Welcome to the February 2010 edition of the International Association of Hedge Funds
Professionals (IAHFP) newsletter
Dear
Members,
Today we will study
several interesting papers and developments:
- The Securities and
Exchange Commission solves the problems that led to the failure to
detect Bernard L. Madoff’s Ponzi scheme by reorganizing its
enforcement division and announcing a new cooperation initiative by
rewarding those who help its investigation.
-
Forecasting Exercises
from the IMF
- The “Volcker Rule” for Financial
Institutions
- Wall Street Reform and
Consumer Protection Act: Myths vs. Facts
- What happened in Davos in January, and how it affects risk
and compliance management.
-
Sarbanes Oxley and Basel ii related issues.
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Contents
1.
Risk
Professionals
2.
Compliance
Professionals
3.
Sarbanes Oxley
Professionals
4.
Basel ii
Professionals
5.
Solvency ii
Professionals
6.
Hedge Funds
Professionals
7. Members of the
Board of Directors
Breaking News
Enforcement Cooperation Initiative by the SEC
The Securities and
Exchange Commission solves the problems that led to the failure to
detect Bernard L. Madoff’s Ponzi scheme by reorganizing its
enforcement division and announcing a new cooperation initiative by
rewarding those who help its investigation.
SEC Announces
Initiative to
Encourage
Individuals and Companies to Cooperate and Assist in Investigations
Washington, D.C.,
Jan. 13, 2010: The Securities and Exchange Commission announced a
series of measures to
further strengthen its enforcement program
by encouraging
greater cooperation from individuals and companies in the agency's
investigations and enforcement actions.
The new initiative
establishes
incentives for
individuals and companies
to fully and truthfully cooperate and assist with SEC investigations
and enforcement actions, and provides new tools to help investigators
develop first-hand evidence to build the strongest possible cases.
The cooperation
initiative is expected to result in invaluable and early assistance in
identifying the scope, participants, victims and ill-gotten gains
associated with fraudulent schemes.
"This is a
potential game-changer for the Division of Enforcement," said Robert
Khuzami, Director of the Division of Enforcement.
"There is no
substitute for the insiders' view into fraud and misconduct that
only cooperating witnesses can provide. That type of evidence can
expand our ability to conduct our investigations more swiftly, and
to act quickly to file charges, freeze assets, and protect
investors."
To improve the
quality, quantity, and timeliness of information and assistance it
receives,
the SEC approved the following measures:
First,
the Division of Enforcement is authorizing its staff to
use various tools to encourage individuals and
companies to report violations and provide assistance to the agency.
The new tools are
laid out in a
revised version
of the Division's enforcement manual in a new section entitled
"Fostering Cooperation."
For many years,
similar cooperation tools have been regularly and successfully used
by the Justice Department in its criminal investigations and
prosecutions.
The new cooperation tools, not previously available in SEC
enforcement matters, include:
-
Cooperation
Agreements
— Formal written agreements in which the Enforcement Division
agrees to recommend to the Commission that a cooperator receive
credit for cooperating in investigations or related enforcement
actions if the cooperator provides substantial assistance such as
full and truthful information and testimony.
-
Deferred
Prosecution Agreements
— Formal written agreements in which the Commission agrees to
forego an enforcement action against a cooperator if the
individual or company agrees, among other things, to cooperate
fully and truthfully and to comply with express prohibitions and
undertakings during a period of deferred prosecution.
-
Non-prosecution
Agreements
— Formal written agreements, entered into under limited and
appropriate circumstances, in which the Commission agrees not to
pursue an enforcement action against a cooperator if the
individual or company agrees, among other things, to cooperate
fully and truthfully and comply with express undertakings.
Second,
the SEC streamlined the process for submitting
witness immunity requests to the Justice Department for
witnesses who have the capacity to assist in its investigations and
related enforcement actions.
Third,
the Commission has set out, for the first time, the way in which it
will evaluate whether, how much, and in what manner to
credit cooperation by individuals to
ensure that potential cooperation arrangements maximize the
Commission's law enforcement interests.
This pronouncement
is expected to provide guidance and serve as an incentive for
individuals to report violations and to cooperate fully and promptly
in enforcement cases.
It is similar to
the so-called "Seaboard Report" that was issued in 2001 and detailed
the factors the SEC considers when evaluating cooperation by
companies.
In the newly
issued policy statement, the SEC identifies
four general considerations:
-
The assistance
provided by the cooperating individual.
-
The importance
of the underlying matter in which the individual cooperated.
-
The societal
interest in ensuring the individual is held accountable for his or
her misconduct.
-
The
appropriateness of cooperation credit based upon the risk profile
of the cooperating individual.
The developments
announced today are the latest in a series of initiatives that are
part of the most significant reorganization of the Enforcement
Division in more than 30 years.
These reforms
include vastly expanding staff training programs, hiring staff with
new skill sets, streamlining management, adding more experienced
investigators to the front lines, revising internal enforcement
procedures, restructuring processes to ensure better sharing of
information, leveraging the knowledge of third parties, and
revamping the way tips are handled.
About the Division
of Enforcement
The Division of Enforcement was created in
August 1972 to consolidate enforcement activities that
previously had been handled by the various operating divisions at
the Commission's headquarters in Washington.
The Commission's
enforcement staff conducts investigations into
possible violations of the federal securities laws, and prosecutes
the Commission's civil suits in the federal courts as well as its
administrative proceedings.
In civil suits, the Commission seeks injunctions, which are orders
that prohibit future violations; a person who
violates an injunction is subject to fines or imprisonment for
contempt.
In addition, the
Commission often seeks civil money penalties
and the disgorgement of illegal profits.
The courts may
also bar or suspend individuals from acting as corporate officers or
directors.
The Commission can
bring a variety of administrative proceedings,
which are heard by administrative law judges and the
Commission itself.
One type of
proceeding, for a cease and desist order, may be instituted
against any person who violates the federal
securities laws.
The Commission may
order the respondent to disgorge ill-gotten funds in these
proceedings.
With respect to
regulated entities (e.g., brokers, dealers and investment advisers)
and their employees, the Commission may
institute administrative proceedings to revoke or suspend
registration, or to impose bars or suspensions from employment.
In proceedings
against regulated persons, the Commission is
authorized to order the payment of civil penalties as well as
disgorgement.
§
202.12 Policy statement concerning cooperation by individuals in its
investigations and related enforcement actions
Cooperation by
individuals and entities in the Commission’s investigations and
related enforcement actions can contribute
significantly to the success of the agency’s mission.
Cooperation can
enhance the Commission’s ability to detect violations of the federal
securities laws, increase the effectiveness and efficiency of the
Commission’s investigations, and provide important evidence for the
Commission’s enforcement actions.
There is a
wide spectrum of tools available to the
Commission and its staff for facilitating and rewarding cooperation
by individuals, ranging from taking no enforcement action to
pursuing reduced charges and sanctions in connection with
enforcement actions.
As with any
cooperation program, there exists some tension
between the objectives of holding individuals fully accountable for
their misconduct and providing incentives for individuals to
cooperate with law enforcement authorities.
This policy statement
sets forth the analytical framework employed by the Commission and
its staff for resolving this tension in a manner that ensures that
potential cooperation arrangements maximize the Commission’s law
enforcement interests.
Although the
evaluation of cooperation requires a case-by-case analysis of the
specific circumstances
presented, as
described in greater detail below, the Commission’s general approach
is to
determine whether, how much, and in what manner to credit
cooperation by individuals by evaluating four considerations:
The
assistance provided by the cooperating individual in the
Commission’s investigation or related enforcement actions
(“Investigation”);
The
importance of the underlying matter in which the individual
cooperated; the societal interest in ensuring that the cooperating
individual is held accountable for his or her misconduct; and
The
appropriateness of cooperation credit based upon the profile of the
cooperating individual.
In the end, the goal
of the Commission’s analysis is to protect the investing public by
determining whether the public interest in facilitating and
rewarding an individual’s cooperation in order to advance the
Commission’s law enforcement interests justifies the credit awarded
to the individual for his or her cooperation.
(a)
Assistance provided by the individual.
The
Commission assesses the assistance provided by the cooperating
individual in the Investigation by considering, among other things:
(1) The value of the individual’s cooperation
to the Investigation including, but not limited to:
(i) Whether the individual’s cooperation resulted in substantial
assistance to the Investigation;
(ii) The timeliness of the individual’s cooperation, including
whether the individual was first to report the misconduct to the
Commission or to offer his or her cooperation in the Investigation,
and whether the cooperation was provided before he or she had any
knowledge of a pending investigation or related action;
(iii) Whether the Investigation was initiated based on information
or other cooperation provided by the individual;
(iv) The quality of cooperation provided by the individual,
including whether the cooperation was truthful, complete, and
reliable; and
(v) The time and resources conserved as a result of the individual’s
cooperation in the Investigation.
(2) The nature of the individual’s cooperation
in the Investigation including, but not limited to:
(i) Whether the individual’s cooperation was voluntary or required
by the terms of an agreement with another law enforcement or
regulatory organization;
(ii) The types of assistance the individual provided to the
Commission;
(iii) Whether the individual provided non-privileged information,
which information was not requested by the staff or otherwise might
not have been discovered;
(iv) Whether the individual encouraged or authorized others to
assist the staff who might not have otherwise participated in the
Investigation; and
(v) Any unique circumstances in which the individual provided the
cooperation.
(b)
Importance of the underlying matter.
The
Commission assesses the importance of the Investigation in which the
individual cooperated by considering, among other things:
(1) The character of the Investigation
including, but not limited to:
(i) Whether the subject matter of the Investigation is a Commission
priority;
(ii) The type of securities violations;
(iii) The age and duration of the misconduct;
(iv) The number of violations; and
(v) The isolated or repetitive nature of the violations.
(2) The dangers to investors or others
presented by the underlying violations involved in the Investigation
including, but not limited to:
(i) The amount of harm or potential harm caused by the underlying
violations;
(ii) The type of harm resulting from or threatened by the underlying
violations; and
(iii) The number of individuals or entities harmed.
(c)
Interest in holding the individual accountable.
The
Commission assesses the societal interest in holding the cooperating
individual fully accountable for his or her misconduct by
considering, among other things:
(1) The severity of the individual’s misconduct assessed by the
nature of the violations and in the context of the individual’s
knowledge, education, training, experience, and position of
responsibility at the time the violations occurred;
(2) The culpability of the individual, including, but not limited
to, whether the individual acted with scienter, both generally and
in relation to others who participated in the misconduct;
(3) The degree to which the individual tolerated illegal activity
including, but not limited to, whether he or she took steps to
prevent the violations from occurring or continuing, such as
notifying the Commission or other appropriate law enforcement agency
of the misconduct or, in the case of a violation involving a
business organization, by notifying members of management not
involved in the misconduct, the board of directors or the equivalent
body not involved in the misconduct, or the auditors of such
business organization of the misconduct;
(4) The efforts undertaken by the individual to remediate the harm
caused by the violations including, but not limited to, whether he
or she paid or agreed to pay disgorgement to injured investors and
other victims or assisted these victims and the authorities in the
recovery of the fruits and instrumentalities of the violations; and
(5) The sanctions imposed on the individual by other federal or
state authorities and industry organizations for the violations
involved in the Investigation.
(d)
Profile of the individual.
The
Commission assesses whether, how much, and in what manner it is in
the public interest to award credit for cooperation, in part, based
upon the cooperating individual’s personal and professional profile
by considering, among other things:
(1) The individual’s history of lawfulness, including complying with
securities laws or regulations;
(2) The degree to which the individual has demonstrated an
acceptance of responsibility for his or her past misconduct; and
(3) The degree to which the individual will have an opportunity to
commit future violations of the federal securities laws in light of
his or her occupation -- including, but not limited to, whether he
or she serves as: a licensed individual, such as an attorney or
accountant; an associated person of a regulated entity, such as a
broker or dealer; a fiduciary for other individuals or entities
regarding financial matters; an officer or director of public
companies; or a member of senior management -- together with any
existing or proposed safeguards based upon the individual’s
particular circumstances.
Note
to § 202.12.
Before the Commission
evaluates an individual’s cooperation, it
analyzes the unique facts and circumstances of the case.
The above principles
are not listed in order of importance nor are
they intended to be all-inclusive or to require a specific
determination in any particular case.
Furthermore, depending
upon the facts and circumstances of each case, some of the
principles may not be applicable or may deserve greater weight than
others.
Finally, neither this
statement, nor the principles set forth herein creates or recognizes
any legally enforceable rights for any person.
Forecasting Exercises
from the IMF
INTERNATIONAL MONETARY FUND, Fiscal Affairs
Department
The State of Public Finances Cross-Country Fiscal Monitor
New evidence on underlying fiscal weakening in
advanced countries during the last few years.
Many advanced economies entered the crisis
with relatively weak structural fiscal positions, and these have
been eroded further, not only by anticrisis measures but also by
underlying spending pressures.
This will raise the bar on fiscal adjustment.
The outlook for emerging economies is
stronger, if fiscal tightening plans materialize in 2010.
But these countries remain exposed to considerable risks, which are
quantified through new statistical analysis.
New estimates of needed medium-term fiscal adjustment in advanced
economies
Government debt in advanced G-20 economies
is projected to reach 118 percent of GDP in 2014,
even assuming some discretionary tightening next year.
Getting debt below 60 percent
by 2030
will require raising the average structural primary balance by 8
percentage points of GDP relative to 2010 (10½ percentage points for
the headline primary balance).
Action will be needed on entitlement spending, on other spending,
and on revenues.
Japan, the United Kingdom, Ireland and Spain
are projected to require the largest fiscal adjustment.
Only Denmark, Korea, Norway, Australia and Sweden
among advanced economies will require little or no medium-term
adjustment to keep debt stocks at safe levels.
What
is the “Volcker Rule” for Financial Institutions?
President Obama has called for new restrictions on the size and scope of
financial institutions to rein in excessive risk-taking and protect
taxpayers.
The proposed legislation is called the “Volcker Rule” in recognition
of the efforts of former Federal Reserve Chairman and current
President’s Economic Recovery Advisory Board Chairman Paul Volcker.
Paul Adolph Volcker, an American economist, was the Chairman of the
Federal Reserve under United States Presidents Jimmy Carter and
Ronald Reagan (from August 1979 to August 1987).
The
Volcker Rule
seeks to reenact to some extent the Glass-Steagall Act
that separated commercial and investment banking.
Obama Called for New Restrictions on Size and Scope of Financial
Institutions to Rein in Excesses and Protect Taxpayers
President Obama joined
Paul Volcker, former chairman of the
Federal Reserve; Bill Donaldson, former chairman of the Securities
and Exchange Commission; Congressman Barney Frank, House Financial
Services Chairman; Senator Chris Dodd, Chairman of the Banking
Committee and the President's economic team to call for new
restrictions on the size and scope of banks and other financial
institutions to rein in excessive risk taking and to protect
taxpayers.
The President’s proposal would strengthen the comprehensive
financial reform package that is already moving through Congress.
“While the financial system is far stronger today than it was a year
one year ago, it is still operating under the exact same rules that
led to its near collapse,” said President Barack Obama.
“My resolve
to reform the system is only strengthened when I see a return to old
practices at some of the very firms fighting reform; and when I see
record profits at some of the very firms claiming that they cannot
lend more to small business, cannot keep credit card rates low, and
cannot refund taxpayers for the bailout. It is exactly this kind of
irresponsibility that makes clear reform is necessary.”
The proposal would:
1.
Limit the Scope
- The President and his economic team will work with Congress to
ensure that no bank or financial institution that contains a bank
will own, invest in or sponsor a hedge fund or a private equity
fund, or proprietary trading operations unrelated to serving
customers for its own profit.
2.
Limit the Size
- The President also announced a new proposal to limit the
consolidation of our financial sector. The President’s proposal will
place broader limits on the excessive growth of the market share of
liabilities at the largest financial firms, to supplement existing
caps on the market share of deposits.
In the coming weeks, the President will continue to work closely
with Chairman Dodd and others to craft a strong, comprehensive
financial reform bill that puts in place common sense rules of the
road and robust safeguards for the benefit of consumers, closes
loopholes, and ends the mentality of “Too Big to Fail.”
Chairman
Barney Frank’s financial reform legislation, which passed the House
in December, laid the groundwork for this policy by authorizing
regulators to restrict or prohibit large firms from engaging in
excessively risky activities.
As part of the previously announced reform program, the proposals
announced today will help put an end to the risky practices that
contributed significantly to the financial crisis.
Obama Announced Economic Advisory Board
President Barack Obama signed an
executive order establishing the new Economic Recovery Advisory
Board.
Modeled on the Foreign
Intelligence Advisory Board created by President Dwight D.
Eisenhower, the Board will provide an
independent voice on economic issues and will be charged with
offering independent advice to the
President as he formulates and implements his plans for economic
recovery.
The Economic Recovery Advisory Board will provide regular briefings
to the President, Vice President and their economic team.
The Board will be
established initially for a two-year term, after which the President
will make a determination on whether to extend the work of the
Board.
Members of the Board are distinguished
citizens outside the government who are qualified on the
basis of achievement, experience, independence, and integrity.
The Board will bring a
diverse set of perspectives and voices
from different parts of the country and different sectors of the
economy to bear in the formulation and evaluation of economic
policy.
The Board will meet regularly and provide advice directly to the
President on the programs to jump-start economic growth and
facilitate economic stability. The Board will also focus on how the
response to the short-run economic crisis is laying the groundwork
for the reforms necessary for longer-run prosperity.
Members of the Board include:
William H. Donaldson, Chairman, SEC (2003-2005)
Roger W. Ferguson, Jr., President & CEO, TIAA-CREF
Robert Wolf, Chairman & CEO, UBS Group Americas
David F. Swensen, CIO, Yale University
Mark T. Gallogly, Founder & Managing Partner, Centerbridge Partners
L.P.
Penny Pritzker, Chairman & Founder, Pritzker Realty Group
Jeffrey R. Immelt, CEO, GE
John Doerr, Partner, Kleiner, Perkins, Caufield & Byers
Jim Owens, Chairman and CEO, Caterpillar Inc.
Monica C. Lozano, Publisher & Chief Executive Officer, La Opinion
Charles E. Phillips, Jr., President, Oracle Corporation
Anna Burger, Chair, Change to Win
Richard L. Trumka, Secretary-Treasurer, AFL-CIO
Laura D'Andrea Tyson, Dean, Haas School of Business at the
University of California at Berkeley
Martin Feldstein, George F. Baker Professor of Economics, Harvard
University
Interesting paper from the US House
Financial Services Committee
The Committee oversees all
components of the nation's housing and financial services sectors
including banking, insurance, real estate, public and assisted
housing, and securities. The Committee continually reviews the laws
and programs relating to the U.S. Department of Housing and Urban
Development, the Federal Reserve Bank, the Federal Deposit Insurance
Corporation, Fannie Mae and Freddie Mac, and international
development and finance agencies such as the World Bank and the
International Monetary Fund. The Committee also ensures enforcement
of housing and consumer protection laws such as the U.S. Housing
Act, the Truth In Lending Act, the Housing and Community Development
Act, the Fair Credit Reporting Act, the Real Estate Settlement
Procedures Act, the Community Reinvestment Act, and financial
privacy laws.
Wall Street Reform and Consumer
Protection Act:
Myths vs. Facts
MYTH: The bill
will put in place permanent bailouts -- encouraging risky behavior
by financial institutions which assume the government will come to
their rescue.
FACT:
Completely untrue. Under this bill, the days
of taxpayer-funded bailouts are over.
The bill establishes a process to dissolve failing large financial
institutions in a way that does not wreakhavoc on the whole economy;
but this is no bailout.
These financial institutions will be allowed
to fail, but in a way that protects the economy.
Under this authority, as a last resort, federal regulators will shut
down these institutions that pose a risk to the whole economy.
They will fire the managers, fire the executives, wipe out
shareholders, sell off the assets, but protect our financial system
and taxpayers from collateral damage.
For a market to function, those who invest and lend in that market
must know that their money is actually at risk.
Institutions and investors must be responsible for their decisions.
Any costs incurred in unwinding these financial institutions
will be borne by Wall Street firms and the big
banks—not taxpayers.
Dissolution will be paid for first by shareholders and creditors, by
any remaining assets of the failed company and then through an
industry-funded effort.
The bill requires big banks and other
financial institutions (with $50 billion in assets) to foot the bill
for any future dissolutions of individual companies.
These institutions would pay assessments based on a company’s
potential risk to the whole financial system if they were to fail.
This bill institutes preventive medicine by making the financial
marketplace more accountable and transparent, long before we get to
the point of a rescue.
We strengthen supervision of large and risky financial institutions
with stronger capital standards and rules against excessive and
overly risky leverage.
MYTH:
This bill adds unnecessary government bureaucracy with a new
Consumer Financial Protection Agency (CFPA) that duplicates the work
of existing agencies and increases regulatory burdens on businesses.
FACT: The new
agency will consolidate and streamline enforcement of roughly 20
laws currently overseen by seven different agencies.
The functions would not be duplicated; rather, they would be
streamlined into a single agency,
thereby reducing regulatory burden and expense, not increasing it –
with the added benefit of more effective consumer protection.
This new agency is necessary as existing regulators failed to stop
abusive lending practices before these practices harmed millions of
consumers and ultimately the entire economy.
Right now, consumer protection is a minor and sometimes ignored
responsibility for a number of agencies but not top priority for any
one of them.
Agencies have ignored their consumer protection mandates in the
past, and former Federal Reserve Chairman Alan
Greenspan never implemented a law passed in 1994 to regulate
subprime lending.
American consumers deserve much better than this.
The CFPA will clean up this mess and make consumer protection its
sole priority.
MYTH:
This bill will assert more government control over financial
markets.
FACT: To prevent
risky financial dealings by Wall Street and the big banks from
decimating the savings and homes of American families and from
freezing access to credit for American’s small businesses, this bill
reins in Wall Street and strengthens accountability in Washington.
Putting in place these kinds of common sense rules of the road will
improve transparency, foster competition, and strengthen the health
of the marketplace.
The central objective of reform is to establish a safer, more stable
financial system that can deliver the benefits of financial
innovation even as it guards against the dangers of excessive risk.
We must ensure that our financial system creates
opportunity and long-term wealth while
reducing risk.
MYTH:
The bill increases the deficit and increases taxes.
FACT: The net
cost of the bill is fully paid for from the TARP.
The TARP was set up to save the financial system from collapse and
the cost of this legislation to prevent a future collapse is a
necessary cost in that effort.
Most of the costs associated with these
reforms are paid for by the financial industry through fees and
assessments—on large banks and non-regulated financial companies
such as payday lenders and check cashing operations, and not on
local community banks or credit unions.
This is a small price to pay to avert another financial disaster,
and these reforms will help spur our economy and thereby reduce the
federal deficit through restored confidence that our financial
institutions are sound— all while we better protect consumer and
investors.
MYTH:
We should just let these large institutions go through bankruptcy,
instead of getting the government involved.
FACT: Bankruptcy
will not stop the type of financial panic that we saw in the fall of
September 2008.
Even President Bush, Vice President Cheney and their Republican
Treasury Secretary and the Chairman of the Federal Reserve rejected
using the Bankruptcy Code as a model for dissolving large,
interconnected financial institutions.
Only in the case of Lehman Brothers did they allow bankruptcy to
proceed.
The aftermath, with a 500 point drop in the stock market, was such a
disaster that two days later the Bush Administration bailed out AIG
because the markets could not sustain another major bankruptcy
filing by a large financial firm.
Bankruptcy, while appropriate in many instances, can be a lengthy
process that may not always allow for the speedy resolution of a
large financial firm in time to avoid a broad financial panic that
could result in major financial and economic disruptions.
As Lehman Brothers navigated bankruptcy court, Business Week
reported "Scores of hedge funds that had
hundreds of millions in cash and other securities parked with
Lehman’s prime brokerage operation in London have had their accounts
frozen.
A number of these hedge funds have filed formal objections with the
bankruptcy court and at least one fund, New York-based Bay Harbour
Management, is mounting a legal challenge to the court’s
hastily-approved sale of Lehman’s brokerage arm to Barclays Capital.
Now a new and even more troubling scenario is arising: legal
disputes stemming from the estimated $1 trillion in derivatives
transactions that Lehman had entered into on behalf of itself and
some of its customers.” [Business Week, 10/2]
Under the bill's dissolution authority, the FDIC will be able to
unwind a failing firm expeditiously and in an orderly manner so that
existing contracts can be dealt with and secured creditors’ claims
can be addressed—much like is done today when
commercial banks become insolvent.
MYTH:
The CFPA limits consumer choices of financial products and stifles
innovation.
FACT:
There will be no limits on innovation.
When we create choices for consumers,
we create competition in the industry that benefits everyone.
All that will be limited are abusive practices of the sort that led
to the current crisis.
The status quo has limited consumer choice by crowding out of the
market better loans for which many borrowers qualified but were not
offered.
The CFPA will ensure that consumers are offered the best loans for
which they qualify, and not just the riskiest loans that are most
lucrative for originators.
MYTH:
The new CFPA will raise costs for consumers as firms have to comply
with new rules and standards and will pass on these costs to
consumers. Consumers will have to pay more just to fund the agency.
FACT:
An agency that could have helped prevent the risky lending practices
that resulted in trillions of dollars of losses in Americans’
retirement savings and home values is well worth the modest costs
involved.
They pale in comparison to the costs of regulatory failure.
Moreover, as the CFPA will streamline enforcement of laws and rules
that currently fall under seven different government agencies, costs
to the companies and prices for consumers may well decline.
MYTH:
This legislation will hurt community and small banks and
merchants—those that didn’t cause the financial meltdown but were
hurt by it.
FACT:
The bill ensures that small banks and credit unions, which play a
key role in their communities, are not subject to undue regulatory
burdens.
• Banks and thrifts under $10 billion in
assets and credit unions under $1.5 billion in assets will continue
to have their consumer protection examinations done by their
existing regulators.
• CFPA will play a backup role unless the primary regulators fail in
their oversight, and these institutions will not see their
assessments for consumer protection exams change under this bill.
Merchants, retailers and other non-financial
businesses will be excluded from the regulation and oversight
of CFPA when they extend credit directly to consumers for the
purchase of goods or services.
Merchants and retailers can continue to provide credit and layaway
plans without becoming subject to new regulation as long as they do
not choose to resell the credit.
Merchants and others are still subject to federal law through the
Truth in Lending Act, which was passed almost
30 years ago.
Also, doctors and other businesses that bill their customers after a
service is provided will be excluded.
MYTH:
The bill is a job killer and will drive up interest rates.
FACT:
This is more scare tactics and fear mongering from the same crowd
that said health care reform was going to kill
grandma.
Defenders of risky business on Wall Street are ignoring the
destruction that lax oversight caused in the financial lives of
Americans and American businesses—and also ignore the increased
investment and entrepreneurship that a stable and growing economy
will generate.
Instituting strong consumer protections, improving transparency, and
rewarding responsible investing are some of the best ways to foster
competitiveness and grow our economy.
After
Davos...
What is the World Economic Forum?
The World Economic Forum is the global
community of business, political, intellectual and other
leaders of society who are committed to improving the state of the
world.
The Forum is an independent, not-for-profit
organization that brings these
leaders together to work on projects that improve people’s lives.
The World
Economic Forum is incorporated as a Swiss not-for-profit
foundation.
The Forum’s headquarters are located on the
outskirts of Geneva in a town called Cologny.
The Forum also has an affiliate in New York,
World Economic Forum USA, a representative office in Beijing and
opened the Japan office in Tokyo in September 2009.
In 1971, Professor Klaus Schwab, then a professor of Business
Administration at the University of Geneva, gathered European
business leaders in
Davos, Switzerland,
for a discussion on global management practices.
The success of this first conference led Professor Schwab to
create the European Management Forum, which
in 1987 changed its name to the World Economic Forum.
How is the
World Economic Forum governed?
The Forum has three main governing bodies:
The Foundation Board,
which has overall responsibility for establishing the long term
direction and objectives of the Forum, and which is comprised of
international public and private sector leaders.
The International Business Council,
which acts as an advisory body providing intellectual stewardship
to the Forum.
The Managing Board,
which is the in-house management team responsible for the
executive oversight and management of the activities and resources
of the Forum.
Who are the World Economic Forum's members and partners?
Members represent the 1,000 leading
companies and 200 smaller businesses - many from the
developing world - that play a potent role in their industry or
region.
They also work closely with communities of leaders from
academia, government, religion, the media,
non-governmental organizations and the arts.
Partners are select member companies who strongly support,
contribute to and benefit from the World Economic Forum’s
commitment to improving the state of the world.
They are actively involved in the organization's activities and
contribute their expertise and resources.
How is the World Economic Forum funded?
The Forum's funding comes from three
sources:
Membership fees
(CHF 42,500)
from the 1,000 foremost companies who are the Forum's members and
partners
Partnership fees
from Strategic Partners (companies that play a leading role in the
Forum) and from partners in the Forum's events
Participation fees
for the Annual Meeting and for regional meetings and summits.
What does the World Economic Forum do?
The World Economic Forum brings together
leaders in business, politics and society for reflection and
connection to generate ideas and proposals, bridging countries and
cultures to address the issues affecting our world.
We also bring the very best minds and
experts to provide the necessary insight to allow leaders to make
decisions that can bring about change for the better.
Conferences like the Annual Meeting in Davos and regional summits
are an occasion for leaders to outline major challenges and define
strategies to address them.
Where are the World Economic Forum's events and who goes?
Forum events take place on almost every continent
each year, and the Annual Meeting in Davos, Switzerland,
is the largest of these.
International and regional leaders, Forum members from the
international business community, governments and institutions
attend these meetings.
Annual Meeting in Davos - What is the Annual Meeting, who attends
and why is it so important?
Business, religious, government, cultural
and society leaders meet each year in Davos, Switzerland,
for the Annual Meeting.
The event provides a platform for these leaders to debate the
difficult global challenges of our planet, identify emerging risks
and ways to address them.
It’s not surprising then that many initiatives and projects have
been created at the Annual Meeting.
Why is it held in Davos?
Since 1971, the scenic village of
Davos has been the traditional site of the Annual Meeting.
Holding the meeting in such a setting rather than a bustling
metropolis allows attendees to focus more easily on the issues at
hand. The alpine location also means that
local authorities are in a better position to implement the high
level of security required for such an event.
What about the protests at the Annual Meeting?
The Forum supports the rights of free speech
and peaceful assembly, but opposes violence and destruction of
property.
In principle, the Forum is supportive of
demonstrations by those who desire to have their voices heard.
But the Forum condemns – vehemently and unequivocally – those who
believe that violence is a legitimate form of public expression or
debate.
In answer to the protests, the Open Forum was launched to give
everyone a voice in the globally focused debates at the Annual
Meeting in Davos.
On a year-round basis, you can also have your say about critical
global issues on the Forum's weblog.
Can the public take part?
The general public cannot take part directly
in the Annual Meeting for reasons of security and space.
But the Forum and civil society organizations - including church,
non-governmental and non-profit organizations - co-organize the
Open Forum.
These are discussions open to the general public, free-of-charge
and held simultaneously with the Annual Meeting in Davos.
The general public can also participate through social media by
joining the discussions through a variety of ways including video
blogs on YouTube, a community on Facebook or
subscriptions to Twitter.
Are events behind closed doors, or are they covered by the media?
Many global and local media organizations
produce special coverage of Forum events.
In fact, nearly one in every five participants at the Annual
Meeting hails from the media sector.
The Forum’s weblog provides even greater
access to sessions, and it is a virtual forum where people unable
to attend the meetings can have their say too.
World Economic Forum Annual Meeting 2010
Davos-Klosters, Switzerland 27 - 31 January
Improve the State of the World: Rethink, Redesign, Rebuild
Purpose
Improving the state of the world requires catalysing global
cooperation to address pressing challenges
and future risks.
Global cooperation
in turn needs stakeholders from business, government, the media,
science, religion, the arts and civil society to collaborate as a
true community.
To this end, the
World Economic Forum Annual Meeting has engaged leaders from all
walks of life to shape the global agenda at the start of the year
for the last four decades.
The
Transformation Continues
The financial crisis of 2008 and the “Great
Recession” of 2009 raise tough questions about the future
of the global economy.
However, they also
provide insights into economic interdependencies, governance gaps
and systemic risks intrinsic to globalization.
These revelations in turn compel us to rethink business models,
financial innovation and risk management.
Rethinking also
triggers attempts at redesign.
National legislatures, supervisory authorities and international
organizations are now redesigning institutions, policies and
regulations with the aim of closing governance gaps, preventing
systemic failures and restoring growth.
However, these
redesign efforts need common vision, collaborative innovation and
public-private partnerships for their long-term success.
The success drivers
are themselves predicated on the individuals
and institutions empowered to take action having the trust of
stakeholder communities.
Decision-makers, therefore, must rebuild trust, not only to
establish the legitimacy of their redesign but also to instil
confidence in their future success.
Rethinking,
redesigning and rebuilding are invariably complex as values, norms
and incentives change and, in turn, reshape stakeholder
communities, social networks, governance structures and industry
models worldwide.
Rethink, Redesign and Rebuild in Davos
The Annual Meeting 2009 theme was “Shaping
the Post-Crisis World”.
The intent was to
absorb the early lessons from the financial crisis and to
understand how risks interconnect, to encourage longer term
thinking and to consider unintended consequences of various calls
for action.
The learning and
transformation will continue into next year along with increasing
expectations for positive change.
In
response to new priorities, the organizing theme for the 40th
World Economic Forum Annual Meeting in 2010 is a call to action,
"Improve the State of the World: Rethink, Redesign and Rebuild".
The pressure to rethink, redesign and rebuild is increasing along
with concern over the current state of the world.
The fiscal and
monetary prescriptions to ease the pain of global economic shocks
are now fuelling anxieties about the creation of new economic
bubbles.
Moreover, the
demographic, behavioural and technological changes linked to the
collapse in global demand are challenging basic assumptions about
the nascent recovery.
Major industries are still contending with cyclical and structural
threats to their business models.
In addition,
weaknesses of governance systems, exposed by the financial crisis,
are mostly unchanged with respect to looming global risks such as
climate change, nuclear proliferation and pandemic.
Driving the rethink at the 40th Annual Meeting will be the Network
of Global Agenda Councils comprised of over 1,000 experts active
in over 70 Councils created to advance solutions to the most
critical challenges facing the world.
The councils will
meet at the Summit on the Global Agenda in November and the Annual
Meeting programme will highlight their recommendations.
Redesign discussions in Davos will leverage the ongoing work of
the Forum’s Global Redesign Initiative (GRI),
an unprecedented multistakeholder dialogue focusing on adapting
structures and systems of international cooperation to the
challenges of the 21st century.
Launched at the
Annual Meeting 2009, the GRI is under the patronage of the
governments of Qatar, Singapore and Switzerland.
The effort to
rebuild trust and confidence needs to begin before, and extend
well beyond next year’s Annual Meeting.
Davos - The Bank of
the Future
Carolyn B. Maloney • Alessandro Profumo • Chukwuma C. Soludo •
Yang Kaisheng
Moderated by Lord Turner - Saturday 31 January
Lord Turner, Chairman, Financial Services
Authority (FSA), United Kingdom, threw out two issues for
discussion.
Will the bank of the future focus on either
commercial banking or investment banking, not both as today’s
universal banks do?
Given the fact that
many banks are being bailed out by governments, will the bank of
the future stop operating globally because taxpayers expect them
to prioritize domestic lending and investing?
Alessandro Profumo, Chief Executive Officer,
UniCredit Group, Italy, believes that the bank of the
future will specialize in commercial activities such as
deposit-taking and lending, or investment bank activities such as
operating proprietary trading desks and underwriting derivatives,
not both.
However, some
investment bank products such as advisory services may cross over
to the commercial side. Profumo thinks the bank of the future will
likely come under pressure to stay home, but warned that the loss
of economies of scale may result in higher costs and a narrower
range of products.
The happy medium may
be a regional business, such as focusing on Europe.
Carolyn B. Maloney, Congresswoman from New
York (Democrat), 14th District, USA, said the
American banks that have been effectively nationalized will be
returned to the private sector, which will then decide how to run
the business.
But while the banks
operate with government money, they will need to be sensitive to
taxpayer expectations, including levels of executive pay and
bonuses.
At least in the US,
the bank of the future may see restrictions
on how much leverage it can take on and the activities it can
engage in, which Maloney said are among the recommendations to US
President Barack Obama by Paul Volcker, the Head of the
President’s Economic Recovery Advisory Board.
“But I don’t
believe we will go back to Glass-Steagall,”
Maloney said,
referring to the 1933 law that banned US bank holding companies
from owning other financial firms.
Its repeal in 1999
led to the rise of universal banks, which then got into trouble as
their self-regulating investment banking arms loaded up on
sub-prime derivatives and other toxic products.
What the bank of the
future will be, said the congresswoman, is transparent,
accountable and regulated by a consistent set of standards that
will penalize risky behaviour and encourage strong risk
management.
But who will those regulators be and what
kind of rules will they enforce?
“There is asymmetry
in our financial systems,” observed Chukwuma
C. Soludo, Governor of the Central Bank of Nigeria.
“Finance is global, but the regulatory framework and supervision
are essentially national.”
The Basel II Accord
does set out international standards on bank capital adequacy,
among other things, but it is a voluntary agreement. “If you don’t
adopt the principles, you are not sanctioned for non-compliance,”
said Soludo. “And if you have a country with
lax regulations, that’s where the next crisis will come from.”
Yang Kaisheng, Vice-Chairman, Industrial and
Commercial Bank of China, People's Republic of China, said
Basel II is
a very positive agreement with which his bank and China’s
financial sector as a whole aim to be in voluntary compliance.
Asked whether
emerging countries such as China are looking for other models now
that the US banking system has proved flawed, Yang said he
believes the US has the capacity to correct its own mistakes.
When it does,
the bank of the future in China will likely
be similar to the bank of the future in the United States.
Davos -
The New Normal
Experts predict that investors will look for
more stability, be forced to use different investment horizons,
and will no longer perceive risk the same way after the financial
crisis.
What does the “new normal” look like for investors?
Key Points
• Financial regulation, while much needed,
must allow for growth and investment in the real economy. The new
normal should be about finance getting back to supporting the real
economy
• We are seeing a return to the “old normal”. Growth and profits
will come from entrepreneurs capitalizing on mega-trends – BRICs,
healthcare costs, social networks, technology, etc. – that have
not changed
• There is concern that investor behaviour has not really changed
and measures need to be taken to prevent a return of the crisis
• The crisis showed that the nature or character of financial
instruments can change. Liquid mortgages quickly became illiquid
real estate, transforming the underlying market structure
• Regulators need to focus on capital standards, risk
concentration and “shadow banking” as opposed to size of financial
institutions. In the US, for example, it was noted that many
community bank losses still have to be worked through the system
• There is risk to recovery if stimulus money is withdrawn too
quickly. In the US, it is estimated that 90% of GDP growth in 2009
was due to the stimulus
Synopsis
Global coordination of financial regulation is needed, while
recognizing that one size does not fit all.
Volatility and “regulatory arbitrage” may be
opportunities for financiers, but they are not good for the real
economy.
Adequate stability and rules are needed to encourage long-term
investments.
There should be better accounting of risks for all stakeholders.
Forward-looking provisioning models were mentioned as a way to
account for risk and return throughout the life cycle of an
investment. There was also discussion on mark-to-market accounting
and whether it was applied to aggressively.
In either case transparency is needed.
Weighting risk in determining capital requirements was encouraged,
as well as
the adoption of the Basel II Accord in the US and elsewhere. The
idea of Basel III was mentioned,
and it was pointed out that three of the world’s six largest banks
are in China.
Davos -
Financial Risk Management
Key Points
• National banking systems have been
affected unequally by the financial crisis – in part because of
differences in regulatory systems and attitudes towards risk.
The experience of countries such as Canada and Brazil, which had
relatively little exposure to the toxic assets at the heart of the
crisis, may offer valuable lessons for regulatory reform
elsewhere.
• The role of technology in
increasing systemic risk has received less attention than it
deserves.
Innovations such as Internet banking allowed marginal players –
such as Icelandic banks – to quickly enter new markets, rendering
traditional regulatory barriers obsolete.
• External regulators can only do so much to
reduce excessive risk taking. Internal governance structures –
compensation policies in particular – must also be changed.
But reform may be difficult to achieve at public corporations,
given that risk takers, such as proprietary traders, often have
little exposure in the event of loss.
• Financial reform will fail unless it
aggressively addresses the issue of regulatory arbitrage – the
ability of firms to take advantage of regulatory loopholes –
between either markets or countries, to gain a cost or other
competitive advantage.
However, policy-makers need to recognize that the development of
innovative products in non-regulated industries will always pose a
threat to existing regulatory systems.
Synopsis
The financial crisis obviously has revealed major flaws in the
management of risk by internal and external regulators.
However, some regulatory systems, and some
countries, have performed better than others.
What lessons can policy-makers, financial managers and investors
learn from the experience of the past two years?
It has been noted that the crisis has been
largely been a developed world affair, with many emerging
financial sectors suffering only modest damage.
In part, this reflects the relatively undeveloped nature of these
sectors; many often lacked the wholesale funding markets and
derivative instruments that caused, or at least magnified, the
crisis in the world’s major financial
centres.
However, the ability of many developing countries to escape the
crisis more or less unscathed also reflects the lessons their
policy-makers and regulators learned from the emerging market
crises of the 1990s – chiefly, the need to beware of sudden
changes in risk tolerance in the short-term money markets for
funding, a threat that risk officers and traders at
Bear Stearns and Lehman Brothers eventually
also learned, much to their sorrow.
As one of the few developed countries to also sidestep the crisis,
Canada offers applicable lessons, such as the need for closer
supervision of mortgage lending practices, including credit
scoring practices, the importance of having the capability for
early regulatory intervention, and the wisdom of supplementing
risk-based capital standards,
such as the Basel II requirements,
with direct controls on leverage.
This largely prevented Canadian banks from using techniques such
as off-balance sheet vehicles to avoid capital requirements.
One of the most dramatic changes revealed by the crisis was the
fact that the size of a nation’s banking system no longer needs to
bear any relation to the size of its economy. T
The ability of Icelandic banks to use the
Internet to bypass the need for physical infrastructure and
quickly gain share in the single European banking market
highlights both the risks that can arise from the intersection of
technology and deregulation, and the need for regulation at the
pan-European or global level.
Although considerable doubts have arisen about the ability of
global policy-makers to create a truly multilateral financial
regulatory system, important steps have already been taken in that
direction, via the creation of the Financial Stabilization Board
and the mutual assessment initiative
endorsed by the G20.
The outline of a broad international regulatory framework now
exists, as well as a timetable for building that framework.
Pressure needs to be brought on political leaders to meet that
timetable.
Davos - The Next
Global Crisis
The G20 is focused on preventing a repeat of
the financial crisis, but the next global crisis to
threaten the global economy is likely to be off the radar screen
of policy-makers, as have previous ones.
What warning signals need our urgent attention?
Key Points
• Three flash points are seen as sparking the next global crisis:
1) out of control sovereign debt;
2) over regulation of the financial system; and
3) protectionism leading to the demise of free trade and
globalization
• Government debt in the US and Europe has risen by more than 75%.
In their zeal to avert a Great Depression, policy-makers might
have mortgaged the future for short-term gain
• Sarbanes Oxley in the US is said to have caused financial
institutions to flee New York for London. With internationally
coordinated regulation, companies have nowhere to go and would be
crushed by excessive global rules
• The benefits of free trade and globalization have not been
distributed equally, causing disenchantment among voters that
could pressure governments to raise trade and other barriers,
which could spark the next global crisis
• The audience voted sovereign debt as most likely to cause the
next global crisis (50.7%), followed by protectionism (37.3%).
Over regulation is regarded as a distant crisis (12%)
Davos -
Regulation and
Capital Market Competition
Marcus
Agius · Charlie McCreevy · Duncan Niederauer · James S. Turley
Moderated by Howard Davies - Friday 25 January
Some
key insights from this session:
The integration of
global financial markets requires a corresponding harmonization of
regulatory systems, including the mutual recognition of
registration, disclosure, capital adequacy and accounting standards.
Progress has been
made, as seen by the adoption of the
Basel I and Basel II
bank capital accords, and the efforts to promote the convergence of
International Finance Reporting Standards with the US GAAP. However,
more needs to be done.
The past few years have seen a "sea change" in
attitudes among US regulators, particularly at the Securities and
Exchange Commission (SEC). US authorities no longer insist on the
superiority of US standards, recognizing that in a fully globalized
market it is not realistic to expect all participants to conform to
the regulatory practices of one country.
While the recent collapse of the US sub-prime mortgage market – and
the subsequent spread of financial volatility to other global
markets – highlights the need for regulatory coordination and
cooperation, it is important for regulators not to overreact.
Policy-makers, in
particular, need to avoid the temptation to pass legislation simply
for the sake of appearing to "do something" about the crisis.
That said, a regulatory response to the crisis is inevitable. The
financial services industry should take a proactive approach and
consult with regulators about possible reforms. Given the complexity
of the issues, any regulatory response will fail without "massive
buy-in" from market participants.
The major credit rating agencies can expect increased regulatory
scrutiny, particularly in the EU.
Perceptions of conflicts of interest in their
relationships with securities issuers, in particular in their
compensation practices, ensure that "things will not remain exactly
the same".
The crisis has
also highlighted the danger of focusing regulatory attention in the
wrong areas, based on perceptions of risk that may be misplaced.
For example, recent years have seen repeated
calls in the US and the EU for tighter regulation of hedge funds and
private equity funds. Yet the sub-prime losses have been most
heavily concentrated in the most heavily regulated entities in the
system – the commercial and investment banks.
The trend towards cross-border consolidation of financial exchanges
– as seen by the 2006 merger of the New York Stock Exchange and
Euronet into the first transatlantic bourse – has helped "catalyse"
the issue of regulatory harmonization. In particular, it has forced
regulators to confront the conflict between the US emphasis on
rule-based regulation and the European preference for
principles-based standards.
Even with the US market, this conflict remains problematic, as seen
by the differing approaches taken by the SEC and the
Commodities Futures Trading Corporation (CFTC),
which has authority over the listed futures and options markets.
The SEC
traditionally has favoured a rules-based approach, while the CFTC
has shown a greater willingness to use principles-based concepts.
Given the tight links between the derivatives and equity markets,
this dichotomy is increasingly problematic.
For this reason,
the US Treasury has encouraged the two agencies to reconcile their
differences.
In the wake of Société Générale’s recent "rogue trader" scandal,
financial institutions will need to redouble their efforts to manage
risk and prevent fraud.
Davos -
President
Sarkozy calls for a “new Bretton Woods”
Davos-Klosters, Switzerland, 27 January 2010
In his opening
address at the World Economic Forum Annual Meeting, President
Nicolas Sarkozy of France said that it will not be possible to
emerge from the global economic crisis and protect against future
crises if the economic imbalances that are at the root of the
problem are not addressed.
“Countries with trade surpluses must consume more and improve the
living standards and social protection of their citizens,” he
remarked.
“Countries with deficits must make an effort to consume a little
less and repay their debts.” The world’s currency regime is central
to the issue, Sarkozy argued.
Exchange rate instability and the under-valuation of certain
currencies lead to unfair trade and competition, he said. “The
prosperity of the post-war era owed a great deal to Bretton Woods,
to its rules and its institutions. That is exactly what we need
today; we need a new Bretton Woods.”
Sarkozy said that
France would place the reform of the international monetary system
on the agenda when it chairs the G8 and G20 next year.
In his address, Sarkozy also called for an examination of the nature
of globalization and capitalism.
“This is not a crisis in globalization; this is a crisis of
globalization,” he said.
“Finance, free
trade and competition are only means and not ends in themselves.”
Sarkozy added that banks should stick to analysing credit risk,
assessing the capacity of borrowers to repay loans and finance
economic growth.
“The role of the
bank is not to speculate.” He also questioned the rewarding of high
compensation and bonuses for CEOs whose companies lose money.
Capitalism should not be replaced but it has
to be changed, the French president declared. “We will only
save capitalism by reforming it, by making it more moral.”
Speaking before Sarkozy, Doris Leuthard, President of the Swiss
Confederation and Federal Councillor of Economic Affairs, told
participants that the international community has to bridge the gap
between rhetoric and reality as it tackles major challenges such as
the global economic crisis, climate change and the
Doha Round of multilateral trade negotiations.
“We must all sit
down together in a responsible manner, bring our part of the
solution to the table and allow a conclusion to be reached that
benefits us all.” While “rhetoric and reality all too often diverge
by large margins,” Leuthard said, the bottom line is that “people
need jobs and a salary.” She concluded: “We have talked enough. It
is now time to get moving.”
Sarbanes
Oxley News
Section 406 of the
Sarbanes Oxley Act
We will start from the Act
SEC. 406. CODE
OF ETHICS FOR SENIOR FINANCIAL OFFICERS.
(a) CODE OF ETHICS DISCLOSURE.—The Commission shall issue rules to
require each issuer, together with periodic reports required
pursuant to section 13(a) or 15(d) of the Securities Exchange Act
of 1934, to
disclose
whether or not, and if not, the reason therefor, such issuer has
adopted a code of ethics for senior financial officers, applicable
to its principal financial officer and comptroller or principal
accounting officer, or persons performing similar functions.
(b)
CHANGES IN CODES OF ETHICS.—The
Commission shall revise its regulations concerning matters
requiring prompt disclosure on Form 8–K (or any successor thereto)
to
require the
immediate disclosure, by means of the filing of such
form, dissemination by the Internet or by other electronic means,
by any issuer of any
change in or
waiver of the code of ethics for senior financial officers.
(c) DEFINITION.—In this section, the term
‘‘code of ethics’’ means such standards as are reasonably
necessary to promote—
(1) honest and ethical conduct, including the ethical handling of
actual or apparent conflicts of interest between personal and
professional relationships;
(2) full, fair, accurate, timely, and understandable disclosure in
the periodic reports required to be filed by the issuer; and
(3) compliance with applicable governmental rules and regulations.
(d) DEADLINE FOR RULEMAKING.—The Commission shall—
(1) propose rules to implement this section, not later than 90
days after the date of enactment of this Act; and
(2) issue final rules to implement this section, not later than
180 days after that date of enactment.
We will
continue with the Final Rule from the SEC
Securities and
Exchange Commission, Final Rule
The final rules require a company to
disclose whether it has adopted a code of ethics that
applies to the registrant's principal executive officer, principal
financial officer, principal accounting officer or controller, or
persons performing similar functions.
If the
company has not adopted such a code of ethics, it must explain why
it has not done so.
Final Definition of "Code of Ethics"
The final rule defines the term "code of ethics" as written
standards that are reasonably designed to deter wrongdoing and to
promote:
• Honest and ethical conduct, including the
ethical handling of actual or apparent conflicts of interest
between personal and professional relationships;
• Full, fair, accurate, timely, and understandable disclosure in
reports and documents that a registrant files with, or submits to,
the Commission and in other public communications made by the
registrant;
• Compliance with applicable governmental laws, rules and
regulations;
• The prompt internal reporting to an appropriate person or
persons identified in the code of violations of the code;45 and
• Accountability for adherence to the code.
We eliminated
the component of the definition requiring the code to promote the
avoidance of conflicts of interest, including disclosure to an
appropriate person or persons identified in the code of any
material transaction or relationship that reasonably could be
expected to give rise to such a conflict, because the conduct
addressed by this component already is addressed by the first
prong of the proposed definition, requiring honest and ethical
conduct and the ethical handling of actual and apparent conflicts
of interest.
We are not adopting commenters'
suggestions that we set forth additional ethical principles that
the code of ethics should address.
We continue to believe that
ethics codes do, and should,
vary from
company to company and that
decisions as to the specific provisions
of the code, compliance procedures and disciplinary measures for
ethical breaches
are best left
to the company.
Such an approach is consistent
with our disclosure-based regulatory scheme.
Therefore,
the rules do
not specify every detail that the company must address
in its code of ethics, or prescribe any specific language that the
code of ethics must include.
They further
do not specify
the procedures that the company should
develop, or the types of sanctions that the company should impose,
to ensure compliance with its code of ethics.
We strongly encourage
companies to adopt codes that are
broader and
more comprehensive than necessary to meet the
new disclosure requirements.
We have added an instruction to the code of ethics disclosure item
indicating that a company
may
have separate codes of ethics for different types of officers.
The instruction also clarifies
that the provisions of the company's code of ethics that address
the elements listed in the definition and apply to those officers
may be part of a broader code that addresses additional issues and
applies to additional persons, such as all executive officers and
directors of the company.
Filing of
Ethics Code as an Exhibit
We proposed to require a company to file a copy of its ethics code
as an exhibit to its annual report.
We received several comment
letters stating that the rules should not include this
requirement.
A common ground for objection
was that some codes are extremely lengthy and therefore would be
difficult to file electronically on our
EDGAR system.
Some also asserted that
ethics codes
may contain a significant amount of detailed information that
would not be of particular interest to investors.
We are not entirely persuaded by the commenters that we should not
require a company disclosing that it has a code of ethics that
applies to its principal executive officer and senior financial
officers to make those provisions of the code available.
However, more flexibility
seems appropriate in light of the fact that many companies already
post their codes on their websites.
We therefore are adopting
rules that will allow companies to choose between
three alternative methods of making their ethics codes
publicly available.
First, a company may file a copy of
its code of ethics that applies to the registrant's principal
executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions and addresses the specified elements
as an exhibit
to its annual report.
Alternatively, a company may post the text
of its code of ethics, or relevant portion thereof, on its
Internet
website, provided however, that a
company choosing this option also must disclose its Internet
address and intention to provide disclosure in this manner in its
annual report on Form
10-K, 10-KSB,
20-F or 40-F
As another
alternative, a company may provide an
undertaking in its annual report on one of these forms
to provide a
copy of its code of ethics to any person without charge upon
request.
If a company is complying with this disclosure item in its annual
report, inclusion of the company's website
address in the annual report will not, by itself, include or
incorporate by reference the information on the company's website
into the annual report, unless the company otherwise acts to
incorporate the information by reference
Also, we understand that a
company may have multiple websites that it uses for various
purposes, such as investor relations, product information and
business-to-business activities.
We intend the requirement to
disclose the company's website address to mean the website the
company normally uses for its investor relations functions.
Will
Obama reforms change considerably before they become law?
Alistair Darling
said yes, because of the "Sarbanes Oxley
Effect".
“America will no doubt be
very
conscious of the Sarbanes-Oxley effect,
where they legislated in haste to fix a problem. What we must
guard against is creating opportunities for arbitrage between
different zones of financial regulation — that is why we need to
work together.”
Alistair Darling, Chancellor of the
Exchequer
(The British Cabinet minister who is responsible for economic and
financial matters)
Basel ii News
Group of Central Bank Governors and Heads of Supervision reinforces
Basel Committee reform package
11 January 2010: The Group of Central Bank Governors and Heads of
Supervision,
the oversight body of the Basel Committee
on Banking Supervision,
met on 10 January at the Bank for International Settlements.
It welcomed the substantial progress of the Basel Committee to
translate the Group's September 2009 agreements into a concrete
package of measures, as elaborated in the Committee's 17 December
2009 Consultative proposals for
Strengthening the resilience of the banking sector and the
International framework for liquidity risk measurement, standards
and monitoring.
Governors and Heads of Supervision requested the Committee to
deliver a fully calibrated and finalised package of reforms by the
end of this year.
President Jean-Claude Trichet, who chairs the Group, emphasised that
"timely completion of the Basel Committee reform programme is
critical to achieving a more resilient banking system that can
support sound economic growth over the long term."
Central Bank Governors and Heads of Supervision welcomed the Basel
Committee's focus on both microprudential reforms to strengthen the
level and quality of international capital and liquidity standards,
as well as the introduction of a macroprudential overlay
to address procyclicality and systemic risk.
They also provided guidance and noted the importance of
making progress in the following key areas:
Provisioning:
It is essential that accounting standards setters and supervisors
develop a truly robust provisioning approach based on expected
losses (EL).
Building on the Basel Committee's August 2009 Guiding Principles for
the replacement of IAS 39,
a sound EL provisioning approach should achieve the following key
objectives:
1) Address the
deficiencies of the incurred loss approach without introducing an
expansion of fair value accounting
2) Promote adequate and more forward looking provisioning through
early identification and recognition of credit losses in a
consistent and robust manner
3) Address concerns about
procyclicality
under the current incurred loss provisioning model
4) Incorporate a broader range of credit information, both
quantitative and qualitative
5) Draw from banks' risk management and capital adequacy systems and
6) Be
transparent and subject to appropriate internal and external
validation by auditors, supervisors and other constituents
So-called
"through-the-cycle" approaches
that are consistent with these principles and which promote the
build up of provisions when credit exposures are taken on in good
times that can be used in a downturn would be recognised.
The Basel Committee
should translate these principles into a practical proposal by its
March 2010 meeting
for subsequent consideration by both supervisors and accounting
standards setters.
Introducing a framework of countercyclical capital buffers:
Such a framework could contain two key elements that are
complementary.
First,
it is intended to promote the build-up of appropriate buffers at
individual banks and the banking sector that can be used in periods
of stress.
This would be achieved through a
combination of capital conservation measures, including actions to
limit excessive dividend payments, share buybacks and compensation.
Second,
it would achieve the broader macroprudential goal of protecting the
banking sector from periods of excess credit growth through a
countercyclical capital buffer linked to one or more credit
variables.
Addressing the risk of systemic banking institutions: Supervisors
are working to develop proposals
to address the risk of systemically important banks (SIBs).
To this end,
the Basel Committee has established a Macroprudential Group.
The Committee should develop a menu of approaches using continuous
measures of systemic importance to address the risk for the
financial system and the broader economy.
This includes evaluating the pros and cons of a capital and
liquidity surcharge and other supervisory tools as additional
possible policy options such as resolution mechanisms and structural
adjustments.
This forms a key input to the Financial Stability Board's
initiatives to address the "too-big-to-fail" problem.
Contingent capital:
The Basel Committee is reviewing the role that contingent capital
and convertible capital instruments could play in the regulatory
capital framework.
This includes possible entry criteria for such instruments in Tier 1
and/or Tier 2 to ensure loss absorbency and the role of contingent
and convertible capital more generally both within the regulatory
capital minimum and as buffers.
Liquidity:
Based on information collected through the quantitative impact
assessment, the Committee should flesh out the details of the global
minimum liquidity standard, which includes both the 30-day liquidity
coverage ratio and the longer term structural liquidity ratio.
Central Bank Governors and Heads of Supervision will review concrete
proposals on each of these topics
later this year.
They endorsed the Committee's approach to extensive consultation on
and comprehensive assessment of the proposed reforms, covering both
the impact on the banking sector and the broader economy, before
arriving at a final calibration of the minimum level of capital and
the buffers above the minimum at the end of this year.
They stressed that
the aim of the new global standards
should be to
achieve a better balance between banking sector stability and
sustainable credit growth.
President Trichet noted that "the Group of Central Bank Governors
and Heads of Supervision will provide strong oversight of the work
of the Basel Committee during this phase, including both the
completion and calibration of the reforms."
The fully calibrated set of standards will be developed by the end
of 2010
to be phased in as financial conditions improve and the economic
recovery is assured
with the aim of implementation by the end of 2012.
This includes appropriate phase-in measures and grandfathering
arrangements for a sufficiently long period to ensure a smooth
transition to the new standards.
Basel Committee on Banking Supervision, The Joint Forum
Stocktaking on the use of credit ratings - June 2009
Introduction
A. Background
In its report to the
G7 titled Report of the Financial Stability
Forum on Enhancing Market and Institutional Resilience, the
Financial Stability Forum (FSF) requested the Joint Forum to
conduct a stocktaking of the uses of external credit ratings by
its member authorities in the banking, securities and insurance
sectors.
The request also suggested that authorities
review whether their regulations and/or supervisory policies
unintentionally give credit ratings an official seal of approval
that discourages investors from performing their own due
diligence.
To implement the FSF request, the Joint Forum Working Group on
Risk Assessment and Capital (JFRAC) prepared and circulated to
member authorities a questionnaire on the use of credit ratings in
their jurisdictions.
The questionnaire was designed to elicit information regarding
member authorities’ use of credit ratings in legislation
(statutes), regulations (rules), and/or supervisory policies
(guidance) affecting, or generated by, such authorities
(collectively, LRSPs).
he questionnaire requested information on the definitions (either
internal or via crossreference to an external source) of “credit
ratings,” “credit rating agencies,” or any related terms as well
as any references to specific credit rating agencies in LRSPs.
Member authorities were also asked questions regarding the usage
of credit ratings and/or references to credit rating agencies (or,
in either case, related terms) in their LRSPs, including an
explanation of what each LRSP was designed to accomplish and the
purpose of using credit
ratings in the LRSP.
Finally, the questionnaire asked member authorities to describe
their assessments, if any, of unintended implications of such
uses, in particular, whether the use of credit ratings has had the
effect of implying an endorsement of such ratings and/or rating
agencies or discouraging investors from performing their own due
diligence.
JFRAC received a total of 17 surveys from member authorities,
representing 26 separate agencies from 12 different countries, as
well as five responses describing international frameworks.
This report is intended to serve as a stocktaking of member authorites’ use of credit ratings.
This stocktaking is based entirely on the responses received from
member authorities in response to the questionnaire circulated by
JFRAC and, with the exception of the descriptions of international
frameworks prepared by member authorities, does not address the
use of credit ratings in any other jurisdictions.
The report is not intended to be, and should not be construed as,
an expository discussion of how credit ratings are developed, what
information they are intended to convey, or how and by whom they
are regulated.
Furthermore, the report does not express any
viewpoint regarding the quality, accuracy, or any other subjective
evaluation of credit ratings and does not take any position on the
appropriateness of member authorities’ use of credit ratings.
Pursuant to the FSF mandate, the questionnaire circulated to
member authorities solicited their individual views on potential
unintended consequences of their use of credit ratings in LRSPs (ie,
the appearance of a “seal of approval”).
In preparing their
responses to this portion of the questionnaire, member authorities
were not expected to conduct any independent research on the
issue, but instead simply to convey their broad impressions and
preliminary views.
As such, the summary of these views in this report should not be
construed as a definitive survey of member authorities’ positions;
the report expresses the range of viewpoints expressed by member
authorities on the issue of the unintended consequences of the use
of credit ratings in LRSPs and takes no independent position on
the subject.
Key terms used
Several key terms that are used throughout this report bear
mention.
The two most significant related terms for subsets of “credit
rating agencies” are
“nationally recognised statistical rating
organisations” (NRSROs), which are regulated by the United States
Securities and Exchange Commission (US SEC), and
“external credit
assessment institutions” (ECAIs), a term set forth in the Basel II
framework.
The term “NRSRO” is defined in United States (US) legislation and
is limited to credit rating agencies that have applied for and
been granted registration by the US SEC.
This statutory definition of NRSRO is cross-referenced extensively
in US regulations as well as in the Canadian Securities
Administrators’ national instrument relating to the
Multijurisdictional Disclosure System (MJDS).
Almost half of the respondents referenced the term “ECAI,” with
several specifically referencing the Basel II framework and/or the
Committee of European Banking Supervisors (CEBS) “Guidelines on
the recognition of External Credit Assessment Institutions” (CEBS
Guidelines) as the source for that term.
While the amended Basel II framework sets forth criteria to be
used by national supervisors for the “recognition” of ECAIs, it
does not contain a
definition of the term.
Consistent with that framework, the Capital Requirements Directive
(CRD) that implements the Basel II framework in the European
Union (EU) does not define an ECAI, but instead sets forth
criteria for the recognition of eligible ECAIs.
A small minority of respondents indicated that their LRSPs include
an explicit definition of the term “ECAI.”
For instance, under the Australian prudential standards, an ECAI
is defined as “an entity that assigns credit ratings designed to
measure the creditworthiness of a counterparty or certain types of
debt obligations of a counterparty.”
The majority of respondents indicated that their
legislation (statutes),
regulations (rules), and/or supervisory policies (guidance) -
LRSPs
reference
specific credit rating agencies.
All but one of those respondents mentioned Moody’s Investors
Service, Standard & Poor’s Ratings Services, and Fitch Ratings.
Several respondents indicated that the individual credit rating
agencies listed in their LRSPs are formally reviewed on a regular
basis, in some cases on a fixed schedule (ie, annually or every
five years).
Several others noted that the Basel II and/or CEBS designation
procedures for ECAIs also applied to the removal of the ECAI
designation.
In addition, a number of respondents indicated that their LRSPs
naming individual credit rating agencies could be amended through
their jurisdiction’s standard legislative or regulatory process.
Finally, the Markets in Financial Instruments Directive (MiFID),
an EU law designed to provide a harmonised regulatory regime for
investment services, defines the term “competent rating agency”
for that specific purpose as an entity that “issues credit ratings
in respect of money market funds regularly and on a professional
basis and is an eligible ECAI within the meaning of Article 81(1)
of Directive 2006/48/EC.”
Basel Framework
Basel II serves as the foundation for the use of credit ratings in
a significant number of member jurisdictions.
These jurisdictions have implemented the Basel II framework into
their domestic LRSPs to varying degrees, with most appearing to
have incorporated the substantial elements of the framework into
their domestic LRSPs.
As alluded to above, the EU implemented Basel II via the CRD,
which applies to both banks and investment firms.
Uses of credit ratings
As described in greater detail below, credit ratings are generally
used in member jurisdictions for five key purposes:
(a) determining capital requirements;
(b) identifying or classifying assets, usually in the context of
eligible investments or permissible asset concentrations;
(c) providing a credible evaluation of the credit risk associated
with assets purchased as part of a securitisation offering or a
covered bond offering;
(d) determining disclosure requirements;
and (e) determining prospectus eligibility.
In general, the member authorities that responded to the survey
reported a greater use of credit ratings in their LRSPs covering
the banking and
securities sectors than in their LRSPs for the insurance sector.
A. Capital
1. Banking and securities sectors
This category features the broadest application of the use of
credit ratings.
Member authorities from every jurisdiction submitting responses
indicated that their LRSPs contained provisions using credit
ratings for the purpose of determining net or regulatory capital,
and more LRSPs are applied to capital requirements than to any
other category of use.
Credit ratings were generally used in those LRSPs as a means of
mapping credit risks to capital charges or risk weights.
A related use for ratings in LRSPs is the determination of margin
rates; for example, certain sovereign bonds and debentures may be
subject to lower margin rates as a result of receiving investment
grade ratings.
In the Basel II framework, external ratings are used for the
purpose of enhancing the risk sensitivity of the framework, for
example, by being incorporated into assessments of the credit
quality of an exposure or creditworthiness of a counterparty – and
thus the imposition of capital requirements.
External ratings are primarily used under the standardised
approach for credit risk,10 but also to risk-weight
securitisations exposures.
The different uses of external ratings generally correspond to
probability of default treatments under the standardised
approaches, and to situations where the use of internally
generated ratings is impossible or difficult given, for instance,
the lack of statistical data for securitised products.
In most cases, for member jurisdictions that have incorporated the
Basel II framework, the external ratings that can be used for the
purpose of determining regulatory capital are limited to those
provided by rating agencies recognised by national supervisors as ECAIs.
Supervisors assess whether these criteria are fulfilled and aim at
identifying rating agencies that issue ratings that are
sufficiently sound and robust to warrant using them to determine
the appropriate regulatory capital levels. Supervisors are also in
charge of articulating the
conditions and details for the use of ratings (eg, in the EU, for
the mapping of external ratings to the regulatory risk-weights or
credit quality steps).
All members of the EU have implemented the CRD, which implements
the Basel II framework for both banks and investment firms.
Within the EU, the decision as to whether or not to recognise an ECAI is within each member’s discretion, although the “joint
assessment
process” set forth in the CEBS Guidelines is designed to achieve a
consistent approach among EU member states.
In Australian LRSPs for authorised deposit-taking institutions,
mappings of credit ratings are used to calculate regulatory
capital risk weights for certain credit risk and securitisation
exposures, as set out in the Basel II framework.
In Canada, all banks have implemented the Basel II framework and
hence external ratings are used to assess the credit risk of an
exposure.
In Japan, credit ratings issued by Designated Rating Agencies (DRA)
are used to estimate market risks and counterparty risks for the
purpose of calculating the capital adequacy ratios for securities
companies.
Japan also noted that for calculating the capital adequacy ratios
for banks and other deposit-taking institutions, credit ratings
issued by ECAIs are used subject to the Financial Services Agency
(JFSA) ordinance under the Banking Act.
In the United States, which features the most widespread use of
credit ratings in LRSPs that establish capital requirements in the
securities and banking sectors, the use of credit ratings for
capital purposes is almost exclusively restricted to those issued
by credit rating agencies
designated as NRSROs through the US SEC’s registration process.
2. Insurance Sector
In the European Union, the existing insurance and reinsurance
directives do not contain any provisions that place reliance on
credit rating agencies.
There is no explicit credit risk charge for the solvency margin in
the Solvency I framework.
The solvency margin in the Solvency I framework is not the sum of
different capital charges related to different risks, but a single
capital charge calibrated to reflect all the risks an insurance
company faces.
Nevertheless, the importance of credit quality is taken into
account in the rules applying to asset allocation; but they are
not based on the use of credit ratings.
For instance, Article 24 of Directive 2002/83/EC establishes rules
for investment diversification without any reference to credit
ratings.
An insurance company must diversify the assets that cover its
liabilities towards policyholders and limit its investments in
certain asset classes as a percentage of total liabililties.
However, a number of member jurisdictions’ national laws
implementing the investment rules of the current Solvency I
Directives do refer to, or place reliance on, ratings in order
to determine whether a certain asset is authorised or eligible to
cover technical provisions.
Moreover, in a number of member jurisdictions, (re)insurance
undertakings are required, as part of their internal reinsurance
policy, to pay special attention to the financial strength of
their reinsurers, using ratings as a proxy.
For example, in the Netherlands, when pension funds reinsure their
assets, they must maintain buffers to cover the risk of the
reinsurance company defaulting on its obligations.
The size of these buffers depends on the credit spread of the
reinsurance company.
As a gesture to the sector, on its website, De Nederlandsche Bank
publishes credit spreads that (smaller) pension funds can use when
they cannot obtain market data.
In the United Kingdom, the Insurance Prudential Sourcebook
provides a table with “listed rating agencies” (A.M. Best Company,
Fitch Ratings, Moody’s Investor Service, Standard & Poor’s Ratings
Services), including credit rating descriptions and “spread
factors.”
With regard to insurance capital resources requirements,
credit ratings from these firms are used in determining assumed
spread stresses.
In the United States, insurance regulators require bonds and
preferred stocks to be reported in statutory financial statements
in one of six National Association of Insurance Commissioners (NAIC)
designations categories that denote credit quality.
If an accepted rating organisation (ARO) has rated the security,
the security is not required to be filed with the NAIC’s
Securities Valuation Office (SVO).
Rather, the ARO rating is used to map the security to one of the
six NAIC designation categories.
The NAIC designations are primarily designed to assist regulators
(as opposed to investors) to monitor the financial condition of
their insurers.
Finally, in light of the impact that the credit market crisis had
on the credit ratings of the financial guarantors and the bonds
they insure, the NAIC announced that the SVO will be issuing
“substitute” ratings for some municipal bonds. In doing so, the
NAIC will be assessing the creditworthiness of the municipality
that issued the debt.
These credit ratings will be used to determine the risk based
capital charge for the security.
The insurance regulators indicated that the proposal will
“decouple” the NAIC rating from the rating agency process.
In Canada, a significant portion of an insurer’s capital
requirement (especially for a life insurer) arises from its
exposure to credit risk.
This component of the overall insurer capital requirement is
determined using asset default factors.
For rated short term securities, bonds, loans and private
placements, these factors are based on the rating agency grade.
In its life insurer capital guideline, the Office of the
Superintendent of Financial Institutions (OSFI) states that:
“A company must consistently follow the latest ratings from a
recognized, widely followed credit rating agency.
Only where that rating agency does not rate a particular
instrument, the rating of another recognized, widely followed
credit rating agency may
be used.
However, if the Office believes that the results are
inappropriate, a higher capital charge would be required.”
Further, in Canada, asset default factors for preferred shares,
where rated, are based on the rating agency grade.
For financial leases where rated, and the lease is also secured by
the general credit of the lessee, the asset default factor is
based on the rating agency grade.
Other examples of the use of credit ratings in LRSPs governing
capital requirements are found in Japan, where credit ratings
issued by DRAs are used to calculate the solvency margin ratios
regarding estimating credit risks for insurance companies, and
Australia, where prudential standards for both general insurers
and life insurers use credit ratings to assign counterparty grades
used in regulatory capital requirements.
B.
Asset Identification
1. Banking and securities sector
The field of LRSPs cited by the second highest number of
respondents was, broadly speaking, asset
identification/categorisation.
This includes, for example, the designation
of permissible investments and/or required investments for mutual
funds as well as the establishment of, and exceptions to,
investment concentration limits for particular types of assets.
In most cases, member jurisdictions reported that credit ratings
were used in both the banking and securities sectors. In addition,
the United Kingdom Financial Services Authority (UK FSA) noted
that credit ratings are not used in any of its three financial
sectors for asset identification.
In the EU, the Undertakings for
Collective Investment in Transferable
Securities Directives (UCITS Directives) on collective
investment schemes does not contain provisions which make
reference to credit ratings.
However, Commission Directive 2007/16/EC,22 which clarifies
certain definitions used in the UCITS Directives, contains two
specific references to credit ratings relating to money market
instruments.
In Japan, a securities dealer is
generally not allowed to be a lead manager for a security issued
by its parent or subsidiary company.
However, it is exempt from this regulation if the security is
rated by a DRA that is subject to the Cabinet Office Ordinance of
Act on Financial Instruments Business Operators Art153(iv) under
the Financial Instruments and Exchange Act.
As in the case of US capital
requirement LRSPs, the extensive banking and securities LRSPs
using credit ratings in the US generally restrict such use to
credit ratings issued by credit rating agencies designated as
NRSROs through the US SEC’s registration process.
Finally, in Canada, both the OSFI and
the Ontario Securities Commission (OSC) use credit ratings in
their LRSPs for asset identification/categorisation purposes, for
example, in OSFI LRSPs determining eligible collateral for
securities lending loans and OSC LRSPs establishing money market
fund investment guidelines.
2.
Insurance sector
In the United States, many state
insurance laws describe permissible investments and/or
concentration limits in terms of ratings and/or NAIC designations
for insurance companies.
For example, New York State insurance law delineates permissible
investments for the portion of assets corresponding to insurance
liabilities.
In describing permissible investments in the obligations of
American institutions (other than an insurance company), the law
indicates that such investments are permitted as long as they meet
one of several criteria.
The list of criteria makes at least two references to rating
agency ratings.
First, investment in the obligations
of American institutions are permitted if they are rated “A” or
higher (or the equivalent thereto) by a securities rating agency
recognised by the Superintendent of Insurance.
Second, such investments are
permitted if such obligations are insured and, after considering
such insurance, are rated “Aaa” (or the equivalent thereto) by a
securities rating agency recognised by the Superintendent of
Insurance.
In addition, some state insurance laws provide limitations on the
types of obligations that financial guarantee insurance companies
can insure.
For example, New York State insurance law
provides that an insurer may insure municipal obligation
bonds that are not investment grade so long as at least 95 percent
of the insurer’s aggregate net liability is investment grade.
In Japan, insurance regulations
restrict the concentration of non-DRA rated assets to specific
ratios calculated under the Insurance Business Law and the
Ordinance for Enforcement of Insurance Business Law.
Ratings are also used in the German insurance sector for asset
identification as one possible criterion to determine the safety
of the asset.
C.
Securitisations and covered bond offerings
1. Banking and securities sectors
A significant number of respondents indicated that their LRSPs
addressing securitisations and/or covered bond offerings used
credit ratings, generally by requiring that securitisations
offered to investors be rated by one or more credit rating
agencies.
The breadth of the use of credit ratings in member authorities’
LRSPs addressing securitisations varied, with some covering all
securitisations and other covering only certain identified types
of securitisations (eg, in Italy, only where securities are sold
to non-professional investors).
The UK FSA noted that ECAI ratings are used to determine the
credit quality of a firm’s securitisations positions.
It also noted that with regard to the “covered bond” regime, it
may consider whether the counterparty has an appropriate credit
rating in considering whether an asset pool is of sufficient
quality.
In the United States and Canada, a number of banking and
securities LRSPs governing asset-backed instruments reference
external ratings.
2.
Insurance sector
No respondent stated that credit ratings are used in the insurance
sector regulation specifically with regard to securitisations.
In practice, supervision of insurance companies necessarily takes
into consideration credit ratings if insurance companies invest in
or guarantee securitisation products.
D.
Disclosure requirements
1. Banking and securities sectors
A significant number of respondents indicated that credit
ratings were used in their LRSPs regulating disclosure.
Such usage fell into two broad categories:
requirements and exemptions.
A number of respondents indicated that their LRSPs required rated
entities to disclose their ratings as well as to disclose when
such ratings were changed (or when they believed changes were
imminent).
Others noted that their disclosure LRSPs contained exceptions for
credit rating agencies, eg, explicitly exempting credit ratings
from requirements to disclose certain documents such as pre-sale
reports.
Several jurisdictions identified unique disclosure requirements.
For example, in Japan, the JFSA requires ECAIs to disclose certain
information regarding the securitisation exposures for credit
ratings to be eligible under the Basel II framework (eg, rating
criteria, rating transition matrix, and transaction-specific
information).
2.
Insurance sector
In Japan, DRA ratings are used to
determine which disclosures must be made with regard to certain
re-insurance contracts.
E.
Prospectus eligibility
Several respondents indicated that credit
ratings play a role in their LRSPs governing prospectuses for
securities offerings.
For example, certain types of prospectuses, such as “short form”
prospectuses, include an investment grade rating as one of the
criteria for eligibility to use the form.
Among EU jurisdications, the UK FSA
noted that in the United Kingdom, there are no references to
credit ratings with regard to prospectuses for equities.
For debt instruments, however, the prospectus must disclose the
credit ratings assigned to an issuer or its debt securities at the
request or with the cooperation of the issuer in the rating
process.
Italian legislation allows, in
certain instances, the sale of investment grade public bonds
issued by OECD States and originally placed with qualified
investors without the use of a prospectus.
In the US and Canada, the US SEC and
OSC each have a number of LRSPs referring to credit ratings in the
context of prospectus requirements, for example, their regulations
governing the use of short-form prospectuses in securities
offerings.
In Japan, issuers can use the
“reference system” of the securities registration statement and
the shelf registration system for the public offering of corporate
bonds if they meet certain requirements, including that they are
rated by DRAs.
Member assessments and initiatives
As noted in the introduction, the questionnaire submitted to
member authorities requested a description of their assessments,
if any, of unintended implications of the use of credit ratings in
LRSPs.
The questionnaire included specific questions as to whether the
use of credit ratings has had the effect of implying an
endorsement of such ratings and/or rating agencies or discouraging
investors from performing their own due diligence.
In addition to answering these questions, members provided the
working group with information concerning a number of initiatives
relevant to both such an assessment and the future use of credit
ratings in LRSPs.
A. Assessments on the impact of the use of credit ratings in LRSPs
No respondent reported that it had conducted a comprehensive,
formal assessment of the impact of the use of credit ratings in
LRSPs on investor behavior.
Nonetheless, many offered their views on the question.
In general, respondents were split as to whether their use of
credit ratings and/or reference to credit rating agencies has had
the effect of implying an endorsement of such ratings and/or
agencies, although a slight majority answered in the affirmative.
Respondents answering in the affirmative were generally cautious
in their analysis with only a small minority providing an
unconditional affirmative response.
Several respondents whose LRSPs use the term ECAI noted that
while Basel II’s introduction of the term
was merely meant to be in line with market practice concerning the
use of credit ratings issued by major credit rating agencies, the
designation of those agencies as ECAIs may have reinforced the
tendency of the marketplace to rely on the ratings excessively.
In addition, a small number of respondents noted that the
eagerness of some smaller credit rating agencies to obtain the
ECAI designation implied a perception that the designation carried
an endorsement effect.
Several respondents indicated some additional possible unintended
consequences of the use of credit ratings in LRSPs.
Some respondents noted that the use of credit ratings in LRSPs
could lead to increased demand for highly rated instruments issued
by off-balance sheet entities, as the use of credit ratings in
LRSPs may have “officialised” credit ratings for those instruments
and therefore made such highly rated investments more desirable.
One respondent suggested that the use of credit ratings in LRSPs
may have led to increased barriers to entry for the credit rating
industry, as the possible endorsement effect of designating
certain credit rating agencies in LRSPs could have negative
business effects on agencies not so designated.
Another respondent noted that the use of credit ratings in LRSPs
may have resulted in an amplified perception of credit risk as
predominant, resulting in reduced attention to other kinds of
risk, in particular liquidity and market
risks.
Finally, one respondent suggested a possible “relaxing effect” on
financial institutions’ internal assessment procedures, as firms
may have placed too much reliance on external ratings in lieu of
performing their own thorough due diligence of investment
opportunitites.
Respondents expressing a belief that their
use of credit ratings and/or reference to credit rating agencies
in LRSPs has not had any untended “endorsement” effects, generally
stressed the purely technical nature of their LRSPs’ use of credit
ratings.
Several respondents indicated that their ECAI
recognition/designation process was based purely on the
verification of a credit rating agency’s compliance with published
criteria and thus did not imply any endorsement.
In addition, a majority of respondents
expressed their belief that their use of credit ratings and/or
reference to credit rating agencies did not discourage investors
from performing their own due diligence.
Several respondents indicated that while there may have been
investor over-reliance on credit ratings, it was not clear whether
the use of credit ratings in LRSPs played a material part in such
over-reliance.
B. New Initiatives relating to credit ratings
1. Banking and securities sector
The US SEC noted that it has issued proposed rule amendments that
would eliminate references to NRSROs and their ratings from most
of its LRSPs, stating that by doing so, it would “remove any
appearance that the Commission has placed its imprimatur on
certain ratings.”
The OSC indicated that it was in the process of considering
replacing the word “approved” in its LRSPs employing credit
ratings with the word “designated” in order to “avoid
misconceptions regarding regulatory endorsement of credit ratings
or credit rating agencies.”
The OSC also noted that the Canadian Securities Administrators
have published a paper for consultation (until February 2009) that
seeks to reduce reliance on credit ratings in Canadian securities
legislation by considering possible alternatives to the use of
credit ratings or removing the references to credit ratings.
On July 31, 2008, the European Commission (EC) published two
working documents for consultative purposes.
The first document sought public views on a draft proposal for a
regulation with respect to the authorisation, operation and
supervision of credit rating agencies.
Following the public consultation, the EC adopted the proposal on
November 12, 2008, in the hope that the Council of the European
Union and the European Parliament would adopt the final proposal
before the next European Parliament elections in June 2009.
The main objective of the EC proposal is to
ensure that ratings are reliable and accurate pieces of
information for investors.
Credit rating agencies will be required to
deal with conflicts of interest, have sound rating methodologies
and increase the transparency of their rating activities.
The proposal also introduces a registration and surveillance
procedure for credit rating agencies whose ratings are used by
credit institutions, investment firms, insurance, assurance and
reinsurance undertakings, collective investment schemes and
pension funds within the EU.
The second document, of particular relevance to the Joint Forum’s
project, identifies in broad terms the references made to ratings
in the existing EU legislation and looks at possible approaches to
the potential problem of excessive reliance on ratings.
The EC proposed three possible (but not
mutually exclusive) approaches:
(1) require regulated and sophisticated investors to rely more on
their own risk analysis, especially for (relatively) large
investments;
(2) require that all published ratings include ‘health-warnings’
informing of the specific risks associated with investments in
these assets; and/or
(3) examine the regulatory references to credit ratings and
revisit them as necessary.
In August 2008, the JFSA added new supervisory “checkpoints” for
financial institutions in order to avoid uncritical reliance on
credit ratings when contemplating investment in structured
products.
The checkpoints seek to encourage an understanding of rating
methodologies and relevance (eg, what does the rating really mean
for purposes of the investment?) as well as establishing better
risk management functions within the organisations.
Since April 2008, in order to meet the checkpoint for the sales of
securitisation products, the JFSA ensures that distributing
institutions are effectively carrying out the collection, risk
valuation and disclosure of the underlying securitised assets, as
well as assessing the risk factors associated with securitised
products without relying solely on credit ratings.
The JFSA’s Financial System Council
has pointed out the necessity to review the use of DRA credit
ratings for the purpose of the reference system and the shelf
registration system for public offerings of corporate bonds.
In December 2008, the JFSA’s Financial System Council has also
reported that credit rating agencies should be regulated under the
framework of the registration system.
2. Insurance sector
Under current LRSPs, US insurers ceding to
reinsurers must obtain collateral from non-US licensed reinsurers
in order to reflect the statutory accounting credit for
reinsurance, but no collateral is required when ceding to US
licensed reinsurers.
Florida recently promulgated rules allowing ceding insurers to
take full credit for reinsurance with reduced collateral for
reinsurance placed with financially strong foreign reinsurers from
qualifying jurisdictions.
In this rule, a preliminary filter, not an
absolute criterion, is based on acceptable ratings from recognized
rating agencies.
New York is finalizing a similar
rule.
Within the frameworks, the reinsurer’s credit ratings serve as a
maximum cap on the amount of collateral reduction that is
available; further analysis and due diligence can, for a given
rating for a specific reinsurer, increase the amount of required
collateral.
On a broader scale in the United States, a
new Reinsurance Regulatory Modernisation Framework has been
adopted by the NAIC’s Reinsurance Task Force.
This framework, which is subject to ratification by the
NAIC, would change the manner and
extent to which US ceding companies can reflect offsets in their
statutory financial statements for reinsurance ceded.
Under the proposed framework, reinsurers (both US and non-US) will
be assigned to one of five rating categories determined by US
insurance regulators based on a number of factors, similar to the
New York and Florida frameworks.
Importantly, one of those factors is the reinsurer’s financial
strength rating provided from a recognized credit rating agency.
In particular, the lowest rating received by the rating agencies
will be used by the regulators to establish the maximum rating of
a reinsurer (eg, the maximum amount of collateral reduction).
The assigned rating category determines the extent to which the
reinsurer is required to collateralise its obligations in order
for US cedants to take credit for that reinsurance.
In July 2007, the EC proposed a revision of EU insurance law that
would replace 14 existing directives with a single directive
designed to improve consumer protection, modernise supervision,
deepen market integration and increase the international
competitiveness of European insurers.
Under the new system, known as Solvency II,
insurers would be required to take account of all types of risk to
which they are exposed and to manage those risks more effectively.
In addition, insurance groups would have a
dedicated ‘group supervisor’ that would enable better monitoring
of the group as a whole.
In February 2008, the EC published an
amended proposal.
The EC’s goal is to have the new system in
operation by 2012.
Currently, there are no references to
external credit ratings or ECAIs in the latest Directive proposal.
The most recent (fourth) draft Quantitative Impact Study (QIS4),
however, would use credit ratings as a proxy for financial
strength.
As this remains a work in progress, however,
it is unclear what the final capital requirements will be.
The precise design of capital requirements in Solvency II,
including the possible counterparty default risk capital charge,
will be set out in the future level 2 implementing measures to be
developed by end 2010.
Conclusion
The stocktaking of the use of credit ratings in the legislation,
regulations, and/or supervisory policies (ie, LRSPs)
of the 26 agencies, representing 12
different jurisdictions, that delivered responses to JFRAC’s
questionnaire reveals a wide spectrum of use.
Member authorities’ responses displayed significant variations
both in the breadth and number of the LRSPs referring to credit
ratings as well as in the categories of LRSPs in which they were
used.
In general, in the jurisdictions covered by the survey, credit
ratings are used predominantly in LRSPs in the banking and
securities sectors, with more limited use in insurance sector
LRSPs.
Geographically, the North Amercian LRSPs
used references to credit ratings –specifically, to credit ratings
issued by NRSROs – significantly more than in the LRSPs of the EU,
Australia, and Japan.
In addition, US and Canadian LRSPs had more
in common with one another, while the LRSPs of the EU, Australia,
and Japan shared similarities to one another.
Notwithstanding the general differences in the way credit ratings
are used in the LRSPs of the member authorities that responded to
the questionnaire, the survey revealed notable similarities among
the respondents as well.
The category of determining regulatory capital clearly displayed
the broadest extent of the use of credit ratings in LRSPs, both in
numbers of LRSPs and in the number of jurisdictions in which they
are used.
The second most significant category of use was
identifying or classifying assets, usually
in the context of eligible investments or permissible asset
concentrations.
The remaining major categories of use were providing a credible
evaluation of the risks associated with assets purchased as part
of a securitisation offering; determining disclosure requirements;
and determining prospectus eligibility.
While no member authority had conducted a formal assessment of the
impact of the use of credit ratings in LRSPs on investor behavior,
almost all appear to have considered the issue.
Respondents were split as to whether their use of credit ratings
and/or reference to credit rating agencies has had the effect of
implying an endorsement of such ratings and/or agencies; however,
a slight majority answered in the affirmative.
Finally, as noted above, the US, Canada, the
EU, and Japan are considering proposals that may lead to various
changes in the use of credit ratings in the LRSPs of those
jurisdictions.
Appendix 1
Definitions of key terms
The terms “credit rating” and “credit rating
agency” are defined only by a minority of respondents, primarily
in regulations (with the US SEC defining both terms in
legislation).
Several respondents noted that the definitions were “implicit” in
their regulations or that familiarity with the terms is
understood.
The two most significant related terms for subsets of “credit
rating agencies” are the US SEC’s “nationally recognised
statistical rating organisation” (NRSRO) and Basel II’s “external
credit assessment institution” (ECAI).
“NRSRO” is defined in US legislation, and
that definition is cross-referenced extensively in US regulations
as well as the Ontario Securities Commission’s definition of
“rating organisation.”
While Basel II sets forth criteria to be used by national
supervisors for the “recognition” of ECAIs, it does not contain a
definition of the term.
Almost half of the respondents referenced
the term “ECAI” in their responses to this question, with several
referencing the Basel II framework and/or the Committee of
European Banking Supervisors (CEBS) “Guidelines on the recognition
of External Credit Assessment Institutions” (CEBS Guidelines) as
well.
A small minority indicated that their LRSPs include an explicit
definition of the term “ECAI.” For instance, under the Australian
prudential standards, an ECAI is defined as “an entity that
assigns credit ratings designed to measure the creditworthiness of
a counterparty or certain types of debt obligations of a
counterparty.”
The Markets in Financial Instruments
Directive (MiFID) includes the term "competent rating
agency" as one that "issues credit ratings in respect of money
market funds regularly and on a professional basis and is an
eligible ECAI within the meaning of Article 81(1) of Directive
2006/48/EC."
Article 81(1) is contained with the EU Capital Requirements
Directive (CRD) that implements the Basel II framework and,
consistent with that framework, does not define an ECAI, but
instead sets forth criteria for the recognition of eligible ECAIs.
Specifically, Article 81 states that “Competent authorities shall
recognise an ECAI as eligible … only if they are satisfied that
its assessment methodology complies with the requirements of
objectivity, independence, ongoing review and transparency, and
that the resulting credit assessments meet the requirements of
credibility and transparency.”
The term “investment grade” and its
variants (eg, “non-investment grade”) are also defined by almost
half of the respondents, with those definitions almost evenly
divided between those that define the term by reference to
specific ratings from specified entities (eg, at or above a Baa
rating from Moody’s) and those that define it by reference to
categories of ratings and/or entities (eg, rated in one of the
four highest categories by an NRSRO).
Other related terms included subsets of credit ratings such as
“approved ratings,” “applicable external
ratings,” and “credit rating grades” as well as subsets of credit
rating agencies such as “approved rating organisations” and
“designated rating organisations.”
One respondent defined the terms “solicited rating” and
“unsolicited rating.”
The US SEC’s definition of the term “NRSRO” is cross-referenced in
a number of US banking regulations as well as several Canadian
securities regulations.
As noted above, almost half of the
respondents referenced the term “ECAI” in their responses to
question I.A.2, with several referencing the Basel II framework
and/or the Committee of European Banking Supervisors (CEBS)
“Guidelines on the recognition of External Credit Assessment
Institutions” (CEBS Guidelines) as well.
While the majority of respondents clarified their implementation
of Basel II,in several cases the responses were unclear on this
point.
The majority of respondents indicated that their LRSPs reference
specific credit rating agencies.
All but one of those respondents mentioned Moody’s Investors
Service, Standard & Poor’s Ratings Services, and Fitch Ratings,
with the exception being a US OTS regulatory bulletin, which
referenced the former two entities only.
DBRS Limited and Japan Credit Rating Agencies were each cited by
several respondents, while Rating and Investment Information,
Inc., Mikuni & Co., Fedafin AG1, and AM Best were each cited by
one respondent.
In several cases, it was unclear as to whether a respondent was
indicating that individual credit rating agencies were mentioned
directly in an LRSP, (eg, ““approved rating organisation” means
each of DBRS Limited, Fitch Ratings Ltd., Moody’s Investors
Service, Standard & Poor’s and any of their successors.”) or that
the LRSP used a term generally, with a list of credit rating
agencies meeting the criteria for that term contained elsewhere (eg,
“Investment grade corporate debt security shall mean any security
that…is rated in one of the four highest ratings categories by at
least one Nationally Recognised Statistical Ratings
Organisation.”)
Several respondents indicated that the
individual credit agencies listed are formally reviewed on a
regular basis, in some cases on a fixed schedule (ie, annually or
every five years).
Several others noted that the Basel II
and/or CEBS designation procedures for ECAIs also applied to the
removal of the ECAI designation.
Finally, a number of respondents indicated that their LRSPs naming
individual credit rating agencies could be amended through their
jurisdiction’s standard legislative or regulatory process.
The majority of respondents cited the ECAI designation procedures
set forth in Basel II as the basis for their
selection of the specific entities, with several referencing the
CEBS Guidelines as well.
The US SEC cited its 2007 regulations establishing a voluntary
registration program for NRSROs.
Several other respondents referred to industry consultation or
widespread market use as the basis for their use of specific
agencies in LRSPs.
Appendix 2
Structural overview of Basel II
The different uses of external credit ratings
This section does not aim at being exhaustive but rather at
explaining the main usages of
ratings.
Pillar
I (Minimum Capital Requirements)
Credit risk
Credit ratings are widely used for the
calculation of capital charges for credit risk in order to
differentiate the exposures in a risk-sensitive manner and set the
capital charges accordingly.
External and/or internal ratings might be used under the revised
framework, but as a general principle, Basel II promotes the use
of internal ratings, in the context of the internal ratings based
approach.
Under the Internal-Rated based Approach,
the risk sensitivity of the regulatory capital requirements is
attained through the use of internally produced credit ratings
models for all the different exposures class (sovereign, bank,
corporate, retail and equity).
External ratings are not supposed to be used for the calculation
of capital charges (with the exception of securitisation exposures
–see below).
However, the implementation of the IRB approach might result in
some marginal indirect uses of external ratings; the main use is
within the area of models validation in, for instance,
benchmarking exercises.
Consequently, external ratings are primarily used in the context
of the standardised approach.
In the standardised Approach, the
risk sensitivity of the regulatory capital requirements is
attained through the recourse to external credit ratings for
exposures within the corporate, sovereign and bank exposure class.
Institutions may only use the external ratings provided by rating
agencies recognised by supervisors (see. Section 4 below), with
the exception of exposures to sovereign where banks might directly
use the ratings provided by export credit agencies.
In practice, the risk weights applied to sovereign, banks and
corporate exposures are differentiated according to the individual
external credit assessment of each exposures.
The Basel II framework provides tables that
pre-map regulatory determined risk-weights to sets of credit
ratings scales from authorised rating agencies, enabling the
simple determination of an exposure’s risk weight (tables mapping
external ratings and risk-weights are specific to each exposure
class).
For example, for corporate exposures, the risk weights applicable
might vary from 20 percent to 150 percent depending on the credit
assessment of the exposure (see table below), whereas under the
Basel 1 framework a 100% risk-weight was applied to all corporate
exposures.
Credit risk mitigation rules define how funded credit protections
(collateral) and unfunded credit protections (guarantees and
credit derivatives) can be recognised.
They are applicable to the standardised approach and to some
extent to the IRB foundation approach.
Credit risk mitigation rules refer to
authorised external ratings in order to:
• Identify the eligible credit protection (for example, only the
guarantees provided by an entity with a rating higher than a
predetermined threshold might be recognised)
• Adjust the extent of the recognition of the credit protection
(for example, haircuts proportionate to the credit quality of the
issuer are applied to collateral under the comprehensive
approach).
The securitisation framework differs from
the general credit risk rules in the way that both the
standardised and the IRB approach use authorised external credit
ratings.
• For banks using the standardised Approach,
the risk sensitivity of the regulatory capital requirements is
attained through the recourse to authorised external credit
ratings for the subset of authorised securitisation transactions.
• For banks using the Internal Ratings based
Approach, the risk sensitivity of regulatory capital
requirements is attained through the recourse to authorised
external credit ratings within the Ratings-based approach and to a
lesser extent within the Internal Assessment Approach, and through
a regulatory setting within the SF (Supervisory formula) when
credit ratings cannot be inferred.
The prescribed long term and short term tables that pre-map
regulatory determined riskweights to sets of credit ratings scales
from authorised ECAIs for the standardised and the IRB approaches
differ; the IRB table is more granular and its risk weights are
different from that of the standardised approach.
Market
risk
When considering market risk measurement, external ratings are
only used for the calculation of the specific risk capital charges
arising from debt position under the standardised approach for
market risk.
In a way similar to what is done within the frame of the credit
risk rule, different risk weights are applied to the trading book
debt positions according to the external ratings of the issuer.
The rules on specific risk also refer to a
notion of qualifying category, which is notably (but not only)
based on its turn on the fulfilment of attaining an
“investment-grade” credit rating from credit rating agencies.
Under the Internal Model Approach,
the risk sensitivity of regulatory capital requirements is
attained through the use of internally designed risk management
models that are subject to supervisory approval.
Given that these models usually focus on general market risk, the
treatment of the capital charge for the area of specific risk
measurement will be made separately if the internally designed
models do not encompass on top a modelling of specific risk.
A fallback on authorised external credit ratings is possible, or
else a broader treatment within the Incremental Risk Capital
charge.
Operational risk
Under all the different approaches used to measure operational
risk, there is no use of external ratings, with the exception of
the treatment of risk mitigation techniques in the Advanced
Measurement Approach (in line with the overall treatment of risk
mitigation techniques under the credit risk rules, the protection
provider must have a rating above a defined threshold).
Pillar II (Supervisory Review Process)
There is no specified use of external ratings in the context of
the Supervisory review process.
Pillar III (Market Discipline)
Pillar III requirements contain specific qualitative disclosure
requirements (among others) with respect to the use of external
credit assessment institutions (ECAIs) and Export Country Agency (ECAs).
• Credit Risk: Disclosures for
Portfolios subject to the standardised and supervisory risk
weights in the IRB approaches (see table 5 of the Revised
Framework).
Qualitative disclosure (a) Names of ECAIs and ECA used, types of
exposures for which each ECAI, ECA is used, alignment of
alphanumerical scale with each bucket or evidence of compliance
with the mapping published by relevant supervisors.
• Securitisation: Disclosure for
standardised and IRB Approaches (see table 9 of the Revised
Framework). Qualitative disclosure ( c ) Names of the ECAIs used
for securitisation and types of securitisation exposures for which
each agency is used.
Authorised external ratings and the notion of “ECAI” (External
Credit Assessment Institution)
Definition of ECAI and the principle of the “recognition”
External ratings that can be used for the capital purposes,
according to the Basel II framework, are limited to the ratings
provided by recognised External Credit Assessment Institutions (ECAI).
Supervisors are in charge of the recognition of ECAI.
The ECAI recognition process has two main
dimensions:
• Identification of the rating
agencies that provide external ratings suitable for capital
calculation purposes.
The BCBS has defined criteria in this respect (see. 4.1 below) and
supervisors are in charge of assessing whether those criteria are
satisfied by the rating agencies willing to be recognised as ECAI.
• Mapping of the external ratings to
the risk-weights (or credit quality steps in the EU CRD
implementation) defined by the Basel II framework (see. 4.2 below)
The ECAI recognition process does not constitute a form of
regulation of ECAIs by supervisors or a form of licensing of
rating agencies.
It simply aims at the determining the ratings that can be used by
banks, by ensuring that the ratings are appropriate for
supervisory and capital purposes.
Eligibility criteria
The key purpose of the recognition criteria is to identify rating
agencies that produce external credit assessments of sufficiently
high quality, consistency and robustness to be used by
institutions for regulatory capital purposes.
In order to achieve this goal, the Basel
Committee on banking supervision has defined criteria that should
be satisfied by rating agencies.
Paragraph 91 of the Basel II framework details those criteria:
•
Objectivity: The methodology for assigning credit assessments must be rigorous,
systematic, and subject to some form of validation based on
historical experience.
Moreover, assessments must be subject to ongoing review and
responsive to changes in financial condition. Before being
recognised by supervisors, an assessment methodology for each
market segment, including rigorous backtesting, must have been
established for at least one year and preferably three years.
•
Independence:
An ECAI should be independent and should not be subject to
political or economic pressures that may influence the rating.
The assessment process should be as free as possible from any
constraints that could arise in situations where the composition
of the board of directors or the shareholder structure of the
assessment institution may be seen as creating a conflict of
interest.
•
International access/Transparency: The individual assessments should be available to both domestic
and foreign institutions with legitimate interests and at
equivalent terms.
In addition, the general methodology used by the ECAI should be
publicly available.
•
Disclosure: An
ECAI should disclose the following information: its assessment
methodologies, including the definition of default, the time
horizon, and the meaning of each rating; the actual default rates
experienced in each assessment category; and the transitions of
the assessments, eg the likelihood of AA ratings becoming A over
time.
•
Resources: An
ECAI should have sufficient resources to carry out high quality
credit assessments.
These resources should allow for substantial ongoing contact with
senior and operational levels within the entities assessed in
order to add value to the credit assessments. Such assessments
should be based on methodologies combining qualitative and
quantitative approaches.
•
Credibility: To
some extent, credibility is derived from the criteria above.
In addition, the reliance on an ECAI’s external credit assessments
by independent parties (investors, insurers, trading partners) is
evidence of the credibility of the assessments of an ECAI.
The credibility of an ECAI is also underpinned by the existence of
internal procedures to prevent the misuse of confidential
information.
In order to be eligible for recognition, an ECAI does not have to
assess firms in more than one country.
The
mapping process
Once it has been assessed that a rating agency meets the ECAI
recognition requirements, its credit assessments are ‘mapped’ by
supervisors to the risk weights (credit quality steps)
defined by the Basel II framework, which in
turn determines the risk weight (amount of capital) to be applied
to each exposure.
The ‘mapping’ is notably based on reference defaults rates (in
particular the 3-year cumulative default rates evaluated over the
long-term), which should ensure the stability of the mapping but
also an equivalent treatment of the ratings provided by the
various rating agencies.
European specific aspects
The uses of external ratings in the CRD (Capital Requirements
Directive - the European implementation of the Basel II framework)
is fully consistent with the international rules.
Nevertheless, two significant differences can be observed :
• in the context of the standardised
approach, external ratings can also be used to risk-weight
exposures to CIUs (Collective Investment Units).
Specific risk-weights are provided for this exposure class.
• The risk-weight tables, that link credit
assessment to risk-weight, are generally more granular.
The CEBS (Committee of European Banking Supervisors) issued in
January 2006 “Guidelines on the recognition of External Credit
Assessment Institutions” which:
(i) Clarify the recognition process at the
European level, by :
• Defining a standard application form, that should be submitted
to supervisors by rating agencies willing to be recognised.
The content of the package should allow supervisors to assess the
application.
• Creating a joint assessment process, applicable to international
ratings agencies (or ratings agencies operating in more than one
country).
(ii) Present CEBS Common understanding of
the ECAI recognition criteria laid down in the CRD
A rating agency can become a recognised ECAI if a member state
supervisor determines that it meets the following criteria in one
or all of the three market segments (financial institutions,
corporate (includes public sector) and securitisations:
• Objectivity – methodology for assigning credit assessments is
systematic, rigorous, continuous, and subject to validation.
• Independence – factors taken into account include ownership and
organisational structure, financial resources, staffing and
expertise, and corporate governance.
• On-going review – responsive to changes in financial conditions
and reviewed at least annually.
• Transparency & disclosure – methodologies need to be public so
users can decided whether they are derived in a reasonable way.
In addition their credit assessments had to be:
• Credible and accepted by the market – market share, revenues,
whether pricing is on the basis of credit assessments.
• Transparent & disclosed - credit assessments need to be
available on an equivalent basis.
(iii) Precise the qualitative and
quantitative factors that should be used by supervisors when
mapping external ratings and regulatory credit quality steps.
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