Global Regulatory Brief: Risk, capital and financial stability, July 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 FRTB in the EU to investment funds in Saudi Arabia, the following regulatory developments in risk, capital and financial stability from the past month stand out: 

• EU: Commission delays application of FRTB by one-year until January 2026
• Switzerland: Federal Council confirms Jan 2025 implementation of final Basel III standards
• Malaysia: Central bank publishes final policy for credit risk capital requirements
• EU: Systemic Risk Board publishes analysis of European private markets
• US: CFTC makes first charge under whistleblower protection rules
• Saudi Arabia: CMA consults on investment fund framework 
• Switzerland: FINMA issues guidance on operational risk management
• US: CFTC approves final capital comparability determinations for certain non-U.S. nonbank swap dealers

EU delays FRTB until January-2026

The European Commission confirmed that it will delay the market risk provisions under the Basel III framework – known as the Fundamental Review of the Trading Book (FRTB) – by one year until January 1, 2026. 

In more detail: The EU Commission has the power to postpone the market risk bank capital rules given the sensitivity of Europe’s banking sector to developments in other jurisdictions such as the US and the UK.

• Commissioner McGuinness stated that the United States is likely to delay its implementation to January 1, 2026 at the earliest
• The EU Commission has chosen to exercise its power to delay FRTB in order to maintain a level playing field internationally

Important reminder: The rest of the EU Basel III standards will be implemented on January 1, 2025 as scheduled as the EU only has the power to delay the market risk element of the Basel implementation package. 

Looking ahead: The EU Commission will adopt the delay to FRTB by way of a delegated act. This will be subject to scrutiny by Member States and Parliament, which will take a minimum of three months.

Switzerland confirms Jan 2025 implementation of final Basel III standards

The Swiss Federal Council confirmed that it will implement the full Basel III standard for bank capital requirements on January 1, 2025 as planned.

In more detail: As part of the Capital Adequacy Ordinance (CAO) framework that implements the final Basel III standards, the Swiss Federal Department of Finance (FDF) was instructed to assess international implementation efforts and recommend policy decisions accordingly.

• Despite delays in some countries, the FDF sees no reason to deviate from its existing timetable and as such the final Basel III standard will therefore enter into force in Switzerland on January 1, 2025
• This will include the revised minimum standard for market risk that prescribes capital requirements for risky aspects of a bank’s businesses – known as FRTB

Malaysian Central Bank publishes policy documents on Capital Adequacy Framework

Bank Negara Malaysia (BNM) has published policy documents to provide final guidance for financial institutions (FIs) to calculate the capital required for credit risk under the standardized approach, in line with Basel III international capital standards.

Summary: The standards and guidance in the policy documents are based on the Basel Committee on Banking Supervision’s (BCBS) Basel framework and the Islamic Financial Services Board’s (IFSB) standard. The documents include requirements for FIs to: 

• Assess whether ratings provided by External Credit Assessment Institutions are sufficiently robust when used for capital computations
• Perform due diligence to ensure that the FI has an adequate understanding at the origination and thereafter, on a regular basis, of the risk profile of their counterparties
• Remove assumptions of implicit government support from the ratings of banking institutions
• Apply a flat risk weight for unrated banking institutions’ exposures, which is similar to the Basel II rather than the Basel III approach
• Check against a series of conditions in order to obtain capital relief from the use of Credit Risk Mitigation instruments

Where necessary, the requirements from the BCBS and IFSB standards have been modified to take into account the unique characteristics of the Malaysian economy and financial system.

Timeline: For FIs implementing the Standardized Approach for credit risk, the policy documents will come into effect on 1 July 2026. 

• The effective date takes into consideration the data and system enhancements required for financial institutions to comply with the more granular requirements under the revised standards
• FIs applying the Internal Ratings-Based Approach for credit risk will not be required to comply with the Capital Adequacy Framework (Standardized Approach for Credit Risk) until such time when the policy document on Capital Adequacy Framework (Internal-Ratings Based Approach for Credit Risk) is finalized and communicated

European Systemic Risk Board publishes analysis of EU private markets

The European Systemic Risk Board (ESRB) published the EU Non-bank Financial Intermediation Risk Monitor 2024 (NBFI Monitor) highlighting the key cyclical and structural risks associated with non-bank financial intermediation in 2023. 

In summary: The results show that structural vulnerabilities in NBFI could amplify cyclical risks to EU financial system stability and that higher interest rates coupled with slow growth could amplify credit risk. 

• This could lead to losses and put a strain on non-bank financial intermediaries engaged in liquidity transformation, especially those with direct exposures to interest rate-sensitive sectors such as real estate, or those that rely on leverage
• High leverage, which is typically associated with alternative investment funds (AIFs), can also build up in some undertakings for collective investment in transferable securities (UCITS) that pursue hedge fund-like strategies
• The report also explores the interconnectedness and cross-exposures of investment funds

Private markets in focus: The report discusses in detail recent developments in private finance – encompassing private equity, venture capital, private debt and real assets – and their implications for financial stability from the EU perspective. 

• More transparency: The report finds that there is a need for more transparency in private finance given the important links with other parts of the financial system and the relative lack of comparable and detailed data for the sector 
• European versus global private market share: The report estimates European private assets under management to be around 23% of the total – around €2.4 trillion – and that this growth has been driven by a favorable regulatory framework and sustained institutional demand
• Private equity: EU-domiciled private equity funds are largely closed-ended and use little leverage, but typical risk indicators need to be interpreted with caution
• Private debt: The net assets of private debt funds have grown but remain smaller than private equity funds

Key vulnerabilities in private finance: The report identifies a number of important vulnerabilities in the private finance space, including:

• Assessing leverage in private equity – The lack of a look-through approach in the regulation of private equity funds complicates the assessment of leverage
• High leverage makes portfolio companies vulnerable – The difficulty in assessing NAV financing strategies at a time of increasing credit risk due to large data gaps
• Valuation – Information asymmetries between fund managers and investors as well as low-frequency valuations generates valuation risk and investor harm
• Interconnectedness – The overlaps between public and private markets mean that disruptions in private markets can spread to the banking sector and institutional investors
• Liquidity risk – Liquidity risks may arise where funds have difficulties in liquidating their assets when approaching the end of their lifespan, though the closed-ended structure of most private equity and debt funds means liquidity mismatch is not currently too concerning
• Macroprudential policy – Potentially weaker borrowers and loan structures in private finance transactions could foster the substitution of credit away from banks toward non-banks. In addition banks themselves might set up private debt funds themselves, which raises questions around regulatory arbitrage

Conclusion: The report concludes that while private finance does not seem to pose an immediate concern from a systemic risk perspective its growth could contribute to financial imbalances in future.

Looking ahead: The ESRB states that it is important to enable adequate information, including on the volume and quality of lending by non-banks, as well as more detailed data on interlinkages with the banking sector and institutional investors.

Other features: In addition to private finance, the report explores two other particular features focusing on specific risks and vulnerabilities:

• Ownership structure of EU fund managers: most EU fund managers belong to banking groups; ownership links between fund managers and other financial institutions can create reputational or step-in risk
• Money market funds (MMFs): the global role played by EU-domiciled MMFs and the regulatory reforms taking place outside of the EU call for a comprehensive assessment of the EU regulatory framework on MMFs to ensure resilience

CFTC makes first charge under Whistleblower Protection Rules

The Commodity Futures Trading Commission (CFTC) fined a global commodities merchant $55 million for multiple Commodity Exchange Act (CEA) violations relating to its physical oil trade and hedging practices. Importantly, the charges include – for the first time – a violation of Regulation 165.19(b) of the Commission’s Whistleblower Rules, which prohibits firms from taking any action that would impede whistleblowing. 

In more detail: The CFTC order found that the firm impeded voluntary communications with the Commission through its use of employment and separation agreements with broad non-disclosure provisions that prohibited the sharing of confidential information with third parties. The CFTC order states that the provisions caused confusion that resulted in an impediment to voluntary and direct communications with the CFTC about possible violations.

Some commissioners remain skeptical: Commissioner Caroline D. Pham opposed the Commission’s decision to charge the firm for violating Regulation 165.19(b), noting that the firm had two savings provisions to permit disclosure and that the decision would likely lead to uncertainty among regulated entities about their own use of non-disclosure provisions. Commissioner Summer K. Mersinger also noted her opposition to the Regulation 165.19(b) charge, stating that “the Commission’s decision to bring this specific charge is inconsistent with the regulation’s text and prior Commission statements regarding the regulation’s intent.”

Saudi Arabia calls for public consultation on draft amendment of investment funds regulations

The Saudi Capital Market Authority (CMA) has opened a consultation on proposed amendments to Investment Funds Regulations. 

Summary: Under the proposals outlined, restrictions would be removed so that public funds can purchase private debt instruments from issuers within the Kingdom. 

• The amendments aim to increase the debt market’s attractiveness by expanding the range of assets available for investment
• They also include investor protection measures – funds will not be able to invest more than 10% of their value into debt instruments from a single issuer and would be required to disclose the credit rating of their debt instruments in quarterly statements

Next steps: Consultation is open until July 12, 2024.

FINMA issues guidance on operational risk management by fund management companies and managers of collective assets

The Swiss Financial Market Supervisory Authority FINMA published guidance on the management of operational risks by fund management companies and managers of collective assets. 

Important context: FINMA has determined that operational risks at supervised institutions are increasing due to digitalization of the financial sector and that there are growing weaknesses in operational risk management by fund management companies and managers of collective assets.

In more detail: FINMA describes weaknesses it has identified and underlines the importance of appropriate operational risk management within fund management companies and managers of collective assets.

• FINMA lists the general principles of appropriate risk management, which also apply to the management of operational risks
• FINMA also describes measures to ensure appropriate management of risks in the areas of information and communication technology, data, cyber, business continuity, legal and compliance as well as outsourcing

CFTC approves final capital comparability determinations for certain Non-U.S. nonbank swap dealers 

The Commodity Futures Trading Commission (CFTC) approved four comparability determinations and related orders finding that the capital and financial reporting requirements in Japan, Mexico, the European Union (France and Germany), and the United Kingdom are comparable to the Commission’s capital and financial reporting requirements for nonbank swap dealers. 

Certain conditions apply: Eligible non-U.S. nonbank swap dealers seeking to rely on a comparability order must notify the Commission of its intention to satisfy the Commission’s capital and financial requirements by substituted compliance and receive a Commission confirmation before relying on a determination.

The Commission notes that although certain differences exist between the foreign jurisdictions and its own requirements, it is its view that they are not inconsistent with a substituted compliance framework, when subject to specified conditions. These conditions include:

• That each non-U.S. nonbank SD relying on an order maintain, at all times, an amount of common equity tier 1 capital (or equivalent) that is equal to or in excess of the equivalent of $20 million
• Requirements to provide the Commission and NFA with copies of certain reports and notices of certain events, including a notice if the non-U.S. nonbank SD experiences a decrease of 30 percent or more in its excess capital or if the firm fails to make or keep current financial books and records

Timeline: The orders will be effective upon their publication in the Federal Register. Several order conditions were granted an additional compliance period of 180 calendar days. 

View the additional regulatory briefs from this month:

• Trading and markets
• Green finance
• Digital finance

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