Global Regulatory Brief: Risk, capital and financial stability, October edition

The Global Regulatory Brief provides monthly insights on the latest risk and regulatory developments. This brief was written by Bloomberg’s Regulatory Affairs Specialists.

Risk, capital and financial stability regulatory developments

As the risks to global financial markets intensify and take on new forms, regulators are demanding more transparency and disclosure from a greater range of market players. The following global developments in risk, capital, and financial stability stand out:

• Singapore: Monetary Authority sets out next steps for market risk capital requirements under Basel III
• UK: FCA writes Dear CEO letter to wholesale banking sector
• US: SEC adopts rule enhancements to prevent misleading or deceptive investment fund names
• US: Federal bank regulatory agencies request comments on proposed rule to require large banks to maintain long-term debt to improve financial stability and resolution
• Australia: Banking supervisor consults on improvements to effectiveness of hybrid capital bonds
• Israel: Securities Authority approves first ‘halal’ funds for Muslim investors
• Malaysia: Central Bank issues draft rules on liquidity risk management
• Global: IOSCO consults on good practices for leveraged loans and examines risk in private finance
• EU: Joint regulators warn of risks associated with the fragile economic outlook

Singapore sets out next steps for market risk capital requirements under Basel III

Following industry consultation on risk based capital adequacy requirements under the final Basel III reforms in Singapore, the Monetary Authority of Singapore (MAS) has issued its response and revised rules.

What this means: The revised standards other than market risk and credit valuation adjustment (CVA) standards will take effect from July 1, 2024.

• Revised market risk and CVA standards: with effect from July 1, 2024 for compliance with supervisory reporting requirements, and with effect from January 1, 2025 for compliance with capital adequacy and disclosure requirements
• Output floor: to commence at 50% from July 1, 2024 and reach full phase-in at 72.5% on Jan 1, 2029

FCA writes dear CEO letter to wholesale banking sector

The UK Financial Conduct Authority (FCA) has written to the chief executives of all wholesale banks in the UK to set out its key priorities for the sector.

At a high level: The letter sets out the FCA’s supervisory work programme over the next two years and underlines the FCA’s expectations that wholesale banks contribute to high standards of market excellence and help strengthen the UK’s position as a vibrant global financial center.

More specifically: The letter sets out the FCA’s approach and expectations across a number of key regulatory themes, including:

• Risk management – The FCA will look to senior management to evidence how they have delivered better risk management and oversight and that boards show that improvements are lasting. Firms can expect increased regulatory engagement during times of market stress to ensure the orderly functioning markets and the FCA will carry out supervisory testing on how embedded improvements in risk management.
• High standards of control – The FCA will ramp up its testing programme with regard to financial crime, market abuse, and conflicts of interest risks. This will include more in-person supervisory assessments. The FCA expects prompt notification of any material issues identified by control function and then effective action from senior management.
• Operational resilience – The FCA expects wholesale banks to be operationally resilient as reliance on third-party services continues to grow; and will use engagement with relevant senior managers to assess whether the lessons of operational resilience events have been learnt.
• Organizational changes – When firms start to consider changes to how they serve clients, their location, their booking model or risk management arrangements, the FCA expects this to be brought promptly to its attention in advance.
• LIBOR transition – While USD LIBOR ceased on June 30, the FCA expects wholesale banks to continue actively transitioning the last of the contracts that reference USD LIBOR and not rely unnecessarily on synthetic LIBOR.
• Consumer Duty – The Consumer Duty sets higher and clearer standards of consumer protection across financial services and the FCA will test the robustness of implementation efforts.
• ESG – Wholesale banks should demonstrate that their financing activities are aligned with their own transition plans, and that product and public-facing commitments relating to ESG are delivered in practice.
• Artificial intelligence – The FCA will engage with wholesale banks on current deployment of artificial intelligence and machine learning as well as plans for the future and the associated control infrastructure.
• Diversity, equity and inclusion – The FCA will consult on draft policy intervention soon and is looking to understand how wholesale banks are playing their role in helping to accelerate the pace of meaningful change on diversity, equity and inclusion in the sector.
• Non-financial misconduct – The FCA expects firms to have effective systems in place to identify and mitigate all kinds of risk, and in the event of non-financial misconduct, there should be appropriate internal procedures.

Next steps: CEOs are expected to discuss the letter with their senior management teams to agree on next steps.

US SEC adopts rule enhancements to prevent misleading or deceptive investment fund names

US Securities and Exchange Commission (SEC) adopted amendments to the Investment Company Act “Names Rule,” which addresses fund names that are likely to mislead investors about a fund’s investments and risks. The amendments modernize and enhance the Names Rule and other names-related regulatory requirements.

The details: The Names Rule currently requires registered investment companies, whose names suggest a focus in a particular type of investment, to adopt a policy to invest at least 80% of the value of their assets in those investments.

• The amendments to the Names Rule will require more funds to adopt an 80% investment policy, including funds with names suggesting a focus in investments with particular characteristics, for example, terms such as “growth” or “value,” or certain terms that reference a thematic investment focus, such as the incorporation of one or more environmental, social, or governance factors
• The amendments will also include a new requirement that a fund reviews its portfolio assets’ treatment under its 80% investment policy at least quarterly, and will include specific time frames (generally 90 days) for getting back into compliance if a fund departs from its 80% investment policy

Next steps: The amendments will become effective 60 days after publication in the Federal Register. Fund groups with net assets of $1 billion or more will have 24 months to comply with the amendments, and fund groups with net assets of less than $1 billion will have 30 months to comply.

US bank regulators consult on proposals to require large banks to maintain long-term debt

Federal bank regulatory agencies requested comments on a proposal that would require large banks with total assets of $100 billion or more to maintain a layer of long-term debt, which would improve financial stability by increasing the resolvability and resiliency of such institutions.

The details: This proposal follows an advance notice of proposed rulemaking issued in October 2022 by the Federal Reserve Board and the Federal Deposit Insurance Corporation that looked at several possible changes, including a long-term debt requirement to promote more orderly resolutions for large banks.

• The recent failures of three large banks have underscored the importance of supplementary, loss absorbing resources that regulators can use to resolve banks in a way that reduces costs and risk of disruption to the banking system
• Comments on the proposal are due by November 30, 2023

Australian banking supervisor consults on improvements to effectiveness of hybrid capital bonds

The Australian Prudential Regulation Authority (APRA) has begun exploring options to improve the effectiveness of Additional Tier 1 (AT1) capital instruments for use in a potential bank stress scenario.

Wider context: AT1 capital instruments, often referred to as “hybrid” bonds, are one of three types of capital that banks can hold to support their resilience and protect depositors.

• The purpose of AT1 is to stabilize a bank by absorbing losses during a period of severe stress or to support an orderly resolution in the unlikely event of a failure
• In such circumstances, a bank could decline to pay discretionary coupons to AT1 investors, convert the instruments to equity or write them off

The concern: Australian banking regulators are concerned AT1 capital instruments will not operate as originally intended due to certain design features and market practices.

• In particular they point to recent episodes of international banking stress that demonstrate how the ATI only absorbs losses at a very late stage of a crisis, in the resolution phase

Looking ahead: APRA has outlined the challenges of using AT1 in an Australian context and called for feedback on a range of potential options to overcome them.

• APRA will hold discussions with industry on these options later this year and will then formally consult on changes to Australian prudential standards or guidance

Israeli regulator approves first ‘halal’ funds for Muslim investors

The Israeli Securities Authority (ISA) has approved for the first time shariah-compliant (halal) mutual funds for distribution.

What this means: These funds are open-end funds that adopt an investment policy committed to assets exposed solely to securities, futures and options deemed suitable under shariah law.

In more detail: The halal rules prohibit, among other things, investing in interest-bearing instruments as well as in companies engaged in the manufacture and trading of arms, the marketing of alcoholic beverages and the raising of pigs or marketing of pork products.

Wider context: The approval of shariah-compliant mutual funds in Israel comes as the regulator seeks to improve the accessibility and diversity of Israeli capital markets.

Malaysia issues draft policies for liquidity risk management

Bank Negara Malaysia (BNM) sets out draft requirements and guidance on liquidity risk management.

What you need to know: BNM wants to ensure that financial institutions are effective in assessing their exposures to liquidity risk and take appropriate measures to address their liquidity needs. The document sets out eleven principles that include having a sound funding strategy, regular liquidity stress testing, maintaining a cushion of liquid assets that can be easily converted during times of stress, and disclosing high-quality liquidity-related information.

The big picture: The role of financial institutions in the maturity transformation of short-term deposits into long-term loans makes them inherently vulnerable to liquidity risk. Effective liquidity risk management helps ensure financial institutions are able to meet their cash flow obligations.

Next steps: BNM requests feedback on the proposals by November 30, 2023 and plans to issue final rules in 2024 with the requirements set to take effect six months thereafter.

IOSCO consults on good practices for leveraged loans and examines risk in private finance

The International Organization of Securities Commission (IOSCO) has published two reports on market risk, calling for an improvement in practices in the markets for leveraged loans (LL) and collateralized loan obligations (CLO). The report also highlights weak transparency in private finance.

Improving leveraged loan markets: The consultation provides an overview of the LL and CLO markets and their evolution over the past decade, and outlines how vulnerabilities could impact investor protection, market efficiency, and reducing systemic risk.

• The report proposes a series of improvements that cover areas such as ongoing disclosure, loan documentation transparency, origination and refinancing, and better aligning interest from loan origination to end investors
• The consultation is open until December 15, 2023 and IOSCO plans to publish final practices by Q1 2024

Emerging risks in private finance: The report outlines IOSCO’s work to better understand the potential vulnerabilities that might arise from private financing activities, which is experiencing rapid growth.

• The report considers how risks in the private market sphere could impact investor protection, market integrity, wider financial stability, and systemic risk
• With private finance having grown during a period of relatively benign macro-financial conditions, the changing economic headwinds present new challenges and could unveil new risks

European regulators warn of risks associated with the fragile economic outlook

The three European Supervisory Authorities (EBA, EIOPA and ESMA – ESAs) issued their joint Autumn 2023 report on risks and vulnerabilities in the EU financial system.

Background context: The ESAs note that the adverse events of recent years such as the war in Ukraine, the volatility in commodity markets, and the turmoil among certain US mid-sized banks has ushered in a period of heightened uncertainty, presenting financial stability risks that require vigilance from market participants.

Specific trends: The report notes how the increase in interest rates has resulted in heterogeneous impacts for the financial services sector, having generated increased net interest income for banks, reduced profitability for insurers, and introduced liquidity risks for the asset management sector.

Looking forward: The ESAs encourage national European regulators and financial institutions to closely monitor the impact from increases in policy rates, to prepare for deterioration in asset quality, to monitor inflation risk, and ensure that effective risk management and governance arrangements are in place. They note the absence of effective risk management for liquidity and interest rate risk during recent problems in the US and Switzerland.

View the additional regulatory briefs from this month:

• Trading and markets
• Green finance
• Digital finance

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