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

Bloomberg Professional Services

January 4, 2024

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

Following a year of intensified and evolving risks to financial markets, regulators are starting 2024 with a range of initiatives across banking, asset management, and insurance sectors to strengthen firm requirements and promote international best practice. From the UK to Japan, the following global developments in risk, capital, and financial stability from the past month stand out:

Japan: Government sets out reform agenda for asset management industry
Hong Kong: Insurance Authority issues draft rules to implement risk based capital regime
UK: PRA publish near-final Basel 3.1 implementation rules
International: FSB and IOSCO publish policies to address vulnerabilities from liquidity mismatch in open-ended funds
Saudi Arabia: Insurance Authority announces start of its operations
UK: FCA consults on reforms for Money Market Funds
US: CFTC proposes new rule on protection of DCO member funds and assets
Switzerland: FINMA publish findings from the Credit Suisse crisis
US: CFTC proposes amendments to capital and financial reporting requirements of swap dealers and major swap participants
US: FSOC releases 2023 annual report

From digital finance, the green agenda and financial stability, we look at vital regulatory matters for 2023 and beyond.

Japan sets out reform agenda for the asset management industry

The Government of Japan published a policy plan designed to reform Japan’s asset management sector and asset ownership.

Important context: Under Prime Minister Kishida, Japan’s Government has taken various measures to achieve greater household savings flow into more productive investments, such as:

Doubling Asset-based Income Plan (November 2022) designed to support steady asset building by households, including significant expansion and permanent establishment of the tax exemption scheme for retail investors
Corporate governance reforms (April 2023) designed to promote sustainable corporate growth and increased corporate value over the medium to long term

Policy plan: To reform Japan’s asset management sector and asset ownership, the ‘policy plan’ centers on the following themes.

Asset management sector reform: Call for major financial groups to develop their plans to describe their asset management business strategy, enhance their investment management capabilities, and improve governance.

Develop product governance principles to clarify the intended customers for individual financial products
Rectify Japan‘s unique business practices and resolve barriers to entry through encouraging single-check calculation of net asset values of investment trusts
Establish special zones with a policy packaged published by summer 2024
Introduce a new program to assist new entrants and request financial institutions use emerging asset managers and not to exclude them simply because their business history is short. Additional plans to deregulate to allow asset managers to outsource middle- and back- office operations

Asset ownership reform: The government pledges to develop ‘asset owner principles’ by summer 2024 that include common principles of investment policy, governance, and risk management.

To reform occupational pension funds by reviewing the investment companies selected for defined benefit (DB) pensions and to promote disclosure of investment policy and portfolio information for defined contribution (DC) pensions
To promote disclosure of investment information in a comparable manner

Financing for growth: To promote investment in start-up companies through the developments of principles for venture capital funds, deregulate investment crowdfunding, promote issuance and circulation of unlisted securities.

To diversify investment opportunities such as alternative investments and sustainable investments through allowing partial inclusion of non-listed equities in investment trusts and enhancing sustainability investment products

Stewardship activities: To work with the Tokyo Stock Exchange (TSE) to follow up on the initiatives of planning, disclosure, and implementation by listed companies.

To promote effective engagement efforts between institutional investors and companies, including through a review of the large shareholding reporting rule

Public relations and communications: To launch the Asset Management Forum in collaboration with domestic and overseas investment companies and investors and establish a preparatory committee for the forum by the end of 2023.

Looking ahead: The Cabinet Secretariat will conduct a review of progress around June 2024.

Hong Kong consults on Risk Based Capital rules for insurance industry

The Hong Kong Insurance Authority (IA) issued proposals detailing the rules to implement the Risk Based Capital (RBC) regime.

In summary: The RBC regime requires insurers to maintain capital that is commensurate with the risks they bear. In formulating the new regime, the IA has observed three overarching principles:

Compliance with relevant Insurance core principles issued by the International Association of Insurance Supervisors (IAIS)
Meeting needs and ensuring competitiveness of insurance industry
Strengthening resilience of insurance industry for protection of policy holders

In more detail: This consultation covers two draft rules, namely:

Valuation and capital rules – Detailed capital adequacy requirements and prescriptive rules for the valuation of assets and liabilities of insurers under Pillar 1 of the proposed RBC regime, covering areas such as the valuation basis, eligibility of capital, capital requirements, as well as fund requirements.
Submission of statements, reports and information rules – These prescribe the information required to be submitted to the IA under Pillar 3 of the RBC regime, including financial statements, regulatory returns, and actuarial reports

Important context: The Insurance (Amendment) Ordinance 2023 was enacted in July 2023 which provides the legal basis for the implementation of the RBC regime for the insurance industry in Hong Kong, empowering the IA to make rules to prescribe detailed requirements to implement the RBC regime.

The consultation comes as Hong Kong seeks to strengthen the financial soundness of insurers and put Hong Kong on a par with international standards
The IA is a member of the International Association of Insurance Supervisors (“IAIS”) and adheres to the Insurance Core Principles (“ICPs”) promulgated by the IAIS, which provide an internationally accepted framework for insurance supervision

Looking ahead: Submissions are due by January 16, 2024 and feedback will help shape the final rules which will be published and submitted to the Legislative Council later in 2024.

UK banking regulator issues near-final Basel bank capital rules

The UK’s Prudential Regulation Authority (PRA) issued its near-final policy statement on certain sections of the Basel 3.1 banking capital standards.

In summary: The PRA has issued its feedback to industry on the implementation of the Basel 3.1 standards and its near-final policy material regarding the scope and levels of application, market risk (FRTB), credit valuation adjustment (CVA) and counterparty credit risk, operational risk, interactions with the PRA’s Pillar 2 framework, and currency redenomination.

Looking ahead: In Q2 2024 the PRA will publish a second near-final policy statement on the remaining sections, including the standardized approach (SA) and internal ratings based approach IRB) to credit risk, credit risk mitigation, the output floor, disclosure (Pillar 3), and reporting.

Status of final rules: The rules are not technically ‘final’ as HM Treasury is still to revoke the relevant parts of the Capital Requirements Regulation (CRR) before the PRA can replace them. Once this happens, the PRA will publish a single, final policy statement.

FSB and IOSCO publish policies to address vulnerabilities from liquidity mismatch in open-ended funds

The Financial Stability Board (FSB) published revised policy recommendations to address structural vulnerabilities from liquidity mismatch in open-ended funds, (OEFs) and the International Organization of Securities Commissions (IOSCO) published final guidance on Anti-Dilution liquidity management tools (LMTs) for the effective implementation of the Recommendations for Liquidity Risk Management for Collective Investment Schemes.

In summary: These recommendations from the FSB and IOSCO aim to achieve a significant strengthening of liquidity management by OEF managers compared to current practices.

Revised FSB recommendations: These are addressed to financial regulatory and supervisory authorities and set out the key objectives for an effective regulatory and supervisory framework to address vulnerabilities arising from liquidity mismatch in OEFs.

To address structural liquidity mismatch in OEFs, the Revised FSB recommendations aim to provide greater clarity on the redemption terms that OEFs can offer to investors, based on the liquidity of the OEF asset holdings
This would be achieved through a categorisation approach, where OEFs would be grouped depending on the liquidity of their assets (e.g liquid, less liquid, illiquid)
OEFs in each category would then be subject to specific expectations in terms of their redemption terms and conditions
Authorities should set expectations for OEF managers to use a mixture of quantitative and qualitative factors when determining the liquidity of OEF assets in normal and stressed market conditions within the context of the domestic liquidity framework set out by authorities
The Revised FSB Recommendations seek to achieve (i) greater inclusion of anti-dilution LMTs in OEF constitutional documents and (ii) greater use of, and greater consistency in the use of, anti-dilution LMTs in both normal and stressed market conditions

IOSCO LMT Guidance: This guidance aims to support the greater use of anti-dilution LMTs by OEFs to mitigate investor dilution and potential first-mover advantage arising from structural liquidity mismatch in OEFs.

The LMT Guidance sets out key operational, design, oversight, disclosure and other factors and parameters that responsible entities should consider when anti-dilution LMTs are used, to promote greater, more consistent, and more effective use of these tools
For example, responsible entities should have appropriate internal systems, procedures and controls in place at all times in compliance with applicable regulatory requirements for the design and use of anti-dilution LMTs as part of the everyday liquidity risk management of their OEFs
Furthermore, anti-dilution LMTs used by responsible entities should impose on subscribing and redeeming investors the estimated cost of liquidity
This encompasses the explicit and implicit transaction costs of subscriptions or redemptions, including any significant market impact of asset purchases or sales to meet those subscriptions or redemptions

Looking ahead: The FSB and IOSCO will both review progress by member jurisdictions in implementing their respective revised recommendations and guidance.

This will begin with a stocktake, to be completed by the end of 2026, of the measures and practices adopted and planned by FSB member jurisdictions
IOSCO will aim to coordinate a stocktake of its recommendations and guidance with the FSB’s stocktake to provide a comprehensive picture
The FSB and IOSCO will, by 2028, assess whether implemented reforms have sufficiently addressed risks to financial stability
This will include, if appropriate, assessing whether to refine existing tools or develop additional tools for use by fund managers or authorities

Saudi Insurance Authority commences its duties

The Chairman of the Board of Directors of Saudi Arabia’s Insurance Authority (IA) announces the start of the IA’s operations as the independent regulator of the insurance sector.

The mandate: The IA seeks to achieve a number of objectives, including the regulation and supervision of the insurance sector in the Kingdom, as well as protecting the rights of policyholders and beneficiaries, establishing the principles of insurance contractual relationships, fostering innovation in insurance products, and raising insurance awareness.

Practical implications: Current regulations, rules, and instructions related to the insurance sector will continue to be in effect until further instructions are issued by the IA.

Wider context: The IA will work to enhance competitiveness through the quality of the services provided and the creation of an attractive investment environment. The authority will also support and strengthen the role of the insurance sector in the national economy.

FCA consults on reforms to the regime for Money Market Funds

The UK Financial Conduct Authority (FCA) issued proposals to enhance the resilience of Money Market Funds (MMFs) based in the UK.

What are MMFs? MMFs are widely used by UK financial institutions as a means by which investors can manage their short-term needs for cash, such as payments to pension holders and staff salaries or for meeting margin calls. In practice, there are few alternatives for larger corporate and financial institutions that meet their needs.

Important context: In a severe market stress such as the onset of the Covid-19 pandemic in March 2020, investors may not be able to get their money back from a MMF quickly, or not without a noticeable and unanticipated loss.

MMFs typically use liquid assets to return money to redeeming investors and if a MMF runs out of liquid assets and investors are still demanding the return of their investment, it would either need to ‘fire sale’ assets in stressed markets and pass the resulting losses on to investors or be ‘suspended’ (temporarily stop returning investors’ money)
There is a ‘first-mover advantage’ in MMFs which can itself also drive additional investor demands for their money back as investors who redeem first in a stress are more likely to get paid out without unanticipated delays or losses

Two main proposals: Alongside other changes, the FCA is proposing two main significant changes to current MMF regulation to reduce the vulnerability of MMFs while maintaining the broad current MMF operating model.

A significant increase in the minimum proportion of highly liquid assets that all MMF types have to hold: This is intended to ensure that MMFs have enough liquid assets to withstand large amounts of withdrawals over a short period in severe but plausible market stresses
‘Delinking’ the levels of liquid assets in important types of MMFs with the need for the MMF manager to impose or consider imposing tools that would reduce the ability of investors to get their money back without unanticipated delays or losses. This is intended to reduce the additional first-mover advantage

Closely related: The UK government has published a draft of the statutory instrument (SI) and a policy note that will replace the existing Money Market Funds Regulation.

International context: The close coordination between the UK Treasury, Bank of England and FCA is part of broader international efforts to address vulnerabilities and increase the resilience of MMFs. The proposals reflect the Financial Stability Board’s (FSB) ongoing work to address MMF vulnerabilities.

Looking ahead: The FCA consultation is open until March 8, 2024 and feedback will help shape future policy decisions.

CFTC proposes new rule on DCO member funds and assets

The US Commodity Futures Trading Commission (CFTC) proposed a rule to provide new protections for clearing member funds and assets held by a Derivatives Clearing Organization (DCO).

The intention: The proposed rule seeks to provide protections for clearing member funds and assets held by a DCO.

In more detail: The rule would require, among other things, that clearing member funds be segregated from the DCO’s own funds and held in a depository that acknowledges, in writing, that the funds belong to clearing members, not the DCO.

In addition, the commission is proposing rules that would enable DCOs to hold customer and clearing member funds at certain foreign central banks subject to certain requirements
The commission is also proposing to require DCOs to conduct a daily calculation and reconciliation of the amount of funds owed to customers and clearing members and the amount actually held for customers and clearing members

Deadline for comments: The comment period will be open for 60 days after publication, with a closing date of February 16, 2024.

Swiss regulator publish findings from the Credit Suisse crisis

The Swiss Financial Market Supervisory Authority (FINMA) published its report on the Credit Suisse crisis in which it analyzes the factors that ultimately led to the loss of confidence in March 2023, including FINMA’s supervisory work with the bank.

Key conclusions – looking back: FINMA considers that Credit Suisse lost the confidence of its clients, investors, and the markets as a result of inadequate implementation of its strategic focus areas, repeated scandals, and management errors.

FINMA underlines the far-reaching and invasive measures supervisory activities it took to rectify deficiencies, particularly in the bank’s corporate governance and in its risk management and risk culture
While the actions taken by the authorities – including the Confederation, SNB and FINMA – to safeguard the solvency of Credit Suisse and support the takeover by UBS protected the bank’s creditors and upheld financial stability, FINMA calls for a number of changes in light of the crisis

Key conclusions – looking ahead: FINMA draws a number of lessons from the Credit Suisse crisis, including

Stronger legal basis: FINMA advocates for more influence on the governance of supervised institutions, potentially a Senior Managers Regime with the power to impose fines and publish enforcement proceedings on a regular basis
Improve capital regulation: In the area of capital requirements, the legal obligation to grant exemptions at the level of the specific institution led to the parent company being weakened. FINMA is therefore calling for stricter standards for regulation at the specific institution level in the context of a review of the “too big to fail” requirements
Focus on additional capital charges: FINMA ordered far-reaching additional capital charges to counter the increased risks from Credit Suisse’s business activities. In future, FINMA will analyze the risks involved in strategy implementation or an inadequate control environment and the resulting potential for losses by financial institutions even more systematically, and will impose and disclose additional capital charges if necessary. It should be examined whether this will also require a change to the regulatory principles
Focus on feasibility of recovery and resolution measures: Some of the measures in the recovery plan reviewed and approved by FINMA could not be implemented as planned during the current crisis. In future, FINMA will therefore place a stronger focus on ensuring that the measures can be implemented effectively and consider tightening up its approval practice. It will also adapt the resolution plan to include faster bank runs and more crisis scenarios

CFTC proposes amendments to capital and financial reporting requirements of swap dealers and major swap participants

The proposed amendments are intended to make it easier for Swap Dealers (SDs) and Major Swap Participants (MSPs) to comply with the CFTC’s financial reporting obligations and demonstrate compliance with minimum capital requirements.

Proposed amendments: The rule would amend the capital and financial reporting requirements of SDs and MSPs by codifying a staff letter relating to tangible net-worth calculations (No. 21-15) and two CFTC no-action staff letters regarding alternate financial reporting requirements for SDs subject to capital requirements of a prudential regulator (No. 21-18 and No. 23-11).

The amendments would also revise financial reporting requirements of SDs relating to approval of subordinated debt for capital, notification timing, and reporting forms

Deadline for comments: The comment period will be open for 60 days after publication and close on February 13, 2024.

FSOC releases 2023 Annual Report

The US Financial Stability Oversight Council (FSOC) unanimously approved its 2023 annual report that reviews financial market developments, describes potential emerging threats to financial stability, identifies vulnerabilities in the financial system, and makes recommendations to mitigate those threats and vulnerabilities.

In summary: FSOC’s recommendations in the annual report cover banking; cybersecurity; artificial intelligence; nonbank financial intermediation; climate-related financial risk; and digital assets.

View the additional regulatory briefs from this month:

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