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“Is your conduct framework adding enough value?” - How Lloyd’s and London market insurers are evolving their conduct frameworks
It’s the most frequent question I’ve been asking my Lloyd’s and London market clients since the turn of the year.
The question itself is testimony to the extent of work that the market has undertaken to design, implement and embed conduct frameworks over the last few years, particularly in relation to delegated authority business. These relatively new frameworks have been working in practice for long enough for the conversation to move towards efficiency and evolution.
Culture remains at the forefront of the global regulatory agenda: central bankers and supervisors set out their views
On 16 and 21 March, Andrew Bailey (Chief Executive of the Financial Conduct Authority), Mark Carney (the Governor of the Bank of England) and William C Dudley (President and Chief Executive of the Federal Reserve Bank of New York), gave speeches on improving culture in banking and financial services. The speeches together highlight the ways in which governance, remuneration and incentives drive the culture of a firm. They also provide a stocktake on regulatory initiatives intended to tackle these issues, and give insights into the areas that will attract particular scrutiny when supervisors assess a firm’s culture. The Governor also outlined a broad framework for addressing conflicts of interest.
Two recent public events, a speech to the ABI by PRA Executive Insurance Director David Rule, and an evidence session to the Treasury Select Committee (TSC) enquiry into Solvency II led by PRA Deputy Governor Sam Woods, with messages reinforced in a subsequent speech by Sam Woods on 20 March on the PRA insurance objective, provide important insights into the PRA’s latest view of Solvency II. But there were also a few straws in the wind as to how the PRA, if given a free hand post-Brexit, might want to adjust the UK prudential insurance regime. This would not involve any wholesale departure from Solvency II, which the PRA thinks is essentially working well, but might involve a limited move towards a less prescriptive, principles-based regime slightly more in the mould of its ICAS predecessor. Notable features of any adjusted regime might include:
- Some streamlining of data collection and transitional recalculation;
- More flexibility on matching adjustment eligibility, particularly on cash flow fixity;
- A continuing role for the risk margin (albeit using a much less interest rate sensitive calibration); and
- Continued application of the quantitative indicator (“QI”) actuarial framework, involving more granular sectoral coverage, to underpin future model approval and change judgements.
The European Commission’s Regulation on indices used as financial benchmarks in financial instruments and financial contracts (the Regulation) forms part of the EU’s response to a series of high profile investigations in recent years into the alleged manipulation of key financial benchmarks, including LIBOR. These investigations raised concerns over the reliability and integrity of financial benchmarks, which underpin transactions worth trillions of dollars. The Regulation aims to reduce the risk of manipulation, bolster the reliability of benchmarks administered and ultimately provide a safer environment for the use of benchmarks in the EU.
The Prime Minister’s announcement of the Government’s decision to trigger Article 50 (Art 50) and commence the process of the UK’s formal withdrawal from the EU is momentous in many ways. However, for financial services firms - many of which have been working on their Brexit contingency planning for six months or more - the significance of today is that it means that they now have a maximum of two years in which to implement their plans.
The majority of large European banks have now released their 2016 Annual Financial Statements which included certain disclosures around IFRS 9 implementation.
The European Securities and Markets Authority (ESMA) has previously issued a public statement outlining its expectations of preparers of financial statements in the lead-up to the implementation of IFRS 9.
2017 Bank of England banking sector stress test exploratory scenario – Profitability in the spotlight
On 27 March the Bank of England (BoE) will publish the scenarios for its 2017 banking sector stress testing exercise. For the first time, the exercise will include an ‘exploratory’ scenario. Run in alternate years alongside the now familiar annual cyclical scenario (ACS), the exploratory scenario will enable the BoE to test the resilience of the banking system to a wider range of threats.
The introduction of IFRS 9 from 1 January 2018 will have a significant effect on regulatory capital across the banking industry, with four-fifths of EU banks expecting their stock of impairments to rise under the new rules according to a Deloitte survey. The European Banking Authority’s (EBA) estimates for the increase of impairment stock (provisions), compared to the current levels under IAS 39, is 18% on average and up to 30% for some firms. This led to an estimated decrease in Common Equity Tier 1 (CET1) and total capital ratios by an average of 59 bps and 45 bps, respectively. As a result, finding a mechanism to smooth any unwanted impacts following the IFRS 9 adoption, by avoiding a capital cliff-effect on day one, has rapidly become a priority for prudential regulators.
On March 9, Emma Dunkley wrote in the Financial Times about the new app-based banks aiming to steal a march on the incumbents. In her words:
“They are not expected to take a significant share of the market from the biggest banks.”
The implementation of the mandatory exchange of initial and variation margin for non-cleared OTC derivative trades in the EU commenced on 4 February for financial counterparties with the largest derivatives portfolios. The introduction of these rules – which was part of the G20’s mandate to reduce the systemic risk posed by the OTC derivatives trading – is expected to lead to an increase in the cost of trading for non-cleared trades.