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P a g e | 1 Inter n atio na l A s s oci a t ion of R isk a nd Co mpl i a n c e Pr o f e s s io na l s ( I A RCP) 12 0 0 G St re e t N W Su i t e 8 0 0 W a s h i ng t o n, D C 2 000 5 - 67 0 5 U SA T e l : 2 0 2 - 44 9 - 9750 www .ri s k - c ompl i a n ce -a ss o c i a tion . c om.

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P age |1

InternationalAssociationofRiskandComplianceProfessionals(IARCP)

1200GStreet NWSuite800Washington,DC20005-6705USATel:202-449-9750www.risk-compliance-association.com

Top10riskandcompliancemanagementrelatednewsstoriesandworldeventsthat(forbetterorforworse)shapedthe week'sagenda,andwhatisnext

DearMember,

Doyouuse“asuiteofmodels”aspartofyourstress-testingframework?

“Itisreasonabletoassumethatanysinglemodelwillalmostcertainlybewrong.”

TheBankofEnglandsaysso.Theywilldothesame:

“TheBankexpectstouseasuiteofmodelstodothis,ratherthanrelyonasinglemodel.

Whyasuiteofmodels?

Thereareanumberofbenefits inusingasuiteofmodelsaspartofthestress-testingframework.

First,thebankingsystemfacesmanydifferenttypesofrisk,includingmarket,credit,fundingandliquidityrisks.

Althoughtheseareofteninterrelated,itisnotrealistic to expectthatasinglemodelwillcapturetheentiretyoftheseriskseffectively.

Moreover,relianceonasinglequantitative toolheavilyexposesthestress-testingexerciseto‘modelrisk’.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |2

Allmodelsareasimplificationofreality,soitisreasonabletoassumethatanysinglemodelwillalmostcertainlybewrong.

Havingrecoursetoasuitehelpsreducethesensitivityoftheresults to aparticularmodel’s‘blindspot’ormiscalibration.

Differentmodelsalsogivedifferentinsightsandperspectivestopolicymakers,servingasausefulcross-checktoeach other.

Indeed,therangeofoutputsfromdifferentmodels canitselfbeinformative,providingusefulinsights topolicymakersonuncertaintiesaroundbanks’ capitalpositions inagivenscenario.

Usingasuiteofmodelsalsoreducestherisk thatindividualbanksmightseekto‘game’thestress-testingframeworkbyseekingtorestructuretheirbalancesheetsinawaythatreducesmeasuredriskunderaparticularmodel.

Finally,fromasystem-wideperspective,relyingonasinglemodelcouldhaveadverseconsequencesfordiversityinrisk measurementandriskmanagementpracticesacrossthesystem.

Usingasuiteofmodelsisnotwithoutcosts,however.Itwilladdsomedegreeofcomplexitytotheoverallexercise.”

Interesting…

Ilovedthe“Itwilladdsomedegreeofcomplexity”part.

Iwouldaddthatitwillincreasethecostofcompliancetoo.IfwewanttohavemoreCommonEquityTier1(CET1)capital,weneedprofitsandinvestors.Everythingthatincreasesthecostmakesmenervous.

ThenewpaperfromtheBankofEnglandisoneofthebestthatcoversthefinancialstresstestingcycle:

“Wehaveagreatexampleofthekeystagesoftheannualstress-testingcycle.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |3

TheUKFinancialPolicyCommittee(FPC)recommendedinMarch2013that,‘lookingto 2014andbeyond,theBankandPrudentialRegulationAuthority(PRA)shoulddevelopproposalsforregularstresstestingoftheUKbankingsystem.

Designcommonscenarios(approximatelytwelveweeks)

TheFPC(FinancialPolicyCommittee,establishedundertheBankofEnglandAct1998,throughamendmentsmadein theFinancialServicesAct2012)liaisingwiththePRABoard,willdesignthecommonscenariosfortheforthcominground.

Thescenarioswillthenbereleasedtobanks.Itisexpectedthatthedatacut-offwillbeatapproximatelythesametimeasthisrelease.

Banks’scenariodesign(approximatelytwelveweeks)

In ordertorunthecommonscenariosusingtheir ownmodels,banksarelikelytohavetoextendthenumberofvariablesprovidedbytheBank.

Individualbankswillalsolikelyberequiredtodesigntheirown,bespoke,scenarios.

Bankswouldbeexpected todomuchofthiswork—forexample,identifyingtherisksthatthebespokescenarioswillarticulate—in parallelwiththedesignofthecommonscenariosbytheFPC.

Giventheexpectationthatthebank-specific scenariosshouldbemoreseverethanthecommonscenarios,bankswillhaveafurthermonthtocalibratetheir ownscenariosaftertheyreceivethecommonscenarios.

BankswillberequiredtosubmitthebespokescenariosforreviewtothePRA.

Independentstress-testinganalysis(approximatelytwelveweeks)

StaffattheBankaswellasindividualbanks themselveswillconductthestress-testinganalysisusingthescenariosthathavebeendeveloped.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |4

Bankswillalsoneedto identifyrealisticmanagementactionsthatcould betakentoimprovetheircapitaladequacy.

Seniorstaffatthebanks shouldbecloselyengagedwithbothaspectsofthisworkandareexpected to beresponsibleforsign-offoftheresultsbeforesubmittingthem tothePRA.

Analysisofstress-testresultsandPRAchallengeofbankresults(approximatelytwelveweeks)

Bankstaffwillsynthesisetheoutputsacrossthesuiteofmodelstoformasingle,overallviewaboutbanks’performanceineachscenario.

ThePRAwillbeinclosediscussionwiththebanksthroughoutthisstage,queryingandchallengingthebanks’ ownresultswhereappropriate.

FPCandPRABoardreviewresultsandagreepolicy actions(approximatelyfourweeks)

Thestress-testresultswillbeconsideredbytheFPCandthePRABoard.

Thetwobodieswillusethis to informtheirjudgementsaroundbankcapitaladequacyatthesystem-wideandinstitution-specificlevel.

ThePRABoardwillalsomakeaqualitativeassessmentofbanks’

stress-testingand capitalplanningprocesses,andassesstheadequacyofbanks’ capitalplanstodeterminewhethertheyaresufficienttomeettheoveralllevelofcapitalisationdeterminedbytheFPCandthePRABoard.

Publicationofoutcomes

TheFPCandPRAwillcommunicatetheoutcomeofthestresstests.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |5

ReadmoreatNumber1below.

Welcome totheTop10list.

BestRegards,

GeorgeLekatisPresidentoftheIARCP

GeneralManager,ComplianceLLC

1200GStreetNWSuite800,WashingtonDC20005,USATel:(202)449-9750

Email:[email protected]

Web:www.risk-compliance-association.comHQ:1220N.MarketStreetSuite804,WilmingtonDE19801,USA

Tel:(302)342-8828

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |6

AframeworkforstresstestingtheUKbankingsystem

ADiscussionPaper

EIOPAFinalReportonPublicConsultationNo.13/009ontheProposalforGuidelinesonForwardLookingAssessmentofOwnRisks(basedontheORSAprinciples)

AspartofthepreparationfortheimplementationofSolvencyII,nationalcompetentauthorities shouldtaketheappropriatestepsin ordertoputinplacefrom1

January2014thepresentGuidelinesontheforwardlookingassessmentof

ownrisks (basedontheORSAprinciples).

StandardsettingAgendaOfficeoftheChiefauditor

Developingandmaintaininghigh-qualityauditingandrelated professionalstandardsisapriorityofthePublicCompanyAccountingOversightBoard("PCAOB"or"Board").

ThePCAOB'sOfficeoftheChief Auditor("OCA")regularlymonitorsauditrisks,challenges,andtheprevailingeconomicenvironmentasitmaintainsandadjustsitsstandard-settingagenda.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |7

ProposalforaDIRECTIVEamendingDirective2009/138/EConthetaking-up

andpursuitofthebusinessofInsuranceandReinsurance(SolvencyII)asregardsthedatesoftranspositionandapplicationandthedateofrepealofcertainDirectives

On19January2011theCommissionadoptedaproposaltoamendDirective2009/138/EC in ordertotakeintoaccountthenewsupervisory architectureforinsuranceandnamelythesettingupoftheEuropeanInsuranceandOccupationalPensionsAgency(EIOPA)on1January2011(COM(2011)8,COD2011/0006)(OmnibusII)andtheentryintoforceoftheLisbonTreatywhichrequiredtheadjustmentofempowermentsfortheCommissiontoadoptimplementingmeasurestoempowermentsfortheCommissiontoadoptimplementinganddelegatedactsaccordingtoArticle290oftheTreatyontheFunctioningoftheEuropeanUnion.

SECAwardsMoreThan$14MilliontoWhistleblower

WashingtonD.C.

TheSecuritiesandExchangeCommissionannouncedanawardofmorethan$14milliontoawhistleblowerwhose

informationledtoanSECenforcementactionthatrecoveredsubstantialinvestorfunds.

Payments towhistleblowersaremadefromaseparatefundpreviouslyestablishedbytheDodd-FrankActanddonotcomefromtheagency’sannualappropriationsorreduce amountspaid toharmedinvestors.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |8

EBAWorkProgramme 2014

ThemainfocusoftheEBA’sregulatorywork

willrelateto theCRDIV/CRRlegislation, in particulartocreditandmarketriskandtheprudentialareasofliquidityandleverage,aswellastotherecoveryandresolutionframework.

RemarksofChairmanGaryGenslerbeforetheISDAEuropeanConference

“Fiveyearsagothisweek,theU.S.economywasinafreefall.

FederalReserveChairmanBernanke andthenTreasurySecretaryPaulsonfacedtheunthinkable– askingtheAmericanpeopleto bailoutfinancialinstitutionsto savetheeconomy.

Fiveyearsago,theswapsmarketwasatthecenterofthecrisis.”

LegislativepackageforbankingsupervisionintheEurozone–frequentlyaskedquestions

TheEuropeanparliamenthasadoptedtodayapackageoflegislativeactstosetupasinglesupervisorymechanism(SSM)thatcontains:

- aCouncilRegulationtogivespecifictasksrelatedtofinancialstabilityandbankingsupervisiontotheEuropeanCentralBank(ECB);

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |9

- aRegulationoftheEuropeanParliamentandoftheCouncildesignedtoaligntheexistingRegulation1093/2010ontheestablishmentoftheEuropeanBankingAuthority(EBA)tothemodifiedframeworkforbankingsupervision.

ESMAclarifiesreportingrequirementsforalternativefundmanagers

TheEuropeanSecuritiesandMarketsAuthority(ESMA)haspublishedfinalguidelinesonthereportingobligationsforalternativeinvestmentfundmanagers(AIFMs).

ESMA’sGuidelines,whichrelatetotheAlternativeInvestmentFund ManagersDirective(AIFMD),willrequireAIFMs–whichincludeshedgefunds,privateequityandrealestatefunds– toregularlyreportcertaininformationtonationalsupervisors.

Thereformofinternationalbanking:someremainingchallenges

SpeechgivenbyPaulTucker,DeputyGovernorFinancialStability,Memberof

theMonetaryPolicyCommittee,MemberoftheFinancialPolicy

CommitteeandMemberofthePrudentialRegulationAuthorityBoard,at theOliverWymanInstituteConference,LondonTuesday1October2013

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |10

AframeworkforstresstestingtheUKbankingsystem

ADiscussionPaper

BackgroundinformationontheFPCandthePRA

TheFinancialPolicyCommittee(FPC)wasestablishedundertheBankofEnglandAct1998,throughamendmentsmadeintheFinancialServicesAct2012.

ThelegislationestablishingtheFPCcameintoforceon1April2013.

The objectivesoftheCommitteearetoexerciseitsfunctionswithaviewtocontributingto the achievementbytheBankofEnglandofitsFinancialStabilityObjectiveand,subjectto that,supportingtheeconomicpolicyofHerMajesty’sGovernment,includingitsobjectivesforgrowthandemployment.

TheresponsibilityoftheCommittee,withregardtotheFinancialStabilityObjective,relatesprimarilytotheidentificationof,monitoringof,andtakingofaction to removeorreduce,systemicriskswithaviewtoprotectingandenhancingtheresilienceoftheUKfinancialsystem.

TheFPCisaccountable to Parliament.

ThePrudentialRegulationAuthority(PRA)isapartoftheBankofEnglandandresponsiblefortheprudentialregulationandsupervisionof banks,buildingsocieties,creditunions,insurersandmajorinvestmentfirms.

Itsetsstandardsandsupervisesfinancialinstitutionsattheleveloftheindividualfirm.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |11

ThePRAhastwostatutoryobjectives:topromotethesafetyandsoundnessofthesefirmsand,specificallyforinsurers,tocontributetothesecuringofanappropriatedegreeofprotectionforpolicyholders.

ItmakesanimportantcontributiontotheBank’scorepurposeofprotectingandenhancingthestabilityoftheUKfinancialsystem.

ThePRA’smostsignificantsupervisorydecisionsaretakenbyitsBoard.ThePRABoardisaccountabletoParliament.

ForewordbytheGovernor

Earlierthisyear,anewregulatoryframeworkcameintoforcein theUnitedKingdom.

TheestablishmentofthePrudentialRegulationAuthority(PRA)broughtprudentialsupervisionofbanks,buildingsocieties,creditunions,designatedinvestmentfirmsandinsurancecompanies to theBankofEngland.

ThecreationoftheFinancialPolicyCommittee(FPC),responsibleformacroprudentialregulationoftheUKfinancialsystem,filledacleargapinthepre-crisisregulatoryarchitecture.

Bothbodieswillhavetomakejudgementsonpossiblethreatstofinancialstability,andwillhave totakeappropriatepolicy andsupervisoryactionstomitigatethesethreats.

ThisDiscussionPapersetsoutproposalsforannual,concurrentstresstestsoftheUKbankingsystem.

Thestresstestswillprovideaquantitative,forward-lookingassessmentofthecapitaladequacyoftheUKbankingsystemandindividualinstitutionswithinit.

TheywillthereforeplayacriticalroleinsupportingboththeFPCandthePRAinmeetingtheirstatutory objectives.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |12

Buildingonthenewregulatoryinfrastructure,thestresstestswillbringtogetherexpertisefromacrosstheBank,includingmacroeconomists,financialstabilityexpertsandsupervisors.

ThiswillmateriallystrengthentheBank’sanalyticalcapability to assessrisksto resilience.

Ourintentionisthatstresstestingevolvesintoanessentialcomponentofourprudentialframework,complementingour capitalandliquiditystandards.

ThispaperhasbeenproducedbystaffattheBankundertheguidanceoftheFPCandthePRABoard.

Itspurposeistogeneratediscussion abouttheappropriatedesignofthestress-testingframework inthemediumterm.

AssetoutintheExecutiveSummaryandelsewhere,theBankisactivelyseekingto elicitfeedbackontheproposalsfromabroadrangeofstakeholders.

Welookforwardtoreceivingyourresponses.

October2013

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |13

Aframeworkforstress testingtheUKbankingsystemExecutivesummary

The FinancialPolicyCommittee(FPC)recommendedinMarch2013that,‘lookingto 2014andbeyond,theBankandPrudentialRegulationAuthority(PRA)shoulddevelopproposalsforregularstresstestingoftheUKbankingsystem.

Thepurposeofthose tests wouldbetoassessthesystem’s capitaladequacy’.

ThisDiscussionPaper—producedbystaffattheBankofEnglandundertheguidanceoftheFPCandthePRABoard—setsoutthemainfeaturesoftheproposedstress-testingframework.

Itsaimis to elicitfeedbackfrominterestedparties tohelpinformFPCandPRABoarddecisionsovertheultimatedesignofthestresstests.

Themainpurposeofthestress-testingframeworkistoprovideaquantitative,forward-lookingassessmentofthe capitaladequacyoftheUKbankingsystemandindividual institutionswithinit.

ItaimstosupportboththeFPCandthePRAinmeetingtheirstatutoryobjectives.

Tofacilitateassessmentofthesystemasawhole,stresstestswillbecarriedoutconcurrentlyacrossthebanks,buildingsocietiesand

PRA-designatedinvestmentfirms(henceforthreferredto as‘banks’)thatare inscope.

Theannualstresstestswilldeliveranintegratedprocessfordeliberationsaroundbankcapitaladequacy,bothatasystem-wideandan

individual-institutionlevel.

AndtheywillprovideadevicethroughwhichtheBankcanbeheldaccountabletoParliament,andthewiderpublic,onitsfinancialstabilityobjective,byallowingtheFPCandthePRABoard to articulatetheresiliencestandardagainstwhichtheyholdthebankingsystem.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |14

Regularstresstestsshouldalsobolsterpublicconfidenceinthestabilityofthesystem,bydemonstratingtherangeofsevere,butplausible,stressesthatauthoritiesexpectbankstobeabletowithstand.

Itisenvisagedthat—overthemediumterm—thestresstestsproposedinthisDiscussionPaperwillcoverthemajorUKbanksandsignificantUKsubsidiariesofforeignglobalsystemicallyimportantbanks.

TheDiscussionPaperalsoconsidersthemeritsofincludingmedium-sizedUKbanks withinthisframework.

Anditnotesthat,giventheirimportancetofinancialstability,theBankisalsoconsideringthemeritsofaseparateconcurrentstress-testingregimeforcentralcounterparties.

UndertheframeworkproposedinthisDiscussionPaper,stresstestswouldexplorearangeofscenarios, including:

(a)commonscenariosappliedacrossallbankstakingpartintheexercise

—thesewouldbedesignedbytheFPC,in consultationwiththePRABoard;and

(b)bespokescenarios,designedbyindividualbanksandapprovedbythePRABoard.

Thebespoke scenariosare intendedtoexploreriskstowhicheachbankwouldbemostvulnerable.

In part,thisisbecauseakeyaimofthestress-testingframeworkistostrengthenbanks’owncapabilitiestoidentifyandquantifyriskstotheirbusinesses.

Thebespoke scenarioswouldbeexpected to resultinhigherlossesforthebanks inquestionthanthecommonstressscenariodesignedbytheFPC.

TheBankexpectsthatthestress-testingframeworkwilluseasuiteofmodels to translatethesescenariosintoprojectionsofbankprofitability

andcapitalratios.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |15

Thiswill involvemodellingbyBankstaffaswellasbyindividualbanksthemselves.

Thisapproachseekstoguardagainsttheriskthatthestresstestbecomesexcessivelyexposedtotheunavoidableweaknessesofanysinglemodel.

Italsoseeks to mitigatetherisksassociatedwithexcessiverelianceon

banks’ownmodelling:banksmayfaceincentives tobeoverly optimisticabouttheimpactofstressscenariosontheir capitalpositionto achieveamorefavourableresultinthestresstest.

Butthesuiteofmodelsdoesleaveagreaterroleforjudgementincombiningmodeloutputstoreachanoverallviewon capitaladequacy.

Overtime,Bankstaffwillalsoseektoenhancethewayinwhichvariousfeedbacks andamplificationmechanisms—forexamplebetweenthebankingsystemandthewidereconomyorbetweenindividualbanks— arecapturedaspartoftheBank’sanalysis.

Thesearelikelytohaveacrucialbearingonsystem-wideresilience.

Bankstaff,underguidancefromtheFPCandthePRABoard,willsynthesisetheoutputsofthesemodelstoformasingle,overallviewabout theperformanceofthesystemandindividualbanksin eachscenario.

Interpretingtheseresults,andreachingajudgementaroundcapitaladequacy,willrequireaviewonthelevelofcapitalthatregulatorswantbanks tomaintaininthefaceofsuchlosses.

Thisisultimatelyapolicydecisionby theFPCandthePRABoard,accordingtotheirrespectiveresponsibilities.

Attheveryleast,banks wouldneed tomaintainsufficientcapitalto beable to absorblossesin thestressscenarioandnotfall below internationallyagreedminimumstandards.

Butthelevelofcapitalthatbankswouldneed tomaintaininthestressscenariocouldbeset abovestrictinternationallyagreedminimaandvary

acrossbanks.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |16

In addition,thestresstestswillproducearangeofotherinformationthatisexpected to informFPCandPRABoardjudgements.

Thiswillincludeaqualitativeassessmentofbanks’ ownstress-testingandcapitalmanagementprocessesandgovernance.

Itisimportantthatcrediblepolicyactionsaretakenin responsetotheresultsofthestresstests.

Tothisend,theresultsofthestress-testingexerciseareexpected tobeusedto:

informtheFPC’sassessmentoftheresilienceofthefinancialsystemand,indoingso,aidformulationofpolicyresponses;and

supportPRABoarddecisionsandactionsonindividualbanks,takingintoaccountanysystem-wide actionsbytheFPC.

Crucially,theresultsofthestresstestsarenotexpected tobemechanicallylinkedtopolicyresponses.

Thisisnotintendedtobeasimple‘pass-fail’regime.

Rather,itaimstodeliveramoregraduatedpolicy framework, wherethemagnitudeofremedialactionstakenwouldbeafunctionofpolicymakers’judgementaroundtheadequacyofbanks’capitalplans.

Forexample,ifthestresstestsrevealedthatindividualbanks—orthesystemasawhole—fell below internationallyagreedminimainthestressscenarios,thiscouldpointtomaterialinadequaciesintheircapitalisation.

In turn,thiswouldlikelyresultinthePRArequiringmaterialremedialactionstostrengthen capitallevels.

Requiredremedialactionswouldlikelybesmallerifstresstestsrevealedthatbanksremainedaboveinternationallyagreedminima,butstillbelowtheappropriatelevelofpost-stresscapitaldeterminedbytheFPCandthePRABoard.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |17

Bankscouldalsoberequiredtotakeremedialactionsinlightofidentifiedinadequaciesintheirstress-testingandcapitalmanagementcapabilities,evenifthePRABoardjudgedthattheywereadequatelycapitalised towithstandtherangeofscenariosexploredaspartofthestress test.

Akeyprincipleunderpinningtheproposedframeworkisthattheoutcomeof,andanalysisassociatedwith,theannualstresstestsshould bemadepublic.

Transparencyovermethodologiesadopted,stress-testresultsaswellaspolicy andsupervisoryresponsesby theFPCandthePRABoardwillsupportthecredibilityoftheframework,facilitateaccountabilityofpolicyinterventionsandincentivisebanks to engagefullywiththeexercise.

TheBankwouldwelcomecommentsfrominterestedpartiesonallaspectsofthispaper.

AmorespecificlistofquestionsonwhichtheBankwouldparticularlywelcomefeedbackissetoutattheendofthisDiscussionPaper.

Commentsshouldbesentby10January2014to:

VasileiosMadourosBankofEnglandThreadneedleStreetLondon,EC2R8AH

Orbyemailto:[email protected]

1Introduction

The FinancialPolicyCommittee(FPC)recommendedinMarch2013that,‘lookingto 2014andbeyond,theBankandPrudentialRegulationAuthority(PRA)shoulddevelopproposalsforregularstresstestingoftheUKbankingsystem.

Thepurposeofthose tests wouldbetoassessthesystem’s capitaladequacy’.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |18

AtitsJune2013meeting,theFPCdiscussedasetofprinciplesthatwouldinformthedesignofthestress-testingframeworkinthemediumterm,asummaryofwhichisprovidedinBox1.

ThisstaffDiscussionPaperdescribesthemainfeaturesoftheproposedframeworkforregularstresstestingoftheUKbankingsystem.

BuildingtheBank’s capabilitiesto deliverthestress-testingframeworkoutlinedinthisDiscussionPaperwilltakeanumberofyears.

The2014exercisewillbeasteppingstonetowardsthemedium-termframework.

Assuch,itisexpectedtobemorelimitedin application(seeBox7).

TheFPCandthePRABoardwillconsidertheprecisedesignofthe2014exerciseinmoredepthoverthecomingmonths.

Thestress-testingframeworksetoutinthisDiscussionPaperwillprovideaquantitative,forward-lookingassessmentofthe capitaladequacyoftheUKbankingsystemandindividual institutionswithinit.

Tofacilitateanalysisoftheresilienceofthesystemasawhole,stresstestswillbecarriedoutconcurrentlyacrossthebanks inscope.

Thiswill deliveranintegratedframeworkfordeliberationsaroundbankcapitaladequacy,atbothsystem-wideandindividual-institutionlevel,bytheFPCandthePRABoard.

ThestresstestswillalsoprovideadevicethroughwhichtheBank canbeheldaccountabletoParliament,andthewiderpublic,onitsfinancialstabilityobjective.

Awell-understoodstress-testingframeworkallowstheFPCandthePRABoardtoarticulatetheresiliencestandardagainstwhichtheyhold thebankingsystem.

Thiswillfacilitatethecommunicationofpolicy interventionsbytheFPCandthePRABoard.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


  • P age |19

  • Itwillalsoimprovethepublic’sunderstandingoftherangeofsevere,butplausible,stressesthatauthoritieswantbanks tobeable towithstand,strengtheningpublicconfidenceinthebankingsystem.

  • ForthepurposesofthisDiscussionPaper,a‘stresstest’isdefinedastheevaluationoftheimpactofdifferentscenariosonthe capitalpositionof banksandthesystemasawhole.

  • Crucially,thestressscenariosshouldnotbeinterpretedasstatesoftheworldthattheFPCorthePRAperceiveaslikelytohappen.

  • Theycharacteriseseverebutplausibleshocks,whichtheauthoritiesexpectbanks tobeable to withstand to reducerisks to financialstability.

  • Similarly,stresstestingisnotaboutmechanisticallycalculatingpointestimatesofbankcapitalratiosinanadversescenario.

  • Rather,itisasetoftoolsthatallowspolicymakers to explorevulnerabilitiesofthebankingsystem,helpingtoidentifyinherentuncertaintiesaroundbankcapitaladequacy.

  • In developingthestress-testingframeworkproposedinthisDiscussion Paper,Bankstaffareseekingto incorporatethelessonsfromtheUnitedKingdom’spastexperiencewithsupervisoryandsystem-widestresstests.

  • Bankstaffhavealsodrawnontheextensiveinternationalexperiencewithstress testing,benefitingfromdiscussionswith—andinsightsof—therelevantauthorities(seeBox2).

  • ThisDiscussionPaperisissuedforpubliccommentandaims to elicitfeedbackfrominterestedparties.

  • Theprecisedesignofthefollowingfeaturesoftheframeworkislikely tobeparticularlyimportantindeliveringstressteststhatareperceivedascrediblebythemarketandareusefultopolicymakers:

  • Scenariodesign:Anystress-testingexercisewillonlybeascredibleas theadversescenariosthatarebeingconsidered.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


P age |20

TheBankexpects toexplorearangeofscenariosinanysingleexercise.

Thiswillacttoreducetherisk thatthesystemasawholeisonlyresilienttoasingle‘badstateoftheworld’.

Akeyaspectofscenariodesignistheextenttowhichthedegreeofseveritywouldvarythroughthecycle,toreflectthechangingprobabilityandimpactofasystemicstressmaterialising.

Byassessingtheresilienceofthebankingsystemtoprogressivelymoreseverescenariosintheupswingofthecycle,stresstests caninformthesettingofcountercyclical policy.

Modellingapproaches:TheBankexpects touseasuiteofmodels

toestimatetheimpactofstressscenarios.

Thisapproachseeksto guardagainsttherisk thattheframeworkbecomesexcessivelyexposed totheunavoidableweaknessesofanysinglemodel.

Italsoleavesagreaterroleforjudgementin combiningmodeloutputstoreachanoverallviewon capitaladequacy.

Bankswillalsobeexpectedtodevelopandusetheirownmodelstojudgethelikelyimpactofstressscenarios.

Infact,akeyaimoftheframeworkistostrengthenriskmanagementandmeasurementstandardswithinbanksthemselves.

Theoutputsofthosemodels canbeusedasanadditionalinputintotheBank’soverallanalysisofbankcapitaladequacy.

TheBankrecognisesthatindividualbanks mightseek to achieveamorefavourableoutcomeinthestresstestsbybeingoverlyoptimisticabout theimpactthatastressscenariowouldhaveontheircapitalposition.

WhiletheBankexpectstobetakinganumberofsteps tomitigatethat risk,thereremainsachoice abouthow muchweightitisappropriatetoplaceontheoutputsofbanks’ownmodels.

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


  • P age |21

  • Disclosure:Akeyprincipleunderpinningthestress-testingframeworkisthattheoutcomeof,andanalysisassociatedwith,thestress-testingexercise shouldbemadepublic.

  • Buttherearebothbenefitsandcostsassociatedwithdisclosureofstress-testoutcomes.

  • TheDiscussionPapersetsoutdifferentoptionsforwhatinformation mightbedisclosed—andatwhatdegreeofgranularity—tofacilitateengagementofdifferentstakeholderswiththestress tests.

  • In consideringtheproposedstress-testingframeworksetoutinthisDiscussionPaper,itisalsoimportant tobeclearaboutthelimitationsofthis toolinservingtheneedsoftheFPCandthePRA.

  • Thestresstestsproposedhere,forexample,willonlyfocusonasubsetof bankswhoseactivitiesarejudgedmostlikelytoposeriskstoUKfinancialstability.

  • Smallerbanks arenotexpectedtobecoveredbythisframework(seebelowforotherPRAstress-testingrequirementsthatapplytoall

  • UK-regulatedbanks).

  • Moreover,theexercisewillfocusprimarilyonriskstobanksolvency.

  • Atleastinitially,fundingandliquidityvulnerabilitiesarelikelytobeincorporatedonlyasamplificationmechanisms.

  • Assuch,thestress-testingframeworkwillnotbethesoleprocessthroughwhichtheFPCandthePRABoardwillarticulatetheirassessmentof bankcapitaladequacy.

  • Theframeworkwillprovidethetwobodieswithanopportunity toundertakeanannual,in-depthassessmentofbanks’resiliencetodifferentstresses.

  • Butthisshouldnotbeinterpretedasanindicationthatsupervisoryactionsormacroprudentialpolicy decisionsaroundbankcapitalwillbemadeonlyaspartofthisprocess.

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BoththeFPCandthePRAwillconsiderwhether interventionsare requiredtosupportbankcapitaladequacythroughouttheyear,inlightof newrelevantinformationandanalysis.

AllPRA-regulatedbanks arealreadyrequired to carryoutstresstestsandscenarioanalysisaspartoftheirInternalCapitalAdequacyAssessmentProcess(ICAAP).

ThePRAisproposingto maintainthisrequirementfollowingtheimplementationofCRDIVandisconsultingonadraftgeneralstresstestandscenarioanalysisruleaspartofitsconsultationonimplementingCRDIV.

Thisrulewouldapply to allbanks,includingthosecoveredbytheproposedstress-testingframeworksetoutin thisDiscussionPaper.

Itisexpectedthatabank’sparticipationintheconcurrentstresstestsproposedinthispaperwillreplacethestresstestingthatbanksarecurrentlyrequiredtoconduct to informthePRA’sCapitalPlanningBuffer.

Butthisframeworkwillnotreplacetherequirementthatbanksundertakestress testsfortheirownriskmanagementpurposes.

Inadditiontodomesticstresstests,anumberofbankswillcontinuetobesubjecttostresstestsco-ordinatedbyotherauthorities.

Forexample,thelargestUKbankshavehistoricallybeenincludedintheEuropeanBankingAuthority(EBA)stresstestsandtheIMF’sFinancialSectorAssessmentProgram(FSAP)exercises.

Andbanks withsignificantoperationsintheUnitedStateswilllikelybeincludedintheComprehensiveCapitalAnalysisand Review(CCAR)operatedbytheFederalReserve.

Theseremainvaluableexercises,butservedifferentobjectivesandarelikelytobeconductedinadifferentwayfromthestresstestsdescribedinthispaper.

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TheBankwillcontinuetoengagewithrelevantauthoritiesinternationally toconsiderhow thevariousinitiativesaroundstress testingcanbe

co-ordinatedtominimiseanyunnecessarycostsofcomplianceforbanks.

TheremainderofthisDiscussionPaperisstructuredasfollows.

Section2setsoutthemain objectivesofthestress-testingframework.

Sections3and4outlinekeyoperationalconsiderations,focusingonfrequencyandtimingaswellascoverageofinstitutions.

Thesubsequentsectionsfocusonthe keyfeaturesoftheBank’sanalyticalapproachtostresstesting:scenariodesign(Section5),theuseofassetqualityreviews to informstresstests(Section6),modellingofstressscenarios(Section7)andtheuseofstress-testoutputstoassessbankcapitaladequacy(Section8).

Section9coverstheremedialactionsthatcouldberequiredinresponsetotheresultsofthestresstestsandSection10exploresdifferentoptionsarounddisclosure.

Finally,Section11setsouttheexpectationsthatthePRAislikely to havefrombanks inrelation tothisexercise.

Giventheroleofthisframeworkininformingpolicy andsupervisoryjudgementsbytheFPCandthePRABoard,thePRAexpectsaclearstep-upinengagementbybankswiththestresstests—includingbytheirBoardsandseniormanagement.

Section12outlinesasetofquestionsonwhichtheBank would particularlywelcomefeedbackfromrespondents tothisDiscussion Paper.

Box1

PrinciplesforstresstestingtheUKbankingsystem

Thisboxsummarises thekeyprinciplesthatareexpected toguidethedesignofthestress-testingframeworkinthemediumterm.

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  • ThesebuildontheprinciplesthatweresetoutbytheFPCintheJune2013FinancialStabilityReport.

  • Theyremainsubjectto adjustmentafterfurtheranalysisanddiscussion.

  • Indeed,akeyobjectiveofthisDiscussionPaperistoelicitfeedbackonthedevelopmentofthestress-testingframeworkbyinterestedparties.

  • Themainprinciplesunderpinningthedesignoftheframeworkare:

  • Purposeofthestresstests.

  • Themainpurposeofthestress-testingframeworkistoprovideaquantitative,forward-lookingassessmentofthe capitaladequacyoftheUKbankingsystemandindividual institutionswithinit.

  • In doingso,itwillinformFPCandPRABoardjudgementsaroundtheneedforpolicyandsupervisoryinterventions.

  • Frequencyofstresstests.

  • Itisenvisagedthatstresstestswillbeconductedonanannual basisandconcurrentlyacrossthebanks thatareinscope.

  • Coverageofthebankingsystem.

  • Theframeworkisexpected to coverthemajorUKbanks aswellassignificantUKsubsidiariesofforeignglobalsystemicallyimportantbanks.

  • Overtime,medium-sizedbanksmightalsobecoveredbytheframework, thoughsubjectedtoaproportionateversionoftheexercise.

  • Scenariodesign.

  • Foreachbank,arangeofscenarioswouldbeappliedaspartoftheexercise.

  • Thesewouldinclude:

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  • commonscenarios,appliedacrossallbanks undertakingthestresstest,designedbytheFPC, in consultationwiththePRABoard;

  • bespokescenarios,designedbybanksthemselvesandapprovedby thePRABoard,withaseveritycalibratedto atleastmatchthecommonscenariosdesignedbytheFPC.

  • Applicationofscenarios.

  • AnalysisoftheimpactofscenariosonprofitabilityandcapitalratioswouldbeundertakenbyBankstaff.

  • Thiswoulduseasuiteofmodels.

  • Thescenarioswouldalsobemodelledbybanks themselves.

  • Theultimateoutputwouldbeasynthesisedviewofbanks’futurecapitalpositionsineachofthescenariosbeingconsidered.

  • Amplificationmechanisms.

  • Overtime,stress testingwillseek to capturetheeffectsofvariousfeedbacks andamplificationmechanisms.

  • Thesearelikelytohaveacrucialbearingonsystem-wideresilience.

  • Communication.

  • Disclosureoftheoutcomeof,andanalysisassociatedwith,thestresstestsshouldaimtosupport thecredibilityoftheframeworkandfacilitateaccountabilityofpolicy interventions.

  • Box2

  • Internationalexperienceofstresstesting

  • Stress testinghaslongbeenestablishedasariskmanagementtoolbybanks.

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Butsincetheonsetoftherecentfinancialcrisis,stresstesting has alsogrowninprominenceasakeymicroandmacroprudentialtool.

NotableexamplesofregulatorystresstestsconductedduringthecrisisincludetheUSSupervisoryCapitalAssessmentProgram(SCAP) in2009andtheEU-widebankingsectorstresstestsin2009–11.

Anumberofcountrieshavealsoputinplaceframeworksforregularstresstestingoftheirrespectivebankingsystems.

In seekingtodrawlessonsforthedesignoftheUKframework,thisboxreviewstheinternationalexperiencewithstresstesting.

Table1summarisestheapproachtakenbyselectedjurisdictions.

Keyfeaturesofinternationalstress-testingregimes

Mostjurisdictionscoversystemicallyimportantbanks:Regulatorystressteststypically coverasubsetofbanks withinajurisdiction—usually thosedeemedtobesystemicallyimportant.

Someauthoritiesseekto capturealargernumberofbanks.

But, inthose cases,stress teststendtobeusedlargelyasasurveillancetool,withtheresultsbeinglesscloselylinked to policy actions.

TheUSauthoritiesalso coversomenon-bankfinancialcompanies,asrequiredundertheDodd-FrankAct.

Themajorityofcountriesconductstresstestsonanannualbasis:Mostcountriesseebenefitsin conductingannualstress-testingexercisesthatareinlinewithbanks’regularcapitalplanningcycle.

Othercountriesconductsemi-annualstresstests,theresultsofwhicharepublishedinFinancialStabilityReports.

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Datarequirementsvaryacrossjurisdictions:Somecountries(suchasSweden)relyexclusivelyonpubliclyavailabledatatorunsupervisorystress tests.

Othercountries(suchasIrelandandtheUnitedStates),requirebanks toprovidegranularloan-leveldataforthemajorityoftheirloan booksasaninputtotheirstress-testingprocesses.

Mostcountriesuseasuiteofmodels:Asa minimum,allcountriesthathave adoptedBaselIIassessthequalityandresultsofbank-ledstresstestsaspartoftheInternalCapitalAdequacyAssessmentProcess(ICAAP).

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Inaddition,anumberofcountriesalsocarryoutregulator-ledstresstestsusinggranularmodelsofbanks’incomestatementitems.

In theUnitedStates,forexample,authoritieshavepubliclystatedthat theyhave40in-housemodelstoprojectbanks’lossesandrevenues.

Furthermore,agrowingnumberofauthoritieshavebeendevelopingtheirsystem-widestress-testingcapabilities.

Mostjurisdictionsusearangeofscenarios:Regulatorsinternationallyrecognisetherisksassociatedwithrelyingonasinglestressscenarioandseektoincorporatearangeofadversescenariosaspartoftheirstresstests.

Thereisagrowingemphasisonbank-designedscenarios,wherebanksareaskedtodesignscenariosmostrelevanttotheirbusinessmodel.

Disclosureofstress-testingmethodsandresultsvariessubstantiallyacrossjurisdictions:Someauthoritieshavebeenveryopenaboutthemethodologiestheyemployandthescenariostheyuseandalsopublishverygranularbank-by-bankstress-testresults.

Othershaveoptedtokeepaspectsoftheirstress-testingregimesprivate.

Theuseofstress-testoutputsalsovariesacrosscountries:Somestresstests,suchas theUSSCAPandtheCCAR,aswellastheEuropeanBankingAuthority(EBA)exercisesinEurope,havedirectimplicationsforbanks’capitalplansanddistributions.

Inmostcountries,theresultsofstress-testingexercisesareusedasoneofasetofinputsintopolicy decisionsaroundbankcapital.

2Purposeofstresstesting

Themainpurposeofthisstress-testingframeworkis toprovideaquantitative,forward-lookingassessmentofthe capitaladequacyoftheUKbankingsystemandindividual institutionswithinit.

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In doingso,itwillsupportboththeFPCandthePRAinmeetingtheirstatutoryobjectives.

TheFPC’sprimaryobjectiveis toidentify,monitorandtakeactiontoremoveorreducesystemicrisks,withaviewtoprotectingandenhancingtheresilienceoftheUKfinancialsystem.

Itssecondaryobjectiveistosupporttheeconomicpolicy oftheGovernment.

ThePRAhasastatutoryobjectivetopromotethesafetyandsoundnessofthefirmsitregulates,withparticularfocusontheharmthatfirmscancause to thestabilityoftheUKfinancialsystem.

Thestress-testingframeworkwillinformtheFPC’sjudgementontheresilienceoftheUKbankingsystemtopossiblefuturesystemicstresses.

ItwillequiptheFPCwithanevidencebaseandaquantitativeapparatustoassesstheneedforpolicy interventions,givenemergingrisksor vulnerabilities.

Assuch,itwill helptheFPCevaluatethebenefitsofanypolicyinterventionsdesignedtomitigatethoserisks.

Thestress-testingframeworkwillalsoinformjudgementsofthePRABoardonthesafetyandsoundnessofindividual institutions.

Itwillhelpthe PRABoardassesstheneedfor,andimpactof,supervisoryresponses,taking intoaccountanysystem-widepolicy actionsbytheFPC.

Theresultsofthestresstestsarenotexpected tobemechanicallylinkedtosupervisoryresponsesbythe PRABoardorsystem-widepolicyactionsbytheFPC.

ByinformingFPCandPRABoardjudgementsaroundbankcapitaladequacy,thestress-testingframeworkwillresultin:

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Anintegrated,regularprocessfordecision-makingaroundbank

  • capitaladequacy.

  • Thestress-testingexercisewillcontribute to anintegratedframeworkfordeliberationsaroundcapitaladequacy,atbothsystem-wideandindividual-institutionlevel,bytheFPCandthePRABoard.

  • Thiswillprovidegreaterclaritytothemarketabouthowthesedecisionsaremade.

  • AdevicethroughwhichtheBankcanbeheldaccountabletoParliament,andthewiderpublic,onitsfinancialstabilityobjective.

  • Awell-understoodstress-testingframeworkoffersonetoolthroughwhichtheFPCandthePRABoardcanarticulatetheresiliencestandardagainstwhichtheyaimtoholdthesystem.

  • Thiswillfacilitatethecommunicationofpolicy interventionsbythetwopolicymakingbodies.

  • Astrengthenedsupervisoryapproach.

  • AsthePRAhasalreadysetout,aninherentfeatureofforward-lookingsupervisionisthat,attimes,thesupervisor’sjudgementwillbeatvariancewiththatofbanks.

  • Thisunderscorestheneedforsuchjudgements to bebasedonevidence.Astrengthenedstress-testingframeworkwillenhance thecredibilityofthesupervisoryapproachbyenrichingthebodyofevidencethatinformssupervisoryjudgementsandhelpingarticulatethosejudgementsmoreclearly.

  • Enhancedpublicconfidenceinthebankingsystem.

  • Acrediblestress-testingframeworkcanstrengthenpublicconfidenceinthestabilityofthebankingsystembydemonstratingtherangeofsevere,butplausible,stresseswhichauthoritiesaimtoensurethatbanks canwithstand.

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  • Improvedrisk andcapitalmanagementpracticeswithinbanks.

  • Theframeworkwillprovideonetoolthroughwhichauthoritiescanaimtoensurethatbanks areheldtohighstandardsintheareasofriskmanagementandcapitalplanning.

  • Whiletheprimarypurposeofthestress-testingframeworkisto informFPCandPRABoardjudgementsaroundbankcapitaladequacy,theframeworkshouldbeexpected todeliveranumberofadditionalregulatorybenefits.

  • Theseinclude:

  • Informingarangeofpossiblepolicy andsupervisoryinterventions.

  • Thequantitativetoolkitunderpinningthestress testswillbeable toinformjudgementsaroundarangeofpotentialinterventionsbytheFPCandthePRABoardthatmightextendbeyondbankcapitalrequirements(seeSection9).

  • Betteraccesstodatabyregulators.

  • Thestress-testingframeworkshouldimproveregulators’accesstohigh-qualitydataonrisk exposures,enhancingtheirunderstandingofbanks’businessmodelsandriskprofiles.

  • Itwillalsofacilitatemoremeaningfulandconsistentanalysisofrisksandvulnerabilitiesacross thebankingsystem.

  • Strengthenedmarketdiscipline.

  • Atransparentstress-testingframeworkshouldenhancemarketdiscipline,byenrichingmarketparticipants’informationsetaroundtheresilienceofindividualinstitutionsandthebankingsystemasawhole.

  • 3Frequencyandtimingofstress tests

  • Itisenvisagedthatthestresstestswillbeconductedonaregularbasisandconcurrentlyacrossthebanksthatarein scope.

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Frequency

Thestress-testingframeworkshouldaimtodeliveratimelyassessmentofcapitaladequacyforindividualinstitutionsandthebankingsystemasawhole.

Banks’balancesheetcomposition,aswellasthenatureandmagnitudeoftheriskstowhichtheyareexposed,canvarysignificantlyovertime.

Asaresult,longlagsbetweentheexerciseswouldbeundesirable.

TheFPCandthePRABoardwillwanttorespondtopotentialthreatstostabilityinatimelymannerandthestress-testingframeworkisexpectedtobeakeyinputintotheirforward-lookingjudgementsaroundbankcapitaladequacy.

Goingintheotherdirection,stresstestingataveryhighfrequencywouldentailmaterialresourcecosts,bothforbanks andregulators.

Thiscouldcompromisethequalityoftheexercise.

Forexample,itwouldrisk thestress-testingexercisebecomingan overlymechanicalprocess,squeezingoutinnovativethinkingaroundnew,emergingrisksorsufficientengagementbykeydecision-makers tointerpret—and actupon—theresults.

In balancingtheseconsiderations,thestresstestsareexpectedtotakeplaceonanannualbasis.

Thisisconsistentwithpracticesinothercountries,suchastheUnitedStates(seeBox 2),aswellasthePRA’sdraftsupervisorystatementonstress testingthatwaspublishedaspartoftheCRDIVConsultationPaper.

Conductingsupervisorystresstestsonaregularbasisentailsanumberofadditionalbenefits.

Itencouragesbanks—andtheauthorities—toinvestcontinuouslyintheirstress-testingcapabilities.

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It can alsooperateasamechanismforguardingagainst‘riskillusion’,byforcingbothbanks andregulatorstothinkhardaboutthetypesofrisksthat canposethreatsto stability.

Finally,conductingregularstress testingwouldavoidtheriskassociatedwithmarketparticipantsinterpretinganauthority-initiatedstresstestasanadversesignalaboutthehealthofthebankingsectororaparticularbank.

Concurrency

Theconcurrentnatureofthestress testsisakeyelementoftheproposedframework.

Thereareanumberofbenefitstosuchanapproach.

Crucially,fromamacroprudentialperspective,carryingoutthestresstestssimultaneouslyallowstheFPCtoassesstheresilienceofthesystemasawhole,ratherthanfocussolelyonindividualbanks.

Forexample,aconcurrentexercise canhelptheFPCassessthebuild-up ofexposurestoaparticularsectoracrossthefinancialsystem.

Anditallowsthe FPCtotakeintoaccountpotentialamplificationmechanismsthatcouldarisedue tothebankingsystem’sresponsetoanadverseshock(seeBox 4).

Thesehavebeenimportantmechanismsofpropagationofinitialshocksinprevioussystemiccrises.

Similarly,fromamicroprudentialperspective,thesimultaneousnatureoftheexercisewilldelivergreaterconsistency inthePRA’sapproachtosupervision.

Forexample,theapplicationofcommonstressscenariosatagivenpointintimehelpsensurethatthePRAholdsbanksagainstthesameresiliencestandard.

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  • Finally,runningstresstestsconcurrentlycanhelpstrengthentheanalyticalrigouroftheexercise.

  • Theauthoritieswillbebetterplacedtochallengestress-testoutputsgeneratedbybanks,forexamplebycomparinglossratesonsimilarportfoliosacrossbanks,orbyincorporatinginsightsfromanalysisofcorporate,householdorothersectorsproducedfromanassessmentofthebankingsystemasawhole.

  • Theconcurrentnatureofthestresstestswillalsofacilitatebenchmarkingofbanks’ capitalmanagementandstress-testingprocesses.

  • Timing

  • Partoftheobjectiveofthestress-testingframeworkistoembedaclearandregularprocessforconducting in-depthanalysisthatinformsFPCandPRABoardjudgementsaroundbankcapitaladequacy.

  • Box3describestheexpectedannualstress-testingcycleinmoredetail.

  • Supervisoryactionsormacroprudentialpolicydecisionsaroundbankcapitaladequacywillstillbetakenoutsideofthisprocess,however,incorporatingarangeofrelevantinformationandanalysis.

  • TheBankexpectsthat—overthemediumterm—theresultsofthestress testsarelikelyto bepublished aboutsixorsevenmonthsafterthedateofthebalancesheetinformationusedasinputsfortheexercises.

  • ThisisbroadlyinlinewithcurrentpracticeintheUnitedStates,wheretheCCARstress teststakeapproximatelysixmonthsfromthedata

  • cut-offuntilpublication.

  • Thisseekstobalanceanumberofconsiderations,including:

  • Timeliness:Itisimportantthattheinputsused,suchasbalancesheetdata,remainrelevantbythetimethatstress-testoutputsareusedtoinformpolicymakers’judgement.

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Qualityofresults:Thereisoftenatrade-offbetweentimelinessand

  • qualityofthestress-testingexercise.

  • StaffattheBank,aswellasatfinancialinstitutions themselves,willneedtohavesufficienttime to ensurerigorousanalysisandinterpretationofthestress-testresults.

  • Seniorstaffengagement:ItiscrucialthatBoardsandseniormanagementofthebanksbeingstresstestedengagecloselywiththisexercise.Theannualcycleshouldallowsufficienttimeforthemtodoso.

  • Governanceandreviewissues:Internalgovernancerequirementsandreviewperiodslimithowquicklythestress testscantakeplace.

  • Also,forbankswithEuropeanoperations,remedialactionsmayneed tobediscussedbyinternationalcollegesofsupervisorsaspartoftheEU’sJointRisk AssessmentandDecisionprocess,withpotentialimplicationsforthelengthandtimingoftheannualcycle.

  • Interactionbetweenbanksandregulators:Theexercisewillinvolveaperiodofengagementbetweenthebanksandtheregulators.

  • Forexample,bankswillbeexpected toexplainandjustifykeyjudgementstakenin theirownmodellingoftheimpactofstressscenarios.

  • Theannualcycleshouldallow sufficienttimeforsuchinteractions.

  • Whileitisimportantthatthereisagreementaboutfacts,suchasbalancesheetdata,stress-testoutcomesarenot theresultofanegotiation betweenbanks andregulators.

  • In consideringtheannualstress-testingcycle,akeyconsiderationwillbetheprecisedateforthebalancesheetinformationusedfortheexercise.

  • Thedateofbanks’annualaccountswouldbeanaturalstarting point.

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Annualaccountshavetheadvantageofbeingexternallyauditedandthiswouldalsoallowinvestorstoassessstress-testresultsagainstinformationthattheyarealreadyfamiliarwith.

Butnotallbanks usethesamereportingdatefortheirannualaccounts,soitwouldnotbepossible to applythisapproachuniformly.

Aimingtouseannualaccountsmightalsoputadditionalstrainsonbanks’resourcesatanalreadybusyperiodoftheyear.

Thisisanarea wheretheBankwouldwelcomefeedbackfromrespondentstothisDiscussionPaper.

Box3

Adescriptionoftheannualstress-testingcycle

Thisboxoutlinesthekeystagesoftheannualstress-testingcycle.

Thesearepresented in broadlychronologicalorder,butsomemaybehappeningconcurrently.

Theboxalsoprovidesabroadindicationofthetimethatwouldbeallocatedtoeachstageoftheprocess.

Thisassumesthatresultsofthestresstestswouldbepublished aboutsix–sevenmonthsafterthedateofthebalancesheetinformationusedasinputsforthestresstests.

Some aspectsofthetimingswilldifferforthe2014exercise,whichisexpectedtotakeplaceoveralongertimescale(seeBox7).

(1)Designcommonscenarios(approximatelytwelveweeks)

TheFPC,liaisingwiththePRABoard,willdesignthecommonscenariosfortheforthcominground.

Thescenarioswillthenbereleasedtobanks.Itisexpectedthatthedatacut-offwillbeatapproximatelythesametimeasthisrelease.

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Banks’scenariodesign(approximatelytwelveweeks)

In ordertorunthecommonscenariosusingtheir ownmodels,banksarelikelytohavetoextendthenumberofvariablesprovidedbytheBank.

Individualbankswillalsolikelyberequiredtodesigntheirown,bespoke,scenariosasdiscussedinSections5and11.

Bankswouldbeexpected todomuchofthiswork—forexample,identifyingtherisksthatthebespokescenarioswillarticulate—in parallelwiththedesignofthecommonscenariosbytheFPC.

Giventheexpectationthatthebank-specific scenariosshouldbemoreseverethanthecommonscenarios,bankswillhaveafurthermonthtocalibratetheir ownscenariosaftertheyreceivethecommonscenarios.

BankswillberequiredtosubmitthebespokescenariosforreviewtothePRA.

Independentstress-testinganalysis(approximatelytwelveweeks)

StaffattheBankaswellasindividualbanks themselveswillconductthestress-testinganalysisusingthescenariosthathavebeendeveloped.

Bankswillalsoneedto identifyrealisticmanagementactionsthatcould betakentoimprovetheircapitaladequacy.

Seniorstaffatthebanks shouldbecloselyengagedwithbothaspectsofthisworkandareexpected to beresponsibleforsign-offoftheresultsbeforesubmittingthem tothePRA.

Analysisofstress-testresultsandPRAchallengeofbankresults(approximatelytwelveweeks)

Bankstaffwillsynthesisetheoutputsacrossthesuiteofmodelstoformasingle,overallviewaboutbanks’performanceineachscenario.

ThePRAwillbeinclosediscussionwiththebanksthroughoutthisstage,queryingandchallengingthebanks’ ownresultswhereappropriate.

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FPCandPRABoardreviewresultsandagreepolicy actions(approximatelyfourweeks)

Thestress-testresultswillbeconsideredbytheFPCandthePRABoard.

Thetwobodieswillusethis to informtheirjudgementsaroundbankcapitaladequacyatthesystem-wideandinstitution-specificlevel.

ThePRABoardwillalsomakeaqualitativeassessmentofbanks’

stress-testingand capitalplanningprocesses,andassesstheadequacyofbanks’ capitalplanstodeterminewhethertheyaresufficienttomeettheoveralllevelofcapitalisationdeterminedbytheFPCandthePRABoard.

Publicationofoutcomes

TheFPCandPRAwillcommunicatetheoutcomeofthestresstests.

4Coverageofinstitutions

Thestress-testingframeworkoutlinedinthisDiscussionPaperisexpectedtofocusonthosebankswhoseactivitiesarejudgedmostlikelytoposerisks to UKfinancialstability.

Aimingforcoverageofallinstitutionsinthefinancialsystemwouldbeunnecessarilycostly,withsmallmarginal benefitsfrompolicymakers’perspectivebeyondacertainpoint.

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  • Principlesfordeterminingthecoverageofstresstests

  • TherearethreemainconsiderationsthattheBankexpectswillinformthedecision to includeinstitutionsinthestress-testingexerciseoverthemediumterm.

  • Institutions’importancetoUKfinancialstability:FinancialstabilityisatthecoreofthestatutoryobjectivesofboththeFPCandthePRA.Soinstitutions’importancetoUKfinancialstabilityisakeyconsiderationindeterminingtheirinclusioninthisstress-testingframework.

  • FPCandPRApowerstorequireremedialactions:InstitutionswouldonlybeincludedifthepowersoftheFPCandthePRAallowedthemtotakeappropriateactionsinformedbythestress-testresults.

  • Banks’legalandregulatorystatusintheUnitedKingdomthereforebecomesakeyconsiderationdeterminingcoverage.

  • Broadcomparabilitybetweeninstitutions:Manyofthebenefitsfromincludingfinancialinstitutionsinaconcurrentstress testarelikelytoariseonlywhentheiractivitiesaresufficientlysimilartothoseofotherfirmscoveredbytheexercise.

  • Additionally,includinganoverlydiverserangeofinstitutions,eachrequiringseparateanalyticaltoolkits,wouldriskmakingtheframeworkexcessivelycomplexto implementandcommunicate.

  • Implicationsoftheseconsiderationsforthecoverageofconcurrentstresstests

  • Basedontheseconsiderations,theBankenvisagesthatthestress-testingframeworkwillincludethemajorUKbanks(seeTableAforarankingofUKbanks by totalassets).

  • TheBankexpectsthisgrouptoincludetheeightbanksthatwerethefocusoftheFPC’sandPRA’srecent capitalshortfallexercise(BarclaysGroup,TheCo-operativeBankplc,HSBCHoldingsGroup,Lloyds

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BankingGroup,NationwideBuildingSociety,RoyalBankofScotlandGroup,SantanderUKplcandStandardCharteredBankGroup).

Adisorderlyfailureofanyoftheseinstitutions,individually,couldposematerialthreatstofinancialstabilityintheUnitedKingdom.

TheBankwillalsobeconsideringhow theprincipalUK-regulatedsoloentitieswithinthesefinancialgroupswillbetreatedaspartoftheexercise.

TheBankisalsoconsideringthemeritsofincludingmedium-sizedUKbanksintheconcurrentstresstests.

Oneoptionwouldbe to includetheseintheframeworkbutconductthestresstestsinawaythatisproportionatetotheirscaleandcomplexity,aswellasprevailingrisks to stability.

This wouldbeconsistentwiththePRA’sduty tohaveregardtotheneedtominimiseanyadverseeffectsoncompetition,inthisinstancethroughthepotentialburdentheexercisewouldplace onbanks.

Forexample,medium-sizedbanks couldbeexemptedfromrunningsomescenariosthatarelessrelevanttotheirbusinessmodels;oranalysismightfocusmostlyonspecificportfolios,withlessdetailontherestofthebalancesheet.

Anotheroptionwouldbetoexemptmedium-sizedbanksfromtheconcurrentstress testsasamatterofcourse,butretaintheflexibilitytochangethescopeoftheconcurrentstresstestsatcertainpointsintime,dependingontherisks beingexploredbytheFPCandthePRABoardinagivenyear.

TheBank’sstartingpositionisthat —overtime—medium-sizedbanksshouldbeincludedinthesteady-stateconcurrentstresstests, in aproportionatefashion.

In part,thiswillhelpdeliveraconsistentapproach to supervision,ensuringthatahighproportionoftheUKbankingsystemisheld tothesamestandardsofresilience.

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TheregulatorybenefitsofincludingsmallUKbanks,whenconsideredindividually,areunlikely to justifythecosts.SotheBankproposesthatthesearenotincludedintheconcurrentstresstestsoutlinedin thisDiscussionPaper.

Buthistoricalexperience—forexampletheUKSecondaryBankingcrisisofthe1970sandtheUSSavingsandLoancrisisinthe1980s— suggeststhatthecollectivefailureofsmallerbankshasthepotentialtoposethreatstostability.

Asaresult,itwillbeimportantfortheFPCtomonitorthebuild-upofcommonvulnerabilitiesacrossthebankingsystemasawhole,includingthosestemmingfromsmallerUKbanks.

Morebroadly,allUK-regulatedbanksarerequiredtoruntheirownstresstestsaspartofexistingregulatoryrequirements.ThePRAisproposingtomaintainthisrequirementfollowingtheimplementationofCRDIV.

TheBankenvisagesthatsignificantUKsubsidiariesofforeignglobalsystemicallyimportantbanksarelikelytobeincludedintheframework.

Theseinstitutions(typicallyinvestmentfirms)areimportantforthefunctioningofUKfinancialmarketsandthecontinuityinprovisionoffinancialservices totherealeconomy.

ButitisunlikelythatUKbranchesofforeignbankswouldbeincludedintheframework.

Branchesarenotdistinct legalentitieswithseparate capitalresources.

ForUKbranchesofEEAbanks,thePRA’spowersandresponsibilitiesarelimitedunderEuropeanlaw.

ForUKbranchesofnon-EEAbanks,wherethehomeregimeisconsideredequivalenttothatoftheUnitedKingdomandwherethePRAhasassureditselfoverresolutionplansandthehomeregulator’ssupervisoryapproach,thePRArelies—wherepossible—onsupervisionbythehomeregulator.

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Finally,itisnotenvisagedthatothertypesoffinancialinstitutionswillbeincludedaspartofthisstress-testingframework.

Themodellingapproachnecessarytoanalysenon-banks,andthekeyriskdriversforthoseinstitutions,canbemateriallydifferentrelativetothoseforbanks.

Forexample,thetypesofrisksfacedbyinsurancecompanies—whomthePRAalreadyrequirestoconductstresstests—canbeverydifferent,includinglongevityrisk forannuityprovidersorclaimsvolatilityfor

non-life insurers.

Moreover,thetypesofpolicy actionsthatanystress testswouldsupportarealsolikelytodiffer.

But,aspartoftheFPC’sregularsurveillanceand,potentially,asaninputintothisframework,itwillbeimportantforthestress teststotakeaccountofrisksstemmingfrom,orpropagatingthrough,partsofthefinancialsectornotincludedwithinthescopeofthisexercise.

Onewaythatthiscouldbe achieved isthroughscenariodesign.

Morebroadly,theBankwillbemindfulofthepossibilitythatcertain investmentfirmscurrentlyregulatedbytheFinancialConductAuthority(FCA)might,atsomepointinthefuture,warrantinclusionintheproposedframework.

AlthoughtheBankisnotcurrentlyproposingtoconductconcurrentstresstestsforinsurersalongsidethoseforthebankingsystem,feedbackfromrespondentsonhow theBankmightbestincorporate theresultsofthestresstestsitalreadyconductsforinsurersintotheframeworkforbanksoutlinedinthisDiscussionPaperwouldbewelcome.

In addition,giventheirimportanceforfinancialstability,theBankwillseparatelyconsidertheneedforastress-testingregimeforcentralcounterparties(CCPs)operatingintheUnitedKingdom.

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Asafirststep,theBankwillbeundertakingathematicreviewoftheadequacyofUKCCPs’ internalstress-testingpracticesduring2014andwillreportconclusions totheFPC.

Buildingonthat,theBankwillconsiderthemeritsofdevelopingaseparateregimeforconcurrent,cross-CCPstress testingthatcouldcomplementtheframeworkforbanksoutlinedinthisDiscussionPaper.

ThiscouldstrengthentheBank’ssystem-wideanalysis,forexamplebysheddinglightontheimpactofhighermargincallsonthesystem.

TheBankwouldwelcomefeedbackfromrespondentsonthemeritsofaconcurrentstress-testingregimeforCCPs,tocomplement,andpotentiallyinform,thatforbanks.

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5Scenariodesign

Therearethreekeyelementsthatdeterminetheoverallanalyticalapproachtostresstesting:

Thedesignofscenarios

Theapproachtomodellingtheimpactofscenariosonprojectedbankprofitabilityand capitalratios

Contingentonthoseoutputs,thestandardsagainstwhichbanksareassessed to reachaviewon capitaladequacy.

Thissectionoutlines theBanks’proposedapproachtoscenariodesign.The othertwo aspectsareconsideredinSections7and8respectively.

Thereisalsoaread-acrossbetweenthelossesexpected to occur inabaselinescenarioandassetqualityreviews.

Theselinks areconsideredinSection6.

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  • AkeyprincipleunderlyingtheBank’sapproachto stress testingis toexplorearangeofscenarios.

  • Anysinglescenarioisalmostcertainnottomaterialise.

  • Anditisnotdesirablefromaregulatoryperspectivethatthebankingsystemasawholeisonlyassessedagainstasingle‘badstateoftheworld’.

  • Moreover,fromapracticalperspective,differencesinbanks’businessmodelsimplythatscenariosthatmightbestressfulforonebankmightbemuchlesssoforanother.

  • Tomaketheframeworkusefulforpolicymakers,stresstestsshouldexploredifferentvulnerabilitiesandmanifestationsofpossiblefuturestresses.

  • Overall,theframeworkislikely to incorporatethreebroadsetsofscenarios:

  • AsetofcommonstressscenariosdesignedbytheFPC,inconsultationwiththePRABoard,andappliedacrossallbanksundertakingthestresstest.

  • Asetofbespokestressscenariosdesignedbyindividualbanks,andapprovedbythePRABoard,withadegreeofseveritycalibratedtomatchatleastthatofthecommonstressscenariosdesignedbytheFPC.

  • AcommonbaselinescenariodesignedbytheFPCandinformedby,amongotherthings,theMPC’sforecastsascommunicatedintheBank’sInflationReport.

  • Thestresstestswouldformallybeapplied to individualbanksundertheauthorityofthePRA,conductedbystafffromacrosstheBankandreportedbacktotheFPC.

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  • Approachtothedesignofcommonstressscenarios

  • Theseverityofthestressscenariosisakeydeterminantofthe overallresiliencestandardtowhichthebankingsystemisbeing heldbytheauthoritiesthroughthestress-testingexercise.

  • Thestressesbeingassumedneedtobebothsufficientlysevere,butalsoplausible.

  • Crucially,thestressesshouldnotbeinterpretedasstatesoftheworldthat theFPCorthePRAperceiveaslikelytohappen.

  • Akeyconsiderationwhendesigningscenariosistheextenttowhichtheseverityofthescenariosbeingexploredmightvaryacrossstresstestsconductedatdifferentpointsintime.

  • Anexplicitlycountercyclicalapproachtoscenariodesignwouldrecognisethevariationintheprobabilityandimpactofsystemicstressesovertime.

  • Forexample,ascreditconditionseaseandleveragebuildsup,thebankingsystemmaybesusceptibletomoresevereshocks.

  • Conversely,in adownturn,withtighteningcreditconditionsandlowerleverage,alessseverescenariomightbemoreappropriate,dependingontheparticularcircumstances.

  • In practice,twobroadapproachesmaybetakenwithrespecttohowtheseverityofagivenscenariorelatestoeconomicandfinancialconditions:

  • Oneoptionwouldbetoaimforabroaddegreeofconsistencyintheseverityoftheshocksapplied.

  • Forexample,assetpricesmightbeassumedtofallbysomepercentagerelativetothebaselineprojection,irrespectiveoftheircurrentlevel.

  • Similarly,thestressscenariomightassumeagivenpercentagepointincreaseintheunemploymentraterelative to thebaselineprojection,regardlessofthecurrentunemploymentrate.

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  • Suchanapproachcouldallow theauthoritiestoidentifyhowchangesinbanks’risk-takingbehaviour(suchaslooseninginloanunderwritingstandardsovertime)mightincreasetheirvulnerabilitytoabroadlystablesetofshocks.

  • And,inadownturn,itwouldensurethatthescenariosresultinsufficientlystressfuloutcomes.

  • Atthesametime,suchanapproachmightamplifyprocyclicalityinthefinancialsector,withthestressscenarioeffectivelybecominglesssevereinanupturn(whenprofitsandassetvaluationsarehigh)andviceversainadownturn.

  • Analternativeapproachmightbetovarytheseverityoftheshocksappliedintheadversescenario,dependingonprevailingeconomicandfinancialconditions.

  • Forexample,assetpricescouldbeassumedtofallrelativetosomelong-runequilibriumlevel.

  • Duringperiodswhen,forexample,housepriceswereabovethatlevel,the sizeoftheshockinthestressscenariowouldbelarger.

  • Similarly,theunemploymentratecouldincreasetoagivenlevelinthestressscenario.

  • Thiswouldmeanthat,atpointsintimewhenunemploymentislow,theincreaseintheunemploymentrateinthestressscenariowouldbelarger.

  • Theseverityoftheshockscouldbefurtheramendedtoreflectthestateofcreditmarkets— forexample,tohelpcaptureamplificationmechanismsbetweenthefinancialsystemandtherealeconomy(seeBox4).

  • Themainadvantageofsuchanapproachisthatitwouldseektoreflecthow systemicriskchangesovertime,reducingprocyclicalityin thesystem.

  • Butitwouldalsorequirejudgementsbypolicymakersonthestateofeconomicandfinancialconditionswhendesigningscenarios.

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  • Forthemedium-termframework,theBankisconsideringtwo possibleapproachestothedesignofthecommonscenarioswithinagiven exercise:

  • Thefirstwouldbetoemployasinglecommonstressscenario.

  • Thiswouldstartfroma‘base’methodology,aimingatabroadlyconstantdegreeofseverity acrossstresstestsconductedatdifferentpointsinthecycle.

  • TheFPCwouldthenoverlayjudgements to increaseorreducetheseverityofcertainshocksovertime,factoring initsviewsaroundtheprobabilityorimpactofsystemicrisksinthedesignofscenarios.

  • Thesejudgementswouldlikelybeinformed,atleastinpart,bytheFPC’ssetofcoreindicators.

  • Whilesimpleroperationally,theuseofasinglecommonscenariowouldcomeatthecostofareducedsetofinformationtoallow theFPCandthePRABoard to informtheirrespectivepolicy andsupervisorytools.

  • Analternativeapproachwouldbetousetwocommonstressscenarios:onethataimsatabroadlyconstantdegreeofseverityacrossstress tests,independentofeconomicandfinancialconditions;andonethatseeks totakeintoaccountprevailingconditionswhencalibratingscenarioseverity,includingthelevelsofleverage,debtandcreditgrowth.

  • Suchaframeworkwouldallow theFPCtoexploreparticularvulnerabilitiesthatmightbeamplifiedbythestateofthefinancialsystemandthewidereconomyatthetime.

  • AnditwouldfacilitatetheuseoftheoutputsofstressteststoinformthesettingoftherespectivetoolsoftheFPCandthePRABoard.

  • TheBank’sapproachtothedesignofthecommonstressscenariosisalsolikelytoincorporatethefollowingprinciples:

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  • Scenarioswillseektoallow theFPCandthePRAtoexploretheimpactofpotentialtippingpointsthatmightleadtosharpchangesintheimpactofstressscenarios.

  • Forexample,iftheeconomy-widedistributionofborrowersissuchthatrepaymentdifficultieswouldincreasesharplybeyondacertainlevelofinterestrates,thedesignofscenarioswouldseek to incorporatethatinformationto ensurethatbanks’businessmodelsaresufficientlystressed.

  • Whilesomedegreeofconsistencyofscenarioseverityovertimemightbedesirable,theframeworkwillneedtobeflexibleenoughtoallowtheFPCandthePRAtoexploredifferentsourcesofsystemicrisk,asthesearelikelytochangeovertime.

  • In consideringtheriskstobeexploredaspartofthestress-testingexercise,theFPCandPRAwilldrawonrisk assessmentanalysisfromacrosstheBank.

  • ThisiscarriedoutbystaffintheFinancialStability,MonetaryAnalysisandSupervisoryareasoftheBank.

  • Thescenariodesignprocesswillalsoseektoincorporatemarketviewsofkeyrisks—forexample,byemployinginsightsfromtheBank’sSystemicRisk SurveyanditsMarketIntelligencefunction.

  • Synthesisoftheseinsightsalreadytakesplace—forexample,duringtheproductionoftheFinancialStabilityReport(FSR). RiskshighlightedintheFSRareparticularlylikelytobeconsideredaspartofscenariodesign.

  • Fromanoperationalperspective,thecommonstressscenariosareexpectedtoincorporatebothmacroeconomicandmarketshocks.

  • TheBankexpectstospecifypathsforkeyvariables,suchasGDPgrowth,unemployment, interestrates,houseprices,etc.

  • ThescenariosarelikelytocoverUKvariablesand,dependingonthepreciserisksbeingexploredbytheFPCandthePRAatthetime,possiblyalsoforeignvariables.

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ArangeofmodelsaswellashistoricalexperiencewillhelpinformthederivationofvariablepathsbyBankstaff.

Butfutureepisodesofstresswillalmostcertainlybedifferentfromthosepreviouslyobserved,forexampleduetofinancialinnovationandchangesinmarketstructures.

Sothescenariosmightincludeshockstoriskfactors,theprecisenatureofwhichmaynothavebeenpreviouslyobserved.Overall,therefore,therewillbearoleforjudgementindesigningthestressscenarios.

Thedurationofscenarioswillbeconsistentwiththerisksthattheyhavebeendesignedtoexplore.

Forexample,scenariosdescribingmacroeconomicoutcomeswould tendtobearoundthreetofiveyearsinduration,whereassuddenandsevereevents,suchasmarketshocks,wouldoccuroverconsiderablyshorterhorizons.

In practice,adversescenariosarelikelytoincludeacombinationoftheseelements.

TheBankexpects tobeprovidingfurtherdetailsofitsapproachtodesigningcommonstressscenariosin futurepublications.

Approachtothedesignofbank-specificscenarios

Allbanksthattakepartin theconcurrentstresstestsproposedinthisDiscussionPaperarelikelytobeexpectedtodesign,andassesstheimpactof,abespokestressscenario.

Banks,liaisingwithPRAstaff,wouldbeexpectedtodevelopscenariosthataremorecloselyalignedtotheirparticularbusinessmodels.

Supervisoryinsightsmaybeusedtoidentifybank-specificvulnerabilities

—forexample,originatingfromparticularexposurestocertainbusinesslinesorregions.

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Insightsfromreversestresstestingbybanksarealsolikelytobeusefultoidentifykeyvulnerabilitiesandguidethedesignofthebespokeadverse scenarios.

Thisprocessshouldyieldimportantinsightstoregulators,includingfroma system-wideperspective.

Forexample,itmightrevealthatanumberofbanksacrossthesystemareparticularlyexposedto acommonsetofvulnerabilitiesthathadnotbeenidentifiedpreviously.

Bespokescenarioswouldneedtobeaccompaniedbyaclearexplanationfromthebanksoftheprocessusedtoidentifytheparticulartypeofstressbeingexplored,thekeyjudgementstakenindeterminingitsseverityand howthepathsofthevariableschosenrelatetoeach other inaneconomicallyintuitiveway.

Akeyprincipleunderlyingtheapproachtodesigningbank-specificscenariosisthatthesewouldbeexpected to resultinhigherlossesthanthecommonscenariodesignedbytheFPC.

Themotivationbehindthesebespokescenariosistoexploreriskstowhich eachbankismostvulnerable.

Itisnatural,therefore,toexpectthatsuchascenariowouldgeneratehigherlossesforthatbankrelative tothecommonstressscenario.

Ifthisisnotthecase,banksmaybe askedbythePRAtoredesignthebespokescenario.

Moreover,failuretodesignasufficientlyseverescenarioislikelytobetakenintoaccountbythePRAwhenassessingtheadequacyofabank’sstress-testingand capitalplanningprocesses.

Thebaselinescenario

TheBankwillwanttoformaviewoftheresilienceofthebankingsystem,andindividual institutionswithinit,underacentralcase.

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This canhelpinformjudgementsovertheadequacyofbanks’financialresources givencurrentexpectations aboutthestateoftheeconomy.

Forexample,duringthetransitionpathtohigherrequirementssetunderBaselIIIandbytheIndependentCommissiononBanking(ICB),thebaselinescenario canprovideusefulinformationaboutthesystem’scapacitytomeetthesehigherstandards,whilecontinuingtoprovidefinancialservices,inlinewiththeFPC’sobjectives.

Banks’projectionsunderthecentralcasearealsoakey inputtosupervisoryassessmentsoftheadequacyofbanks’capitalplanningprocesses.

Bankstaffwillproduceprojectionsofkeymacroeconomicvariablesforthebaselinescenario.

Theseareexpectedtobeinformedby,amongotherthings,theMPC’scentralviewoftheeconomy,ascommunicatedintheBank’sInflationReport.

Banksrunningthestresstestswillbeexpected to generateprojectionsusingthebaselinescenario.

Butthisscenarioisnotintendedtobeasubstituteforbanks’ ownarticulationofcentralexpectationsoffutureeconomicconditions,whichtheywouldcontinueto useforawiderangeof internaluses.

6Assetqualityreviewsandstress testing

Assetqualityreviewsareawell-establishedregulatory tool intheUnitedKingdom.

ThissectiondescribesthepurposeofthesereviewsandhowtheBankenvisagestheyarelikely to interactwiththestress-testingexercise.

Whatareassetqualityreviews?

Regulatorsconductassetqualityreviewsatabusinessunitorportfolioleveltoensurethatbanks’assetvaluationsreflectexpectedasset

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performanceand toidentifyriskstoassetperformancethatneedtobereflectedinbanks’capitalrequirements.

Morespecifically,supervisorsuseassetqualityreviewstoensurethat,withintheconstraintsofaccountingrules,adequateprovisionsareheldagainstassetsheldatamortisedcost.

Assetqualityreviews can alsobeused toensurethatmarked-to-marketassetsarevaluedprudently.

Anyadjustmentstoprovisionsandvaluationswillhaveanimpactonbanks’measuredcapitalresources.

Inaddition,assetqualityreviewsareusedtoensurethattherisksinherentintheportfoliosinvestigatedareappropriatelyreflectedinbanks’Pillar1(and,wherematerial,Pillar2A) capitalcalculation.

Broadly,assetqualityreviews canhavefourlevelsofgranularity(TableB).

Level1reviewsincludeanassessmentofregulatoryandmanagementinformationonassetquality.

Deeperreviewsmightincludediscussionswithabank’smanagement,useofspecialiststaff,andexaminationsofindividualloan files.

ThePRA’sapproachto assetqualityreviewsisproportionate to thelevelofriskandcomplexityoftheassetsconcerned.

Moreintensereviewsareconductedonassetportfoliosthatcanmateriallyaffect abank’sresilience,thatarecomplexandinherentlydifficulttovalue,orthatappearhighlysusceptibletolosses.

ThePRA’sassetqualityreviewsarethereforetypicallytailoredtothebank’scircumstances.

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AssetqualityreviewstakeplacecontinuouslyaspartofthePRA’ssupervisoryprocesses.

Reviewsofindividualbanks’assetsareconductedperiodicallyandoccuratdifferenttimesforeachbank.

Thematicreviewsofparticulargroupsofassetsarealsoconducted,ofteninresponsetoaspecificriskorconcern,coveringmultiplebanks atthesametime.

Whileassetqualityreviewswillcontinuetobeundertakenthroughouttheyear,theresultswillbeofdirectrelevance to stresstests.

TheFPCwillreceiveregularreportsonassetqualityreviews,to helpidentifycommonthemesinthosereviewsthatarerelevanttoUKfinancialstability.

Interactionwithstress testing

Stress testsareusedprimarilytoassesstheamountofcapitalthatabankmightrequireintheeventofanadverseshock.

Acriticalpreconditiontomakethatassessmentisthatbanks’reportedcapitalpositionsarestatedaccurately.

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Assetqualityreviewshelpensurethis,bothintermsofcapitalresourcesandcapitalrequirements.

Forexample,ifassetqualityreviewsrevealedthatprovisionsheldagainstcertainloanportfolioswereinadequate,thelevelofprovisionscouldbeadjusted,reducingthebank’smeasuredcapitalresources.

Alternatively,ifassetqualityreviewsrevealedinadequaciesinPillar1orPillar2Acapitalrequirements(forexample,ifexposureswerefoundtobeassignedbyabanktoinappropriateriskgrades),adjustmentscouldbemade to increasethoserequirements.

Stress testswouldthenbeappliedtoadjustedcapitalpositions,startingfromasoundbase.

Fullaccountwouldbetakenduringthestress-testinganalysisofthelevelofprovisionsalreadyheld bybanks.

Assetqualityreviewsmayalsorevealinformationabouttheperformanceofaportfolioinastressand,so,aidtheevaluationoftheimpactofan adversescenario.

Forexample,theymayrevealthatloanswereoriginatedwhenthebankhadaparticularlyhighrisk appetite.

Takentogetherwithadjustments tothestartingcapitalposition,thiswouldnot‘doublecount’the capitalrequiredtoprotectthebankfromanunexpectedshock.

Rather,theadditionalinformationfromassetqualityreviewswouldbeusedappropriatelytoassessthebank’sabilitytowithstandthatshockaspartofthestresstests.

In thisway,theinformationfromassetqualityreviewsandstresstestswouldbecomplementary.

Assetqualityreviews can alsohelpindesigningstressscenariosbyidentifyingthoserisks thatshouldsubsequentlybeexploredeither

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throughcommonoridiosyncraticscenarios—forexample,whereriskstoassetperformancearehighlyconcentrated.

Thesetypesofweaknesscouldincreasethescaleandlikelihoodofabank’slossesduringastressscenariobutmaynotbeapparentfrommoreaggregateddatausedin astress test.

Morebroadly,sincetheinformationfromthebaselineforecastofcreditlossesinastresstestwillalsocontainusefulinformationaroundtheadequacyofprovisioning,acomparisonofthebaselineforecastsofcreditlossesandcurrentprovisionsheldbybanks islikelytobeausefuladditional diagnosticofcapitaladequacy.

7Modellingofscenarios

Anecessarybuilding blockforprovidingaquantitative,forward-lookingassessmentofbankcapitaladequacywillbeasynthesisedviewofbanks’future capitalpositionsineachofthescenariosbeingconsidered.

Thisrequiresasetofquantitativetoolstotranslatethemacroeconomicandmarketvariablespathsintoprojectionsofbankprofitabilityandcapitalratios.

TheBankexpectstouseasuiteofmodelstodothis,ratherthanrelyonasinglemodel.

Whyasuiteofmodels?

Thereareanumberofbenefits inusingasuiteofmodelsaspartofthestress-testingframework.

First,thebankingsystemfacesmanydifferenttypesofrisk,includingmarket,credit,fundingandliquidityrisks.

Althoughtheseareofteninterrelated,itisnotrealistic to expectthatasinglemodelwillcapturetheentiretyoftheseriskseffectively.

Moreover,relianceonasinglequantitative tool heavilyexposesthestress-testingexerciseto‘modelrisk’.

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Allmodelsareasimplificationofreality,soitisreasonabletoassumethatanysinglemodelwillalmostcertainlybewrong.

Havingrecoursetoasuitehelpsreducethesensitivityoftheresults to aparticularmodel’s‘blindspot’ormiscalibration.

Differentmodelsalsogivedifferentinsightsandperspectivestopolicymakers,servingasausefulcross-checktoeach other.

Indeed,therangeofoutputsfromdifferentmodels canitselfbeinformative,providingusefulinsights topolicymakersonuncertaintiesaroundbanks’ capitalpositions inagivenscenario.

Usingasuiteofmodelsalsoreducestherisk thatindividualbanksmightseekto‘game’thestress-testingframeworkbyseekingtorestructuretheirbalancesheetsinawaythatreducesmeasuredriskunderaparticularmodel.

Finally,fromasystem-wideperspective,relyingonasinglemodelcouldhaveadverseconsequencesfordiversityinrisk measurementandriskmanagementpracticesacrossthesystem.

Usingasuiteofmodelsisnotwithoutcosts,however.Itwilladdsomedegreeofcomplexitytotheoverallexercise.

Synthesisingmodeloutputsalsorequiresregulatoryjudgement,whichmightmaketheanalysislesstransparenttostakeholders(seeSection8).

Giventhis,insynthesisingdifferentmodeloutputs,transparencyaroundthekeyjudgementsinvolvedin reachingan overallviewoncapitaladequacywillbeimportant.

Whatrangeofmodelswilltheframeworkemploy?

Modelscanvaryin severalrespects—forexample,intheirlevelofgranularity,thetypeofriskstheyseek tocover,ortheircalibration.

Broadlyspeaking,theBankexpects to employfourmaintypesofmodelsandassociatedanalysis(Chart1):

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  • Granular,regulator-developedstress-testingmodels:Thesearemostlybank-levelorasset-specificmodelsthataimto capturethedetailofspecific businessactivitiesandassettypes.

  • Theyarecalibratedandrunbyregulators.

  • Coarser,system-widestress-testingmodels:Lessgranularmodellingapproaches,suchastheBank’s RiskAssessmentModelofSystemicInstitutions(RAMSI),arebetterabletotakeasystem-wideviewofrisk.

  • Forexample,theyseek to incorporatefeedbacksandamplificationmechanismsofinitialshocks,suchasinteractionsbetweeninstitutionswithinthebankingsystemorbetweenthebankingsystemandthewidereconomy(seeBox4).

  • They canbeusedtoexploreawiderrangeofscenariosinamoreflexibleandtimelymanner.

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  • Andtheyallow policymakerstoimposetop-downjudgementsmoreeasily.

  • Banks’ownstress-testingmodels:Thesesharemanyofthecharacteristicsofgranular,regulatory-runmodels.

  • Theybenefitfrombetteraccesstodata,anevengreaterdegreeofgranularityandgreatertailoringto theunderlyingportfoliosbeingassessed.

  • Whilebanks’ incentivesarenotalwaysfullyalignedwiththoseofregulators,valuableinsightsmaybegainedthroughcomparingtheoutputsofbanks’ownmodelswiththoserunbytheauthoritiesaswellasthroughpeeranalysis.

  • Other‘satellite’models:Whilenottraditional‘stress-testing’models,theframeworkisexpected toemployanumberofmodelsandanalyticaltoolsdevelopedacrosstheBanktoinformaneconomy-wideviewofrisksanddevelopmentsacrossdifferentsectors.

  • Theseresults canthenbecompared totheaggregatedresultsacrossthebankingsystem.

  • Forexample,itcouldbethatprojectedimpairmentsonlendingto aparticularsectorappearreasonablewhenconsideredonabank-by-bankbasis,butnotwhenaggregatedandcomparedwithanalysisofthatsectorasawhole.

  • TheBankalsoexpectstocollaboratewith otherinstitutions— for example,theIMForforeignregulators—whenmodellinglossesinforeignjurisdictions.

  • TheBankwillcontinuetoimproveitscapabilitiesanddevelopnew modelscontinuously.

  • Thesuiteofmodels,asaresult,willevolveovertime.

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Thisisanongoingareaofresearch,especiallyin theareasofincorporatingsystem-wideamplificationmechanismsinsystem-widestress testing(seeBox4).

Granularityofregulatorymodelsandanalysis

Granular,regulator-developedstress-testingmodelsareimportantforhelpingtheauthoritiesexplorebanks’vulnerabilities to differentsourcesofrisk.

In doingso,they canstrengthenprudentialsupervisionbyenrichingthebodyofinformationthatsupportssupervisoryjudgements.

Theycanalsohelptoreducerelianceonstress-testprojectionsproducedbybanks’ownmodels(seefurtheronthisbelow),allowingregulatorstoreachanindependent, in-depthviewofabank’srisk profile.

Theappropriatedegreeofgranularityfortheseregulatorymodelsisakeydesignconsideration.

Here,granularitydefinesthelevelofdetailatwhichbanks’riskexposuresarecapturedindataand,subsequently,modelled.

Forexample,whenconsideringabank’smortgagebook,relevantriskfactorsmightincludetheloantovalue(LTV)ratio,producttype(forexample,interest-onlyorrepayment),typeofborrower(prime,sub-primeorbuy-to-let)andwhetherornotrepaymentsarefullyup-to-dateorinarrears.

Thelevelofgranularitydeterminesboththenumberofsuchriskfactorsusedinmodelling;andwhetherdataaboutsuchriskfactorsarecollectedatthelevelofindividualloansorforagroupofloansthatsharesimilarcharacteristics.

Ontheonehand,themainbenefitofgreatergranularityisthat,inprincipleatleast,additionalinformationaboutrelevantrisk factorsshouldhelpassesstheimpactofdifferenteconomicshockswithgreateraccuracy.

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Ifimportantinformationiseitheromitted,orreducedtosummarystatistics,theassessmentofrisksmightbemisleading.

Thereislikelytobeaminimumlevelofgranularityabovewhichtheeffectofmaterialdriversofriskstarts tobemisrepresented—orevennotreflectedatall—inlossestimatesfortheindividualportfoliosconcerned.

Forexample,ignoringthedistributionofLTVratiosacrossborrowerscouldresultinanoverorunderestimationofrisk indifferentbanks’mortgagebookswhenassessingthepossibleimpactofashockoriginatinginthehousingmarket.

Ontheotherhand,thecostsassociatedwithhighlevelsofdetailmayoutweighthebenefitsbeyondacertainpoint.

Mostobviously,thereisaresourcecostforbanks toproduce,andregulatorstoprocess,understandanduselargedatasets.

Moreover,thereareanalyticalrisksassociatedwithhighdegreesofcomplexity.

Forexample,usingalargenumberofexplanatoryvariablesinmodelscanleadto ‘over-fitting’problems,whereestimatedrelationshipsperformwellat capturingobservedrelationshipsin-sample,butlesssoinforecastingout-of-sample.

Andexcessivefocusongranularityrisksdistractingattentionawayfromthebigrisksfacingindividualbanksandthesystem asawhole.

Itmaybethatthecorrelationsbetweenrisk factorsorother interactionsareultimatelymoreimportantindicatorsofsystemicrisksthantheindividualrisk factorsthemselves.

Theuseofasuiteofmodels—asproposedinthisDiscussionPaper— willguardagainstsomeoftheserisks.

Theseconsiderationsimplythattheappropriatedegreeofgranularityinregulatorymodelsislikelytovaryaccordingto thetypeofexposureoractivitybeingconsidered.

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Forexample,wherebanksholdalargenumberofcomparativelyhomogenousassets,itmaybe acceptableto aggregatetheseintogroupsthatsharesimilarriskcharacteristics— forexample,multiplemortgagesthathavesimilarLTVratios,paymentstatusandarewithinasimilarproductcategory.

Butotheractivities—suchasahighlyconcentratedportfoliooflargecommercialrealestateexposures—mightrequirealoan-levelassessment.

Itisalsoimportanttoemphasisethatstresstestingisnottheonlyapproachthroughwhichregulatorsseektounderstandbanks’riskexposures.

Therewillremainanumberofothercomplementarysourcesofinformation,includingassetqualityreviews(discussedinSection6).

In fact,assetqualityreviewsmayinformtheappropriatelevelofgranularityofstress-testingmodels.

TheBankwouldwelcomefeedbackfromrespondentstothisDiscussion Paperontheappropriategranularityforstress-testingmodels.

DisclosureofinformationaroundregulatorymodelsIrrespectiveoftheultimatechoiceofmodels,akeypolicyquestionisthedegreeoftransparencyaroundthedetailofregulatorymodels.

Thisinvolvesatrade-off.

Disclosinggranularinformationaboutregulatorymodelsmightreduceincentivesforbankstodevelopandimprovetheirownrisk measurementsystems.

Suchexcessiverelianceonregulatorymodelscouldhaveadverseconsequencesforsystem-widediversity.

Moreover,banksmightusethisinformationto‘arbitrage’thestresstests,structuringtheirbalancesheetsinawaythatmightreducemeasured,butnotactual,risk.Similarconcernsaround‘managingmodels’,ratherthan

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managingrisk,havealsobeenexpressedinthecontextofmodelsusedtodetermineriskweightsintheBaselframework.

Going inthe otherdirection, disclosureofinformationaroundmodelsmightgivebanksandthemarketgreaterconfidenceabouttheapproachesusedbyregulators.

Makingthisinformationavailablepubliclywouldallow academicsandindustryprofessionals to peerreviewthesemodelsandassistin theirdevelopment.

Andbeingabletoshareknowledgeabouttheadvantagesand disadvantagesofdifferentmodellingapproachescouldprovefruitfulfromarisk managementperspective.

TheBank’sstartingpositionistofavourdisclosureofhigh-levelinformationaboutthemodelsusedforstresstesting,butnottheirprecisecalibration.

Thisisanarea wheretheBankwouldwelcomefeedbackfromrespondentstothisDiscussionPaper.

Relianceonbanks’ ownmodels

TheBankexpects tousetheresultsfrombanks’ ownmodelsasaninputintoitsanalysistoformaviewofthelikelysizeofstressedlossesinadversescenarios.

TheBankrecognises,however,thattheuseofbanks’ownmodelsaspartofthestress-testingexercisecanleadtoa‘principal-agent’problem.

Thisisdue to apossiblemisalignmentofincentives:iftheconcurrentstress-testingexercisehas thepotentialto lead to remedialactionsbybanksthattheywouldnotthemselveshavechosentotake,bankswillfaceincentivestoprovidean overlyoptimisticviewoftheimpactofadverse scenariosontheir capitalposition.

TheBankexpects totakeanumberofstepstohelpreducethisproblem.

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  • Theseinclude:

  • Comparisonofbanks’projectionswiththosefromregulatorymodels:TheBankwilluseasuiteofmodels to produceits own projections,rangingfromindividual-bankportfoliostosystem-widelevelsofgranularity.

  • Whereabank’s ownprojectionsdiffersubstantiallyfromthoseproducedbytheBank’ssuiteofmodels,particularly intheabsenceof

  • well-substantiatedargumentstojustifythis,thiswillinformtherelative

  • weightsattachedbyBankstafftobanks’ownprojections.

  • Peercomparison:Theconcurrentnatureofthestress testmeansthattheresultsforsimilarportfolioscanbecomparedacrossbanks.Such peeranalysiswillhelpflagobviousoutliers.

  • Regulatoryexperience:TheBankwillbeengagingwithotherregulatorstounderstandpastlossexperiencesandexpectationsoflossesunderstress,especiallyin thecontextofmodellinglossesin foreignjurisdictions.

  • Morebroadly,tohelpalignincentives,banks willlikelyberequiredtohaveinplacearobustgovernanceprocessaroundstresstesting(seeSection11formoredetailsaroundexpectationsofbanksaspartofthisframework).

  • Disclosureofstress-testresults—totheextentthatmarketdisciplineiseffective—shouldalsocontribute to ensuringthatbanks takeactiveaction to reportaccuratelyandstrengthenmodellingstandards.

  • Modellingbanks’assumedresponsestoscenarios

  • Banks’businessstrategiescontinuouslyadapt tochangesintheprevailingandexpectedoperatingenvironment.

  • Itis,therefore,reasonabletoincorporateatleastsomeofbanks’proposedresponsestomacroeconomicandmarketshockswhenevaluatingtheimpactofscenariosonbankcapitaladequacy.

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Suchresponses canrangefrom‘businessasusual’actions,suchasadjustmentstointerestrateschargedoncertainproductsfollowingachangein BankRate,through tomanagement actionstakenin responseto capitalorliquiditypressures,suchasconstrainingdividend distributionsorreducingcertainexposures.

AsexplainedinSection11,whenbanksmodeltheimpactofagivenscenario,theywouldbeexpectedtotakeaconservativeapproachtoincorporatingmanagement actions.

Suchresponsesshouldbeincludedonlyifbanks could,andrealisticallywould,takesuchactions.

In makingthatassessment,banksshouldaccountforfactorssuchasmarketconditionsinthestressscenarioandanyeffectthoseactionswouldhaveonthebank’sreputationwithitscounterpartiesandinvestors.

Bankswouldalsoneedtobeable topresenttheirresultsgrossandnetofthesemanagementactions.

Morebroadly,whenevaluatingtheimpactofdifferentscenariosoncapitaladequacy,Bankstaffwillseektoensurethatdifferentbanks’proposedresponsesareconsistentinanaggregatesense.

Forexample,ifmultiplebanksexpecttodisposeofsimilarassetsunderagivenscenario,itmightbeappropriatetoassumethatthosesaleswould bemadeatlowerpricesthan otherwise.

Alternatively,ifallbanks intended to increasetheirrelianceonaparticulartypeoffunding,Bankstaffwouldassesswhethertheassumedcostofthatfundingisrealisticinaggregate.

Inpart,suchassessmentswillallowBankstafftoincorporatesomeoftheeffectsofsystem-widefeedbacksandamplificationmechanisms(seeBox 4).

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Box4

Modellingofamplificationmechanisms

Relativelysmallinitialshockscanhavelargeadverseeffectsontheprofitabilityand capitalpositionofthebankingsystemasawholeinthepresenceofamplificationmechanisms.

Sucheffectsaretypicallynotmodelledinbank-specificstresstests,whichtend totakeapartial-equilibriumapproachto risk measurement.

But,aswasevidentfromtherecentcrisis,ignoringsystem-wideamplificationchannelscan materiallyoverestimatetheresilienceofthesystem.

Itis,therefore,crucialthatthestress-testingframeworkseekstoaccountforspilloversthatmightarisefrombanks’andotheragents’responsestoinitialadverseshocks,seekingto takeageneralequilibriumviewofsystemicstability.

Thisboxdiscusseshow someoftheseamplificationmechanismsmightbe capturedaspartofthestress-testingexerciseoverthemediumterm.

Because—bydefinition—theseeffectsoperateacrossbanksor intheeconomymorebroadly,itisexpectedthattheseeffectswouldbeprimarilymodelledbytheBank,ratherthanbyinstitutionscoveredintheexercise.

Theanalyticaltoolsforfully capturingtheseeffectsarestillbeingdeveloped:intheshort term,itislikelythattheywillbe capturedimplicitlyinthedesignofscenarios,throughanalysisofthesystem-wideconsistencyofbanks’projectedmanagement actions(seeSection7),orincorporatedthroughjudgement.

Typeofamplificationmechanisms

Broadly,amplificationmechanismscanoccurbetweenbanks,between banksandtherealeconomy,andbetweenbanks andnon-bankfinancialcompanies.

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  • Interactionsbetweenbanks

  • Therearedifferentchannelsofcontagionwithinthebankingsystemthatcan amplifytheimpactofinitialshocks.

  • Theseinclude:

  • Interbankexposures:Banksareoftenexposedtoeach otherthrougharangeoffinancialinstruments,includinginterbankloans,derivativesorholdingsoftradeddebtsecurities.

  • Ifonebanksufferslossesordefaults,exposuresofotherbanks wouldfallinvalue,resultinginlossesandanerosionofcapitalresourcesforotherfinancial institutionsin thesystem.

  • Firesales:Contagionmightalsooccurintheabsenceofoutrightdefault.

  • Forexample,facedwithalossofaccesstoprivatefundingmarkets,banksmightrespondbysellingassetsinthemarket,eithertoraiseliquidityortocuttheirrisk exposures.

  • Thismaypushdownthepricesoftheseassetsandcausemark-to-marketlossesat otherbanks.

  • Thismechanismislikelytooperatemoststronglyifanumberofbanksareexposedtosimilarrisksormarkets.

  • Liquidityhoarding:Banksmayalsohoardliquiditytobuilduptheirliquidassetbuffersduringtimesofstress.

  • Other institutionsreliantonborrowing in theinterbankmarketmay,inturn,seeanincreasein theirborrowingcostsandaworseningoftheirliquiditypositions.

  • Thesebanksmayultimatelyloseaccesstoshort-termfundingmarketsorseetheirprofitabilityandcapitalpositionsimpaireddue tohigherfundingcosts.

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Confidencechannels:Solvencyconcernsatonebankcanspreadto

otherbanks viaaconfidencechannel.

Forexample,distressatonebankmayrevealinformationaboutthelikelihoodoffailureat otherbanks.

Soinvestorsmaybecomeconcernedabout,andwithdrawfundingfrom,banksthattheyperceivetobesimilartoadistressedbank.

InteractionsbetweenthebankingsystemandtherealeconomyStress teststypicallyseektomodeltheimpactofamacroeconomicscenarioonbanks’financialhealth.

Indoingso,theytendtofocusonlyonthefirst-roundeffectsoftheshock

—forexample,bymodellingtheeffectofa changeinmacroeconomicvariablesonlossratesforagivenassetclass.

In reality,theinteractionsbetweenthebankingsystemandtherealeconomyarericherandoperateinbothdirections.

Thefirst-roundeffectsdescribed abovewilloftenresultineitheralooseningortighteningofthe capitalandfundingconstraintsabankfaces.

Forexample,anincreaseinimpairmentscouldlead toareductionin abank’s capitalratioand,ifthisissufficientlylargeorisexpectedtocontinue,aworseningofthetermsonwhichthey canaccessfundingmarkets.

This canaffectboththesizeandcompositionofbalancesheetsthatabank’smanagementwillchoose to operate.

Ifalargeenoughproportionofthebankingsystemrespondsin asimilarwaytoacommonshock,this can resultinamaterialchangeintheprovisionoffinancialservices totherealeconomy.

Achangeinthesupplyofcreditisa keychannelthroughwhichtherealeconomymaybeaffected.

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Thismighthappenthrough changestopriceornon-priceterms—for example,bychangingthespreadoverBankRatechargedonnewfloating-ratemortgagesorthemaximumloan to valueratioatwhichbanksarewillingtolend.

Totheextentthatthisresultsinmaterialchangesintheaggregatequantityoflending,itmayalsolead todifferentoutcomesforeconomicoutput,assetpricesandthefinancialhealthofborrowers.

Thereare,ofcourse,manyotherwaysinwhichchangesinthescaleandmixofbanks’activitiescanaffect therealeconomy.

Areductioninbanks’riskappetite,forexample,mightmeantheyarelesswillingto underwritecorporateequityissuance,therebyreducingthecapacityofthecorporatesectortoraiseexternalfinancing.

Alternatively,banksmaybelesswillingtoenter intofinancialcontracts

—forexample,optionsandswaps—withcompanies,therebyaffectingcompanies’abilitytomanagetheirfinancialriskeffectively.

Wherethesefeedbacks exist,theyhaveatendencytogenerateself-reinforcingcyclesofbehaviour.

Forexample,duringaneconomicdownturn,banksmightbelesswillingtofinancecommercialrealestate(CRE)projects,whichcouldcontributetoCREpricedeclines,in turnmakingbanks lesswillingto lend.

Inthisway,aninitiallymoderateadverseshockcoulddevelopintoamoreseverelyadversescenario.

Interactionsbetweenbanksandnon-bankfinancialcompanies

Thenon-bankfinancialsector includesawiderangeoffinancialinstitutionssuchasinsurancecompanies,pensionfunds,privateequityfirms,hedgefunds,centralcounterpartiesandmoneymarketfunds(MMFs).

Shocks canpropagate acrossthefinancialsystemthroughthebehaviourofthenon-bankfinancialsector.

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Forexample,intherecentcrisis,LehmanBrothers’defaultcausedtheReservePrimaryFundto‘breakthebuck’.

This,inturn,ledtosignificantwithdrawalsfrom otherMMFs.Asaresult,theMMFsectorasawholereduceditsexposures to riskyassets,includinglendingtothebankingsector.

ThisthenledtoaseveredeteriorationintheliquiditypositionsofbanksreliantonfundingfromMMFs.

Incorporatingamplificationmechanismsinstress-testingmodels

Spilloverandfeedback analysisisanimportantelementofstresstestsin increasinglyinterconnectedfinancialsystems.

Butthedevelopmentofstress-testingmodelsinthisarearemainsatarelativelyearlystage.

TheBank’ssystem-widestress-testingmodel(RAMSI)aimstocaptureatleastsomeofthechannelsoutlinedabove.

Atthisstage,modellingcapabilitiesarelimitedto capturingcertainfeedbackeffectsbetweenbanks.

Forexample,ifbankfundamentals—suchasbankprofitabilityandsolvency—areprojected toworsen,banks experiencehigherfundingcostsinthemodel.

And,beyondcertainthresholds,banks couldbeentirelyshutoutofcertainfundingmarkets.

Moreover,whenbanks sufferlossessoseverethattheir capitalratiofallsbelowathresholdratio,feedbackeffectscan causelossestootherbanks,forexamplethroughcounterpartyexposuresandassetfiresales.

Goingforward,particularlygiventheG20commitmenttohaveallstandardisedOTCderivativecontractscentrallycleared,centralcounterpartieswillbeabsolutelyvitalnodesinthefinancialsystem.

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  • Giventhat,theBankplanstoconsidertheneedforastress-testingregimeforcentralcounterpartiesseparately(seeSection4).

  • Othercentralbanksalsoincorporateelementsofamplificationmechanismsintheirstress-testingframeworks.

  • TheBankofCanada,forexample,incorporatesanetworkofinterbanklinkagesaswellasassetfiresaleeffectsinitsstress-testingapproach.

  • Theirresultssuggestthatriskstothesystemasawholecanbemateriallyunderestimatedifsecond-roundeffectsarenottakenintoaccount.

  • Similarly,theBankofJapanincorporatesfeedbackloopsbetweenthefinancialsystemandtherealeconomy.

  • Thisusesamodellingframeworkto gaugetheimpactofacontractioninthesupplyoflendingbybanks ontherealeconomy.

  • Overall,thereremainmaterialchallengesin capturingfeedbacks and amplificationmechanismsinstresstests.Thisisforatleasttwo reasons:

  • Dataavailability:Lackofdataremainsanobstacletomodellingamplificationmechanisms.

  • Forexample,detaileddataoninterbankexposurenetworkshasonlybecomeavailablerelativelyrecently.

  • Evennow,thereareclearlimitationstotheinformationavailabletoallowauthoritiestomaptheentirefinancialnetwork,includingnon-banks.

  • Similarly,thelimitednumberoffinancialcrisesimplythatestimatesproducedbymodels—forexampleinthecontextoftheinteraction betweenthefinancialsystemandtherealeconomy—oftenreflect‘average’relationships,whichmightwellbreakdownintimesofstress.

Analyticalcapability:Thefullrichnessofthisareahasonlyrecently

startedtobeexploredbytheacademiccommunity.

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Issuesaroundtherelationshipbetweenthefinancialsectorandtherealeconomyhavecometo theforeagaininlightoftherecentcrisis,butremainfarfromperfectlyunderstood.Similarly,thebehaviouralresponseofbanksand othermarketparticipantstoinitialshocksisnow anareaofgrowingresearch,butmaterialuncertaintiesremain.

8Outputsofstresstests

Theproposedstress-testingframeworkwillproducearangeof quantitativeandqualitativeinformation.

Thissectionoutlineshowthisinformationislikelytobeused to informFPCandPRABoardjudgementsaroundbankcapitaladequacy.

Synthesisingmodeloutputs

Usingasuiteofmodelsimpliesthatthereislikely to bearangeofoutcomesforeachbankundereachscenario.

Theremightbeusefulinformationinthatrangeofoutcomesitself,asithelpsillustratetheinherentuncertaintyinestimatingprojectionsand providesanindicationofhowmuchconfidencepolicymakerscanhaveintheresults.

Ultimately,though,Bankstaffwillneedtosynthesisetheoutputsofthesemodels to formasingleviewofeachbank’sperformanceineachscenario.

Therearedifferentpossibleapproachestosynthesisingmodeloutputs.

Theserangefrompurelymechanicaltechniquestoentirelyjudgement-basedapproaches.

Onbalance,theBankexpectsthatjudgementwillplayacrucialroleincombiningmodeloutputs.

Usingpurelymechanicalrules—forexample,calculatingthemean projectedvalueacrossdifferentmodels—risksdilutingthemainbenefitofasuiteofmodelsapproach:thefactthatsomemodelshavebeenspecificallydesigned to analysecertaintypesofrisk.

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Knowledgeofrespectivemodels’strengthsandlimitationscanbeexploitedbetterbyapplyingjudgementtosynthesisetheoutputsof differentmodels.

Frameworkforassessingcapitaladequacy

Theprocessoutlined abovewillresultinacentralviewofthesizeofstressedlossesin agivenscenarioand,hence,remainingcapitalresources.

Interpretingtheseresults,andreachingajudgementaroundbankcapitaladequacy,requiresaviewonthelevelofcapitalthatregulatorswantbanks tomaintaininthestressscenario.

Thisisoftenreferredto asthe‘hurdlerate’.

Ultimately,thisisapolicydecisionby theFPCandthePRABoard.

Butthereareanumberofconsiderations theFPCandthePRABoardmighttakeintoaccountin consideringthelevelofcapitalbanks shouldmaintaininastress.

Akeyconsiderationwillbetheminimumlevelofcapitalrequiredbyinternationallyagreedstandards.

Banksneed tomaintainsufficientcapitalresourcestobeableto absorblossesinthestressscenarioandremainabovetheseminimumrequirements.

Minimum capitalstandardshavebeensetinternationallybytheBaselCommitteeonBankingSupervisionandtransposedintoEuropeanlegislationundertheCapitalRequirementsRegulationandDirective(CRDIV).

Forexample,underthePRA’sproposedimplementationofCRDIV,theminimumPillar1commonequityTier1capitalrequirementwillbesetat4.5%from1January2015onwards.

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Butrequiringbankstoremainaboveinternationallyagreedminimain astressmaybeinsufficient tomitigaterisks to financialstability.

Thereare otherfactorsthattheFPCandthePRABoardwillconsiderwhensettingthehurdlerate.

Forexample,somerisks,suchascreditconcentrationrisk andinterestrateriskinthebankingbook,arenotcoveredby

Pillar1capitalrequirements.

And,insomecircumstances,thePillar1riskweightsgeneratedbytheBaselframeworkmightbeinadequate,givenprevailingeconomicandfinancialconditions.

Forexample,capitalrequiredagainstbanks’tradingbooksbefore thefinancialcrisisproved tobemateriallyundercalibratedinlightofrealisedlosses.

Thesefactorscouldlead bankstolose accesstoprivatefundingmarketsinaperiodofstressbeforehittinginternationallyagreedminima.

Theremightbecircumstances,forexample,whereabank’sperceivedcreditworthinesscouldbeaffectedifits capitalratiofell,orwasexpectedtofall,materiallybelow 7%.

In turn,thiscouldmakeprivatefundingexpensiveorunavailablealtogether.

Fundingstrainscanhavematerialadversefinancialstabilityeffects.

Forexample,banksmightrespondbycuttinglendingtotherealeconomy,hoardingliquidityorfiresellingassets.

Ifbanks’capitalisadequate tomaintainaccess to fundingmarketsandcontinuetoprovidefinancialservices totherealeconomythroughastress,prospectsforfinancialstabilitywillbeenhanced.

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Finally,uncertaintyoverbanks’andregulators’abilitytoexploredifferentstressscenariosandmodeltheirimpactisalsoaconsiderationinsettingthehurdlerate.

Confidencethatabankwillremainaboveagivenlevelofcapitalwilldependonthedegreeofuncertaintyaroundprojectionsofstressedlosses.

Thegreaterthatuncertainty,thehigherthehurdlerateitmightbeprudenttosettoguardagainstrisks to financialstability.

Thismightincludeanyfactorsthathavenotbeenexplicitlymodelled.

Forexample,ifmacroeconomicfeedbacks arenottakenintoaccount,policymakersmightwant to setthehurdlerateatahigherleveltoaccommodatethese.

In practice,thesefactorsmeanthatthelevelofcapitalthatbanks would needtomaintaininordertosurviveinastressscenariocouldbesetabovestrictregulatoryminima.

Theyalsoimplythatjudgementsontheappropriatehurdlerateforthebankingsystemasawholecouldvaryovertime,inlightofthethreatsinthemacroeconomicandfinancialenvironment.

Moreover,individualbanks’idiosyncrasies(suchastheirresolvability,theextent towhichthey canraiseexternalequity capitalorthesizeofrisksnotcoveredbyPillar1capitalrequirements)suggestthatrequired post-stresscapitalratiosarelikelytovaryacrossbanks.

Further,assetoutinSection9,thisisnotintendedtobea‘pass-fail’regime,butonethattakesagraduatedapproachtoremedialactionsrequiredinresponseto thestresstests,dependingonFPCandPRABoardviewsaroundtheadequacyofbanks’capitalisationandthethreatstothesystem.

The adequacyofbanks’capitalresourcesislikelytobejudgednotonlywithreferencetorisk-basedcapitalratios,butalsoleverageratios.

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  • Thisisforanumberofreasons.

  • First,becausetheleverageratioislikelytobecomepartofthePillar1frameworkunderBaselIII.

  • Second,partlyasaresult,becausethemarketmayjudgebanks’resilienceagainstaleveragestandardaswellasrisk-basedstandards.

  • Thismatterswhenassessingbanks’ability tomaintainaccess to privatefundingmarkets.Finally,becauseleverageislesssusceptible to theinadequaciesofriskweights,forexampleduetomodelarbitrageandriskmismeasurement.

  • OutputstoinformFPCandPRAjudgements

  • Therangeofoutputsthatthestress-testingexercisewillproduce—for eachbank,ineachscenario, in eachperiodoftheforecasthorizon—ispotentiallyveryrich.

  • KeyoutputsthatareexpectedtoinformFPCandPRABoardjudgementsaroundbankcapitaladequacyinclude:

  • Banks’risk-basedcapitalandleverageratiosintherangeofscenariosagainstwhichtheyhavebeentested.Combinedwithaviewontheappropriatehurdlerates,this canbetranslatedintonominalcapitalshortfalls.

  • Rangesofoverallcapitalandleverageratiosprojectedfromthesuiteofmodels—toprovideanindicationoftheuncertaintyaroundcapitaladequacy.

  • Projectionsofthecapacityofthebankingsystemasawholetoexpandlending, bothunderthebaselineandintherangeofadversescenarios.

Sectororportfolio-specificlossrates—eitherforindividualbanks

orforthesystemaswhole—relative tocapitalrequirementsagainstthoseexposures.

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  • Thesemightprovideusefulinformationaboutthecalibrationofsectoralcapitalrequirements(seeSection9).

  • Changesintheimpactofastressscenario overtime,whichcould beindicativeofchangesinthelevelofrisk-takingofthebankingsystem.

  • Aqualitativeassessmentofbanks’ownstress-testingand capitalmanagementprocessesandgovernance.

  • SeeSection11foradiscussionofwhatthePRAislikelytoexpectfrombanksintheseareas.

  • Nosinglequantitativeoutputofthestress-testingexerciseisexpectedtobelinkedmechanically to policy responses.

  • TheFPCandthePRABoardwillusetheinformationfromthestresstests

  • —inconjunctionwithotheranalysis— toreachanoveralljudgementaboutthecapitaladequacyofindividualbanksandthebankingsystemasawhole.

  • 9Remedialandpolicy actions

  • Itisimportantthatcrediblepolicyactionsaretakenin responsetotheresultsofthestresstests.

  • Tothisend,theresultsofthestress-testingexerciseareexpected tobeusedto:

  • informtheFPC’sassessmentoftheresilienceofthefinancialsystemand,indoingso,aidformulationofpolicyresponses;and

  • supportPRABoarddecisionsandactionsonindividualbanks,takingintoaccountanysystem-wide actionsbytheFPC.

  • Asmentionedpreviously,theresultsofthestress-testingexercisearenotexpectedtobemechanicallylinkedtopolicy responses.

  • Thisisnotintendedtobeasimple‘pass-fail’regime.

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  • Rather,itaimstodeliveramoregraduatedpolicy framework,withthemagnitudeofremedialactionstakenbeingafunctionofregulators’judgementaroundcapitaladequacy,drawingonarangeofinformation.

  • Asthestress-testingexerciseisfocusedonprovidingaquantitative,forward-lookingassessmentofcapitaladequacy,itislikelythatpolicyresponsesby theFPCandthePRAwouldfocusonbankcapital.

  • Buttheexercisemightalsoyield insightsthatlead theFPCandthePRA totakeactionsbeyondbankcapital.

  • Thesetwo setsofpolicy responsesarediscussedinturn.

  • Policyresponsestostrengthencapitaladequacy

  • Theprimaryoutcomeofthestress-testingexercisewouldbeanassessmentbythePRABoardofindividualbanks’capitalplans.

  • This woulddeterminewhetherbanks’originalcapitalplansaresufficient tomeettherequiredlevelofcapitalisationdeterminedjointlybytheFPC(forsystem-widepurposes)andthePRABoard(forbank-specificpurposes).

  • IfthePRABoardjudgedthatthiswasnotthecase,itwouldhavediscretiontorejectbanks’originalcapitalplansandpowerstorequireadditionalactions toincrease capitallevelsoveraspecifiedtimeperiod.

  • TofacilitatePRABoarddecisions,whensubmittingtheiroriginalcapitalplans,banksarealsolikelytobeexpectedtosubmitarangeofadditionalactionsthatcouldbetaken to reachahigherlevelofcapitalisation.

  • Thesewouldbeactionsthatbankscouldtakeimmediately,tostrengthentheirability towithstandshocksinthefuture.

  • Therangeofactionsthatbanks couldberequiredtotakebythePRAtostrengthencapitalisationlevelsinclude:

  • constrainingdividenddistributions,sharebuybacksordiscretionarypaymentsoncertainTier1capitalinstruments;

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constraining(variable)remunerationtostaff;

issuingequityorothercapitalinstrumentsthatcandefinitely

  • absorblossesona‘goingconcern’basis(outsideofresolutionorliquidation);

  • engaginginliabilitymanagementexercises;and

  • reducingcertainriskexposuresorbusinesslines.

  • ThemagnitudeofrequiredremedialactionswouldbedeterminedbytheFPC’sandPRA Board’sjudgementsaroundbankcapitaladequacy.

  • Forexample,ifstress testsrevealedthatcapitalratiosofindividualbanks

  • —orthesystemasawhole—fellbelowinternationallyagreedminimainanyofthestressscenarios,thiscouldpointtomaterialinadequaciesintheircapitalisation.

  • Inturn,thiswouldlikelyresultinthePRArequiringmaterialadjustmentstobanks’current capitalplanstostrengthentheirabilitytowithstandshocks.

  • Ifstresstestsrevealedthat capitalratiosofbanks—orthesystemasawhole—remainedabovetheinternationallyagreedminimuminthestressscenarios,butstillsomewhatbelowanappropriatehurdlerate,requiredadjustments to capitalplanswouldlikelybesmaller.

  • AkeystepintheprocesswillbethesettingofcapitalbuffersorrequirementsbytheFPCandthePRABoard.

  • Theresultsofstresstestsareexpectedtobeusedasaninput to informthejudgementsofthetwobodiesaroundtheserequirements.

  • Fromasystem-wideperspective,theFPCcouldchoosetorespondtoinformationfrom,andresults of,thestresstestsbyusingitsmacroprudentialtools(seeBox5).

  • Thesettingofthecountercyclicalcapitalbuffer(CCB)andsectoralcapitalrequirements(SCR)isexpectedtobeguided, inpart,byasetof

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coreindicators,apreliminarylistofwhichwaspublishedintheDraftPolicyStatement inJanuary2013.

Theresultsofthestresstestswillprovideaforward-lookingviewofanumberoftheseindicatorsandarichsetofanalysisonbankingsystemresilience.

Forexample,stress-testresultsmightpointtoageneralisedincreaseinrisk-takingby thebankingsystem,resulting in largerreductionsincapitalratiosin theadversescenariosovertime.

ThiscouldleadtheFPCtorespondbyincreasingtheCCBrate.

Symmetrically,stress-testresultsmayalso informtheFPC’sjudgementaroundthereleaseoftheCCB.

Theoutputsofstress testsmightalsopointtospecificvulnerabilitiesincertainsectors,whichcouldinformthecalibrationofanSCR.

AndtheFPCmightusetheresultsofthestress-testingexercisetomakearangeofRecommendations to thePRAaroundbankcapital.

Forexample,the FPCmightrecommendthatthePRAsetsaflooroncertainrisksweightsto guardagainsttherisk thatinadequatecapitalisbeing held againstaspecificclassofassets.

Fromabank-specificperspective,thePRAislikelytousetheresultsofstress testsasaninputtosettingthePRABuffer,whichisexpectedtoreplacethecurrentCapitalPlanningBuffer induecourse.

Relatedtothis,theresultsofthestresstestswillinformthePRA’sjudgementaboutproximity to failure,ascapturedin abank’spositionwithintheProactiveInterventionFramework(PIF).

Akeyelementofthesupervisoryjudgementaboutabank’sproximitytofailureistheadequacyofitscapitalposition.Stress-testresults,therefore,arelikelytobeanimportantinputinformingthatjudgement.

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Policyresponsesbeyondbankcapital

In additionto,orasanalternativeto,actionsaimedatinfluencingthelevelofcapitaldirectly,otheractionscouldalsobetakenin responsetothestress-testresults.

Fromasystem-wideperspective,thestress-testingexercisemayunearth undesirablelevelsofinterconnectednessinthebankingsystem,whichcouldactaspropagationmechanismforshocks.

In response,the FPCcouldchoose,forexample,torecommendthatthePRAtightensmarginrequirementsonderivativesorrepurchase agreements.

OritcouldrespondbyrecommendingthatthePRAtightensliquidityrequirements,sothat—ifashock materialises—firesalesofilliquidassetsarereduced.

Fromabank-specificperspective,theexercisemightrevealweaknessesinbanks’stress-testingandcapitalplanningprocessesandgovernance.

In thosecircumstancesthePRAwouldconsiderwhatactionwasappropriate toensurethatshortcomingswereaddressed.

ThePRAhasavarietyofformalpowersavailable.Additionalcapitalrequirementsmightbeonetool.

Withdrawingcertainpermissions,changingbanks’managementandrequiringspecific actions to improvebanks’stress testing,riskmanagementorcapitalplanningprocessesare others.

Box5

TheFinancialPolicyCommittee’sstatutorypowers

The FinancialServicesAct2012createdtheFinancialPolicyCommittee(FPC).

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TheFPC’sstatutoryresponsibilityisthe‘identificationof,monitoringofandtakingofactiontoremoveorreducesystemicriskswithaviewtoprotectingandenhancingtheresilienceoftheUKfinancialsystem’.

ThisisinordertomeettheFPC’sobjectivesofcontributingtotheBank’sFinancialStabilityObjectiveand,‘subject tothat,supportingtheeconomicpolicyofHerMajesty’sGovernment,includingitsobjectivesforgrowthandemployment’.

TheFPC’s actionsmustnot,inthewordsofthelegislation,have‘asignificantadverseeffectonthecapacityofthefinancialsectortocontributetothegrowthoftheUKeconomyinthemediumorlongterm’.

TheFPChastwo mainpowersatitsdisposal.ThefirstisapowertomakeRecommendations.

Itcan makeRecommendations to anybody.ButtheFPChasaspecialpowertorecommend,ona‘complyorexplain’basis,totheregulators—thePrudentialRegulationAuthority(PRA)andtheFinancialConductAuthority(FCA)—thattheyexercisetheirfunctionsinaparticularway,suchastoadjusttherulesthatbanksand otherregulatedfinancialinstitutionsmustabideby.

Shouldtheregulatorsdecidenot to implementRecommendationsmadeona‘complyorexplain’basis,theyarerequiredbythelegislation toexplainpubliclytheirreasonsfornotdoingso.

Thesecondpoweristo giveDirectionstothoseregulatorstoexercisetheirfunctionstoensuretheimplementationofamacroprudentialmeasure.

TheFPChasbeengrantedpowersofDirectionoversectoralcapitalrequirements(SCRs)andtheGovernmenthasproposedtomaketheFPCresponsibleforsettingthecountercyclicalcapitalbuffer(CCB)rate.

TheCCBtoolwillallow theFPCtochange capitalrequirementsabovenormalmicroprudentiallevelsinrelationtoallloansandexposuresof banks toborrowersintheUnitedKingdom.

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Thepower to settheCCBwillbeprovided to theFPCinregulationsimplementingtheEU’sCapitalRequirementsDirectiveandRegulation(CRDIV).

TheSCRtoolismoretargetedthantheCCB,andallowstheFPCtochange capitalrequirementsabovemicroprudentialstandardsonexposurestospecificsectorsjudgedtoposearisktothesystemasawhole.

Specifically,the FPCisable to adjustSCRsforbanks’exposurestothreebroadsectors(residentialproperty,includingmortgages;commercialproperty;andotherpartsofthefinancialsector),aswellasmoregranularsubsectors(forexample,tomortgageswithahighloantovalueorloantoincomeratiosatorigination).

10Disclosure

Akeyprincipleunderpinningtheproposedstress-testingframeworkisthattheoutcomeof,andanalysisassociatedwith,thestress-testingexerciseshouldbemadepublic.

Thissectionexploreswhatinformationmightbedisclosedtoenhancethetransparency,accountabilityandcredibilityofthestresstests.

Theoptionsexploredinthesectionrelate to themedium-termframework.

Thepreciseformofdisclosureislikelyto evolve overtime.

In somecases,thereare optionsaroundwhether informationisdisclosed bytheFPC,PRAorbybanksthemselves.

TheBankwillworkwiththeinstitutionscoveredbytheexercisetoensureaco-ordinateddisclosureprocess.

Morebroadly,publishedinformationrelatingtostresstestsismeanttocomplement—ratherthanduplicate— therangeof initiativesaroundstrengtheningbankdisclosure.

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Benefitsandcostsofdisclosure

Anappropriatelydesigneddisclosureregimeforstresstestingshould deliverthefollowingbenefits:

Facilitate accountabilityofpolicyinterventions:Akeyobjectiveof

  • thestress-testingframeworkis to actasonedevicethroughwhichtheBank canbeheldaccountableonitsfinancialstabilityobjective toParliamentandthewiderpublicandexplainitspolicydecisions.

  • Achievingthisobjectiverequirestransparencyabouttheexercise.

  • Supportthecredibilityoftheframeworkwithmarketparticipantsandotherstakeholders:Disclosurecanhelpassurestakeholders—includingParliamentandthepublic— thattheoverallmethodologicalapproachissensible,thefinalresultsareplausibleandtheprocessthatgeneratesthoseresultsisrobust.

  • Incentivisebankstoengagefullywiththeexercise:Revealinginformationaboutbanks’performanceinstresstests tothe public,coupledwithacommitmentonbehalfoftheauthoritiestofollow upfindingswithpolicyactions,willincentivisebankstoengagemorefullywiththeexercise.

  • Enhancemarketdisciplinebyreducinginformationasymmetries:Disclosureofresultsshouldstrengthenmarketparticipants’understandingofUKbanks’abilitytowithstandcertainseverescenarios.

  • Thisshouldstrengthenmarketdisciplinein anupturnandmitigateriskstomarketfunctioning in adownturn.

  • Therearealsopotentialcostsassociatedwithdisclosure.Theseinclude:

Self-fulfillingexpectations:Disclosuresthatrevealproblemswith

individualinstitutions,orthesectorasawhole,havethepotentialtoprecipitatetheoutcomespolicymakersaretryingto avoid.

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Tomitigatetheriskofself-fulfillingoutcomes,anydisclosurewouldneedtobeaccompaniedbyacrediblesetofremedialactionsthatcanbeimplementedbybanks ortheauthorities.

Thatunderlinestheimportanceofprogresstoachievecredibleresolutionregimesas theultimatebackstopmechanismfordealingwith undercapitalisedbanks.

Accompanyingcommunicationswouldalsoneed tomakeclearthatthestressscenariosandtheassociatedestimatedimpacts,whileplausible,arenotoutcomesthattheauthoritiesperceive tobelikely.

Moralhazard:Publishingresultsofstressteststhatsuggestabank

  • isresilientagainstasevereadversescenariomaybeinterpretedby themarketasasignthattheregulatorisprovidinga‘cleanbillofhealth’toindividualbanks andthesystemasawhole.

  • Thiscoulddisincentivisemarketparticipantsfromconductingtheirown,independentanalysisandrisk management.

  • Ontheotherhand,notdisclosingresultsmightinducemoralhazardon behalfoftheauthorities,weakeningtheir incentives to takepromptandeffectivepolicy responses.

  • Disclosureofcommerciallysensitiveinformation:Disclosurethatallowsmarketparticipantstoinferbanks’businessstrategiescouldhaveanadverseimpactontheircompetitiveness.

  • Resourcecosts:Theincreasedintensityofinternalvalidationandgovernanceassociatedwithpublicdisclosureswillcreateadditionalcostsforbothregulatorsandbanks.

  • Thesecosts,however,arealsolikelytoimprovethecredibilityoftheexercise.

  • Optionsaround disclosure

  • Stress-testingdisclosurescanbegroupedintothreebroadcategories:

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Policyoutcomes/remedialactions:Thiscoversinformationabout

theuseofformalpowersbytheFPCorthePRAinformedbythestress-testfindings,theauthorities’opinionofbanks’capitalplans,remedialactionsrequestedandthetimescaleoverwhichauthoritiesexpecttheactions tobecompleted.

Approach:Thisisthesetofinformation abouthowtheauthorities

  • conductstress tests.

  • Forexample,itcoversthescenariosbeingconsidered,thetypesofmodelsemployed,anylossratesassumedforparticularclassesofassetsandtherisksanalysedaspartbytheexercise.

  • Results:Thisisthesetofinformationonthefindingsoftheexerciseanditsusetoinformauthorities’judgementsaroundpolicyactions.

  • Resultscouldbedisclosedonanaggregateorbank-specificbasis.

  • Thereisarangeofoptionsforthelevelofdisclosurethatcouldbemadewithineachofthesecategories,whicharediscussedfurtherbelow.

  • Disclosureofsometypesofinformationcoulddifferacrossthebaselineandstressscenarios,oracrossthecommonandbank-specificscenarios.

  • Giventheneedtobalancethebenefitsandcostsofdisclosure,thetypeandgranularityof disclosureisanareawheretheBank wouldwelcomefeedbackfromrespondents tothisDiscussionPaper.

  • The aboveareasdonotcovermoregeneraldisclosureofdataonbanks’exposures.

  • Whilethese canbeimportant tostrengthentransparency,publishedinformationrelatingtostresstestsismeanttocomplement—ratherthan duplicate—therangeofinitiativesaroundstrengtheningbankdisclosure,suchastheproposalsoftheFinancialStabilityBoard’sEnhancedDisclosureTaskForceorthePRA’sintentiontopublishsomeregulatoryreturns.

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  • Thatsaid,theremaybeinstanceswhereauthoritiesjudgethatdisclosureofstresstestscouldusefullybeaugmentedto includethesizeofexposurestoparticularassettypes.

  • (i)Disclosureofpolicyoutcomes/remedialactions

  • TheBankexpects,ataminimum,todisclosethepolicy decisionsinformedbythestress-testingexercise.Thiswillbeimportanttoensurethattheexerciseisseenascrediblebythemarketand to facilitatepublicaccountabilityoftheFPCandthePRA.Morespecifically:

  • FPCsystem-widepolicyactions:Thisincludessystem-widepolicyactionstakenbytheFPC,suchastheuseofmacroprudentialtoolsandanyRecommendations tothePRA,FCAorotherbodies.

  • In mostinstances,thosepolicyactionsareexpectedtobereflectedintheRecordoftheFPCmeetingandtheFinancialStabilityReport.

  • PRAbank-specificactions:ThePRAexpectstobedisclosingitsassessmentoftheadequacyofbanks’capitalplans.

  • Butdisclosureofspecific remedialactionsrequestedbythePRAmaybebettermadebybanksthemselves,as theyarelikelytobein astrongerposition toexplainany actionsinthecontextoftheirwiderbusinessstrategy.

  • (ii)Disclosureofapproach

  • TheBankexpects tobedisclosingsufficientinformationaroundthemethodology to ensurekeystakeholders,includingParliamentandthemarket,canengagewiththebroadanalyticalapproachoftheexercise.

  • Specificelementsoftheoverallapproachthatcouldformpartofthedisclosureframework include:

  • Scenarios:Disclosingthecommonregulatoryscenariosagainstwhichallbanks willbeassessedshouldhelpmarketparticipantsassessthedegreeofseverityoftheexercise.

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  • Itwillalsoallow theFPCandthePRAtocommunicatetheresiliencestandardagainstwhichtheyaimtoholdthebankingsystem.ThePRAcouldalsorequiredisclosureofhigh-levelinformationonbank-specificscenarios.

  • Analyticalmethodology:Thereisarangeofinformationonspecificaspectsofthemethodologyusedthatcouldbedisclosed.

  • Examplesincludethetreatmentofcertaintypesofexposures, howfundingrisksareincorporatedintheexerciseandtheapproachtakenwithrespect tomanagement actions.

Models:AsmentionedinSection7,thereisatrade-offassociated

withdisclosureofspecific regulatorymodels.

Whileitisusefultoencouragepublicchallengeto,andbanks’understandingof,themodellingapproaches,thereareimportantrisksassociatedwithbanks convergingto thesuiteofregulatorymodelsoradjustingexposurestoarbitragethestress-testingexercise.

(iii)Disclosureofresults

Thecredibilityofthestress-testingapproachisnotasufficientconditionfortheassociatedpolicyactionsalsotobeseenascredibleandjustifiable.

Thisrequiresinformationontheeventualresultsofthestresstests—and howthiswasusedtoinformjudgementsovercapitaladequacyandrelatedpolicy actions.

Thissetofinformationislikelytobeparticularlyimportanttostrengthen publicaccountabilityoftheFPCandPRA.

Theproposedframeworkislikelytoincorporatedisclosureofresultsbothonasystem-wideandbank-specific basis.

Morespecifically:

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  • System-wideresults:Disclosureofaggregatestress-testingresultscan helpstakeholdersunderstandthereasonsforpolicy actionstakenby theFPCaswellasillustratekeyFPCjudgements.

  • Examplesofaggregateresultsinclude:thedistributionofpost-stresscapitalorleverageratiosacrossthebankingsystem;aggregatesystem-widelosses;orsector-specificlossrates.

  • Suchinformation canalsobeusedtostrengthenthecredibilityoftheexercise.

  • Forexample,publicationofaggregatelossrates—andcomparisonofthosewithlossratesduringtheGreatDepression—contributedtostrengtheningthecredibilityoftheUSSupervisoryCapitalAssessmentProgram(SCAP)in2009.

  • Bank-specificresults:Disclosureofindividualbanks’performanceinthestresstest(egstressedrisk-basedcapitalandleverageratios)couldsupplementdisclosuresonanaggregateleveltoenhance thetransparencyofthestresstests.

  • However,whileacertainleveloftransparencymaybedesirable,thereisaquestionaroundtheoptimaldegreeofgranularityindisclosing

  • bank-specific results.

  • Forexample,disclosingindividualbanks’lossesonaportfolio basiswouldallowthemarketto comparemodelled,stressedlossratesacrossbanksonaconsistentbasis.

  • But,ataverygranularlevel,itcouldalsorisk revealingcommerciallysensitiveinformation.

  • TableCsummarisespossibleoptionsarounddisclosureofstress-testresults.

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Expectationsofbanks

ThissectionsetsoutthePRA’slikelyexpectationsofbanks inrelationtotheregularstress testsproposedinthisDiscussionPaper.

Regulatoryexperienceofbanks’ownstress-testingpractices

ThePRA,andpreviouslytheFinancialServicesAuthority(FSA),hasrequiredbankstoundertakestress-testingexercisesforanumberofyearsaspartofitssupervisoryapproach.

Thereareanumberofaspectsofthisthathaveworkedwellin thepast.

Andthisexperienceprovidesagoodplatformonwhich tobuild theconcurrentstress-testingframework,fromtheperspectiveofbothbanksandregulators.

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Buttherearealsoareaswherebanks’stress-testingpracticeshavefallenshortoftheFSA’sexpectations inthepast.

Examplesinclude:

insufficientengagementbybanks’Boardsandseniormanagement

  • withthestress-testing process;

  • insufficientintegrationofstresstestingwithbanks’annualbusinessplanningprocess,includingtheuseofstresstestsasachallengetobusinessplans;

  • inadequaciesinscenariodesign,includingthefailure to identifykeyvulnerabilities,overlyoptimisticbaselineassumptionsandinsufficientlystressfuladversescenarios;

difficultiesinreconcilingriskdatawithreportedbalancesheetsand

risk-weightedassets;

stress-testinginfrastructuresthathavenotbeensuitablefor

  • bank-widestresstesting;

  • insufficientlyjustifiedor internallychallengedassumptionsandjudgementsaroundthetranslationofmacroeconomicshocksintoprojectedlosses,includingoverestimationofbanks’abilitytocontrolmarginsandgenerateprofitsin stressscenarios;and

  • inadequatedeterminationandquantificationofrelevantmanagementactionsunderdifferentstressscenarios.

  • Suchpractices,wheretheyoccur,areatoddswiththeimportancethatthePRAwillexpectbanks to attach tothisstress-testingframework.

  • TheresultsofthestresstestsproposedinthisDiscussionPaperwillbeakeyinputinformingFPCandPRABoardjudgementsaroundbankcapitaladequacy.

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  • ThePRA,therefore,islikely to expectastepchangeinthelevelofengagementwith,anddegreeofrigourappliedto,banks’stress-testingprocesses.

  • Aqualitativeassessmentofbanks’stress-testingand capitalplanningprocessesandgovernancewillalsoenablethePRAtomonitorthedevelopmentofbanks’capabilitiesintheseareas.

  • Expectationsaroundscenariodesign

  • TheframeworkproposedinthisDiscussionPaper incorporatesasetofcommonscenariosdesignedbytheFPCandabespokescenariodesignedbybanksthemselves,liaisingwiththePRA.

  • Thecommonscenarioswillcoveralimitedsetofmacroeconomicandmarketvariables.

  • Bankswillbeexpectedtoextendthesetocovertherangeofvariablesthatarenecessaryfortheirownmodellingpurposes.

  • ThePRAwillexpectbanks todothisinawaythatisconsistentwiththescenariodesignedbytheFPC,takingaconservativeapproachwherenecessary.

  • Bankswillbeexpectedtobeabletoarticulate,andjustifytosupervisors,thekeyjudgementsmadeaspartofthisprocess.

  • Bankswillberesponsiblefordevelopingthebespokescenarios,workingwiththePRA.

  • Thisshouldbetailoredto abank’sparticularbusinessmodel,stressingthespecificbusinesslinesandmarketsinwhichthebankoperates.

  • ThePRAwillexpectthedesignofthisscenariotobe informedbybanks’existingstress-testingandrisk identificationprocesses,includingreversestress testing.

  • Bankswillalsobeexpectedtoexplainandjustifythekeyjudgementsand benchmarkstheyhaveusedindevisingthisscenario.

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  • Theoutcomesofthebank-specific stressscenariosshouldbeatleastas severeasthecommonstressscenario.

  • Expectationsaroundbanks’ ownforecasting

  • Aspercurrentpractices,thePRAwillexpectbanks tobeable toarticulate,andjustify,thekeyunderlyingassumptionsandmodellingchoicesused toderivetheirresultsaswellasthelimitationsoftheiranalysis.

  • Specificresponsibilitiesofbankswithregardtothisexercisewillincludethefollowing:

  • Bankswillbeexpectedtosupplythenecessarydata,asspecifiedinBox6,toallow Bankstaffto runthecommonscenariosindependentlyusingtheir ownmodels.

  • Bankswillbeexpectedtoprovide thePRAwithsufficientlygranularoutputsandqualitativeexplanatoryinformation toallow adetailed comparisonoftheirresultsagainsttheBank’sownanalysis.

Bankswillneedtodocumentthemethodologiesusedandthekey

judgementsmadeinderivingtheoutput,aswellastheresultsofthestress tests.

Wherebanks haveindependentvalidation,modeloversightand

modelapprovalprocessesforthepurposeofmanagingregulatorymodels,theywillneedto apply thesamelevelofrigourtothedevelopmentandmaintenanceoftheirstress-testingmodels.

In runningthedifferentscenarios,bankswillbeexpected toprojectboththeircapitalresourcesandtheir capitalrequirementsoverthespecifiedtimehorizon.

In assessingtheimpactofadverseshocksontheir capitalpositions,banksshouldonlyincludefinancialresourcesthatcouldreasonablyberelieduponasbeingavailableinthecircumstancesofthescenario,includingbytakingaccountofanylegalorotherrestrictionsontheuseoffinancialresources.

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Additionally,banksshouldnotassumethattheybenefitfroma‘flighttoquality’orsimilareffectswhenrunningscenarios.

Bankswillalsobeexpectedtoidentifyanyrealisticmanagement actionsthatcouldbetakentomaintainorrestoretheircapitaladequacyin astressscenario.

Here,managementactionsaredefinedasstepsthatbanks couldtakeinresponse to capitalorliquidityinadequaciesintheeventthattheywerenecessaryinagivenscenario.

Theyarenotintendedtocapture‘businessasusual’responsesthatbankswouldinany caseexpect to takeinthatscenario.

Managementactionsshouldonlybeincludedwhereabankcould,andrealisticallywould,takesuch actions,taking intoaccountfactorssuchasmarketconditionsinthestressscenarioandanyimpactofthoseactionsonthebank’sreputationwithitscounterpartiesandinvestors.

Itislikelythatthesewouldbeinformed,atleastinpart,bytherecoveryplansthatbanksarebeingrequired todevelop.

Thelistofmanagementactionswillbeexpectedtobesignedoffbybanks’Boards.

Bankswillneedtobeable topresenttheirresultsgrossandnetofthesemanagementactions.

Banksshouldusetheresultsofthestress-testingandscenarioanalysisnotonly to assesscapitalneeds,butalsotodeterminewhethermeasuresshouldbeputinplacetominimisetheadverseeffectonthebankiftheriskscoveredbythestresstestdidmaterialise.

Suchmeasuresmightbeacontingencyplanormightbemoreconcreteriskmitigation.

Expectationsaroundgovernance

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  • ThePRA’sassessmentofbanks’performance inthestresstestwilltakeintoaccountthegovernancearrangementsthatbanks haveinplace,thedegreeofengagementoftheirseniormanagementandBoardsandtherigourwithwhichthePRAconsiderstheirstress testingtohavebeencarriedout.

  • ThePRAwillexpectfullengagementbybanks’Boardsandseniormanagementtoensurethattheirobligationsunderthestresstestareadequatelydischarged.

  • Theoutputofthestresstestmustbereviewedandsignedoffbythegoverningbody.

  • Thiswillrequirebanks’Boards to gainareasonableunderstandingofhowtheseestimateshavebeenarrivedat.

  • Banks’internalauditfunctionswillbeexpectedto attestthatappropriateprocessesandcontrolsareinplacetoensuredataquality, appropriatemodelcontrolsandrobustchallengeofresults.

Bankswillbeexpectedto assign adequateresources, includingIT

systems,whichareproportionatetothenature,scaleandcomplexityoftheiractivities.

Aspartoftheannualstress-testingprocess,the PRAwillbeassessingtheextenttowhichbanksmeetitsexpectationsinrelationtothisframework.

Ifthesearenotmet,thePRABoardmayconsiderappropriateremedialactionsassetoutinSection9ofthisDiscussionPaper.

Box6

Datasubmissions

Datasubmissionsforthestress-testingframeworkwillbedeterminedby themodellingmethodologiesusedbytheBankandthelevelofgranularityatwhichthescenarioimpactsneed tobeunderstood.

ThesearelikelytobuildonframeworksdevelopedbythePRAtorun bank-widestresstestsonindividual institutions.

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Firmdatasubmissionframework

Overthepasttwo years,thePRA(andbeforethattheFSA)hasbeen designingandimplementing, in collaborationwithanumberoflargeUKbanks,acomprehensiveframeworkforthesubmissionofthedatanecessaryforconductingstresstests:thefirmdatasubmissionframework(FDSF).

TheFDSFislikelytobeanessentialcomponentofthefuturestress-testingprocess.

GiventheimportanceofthestresstestsininformingPRABoardandFPCdecisionsaroundbankcapitaladequacy,itisparticularlyimportantthatbanksconsiderthisengagementapriorityandmeetthecorrespondingtimelinesasagreedwiththePRA.

OneofthecoreFDSF principlesisthatthePRAusesbanks’owndataanddefinitions,whicharethenmappedtothePRA’sframework.

Thisseekstoleveragebanks’ internalrisk-reportingprocessesandavoidadisconnectbetweenthedatausedbybanks andthosesent to thePRA.

Italsomeansthatimprovementsinbanks’ownability to aggregateanddrill downintotheirdata—theneedforwhichhasbeenmanifestsincethe2008crisisandemphasisedintheBaselCommittee’sRiskDataAggregationPrinciples—willbenefitboththebanksandthePRA.

ThesearedatathatthePRAalsoneedsoutsideoftheannual

stress-testingcycletorunpeeranalysesthatinformjudgement-based supervisionthroughouttheyear.

Anditisinformationthatbanksthemselvesneedtobeabletoaccesstomanagetheir ownriskseffectively.

UndertheFDSF,banks areexpectedtoclean andcheckthedataforqualityandcompletenessbeforesubmittingthemtothePRA.

Lookingahead,thePRAexpectstomove to astrictdataqualityregime.

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IfdatasubmissionsdonotmeetspecifiedPRAstandards,thePRAislikelytorejectthemandrequirethatthebankcorrectsandresubmitsthedatainatimelymanner.

In addition,failureofabanktosubmitdataofadequatequalityandtimelinessmay,inandofitself,resultinthePRAtakingaconservativeviewontheoveralloutcomeofthestresstestforthatbank.

Datainfrastructure

Majorbanks aregenerallybuildingstrategic solutions tomeetreportingrequirementsandtheFDSF.

Wherethesewillnotbefullyinplacebeforesubmissionofdataisdueforthe2014stresstest(seeBox7),itisimportantthatshort-termsolutionsseektoalignwithstrategiclonger-termsolutionsasswiftlyaspossible.

Itisalsokeythatbanks’seniormanagementdevoteappropriateresourcestothenecessaryupgradeoftheirdatainfrastructuretoenablethemtoserviceinternalandexternaldataneeds easily.

BasedonthePRA’sobservations todate,thismayrequiretheprofileofdatainitiativesinsomebankstoberaisedmaterially.

ThePRA—andtheBankmorebroadly—arethemselvesmakingsubstantialinvestmentsininfrastructureforcollectingandhandlingdata,tosupportmicroprudentialsupervisionandmacroprudentialpolicymaking.

Itisimportantthat,asbanksinvestininfrastructuretoimprovetheirown datareportingandaggregation capabilities,theydonotbuildstructuresorprocessesforthesolepurposeofstress-testingdatasubmissions.

Theabilityofbankstoprovidethesedatashouldbeaby-productoftheirimprovedinternaldata capabilities,integratingexistingandplannedarchitecturesforotherdatasubmissionrequirementssuchastheCommonReportingFramework.

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  • ItishopedthattheFDSFwillconsiderablyenhancebanks’ability toprovidecleanandtimelydatafortheseothercomplementaryregulatoryinitiatives.

  • 12FeedbackontheDiscussionPaper

  • TheBankwouldwelcomecommentsfrominterestedpartiesonthedifferentelementsofthestress-testingframeworkproposedinthispaper.

  • In consideringthedevelopmentofthemedium-termframework,theBankhopes to engagewithabroadrangeofstakeholders,includingParliament,banks,marketparticipants,academics,foreignregulatorsandother interestedparties.

  • AlthoughtheBankiskeentoelicitviewsonallaspectsofthispaper,itparticularlywelcomesfeedbackonthefollowingquestions:

  • Whatarerespondents’viewsontheproposedcoverageoftheconcurrentstress tests?Shouldmedium-sizedbanksbeincludedintheproposedframework?

  • Whatarerespondents’viewsonthemeritsofastress- testingframeworkforotherfinancialinstitutions, in particularcentralcounterparties?

Whatarerespondents’viewsontheproposedapproach to scenario

  • design,especiallyontheextent towhichtheseverityofshocksshouldvarythroughthecycle?

  • Whatarerespondents’viewsontheBank’sproposaltouseasuiteofmodelstoassesstheimpactofscenariosonbanks’capitalratios?Howdorespondentstradeoffthebenefits ofreducedrelianceonasinglemodelagainstthepotentialcostsoftheneed to synthesisedifferentmodeloutputs?

  • Whatarerespondents’viewsonthenecessarydegreeofgranularityofstress-testdisclosurestohelpstrengthenthecredibilityofthe

  • stress-testingframeworkandfacilitateaccountabilityoftheFPCandthePRABoard?

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Fromanoperationalperspective,theBankiskeentoensurethat

theannualstresstestsareconductedinamannerthatreducesanyunnecessary‘peak-load’problemsforbanks inscope.

It wouldthereforewelcomerespondents’viewsontheproposedannualstress-testingcycle.

Box7

Emergingplansfor2014

BuildingtheBank’sstress-testingcapability todelivertheframeworkoutlinedinthisDiscussionPaperwilltakeanumberofyears.

Relativetotheproposedsteady-stateframework,the2014stresstestisexpectedtofocusonasmallersetoffirms;incorporateamorelimitedassessmentofsystem-wideamplificationmechanisms;andbeconductedoveralongertimeframe.

Coverage

The2014stress testwillcovertheeightmajorUKbanks.

Thestress-testingapproachforotherPRA-regulatedfirmswillnotbeaffectedbythe2014stress test.

Scenarios

The2014stress testwillincorporatethreescenarios:acommonbaseline;acommonstressscenario;andaninstitution-specificstressscenarioforeachbank.

Thecommonscenarioswillbedesignedbythe FPC,inconsultationwiththePRABoard.

Theinstitution-specific scenarioswillbedesignedbybanksandapprovedby thePRABoard.

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TheBankexpectstheinstitution-specificstressscenarios to resultin higherlossesthanthecommonstressscenariodesignedbytheFPC.

Thecommonscenarioswillbepublishedby31March2014.

BankswillneedtobroadenthecommonscenariostocoveramorecomprehensiverangeofvariablesforwhichtheBankwillnotbeprovidingafuturepath.

BankswillneedtofinalisetheirbespokescenarioswiththeBankduringApril2014.

Data

The overallexercisewillbebasedoncalendaryear-end2013data.

Themajorityofbanks in scopeforthe2014exercisehavealreadybeenengagedwiththePRAforsometimeoverthesubmissionofdetailedportfolioinformation.

ThisisimportantforthePRAtobeabletoundertakeits owndetailedanalysis.Banks areexpectedtoadheretothetimetableforplanneddatasubmissionsinordertofacilitatethe2014exercise.

Wherebanks’datasubmissiontimetablesstartlaterthanrequiredforthe2014exercise,orbanks havenotyetdiscussedthesubmissionofdetailed portfolioinformation,thePRAwillbeaskingthosebankstosubmittherequireddetailedportfolioinformationby12March2014.

ThePRAmayalsorequestadditionaldata to supporttheexercise.

Thesedatawillalsoberequiredby12March2014.Totheextentthatadditionaldataarerequired,thePRAwillpublish templatesandinformationrequestsby31December2013.

Stress-testanalysis

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Bankswillbeexpectedtoanalysetheimpactofthescenariosduring2014Q2.

Theresultsoftheanalysisareexpectedtobeapprovedby eachbank’sBoardbeforebeingsubmittedtothePRAby30June2014.

Resultsshouldbesubmittedbothnetandgrossofmanagementactions.

Banksshouldonlyproposemanagementactionsthattheywouldbepreparedtoenact.

In parallel,andthrough to2014Q3,Bankstaffwillperformtheir ownanalysisusingsomeoftheregulatorymodelsdescribedinSection7.

Thisincludesrunninggranular,regulatorymodelsandsensitivityanalysis to compareagainstbanks’ownresults.

Bankstaffwillalsoruncoarser,system-widemodels,whichaim to capturefeedbacksandinteractionswithinthefinancialsystemintimesofstress.

Andtheywillundertakepeeranalysisaswellascomparisonsof bank-levelresultswithoutputsofeconomy-widemodels.

Bankstaffwillsynthesisetheoutputsofthesemodelstoarriveatacentralviewoffirmprofitabilityand capitalratiosin eachofthescenarios.

BanksshouldexpectinteractionswiththePRAduringthisanalysisphasetofocusonquestionsarounddataaccuracyandcompletenessaswellasunderstandingofbanks’keyassumptionsandjudgementstakenaspartoftheirmodellingapproach.

FPC/PRABoarddecisionsanddisclosure

TheoutcomeofthisanalysiswillbeconsideredbytheFPCandthePRABoardduring2014Q4andwillbeused toinformanyremedialactionseitheratthesystemor individual-banklevel.

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Thepreciseformofdisclosureofthe2014exercisewillbedeterminedby theFPCandthePRABoardoverthecourseofnextyear.

Itisanticipatedthattheresultsoftheexercisewillbecommunicatedpubliclybytheendof2014.

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  • EIOPAFinalReportonPublicConsultationNo.13/009ontheProposalforGuidelinesonForwardLookingAssessmentofOwnRisks(basedontheORSAprinciples)

  • SectionI:GeneralProvisionsforpreparatoryGuidelines

  • Guideline1-GeneralprovisionsforGuidelines

    • AspartofthepreparationfortheimplementationofSolvencyII,nationalcompetent

  • authoritiesshouldtaketheappropriatestepsinordertoputinplacefrom1January2014thepresentGuidelinesontheforwardlookingassessmentofownrisks(basedontheORSAprinciples).

    • Nationalcompetentauthoritiesshouldensurethatinsuranceandreinsuranceundertakingsandgroupstake theappropriatestepsto

  • establishaprocesstodevelopaforwardlookingassessmentofownrisks;and

  • compilequalitativeinformationsupportingtheforwardlookingassessmentofownrisksthatwillallow nationalcompetentauthoritiestoreviewandevaluatethequalityoftheprocess.

  • Guideline2-ProgressreporttoEIOPA

  • 4.24.NationalcompetentauthoritiesshouldsendtoEIOPA,aprogressreportontheapplicationoftheseGuidelinesbytheendofFebruaryfollowingeachrelevantyear,thefirstbeingby28February2015basedontheperiod1January2014 to31December2014.

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  • Guideline3-Applicabilityofthethresholdfortheforwardlookingassessmentofownrisks

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethatallundertakingsandgroupsfallingunderSolvencyIIDirectiveperformanassessmentoftheiroverallsolvencyneeds,starting in 2014.

    • Nationalcompetentauthoritiesshouldrequirethatundertakingsrepresentingatleast80%ofthemarketshareasdefinedinGuideline5to7inthe“Guidelinesonsubmissionofinformationtonationalcompetentauthorities”performanassessmentofwhethertheundertakingwouldcomplyonacontinuousbasiswiththeSolvencyIIregulatory capitalrequirementsandtherequirementsontheSolvencyIItechnical provisionsstartingin2015.

  • Forthat technicalspecificationsonthecalculationoftheSolvencyIIregulatorycapitalrequirementsandonthecalculationoftechnical provisionswillbeprovided.

    • NationalcompetentauthoritiesshouldrequirethatgroupssubmittingannualquantitativeinformationasdefinedinGuideline9inthe“Guidelinesonsubmissionofinformationtonationalcompetentauthorities”performanassessmentofwhetherthegroupwouldcomplyonacontinuousbasiswiththeSolvencyIIregulatorycapitalrequirementsandtherequirementsontheSolvencyIItechnical provisionsstartingin2015.

  • Forthat technicalspecificationsonthecalculationoftheSolvencyIIregulatorycapitalrequirementsandonthecalculationoftechnical provisionswillbeprovided.

    • Nationalcompetentauthoritiesshouldallowthatundertakingsandgroupswhichareinthepre-applicationprocessforaninternalmodelmakeuseofthismodelforthepurposeoftheassessmentsonregulatorycapitalrequirements,providedthattheundertakingsandgroupsconcernedalsoperformtheassessmentforpreparingfortheeventuality thattheapplicationtousetheinternalmodelunderSolvencyIIwouldberejectedbythenationalcompetentauthority.

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    • Whereanundertakingwhichisnotinthepre-applicationprocessforaninternalmodelfallswithinthethresholdreferredtointheparagraph1.26andagroupfallswithinthethresholdreferred to inparagraph1.27.,forthecalculationoftheSolvencyIIregulatorycapitalrequirementsnationalcompetentauthoritiesshouldrequiretheundertakingorthegrouptoperformanassessmentofthesignificanceofthedeviationofitsrisk profilefromtheassumptionsunderlyingtheSolvencyIISolvencyCapitalRequirementcalculation,starting in 2015.

  • Forthat technicalspecificationsonthecalculationoftheSolvencyIIregulatorycapitalrequirementsandonthecalculationoftechnical provisionswillbeprovided.

  • SectionII:ForwardLookingAssessmentofOwnRisksGuideline4–Proportionality

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethattheundertakingdevelopsfortheforwardlookingassessmentofownrisksits ownprocesseswithappropriateandadequatetechniques,tailoredtofitintoitsorganisationalstructureandrisk-managementsystemandtakingintoconsiderationthenature,scaleandcomplexityoftherisksinherent tothebusiness.

  • Guideline5–Roleoftheadministrative,managementorsupervisorybody:top-downapproach

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethattheadministrative,managementorsupervisorybodyoftheundertakingtakes anactivepartintheforwardlookingassessmentofownrisks,includingsteering,howtheassessmentistobeperformedandchallengingtheresults.

  • Guideline6–Documentation

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethattheundertakinghasatleastthefollowingdocumentationontheforwardlookingassessmentofownrisks:

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Thepolicyfortheforwardlookingassessmentofownrisks;

recordofeachforwardlookingassessmentofownrisks;

aninternalreportoneachforwardlookingassessmentofownrisks;and

asupervisoryreportoftheforwardlookingassessmentofownrisks.

Guideline7–Policyfortheforwardlookingassessmentofownrisks(basedontheORSAprinciples)

4.33.In accordancewithArticles41and45ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethattheadministrative,managementorsupervisorybodyoftheundertakingapprovesthepolicyfortheforwardlookingassessmentofownrisks.

Thispolicy shouldincludeatleast:

adescriptionoftheprocessesandproceduresinplacetoconduct theforwardlookingassessmentofownrisks;

aconsiderationofthelinkbetweentherisk profile,theapprovedrisktolerancelimitsandtheoverallsolvencyneeds;and

informationon:

how andhow oftenstresstests,sensitivityanalyses,reversestresstestsorotherrelevantanalysesaretobeperformed;

dataqualitystandards;and

thefrequencyoftheassessmentitself andthejustificationofitsadequacyparticularlytakingintoaccounttheundertaking’srisk profileandthevolatilityofitsoverallsolvencyneedsrelative to itscapitalposition;and

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  • (iv)thetimingfortheperformanceoftheforwardlookingassessmentofownrisksandthecircumstanceswhichwouldtriggertheneedforaforwardlookingassessmentofown risksoutsideoftheregular

  • time-scales.

  • Guideline8–Recordofeachforwardlookingassessmentofownrisks(basedontheORSAprinciples)

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethattheundertakingappropriately evidencesandinternallydocumentseachforwardlookingassessmentofownrisks anditsoutcome.

  • Guideline9–Internalreportontheforwardlookingassessmentof ownrisks(basedontheORSAprinciples)

    • In accordancewithArticle41,44and45ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethattheundertakingcommunicatestoallrelevantstaffatleasttheresultsandconclusionsregardingtheforwardlookingassessmentofown risks,oncetheprocessandtheresultshavebeenapprovedbytheAMSB.

  • Guideline10–SupervisoryReportoftheforwardlookingassessmentofownrisks(basedontheORSAprinciples)

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethattheundertakingsubmitsthesupervisoryreportoftheforwardlookingassessmentofownriskswithin2weeks oftheAMSBhavingreviewedandapprovedtheassessments.

  • Thesupervisoryreportshouldpresentatleastthefollowing:

  • thequalitativeandquantitativeresultsoftheforwardlookingassessmentandtheconclusionsdrawnbytheundertakingfromthoseresults;

  • themethodsandmainassumptionsused;and

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  • c)whereapplicableaccordingto thethresholdsintroduced,acomparisonbetweentheoverallsolvencyneeds,theregulatory capitalrequirementsandtheundertaking's ownfunds.

  • SectionIII:Specificfeaturesregardingtheperformanceoftheforwardlookingassessmentofownrisks(basedontheORSAprinciples)

  • Guideline11–Valuationand recognitionoftheoverallsolvencyneeds

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethattheundertaking,ifitusesrecognitionandvaluationbasesthataredifferentfromtheSolvencyIIbasesintheassessmentofitsoverallsolvencyneeds,explainshowtheuseofsuchdifferentrecognitionandvaluationbasesensuresbetterconsiderationofthespecificriskprofile,approvedrisk tolerancelimitsandbusinessstrategyoftheundertaking,whilecomplyingwiththerequirementforasoundandprudentmanagementofthebusiness.

    • Nationalcompetentauthoritiesshouldensurethattheundertakingquantitativelyestimatesonbesteffortbasistheimpactontheoverallsolvencyneedsassessmentofthedifferentrecognitionandvaluation basesinthose caseswhererecognitionandvaluationbasesthataredifferentfromtheSolvencyIIbaseshavebeenusedintheassessmentofitsoverallsolvencyneedsstartingin2015undertheconditionthatthetechnicalspecificationshavebeenprovidedbyEIOPA.

  • Guideline12–Assessmentoftheoverallsolvencyneeds

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethattheundertakingassessesitsoverallsolvencyneedsandthenexpressestheoverallsolvencyneedsinquantitative termsandcomplementsthequantificationbyaqualitativedescriptionofthematerialrisks.

    • Whereappropriate,nationalcompetentauthoritiesshouldensurethattheundertakingsubjectstheidentifiedmaterialriskstoasufficiently

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  • widerangeofstresstestorscenarioanalysesinordertoprovideanadequatebasisfortheassessmentoftheoverallsolvencyneeds.

  • Guideline13–Forward-lookingperspectiveoftheoverallsolvencyneeds

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethattheundertaking’sassessmentoftheoverallsolvencyneedsisforward-looking,includingamediumtermorlongtermperspectiveasappropriate.

  • Guideline14–Regulatorycapitalrequirements

    • In accordancewithArticle45ofSolvencyIIDirectiveandinaccordancewithGuideline3ontheapplicabilityofthethresholdfortheforwardlookingassessmentofown risks,nationalcompetentauthoritiesshouldensurethataspartofthisassessmenttheundertakinganalyseswhethertheundertakingwouldcomplyonacontinuousbasiswiththeSolvencyIIregulatorycapitalrequirementsandincludesatleast:

  • thepotentialfuturematerialchangesintherisk profile;

  • thequantityandqualityofitsownfundsoverthewholeofitsbusinessplanningperiod;and

  • thecompositionofownfundsacrosstiersandhow thiscompositionmaychangeasaresultofredemption,repaymentandmaturitydatesduringitsbusinessplanningperiod.

  • Guideline15–Technicalprovisions

  • 4.43.In accordancewithArticle45ofSolvencyIIDirectiveandinaccordancewithGuideline3ontheapplicabilityofthethresholdfortheforwardlookingassessmentofown risks,nationalcompetentauthoritiesshouldensurethattheundertakingsensurestheactuarialfunctionoftheundertakingto:

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  • provideinputas towhethertheundertaking wouldcomplycontinuouslywiththerequirementsregardingthecalculationoftechnical provisions;and

  • identifypotentialrisks arisingfromtheuncertaintiesconnectedtothiscalculation.

  • Guideline16–DeviationsfromassumptionsunderlyingtheSCR calculation

    • InaccordancewithArticle45ofSolvencyIIDirectiveandinaccordancewithGuideline3ontheapplicabilityofthethresholdfortheforwardlookingassessmentofown risks,nationalcompetentauthoritiesshouldensurethattheundertakingassesseswhetheritsriskprofiledeviatesfromtheassumptionsunderlyingtheSolvencyIISolvencyCapitalRequirementcalculationandwhetherthesedeviationsaresignificant.

  • Theundertakingmayasafirststepperformaqualitativeanalysisandifthatindicatesthatthedeviationisnotsignificant,aquantitativeassessmentisnotrequired.

  • Guideline17–Linktothestrategicmanagementprocessanddecision-makingframework

    • In accordancewithArticle45ofSolvencyIIDirective,nationalcompetentauthorities shouldensurethattheundertakingtakesintoaccounttheresultsoftheforwardlookingassessmentofownrisksandtheinsightsgainedduringtheprocessofthisassessmentinatleast:

  • its capitalmanagement;

  • itsbusinessplanning;and

  • itsproductdevelopmentanddesign.

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  • Guideline18–Frequency

    • In accordancewithArticles45and246ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethattheundertakingperformstheforwardlookingassessmentofown risksatleastannually.

  • SectionIV:SpecificitiesoftheGroupintheforwardlookingassessmentofownrisks(basedontheORSAprinciples)

  • Guideline19–Scopeofgroupforwardlookingassessmentofownrisks(basedontheORSAprinciples)

    • In accordancewithArticles45and246ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethattheresponsibleentitydesignsthegroupforwardlookingassessmentofownriskstoreflectthenatureofthegroupstructureanditsriskprofile.

  • Alloftheentitiesthatfallwithinthescopeofgroupsupervisionshouldbeincludedwithinthescopeofthegroupforwardlookingassessmentofownrisks.

  • Thisshouldincludeinsurance,reinsurance,non-insuranceand

  • non-reinsuranceundertakings,andbothregulatedandnon-regulatedentities,situatedin theEEAandoutsidetheEEA.

  • Guideline20–Reportingtothesupervisoryauthorities

    • In accordancewithArticles45and246ofSolvencyIIDirectiveandincasetheresponsibleentityappliesforthesubmissionofasingleforwardlookingassessmentofown risks’document:

  • a) Thegroupsupervisorshouldformaviewwhethertoallow thegrouptoperformasingleforwardlookingassessmentofownrisksdocument,ifthereisnootherdecisionprocessinforceinthecollege,andifnomemberthatwouldotherwisereceiveanindividualforwardlookingassessmentofownrisksdocumentdisagrees;and

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  • b)whereoneormoreofthesubsidiarieshasitsheadofficeinaMemberStatewhoseofficiallanguagesaredifferentfromthelanguagesin whichthesingleforwardlookingassessmentofown risksdocumentisreported,thesupervisoryauthorityconcernedshouldconsultwiththegroupsupervisor,thecollegeofsupervisorsandthegroupitselfbeforerequiringtheundertakingtotranslatethepartoftheforwardlookingassessmentofownrisksdocumentthatconcernsthesubsidiary intoanofficiallanguageoftheMemberStateinwhichthesubsidiaryhasitsheadoffice.

  • Guideline21–Assessmentofthe impact ofgroupspecificrisks onoverallsolvencyneeds

    • In accordancewithArticles45and246ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethattheresponsibleentityinthegroupforwardlookingassessmentofownrisksadequatelyassessestheimpactofallgroupspecificrisksandinterdependencieswithinthegroupaswellas,andtheimpactoftheserisksandinterdependenciesontheoverallsolvencyneeds,taking intoconsiderationthespecificitiesofthegroupandthefactthatsomerisksmaybescaledupatthelevelofthegroup.

  • Guideline22–Generalruleforgroupforwardlookingassessmentofownrisks(basedontheORSAprinciples)

    • In accordancewithArticles45and246ofSolvencyIIDirectiveandin accordancewithGuideline8ontherecordofeachforwardlookingassessmentofownrisks,nationalcompetentauthoritiesshouldensurethattheresponsibleentityincludesintherecordofthegroupforwardlookingassessmentofownrisksatleastadescriptiononhow thefollowingfactorsweretakenintoconsiderationfortheassessmentofoverallsolvencyneedsandtheassessmentofcontinuouscompliancewithregulatoryrequirements:

  • a) Theidentificationofthesourcesofownfundswithinthegroupandifthereisaneedforadditionalownfunds;

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  • theassessmentofavailability,transferabilityorfungibilityofownfunds;

  • referencestoanyplannedtransferofownfundswithinthegroup,whichwouldhaveamaterial impactonanyentityofthegroup,anditsconsequences;

  • alignmentofindividualstrategieswiththeonesestablishedatthelevelofthegroup;and

  • specificrisksthegroupcouldbeexposedto.

  • Guideline23–Specificrequirements forasingleforwardlookingassessmentofownrisks’document

    • In accordancewithArticles45and246ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethattheresponsibleentity,whenapplyingtosubmitasingleforwardlookingassessmentofownrisks’document,providesanexplanationofhow thesubsidiariesarecoveredandhowtheAMSBsofthesubsidiariesare involvedintheassessmentprocessandapprovaloftheoutcome.

  • Guideline24–Internalmodelusers

    • In accordancewithArticles45and246ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethat,inthe caseofaninternalmodelpre-application,theresponsibleentitydescribesinthegroupforwardlookingassessmentofownriskswhichentitieswithinthegroupdonotusetheinternalmodeltocalculatetheirSCRandexplainwhythisisthecase.

  • Guideline25–Integrationofrelatedthird-countryinsuranceandre-insuranceundertakings

    • In accordancewithArticles45and246ofSolvencyIIDirective,nationalcompetentauthoritiesshouldensurethattheresponsibleentityassessesintheassessmentofthegroupoverallsolvencyneedstherisksofthebusinessinthirdcountriesinaconsistentmannerasitdoesforEEA-

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  • businesswithspecialattention totheassessmentoftransferabilityandfungibilityofcapital.

  • ComplianceandReportingRules

    • ThisdocumentcontainsGuidelinesissuedunderArticle16oftheEIOPARegulation.InaccordancewithArticle16(3)oftheEIOPARegulation,CompetentAuthoritiesshallmakeeveryefforttocomplywithguidelinesandrecommendations.

    • CompetentauthoritiesthatcomplyorintendtocomplywiththeseGuidelinesshouldincorporatethemintotheirregulatoryorsupervisoryframeworkinanappropriatemanner.

    • CompetentauthoritiesshallconfirmtoEIOPAwhethertheycomplyorintendtocomplywiththeseGuidelines,withreasonsfornon-compliance,within2monthsafterthepublication.

    • In the absenceofaresponsebythisdeadline,competentauthoritieswillbeconsideredasnon-complianttothereporting.FinalProvisiononReview

    • TheseGuidelinesshallbesubjecttoareviewbyEIOPA.

    • In particular,theyearof2015referredtoin Guideline3mayberevisedbasedonthelatestdevelopmentsontheOMDIInegotiations.

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StandardsettingAgendaOfficeoftheChiefauditor

Developingandmaintaininghigh-qualityauditingandrelated professionalstandardsisapriorityofthePublicCompanyAccountingOversightBoard("PCAOB"or"Board").

ThePCAOB'sOfficeoftheChief Auditor("OCA")regularlymonitorsauditrisks,challenges,andtheprevailingeconomicenvironmentasitmaintainsandadjustsitsstandard-settingagenda.

TheagendaisdeterminedbasedonconsiderationoftheresultsofthePCAOB'soversightofregisteredpublicaccountingfirms,monitoringoftheenvironment,consultationwiththeBoard'sStandingAdvisoryGroup("SAG"),inputfromtheBoard'sInvestorAdvisoryGroup("IAG"),discussionwiththeU.S. SecuritiesandExchangeCommission("SEC")staff,andotherfactors.

OCAcontinuallyevaluatestheBoard'sstandardsandtakes apriority-basedapproachindeterminingwhichstandardsneed tobeamended.

In doingso,thePCAOB'sgoalis toimproveauditingstandardsasitdeemsnecessarytoprotecttheinterestsofinvestorsand to furtherthepublicinterestinthepreparationofinformative,accurate,andindependentauditreports.

Thedevelopmentofnewormodifiedauditingstandardsreflectseconomicconsiderations,consistentwiththepublicinterestandinvestorprotection.

Aspartoftheprocess,considerationalsoisgiven to theapplicabilityof newstandardstoauditsofemerginggrowthcompanies(EGCs)andwhethersuchapplicationwillpromoteefficiency,competition,andcapitalformation.

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In addition,aspartofitsstandard-setting process,OCAtakesintoconsiderationtheworkofotherstandardsetters(forexample,theFinancialAccountingStandardsBoard("FASB"),InternationalAccountingStandardsBoard("IASB"),andInternationalAuditingandAssuranceStandardsBoard) inthedevelopmentofnewormodifiedauditingstandards.

Forexample,OCAiscloselymonitoringtheworkoftheFASBandIASBaccountingprojects(includingtheprojectsonrevenuerecognitionandgoingconcern)andisevaluatingtheneedforneworrevisedauditingstandardsorforstaffguidanceinresponse to potentialupcomingchangestoU.S.generallyacceptedaccountingprinciplesandInternationalFinancialReportingStandards.

Thisstandard-settingagendawaspreparedby thestaffoftheOfficeoftheChief Auditor.

ItisnotastatementoftheBoard;nordoesitnecessarilyreflecttheviewsoftheBoard, individualBoardmembers,orotherstaff.

Finally,OCAissuesstaffauditpracticealertstohighlightnew,emerging,orotherwisenoteworthycircumstancesthatmayaffecthow auditorsconductauditsundertheexistingrequirementsofPCAOBstandardsandrelevantlaws.

Thefollowingtableandoverviewofprojects,presentsOCA'scurrentstandard-settingagendaandkeymilestones.

Timingofstandard-settingprojectsissubjecttochange.

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Standard-SettingBriefProjectOverview

1.TheAuditor'sReportingModel.OnAugust13,2013,theBoardissuedforpubliccommentproposedauditingstandardsandrelatedamendmentsontheauditor'sreportandtheauditor'sresponsibilitiesregardingotherinformation.

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Theproposedauditorreportingstandardwouldretainthepass/failmodelin theexistingauditor'sreportbutwouldprovideadditionalinformation to investorsandotherfinancialstatementusersabouttheauditandtheauditor.Specifically,theproposedauditorreportingstandardwouldrequire:

thecommunicationofcriticalauditmatters;

theadditionofnewelementstotheauditor'sreportrelated to auditorindependence,auditortenure,andtheauditor'sresponsibilitiesfor,andtheresults of,theauditor'sevaluationofother informationoutsidethefinancialstatements;and

enhancementstoexistinglanguageintheauditor'sreportrelated totheauditor'sresponsibilitiesforfraudandnotestothefinancialstatements.

Theproposedother informationstandardwould:

enhancetheauditor'sresponsibilitywithrespect to other information;

requiretheauditortoevaluatetheother informationforamaterialmisstatementoffactaswellasfora materialinconsistencywithamountsor information,orthemanneroftheirpresentation, in theauditedfinancialstatements;and

requirecommunicationintheauditor'sreportregardingtheauditor's responsibilitiesfor,andtheresultsof,theauditor'sevaluationoftheotherinformation.

ThecommentperiodontheproposalendsonDecember11,2013.

TheBoardisconsidering holdingapublicroundtablein2014to discusstheproposedstandardsandcommentsreceived.

Forfurther information,seeRulemakingDocketNo.034.2

2.

AuditsofBrokersandDealers.OnJuly12,2011,theBoardproposed

two attestationstandardsforauditsofbrokersanddealersinlightof

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amendmentstoRule17a-5undertheSecuritiesExchangeActof1934proposedbytheSEC.

TheBoardalsoproposedanauditingstandardforauditsofsupplementalinformationaccompanyingauditedfinancialstatements.

Theproposedauditingstandardwouldapplywhentheauditorofthecompany'sfinancialstatementsisengagedtoauditandreportonsupplementalinformationthataccompanies theauditedfinancialstatements.

ThecommentperiodendedonSeptember12,2011.

ThestaffhasanalyzedthecommentsreceivedandtheSEC'samendmentstoitsRule17a-5andthestaffisdraftinganadoptingreleasefortheBoard'sconsideration.

In addition,thestaffisdraftingguidanceonapplyingPCAOBstandardsinauditsofbrokersanddealers.Forfurtherinformation,seeRulemakingDocketNo.035andRulemakingDocketNo.036.

3.AuditTransparency:IdentificationoftheEngagementPartnerandOtherPublicAccountingFirmsorPersonsThatAreNotEmployedbytheAuditorbutParticipateintheAudit.

OnOctober11,2011,theBoardissuedforpubliccommentproposedamendmentstoitsauditingstandardsandannualreportingform.

Theproposedamendmentswouldimprovetransparencyofauditsbyrequiringthedisclosureoftheengagementpartneranddisclosureofotheraccountingfirmsandotherpersonsthat tookpartin theaudit.

ThecommentperiodendedonJanuary9,2012.

ThestaffhasanalyzedthecommentsreceivedandisdraftingrevisionsfortheBoard'sconsideration.Forfurther information,seeRulemakingDocketNo.029.

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4.RelatedParties.OnMay7,2013,theBoardissuedforpubliccommentareproposedauditingstandardandreproposedamendmentstocertainofitsauditingstandards.

Thereproposaladdressedthefollowingareas:

evaluatingacompany'sidentificationof,accountingfor,anddisclosureof,relationshipsandtransactionswithrelatedparties;

identifyingandevaluatingacompany'ssignificantunusualtransactions;and

obtaininganunderstandingofacompany'sfinancialrelationshipswithitsexecutiveofficersaspartoftheauditor'sriskassessment.

ThereproposalwasdiscussedwiththeSAGonMay15,2013.ThecommentperiodendedonJuly8,2013.

ThestaffisanalyzingthecommentsreceivedandisdraftinganadoptingreleasefortheBoard'sconsideration.

Forfurther information,seeRulemakingDocketNo.038.

5.FrameworkforReorganizationofPCAOBAuditingStandards.

OnMarch26,2013,theBoardissuedforpubliccommentapotentialframeworkforreorganizingtheBoard'sexisting interimand

PCAOB-issuedauditingstandardsintoatopicalstructurewithasingle,integratednumberingsystem,alongwithcertainamendmentstoitsrules

andstandards– Phase1.

Theproposedreorganizationisintended topresentthestandardsin alogicalorderthatgenerallyfollowstheflow oftheauditprocessandisintended tohelpusersnavigatethestandardsmore easily.

ThecommentperiodendedonMay28,2013.Afterconsiderationofthecommentsreceived,theBoardintends toreleaseandseek commenton

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theamendmentsnecessary to implementthereorganizationoftheauditingstandards–Phase2.

ThestaffisdraftingamendmentsfortheBoard'sconsideration.Forfurther information,seeRulemakingDocketNo.040.

6.

Auditors'ResponsibilitieswithRespecttoOtherAccounting

Firms,IndividualAccountants,andSpecialists.

ObservationsfromtheBoard'sreviewsofauditsinvolvingotheraccountingfirms,individualaccountants,andspecialistsindicateaneedforimprovementinauditproceduresperformedby otheraccountingfirms,individualaccountants,andspecialistsandintheleadauditor'soversightoftheir work.

Further,overthelastseveraldecades,therolesofotheraccountingfirms,individualaccountants,andspecialistshavetakenongreatersignificanceinaudits.

Asaresult,thestaffisdraftingfortheBoard'sconsiderationaproposaltoimprovetheplanning,supervision,andotheraspectsofsuchaudits.

GoingConcern.Inresponse to commentsreceivedfrommembersoftheSAGandinputfromtheIAG,thestaffisevaluatingpotentialrevisions to thegoingconcernauditingstandard.

Aspartofthatprocess,thestaffis monitoringthe activitiesofotherstandardsettersinthisarea.Forexample,onJune26,2013,FASBissuedaproposedaccountingstandardupdateregardingdisclosureofuncertaintiesaboutanentity'sgoingconcernassumption.

Anyproposedrevisionstotheauditingstandardwouldtakeintoconsiderationrelevant activitiesthatmayresultinchangestotheaccountingstandards.

QualityControlStandards,IncludingAssignmentandDocumentationofFirmSupervisoryResponsibilities.

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DeficienciesidentifiedbyPCAOBinspectorsintheirreviewsofissuerauditssuggestthatimprovementsareneededin firms'systemsofqualitycontrol.

Forinstance,thePCAOB'sinspectionstaffroutinelyidentifiesauditdeficienciesthatshouldhavebeendetectedandremediedbeforetheauditreportwasissued.

Improvementsofthefirms'systemsofqualitycontrolcouldhavesignificantpotentialtoimproveauditqualitybynotonlydetectingmoreauditdeficienciespriortotheissuanceoftheauditreport,butalsobypreventinganddeterringtheoccurrenceofmanysuchdeficiencies.

Asaresult,thestaffisdevelopingaconceptreleasetoexploreimprovementstotheexistingqualitycontrolstandards,includingtheSECPracticeSectionrequirements.

Thisprojectalsoconsiderspotentialimprovements tothequalitycontrolstandardsregardingfirmsupervisoryresponsibilities.

Forfurther informationonassignmentanddocumentationoffirmsupervisoryresponsibilities,seeRulemakingDocketNo.031.

9.AuditingAccountingEstimates,IncludingFairValueMeasurementsandRelatedDisclosures.

Inresponsetoissuesidentifiedduringtheinspectionofaccountingfirms,commentsreceivedfrommembersoftheSAG,andFASB'sproposedaccountingstandardonfinancialinstruments,thestaffisdraftingfortheBoard'sconsiderationaproposalforastandardonauditingaccountingestimates,includingfairvaluemeasurementsandrelateddisclosures.

Similarto otherstandardsetters,thestaffisdraftingacombinedstandard to addressabroadrangeofmattersinthearea ofauditingaccountingestimatesandfairvaluemeasurements.

ThisprojectalsoisbeinginformedbythePricingSourcesTaskForceoftheBoard'sStandingAdvisoryGroup,whichhasfocusedontheauditing

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ofthefairvalueoffinancialinstrumentsthatarenot activelytradedandontheuseofthird-partypricingsources.

AuditorIndependence,Objectivity,andProfessionalSkepticism.

OnAugust16,2011,theBoardissuedaconceptreleasetosolicitpubliccommentonways toenhanceauditor independence,objectivity,and professionalskepticism,includingthroughmandatoryrotationofauditfirms.

Mandatoryrotationwouldlimitthenumberofconsecutiveyearsforwhicharegisteredpublicaccountingfirmcouldserveastheauditorofapubliccompany.

ThecommentperiodendedonDecember14,2011.

TheBoardheldthreepublic meetingsin2012todiscussauditorindependenceandmandatoryauditfirmrotation.

Inconnectionwitheachofthesepublicmeetings,theBoardreopenedthecommentperiodontheconceptreleasetoprovideanopportunityformembersofthepublictooffertheirviews,includingviewsonnewinformationmadeavailableasaresultofthemeetings.

ThelatestextendedcommentperiodclosedonNovember19,2012.ThestaffisanalyzingtheresultsoftheBoard'soutreachandnextstepscontinuetobeconsidered.

OnDecember4,2012,informedbyinspectionobservationsandcommentsheardatthesepublicmeetings,thestaffissuedStaffAuditPracticeAlertNo.10,MaintainingandApplyingProfessionalSkepticisminAudits.

Thestaffalsocontinuestomonitortheactivitiesofotherregulators,standardsetters,andlegislativebodiesinthisarea.Forfurtherinformation,seeRulemakingDocketNo.037.

Confirmation.OnJuly13,2010,theBoardissuedforpubliccommentaproposedauditingstandard.

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ThecommentperiodendedonSeptember13,2010.

Thestaffhasanalyzedthecommentsreceivedandisplanningto draftareproposalfortheBoard'sconsideration.Forfurtherinformation,seeRulemakingDocketNo.028.

12.SubsequentEvents.In response tothecommentsreceivedfrommembersoftheSAG,thestaffisevaluatingpotentialimprovementstothesubsequenteventsauditingstandard.

ThePCAOBisanonprofitcorporationestablishedbyCongresstooverseetheauditsofpubliccompaniesinordertoprotectinvestorsandthepublicinterestbypromotinginformative,accurate,andindependentauditreports.

ThePCAOBalsooverseestheauditsofbrokersanddealers,includingcompliancereportsfiled pursuant to federalsecuritieslaws,topromoteinvestorprotection.

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  • ProposalforaDIRECTIVEamendingDirective2009/138/EConthetaking-upandpursuitofthebusinessofInsuranceand

  • Reinsurance(Solvency II)as regardsthedatesoftranspositionandapplicationandthedateofrepealofcertainDirectives

  • EXPLANATORYMEMORANDUM

  • CONTEXTOFTHEPROPOSAL

    • Groundsforandobjectivesoftheproposal

  • Directive2009/138/EC (SolvencyII)providesamodern,risk-basedsystemforthesupervisionofEuropean insuranceandreinsuranceundertakings.

  • Thesenewrulesareessentialinordertoensureasafeandsolidinsurancesectorthat canprovidesustainableinsuranceproductsandsupporttherealeconomythroughlong-terminvestmentsandadditionalstability.

  • Directive2011/89/EU(Ficod1)amendscertaindirectivesincludingSolvencyIIasregardsthesupplementarysupervisionoffinancialentitiesinafinancialconglomerate.

  • On19January2011theCommissionadoptedaproposaltoamendDirective2009/138/EC in ordertotakeintoaccountthenewsupervisory architectureforinsuranceandnamelythesettingupoftheEuropeanInsuranceandOccupationalPensionsAgency(EIOPA)on1January2011(COM(2011)8,COD2011/0006)(OmnibusII)andtheentryintoforceoftheLisbonTreatywhichrequiredtheadjustmentofempowermentsfortheCommissiontoadoptimplementingmeasurestoempowermentsfortheCommissiontoadoptimplementinganddelegatedactsaccordingtoArticle290oftheTreatyontheFunctioningoftheEuropeanUnion.

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Theproposalalsoincludedprovisionstoextendthetransposition,repealandapplicationdatesinDirective2009/138/EC.

Theserulesareimportantin ordertoensureasmoothtransition to thenewregime.

In additionandinordertobecomefullyoperational,theSolvencyIIregimealsorequiresahighnumberofdelegatedandimplementingactsbytheCommission,providingimportantdetailsondifferenttechnicalmatters.

Manyoftheseso-called"level2"rulesarecloselylinkedtoOmnibusIIandcannotbepresentedbytheCommissionbeforethepublicationofOmnibusII,whichwillalsoclarifythescopeofmanydelegatedandimplementingactempowerments.

ThedeadlinefortranspositionandapplicationofDirective2009/138/ECwasinitially31October2012and1November2012respectively,butpendingtheoutcomeoftheon-goinglegislativenegotiationson OmnibusII,Directive2012/23/EU(QuickFix)postponedthesedatesto30June2013and1January2014respectively.

Directive2012/23/EUalsopostponesthedatewhentheexistinginsuranceandreinsurancedirectives(Directives64/225/EEC,73/239/EEC,73/240/EEC,76/580/EEC,78/473/EEC, 84/641/EEC,

87/344/EEC,88/357/EEC, 92/49/EEC,98/78/EC,2001/17/EC,

2002/83/EC and2005/68/EC,asamendedbytheactslistedin PartAofAnnexVI)thatarecollectivelyreferredtoasSolvencyIwillberepealed.

Instead of1November2012,thosedirectiveswillnowberepealedwitheffectfrom1January2014.

Themostcontroversialissueintheon-goinglegislativenegotiationsbetweentheEuropeanParliament,theCouncilandtheCommissionistheintroductionofmeasuresonthetreatmentofinsuranceproductswithlong-termguaranteesunderthenewSolvencyIIinsuranceregulatoryregime(“Long-termguaranteepackage”orLTGpackage).

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SincenoagreementontheLTGpackagecouldbeachievedinSeptember2012,negotiationsweresuspended.

TheEuropeanParliament,theCouncilandtheCommissionthenmandatedtheEuropeanInsuranceandOccupationalPensionsAuthority(EIOPA)tocarryoutatechnicalassessmentofthemeasures,inordertoprovideatechnicalbasisforapoliticalagreementonOmnibusII.

On14June2013EIOPApublisheditstechnicalfindingsonthelong-termguaranteesassessment.

ThesetechnicalfindingsconfirmfirstlytheimportanceoflongtermguaranteemeasuresformanyMemberStatesinperiodsoffinancialstresssuchasthoseexperiencedin2011andsecondlythatapackageofdifferentmeasuresisneededtocaterforthedifferentinsuranceproductsofferedinMemberStates.

TheEIOPAfindingsproposeanumberofmeasuresintendedtofacilitatetheprovisionofinsuranceproductswithlong-termguaranteesagainstartificialfinancialmarketvolatility.

Thesefindingsconstitute theparametersforapoliticalagreementonOmnibusII.

Accordingto theCommissionreporton27June2013,itshouldbepossibletofindacompromisewithinthescopeofthemeasuresthatEIOPArecommends.

AlthoughlegislativenegotiationsbetweentheEuropean Parliament,theCouncilandtheCommissionresumedon10July2013,itisveryunlikelythatthenegotiationsonOmnibusIIwillbeconcludedintime to publishtheOmnibusIIDirectiveintheOfficialJournalbeforethedateofapplicationofDirective2009/138/EC,asamendedbyDirective2012/23/EU.

Leavingthatdateunchangedwouldresultin Directive2009/138/ECbeingimplementedbeforetheentryintoforceofthetransitionalrulesandrelevantadaptationsprovidedforbytheOmnibusIIproposal.

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In viewofthefactthatthenegotiationsonOmnibusIIhavenotyetbeenfinalisedthedateoftranspositionof30June2013,whichhasalreadyelapsed,shouldbeextendedonelasttime.

LeavingthedatesunchangedwouldimplythatSolvencyIIneedstobeimplementedwithoutthetransitionalrulesandotherimportantadaptationsforeseen in OmnibusII.

In ordertoavoidcontinuedlegaluncertaintyandensurethelegalcontinuityofthecurrentSolvencyprovisions(SolvencyI)untilthecompleteSolvencyIIpackageisinplace,itisproposedthattherelevant transpositiondateinDirective2009/138/ECisextendedonelasttimeto31January2015.

Itisimportant to allow supervisorsandinsuranceandreinsuranceundertakingssometimetopreparefortheapplicationofSolvencyII.

ItisthereforeproposedtoextendthedateforfirstapplicationofSolvencyIIonelasttimeto1January2016.

Thiswillmakeitpossible to startthesupervisoryapprovalprocedures

e.g.for internalmodelsandundertakingspecificparameters.

Thepartiestotheon-goinglegislativenegotiationshaveagreedthatthereshouldbenofurtherchanges to eitherthetranspositionorapplicationdatesduringtheOmnibusIInegotiationsinordertoensurelegalclarityforinsuranceandreinsuranceundertakingssupervisoryauthoritiesduringtheirpreparations.

ItisevidentfromthechronologicalorderofeventsthatthepostponeddatesfortranspositionandapplicationofDirective2009/138/EC alsoapplytotheamendmentstoArticles212to 216,219,226,231,233,235,243

to247,249,256,257,258,262and263ofthatDirectivewhichweremadebyDirective2011/89/EC.

ThedateofrepealofSolvencyIshouldbeamendedaccordingly.

In viewofthe aboveandgiventheveryshortperiodoftimeleftbefore1January2014,thisDirectiveshouldbeadoptedbytheEuropean

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  • ParliamentandtheCouncilasamatterofurgencyandenterintoforcewithoutdelay.

  • ThisDirectiveisnecessaryinordertopreventalegalvacuumarisingafter1January2014.

  • The absenceofthisDirectivewouldresultin agapbetweentheEUlegalsystem(SolvencyII)andthatofMemberStates (whereSolvencyIastransposedwouldremaininforce).

  • Thiswouldlead to legaluncertaintyforsupervisoryauthorities,undertakingsandMemberStates.

    • Directive2009/138/EC(SolvencyII)

  • ThisDirectiveestablishesanewandmodernsolvencyregimeforinsurersandreinsurersintheEuropeanUnion.

  • Itprovidesforaneconomic,risk-basedapproachwhichprovidesincentivesfor insuranceandreinsuranceundertakingstoproperlymeasureandmanagetheirrisks.

    • Directive2011/89/EC(Ficod1)

  • ThisDirectiveamendscertaindirectivesincludingDirective2009/138/EC asregardsthesupplementarysupervisionoffinancialentitiesinafinancialconglomerate.

  • Article4ofDirective2011/89/EC amends theArticles212-216,219,226,

  • 231,233,235,243– 247,249,256,257258,262and263ofDirective

  • 2009/138/EC andArticle6ofDirective2011/89/EC prescribesthatMemberStatesshallbeincompliancewiththesenewprovisionsfrom10June2013.

    • Directive2012/23/EU(QuickFix)

  • ThisDirectiveamendsDirective2009/138/ECandpostponesthedateforitstranspositionfrom31October2012to30June2013,insertsthedateof

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  • itsapplicationfrom1January2014andpostponesthedateofrepealofSolvencyIfrom1November2012 to 1January2014.

  • 1.5.ProposalCOM(2011)8(theOmnibusIIDirective)

  • ThisproposalaimstoamendDirective2009/138/ECin ordertoadaptSolvencyIItothenewsupervisoryarchitectureforinsuranceandnamelythesetting-upoftheEuropean InsuranceandOccupationalPensionsAuthority(EIOPA)on1January2011(COM(2011)8,COD2011/0006).

  • Itproposes topostponethetranspositiondeadlineofSolvencyIIto 31December2012.

  • RESULTSOFCONSULTATIONSWITHTHEINTERESTEDPARTIESANDIMPACTASSESSMENTS

    • Transmissionofthisproposaltothenationalparliaments

  • Draftlegislativeacts,includingproposalsfromtheCommission,senttotheEuropeanParliamentandtotheCouncilmustbeforwardedtonationalparliamentsinaccordancewiththeProtocol(No1)ontheroleof nationalParliamentsin theEuropean Union,annexed to theTreaties.

  • Accordingto Article4oftheProtocol,aneight-weekperiodmustelapsebetweenadraftlegislativeactbeingmadeavailabletonationalparliamentsandthedatewhenitisplacedonaprovisionalagendafortheCouncilforitsadoptionorforadoptionofapositionunderalegislativeprocedure.

  • However,exceptionsarepossibleunderArticle4in casesofurgency,thereasonsforwhichmustbestatedintheactorpositionoftheCouncil.

  • TheCommissioninvitestheEuropeanParliamentandtheCounciltoconsiderthisproposalasacaseofabsoluteurgencyforthereasonsexplainedabove.

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  • 2.2.Impactassessment

  • ThisproposalisnotaccompaniedbyaseparateImpactAssessmentasanimpactassessmentfortheSolvencyIIDirectivehasalreadybeenundertakenandthisproposalonlyaimsataddressingthefactthatthepublicationofOmnibusIIintheOfficialJournaloftheEuropeanUnionwillbelaterthantheapplicationdateof1January2014.

  • Doingnothingatthisstagewouldcreateaveryuncertainlegalsituationafter1January2014.

  • AgapwouldexistbetweentheEUlegalsystem(SolvencyII)andthatofMemberStates(whereSolvencyIastransposedwouldremainin force).

  • Thiswouldlead to legaluncertaintyforsupervisoryauthorities,undertakingsandMemberStates.

  • TheFrameworkDirectivewouldneedtobeimplementedwithoutthetransitionalrulesand otherimportantadaptationsforeseeninOmnibus

  • II.Consequently,supervisoryauthorities,undertakingsandMemberStateswouldhave toproceedwithimplementingaregimethatwould need toberevisedagainintheverynearfuture,whichwouldnotbe

  • efficient.

  • TheproposedamendmentaffectsonlytheobligationonMemberStatestotransposebytheDirectiveby30June2013,extendingitto31December2014.ItalsoforeseestheextensionoftheapplicationoftheSolvencyIIDirectivefrom1January2014to1January2016(andthesameextensionforthedateofrepealofSolvencyI).

  • ItdoesnotalterthesubstanceoftheDirectiveinquestionanddoesnotthereforeimposeanyadditionalobligationsonbusinesses.

  • LEGALELEMENTSOFTHEPROPOSAL

    • Summaryoftheproposedmeasures

  • TheproposalamendsArticle309(1)ofDirective2009/138/ECbysettinguplaterdatesforitstransposition(31January2015)anditsapplication(1January2016).

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  • ItalsoamendsArticles310and311accordinglybysetting-upanewdatefortherepealofSolvencyI(1January2016).

    • Legalbasis

  • Articles53(1)and62oftheTreatyontheFunctioningoftheEuropeanUnion.

    • Subsidiarityprinciple

  • Thesubsidiarityprincipleappliesas theproposalconcernsafieldwhichdoesnotfallwithintheexclusivecompetenceoftheEuropeanUnion.

  • The objectivesoftheproposalcannotbeachievedsufficientlybytheMemberStates,astheprovisionsofdirectives cannotbeamendedorrepealedatnationallevel.

  • The objectivesoftheproposalcanbe achievedonlybyEUaction,asthisproposalamendsanactofEUlawwhichisinforce,andthisissomethingwhich cannotbedoneby theMemberStatesthemselves.

  • TheprincipleofsubsidiarityiscompliedwithinthattheproposalamendsexistingEUlegislation.

    • Proportionalityprinciple

  • Theproposalcomplieswiththeproportionalityprincipleforthefollowingreason.

  • ItdoesnotalterthesubstanceofthecurrentEUlegislation:itisrestrictedtopostponingthedateoftranspositionofDirective2009/138/ECuntil31January2015;inordertoavoidcontinuedlegaluncertaintynow thatthecurrentdeadlinefortransposition(30June2013)hasexpired.

  • Italsoprovidesforanew,laterapplicationdateforSolvencyIIandconsequentrepealofSolvencyI(1January2016).

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  • 3.5.Choiceofinstruments

  • Proposedinstrument(s):directive.

  • No otherinstrumentwouldhavebeensuitable.Asthisisanamended directive,theonlywayforwardistoadoptanotherdirective.

  • BUDGETARYIMPLICATION

  • TheproposalhasnoimplicationfortheEUbudget.

  • OPTIONALELEMENTS

  • Simplification

  • Thenewproposalassuchcontainsnosimplificationelements.ItisaimedsolelyatpostponingthedatefortranspositionofDirective2009/138/EC to31January2015andprovidingforanewapplicationdateof1January2016.

  • Repealofexistinglegislation

  • The adoptionoftheproposalwillnotin itselfentailtherepealofexistinglegislation;itmerelyadjuststhedateoftherepealalreadyforeseeninDirective2009/138/EC.

  • EuropeanEconomicArea

  • ThisdraftinstrumentisconcernedwithasubjectcoveredbytheEEAAgreementandmustthereforebeextendedtocovertheEuropeanEconomicArea.

  • Detailedexplanationoftheproposalbychapterorbyarticle

  • ThisproposalpostponesthedateoftranspositionofDirective2009/138/EC to31January2015.

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Article1(1)oftheproposalamendsArticle309(1)ofDirective2009/138/EC accordingly.Italsoprovidesforanew,laterdateofapplicationofSolvencyII(1January2016).

Article1(2)amendsthedateofrepealofSolvencyI(from1January2016)inArticle310andArticle1(3)providesforthesamedateasdateofapplicationoftheprovisionsofSolvencyIre-castedbySolvencyIIinArticle311.

Proposalfora

DIRECTIVEOFTHEEUROPEANPARLIAMENTANDOF

THECOUNCILamendingDirective2009/138/EC onthetaking-upandpursuitofthebusinessofInsuranceandReinsurance(SolvencyII)asregardsthedatesoftranspositionandapplicationandthedateofrepeal ofcertainDirectives

(TextwithEEArelevance)

THEEUROPEANPARLIAMENTANDTHECOUNCILOFTHEEUROPEANUNION,

Havingregard to theTreatyonthe FunctioningoftheEuropeanUnion,andinparticularArticle53(1)andArticle62thereof,

HavingregardtotheproposalfromtheEuropeanCommission,Actinginaccordancewiththeordinarylegislativeprocedure,

Whereas:

(1)Directive2009/138/EC oftheEuropeanParliamentandoftheCouncil1providesamodern,risk-basedsystemfortheregulationandsupervisionofEuropeaninsuranceandreinsuranceundertakings.

Thesenewrulesareessentialinordertoensureasafeandsolidinsurancesectorthat canprovidesustainableinsuranceproductsandsupporttherealeconomythroughlong-terminvestmentsandadditionalstability.

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Directive2011/89/EUoftheEuropeanParliamentandoftheCouncil introducessomechanges toArticles212 to 262ofDirective2009/138/EC tobeintroducedfrom10June2013.

Directive2012/23/EUoftheEuropeanParliamentandoftheCouncil3postponesthedatefortranspositionofDirective2009/138/ECfrom31October2012 to 30June2013,thedateofapplicationfrom1November2012to1January2014andthedateofrepealoftheexistinginsuranceandreinsuranceDirectives,namelyCouncilDirective64/225/EEC4,FirstCouncilDirective73/239/EEC5,CouncilDirective73/240/EEC6,CouncilDirective76/580/EEC7,CouncilDirective78/473/EEC8,CouncilDirective84/641/EEC9,CouncilDirective87/344/EEC10,SecondCouncilDirective88/357/EEC11,CouncilDirective92/49/EEC12,Directive98/78/ECoftheEuropeanParliamentandoftheCouncil13,Directive2001/17/EC oftheEuropeanParliamentandoftheCouncil14,Directive2002/83/EC oftheEuropeanParliamentandoftheCouncil15andDirective2005/68/ECoftheEuropeanParliamentandoftheCouncil16(collectivelyreferred to as'SolvencyI')from1November2012to1January2014.

On19January2011theCommissionadoptedaproposalforaDirectiveoftheEuropeanParliamentandoftheCouncilamendingDirectives2003/71/EC and2009/138/EC(hereinafterreferredto asthe'OmnibusIIproposal') inordertotakeintoaccountthenewsupervisory architectureforinsuranceandnamelythesetting-upoftheEuropeanSupervisoryAuthority(European InsuranceandOccupationalPensionsAuthority(EIOPA).

TheOmnibusIIproposalalsoservesasa means to adaptDirective2009/138/EC totheentryintoforceoftheTreatyonthe FunctioningoftheEuropeanUnionbyadjustingtheempowermentsfortheCommissionto adoptimplementingmeasures to empowermentsfortheCommissionto adoptimplementinganddelegatedacts.

ThereisaclearriskthatthereisnotenoughtimetoadopttheOmnibusIIproposalandpublishitintheOfficialJournaloftheEuropeanUnionbeforetherelevantArticlesofDirective2009/138/ECaretoapply.

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Leavingthedatesfortransposition,applicationandrepealunchangedwouldresultin Directive2009/138/EC beingimplementedbefore theentryintoforceofthetransitionalrulesandofrelevantadaptations,includingfurtherclarificationofdelegatedandimplementingactempowerments,providedforbytheOmnibusIIproposal.

In ordertoavoidoverlyburdensomelegislativeobligationsforMemberStatesunderDirective2009/138/EC andlateronunderthenewframeworkenvisagedbytheOmnibusIIproposal,itisappropriate topostponethedatesfortranspositionandapplicationofDirective2009/138/EC andallowingsupervisorsandinsuranceandreinsuranceundertakingssufficienttimefortheintroductionofthenewarchitecture.

ItisevidentfromthechronologicalorderofeventsthatthepostponeddatesfortranspositionandapplicationofDirective2009/138/EC alsoapplytotheamendments toArticles212to216,219,226,231,233,235,243 to 247,249,256,257,258,262and263ofthatDirectivewhichweremadebyDirective2011/89/EC.

Forreasonsoflegalcertainty,thedateofrepealofDirectives64/225/EEC,73/239/EEC,73/240/EEC76/580/EEC,78/473/EEC,84/641/EEC,87/344/EEC,88/357/EEC,92/49/EEC,98/78/EC,2001/17/EC,2002/83/EC and2005/68/EC shouldbepostponedaccordingly.

Giventheveryshortperiodoftimeleftbefore theexpiryofthedeadlineslaiddowninDirective2009/138/EC,thisDirectiveshould

enter intoforcewithoutdelay.

Consequently,itisalsojustifiedtoapplytheexceptionforurgentcasesprovidedfor inArticle4ofProtocol(No1)ontheroleofnationalParliamentsintheEuropean Unioninthiscaseasregardsthetransmission tonationalParliamentsoftheproposalforthisDirective,

HAVEADOPTEDTHISDIRECTIVE:

Article1

Directive2009/138/EC isamendedasfollows:

1.Article309(1)isamendedasfollows:

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2.(a)

inthefirstsubparagraph,thedateof“30June2013”is

replacedbythatof“31January2015”

(b)inthesecondsubparagraph,thedateof“1January2014”isreplaced bythatof“1January2016”.

3.

In thefirstparagraphofArticle310,thedate“1January2014”is

replacedbythatof“1January2016”.

4.

In thesecondparagraphofArticle311,thedate“1January2014”is

replacedbythatof“1January2016”.Article2

ThisDirectiveshallenter intoforceonthedayfollowingthatofits

publicationintheOfficialJournaloftheEuropeanUnion.

Article3

ThisDirectiveisaddressedtotheMemberStates.

DoneatBrussels,

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SECAwardsMoreThan$14MilliontoWhistleblower

WashingtonD.C.

TheSecuritiesandExchangeCommissionannouncedanawardofmorethan$14

milliontoawhistleblowerwhoseinformationledtoanSECenforcement

actionthatrecoveredsubstantialinvestorfunds.

Payments towhistleblowersaremadefromaseparatefundpreviouslyestablishedbytheDodd-FrankActanddonotcomefromtheagency’sannualappropriationsorreduce amountspaid toharmedinvestors.

TheawardisthelargestmadebytheSEC’swhistleblowerprogram todate.

TheSEC’sOfficeoftheWhistleblowerwasestablishedin2011asauthorizedbytheDodd-FrankAct.

Thewhistleblowerprogramrewardshigh-qualityoriginalinformationthatresultsinanSECenforcement actionwithsanctionsexceeding$1million,andawardscanrangefrom10percentto30percentofthemoneycollectedin acase.

“Ourwhistleblowerprogramalreadyhashadabigimpactonourinvestigationsbyprovidinguswithhighquality,meaningfultips,”saidSECChairMaryJoWhite.

“Wehopeanawardlike thisencouragesmoreindividualswithinformationto comeforward.”

Thewhistleblower,whodoesnotwishtobeidentified,providedoriginalinformationandassistancethatallowedtheSEC to investigateanenforcementmattermorequicklythanotherwisewouldhavebeen possible.

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Lessthansixmonthsafterreceivingthewhistleblower’stip,theSECwasable tobringan enforcementactionagainsttheperpetratorsandsecureinvestorfunds.

“Whileitiscertainlygratifyingtomakethissignificantawardpayout,theevenbetternewsfor investorsisthatwhistleblowersarecomingforwardtoassistusinstopping potentialfraudinitstrackssothatnofutureinvestorsareharmed,”saidSeanMcKessy, chiefoftheSEC’sOfficeoftheWhistleblower.

“Thatultimatelyiswhatthewhistleblowerprogramisallabout.”

TheSEC’sfirstpaymenttoawhistleblowerwasmadeinAugust2012andtotaledapproximately$50,000.

In AugustandSeptember2013,morethan$25,000wasawardedtothreewhistleblowerswhohelpedtheSECandtheU.S.DepartmentofJusticehaltashamhedgefund,andtheultimatetotalpayoutinthatcaseonceallsanctionsarecollectedislikelytoexceed$125,000.

Bylaw,theSEC mustprotecttheconfidentialityofwhistleblowersandcannotdiscloseanyinformationthatmightdirectlyorindirectlyrevealawhistleblower’sidentity.

Formoreinformationaboutthewhistleblowerprogramandhowtoreportatip,visitwww.sec.gov/whistleblower.

Welcome totheOfficeoftheWhistleblower

OfficeoftheWhistleblower

Assistanceandinformationfromawhistleblowerwhoknowsofpossiblesecuritieslawviolations canbe amongthemostpowerfulweaponsinthelawenforcementarsenaloftheSecuritiesandExchangeCommission.

Throughtheirknowledgeofthecircumstancesandindividualsinvolved,whistleblowerscanhelptheCommissionidentifypossiblefraudandotherviolationsmuchearlierthanmightotherwisehavebeenpossible.

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ThatallowstheCommissiontominimizetheharmtoinvestors,betterpreservetheintegrityoftheUnitedStates' capitalmarkets,andmoreswiftlyhold accountablethoseresponsibleforunlawfulconduct.

TheCommissionisauthorizedbyCongresstoprovidemonetaryawardstoeligibleindividualswhocomeforwardwithhigh-qualityoriginalinformationthatleadstoaCommissionenforcementactioninwhichover

$1,000,000insanctionsisordered.

Therangeforawardsisbetween10%and30%ofthemoneycollected.

TheOfficeoftheWhistleblowerwasestablishedtoadministertheSEC'swhistleblowerprogram.Wegreatlyappreciateyour interest,andwehopethatthiswebsiteanswersanyquestionsyoumayhave.

Weunderstandthatthedecision tocomeforwardwithinformation aboutsecuritiesfraudorotherwrongdoingisnotonetakenlightly,andwearehereto answeranyquestionsyoumayhave.

YoucanreachtheOfficeoftheWhistleblowerat(202)551-4790.

QuestionsandAnswers

WhatistheSECWhistleblowerProgram?

TheWhistleblowerProgramwascreatedbyCongress toprovidemonetaryincentivesforindividualstocomeforwardandreportpossibleviolationsofthefederalsecuritieslawstotheSEC.

Undertheprogrameligiblewhistleblowers(definedbelow)areentitledtoanawardofbetween10%and30%ofthemonetarysanctionscollectedinactionsbroughtbytheSEC andrelatedactionsbroughtbyotherregulatoryandlawenforcementauthorities.

TheProgramalsoprohibitsretaliationbyemployersagainstemployeeswhoprovideuswithinformation aboutpossiblesecuritiesviolations.

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Whoisaneligiblewhistleblower?

An“eligiblewhistleblower”isapersonwhovoluntarilyprovidesuswithoriginalinformationaboutapossibleviolationofthefederalsecuritieslawsthathasoccurred,isongoing,orisabouttooccur.

Theinformationprovidedmust lead to asuccessfulSEC actionresultinginanorderofmonetarysanctionsexceeding$1million.Oneormorepeopleareallowedtoactasawhistleblower,butcompaniesororganizations cannotqualifyaswhistleblowers.

Youarenotrequiredto beanemployeeofthecompanytosubmitinformationaboutthatcompany.

Whatdoes itmeanto“voluntarily”provideinformation?

Yourinformationisprovided“voluntarily”ifyouprovideittousoranotherregulatoryorlawenforcementauthoritybefore

werequestitfromyouoryourlawyeror

Congress,anotherregulatoryorenforcementagencyorself-regulatoryorganization(suchasFINRA)asks youtoprovidetheinformationinconnectionwithaninvestigationorcertainexaminationsorinspections.

Whatis“originalinformation?”

“Originalinformation”is informationderivedfromyourindependentknowledge(factsknowntoyouthatarenotderivedfrompubliclyavailablesources)orindependentanalysis(evaluationofinformationthatmaybepubliclyavailablebutwhichrevealsinformationthatisnotgenerallyknown)thatisnotalreadyknownbyus.

Soifwereceivedyour informationpreviouslyfromanotherperson,thatinformationwillnotbeoriginalinformationunlessyouweretheoriginalsourceoftheinformationthattheotherpersonsubmitted.

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Howmightmyinformation“leadto”asuccessfulSECaction?

Yourinformationsatisfiesthe“ledto”criterionifyourinformationcausesus toopenanewinvestigation,re-openapreviouslyclosedinvestigationorpursueanewlineofinquiryinconnectionwithanongoinginvestigation,andwebringasuccessfulenforcementactionbasedatleastinpartontheinformationyouprovided.

Additionally,youmaystillbeeligibleifyourinformationrelatestoanongoingexaminationor investigation,iftheinformationyouprovidesignificantlycontributes tothesuccessofourresultingenforcementaction.

Youmayalsobeeligibleifyoureportyour informationinternallyfirsttoyourcompany,andthecompanylaterreportsyourinformation tous,orreportstheresultsofaninternal investigationthatwaspromptedbyyourinformation,aslongasyoualsoreportdirectly touswithin120days.

Iworkatacompanywithaninternalcomplianceprocess.CanIreportinternallyandstillbeeligibleforawhistlebloweraward?

Althoughinternalreportingisnotrequiredtobeconsideredforanaward,youmaybeeligibleforanawardforinformationyoureportedinternallyifyoualsoreporttheinformation touswithin120daysofreportingitinternally.

Underthesecircumstances,wewillconsideryourplacein linefordeterminingwhetheryourinformationis“originalinformation”tobethedateyoureporteditinternally.

In addition,ifthecompanytowhichyoureportedconductsaninvestigationandreports theresultstous,youwillbenefitfromalltheinformationtheCompany’sinvestigationturnsupwhenweareconsideringwhetheryoushouldreceiveanawardandifsowheretheawardshouldfall inthe10%to30%range.

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Iprovided informationtotheSECbeforetheenactmentofDodd-FrankonJuly21,2010.AmIeligibleforanaward?

No.Thestatutemakesawardsavailableonlyin connectionwithinformationsubmittedtotheSECafterJuly21,2010.

HowdoIsubmitinformationundertheSECwhistleblowerprogram?

Inordertoqualifyforanawardunderthewhistleblowerprogram,youmustsubmityourinformationeitherthroughouronlineTips,ComplaintsandReferralsquestionnaireorbycompletingourhardcopyForm-TCRandmailingorfaxingittotheSEC OfficeoftheWhistleblower,100 FStreetNE,MailStop5971,Washington,DC20549,Fax(703)813-9322.

CanIsubmitmyinformationanonymously?

Yes,youmaysubmit anonymously.

Todoso,youmusthaveanattorneyrepresentyouinconnectionwith yoursubmission.

Youmust alsoprovidetheattorneywithacompletedFormTCRsignedunderpenaltyofperjuryatthetimeyoumakeyouranonymoussubmission.

WilltheSECkeepmyidentityconfidential?

Whetherornotyouseekanonymity,theSECiscommittedtoprotectingyouridentity tothefullestextentpossible.

Forexample,wewillnotdiscloseyour identityinresponsetorequestsundertheFreedomofInformationAct.

However,therearelimitsonourabilitytoshieldyour identityandincertaincircumstanceswemustdiscloseitto outsideentities.

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Forexample,inanadministrativeorcourtproceeding,wemayberequiredtoproducedocumentsorotherinformationwhichwouldreveal youridentity.

In addition,aspartofourongoing investigatoryresponsibilities,wemayuseinformationyouhaveprovidedduringthecourseofourinvestigation.

In appropriatecircumstances,wemayalsoprovideinformation,subject toconfidentialityrequirements,toothergovernmentalorregulatoryentities.

HowwillIlearnabouttheopportunitytoapplyforanaward?

Wewillpostonthiswebsitenoticesofactionsexceeding$1millioninsanctionssothatanyonewhobelievestheymaybeeligiblewillhaveanopportunitytoapplyforawhistlebloweraward.

In addition,ifwehavebeenworkingwithyouandbelieveyoumaybeeligible,wewillcontactyouoryourattorneydirectly to alertyoutotheopportunitytoapplyforanaward.

HowdoIapplyforanaward?

Oncethe caseyoubelieveyourinformationledtoisposted,youmustcompleteandreturnFormWB-APPwithin90calendardaystotheOfficeoftheWhistleblowerviamailto100 F Street,NE,MailStop5971,WashingtonDC20549,orbyfax(703)813-9322.

WhatfactorsdoestheSECconsiderindeterminingtheamountoftheaward?

TheRulesrequirethatweconsidermanyfactorsindeterminingtheamountofanawardbasedontheuniquefactsandcircumstancesofeachcase.

Wemayincreasetheawardpercentagebasedontheexistenceofthesefactors:

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Thesignificanceoftheinformationyouprovidedustothesuccessofanyproceedingbroughtagainstwrongdoers.

Theextentoftheassistanceyouprovideusin ourinvestigationandanysuccessfulproceeding.

Ourlawenforcementinterestindeterringviolationsofthesecuritieslawsbymakingawardstowhistleblowerswhoprovideinformationthatleadstothesuccessfulenforcementoftheselaws.

Whether,andtheextent towhich,youparticipatedinyourcompany'sinternalcompliancesystems,suchas,forexample,reportingthepossiblesecuritiesviolationsthroughinternalwhistleblower,legalorcomplianceproceduresbefore,oratthesametime,youreportedthemtous.

Wemayreducetheamountofanawardbasedonthesefactors:

Ifyouwereaparticipantin,orculpableforthesecuritieslawviolation(s)youreported.

Ifyouunreasonablydelayedreportingtheviolation(s)tous.

Ifyou interferedwithyourcompany'sinternalcomplianceandreportingsystems,suchas,forexample,makingfalsestatementstoyourcompliancedepartmentthathindereditsefforts to investigatepossiblewrongdoing.

CanIappealtheSEC'sawarddecision?

Itdepends.IftheCommissionfollowsthefactorsdescribedabove,authorizesanaward,andtheamountawardedisbetween10%and30%ofthemonetary sanctions collectedintheCommissionorrelatedaction,thentheCommission’sdeterminationoftheamountoftheawardisnotappealable.

IftheCommissiondeniesyourapplicationforanaward,youmayfilean appealinanappropriateUnitedStatesCourtofAppealswithin30daysofthedecisionbeingissued.

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WhatrightsdoIhaveifmyemployerretaliatesagainstmeforsubmittinginformationtotheSEC?

Employersmaynotdischarge,demote,suspend,harass,or inanywaydiscriminateagainstyoubecauseofanylawfulactdonebyyouinprovidinginformationtousunderthewhistleblowerprogramorassistingusinanyinvestigationorproceedingbasedontheinformationsubmitted.

Ifyoubelievethatyouremployerhaswrongfullyretaliatedagainst you,youmaybringaprivateactionin federalcourtagainstyouremployer.

Ifyouprevail,youmaybeentitled to reinstatement,doublebackpay,litigationcosts,expertwitnessfees,andattorneysfees.

TheCommissioncanalsotakelegalactioninanenforcementproceedingagainstanyemployerwhoretaliatesagainstawhistleblowerforreportinginformation tous.

Also,undertheSarbanes-OxleyAct,youmaybeentitledtofileacomplaintwiththeDepartmentofLaborifyouareretaliatedagainstforreportingpossiblesecuritieslawviolations,includingmakinginternalreports to yourcompany.

Formoredetails,pleaseseetheOSHA FactSheetonfilingwhistleblowercomplaintsundertheSarbanes-OxleyAct.

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EBAWorkProgramme 2014

In accordancewithRegulation(EU)No1093/2010oftheEuropean

ParliamentandoftheCouncilof24November2010establishingtheEuropeanBankingAuthority(EBA),theEBA’sworkprogramme

describesandsummarisesthemainobjectives,deliverablesandcorrespondingprioritiesoftheEBAin2014,derivedfromthetasksspecifiedintheRegulationandfromtherelevantEUbankingsector

legislation.

Summaryofthemaintasks

ThefundamentalobjectivefortheEBAintheregulatorypolicyareawillbetocontinuetoplayacentralrolein thedevelopmentofthesinglerulebook,withtheaimtocontributeto achievementofalevelplayingfieldforfinancialinstitutionsaswellas to raisethequalityoffinancialregulationandtheoverallfunctioningoftheSingleMarket.

ThemainfocusoftheEBA’sregulatoryworkwillrelate totheCRDIV/CRRlegislation, in particulartocreditandmarketriskandtheprudentialareasofliquidityandleverage,aswellas to therecoveryandresolutionframework.

TheEBA’soversightactivities in2014willcontinuetofocusonidentifying,analysingandaddressingkeyrisksintheEUbankingsectorensuringtheyaddvaluetothesuiteofrisksproductsproducedintheEU.

TheEBAwillcontinuetomonitorcapitallevelsaswellascapitalplansforconvergingtowardsthenewstandards.

Lastbutnotleast,theEBAiscommittedtoenhancetheprotectionof bankingconsumersandpromotetransparency,simplicityandfairnessforconsumerfinancialproductsandservicesacrosstheSingleMarket.

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Inthiscontext,itwillfocusitsconsumerprotectionactivitiesonfulfillingmandatesassignedtotheEBAundertheMortgageCreditDirective(MCD),theproposedBankAccountPackage,theproposedreviewofthePaymentServicesDirective(PSD),andoninitiativessuchasthe

self-placementoffinancialinstruments.

The abovethreeareas-Regulation,Oversight,andConsumerProtection-arerepresentingthecorefunctionsoftheEBAthatarelaid downintheEBAregulation.

Besides,aseparatehorizontalunit,PolicyAnalysisandCoordination,providestheinternalandexternalpolicycoordinationbetweenthecorefunctionsoftheEBAandexternalstakeholders,aswellasprovidesthelegalreviewandassessestheimpactoftheEBA’spolicyproposals,andsupportstheEBA’speerreviewwork.

Further,thesupportfunctionssummarisedasOperationsareplayingacriticalroleinensuringthattheEBA canperformitscorefunctions.

In 2014,theEBAwilltakeoverthechairmanshipoftheJointCommittee,fromEIOPA.

UndertheEBAchairmanship,theJointCommitteewillgivein2014highpriority totheareasofconsumerprotection,cross-sectoralriskanalysisandassessmentofanalysing interactionsandpossibleunintendedconsequencesbetweenSolvencyII,theCRDIV/CRRlegislation,andtheRecoveryandResolutionlegislativeframework.

Itwillcontinuetopursuetheregulatoryworkalreadyunderwayinkeyareassuchasfinancialconglomerates,anti-moneylaundering,benchmarksettingprocessesandcreditratingagenciesandwillenhancevisibilityofitsworktoexternalstakeholders.

Thetasksenvisagedin theEBAWorkProgramme2014arewithoutprejudicetothemandatesenshrinedintheWorkProgramme2014oftheJointCommitteeofthethreeESAs.

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5.By2January2014,theEuropean CommissionwillpublishareportontheassessmentoftheEuropeanSystemofFinancialSupervision,asperArt.81ofESAsRegulations.

TheEBAwillawaittheoutcomeoftheassessmentandwillconsiderimplementationofpossiblerecommendations,asappropriate.

In addition,furtherviewswillbeexchangedwithotherESAsonpossibleimprovementsoftheESA’sframework.

Bankingunion/SSMdevelopments

6.

EstablishmentoftheSingleSupervisoryMechanism(SSM)inthe

EUwillhavesomeimportantrepercussionsontheexecutionofthemandateoftheEBA.

TheEBAwillneedtobecognisantoftheneedtoaddspecificvalueinthecontextofthechanging institutionalEUstructuresinrelationto theformationoftheSSM.

TheSSMwillcallforenhancedoperationalrelationshipsinallthefieldsandwithallthepartiesinvolved, inparticularwiththeEuropeanCentralBank.

Ensuringeffectivecooperationonjointprojectssuchasstresstestingwillbecrucialinthiscontext.

Further,theSSMwillcallontheUnionforanevenstrongercommitment tothesinglerulebook,andinparticulartounifiedsupervisorymethodologiesandpractices,wheretheEBAwillbringitscontributionandexpertisebydevelopmentofaSingleSupervisoryHandbook,interalia.

Astheonlybodywellplacedtoofferthematicmicroprudentialinsights to thebankingsectoracrosstheSingleMarket,theEBAwillneedtoensurethatitsrisk infrastructure,includingdataandriskreports,focusonthisspecificvalueaddedandmakemaximumuseoftheEBA’sEUwidedataandsupervisoryinsights,includingthroughitsparticipationincollegesofsupervisors.

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  • PrioritisationofEBAtasks

  • 9.AdetailedlistofalltheEBA’stasksispresentedintheAnnex,withtheattachedpriorities.2Classificationoftheprioritiesisprovidedbasedonthefollowingprinciples:

  • Priority1hasbeenassignedto

  • tasksderivingfromalegislativeproposalwithadeadlinefalling in2014;

  • taskswhichtheEBAconsiderasthemosturgentwithrespecttoensuringaccomplishmentofitsobjectives(i.e.improvingthefunctioningoftheinternalmarket,ensuringeffectiveandconsistentlevelofregulationandsupervisionintheEU,andprotectingpublicvalues,includingthestabilityofthefinancialsystem);and

  • tasks takingintoconsiderationEBAhumanandfinancialresources;

  • Priority2hasbeenassignedto

  • lessurgenttasks,thatwillonlybeaccomplishedinasfarasthesedonotconstraintheEBA’sabilitytomeetpriority1tasksi.e.taskswhichdonotcomplywithallthreeaboveconditions(i.e.deadlineisbeyond2014;TheEBAdoesnotconsiderthemasthemosturgentwithrespect toaccomplishmentofitsobjectives;orthatwillprobablynotbe achievedtakingintoconsiderationtheEBA’shumanandfinancialresources);and

  • taskswhich canbetriggeredexternally(e.g.requestfornon-bindingmediation)andtheEBA cannotpredictpossible casesfor2014`

Priority3hasbeenassignedtotaskswiththeleasturgency,i.e.can

beaccomplishedinthemediumorlongterm.

10.In additiontothehighnumberofdeliverablessoughtfromtheEBAinthesectorallegislationfallingundertheEBA’sremit- inparticularintheCRDIV/CRRlegislation(pleaseseethesectionbelow)-thetimingoftheproductsenvisagedisveryconcentratedastheimplementationscheduleneedstoremainconsistent.

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Mostproductsareexpectedtobefinalisedby2014,thus,theconcentrationoftheEBA’sworkwillbeveryhighduringthisperiod.

BaseduponthecapacityavailableatboththeEBAandatthenationalauthorities,itisexpectedthatnotallactivitiescanbeundertakenascurrentlyproposedwithoutadditionalhumanresourcesattheEBA.

Regulation

ThefundamentalobjectivefortheEBAintheregulatorypolicyareawillbetocontinuetoplayacentralrolein thedevelopmentofthesinglerulebook,withtheaimtocontributeto achievementofalevelplayingfieldforfinancialinstitutionsaswellas to raisethequalityoffinancialregulationandtheoverallfunctioningoftheSingleMarket.

ThemainfocusoftheEBA’sregulatoryworkwillrelatetotheCRDIV/CRRlegislation:theEU'sruleson capitalrequirementsforbanksandinvestmentfirmsthroughouttheSingleMarket,whichenteredintoforceinsummer2013andwillapplyfrom1January2014.

Thispackageaimstostrengthenbankcapitalrequirements,introducesamandatory capitalconservationbufferandadiscretionalcountercyclicalbuffer,envisagesnewregulatoryrequirementsforliquidityandonleverage,aswellasadditionalcapitalsurchargesforsystemicallyimportantbanks.

TheEBAis toplayacrucialroleinthe technicalimplementationandapplicationoftheCRDIV/CRRframework,asnearly250deliverablesareexpectedfromtheEBA,withmanyofthemduein2014.

Themajorityoftheseproductsrelatetothedevelopmentofmoredetailedtechnicalrules,mostlyviathedevelopmentofbindingregulatoryorimplementingtechnicalstandards.

AnoverviewofthemaindeliverablesundertheCRDIV/CRRlegislationwithdeadlinetillendof2014isprovidedin thebelowtable.

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13.BesidesrealisationoftheSingleRulebookinbanking(inparticularthroughdevelopmentofdrafttechnicalstandardsandguidelines),whichrepresentsakeypriorityfortheEBAintheareaofRegulation,theEBA

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foreseestoproduceanumberofdeliverablesinthenewprudentialareaofliquidityandleverage.

Workwillalsocontinueondefinitionsforhighqualityliquidassets(HQLA),oneconomicimpactassessment,andonliquiditycoverageratio.

In thearea ofcreditrisk,theEBAwillprepareareportonthe

pro-cyclicalityandcomparabilityofIRB(internalratings-based)models.

GiventheimportanceofIRBmodelsintheriskmanagementofinstitutions,thisisconsideredcrucialtoensureuniformimplementation oftheCRRacrossinstitutions,andthustoavoidinefficientandlessprudentialriskallocationwithininstitutions.

In thearea ofcreditrisk,substantialworkwillalsobeundertakenondraftingofalargenumberoftechnicalstandardsregardingtheIRBandstandardisedapproach,includingmappingofcreditratingstocreditqualitystepsforabout25registeredratingagencies.Similarworkwillbefollowedintheareaofmarketrisk,inparticularwithrespect to CVA(creditvalueadjustment).

TheEBAhasalsoinitiateditspreparatorywork inviewoflegislativemandateswhichwillbeassignedtotheEBAupontheapprovaloftheRecoveryandResolutionDirective(RRD)andtherevisionoftheDepositGuaranteeSchemesDirective(DGS).

TheformerDirectiveintroducesaUnion-widecrisismanagementframeworkanddefinesathree-foldrolefortheEBAinrecoveryandresolutionprocedures,givingtheEBAmandates to developbindingtechnicalstandardsandguidelinesformingaSingleRulebook,vestingtheEBAwithamediationrulebetweennationalauthoritiesfor

cross-bordergroups,andsettingtheEBAasapointofcontactandcoordinatorforrelationshipsbetweentheEUandthirdcountries.

AlthoughtheframeworkoftheRRDisstillunderdiscussion(includingfinaldeliverydates),theEBAhasstartedworkinginlightoftheamountandcomplexityofthemandates.

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In 2014,theEBAwillfocusonalltechnicalstandardsandguidelinesthatrelateto:earlyintervention,resolutiontriggers,recoveryplans,resolutionplans,valuation,DGS,andbail-in.AnoverviewofthedraftlegislativemandatesassignedtotheEBAundertheRRDframeworkisprovided below.

16.AnextensivenumberoffurtherregulatorymandatesareassignedtotheEBAinseveralothersectorallegislations,inparticularintheAntiMoneyLaunderingDirective(AMLD),butalsointheEuropeanMarketInfrastructureRegulation(EMIR),Marketin FinancialInstrumentslegislation(MiFID/MiFIR),CreditRatingAgenciesRegulation(CRA),AuditRegulation,andCentralSecuritiesDepositoriesDirective(CSD).

Completelistofdetailed tasksinprovidedintheaccompanyingannex.

In July2013,theEBAlaunchedan online"SingleRulebookQ&A"toolwhichallowsinstitutions,supervisorsand otherstakeholdersto submittheirquestionsontheCRDIVpackage,relatedTechnicalStandards,andEBAGuidelines.

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In 2014,EBAwillcontinue to implementtheQ&Aprocess,withtheaimtosupplementtheSingleRulebookandtoensurethatitembodiesa‘living’andevolvingregulatoryframework.

PeerreviewandpressureareexpectedtocontinuetoplayadrivingforceinensuringadherencetoandcompliancewiththeresponsesprovidedintheQ&Aprocess,eventhoughtheyhavenoforceinlaw.

Oversight

17.ThemainEBAobjectivesintheareaofoversightarethefollowing:

delivering independentandhighqualityanalysisofEUbanks andtheEUbankingsector,in coordinationwiththeworkofCompetentSupervisoryAuthorities,theESRBandEUpolicymakingbodies,andleadingtoconcerted policy responses;

ensuringrelevantandsounddataisavailableforeffectivesupervisoryoversightandmarketdiscipline;

activelycontributing in achievingconvergenceinsupervisorypracticesandthebuildingofacommonsupervisorycultureacross theSingleMarket;

promotingandmonitoringsupervisorycooperationcollegestructuresthatareefficientandsubstantive;and

promotingsupervisoryconsistencyintheinterestofthesinglemarket.

Withtheaimto achievetheaboveobjectives,theEBA’soversightactivitiesin2014willcontinuetofocusonidentifying,analysingandaddressingkeyrisksin theEUbankingsectorensuringtheyaddvaluetothesuiteofrisksproductsproducedintheEU.

TheEBAwillcontinuetomonitorcapitallevelsaswellascapitalplansforconvergingtowardsthenewstandards.

TheEBAwillalsocontinuetoworkwithrelevantcompetentauthoritiestounderstandtheimpactofdeterioratingassetqualityon

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banks’balancesheetandtopromotetheongoingprocessofbalancesheetrepairandbanks’efforts to restoresustainablefundingstructures.

Inparticular,theEBAwillliaisewiththeECBandcompetentauthoritiesinnon-eurozonecountriescarryingoutassetqualityreviews.

TheEU-widestresstestwillthusleverageonrobuststartingpoints.

TheEBAwillcontinueitsregularthematicanalysisonanumberofareasincludingthefinalisationoftheworkonconsistencyofoutcomesinrisk weightedassets(RWAs),thesustainabilityofbanksbusinessmodelsandreviewsofbanks’assetquality.

Asrequestedbythelegislation,theEBAwillalsostartaregularbenchmarkingoftheoutcomeofbanks’internalmodels.

Regularproductswillincludefrequentfundingandliquidityupdatesdrawingonsupervisoryandmarketintelligence,quarterlyupdates totheESRBandsemi-annualrisk assessmentreports,submittedtoEUinstitutions.

TheEBAwillusesupervisorydata– whichwillimproveinquantityandcomparabilitywiththeentryintoforceofthenewsupervisoryreportingin2014– alongwithmarketintelligenceandinputfromcolleges to preparebankingsectorreports.

Cross-sectoralrisk reportswillcontinue to bepreparedincollaborationwiththeJointCommittee,andwillbesentonasemi-annual basistotheFinancialStabilityTableoftheEconomicandFinancialCommitteeoftheCounciloftheEU.

TheEBAwillalsomaintainandfurtherdevelopitskeyriskindicatorsanditssuiteofrisk dashboards,including internalEBAbankleveldashboards,peergroupdashboards tobesharedwithsupervisorycolleges/NSAsandasectoraldashboardforEBAandESRBdiscussions.

In thearea ofreportingandtransparency,theEBAwillcontinuetoprovideassistancewithanyimplementationissuesalsothroughthe

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Question&Answers(Q&A)processonthecommonreportingframework,COREPandFINREP.

TheEBAwillalsoissueguidelinesonPillar3forstrengtheningtransparencyacrosstheEUbankingsectorandpromoteconsistentandappropriatetransparencyonthematicissues.

TheOversightworkwillalsoinvolvepromotingtheconvergenceofsupervisorypracticesacrosstheSingleMarket,bythedevelopmentoftheGuidelinesforthecommonmethodologyforsupervisoryreviewandevaluationprocessandthemethodologyforassessmentofrisksaspartofthesinglerulebook.

TheGuidelineswillbecomplementedbythedevelopmentoftherelevantpartsofthesinglesupervisoryhandbook.

TheEBAwillcontinueitsworkinpromotingandmonitoringsupervisorycooperationincollegestostrengthenEuropeansupervisionofcross-borderbankinggroups.TheEBAstaffwillparticipate,supportandmonitorcolleges.

TheEBAstaffwillalsoassistnationalsupervisoryauthorities inimplementingthenewbidingtechnicalstandardsrelatedtothesupervisorycooperationaswellasin coveringnewtasks (e.g.assetqualityreview,recoveryplansassessment).

AsaconsequenceoftheestablishmentoftheSSM,therewillbeashifttowardsthosecollegeswithsignificantoperationsintheSSMaswellas outsidetheSSM.

TheEBAwill, whereappropriate,applyitsroleinbindingandnon-bindingmediation.

Newtasks intheareaofmediationareenvisagedstemmingfromtheentryintoforceoftheCRDIV,wheretheEBAmediationrolewillalsobefurtherstrengthened.

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EBAwillactivelyfacilitateand, wheredeemednecessary,coordinateanyactionsundertakenbythenationalcompetentsupervisoryauthorities,incaseofadversedevelopments/crisis situations.

In crisismanagementtheEBAwillhaveasignificantroleinassistingthediscussionsonassessmentofrecoveryandresolutionplansbetweenrelevantcompetentauthoritiesincolleges,aswellasassistintheprocessofestablishmentofresolutioncolleges.

ConsumerprotectionandFinancialInnovation

In thearea ofconsumerprotection,theEBAhasanEU-wideresponsibilityandisfullycommittedtopromotingtransparency,simplicityandfairnessinthemarketforconsumerfinancialproductsorservicesacrosstheSingleMarket.

In 2014theEBA’sconsumerprotectionandfinancialinnovation unitwillcontinue tocollect,analyseandreportonconsumertrendsandanalysisofbanks' activitiesinstructuredproductsandtheretailisationthereof.

ItwillpursueseveralmandatesenvisagedtobeassignedtoEBAintheCommission’sproposedBankAccountDirective.

Thiswill includeinteraliadevelopmentofGuidelines to NSAs

forestablishmentofmostcommonservices;

forestablishmentofreasonablecostsforabasic account;and

fortherightofestablishmentoffreedomtoprovideservices.

In addition,theEBAwillworkon,andcontributeto,cross-cuttingEBAworkresultingfromtheCommission’sproposedrevisionofthePaymentServicesDirective(PSD),whichmayincludemandatestotheEBA todevelopGuidelines

to facilitatepaymentserviceprovidersinqualifyingmajor incidents;and,inclosecooperationwithECB,developmentofGuidelines

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  • topaymentserviceprovidersonstateoftheartcustomerauthentication;and

  • ontheestablishment,implementationandmonitoringofsecuritymeasures,includingcertificationprocesses.

  • Thiswillalsoinvolvedevelopmentofdraft RTSsonsettingthe technicalrequirementsregardingtheaccesstoinformationcontainedinthenationalpublicregisters,andspecifyingtheframeworkforthecooperationandexchangeofinformationofcompetentauthoritiesofthehomeMemberStates.

  • In carryingoutmandatesassigned totheEBAintheproposedMortgageCreditDirective(MCD),theEBAwilldraftaRTSonprofessionalindemnityinsuranceofmortgagecreditintermediaries.

  • Further,asandwhentheimplementationoftheMCDhasprogressed,theEBAwilldevelopGuidelinesinsupportoftheMCDonResponsibleMortgageLending,andonTreatmentofMortgageBorrowersinArrears,buildingupontheOpinionsonGoodPracticesissuedintheaboveareasin June2013.

  • TogetherwithESMA,theEBAwillalsodeveloparegulatoryresponsetothephenomenonofbanks’“selfplacement”offinancialinstruments totheirownretaildepositors.Finally,aConsumerDaywillbeorganisedjointlywiththeconsumerunitsofESMAandEIOPA,inEBApremisesinLondoninsummer2014.

  • Operations

  • In thearea ofOperations,EBAwillfocusonfollowingactivitiesin belowareas:

  • Finance:assessmentofintroductionofActivityBased Managementsystem,includingActivityBasedBudgetingaswellasimprovedbudgetmonitoringandexecution;alignmentofEBA FinancialRegulationwiththenewframeworkfinancialRegulationtobeadopted bytheCommissionattheendof2013;

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  • Humanresources:implementationandimprovementofHRpoliciesinlinewiththeStaffRegulations,suchaseducationcontribution policythatrequiresestablishmentofcontractswithindividualschools;

  • Procurement:closemonitoringandtimelyperformanceofallprocurementsasdefinedinthe2014ProcurementPlan;

Communications:furtherenhancementofEBAwebsite,mediaand

  • pressmonitoring;and

  • IT: implementationofprojectsstemmingfromapprovedITStrategy,suchasDataCollection,ReportingandAnalysisplatforms,DocumentManagementSystem,etc.

  • In additiontoabove,EBAwillcontinuetoimproveeffectivenessandefficiencyofexistingsupportandadministrativeprocesses.ItwillcontinuetopursuesuccessfulcooperationwithothertwoESAswiththeaimtoleverageonpotentialeconomiesofscale in supportfunctions.

  • EBAwillcontinuetobefundedbytheEuropeanCommissionandtheNationalCompetentAuthorities.

  • Policyanalysisandcoordination

  • ThemainobjectivesoftheEBA’sPolicyAnalysisandCoordinationUnitwillbetoprovideguidanceandsupportonimpactassessmentofthepolicy andsupervisoryproducts(technicalstandards,guidelines,recommendations,etc).

  • TheUnitwillprovidesupportofthemaingoverningbodiesoftheBoard ofSupervisorsandtheManagementBoard,includingtheplanning,preparationandfollow upofactionagreedoftheirmeetings.

  • TheUnitwillensuretheinternalandexternalcoordinationoftheEBA’spolicy andsupervisoryworkbetweendepartments/unitsandwithexternalbodies,suchastheBCBSandIMF,andothermembersoftheESFS,andinstitutions,includingtheEuropeanCommission,theCouncil(anditsEFC andFSC),andtheEUParliament(anditsECONCommittee).TheUnitwillprovidethecoordinationandprovisionof

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supportinrelationtoEBA’schairmanshipoftheESAsJointCommitteein2014.

ThisUnitwillalsocoordinate theEBA’ssupervisorytrainingactivitiesofferedtoNSAs,andwillprovidesupporttotheEBA’sBankingStakeholderGroup,EBA’sReviewPanelandESAs’BoardofAppeal.

Legalsupport

TheLegalUnitwillprovidethelegalanalysisandadviceonthepolicy andsupervisorydocumentspreparedby theRegulationandOversightdepartments,andConsumerProtectionandFinancialInnovationUnit(technicalstandards,guidelines,opinions,recommendations,peerreviewsetc),andprovidelegalassistancepertainingto fieldsacross theEBA, inordertoensurealegallysoundenvironmentfortheAuthorityandidentifypossiblelegalproblemsassociatedwiththeEBA’s activities.

2014willseethefurtherstrengtheningofdeliverablesrelatedtotheEBA’sinstitutionalsettingsuchasinteralia,thenegotiationanddraftingofagreementsand otherundertakings,advisorysupport,conclusionofcontracts,servicelevelagreements,rulesofprocedure,implementingrules,frameworkagreements,MoUs,andthecompletionandexecution ofallrelatedformalities.

OngoingobligationsrelatedtoRegulation(EU)No45/2001andRegulation(EU)No1049/2001willalsobestrengthened.2014willseefurtherproactivecontributiontothe overalldevelopmentoftheEBA’slegalframework,combinedwiththeconstantmonitoringandimplementationoflegislativeinstrumentsapplicable totheAuthority,topreventitfromincurringlegalrisks.

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RemarksofChairmanGaryGenslerbeforetheISDAEuropeanConference

Thankyou,Bob,forthatintroduction.

IwouldalsoliketothanktheInternationalSwapsandDerivativesAssociation(ISDA)fortheinvitation to speakatthisannualEuropeanconference.

Fiveyearsagothisweek,theU.S.economywasin afreefall.FederalReserveChairmanBernanke andthenTreasurySecretary

Paulsonfacedtheunthinkable– askingtheAmericanpeopleto bailout

financialinstitutionsto savetheeconomy.

Fiveyearsago,theswapsmarketwasatthecenterofthecrisis.

Itcostmiddle-classAmericans– andhardworkingpeopleacrosstheglobe– theirjobs,theirpensionsandtheirhomes.

Fiveyearsago,therewasnoreportingofswaps tothepublicortoregulators

Fiveyearsago,theswapsmarketwaslargelyuncleared.Fiveyearsago,unregulateddealersdominatedthemarket.

Fiveyearsago,swapswerenotexchangetraded– allclassicattributesofadarkmarket.

PresidentObamathenmetin2009withtheG-20leadersin Pittsburgh.Theycommittedtobringingtheswapsmarketintothelightthroughtransparencyandoversight.

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ThePresident,workingwiththeU.S.Congress,in2010gavethetaskofimplementingswapsmarketreformtotheCommodity FuturesTradingCommission(CFTC)andsecurity-basedswapsmarketreformtotheSecuritiesandExchangeCommission.

Today,theCFTChassubstantiallycompletedthesereforms.

TheCFTC’s61finalrules,ordersandguidancehavebroughttrafficlights,stopsigns,andspeedlimits totheoncedarkandunregulatedswapsroads.

Thisneweraofswapsmarketreformbegan to beimplementedlastOctober12.

Withnumerousimplementationdatesbehindusandanumberofcriticaldatescomingup,thetransitiontoareformedswapsmarketisfullyinmotion.

Thisrepresentsaparadigmshifttoatransparent,regulatedmarketplace.

Transparency

Today,thepublic canseethepriceandvolumeofeachswaptransaction asitoccursonawebsite,like amodern-daytickertape.

Further,halfoftheswapsmarket(byvolume)isbeingreportedtothepublicwithoutdelay– orasCongressmandated“assoonastechnologicallypracticable.”Soonswapswillbetradedontransparentplatforms.

Thistransparencylowerscostsforinvestors,consumersandbusinesses.Itincreasesliquidity,efficiencyandcompetition.

Regulatorshavebenefitedaswell.

Nearly$400trillioninmarketfacingswapsnow arebeingreportedintodatarepositories.

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Thereisstillworktobedonetoensurethedatainthewarehousesisreliableandaccessible.Thereisstillworktobedone to aggregateacrossdatawarehousesaswell.Butthismarkettransparencyisareality.

Thistransparencyalsospanstheentiremarketplace– clearedaswellasbilateralorcustomizedswaps.

Allcategoriesofmarketparticipantfromswapdealerstoend-usersnowaretoreporttransactions.

Everyproduct,withoutexception, nowmustbereported– interestrate;cross currency;foreignexchange;creditindex;equityindex;andcommodities,suchasenergyandagricultural.

OnSeptember30,thefar-flungoperationsofU.S.financialentities,theguaranteedaffiliatesandthebranchesofU.S.persons,alsowillbeginrequiredpublicreporting.

Further,startingOctober2thepublicwillbenefitfromthecompetitionandtransparencythatswapexecutionfacilities(SEFs)willbringtothemarketplace.

Allmarketparticipantswillhaveimpartialaccess toSEFswherethey canleavelive,executablebidsoroffersin anorderbook.

Wehave18SEFapplications,withsevenofthemnow temporarilyregistered.

ThesereformswillfinallyclosewhathadbeenknownintheU.S.asthe“EnronLoophole,”whichhadallowedforunregistered,multilateralswapstradingplatforms.

Fiveyearsago,thismarkettransparencywasnonexistent.

Clearing

Thismonth,withthecompletionofphasedimplementation,mandatoryclearingofinterestrateandcreditindexswapsisareality.

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Clearinghouseslowerriskandpromoteaccessformarketparticipants.

In themonthofAugust,evenbeforeourlastdomesticclearingcompliancedate,63percentofnewinterestrateswapswerecleared.

In total,nearly$180trillionoftheapproximately$330trillionmarketfacing interestrateswapsmarket,or53percent,wasclearedattheendofAugust.

Thiscomparestoonly21percentofthemarketin2008,accordingtoinformationonISDA’swebsite.

OnOctober9,theguaranteedaffiliatesandbranchesofU.S.personsalsowillcomeintocentralclearing.

ThisincludeshedgefundsthatareoperatingintheUnitedStatesbutareincorporatedintheCaymanIslands.

Aswemoveinto2014,Iwouldanticipatethatclosertotwo-thirdsoftheinterestrateswapsmarketwillbeincentralclearing.

Yetfiveyearsago,therewasnorequiredclearingintheswapsmarket.

We’vealsomadesignificantprogresssincethecrisisonreformstoprotectbothfuturesandswapscustomersthroughtheCFTC’sgrossmarginingandtheso-called“LSOC”(legalsegregationwithoperationalcomingling)rules.

Commissionersnowareconsideringfinalrulesthatwouldfurtherstrengthencontrolsaroundcustomerfunds.

SwapDealerOversight

In 2008,swapswerebasicallynotregulatedintheUnitedStates,EuropeorAsia.

Amongthereasonsforthis,itwasclaimedthatfinancialinstitutionsdid notneed tobespecificallyregulatedfortheirswapsactivity,astheyor

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theiraffiliatesalreadyweregenerallyregulatedasbanks,investmentbanks,or insurancecompanies.

AIG’s downfallwasaclearexampleofwhathappenswithsuchlimitedoversight.

Today,wehave82swapdealersandtwomajorswapparticipantsregistered.

Thisgroupincludestheworld’s16largestfinancialinstitutionsintheglobalswapsmarket,commonlyreferredto astheG16dealers.Italsoincludesanumberofenergyswapdealers.

Thesereformshelpprotectthepublic,lowerrisk andincreasemarketintegrityasswapdealersnowmust reporttheirtransactionsandcomplywithsalespracticeandotherbusinessconductstandards.

WorkingcloselywithourcounterpartsinEurope,wehaveessentiallyidenticalriskmitigationrulesthatincludepromotingthetimelyconfirmationoftradesanddocumentationofthetradingrelationship.

ThroughISDAprotocols,9,100marketparticipantshaveamendedtheirdocuments toconformtothenewU.S.risk mitigationrequirements,and5,200marketparticipantshaveconformedtoEuropeanstandards.

Morethan10,900marketparticipantsareadheringtoISDA’sprotocolsfor salespractices.

Thesereformswillsignificantlylowertherisk oftheswapsmarkettothepublicandtheeconomy.

Fiveyearsago,suchoversightofswapdealersdidnotexist.

InternationalCoordinationonSwapMarketReform

AIGnearlybroughtdowntheU.S.economythroughtheoperationsofitsoffshoreguaranteedaffiliate.

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Itwasn’ttheonlyU.S.financialinstitutionthatbroughtriskbackhomefromitsfar-flungoperationsduringthe2008crisis.

ItwasalsotrueatLehmanBrothers,Citigroup,andBearStearns.Tenyearsearlier,itwastrueatLong-TermCapitalManagement.

Thenatureofmodernfinanceisthatfinancialinstitutionscommonlysetuphundreds,oreventhousands,oflegalentitiesaroundtheglobe.

Whenarunstartsonanypartofanoverseasaffiliateorbranchofamodernfinancialinstitution,risk crossesinternationalborders.

TheU.S.CongresswasclearintheDodd-FrankWallStreetReformandConsumerProtectionAct(Dodd-FrankAct)thatthefar-flungoperationsofU.S.enterprisesaretobecoveredbyreform.

TheCFTC,coordinatingcloselywithglobalregulators,completedguidanceonthecross-borderapplicationoftheDodd-FrankActinJuly.

Swapsmarketreform coverstransactionsbetweennon-U.S.swapdealersandguaranteedaffiliatesofU.S.persons,aswellasswapsbetweentwoguaranteedaffiliates.

Further,theguidance capturesoffshorehedgefundsandcollectiveinvestmentvehiclesthathavetheirprincipal place ofbusinessin theU.S.orthataremajorityownedbyU.S.persons.

Theguidanceembracestheconceptofsubstitutedcomplianceswheretherearecomparableandcomprehensiverulesabroad.

Wearecurrentlyreviewingsubmissionsforentity-levelsubstitutedcomplianceinsixjurisdictions(theEuropeanUnion,Australia,Canada,HongKong,JapanandSwitzerland).

We’reconsultingcloselywithregulatorsinthosejurisdictionsandlookforwardtomakingdeterminationspriortoDecember21ofthisyear.

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BenchmarkInterestRates

Fiveyearsago, interestratebenchmarkssuchasLIBORandEuriborwerebeingreadilyandpervasivelyrigged.

WorkingwiththeFinancialConductAuthorityandtheU.S.JusticeDepartment,webroughtactionsagainstthreeglobalbanksforsuchabuses.

LIBORandEuriborarecriticalreferenceratesforglobalfuturesandswapsmarkets.

In theU.S.,LIBORisthereferenceratefor70percentofthefuturesmarketandmorethanhalfoftheswapsmarket.

Itisthereferencerateformorethan$10trillionin loans.

Wemustensurethatthesebenchmarkinterestrateshavemarketintegrityandthattheyarebasedonfact,notfiction.

Theinterbank,unsecuredmarketthatthebenchmarksareintended tomeasure,however,essentiallynolongerexists,particularlyforlongertenors.

TheU.S. FinancialStabilityOversightCouncilrecommendedthatU.S.regulatorsworkwithforeignregulators,internationalbodies,andmarketparticipants topromptlyidentifyalternativeinterestratebenchmarksanchoredin observabletransactionsandsupportedbyappropriategovernancestructures,andtodevelopaplan to accomplishatransition.

AnInternationalOrganizationofSecuritiesCommissions(IOSCO)taskforcetookanimportantstepin announcing newprinciplesinJulythatrequirebenchmarkstobeanchoredbyobservabletransactionsandsubjecttorobustgovernanceprocessesthataddresspotentialconflictsofinterest.

BuildingonIOSCO’swork,the FinancialStabilityBoardisinitiatingareviewofalternativestoexistingbenchmarkinterestrates,aswellasconsideringanypotentialtransitionissues.

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IwanttothankMartinWheatley,withwhomI’veworkedsocloselyontheseissues,forallofhiseffortsandleadership.

Conclusion

In thefiveyearssincethefinancialcrisis,theswapsmarkethasexperiencedaparadigmshift.

Nolongeristhemarketclosedanddark.

Withthesubstantiallycompletedreforms,thepublicandregulatorshavetransparency.

Wehaveamajorityofthemarketmovingto centralclearing.

Wehaveoversightofswapdealers,includingthefar-flungoperationsof

U.S financialinstitutions.

Thepublicandthemarketsarebenefittingfromthesecommon-senserulesoftheroad.

I’dlike to closebysayingthattheCFTCiscurrentlyanunderfunded agency.Weareonlyslightlylargerthanwewere20yearsago.Atthattime,weoversawjustthefuturesmarket,whichislessthanatenthofthe sizeoftheswapsmarketwenow overseeaswell.

Itiscriticaltothepublic’sconfidenceinthesemarketsthattheregulatoriswellfunded.Investmentsinbothpeopleandtechnologyareneededforeffectivemarketoversight– like havingmorecopsonthebeat.

It’sonlywithawell-fundedCFTCthatmarketparticipants,includingthisassociation’smembers,willgettimelyreviewsofapplicationsandpetitionsand answers to yourquestions.

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  • LegislativepackageforbankingsupervisionintheEurozone– frequentlyaskedquestions

  • Whathas beenvoted?

  • TheEuropeanparliamenthasadoptedtodayapackageoflegislativeactstosetupasinglesupervisorymechanism(SSM)thatcontains:

  • aCouncilRegulationtogivespecifictasksrelatedtofinancialstabilityandbankingsupervisiontotheEuropeanCentralBank(ECB);

  • aRegulationoftheEuropeanParliamentandoftheCouncildesignedtoaligntheexistingRegulation1093/2010ontheestablishmentoftheEuropeanBankingAuthority(EBA)tothemodifiedframeworkforbankingsupervision.

  • The textswillcomeintoforceafterformaladoptionbytheCouncilof MinistersandpublicationintheOfficialJournal.

  • Whyisasinglesupervisorymechanismnecessaryandwhenshould itbeinoperational?

  • Therearecurrentlyvulnerabilitiesinthebankingsectorwhichhaveanegativeimpactonthesovereigndebtcrisis.

  • Thenegativefeedback loopsbetweenindividualMemberStatebudgetsandsomeoftheirbanks areathreat to financialstabilityintheEU.

  • Thisproblemposesspecificriskswithintheeuroareawherethesinglecurrencyincreasesthelikelihoodofnegativespill-overeffectsacross borders.

  • Furthermore,thetrendoffinancialinstitutionstoincreasinglyfocusontheirnationalhomemarketssignificantlyunderminesthesinglemarket

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forfinancialserviceswhichconstitutesanimportantbasisforeconomicgrowth.

ItalsoimpairsthetransmissionofmonetarypolicyimpulsesbytheECB intoactuallendingtotherealeconomy.

Therefore,inMay2012,aspartofalongertermvisionforeconomicandfiscal integration,theCommissioncalledforabankingunion to restoreconfidenceinbanksandtheeuro.

TheJune2012EuropeanCouncildecidedthatthecountriesoftheeuroarea wouldcreateasinglesupervisorymechanismforbanks.

WhilsttheECBmaygraduallyassumesupervisionofsomebanksatanearlierdate,theECBwillassumeitstasks in fulloneyearaftertheentryintoforceoftheregulation.

Willallbanksbecoveredoronlybigbanksfromtheeuroarea?

Thesinglesupervisorymechanismwillcoverall(approximately6,000)banksintheeuroarea.

AlthoughlargebanksofsystemicimportanceareattheheartoftheEuropeansupervisoryframework,recentexperienceshowsthatrelativelysmallerbanks canalsoposeathreattofinancialstability.

Itisthereforeessentialthatthesupervisorytasks conferredontheECBcan beexercisedoverallthosebanks.

ThedegreeofdirectEuropeansupervisionby theECBonadailybasisandtheroleplayedbynationalsupervisorswillvaryaccordingto thesizeofbanks.

ButtheECBwillberesponsibleforensuringappropriatemonitoringofallthosebanks'performanceoftheirsupervisorytasks.

TheECB willparticularlyhaveresponsibilityfordirectsupervisionofbankshavingassetsofmorethanEUR30billionorconstitutingatleast20%oftheirhomecountry's GDPorwhichhaverequestedorreceived

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directpublicfinancialassistancefromtheEuropeanFinancialStabilityFacility(EFSF)ortheEuropeanStabilityMechanism(ESM).

WhiletheSSMwillcoverallbanksin theeurozone,nationalsupervisorswillhaveresponsibilityforday-to-daysupervisionoflesssignificantbanks.

However,theECBmayatanymomentdecidetodirectlysuperviseoneormorecreditinstitutionstoensureconsistentapplicationofhighsupervisorystandards.

TheworkofnationalsupervisorsisintegratedintotheSingleSupervisoryMechanism:forinstance,theECBwillsendgeneralinstructionstonationalsupervisors,andnationalsupervisorshaveadutytonotifytheECBofsupervisorydecisionsofmaterialconsequence.

WhatarethecompetencesoftheECBinthetransitionalphase?

ThelegislativepackageontheSSMwillenter intoforcefivedaysafteritspublicationintheOfficialJournal.

TheECBshallexerciseitstasks infulloneyearaftertheentryintoforce.

In themeantime,theECB hastopublishthedetailedoperationalarrangementsfortheimplementationofthetasksconferredonitandhastosendquarterlyreportstotheEuropeanParliament,theCouncilandtheCommissiononprogressmadeintheoperationalimplementationoftheRegulation.

TheECBmayalsostartcarryingouttasks conferredonitbytheRegulation(withouttakingsupervisorydecisions)inrespectofanycreditinstitutionfollowingadecision to thecreditinstitutionconcernedandtothenationalcompetentauthority.

UponunanimousrequestbytheESM,theECBmaytakeoverdirectsupervisionofacreditinstitutionasapreconditionfordirectrecapitalisationfollowingadecisionaddressed totheentitiesandthenationalsupervisoryauthorityconcerned.

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  • Whywillthe ECBbetheinstitutioninchargeofsupervisingtheeuroareabankingsystem?

  • ThereareseveralreasonswhytheECBisbestplacedforcarryingoutbankingsupervision:

  • TheECBwillensureatrulyEuropeansupervisionmechanismthatisnotprone to theprotectionofnational interestsandwhichwillweakenthelinkbetweenbanksandnationalsovereigns.

  • TheECB'sstrongfocusandexpertiseonfinancialstabilitywillensurethatfinancialstabilityrisksaresufficientlytakenintoaccount.

  • TheTreatyonthefunctioningoftheEuropeanUnion(TFEU,article127(6))stipulatesthatsupervisorytaskscanbeconferredontheECB.Finally,theorganisationalprincipleslaiddowninthelegislativepackagewillensuretheseparationoftheECB'smonetarypolicytasks fromitssupervisorytasks.

  • Whatexactlywillthepowersofthe ECBbe?Whatwillitdoinpractice?

  • TheECBwillbeexclusivelyresponsibleforkeytasksconcerningtheprudentialsupervisionofcreditinstitutions.

  • In particular,itwill:

  • authoriseandwithdraw theauthorisationofallcreditinstitutionsintheeuroarea;

  • assess acquisitionanddisposalofholdingsinbanks;

  • ensurecompliancewithallprudentialrequirementslaiddownin EUbankingrulesandset, wherenecessary,higherprudentialrequirementsforbanks toprotectfinancialstabilityundertheconditionsprovidedbyEUlaw.

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  • carryoutsupervisorystress teststosupport thesupervisoryreview,andcarryoutsupervisiononaconsolidatedbasis– suchstress testsareasupervisorytoolalsousedbynationalauthoritiestoassessthestabilityofindividualbanks;theywillnotreplacethestress testscarriedoutbytheEBAwithaviewtoassessingthesoundnessofthebankingsectorintheSingleMarketasawhole;

  • closelycooperatewithnationalcompetentauthoritiesintheexerciseofmacro-prudential powersandtoimposehighercapitalbuffersthannationalcompetentauthoritiessubjecttospecificconditions;

  • carryoutsupplementarysupervisionovercreditinstitutionsinafinancialconglomerate;

  • applyrequirementsforcreditinstitutionstohaveinplace robustgovernancearrangements,processesandmechanismsandeffectiveinternalcapitaladequacyassessmentprocesses;

  • carryoutsupervisorytasksinrelationtoearlyinterventionwhenriskstotheviabilityofabankexist, in coordinationwiththerelevantresolutionauthorities.

  • NationalauthoritieswillassisttheECB.TheywillprepareandimplementtheECBactsundertheoversightoftheECB, includingday-to-daysupervision activities.

  • MoreovernationalsupervisoryauthoritieswillremainresponsibleforcarryingouttasksnotconferredontheECB,including,forexample,onissuesofconsumerprotection,receivingnotificationsfromcreditinstitutionsinrelationtotherightofestablishmentandthefreeprovisionofservices,supervisingcreditinstitutionsfromthirdcountriesestablishingabranchorprovidingcross-borderservicesintheEU,supervisingpaymentsservices,carryingoutday-to-dayverificationsofcreditinstitutions,preventingtheuseofthefinancialsystemforthepurposeofmoneylaunderingandterroristfinancing.

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Whichpowerswillthe ECBhavetocarryoutitstasks?

In ordertoexecuteitstasks,theECBwillhavethenecessarysupervisoryandinvestigatorypowersoncethislegislativepackageentersintoforce.

TheECB'ssupervisorypowerswillbethesameasthepowerswhichcompetentauthoritiesshallbegrantedunderapplicableUnionlaw.

UndertheCapitalRequirementsDirective(CRDIV)package,competentauthoritiesareequippedwithabroadrangeofsupervisorypowers-forexamplethey can requestbanks tostrengthentheirgovernanceorimprovetheircapitalsituation.

TheECBwillbeconsideredacompetentauthorityandwillhaveallpowersavailabletocompetentauthoritiesundertheCapitalRequirementsDirective(CRDIV)package.

TheECB'sinvestigatorypowersareprovidedfor intheRegulationitself.

Theseincludeforexamplethepowertorequestallnecessaryinformation,toconductallnecessary investigationsofcreditinstitutionsandthepersonsinvolvedintheactivitiesoftherespectiveinstitutionsaswellastocarryouton-siteinspections.

TheECBmayalsoimposepecuniarysanctionswhereEuropeanUnionlawconferssuchpowersonsupervisoryauthorities.

Whatwouldtheroleofnationalsupervisoryauthoritiesbeinthenewcontext?

Nationalsupervisorshaveanimportantandlong-establishedexpertiseinthesupervisionofcreditinstitutionswithintheirterritoriesandhaveestablishedalargebodyofdedicatedandhighlyqualifiedstaffforthesepurposes.

Nationalsupervisorswillthereforecontinue toplayapivotalroleinbankingsupervisionin theMemberStatesundertheSSM.

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First,inaccordancewithTreatyrulestheECBcanonlybeassignedspecifictasks,notoverallresponsibilityforsupervision.

Asaconsequence,certainkeysupervisorytasksnecessaryforthesupervisionofcreditinstitutions,notablyallkeytasks relatedtofinancialstability,areconferredontheECBwhilealltasksnotspeltoutintheregulationwillremainthecompetenceofnationalsupervisoryauthorities.

Theseinclude– amongstothers-thepowerstosupervisecreditinstitutionsfromthirdcountriesestablishingabranchorprovidingcross-borderservicesin theEU,tosupervisepaymentsservices, toimposepecuniarysanctionsoncreditinstitutionsforbreachesofEUlegalactsexceptwherethebreachconcernsanECBactortocarryoutday-to-dayverificationsofcreditinstitutions.

Second,nationalsupervisorswillhaveresponsibilityforday-to-daysupervisionoflesssignificantbanks.

Thirdly,evenforthetasksconferredontheECB,mostday-to-dayverificationsandothersupervisoryactivitiesnecessarytoprepareandimplementtheECB'sactscouldbeexercisedbynationalsupervisorsoperatingasanintegralpartoftheSSM.

AnSSMcoveringallbanksin theparticipatingMemberStates canonlyworkbasedonamodelwhichintegratesastrongrolefornationallevelsupervisoryexpertise.

TheproposalrecognisesthatwithintheSSM,nationalsupervisorsarein manycasesbestplacedtocarryoutsuchactivities,due to theirknowledgeofnational,regionalandlocalbankingmarkets,theirsignificantexistingresourcesandtolocationalandlanguageconsiderations,andthereforeenablestheECBto relyonnationalauthoritiestoasignificantextent.

Howwoulddemocraticaccountabilityofthe ECBbeensured?

TheECBwillbeindependentwhencarryingoutbankingsupervisionandwillbesubjecttostrongaccountabilityprovisionstoensurethatitusesitssupervisorypowersinthemosteffectiveandproportionateway,within

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theboundariessetbytheTreatyinparalleltothearrangementsprovidedfortheEuropeanSupervisoryAuthorities.

TheECBshallthereforebeaccountableforitstasks totheEuropeanParliament(EP)andto theCouncil.

TheECBwillbesubjecttoregularreportingrequirementsandwillrespondtoquestions.Thechairofthesupervisoryboardwillpresentan annualreportontheECB'ssupervisoryactivitiestotheEPandtheEurogroupandmaybeheardbythecompetentcommitteesoftheEPonotheroccasions.

TheECBwillalsobeobligedtorespondto anyquestionsaskedbytheEPanditsmembersonitssupervisoryactivities.

ThelegislativepackagealsoprovidesforarightoftheParliament toreceiveallrelevantinformation– viain-camerahearingsincaseofconfidentialinformation-andhave accessto relevantdocumentsand toenquiryontheECBactivity.

TheECBandtheParliamenthaveagreedonarrangementsonthepracticalmodalitiestoexercisedemocraticscrutiny,includingonaccesstoinformationincludingsummariesofdiscussionsin theSupervisoryBoard,cooperationininvestigationsandinformationontheselection procedureoftheChairoftheSupervisoryBoard.

Moreover,undertheTreaty,thePresidentandtheVice-PresidentoftheGoverningCouncilas thebodywithfinalresponsibilityfortheECB'saction,aswellastheothermembersoftheExecutiveBoard,areappointedbytheEuropeanCouncilfollowingaproposalmadeby theECBwhichhastobeapprovedbytheParliament.

TheChairwillbechosenonthebasisofanopenselectionofwhichtheCouncilandtheEPshallbedulyinformed.

TheCouncilandEPcanexpresstheirviewsontheadequacyoftheperformanceoftheChair towhichtheSupervisoryBoardhas to react.

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Asregardsthebudget, in accordancewith314(1)TFEUtheECB'sbudgetisnotpartoftheUnionbudget.

Nevertheless,withaviewtoensuringaccountabilitywithinthisframework,theECBwillberequiredtodevelopaseparatebudgetlineforsupervisorytasks fromitsgeneralbudget.

Expendituresrelatingto theECB'ssupervisorytaskswillbefinancedbychargingfeesfromsupervisedinstitutions.

HowwilltheECBbeabletodealwiththenew tasks:willitgetmorestaffandbudget?

NationalsupervisoryauthoritieswillcarryoutmostofthepreparationandimplementationoftheECB'ssupervisorydecisions.

TheECBwillhavetobuildupthenecessaryresources to ensuredecision-makingandoverallcoordinationoftheSingleSupervisoryMechanism.

ThoseresourcesshouldbeobtainedinawaythatensurestheECB'sindependencefromundueinfluencesbynationalcompetentauthoritiesandmarketparticipants,andseparationbetweenmonetarypolicy andsupervisorytasks.

Thecostsofsupervisionshouldbebornebythebankswhicharesubject toit.

TheexpenditurerelatingtotheperformanceofthesupervisorytaskswillthereforebefinancedprimarilybyfeesleviedbytheECBonthecreditinstitutionssubjecttoitssupervision,andwillbebasedonthesizeandtherisksposedbytheseinstitutions.

WhyshouldtheECB'ssupervisorytasksbecarriedoutinoperationalseparationfromitsmonetarypolicytasks?

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WithintheECBanoperationalseparationbetweenmonetarypolicytasksandsupervisorytasksisnecessarytoeliminatepotentialconflictsofinterestbetweenthesetwotasks.

Conflictsofinterestcouldforinstanceemergein asituationwhereinorder tomeetthemonetarypolicyobjectiveofpricestability,interestratesneed toberaised,whilethismightatthesametimehaveadverseeffectsonthesolvencyandprofitabilityofthebankingsector.

Therefore,theproposallaysdownanumberoforganisationalprinciplestoensureaclearseparationbetweenmonetarypolicyandsupervisionwhileatthesametimeallowingtheECBtotakefulladvantageofthesynergiesbetweenmonetarypolicy andsupervision.

Toimplementthenecessaryseparationbetweenbothtasksandensureappropriateattention to supervisorytasks,theECBwillensurethat:

AllpreparatoryandexecutingactivitieswithintheECBwillbecarriedoutbybodiesandadministrativedivisionsseparatedfromthoseresponsibleformonetarypolicy.

TothisendasupervisoryboardwillbesetupthatwillpreparedecisionsonsupervisorymatterswhichwillbesupportedbyasteeringcommitteeoflimitedcompositionwhichwillincludeafurtherECBrepresentative,inadditiontotheChairandtheVice-Chair, who ensurerepresentationoftheEuropeaninterest.

TheGoverningCounciloftheECBwillbeultimatelyresponsiblefortakingdecisionsbutmaydecide todelegatecertaintasksordecision-makingpower to thesupervisoryboard.

ThesupervisoryboardwillbeledbyaChairandaVice-ChairelectedbytheECBGoverningCouncilandcomposedin,additiontothem,offourrepresentativesoftheECBandofonerepresentativeofeachnationalcentralbankorothernationalcompetentauthority.

FurthermoreamediationpanelwillbeestablishedtosolvedisagreementsthatmayarisebetweennationalcompetentauthoritiesandtheGoverningCouncil.

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Finallyspecificprovisionsonstaffareintroduced to preventconflictsofinterestandinparticulartheestablishmentofproceduresprovidingforappropriatecooling-offperiods,aswellprovisionsonwhistleblowing.

WhatwilltheimpactoftheSSMontherelationshipbetweenhomeandhostsupervisorsofbanksactiveinseveralEuroareaMemberStates?

Today,day-to-daysupervisionofcross-borderbanks iscarriedoutbynationalsupervisors.

UnderEUlawthehomesupervisorandthehostsupervisorsofotherMemberStateswherethebankestablishesbranchesorsubsidiariesorprovidescross-borderserviceshave to coordinatetheiraction.

Oneimportantforumforcoordinationis thecollegesofsupervisorsbringingtogetherallsupervisorsresponsibleforsubsidiariesinabankinggroup.

WiththecreationoftheSSM,manysupervisorytasksin theeuroareaMemberStateswillbecarriedoutbytheECBforallMemberStatesconcerned.

Nevertheless,existinghome/hostsupervisorcoordinationproceduresandcollegesofsupervisorswillcontinuetoexistastheydotoday,asfarascoordinationwithsupervisorsinnon-euroarea MemberStatesisconcerned.

Non-euroarea MemberStateswillretainalltheirexistingpowersand prerogatives.

However,to theextentthattheECBhastakenoversupervisorytasks,itwillcarryoutthefunctionsofthehomesupervisorforeuroarea banksandthehostsupervisorforotherbanks activewithintheeuroarea.

Theobligations to cooperateinconsolidatedsupervisionandbetween homeandhostsupervisors,toexchangeinformationand tocoordinatewithincollegeswillapplyfullytotheECB.

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CollegesofsupervisorswillbetheforumforcoordinationbetweentheECBandnationalsupervisorsofnon-euroareaMemberStates.

ForcoordinationwithintheEurozone,thenewarrangementswithintheSSMwillsubstitutethecomplexinteractionbetweenhomeandhostcountryauthoritiesandwithincolleges.

TheECBwillexerciseatthesametimethepowersoftheformerhomesupervisorandtheformerhostsupervisor.

BothwillberepresentedontheECBsupervisoryboardandwillthereforehaveavoiceovertheexerciseofallthosepowers.

TheSSMwillbefreeto setup internalcoordinationgroupsdealingwiththesupervisionofspecific cross-borderbanks andinvolvingtherelevantnationalsupervisors.

Howwouldnon-euroareacountriesbeabletojointhesinglesupervisorymechanism?

UndertheTreaty,theECBcannotexercisebindingpowersoutside theeuroarea.Therefore,non-euroareaMemberStatescannotbefullypartofthesinglesupervisorymechanism.

Nevertheless,non-euroareacountriesmaynotifytheECBoftheirintention to jointheSSMbyestablishingclosecooperationbetweentheircompetentauthoritiesandtheECB.

Tothatpurpose,theywillhavetotakeallnecessarymeasures to ensurethattheirnationalcompetentauthoritieswillabidebyandimplementrelevantECBacts.

Wherealltheconditionsforestablishingclosecooperationaremet,theECB wouldbeobligedtotakeadecisionto establishsuchclosecooperation,allowingthenon-euroareacountrytotakepartindeliberationsinthesupervisoryboard,whichwouldtherebygainaccesstoallinformationavailablewithintheSSM.

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TheECBortheMemberStatesatstakemayterminatetheclosecooperationsubjecttocertainspecificconditions.

WhatimpactdoestheSSMhaveontheroleoftheEuropeanBankingAuthority?

TheEuropeanBankingAuthority(EBA)andtheEuropeanSystemofFinancialSupervisionestablishedin2011havesignificantlyimprovedcooperationbetweenbankingsupervisorswithintheUnion.

TheEBAismakingimportantcontributionstothecreationofasinglerulebookforfinancialservicesintheUnion,andhasplayedacrucialroleinimplementing inaconsistentwaytherecapitalisationofmajorcreditinstitutionsoftheUnionasagreedbytheinformalMeetingofMembersoftheEuropeanCouncilinOctober20112.

ItisresponsiblefortheEU-widestress testexercisestoassesstheresilienceoffinancialinstitutionstoadversemarketdevelopments,aswellas to contributeto theoverallassessmentofsystemicrisk intheEUfinancialsystem.

However,day-to-daysupervisionhasremainedatnationallevel.

TheECBwillcarryoutsupervisorytaskswhicharecurrentlycarriedoutbynationalsupervisorsin theEuroarea,notbytheEBA.

TheECBwillcooperatewiththeEBAwithintheframeworkoftheEuropeanSystemofFinancialSupervision.

TheroleofEBAwillbepreserved.

Itwillcontinuedevelopingthesinglerulebookapplicabletoall27MemberStatesandenhanceconvergenceofsupervisorypracticesacrossthewholeUnion.

TherevisedEBARegulationalsoasks theEBAtodevelopaSingleSupervisoryHandbook to complementtheEU'ssinglerulebookandensureconsistencyinbanksupervisionacross the28countriesin the

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singlemarket,andstrengthensitsroleandresponsibilitiestocarryoutstress tests.

HowwouldtheECBinteractwithEuropeanSupervisorauthorities?

ThenewEuropeanSupervisoryAuthorities–theEuropeanBankingAuthority(EBA),theEuropeanSecuritiesandMarketsAuthority(ESMA),andtheEuropeanInsuranceandOccupationalPensionsAuthority(EIOPA)– willallretainexisting powersandtasks.

In particulartheywillcontinuetocontribute tothecreationofasinglerulebookand to establishingalevelplaying-fieldinthesinglemarket.

Theproposedamendments totheEBARegulationwillensurethattheEBA cancontinuetofulfilitsmissioneffectivelyasregardsallMemberStates.

Inparticular,theEBAisenabledtoexerciseitspowersandtasksnotonlyvis-à-visnationalsupervisorsbutalsovis-à-vistheECBasaEuropeaninstitution.

In ordertoensureEBAdecision-makingstructurescontinuetobebalancedandeffectiveandpreservetheinterestsofallitsmembers,theamendmentstotheEBARegulationwilladaptvotingarrangementswithintheEBA,allowingtheEBAtocontinuefulfillingitsmissioninanoptimalway.

HowwillthevotingmodalitiesundertheEBAregulationbemodified(decisionssubjecttoqualifiedmajority/simplemajority)?

WithintheEBA,todayasamatterofprincipledecisionsaretakenbysimplemajority(onemember,onevote)bythemembersoftheEBA'sBoardofSupervisors.

AsregardsbindingEBApowers,thisincludesdecisionsontheapplicationofEUlawin thecontextofthebreachoflawprocedure,

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actionin emergencysituationsandsettlementofdisagreementsbetweennationalauthorities(inthelattercasesubjecttoaspecificvotingprocedurein certaincases).

Ontheotherhand,decisionsinrelationtotheadoptionofguidelinesand recommendationsandofdraft technicalstandardsaswellasonbudgetarymattersaretakenbyqualifiedmajority(asdefinedinArticle16

(4)TEUandinArticle3oftheProtocol(No36)ontransitionalprovisionsbasedontherulesapplicableintheCouncil.

Today,supervisorsofeuroareaMemberStates–iftheyallcasttheirvotesinthesameway - haveasimplemajoritybutdonothaveaqualifiedmajorityofthevotesin EBA'sBoardofSupervisors.

In ordertoensureEBAdecision-makingstructurescontinuetobebalancedandeffectiveandpreservetheinterestsofallitsmembers,votingarrangementswithintheEBAwouldbeadapted.

Decisionstakenbysimplemajorityorbyqualifiedmajoritywillnowrequiresupportbyasimplemajorityofbothparticipatingand

non-participatingMemberStates tobeadopted.

Today'sproposaldoesnotpropose to amendthecompositionoftheBoardoftheEBA,whichdealswithmattersbothrelatedtothefutureactivitiesoftheSSMandothermatters,butensuresthattheECB'ssupervisoryarmparticipatesfullyin theboardoftheEBA.

Thevotingarrangementswillbe subjectreviewincasethenumberofnon-participatingMemberStateswillbefourorlessinthefuture.

HowwillthepackageinteractwiththeCapitalRequirementsDirective(CRD)IV?

TheCRDIVpackage,whichwillbeapplicableasof1January2014,isset toregulate theactivitiesofbanksandtheprudentialframeworkthatgovernsthewholeEUinternalmarketandthereforeconstitutesanimportantelementoftheSingleRulebook.

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SupervisionatEuropeanlevelwillbuildontheSingleRulebook,justassupervisionoutsideoftheSSMwill.

TheECBwillexerciseitssupervisorytasks in accordancewiththeEUsupervisoryframeworkestablishedbytheCRDIVpackage.

Whatdoesthismeanfortheproposalsondepositguaranteeschemesandbankresolution?

Workonfinalisingthecurrentproposalsondepositguaranteesschemes(DGS)(IP/10/918)andbankrecoveryandresolution(IP/12/570)isbeingacceleratedinorder tohavethemadoptedbytheendof2013.

Thiswillestablishthecommonframeworkofrulesforprotectingdepositsandfordealingwithbanksindifficultyacross theEU'ssinglemarket,coveringallrelevantdefinitions,powers,objectives,principles,tools,procedures,safeguards etc.

Mostimportantly,itwillsetinmotiontheprocessofmakinginstrumentsavailabletomakesurethatbankspayforbankrestructuring,ratherthantaxpayers,viabail-inmechanismsandnationalresolutionfunds.

HowdotheSSMandfutureSingleResolutionMechanisminterrelate?

TheSSMRegulationconcernsthedailytaskofbankingsupervision.

ConsistentwiththeexistingEUregulatoryframeworkforbankingsupervisionaswellastheCommission'sproposalforbankrecoveryandresolution(IP/12/570),itincludessomepowersin termsofearlyinterventionifabankbreachessomeofitsregulatoryrequirements.

In suchascenario,someofthepossiblemeasureswhichthesupervisorcouldtakeincluderequiringthebanktoreduceitsexposures to certainrisks,toincreaseitscapital,orto implementchanges to itslegalorcorporatestructures.

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Allothertasksrelated to resolutionremainwiththenationalauthoritiesor,in thefuture,withthesingleresolutionmechanism,whichwasproposedbytheCommissionlastJuly.

Thissingleresolutionmechanism(SRM) whenagreed, wouldhavetheresponsibility to resolvebanks andtocoordinateinparticulartheapplicationofresolutiontoolstobankswithinthebankingunion.

ItwillbeanaturalcomplementtotheestablishmentofasinglesupervisorymechanismandtheSSMwillplayakeyroleintheresolution process.

Accordingto theCommission'sproposalforaSRM,abankwouldbeplacedintoresolutionwhenitwasfailingorlikelytofail,whennoprivatesectorarrangementcouldavertfailure,andwhenresolutionwasinthepublicinterestbecausethebank’sfailure woulddamagefinancialstability.

In practice,thefirststepinthatprocesswouldbefortheECB,asthesupervisor,to signal whenabankintheeuroareaorestablishedinaMemberStateparticipatingintheBankingUnionwasinseverefinancial difficultiesandneededtoberesolved

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ESMAclarifiesreportingrequirementsforalternativefundmanagers

TheEuropeanSecuritiesandMarketsAuthority(ESMA)haspublishedfinalguidelinesonthereportingobligationsforalternativeinvestmentfundmanagers(AIFMs).

ESMA’sGuidelines,whichrelatetotheAlternativeInvestmentFund ManagersDirective(AIFMD),willrequireAIFMs–whichincludeshedgefunds,privateequityandrealestatefunds– toregularlyreportcertaininformationtonationalsupervisors.

TheGuidelinesclarifyprovisionsoftheAIFMDonrequiredinformation,whichwillhelptohaveamorecomprehensiveandconsistentoversightofAIFMs’activities.ESMAhasalsopublishedanOpinionthatproposesintroducingadditionalperiodicreportingincludingsuchinformationasValue-at-Risk ofAIFsorthenumberoftransactionscarriedoutusinghighfrequencyalgorithmictradingtechniques.

StevenMaijoor,ESMAChair,said:

“Oneofthe keyobjectivesoftheAIFMDisbringingthealternativefundworldundersupervisionthusprovidingmoretransparencytoinvestorsandregulators.

AstheAIFMDcameintoforceinJuly,bothAIFMsandnationalsupervisorsnowneed topreparefortheirregulatoryfilingsasitisthesereportswhichwillenablesupervisorstomonitorthesystemicrisksofAIFs.

In orderto achievethisobjective,nationalsupervisorsshouldreceiveallthenecessaryinformationin ordertoensureanappropriateoverviewofthesector.

OurguidelinesandOpinionwillhelptostandardise thereportingacrosstheEU.

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Itwillalsofacilitatetheexchangeofinformationbetweennationalregulators,ESMAandtheESRB.”

Managersneed to reportinvestmentstrategies,exposureandportfolioconcentrationAccordingtotheGuidelines,keyelementsAIFswillhavetoreport to nationalsupervisorsincludeinformationon:

Portfolioconcentration:

thebreakdownofinvestmentstrategiesofAIFs

theprincipalmarkets/instrumentsinwhichanAIFtrades;totalvalueofassetsundermanagementofeachAIFmanaged;turnoveroftheAIFs;and

principalexposuresandmostimportantportfolioconcentrationof

theAIFs.

ThekeyelementsoftheadditionalinformationproposedbyESMA’sOpinionwouldinclude:

Riskprofile:

AIFs’risk measures;

theliquidityprofileoftheAIFs;andtheleverageoftheAIFs.

ESMAisalsopublishingsometechnicalsupportingmaterial(aconsolidatedreportingtemplate,detailedITguidanceforfilingoftheXMLandtheXSDschema) thatwillfacilitatethereportingbyAIFMs toregulators.

Nextsteps

TheGuidelineswillbetranslatedintotheofficiallanguagesoftheEU.

NationalcompetentauthoritieswillthenhavetwomonthsfromthedateofthepublicationofthetranslationsonESMA’swebsite,toconfirmtoESMAwhethertheycomplyorintendtocomplywiththeGuidelinesbyincorporatingthemintotheirsupervisorypractices.

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Notes

1.

ESMA’sAIFMDreportingGuidelines,Opinionandthereporting

templatesareavailableonESMA’swebsite.

ESMAisanindependentEUAuthoritythatwasestablishedon1January2011andworkscloselywiththeotherEuropeanSupervisoryAuthoritiesresponsibleforbanking(EBA),andinsuranceandoccupationalpensions(EIOPA),andtheEuropeanSystemicRisk Board(ESRB).

ESMA’smissionistoenhancetheprotectionofinvestorsandpromotestableandwell-functioningfinancialmarketsintheEuropeanUnion(EU).

Asanindependentinstitution,ESMA achievesthisaimbybuildingasinglerulebookforEUfinancialmarketsandensuringitsconsistentapplicationacrosstheEU.ESMAcontributes totheregulationoffinancialservicesfirmswithapan-Europeanreach,eitherthroughdirectsupervisionorthroughtheactiveco-ordinationofnationalsupervisoryactivity.

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Thereformofinternationalbanking:someremainingchallenges

SpeechgivenbyPaulTucker,Deputy

GovernorFinancialStability,MemberoftheMonetaryPolicyCommittee,Memberofthe FinancialPolicyCommitteeandMemberofthePrudentialRegulationAuthorityBoard,atthe OliverWymanInstituteConference,LondonTuesday1October2013

Overthenextfewyearstheinternationalregulatoryauthoritieswillmovetowardscompletingtheprogrammeofreformingtheglobalfinancialsystem.

Domestically,thatwillmeanimplementingthosereforms,asdiscussedintheRecordoftheFinancialPolicy Committee’slatestmeetingpublishedthismorning.

Today,Iplantosketchafewoftheissuesin bankingregulationthatIthinkwillconfrontpolicymakersastheytakethisforward.

Ishouldstressattheoutsetthatthesearemyviewsanddonotnecessarilyrepresenttheviewsofanyofthedomesticor internationalbodiesofwhichIamamember.

Justasascenesetter,letmerecapthecentralcomponentsoftheinternationalreformprogramme,ledbythe‘G20’FinancialStabilityBoard.

Theyareessentiallyasfollows.

Tomakebanksmoreresilienttostress–theessentialstepsare,ofcourse,newregulatoryrequirementsforcapitalandliquidity.

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Second,toensurethatbanks andotherfinancialfirmscanfail in anorderlywaywithouttaxpayersolvencysupport–that’stheresolutionagenda.

Third,tosimplifythenetworkofcounterparty-creditexposures amongstbanksand othersthatarisesfromderivativestransactions–centralcounterparties(CCPs).

Fourth,toensurethatthoseCCPsarenotthemselvesTooImportantToFail– resolutionagain,plusrulestoallocatelossesamongstbankclearingmembersandotherssothatadistressedCCPcanrecoverwithoutgoing into resolution.

Fifth,toensurethatthereregulationofbanksdoesnotsimply causethesystemicrisksassociatedwithexcessleverageandliquiditymismatchestobereinventedoutsidebanks–theshadowbankingreforms.

Andsixth,tomakesecuritisationsaferandmoreefficient–acomplicatedraftofreforms,includingoverduestepstoremovemechanisticrelianceonCreditRatingAgencyratings.

Cumulatively,thosereformswillchangethefaceofglobalfinance– for thebetter.

Butnodoubttherewillalsobeeffectsthathavenotbeenanticipated,resulting in aneedforrunningrepairs–apointtowhichIwillreturn.

Theworktoproducethereformshasalsorevealedconceptualgapsandflawsintheinheritedregulatoryframeworkthatwill,soonerorlater,needtobeaddressed.

ThatiswhereIshallbegin.

The capitalframework:goingconcernv.goneconcernloss-absorbency

Perhapsmostimportant, policymakershavefocusedmorecloselythaneverbeforeonwhathappenswhenabankordealerfails.

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Regulatorypolicyneedstoworkbackwardsfromthat,sincebanks areregulatedin ordertoreducethecostsoffailure.

Policymakersare,therefore,now engagingwiththecrucialdistinctionbetweenthosepartsofabank’scapitalstructurethatabsorblossesinagoingconcern– namely,equity– andthosethat cansmoothly absorblossesinresolutionorliquidation.

TherecentG20LeadersSummitcalledontheFinancialStabilityBoardtoproduceplansoverthecomingyearforthelevelandlocationof

gone-concernloss-absorbingcapacity(orGCLAC)inglobalbanksand dealers.

In anutshell,thiswillbeapolicy fortheamountoftermbondeddebtissuedbybanks,andwhereinthegroupstructureitisissuedfrom.

IbelievethatintimetheBaselCapitalAccordcouldusefullyberecastsothatithasdistinctcomponentsforgoing-concernandgone-concernrequirements.

Thatwouldreplacewhat to mymindisthefuzzydistinctionbetweenwhatare termed‘Commonequitytier1’,‘Additionaltier1’and‘Tier2’capital–notallofwhichiscapitalintheordinarysenseofthetermthatitcan absorblossesoutsideofliquidation.

The otherelementofthispolicy – which,again,theFSBwillbeaddressing– iswherein agroupGCLACshouldbeissuedfrom,iewhetherfromthegroupholdingcompany,fromintermediateregionalornationalholdingcompanies,orfromoperatingbanksanddealers.

Thisturnsonthetypeofresolutionstrategymostappropriateforaparticulargroup;ietop-downorSinglePointofEntry(SPE)whereawhole-groupresolutionisexecutedfromthetop,orMultiplePointofEntry(MPE)whereagroupissplitintopartswhich,asnecessary,areresolvedseparately.

Ofcourse,itisinoperatingcompanies–banksanddealers–thatlife-threateninglossesaregenerated.

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Wherethoselossesexceedtheequitybaseofanoperatingsubsidiary,theyneedeithertobeabsorbedbydebtissuedintotheexternalmarketortobepassedupthegroupstructureviaintra-groupdebtorguarantees.

Thefirst–GCLAC,ietermdebt,issuedtothemarket–isassociatedwithMultiple-Point-of-Entryresolutions.

Thelatter,wherelossesflowtothetopofafinancialgroup,areassociatedwithSingle-Point-of-Entryresolutions.

Thechoiceofhow equityandgone-concernloss-absorbingcapacityshouldbedistributedacrossagroupis,therefore,partandparcelof decidingitspreferredresolutionstrategy.

Thatwasnotunderstoodasinternationalbanking policywasdevelopedoverrecentdecades,andsetsupmynextissue.

ReconcilingtheBaselConcordat,theCorePrinciplesofBankingSupervision,theCapitalAccord,andresolutionpolicy

Thedevelopmentofinternationalpolicyonresolutionis,arguably,exposinganunderlyingneedtoreconciletheprovisionsofvariousinternationalagreementsinbankingregulationandsupervision.

Therearethreethatarerelevant:theConcordat,theCorePrinciplesandtheCapitalAccord.

BearwithmeforamomentwhileIsetupthepointIwantto make.

TheConcordatestablishesthedivisionoflabouramongsthomeandhostauthorities– thefoundationstoneof internationalco-operation amongstbanksupervisors.

Firstagreedin1975inthewakeofthefailureHerstatt,updatedafterBancoAmbrosianoin1983andagainin 1992followingtheclosureofBCCI,theConcordatwasmostrecentlyspringcleanedin1996.

Itispremisedupon'consolidatedsupervision'ofabankinggroupasawhole.

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Whatthatmeansisthatsolongasthehostsupervisorsoflocaloutletsofaninternationalbankinggrouparesatisfiedthatthehomesupervisoriscapableofsupervisingtheconsolidatedgroupasawhole,thedistribution ofcapitalresourcesacrossthegroup,bothwithinandacrossjurisdictions,canbeunfettered.

In principle,legalentitieswithinthegroupcanbelightly capitalisedsolongthereisadequate capitalinthegroupasawhole.

Meanwhile,the(1997/2006/2012)CorePrinciplesforEffectiveBankingSupervision5setoutminimumstandardsforprudentialsupervision.

Supervisorsarerequiredto lookatabankonasolobasis;onaconsolidatedbasiscoveringallrelatedbankingentitiesinagroup;andonagroup-widebasis,ietakingintoaccountnon-bankingrelatedentitiesaswell.

UnderPrinciple12,ahomesupervisorshouldsuperviseabankonaconsolidatedbasis,but“inaddition...theresponsiblesupervisorsupervisesindividualbanks inthegroup.

Theresponsiblesupervisorsupervises eachbankonastand-alonebasisandunderstandsitsrelationshipwithothermembersofthegroup.”

UnderPrinciple16,jurisdictionsmay–Istress,may– alsoopt to beassessedbytheIMFforcompliancewiththePrinciplesagainstthe“additional”criterionthatasupervisorshouldensureanadequatedistributionofcapitalwithinabankinggroup.

But,to repeat,thatisnotanobligation.

Sosummingup,aswiththeConcordat,acountry’sprudentialregimecouldbejudgedascomplyingwiththeCorePrincipleseventhoughitdoesnotensurethatthedistributionofcapitalacrossabankinggroupleavesitsindividualentitiesadequatelycapitalised.

Finally,theCapitalAccord–now initsthirdincarnation– applies tobankinggroupsonaconsolidatedbasis(oratasub-consolidatedbasis

fordifferent tiersofagroup).

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TheAccordgivesjurisdictionsanoptiontoapplycapitalrequirementsonasolo-basistoindividuallegalentitiesasanalternativetoapplyingtherequirements toconsolidatedgroupsoflegalentities,butthereisnorequirement to exercisethatoption.

Again,then,thereisnohardrulethatensuresasensibledistributionofcapitalacrossindividualentitieswithinagroup.

Ifyoucannotfitallthattogether,you canbeexcused!Here’sanattempttomakesenseofit.

ThereappearstobeadisconnectbetweentheConcordat(consolidated supervision);theCorePrinciples(bothconsolidatedandsoloperspectiverecognisedasimportant,butnomandatedsolo capitalrequirements); andtheCapitalAccord(consolidatedandsub-consolidated,withsolosubjecttodeductionsallowedbutnotrequired).

Or,put anotherway,eachofthethreeBCBSdocumentsdoesanimportantjobbutnoneofthemaddresses thedistributionofcapitalacrossagroup.

Thatisagap.

Donotassumethatthisisatheoreticalpoint.

Itisonereasontherehavebeenattemptsbyregulatorstoshoreupthefinancialsoundnessoflocalsubsidiariesduringthecrisis.

Inacrisis,sovereigncountriescareabouttheinternationaldistributionoflosses.

Standardsettersshouldlookintothis.

Theyshoulddosointhelightoftheprinciplesandpoliciesthathavebeenagreedonhowtoimprovetheresolvabilityofbanks– atboththeconsolidatedandsololevel.

Because,quitesimply,itislegalentitiesthatfail.

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ForgroupsforwhichSingle-Point-of-Entry– broadly,bailinofdebtissuedthroughaholdingcompany– isthepreferredresolutionstrategy,localsubsidiesneedacombinationofequityandintragroupGCLAC(ieintragroupbonds)thatpermitslossestoflow smoothlytothetopco.

Bytransferringlossesupwards,anailingsubsidiaryisrecapitalised.

Whetherthatsufficesforthehostauthoritieswilldependontheirconfidenceinthe capacityandwillingnessofthegroup'shomeauthoritiestoexecuteaneffectiveresolutionofthetopco.

Bycontrast,forgroupsforwhichMultiple-Point-of-Entry–breakingupagroup– isthepreferredresolutionstrategy,thehostauthoritiesofasubsidiaryidentifiedfor'separation'mustensurethatithasacapitalstructureandsufficientoperational independence to enablethemtoresolveitthemselveswiththeirparticularsetofpowers.

Putsimply,forfirmswithinagroupforwhichSPEisthepreferredresolutionstrategy,thegroupaswholeisasourceofstrengthonwhichlocalsupervisorscanplace weight.

ThatislesstrueforgroupsforwhichMPEisthepreferredresolutionstrategy.

Summingup,fromaresolutionperspective,thedistributionof

loss-absorbingcapacity(thesumofgoing-concernandgone-concernlossabsorbency)iscrucial.

Yet,fromaregulatoryandsupervisoryperspective,thereisasyetnointernationalstandardthatrequiresabankinggrouptoensureasensibledistributionofequity(anddebt)withinthegroup.

Theinternationalstandardsonbankingwillneed to catchup.Thecalibrationofcapitalrequirements:stresstesting

Buthowmuchcapital(equityandgone-concernloss-absorbingcapacity)shouldabankhave,andhowshouldregulatorsdecide?

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Iwillconcludebysayingsomethingabouthow stress testingcanhelp.

Theminimumstandardsetin theBaselCapitalAccordisjustthat:aminimumstandard.

Therehas tobeprovisionforadd-onsforindividualbanks’particularcircumstances;andalsofortemporaryacross-the-boardincreaseswhentheenvironmenthasbecomemorethreateningthananythingenvisagedwhentheAccordwascalibrated,iewhentheworldhasbecomeextraordinarilyrisky.

In theUnitedKingdom,the FinancialPolicy Committee(FPC)has thepowertorecommend,ordirect,themicro-supervisors tovarycapitalrequirementstemporarily inordertoprotectagainstjustsuchunusualthreatstostability.

Butinordertousethosedegreesoffreedom,policymakersneedagoodframeworkforassessingbanks' capitaladequacyindifferentcircumstances,bothatthelevelofthesystemawholeandfor individualfirms.

TheBankofEngland– FinancialPolicyCommitteeandPrudentialRegulationAuthority– believethataregimeofconcurrentstresstestingofbanksisanimportantpartofthe answer.

Followingarecommendationfromthe FPCearlierin theyear,theBankhastodaypublishedaDiscussionPapersettingoutplans,tobeimplementedprogressivelyoveranumberofyears,forjustsucha

stress-testingregimefortheUnitedKingdom.

In broadterms,eachyeartheFPCwoulddesigna(setof)commonscenario(s)thatitjudgesthebankingsystemneeds tobeable tosurvive;thePRAwouldapplythosescenariostothemajorbanks,dealersandbuildingsocieties,alongsidemorefirm-specificscenarios;drawingonanalysisfromacrossthewholeinstitution,Bankstaffwouldanalysecapitaladequacyunderstressdrawingonarangeofmodels,includingfirms’ownmodels.

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TheresultswouldinformjudgmentsbytheFPCandthePRABoardonwhetherremedialmeasureswereneeded.

In somedegree,boththestressscenariosandtheresultswouldbepublished.

Thatverybriefsummaryleavesalotofquestionsunanswered,butsufficetosaythatwebelievethatastress-testingregimecanenhancethequalityoftheBank’smacroandmicroprudentialsupervisionand,overtime,underpinconfidencein thebankingsystem.

In addition,Ibelievethatastress-testingregimewillbeveryimportantforanotherreason:accountabilitytothepublicviaParliament.

TheBankofEnglandnowhasextensivepowersasamicrosupervisorofindividualfirmsandamacrosupervisorofthefinancialsystemasawhole.

Parliamenthassetobjectivesforboth–primarily,safetyandsoundnessforthePRA,andtheresilienceofthesystemfortheFPC.

Butunlikeinmonetarypolicy,wedonothaveaquantifiedtarget–and,tobeclear,wedonotthinkthatthatwouldbepossible.

Tohavesuchpowerwithlimitedtransparencywouldbeuncomfortable.

Ifnothingelse,itwouldleavetheBankinapositionwheresupervisionwasof interestonlywhenitobviouslygoeswrong.

Weneedtoengagesociety–public,Parliament–indebatesabouttheresilienceofthefinancialsystemandhowwearesupervisingitinthegoodtimesaswellasin badtimes.

TheFPCandPRAhavealreadytakenvariousstepstohelpwiththis–thesix-monthlyFinancialStabilityReview,thepublishedRecordofFPCpolicymeetings,theCommittee’sstatementontheuseofitsdirectivepowers,thePRA'sApproachdocumentandannualreport,andsoon.

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Butstress testingcanprovideaquantumleap intransparencyandaccountability.

Forexample,the FPCwillneedtobeable to defenditschoiceofstressagainstquestionsandcriticismsthatthescenariosaretooextremeornot toughenough.

Thatwillimplicitlybeahealthydebateaboutobjectives.

Atthemicro-supervisorylevel,thePRABoardwillneedtoexplainsomeofitsremedialmeasuresusingthepublishedstresstests.

Thiscanmakeforaricherpublicdiscussionofprudentialsupervision,aswellasencouragingfirmstoaddresslatentvulnerabilitiespromptly.

Thatbringsmebacktoresolution.

Occasionallyafirmwillberevealedtobesofeeblethatmajorsurgeryisneeded.

Sometimesrecoverymeasures,overseenbythesupervisors,willsuffice.

Sometimestheywillnot,withafirmhavingto gointoresolutioninstead.Asensiblestress-testingregime– indeedeffectivesupervisionin general

– cannotworkwithoutawell-designedresolutionregime.

Thatshouldnotbeasurprise,butisinfactoneofthegreatlessonsofthecrisis.

Conclusion

Overpastdecades,banking,andbankingsupervision,somehow gotdetachedfromthemostessentialtruth:thatbanks canfail.

Thus,wehavebanksusingbrandsthatdonotrepresentanylegalentity,asifbanksweresimplytryingtosellsomething,notrunningabusinessin borrowingandlending.

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Wehaveaninternationalregimethatencouragesbutdoesnotrequireadequateloss-absorbencyineachandeveryentitywithinabankinggroup.

Wehavehadaregimethatisfocusedonthe capitalneededin agoingconcern,butnotontheorganisationaland capitalstructuresthatwould helptheauthoritiestocontaindisorderinthefaceofchronicdistress.

Allthoseissuesarenow,Ibelieve,intheopen.Thereisaclearwayforwardonresolution.

Buttherewillhavetobesomeconsequentialrecastingoftheinternationalregulatoryregime.

Ofcourse,noneofthereformswillbefoolproof.Mistakeswillbemade;mistakeswe cannotsee.

In future,ithas tobepossibletomakerunningrepairstotheregimewherefaultlinesareexposed.

Stress testing–notonlyofbanks butofCCPsand, in time,ofotherintermediaries– canhelp toexposethosefaultlines.

It canhelptocalibratemacroandmicroprudentialpolicy.

Andagoodstress-testingregimewillmakeiteasiertoexplainanddefendthestandardofresiliencethattheBankrequires.Andforthat,theBankcan beheld to account.

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Disclaimer

TheAssociationtries toenhancepublic access toinformationaboutrisk andcompliancemanagement.

Ourgoalis tokeepthisinformationtimelyandaccurate.Iferrorsarebroughttoourattention, we willtry tocorrectthem.

Thisinformation:

-

isofageneralnatureonlyandisnotintendedtoaddress thespecific

circumstancesofanyparticularindividualorentity;

-

shouldnotbereliedonintheparticularcontextofenforcementorsimilar

regulatory action;

-

isnotnecessarilycomprehensive,complete,oruptodate;

-

issometimeslinkedtoexternalsitesoverwhich theAssociationhasnocontrol

andfor whichtheAssociationassumesnoresponsibility;

-

isnotprofessionalorlegaladvice(ifyouneedspecificadvice,youshould

alwaysconsulta suitablyqualifiedprofessional);

-

isinnowayconstitutiveofaninterpretativedocument;

- doesnotprejudgethepositionthattherelevantauthoritiesmightdecide totakeonthesame mattersifdevelopments, includingCourtrulings,were toleadittorevisesomeoftheviewsexpressedhere;

-

doesnotprejudgetheinterpretationthattheCourtsmightplaceonthematters

atissue.

Pleasenotethatit cannotbeguaranteedthattheseinformationanddocumentsexactlyreproduceofficiallyadoptedtexts.

Itisourgoaltominimizedisruptioncausedbytechnicalerrors.

Howeversomedataorinformationmayhavebeencreatedorstructuredinfiles orformatsthatarenoterror-freeand we cannotguaranteethatourservicewillnotbeinterruptedorotherwiseaffectedbysuchproblems.

TheAssociationacceptsnoresponsibilitywithregardtosuchproblemsincurredas aresultofusingthissiteoranylinkedexternalsites.

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CertifiedRiskandComplianceManagementProfessional (CRCMP)distancelearningandonlinecertificationprogram.

CompanieslikeIBM, Accentureetc.consider the CRCMPapreferredcertificate.Youmayfindmoreifyousearch(CRCMPpreferred certificate) usinganysearchengine.

Theall-inclusivecostis $297.Whatisincludedintheprice:

Theofficialpresentationsweuse

inourinstructor-ledclasses(3285slides)

The2309slidesareneeded for theexam,asallthequestionsare basedon theseslides.Theremaining976slidesareforreference.

Youcanfindthecoursesynopsisat:

www.risk-compliance-association.com/Certified_Risk_Compliance_Training.htm

Upto3OnlineExams

Youhaveto passoneexam.

Ifyoufail, youmuststudytheofficial

presentationsandtryagain,but youdonotneedto spend money.Upto 3examsareincludedintheprice.

To learnmoreyoumayvisit:

www.risk-compliance-association.com/Questions_About_The_Certification_And_The_Exams_1.pdf

www.risk-compliance-association.com/CRCMP_Certification_Steps_1.pdf

PersonalizedCertificateprintedinfullcolor

Processing,printing,packingandpostingto yourofficeorhome.

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D.TheDoddFrankActandthenewRiskManagementStandards(976slides,includedinthe3285slides)

TheUSDodd-Frank WallStreet Reform andConsumerProtectionAct isthe mostsignificant pieceoflegislationconcerning thefinancialservicesindustryinabout80years.

What doesitmeanforriskandcompliancemanagementprofessionals?Itmeansnewchallenges,newjobs,newcareers,andnewopportunities.

Thebillestablishesnewrisk managementandcorporategovernance principles,setsupanearly warning

systemto protect theeconomyfrom futurethreats,andbringsmore

transparencyandaccountability.

ItalsoamendsimportantsectionsoftheSarbanesOxley Act.Forexample,itsignificantlyexpandswhistleblowerprotectionsunder the SarbanesOxleyActandcreatesadditionalanti-retaliationrequirements.

Youwill findmoreinformation at:

www.risk-compliance-association.com/Distance_Learning_and_Certification.htm

InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com


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