Category Archives: Regulatory Risk

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6 Key Areas of RM for the Banking Industry

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If you haven’t heard enough about risk management within the banking industry, well, that’s a good thing. The more ideas about the discipline and how it can be implemented within the sometimes-risk-loving financial institutions, the better.

On that note, Ernst & Young recently released “CFO Report: Bank Capital Management in Uncertain Times.” The report covers, as stated, capital management strategies, but it also delves into the areas of risk management getting the most attention at global banks. Since the financial crisis, banks recognize that the quantitative risk models many had relied upon are no longer adequate. The survey found that CFOs, chief risk officers and the organizations that they are a part of are coming together to focus on six key areas of risk management:

Reassessment of business strategy
Analysis and implementation of capital optimization opportunities
Monitoring and revision of capital adequacy goals
Reduction of the complexity of business operations and rationalization of legal entity structure
Improvements in reporting
Improvements in data quality and systems
  1. Reassessment of business strategy
  2. Analysis and implementation of capital optimization opportunities
  3. Monitoring and revision of capital adequacy goals
  4. Reduction of the complexity of business operations and rationalization of legal entity structure
  5. Improvements in reporting
  6. Improvements in data quality and systems

Peter Davis, E&Y’s director of credit risk services, talks about capital management and understanding the risks associated with a new regulatory environment (read: Basel III) in this brief but informative video.

Environmental Risk: Not a Hot Topic For Spain’s Businesses

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spanish flagBack in May, the European Union’s environmental liability directive was officially put into place, exposing European risk managers to greater liabilities for environmental damage caused by companies that pollute as part of their normal business operations.

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But not all of the EU’s 27 member states are taking charge of their new responsibility. Spain, for one, has shown a lack of awareness when it comes to environmental risks, legislation and avenues of protection available.

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According to the Business Environmental Liability study, more than half of the 700 businesses studies in Spain did not have environmental liability coverage.

The survey also revealed that of those companies that said they had cover in place against environmental damage, only 10% had a policy that conformed to established regulations (Law 26/20071). Companies cited their multi-risk policy/financial guarantee, public liability and general business insurance policies as providing environmental risk protection. However, these products do not conform to the requirements of Law 26/20071 on Environmental Liability.

It seems apparent that many businesses in Spain do not fully understand the implications of the EU’s environmental liability directive. In fact, a whopping 65% of companies surveyed said they were unaware that the Spanish government has the ability to make it a requirement for these companies to have a fund, collateral or insurance to cover them from possible environmental damage.

Though numerous insurers jumped at the chance to offer environmental liability coverage to the EU market, a lack of demand has been evidenced from the beginning of the directive’s establishment.

Risk managers don’t seem to be “aware of how much of a strict regime is now in place and the cost of responding to that regime if you have a problem,” said Simon White, London-based environmental branch manager for XL Insurance.

Why is Spain a laggard when it comes to this topic? If the country’s businesses don’t get on board soon with the EU’s environmental liability directive, it will affect not only their bottom line, but also their reputation.

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Financial Reform and Regulatory Expansion

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Whether you like it or not, the Dodd-Frank Wall Street Reform and Consumer Protection Act is now law. Passed by the Senate finally last week and signed by President Obama yesterday, financial reform will have wide-ranging implications for the financial services sector (including the insurance industry), the rest of corporate America and, really, just the whole country.

The most immediate effect will be the creation of new regulatory groups.

The National Law Review published a great breakdown. Here are the four more interesting additions.

Consumer Financial Protection Bureau
Will write consumer protection rules for banks and nonbank financial firms offering consumers financial services or products and ensure that consumers are protected from “unfair, deceptive, or abusive” acts or practices.

Federal Insurance Office
Will monitor all aspects of the insurance agency and identify issues or gaps in regulation that could lead to systemic risk.  Based upon its findings, the FIO will make recommendations to the FSOC regarding insurance institutions that pose a systemic risk and should be subject to greater regulatory oversight.

Financial Stability Oversight Council
Will identify risks and emerging threats to the financial stability of the United States arising from large bank holding companies and systemically important nonbank financial companies and respond with appropriate regulation to reduce the risk from their size and activities.

Office of Financial Research
Will have the power to subpoena financial information from institutions under the supervision of the Fed.  The OFR may require periodic and other reports from any nonbank financial company or bank holding companies.

The law also includes provisions surrounding “too big to fail,” the “Volker rule,” derivatives, hedge funds and “predatory” lending, but the regulatory changes are the most significant. And while it will be interesting to see how these new agencies take shape, the expanded mission of the SEC is the real story here.

I don’t think it’s a stretch to say that the SEC has been an abject failure since (at least) the turn of the millennium. I’m sure there was some good work done by the agency during this time, but if its core mission is to safeguard Americans from being duped by the unintelligible complexity masking the activity of Wall Street, the financial watchdog could not have performed more miserably. On its watch, complex, risk-laden transactions proliferated and — once the mirage of risk-free mortgage securities disappeared — ran the global economy head first into a brick wall. And this failure to check the financial institutions culpable was so great that, more than two years after Bear Stearns collapsed, nearly 10% of Americans still can’t find a job.

The Washington Post details the SEC’s expansion.

The SEC is required to issue 95 new regulations governing a wide swath of the financial sector, dozens more than the Federal Reserve, the new Consumer Financial Protection Bureau or other federal agencies. The SEC is also slated to complete 17 one-time studies and five new ongoing reports, according to a tally by the law firm Davis Polk & Wardwell.

The SEC will serve on the new Financial Stability Oversight Council, a new interagency body meant to spot emerging risks to the overall financial system. It will have to write rules to supervise the multibillion-dollar market of derivatives linked to stocks and bonds. It will begin examining the activities of hedge funds and private equity firms and tighten oversight of credit-rating agencies. And it will do studies of short selling and whether brokerage and investment firms must meet higher standards.

Perhaps only the Office of Thrift Supervision can compete with the SEC in terms of the new law’s impact. But in contrast to the SEC, which is gaining so many new responsibilities, OTS, which regulated home lenders, is being abolished.

Indeed, the SEC is coming out of the financial regulatory overhaul far stronger than many observers of the agency might have anticipated.

While in some ways it seems counterintuitive to task what some have perceived to be a failed agency with greater authority, I suppose some body has to do it. And change — for the better — is theoretically what reform is all about.

So … Enter a new stage of regulation, as John Lester and John Bovenzi succinctly point out.

Enactment of Dodd-Frank … marks only a new stage of financial reform, as the debate shifts to the rulemaking efforts of federal agencies. The complexity of the law and the many decisions delegated to regulators makes it difficult to predict which of the law’s many provisions will come to be the most significant. Ultimately, it will be regulators who determine the true impact of the law.

And that’s what has so many people scared — including business leaders who think regulators will be too draconian and SEC critics who think regulators will be too inept.

The Supreme Court’s Sarbanes-Oxley Ruling in Plain English

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If you’re like me, you’re not that smart. And when you read complicated articles like this New York Times breakdown of Monday’s Supreme Court decision involving Sarbanes-Oxley, your head starts to hurt a little. Wait? What exactly happened? Will this change anything for companies?

Fortunately, Anand Rao, partner at Diamond Management & Technology Consultants, is an expert in the history of and the controversy surrounding Sarbanes-Oxley and can clearly explain exactly what you need to know about the Supreme Court’s ruling.

supreme court

Jared: What was the main controversy about Sarbanes-Oxley that the Supreme Court was ruling on?

Rao: Sarbanes-Oxley was passed in 2002 as a response to some of the accounting issues related to Enron and Worldcom. The law created the Public Company Accounting Oversight Board (PCAOB) to regulate the accounting industry. The five board members were accounting specialists appointed by the Securities and Exchange Commission. The SEC could remove board members if there was a good cause to do so.

Free Enterprise Fund, a nonprofit advocacy group, along with a small Nevada accounting firm Beckstead and Watts challenged the creation of the PCAOB in Sarbanes Oxley, specifying that the removal of board members by the commission for just cause contravened the separation of powers in the U.S. Constitution as it gave wide-ranging executive power to board members without subjecting them to presidential control.

Jared: Why did the Court rule against this structural set-up?

Rao: With a 5-4 majority ruling, the Supreme Court declared that the act “not only protects Board members from removal except for good cause, but withdraws from the President any decision on whether that good cause exists.” It claimed that “by granting the Board executive power without the Executive’s oversight, this Act subverts the President’s ability to ensure that the laws are faithfully executed.” To remedy this situation the Supreme Court has ruled that the SEC now may remove the Board members at will, without the need to demonstrate a good cause.

However, the Supreme Court made it very clear that this had no bearing on the remaining aspects of the Sarbanes Oxley Act by stating that the “unconstitutional tenure provisions are severable from the remainder of the statue.” So for all practical purposes, there will be no change to the way PCAOB operates.

Jared: Will the change have any effect on companies? How about risk and compliance employees? Insurance companies?

Rao: Although the Supreme Court ruling impacts how board members may be removed, it has no impact on what public companies need to do. All public companies will continue to be subject to the same requirements as before under the Sarbanes Oxley Act and there will be no change to the operational functioning of the public companies. Similarly, there will be no impact to risk and compliance employees or insurance companies – it’s just a re-validation that the act is here to stay.