Liquidity reporting. Implementation challenges and the impact of Brexit

Transcription

1 Liquidity reporting Implementation challenges and the impact of Brexit

2 Contents 1. Background 3 2. Introduction 5 3. Brexit timelines 7 4. Liquidity timelines 8 5. Challenges faced by FS captives in implementing liquidity reporting 9 6. Challenges in implementing liquidity reporting from a Capital Requirements Directive IV (CRDIV) perspective due to Brexit Our recommendations 12

3 Background The Basel Committee on Banking Supervision (BCBS), also known as the Committee on Banking Regulations and Supervisory Practices, was established by the central bank Governors of the Group of Ten countries at the end of 1974 because of serious disturbances in international currency and banking markets. It is headquartered at the Bank for International Settlements in Basel. This Committee is the primary global standard setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Its mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability. The Committee has established a series of international standards for bank regulation like the Basel Concordat, which was first issued in In addition, in the recent past, it has issued landmark publications of the accords on capital adequacy, which are commonly known as Basel I, Basel II and Basel III. Basel III introduced liquidity requirements to ensure that banks had enough liquidity during times of financial stress. Liquidity is the ability of a bank to fund increases in assets and meet obligations as they become due. The fundamental role of banks, which is maturity transformation of short-term deposits into long-term loans, makes them inherently vulnerable to liquidity risk, both of an institution-specific nature and that which affects markets as a whole. Effective liquidity risk management helps ensure a bank s ability to meet cash flow obligations, which are uncertain as they are affected by external events and other agents behaviour. During the early liquidity phase of the financial crisis that began in 2007, many banks, despite adequate capital levels, experienced difficulties because they did not manage their liquidity in a prudent manner. The crisis drove home the importance of liquidity for the proper functioning of financial markets and the banking sector. Prior to the crisis, asset markets were buoyant and funding was readily available at low cost. The rapid reversal in market conditions illustrated how quickly liquidity can evaporate, and that illiquidity can last for an extended period of time. The banking system came under severe stress, which necessitated central bank action to support both the functioning of money markets and, in some cases, individual institutions. 3 Liquidity reporting Implementation challenges and the impact of Brexit

4 The difficulties experienced by some banks were due to lapses in basic principles of liquidity risk management. In response, the Committee developed the following: In 2008, it published the Principles for Sound Liquidity Risk Management and Supervision. These provide detailed guidance on the management and supervision of funding liquidity risk, and should help promote better risk management in this critical area. In 2013, to complement these principles and further strengthen its liquidity framework, BCBS introduced: Liquidity coverage ratio (LCR) to promote short-term resilience of a bank s liquidity risk profile by ensuring that it has sufficient highquality liquid assets (HQLA) to survive a significant stress scenario lasting for one month and Net stable funding ratio (NSFR) to promote resilience over a longer time horizon i.e. a one-year time horizon by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing basis In addition, the Committee also developed a set of monitoring tools to further strengthen and promote global consistency in liquidity risk supervision. These tools are supplementary to the LCR and are used for ongoing monitoring of the liquidity risk exposures of banks, and in communicating these exposures among home and host supervisors. During this period, a major political event, Brexit, shook the European Union (EU) on 23 June 2016 when the UK decided to leave the EU, with 51.9% of the ballot voting in favour of this decision in a referendum. While Brexit is set to impact all sectors, understanding and quantifying its impact on the financial services (FS) sector in particular and on the regulatory environment in both the EU and UK are and will continue to be a challenging task. Brexit could destabilise the financial market, thus increasing risk and complexities in transition and transformation. This report focuses on two types of challenges faced by FS captives based out of India: Challenges in the implementation of liquidity reporting like the LCR, NSFR and additional liquidity monitoring metrics (ALMM) and Challenges in the implementation of liquidity reporting due to Brexit 4 Liquidity reporting Implementation challenges and the impact of Brexit

5 Introduction I] Liquidity coverage ratio (LCR) The objective of the LCR is to promote the short-term resilience of the liquidity risk profile of banks. It does this by ensuring that banks have an adequate stock of unencumbered HQLA that can be converted easily and immediately in private markets into cash to meet their liquidity needs for a 30-calendar day liquidity stress scenario. Stock of HQLA Total net cash outflows over the next 30 calendar days As per BCBS, banks have to maintain a ratio of greater than or equal to 100%; however, the timeline for implementation has been phased in from a minimum of 60% in 2016, increasing by 10% every year to 100% in II] Net stable funding ratio (NSFR) > _ 100% The NSFR is the amount of available stable funding relative to the amount of required stable funding. This ratio should be equal to at least 100% on an ongoing basis. Available stable funding (ASF) is the portion of capital and liabilities expected to be reliable over the time horizon considered by the NSFR, which extends to one year. Required stable funding (RSF) is the amount of stable funding that a bank is required to hold given the liquidity characteristics and residual maturities of its assets and the contingent liquidity risk arising from its off-balance sheet exposures. Available amount of stable funding Required amount of stable funding > _ 100% The draft consultative document was published by BCBS in October 2014, and the observation period was scheduled until 2017, with implementation in III] Additional liquidity monitoring metrics (ALMM) In 2013, the European Banking Authority (EBA) proposed Implementing Technical Standards (ITS) aimed at developing additional metrics other than the liquidity coverage and stable funding requirements with a view to providing supervisors with an adequate toolkit to assess liquidity risk and to facilitate their work in performing reviews of internal liquidity adequacy assessment processes (ILAAP). The following metrics have been proposed in the draft ITS: Maturity ladder, both contractual and behavioural This is similar to the contractual maturity mismatch put forward by the BCBS text and provides insight into the extent to which a bank relies on maturity transformation under its current contracts. The maturity of the outflows and inflows that are to be reported in both contractual and behavioural templates ranges from open maturity up to greater than 10 years. Concentration of funding by counterparty This metric allows the identification of sources of wholesale and retail funding of such significance that their withdrawal could trigger liquidity problems. Financial institutions are expected to report the top 10 largest counterparties from which funding obtained exceeds a threshold of 1% of total liabilities, together with information such as the counterparty name, counterparty type and location, product type, currency, amount received, weighted average and residual maturity. 5 Liquidity reporting Implementation challenges and the impact of Brexit

6 Concentration of funding by product type It seeks to collect information about the institution s concentration of funding by product type (i.e. retail funding and wholesale funding). Institutions are expected to report the total amount of funding received from each product category when it exceeds a threshold of 1% of total liabilities. Prices for various sources of funding This metric seeks to collect information about the average transaction volume and prices paid by institutions for funding with different maturities, ranging from overnight to 10 years. Rollover of funding This metric seeks to collect information about the volume of funds maturing and new funding obtained (i.e. rollover of funding) on a daily basis over a monthly time horizon. 6 Liquidity reporting Implementation challenges and the impact of Brexit

7 Brexit timelines For reference purposes, we have created a brief snapshot of the Brexit timelines in the context of this document. The European Union (Withdrawal) Bill has its first reading in the House of Lords. The EU has suggested that November is the latest the deal can be finalised. If not, then the EU Summit in December will reconsider if the EU-UK still want to reach an agreement. Transition and implementation period to begin on 30 March The EU wants the transition period to end by December January 2018 November/ December March 2019 December 2020 March 2017 October 2018 March 2019 The UK Prime Minister formally triggered Article 50 and began the twoyear countdown to the UK formally leaving the EU. The terms of the Withdrawal Agreement are expected to be decided at the EU Summit. A political declaration on the future relationship between the UK and the EU is also expected at this point. Assuming the Withdrawal Agreement and Implementation Bill are concluded, voted on and approved by the Parliament, the UK is expected to leave the EU on 29 March Liquidity reporting Implementation challenges and the impact of Brexit

8 Liquidity timelines LCR: Banks to report 70% ratio ALMM: Implementation of the technical standards and proposed amendments to the maturity ladder report LCR: Banks to report 90% ratio ALMM: Implementation of the revised maturity ladder report NSFR: Banks to begin implementation of the ratio by January LCR: Phased implementation begins. Banks to report 60% ratio LCR: Banks to report 80% ratio LCR: Banks to report 100% ratio 8 Liquidity reporting Implementation challenges and the impact of Brexit

9 Challenges faced by FS captives in implementing liquidity reporting Based on our experience in supporting the FS captives of EU, UK and US banks in India with the implementation of the LCR, NSFR and ALMM, we discuss some of the common challenges that arise below. Process and controls: Reference data and static data required for enrichment of trade data is sourced from multiple systems and poses a risk to the accuracy and completeness of liquidity reporting if any system fails to send data at the scheduled time and of standard quality Lack of coherence and consistency in the liquidity data and data processing due to different regional and consolidated reports required by the regulators High degree of manual intervention in dayto-day processes of reporting and analysis leaves the reporting prone to errors Accuracy and completeness of the data used for reporting will be hampered without a robust reconciliation framework In the absence of maker-checker controls, accurate regulatory reporting could be impacted Systems and infrastructure: IT infrastructure and systems (either inhouse or third party) are sometimes not flexible enough to incorporate changes; their processing time is hampered due to data volumes; and ownership is not defined. This could result in delays in report generation, thus leading to regulatory repercussions. Building of incorrect or incomplete business logic required for reporting into the systems leads to manual workaround or adjustments, which increases not only operational risk due to possible errors but also non-compliance with regulations. Banks could be heavily fined due to such process and reporting gaps. Treasury booking models and front office systems are not correctly set up to create the pipeline of trades and capture all necessary information related to the trade. There is no central data repository (golden source) for all of the external and internal liquidity reporting, which may lead to inconsistencies in the balances reported given that multiple data sets are in use. Regulatory: In case of amendments or additions to the regulations, complexities increase as these have to be incorporated into the systems, which could impact existing processes. On-shore stakeholders have subject matter expertise, particularly around technical aspects of regulatory reporting. This increases dependency on them and limits any critical offshore decision making due to limited exposure. 9 Liquidity reporting Implementation challenges and the impact of Brexit

10 Challenges in implementing liquidity reporting from a Capital Requirements Directive IV (CRDIV) perspective due to Brexit The impact of Brexit varies across banks due to factors like cross-border trading activity, geographical operations, extent of their presence in the UK and EU and the complexity of the institution. A bank that has higher cross-border trading activity would incur higher costs and take more time to implement Brexit in comparison to one that has limited cross-border trading activity. However, each bank might have a different strategy to tackle Brexit depending on its clientele in the EU and the UK and agreement to trade with the bank post implementation. Banks could either migrate part of their operations to an existing legal entity, expand operations in their current setup or set up an altogether new legal entity in the EU. The challenges below are based on the assumption that the bank decides to set up a new legal entity within the EU to continue to provide wholesale and investment banking services to its existing and new clients. 01 The CRDV implementation timelines are uncertain due to political negotiations and could be anytime post So, banks face not only the challenge of implementing CRDIV in the current mayhem but also of transitioning to a new operating model to be compliant with the future regulatory reforms. 03 Regulatory and IT licences are procured or leveraged for the new entity in a timely manner. An additional cost would be incurred if new licences are to be bought to enable the new entity to be compliant with the regulations. 02 The timeline for submission of reports for the new entity and the group entity may not be the same and amendments to the existing regulation or introduction of new regulations will increase the complexity, cost and time of implementation, which poses a risk to the bank. 04 If existing infrastructure in terms of trading desks and treasury booking models are being leveraged from existing entities, it is quite possible that it might not be as per the regulations of the local authority. 10 Liquidity reporting Implementation challenges and the impact of Brexit

11 Some additional challenges are discussed below: Systems and infrastructure: Existing systems leveraged should be able to handle the volume of trades. There could be an additional cost if these systems have to be upgraded or new ones have to be procured. Trade data, reference data and static data required for enabling reporting should be set up; lack of these could result in wrong/incomplete reporting. IT systems will have to be amended to create a pipeline for consolidated group reporting as the new legal entity will be added. Batch and runtime of trade booking, processing and reporting should be factored in, as reporting will be done for the new entity and the consolidated region. Timely availability of data, both for local and consolidated reporting, is a prerequisite for ensuring reporting compliance. People A new treasury team will have to be set up for the new entity, which is an additional cost either through new recruitments and training or relocation of existing employees, assuming the visa process will be smooth post Brexit. There will be an additional cost of resources if the new entity s business as usual (BAU) work of data retrieval, testing and report submission is outsourced to other subsidiaries of the bank. There is also a duplication of efforts in this scenario, which could lead to inconsistency in processes and operational risk. 11 Liquidity reporting Implementation challenges and the impact of Brexit

12 Our recommendations Good human resource planning is necessary to either relocate, downsize or retain staff depending on the implementation strategy adopted by the bank so as to minimise the cost of setting up a new treasury team. Using existing regulatory approvals and IT licences rather than obtaining new approvals wherever possible would minimise the time, cost and resources required. However, if new approvals cannot be avoided, it is necessary to identify them at an early stage, engage with the regulators, submit applications for approvals and additional information, and manage the process to completion. This would help the banks develop plans with more certainty. Planning the use of existing IT infrastructure and minimising the need for new infrastructure to eliminate repetitive tasks along with clear definition of ownership will help in avoiding delays in processing and report submission. Defining business logic and ensuring required transactional and reference data to support it is available well before the implementation phase will eliminate manual tasks, errors which could lead to duplication of efforts, heavy regulatory fines and operational risk. Banks must have an appropriate liquidity risk management framework in place to manage liquidity risk and adequate liquidity resources to meet potential cash outflows over the applicable internal and regulatory stress scenarios. In order to ensure timely reporting and compliance, a strategic data warehouse for internal and external liquidity reporting must be set up as per the BCBS 239 requirements, providing granular-level data and making sure data quality, accuracy and integrity are maintained. Coherence in regional and consolidated group reporting can be achieved by bringing together a common upstream system and calculation engine with timely availability of data. Having a two-way reconciliation process with general ledger (GL; books and records) and golden liquidity source systems ensures completeness of data with respect to capturing of all product categories in liquidity reporting. Banks must carry out consistency checks among internal and external liquidity reports to prevent reporting of inconsistent balances. Significant investments in IT and infrastructure are needed to harmonise data flows by creating a bank-wide central repository of all liquidity data that serves as a golden source for all liquidity reporting. 12 Liquidity reporting Implementation challenges and the impact of Brexit

13 Bibliography Association for Financial Markets in Europe. (April 2017). Implementing Brexit: Practical challenges for wholesale banking in adapting to the new environment. Retrieved from downloads/publications/afme-implementingbrexit-2017.pdf BCBS. (September 2008). Supervision Principles for Sound Liquidity Risk Management and Supervision. Retrieved from BCBS. (January 2013). Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools. Retrieved from BCBS. (2014). Basel III: The Net Stable Funding Ratio. Retrieved from bis.org/publ/bcbs271.pdf BIS. (14 April 2018). History of the Basel Committee. Retrieved from htm?m=3%7c14%7c573%7c76 BIS. (5 June 2018). Basel Committee Charter. Retrieved from charter.htm?m=3%7c14%7c573%7c70 EBA. (2013). Consultation Paper on Draft Implementing Technical Standards on Additional Liquidity Monitoring Metrics under Article 403(2) of the draft Capital Requirements Regulation (CRR). Retrieved from documents/10180/204373/cp-on-additionalmonitoring-metrics-for-liquidity---final-to-bepublished.pdf Kraemer, D., & Ash, S. (22 August 2018). Brexit: Key dates and potential hurdles. Retrieved from uk-politics UK Parliament. (7 November 2018). Brexit timeline: events leading to the UK s exit from the European Union. Retrieved from ResearchBriefing/Summary/CBP-7960 Contact us Vivek Iyer, Partner Shiva Iyer, Director Venkatesh Atreya, Manager Romit Salecha, Assistant Manager Vanessa Fernandes, Experienced Consultant

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