Global Regulatory Brief: Risk, capital and financial stability, June 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
Recent periods of financial stress and the proliferation of risks across the financial system are fueling the development of regulatory initiatives to strengthen requirements and promote international best practice. From interest rate risk in Dubai to capital market exposure in India, the following global developments in risk, capital and financial stability from the past month stand out:
- Dubai: FSA consults on interest rate risk in the banking book
- India: Reserve Bank of India adjust capital market exposure norms
- EU: Council adopts banking package text implementing Basel III standards
- EU: New rules on withholding tax procedures
- EU: ECB assess bank and non-bank risks to financial stability
- EU: ECB publishes guidance on risk data aggregation and risk reporting
- UK: FCA and HMT publish roadmap on implementing Overseas Funds Regime
- US: CFTC approves final rules on large trader reporting for futures and options
- US: CFTC approves final rule on capital and financial reporting requirements for swap dealers and major swap participants
Dubai regulator consults on interest rate risk in the banking book
The Dubai Financial Services Authority (DFSA) issued a consultation on proposals to update the existing regulatory framework on the treatment of interest rate risk in the banking book (IRRBB) and to introduce a new requirement for producing a risk appetite statement.
In summary: The DFSA proposes to update the existing IRRBB requirements to bring them in line with the latest Basel standard on IRRBB as part of the Basel III implementation project.
Treatment of IRRBB: The DFSA proposes to continue treating IRRBB as a pillar 2 risk, which means that firms are not automatically subject to capital requirements for IRRBB and should address IRRBB under their internal processes and maintain adequate internal capital accordingly.
Other key proposals: The DFSA also seeks feedback on the following proposals:
- The introduction of a new requirement for producing a risk appetite statement and validation of models used for IRRBB
- Requiring Authorized Firms to measure the impact of IRRBB on economic value of equity (EVE) and earnings and report the outcomes of both measurements to the DFSA
- Deviating from the Basel framework in setting different floors for post-shock interest rates and the local interest rate shocks
- Introducing a standardized framework for measuring the impact of IRRBB
Looking ahead: The deadline for providing comments on this Consultation Paper is August 1, 2024 and the DFSA will consider responses as it finalizes the amended Rulebook.
Reserve Bank of India adjusts bank capital market exposure norms
The Reserve Bank of India (RBI) has revised its guidelines for custodian banks on the issuance of Irrevocable Payment Commitments (IPCs) in light of the new T+1 settlement regime for stocks.
Context: India finished implementing a T+1 settlement cycle in the securities market in January 2023, and consulted on moving toward T+0 and instant settlement in January this year.
Background: The move to T+1 settlement had prompted the RBI to review the risk-mitigating measures set out in the existing guidelines on issuance of IPCs by banks, which were prescribed based on the former T+2 settlement cycle.
Changes: Under the revised guidelines, the maximum intraday risk to custodian banks issuing IPCs would be considered as capital market exposure (CME) at 30% of the settlement amount
- This is based on the assumption of 20% downward price movement of the equities on T+1, with an additional margin of 10% for further downward movement of price
- In case margin is paid in cash, the exposure will stand reduced by the amount of margin paid
- In case margin is paid by way of permitted securities to mutual funds/foreign portfolio investors, the exposure will stand reduced by the amount of margin after adjusting for exchange-prescribed haircuts
- Under the T+1 settlement cycle, the exposure shall normally be intraday
- However, if exposure remains outstanding at the end of T+1 Indian Standard Time, the bank will have to maintain capital based on the outstanding capital market exposure as required under the Basel III Capital Regulations
EU Council adopt legislation to implement Basel III
The European Union (EU) Council representing the Member States adopted legislation to implement the Basel III banking capital standards in the bloc.
In more detail: The reforms’ main feature is the introduction of an “output floor” that limits the risk of excessive reductions in banks’ capital requirements and makes those requirements more comparable.
- Beyond the implementation of Basel III standards, the new rules harmonize minimum requirements applicable to the authorisation of branches of third-country banks and the supervision of their activities in the EU
- They also set a transitional prudential regime for crypto assets and introduce amendments to enhance banks’ management of Environmental, Social and Governance risks
Looking ahead: The amended capital requirements regulation (CRR) and capital requirements directive (CRD) will now be published in the EU’s Official Journal and enter into force 20 days later.
- Member states will have 18 months to transpose the directive into national legislation
- The regulation will apply from January 1, 2025
New EU rules on withholding tax procedures
EU member states reached an agreement on a proposal for faster procedures to obtain double taxation relief, which is intended to help boost cross-border investment and help fight tax abuse.
Objective: The so-called FASTER initiative aims to make withholding tax procedures more efficient for cross-border investors.
Context: EU member states currently levy taxes on dividends and interests paid to investors who live abroad, who at the same time have to pay income tax in their country of residence on the same income. Despite treaties between member states on double taxation, lengthy procedures to claim withholding tax relief are considered an important barrier impeding more integrated capital markets in the EU.
Key measures:
- Common EU digital tax residence certificate that tax paying investors will be able to use in order to benefit from the fast-track procedures to obtain relief from withholding taxes
- The digital certificate will be provided to a natural person or entity deemed resident in a jurisdiction for tax purposes through an automated process
- Member states will be able to have two fast-track procedures complementing the existing standard refund procedure for withholding taxes, these are:
- A “relief-at-source” procedure where the relevant tax rate is applied at the time of payment of dividends or interest
- A “quick refund” system where the reimbursement of overpaid withholding tax is granted within a set deadline
- Standardized reporting obligation for financial intermediaries via national registers
Next steps: The agreed text will go through a legal linguistic check and the rules will then need to be formally adopted by the Council of the EU before being published in the EU’s Official Journal in Q4 2024.
Member states will have to transpose the new directive into national legislation by December 31, 2028 and will have to become applicable from January 1, 2030.
ECB assess bank and non-bank risks to financial stability
The European Central Bank (ECB) published its May 2024 Financial Stability Review in which it concludes the outlook remains fragile even if financial stability conditions have improved in the euro area.
Challenges for euro area banks: The ECB finds that challenges for euro area banks may arise from three sources.
- First, worries about bank asset quality are growing, given signs of mounting losses in some loan portfolios that are more sensitive to cyclical downturns, notably commercial real estate
- Second, bank funding costs seem set to remain high, even if policy rates start declining
- Third, banks’ revenues may be dampened as operating income weakens due to still-muted loan growth and lower income on variable-rate loans ahead
- The ECB encourages macroprudential authorities to maintain existing capital buffers to ensure that they are available to banks in the event of headwinds, together with borrower-based measures that ensure sound lending standards
Non-bank sector: The ECB recommends the implementation of a comprehensive macroprudential framework for non-banks and more integrated EU-wide supervision of these entities as a means of mitigating financial stability risks.
The ECB concludes that a resilient non-bank financial sector would support progress towards a capital markets union in Europe, helping to ensure that non-banks provide a stable source of finance to the real economy through the cycle.
In parallel – AI in focus: The ECB also published a paper that looks into the benefits and risks for individual financial institutions using artificial intelligence (AI) and the potential implications for financial stability. The ECB finds that wide adoption of new AI tools by individual firms can have systemic effects through technological penetration and supplier concentration.
- Technological penetration: If AI is widely adopted across different financial entities for an increasing number of processes and applications, more areas of the financial system will be affected by the challenges and opportunities associated with AI
- Supplier concentration: If a majority of financial institutions use the same or very similar foundation models provided by a few suppliers, it is likely that decisions based on AI will suffer from similar biases and technological challenges, and reliance on system providers will increase
- While the levels of technological penetration and supplier concentration are difficult to predict, regulatory initiatives may need to be considered if market failures become apparent that cannot be tackled by the current prudential framework
ECB publishes guidance on risk data aggregation and risk reporting
The European Central Bank (ECB) published its final guide on effective risk data aggregation and risk reporting, which aims to specify and reinforce supervisory expectations.
Key focus: The guidance sets out the minimum supervisory expectations compiled by the ECB in conjunction with the national competent authorities, and explains in detail how the ECB applies the relevant national laws.
The ECB notes that the guide is intended to complement, and not replace, the guidance already provided by the ECB since 2016 through public communications and in institution-specific supervisory activities.
Feedback published: The ECB published a feedback statement setting out its response to the comments it received to the consultation on the draft version of the guide in July 2023.
FCA and HMT publish roadmap on implementing Overseas Funds Regime
The UK Financial Conduct Authority (FCA) and HM Treasury (HMT) have published a joint roadmap explaining how the Overseas Funds Regime (OFR) is intended to be opened to European Economic Area (EEA) funds authorized under the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive.
Context: This publication follows the UK Government decision in January 2024 to grant equivalence in relation to EEA UCITS funds with the wider ambition to create a more streamlined process for overseas investment funds to be sold to UK retail investors.
Timeline: The roadmap sets out the key stages of the process so that operators of EEA UCITS that wish to use the OFR as a gateway to the UK market can prepare. While the timings are subject to change, the roadmap gives the key stages of the process so that operators of EEA UCITS that wish to use the OFR as a gateway to the UK market can prepare.
- Q2 2024: Legislation is intended to be laid to enact the equivalence decision
- July 2024: The FCA’s final rules for OFR funds will be likely to come into effect
- Q3 2024: The Government intends to issue a consultation on the application of Sustainability Disclosure Requirements (SDR) and labeling for OFR funds and whether the regime should be extended to include OFR funds
- Q3 2024: The OFR gateway opens
- End-2024: The Government aims to lay any legislation required to implement its decision on SDR and labeling for OFR funds, likely to come into force in H2 2025
Important details: Following the commencement of planned forthcoming Government legislation, funds which miss their allocated landing slots will be removed from the Temporary Marketing Permissions Regime (TMPR).
- The fund will cease to be a recognised scheme and cannot be promoted to retail investors until it has made a successful application under the OFR and becomes recognised again
- Recognition will allow the fund operator to access the market immediately under the OFR
Money-market funds: Money-market funds (MMFs) are not in scope of the Government’s equivalence determination and as long as the TMPR remains in place, MMFs that are recognised under it can continue to be promoted.
- The TMPR for all EEA UCITS funds, including UCITS MMFs, is due to close at the end of 2026
- The Government is designing a more permanent access route for overseas MMFs, and has consulted on this in December 2023
Retail disclosure: The Government and the FCA are reforming the UK’s point-of-sale disclosure requirements for retail-facing financial services products and the Government will lay legislation to create a new framework for Consumer Composite Investments (CCI), including overseas recognised funds, in due course.
It is expected that overseas recognised funds will be required to follow FCA rules under the new UK retail disclosure framework for CCIs from January 1, 2027 at the latest.
Sustainability disclosure requirements and labeling: The Government intends to consult in Q3 2024 on whether the UK’s Sustainability Disclosure Requirements (SDR) and labeling regime should be extended to apply to OFR funds. If, following consultation, the Government chooses to extend the regime to OFR funds, the FCA expects that it would need to make rules (subject to consultation processes) reflecting that decision.
CFTC approves final rules on large trader reporting for futures and options
The Commodity Futures Trading Commission (CFTC) approved final rules to amend its large trader reporting regulations for futures and options. These regulations require futures commission merchants, clearing members, foreign brokers, and certain reporting markets (reporting firms) to report to the Commission position information for the largest futures and options traders.
Changes include:
- Replacement of the data elements currently enumerated in the CFTC’s regulations with an appendix specifying applicable data elements
- Publication of a separate Part 17 Guidebook specifying the form and manner for reporting
- Removal of the 80-character data submission standard in the CFTC’s regulations to be replaced with an FIXML standard
Timeline: The final rules are effective 60 days after publication in the Federal Register. Reporting firms must comply with the final rules two years after publication in the Federal Register.
CFTC approves final rule on capital and financial reporting requirements for swap dealers and major swap participants
The CFTC approved a final rule that amends the capital and financial reporting requirements of Swap Dealers (SDs) and Major Swap Participants (MSPs).
The intention: The amendments are intended to make it easier for SDs and MSPs to comply with the CFTC’s financial reporting obligations and demonstrate compliance with minimum capital requirements.
Specifically, the amendments make changes consistent with CFTC Staff Letter No. 21-15 regarding the tangible net worth capital approach for calculating capital under CFTC Regulation 23.101, as well as CFTC Staff Letter No. 21-18, as further extended by CFTC Staff Letter No. 23-11, regarding the alternate financial reporting requirements for SDs subject to the capital requirements of a prudential regulator. The amendments also revise certain Part 23 regulations regarding the financial reporting requirements of SDs, including the required timing of certain notifications, the process for approval of subordinated debt for capital, and the information requested on financial reporting forms to conform to the rules.
Compliance Timeline: The effective date of the final rule is 30 days from the date of publication in the Federal Register and has a compliance date of September 30, 2024.
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