alternative system would better serve the public interest and the protection of investors. The Commission requested public comment to assist the staff in carrying out this study. The Commission received thirty-two comment letters in response to its solicitation for comment. Six of the comment letters were submitted by NRSROs. The remaining twenty-six comment letters were submitted by other interested parties, including organizations representing investors, trade organizations, non-profit organizations, brokerage and financial services firms, academics and individuals. The staff reviewed each comment letter. The comment letters helped to inform the staff and raise complex issues for consideration. The staff also gathered information about the credit rating process for structured finance products, conflicts of interest in the issuerpay and subscriber-pay systems and alternative models for compensating NRSROs through:
(1) a review of certain studies, articles, and testimony; (2) meetings with proponents of alternative models; and (3) meetings with NRSROs. The staff’s study focused on the Section 15E(w) System and potential alternatives to that system, including an existing rule (Rule 17g-5) under the Exchange Act that is designed to mitigate the issuer-pay conflict with respect to structured finance products. This report – which was prepared by Commission staff and approved for release by the Commission – is being submitted to Congress pursuant to section 939F. The views expressed in this report are those of the Commission staff and do not necessarily reflect the views of the Commission or the individual Commissioners. The report identifies potential benefits and concerns with respect to the Section 15E(w) System and potential alternatives to that system. The report also identifies potential regulatory or statutory changes the Commission could consider if the Commission determined to implement the Section 15E(w) System or one or more of the potential alternatives.
The credit rating process for structured finance products used by NRSROs generally is similar, at least with respect to the more common types of products such as RMBS. The following summarizes the general process for rating a non-synthetic structured finance product. The issuer of the securities to be rated is a bankruptcy remote entity (typically a trust or a limited liability company) that is created solely to
hold a pool of assets that generates cash flows, which are used to pay principal and interest on securities issued by the issuing entity. The securities typically are issued in “tranches” that are assigned priorities in terms of receiving interest and principal payments from the cash flows generated by the asset pool and incurring losses resulting from the failure of the assets in the pool to perform (e.g., because of defaults). The tranche that is the last to incur losses has the highest level of “credit enhancement.” This tranche receives the highest credit rating and, generally, the arranger of the transaction seeks to obtain a credit rating that is in the highest category of credit rating the NRSRO issues (e.g., “AAA”). Usually, the arranger seeks to design a capital structure for the issuer that will result in securities at given tranches receiving specific credit ratings that are demanded by the potential investors in the securities (e.g., the arranger will seek to design a capital structure that results in a “AAA” rating for securities in the most senior tranche). The investors may require specific credit ratings to obtain benefits or relief under statutes and regulations using the term NRSRO. They also may require specific credit ratings to meet investment guidelines or contractual requirements. The arranger initiates the rating process by sending the NRSRO data on the assets to be held by the issuing entity (e.g., mortgages, student loans, credit card receivables or, in the case of CDOs and CLOs, the underlying RBMS or ABS), the proposed capital structure of the trust, and the proposed level of credit enhancement for each tranche of security to be issued by the issuing entity. The NRSRO assigns a lead analyst, who is responsible for analyzing the information and, ultimately, for formulating a ratings recommendation that will be submitted to a rating committee.
The lead analyst uses quantitative expected loss models and qualitative analysis to develop predictions as to how the assets in the pool held by the issuing entity likely will perform under market stresses of varying severity. These predictions include assumptions regarding the amount of principal likely to be recovered in the event of default when the asset is secured by collateral. The analyst typically reviews different characteristics of each asset in the pool. For example, in the case of an RMBS (which holds a pool of residential mortgages), the analyst reviews the value of the property relative to the amount of the loan, the amount of equity the borrower has in the property, the geographic location of the property, the credit score of the borrower, the income and net worth of the borrower, and the amount of documentation provided by the borrower to verify the borrower’s financial condition. The analyst also may consider other factors, such as the quality of the loan servicer or the actual performance of similar pools of assets. The purpose of this loss analysis is to determine how much credit enhancement a given tranche would need for a security in that tranche to receive a particular category of credit rating (e.g., a “AAA” rating). The analyst next evaluates the proposed capital structure of the issuer. Generally, the arranger proposes a capital structure with credit enhancement levels to obtain desired credit ratings for securities in each tranche. The analyst reviews the proposed credit enhancement levels against the predictions as to how the assets in the pool will perform to determine whether the amount of credit enhancement at each tranche is sufficient to support the desired credit rating.
If the analyst concludes that the capital structure of the issuer will not support the desired rating for a security in a particular tranche, the analyst typically conveys this preliminary conclusion to the arranger. The arranger requests this preliminary view from the analyst because – as noted above – the potential investors who will purchase the securities generally demand specific credit ratings. Consequently, if the securities will not receive the credit rating sought by the potential investors, the arranger may not be able to sell them. In the case where the analyst’s preliminary view differs from the expectation of the arranger, the arranger can accept the lower credit ratings or take steps to obtain the desired credit ratings. These steps can include changing the composition of the asset pool so that it yields better expected loss measures or adjusting the capital structure of the issuer to increase the level of credit enhancement at a given tranche. The next step in the process is to perform a cash flow analysis on the interest and principal expected to be received by the issuing entity from the asset pool to determine whether these cash flows will be sufficient to pay the interest and principal due on each security, as well as to cover the administrative expenses of the issuing entity. The analyst uses a quantitative model often developed by the NRSRO that analyzes the amount of principal and interest payments from the assets over the terms of the securities under various stress scenarios. The outputs of this model are compared against the required payments on the securities specified in the transaction’s legal documents. In addition to the expected loss and cash flow analysis, the analyst reviews the legal documentation of the issuing entity to evaluate whether it is bankruptcy remote (i.e., isolated from the effects of any potential bankruptcy or insolvency of the arranger).
The analyst also reviews operational and administrative risk associated with the issuing entity, using the results of periodic examinations of the principal parties involved in the issuance of the security, including the asset originators, the servicer of the assets, and the trustee. In assessing the servicer, for example, an NRSRO might review its past performance with respect to loan collections, billing, recordkeeping, and the treatment of delinquent loans. Following these steps, the analyst develops a rating recommendation for the securities in each tranche. The recommendation is presented to a rating committee, which may be comprised of a lead analyst, a senior analyst, and a chairperson, among others. An analyst is not allowed to participate on a committee if he or she has a conflict of interest. Potential conflicts of interest may be monitored throughout the rating process. Conflicts of interest also are controlled by internal procedures, such as requiring credit ratings to be determined by a committee rather than individual analysts, requiring rating committees to act by majority vote, and physically or substantively segregating rating committees from business functions. Generally, the rating committee votes on the rating for the securities in each tranche and usually notifies the issuer privately of the rating decision. An issuer may be able to appeal a rating decision, although the appeal is not always granted, and, if granted, may not necessarily result in any change in the rating decision. In those cases where appeals are granted, the issuer may be entitled to a decision by a second rating committee, but the standards for changing a
rating are generally very stringent (e.g., missing or materially misinterpreting critical information). Final rating decisions are published and subsequently monitored and maintained through surveillance processes. Generally, the analyst who monitors the rating after it is issued is different than the analyst who performed the initial rating. The surveillance process generally includes a periodic review of the performance of the assets in the pool, including delinquency and loss trends. If it is determined that the asset pool is performing differently than predicted, the surveillance analyst may recommend taking a rating action by presenting the recommendation to a rating committee. An NRSRO that operates under an issuer-pay model typically is paid only if the credit rating is issued, though sometimes it receives a partial fee for the analytic work undertaken if the credit rating is not issued. The issuer will pay an initial rating fee to the NRSRO when the transaction is sold. A surveillance fee for maintaining the rating also may be paid at closing or over the life of the securities.
New DARPA challenge is looking for innovative approaches to adaptive, software-based radio communications Radios are used for a wide range of tasks, from the most mundane to the most critical of communications, from garage door openers to military operations. As the use of wireless technology proliferates, radios and communication devices often compete with, interfere with, and disrupt the operations of other devices. DARPA seeks innovative approaches that ensure robust communications in such congested and contested environments. The DARPA Spectrum Challenge is a competition for teams to create software-defined radio protocols that best use communication channels in the presence of other users and interfering signals. Using a standardized radio hardware platform, the team that finds the best strategies for guaranteeing successful communication in the presence of other competing radios will win. In addition to bragging rights for the winning teams, one team could win as much as $150,000. High priority radios in the military and civilian sectors must be able to operate regardless of the ambient electromagnetic environment, to avoid disruption of communications and potential loss of life. Rapid response operations, such as disaster relief, further motivate the desire for multiple radio networks to effectively share the spectrum
without requiring direct coordination or spectrum preplanning. Consequently, the need to provide robust communications in the presence of interfering signals is of great importance. “The Spectrum Challenge is focused on developing new techniques for assured communications in dynamic environments – a necessity for military and first responder missions. We have created a head-to-head competition to see who can transmit a set of data from one radio to another the most effectively and efficiently while being bombarded by interference and competing signals,” said Dr. Yiftach Eisenberg, DARPA program manager. “To win this competition teams will need to develop new algorithms for software-defined radios at universities, small businesses and even on their home computers.” Registration for the Spectrum Challenge is expected to officially open in January 2013. Any U.S. academic institution, business, or individual, is eligible to compete, with certain restrictions. More information and additional details can be found at Spectrum Challenge website.
The DARPA Spectrum Challenge is a competition to demonstrate a radio protocol that can best use a given communication channel in the presence of other dynamic users and interfering signals. The Challenge is not focused on developing new radio hardware, but instead is targeted at finding strategies for guaranteeing successful communication in the presence of other radios that may have conflicting co-existence objectives.
The Spectrum Challenge will entail head-to-head competitions between your radio protocol and an opponent's in a structured testbed environment. In addition to bragging rights for the winning teams, one team could win as much as $150,000.
Radios are used for a wide range of tasks, from the most mundane to the most critical of communications, from garage door openers to military operations. As the use of wireless technology proliferates, radios can often compete with, interfere with, and disrupt the operations of other radios. DARPA seeks innovative approaches that ensure robust communications in such congested and contested environments. Other factors that motivate the need for intelligent use of spectrum include: High priority radios in the military and civilian sectors must be able to operate regardless of the ambient electromagnetic environment, to avoid disruption of communications and potential loss of life. Response operations, such as disaster relief, further motivate the desire for multiple radio networks to effectively and efficiently share the spectrum without requiring direct coordination or spectrum preplanning.
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