Enterprise Risk and Regulatory Compliance

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Reginald Joseph
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1 Enterprise Risk and Regulatory Compliance May 2014 Stephen O Brien Head of Capital, Liquidity and Risk Policy Westpac Institutional Bank

2 The 2014 economic landscape shows the first real signs of recovery since the financial crisis In 2013 Outright recession in Europe Uncertainty around the impact of US tapering Protracted monetary easing in Australia In 2014 Advanced economies looking in better shape than at any time since the crisis though imbalances remain (e.g. Western government debt) Emerging markets including China are showing signs of slowing Policy-driven slow-down in China External financing vulnerability for India and commodity exporters Domestic outlook House prices have been rising strongly, construction set to lift as well. Non-mining investment remains weak Mining capital expenditure boom has peaked Terms of trade moving lower Fiscal policy is tightening Labour market indicates net balance is unfavourable for now Interest rates expected to be on hold Currency has firmed 2

3 While the regulatory change agenda continues to expand, with direct and indirect impacts Capital Market risk Derivative reform Basel III definitions and minimums Basel 2.5 Central clearing Capital buffers Conservation, counter-cyclical Leverage ratio Systemically important banks Stressed VaR, CVA Fundamental review of the Trading Book Interest Rate Risk in the Banking Book Counterparty credit risk SA-CCR, CVA, CCP Margin requirements Variation, initial Trade reporting Bail-ins Related market developments OIS discounting Liquidity risk Supervision and business structure FVA Liquidity Coverage Ratio Recovery and resolution planning Segregation, ring-fencing Other Net Stable Funding Ratio Volcker rule Data Conglomerate supervision Benchmark reviews Supervision Large exposures Remuneration Securitisation Disclosure Trader monitoring Conduct risk / risk culture 3

4 that need to be navigated in combination with other significant change drivers in the institutional banking world. Regulatory reform and market developments Cyclical Economic growth (developed / emerging) Liquidity flows Government policy Market uncertainty Competitive landscape Lower government / corporate investment Structural Product development Pricing differentiation / margin compression Technology and data Central clearing and trade repositories Balance sheet / capital structure Enterprise risk How can Risk respond to turn change into a sustainable competitive advantage? 4

5 Several key reforms are finalised but a substantial number of unknowns remain. Implementation Confirmed Basel 2.5 (CVA, stressed VaR) Recovery plans Derivative reporting Volcker rule Liquidity Coverage Ratio (LCR) Margin for non-centrally cleared derivatives Systemically Important Banks Capital cons. / countercyclical buffer In progress Conglomerate supervision Mandatory central clearing Capital for central counterparties Leverage Ratio Standardised Approach to CCR (SA-CCR) Internal Model Method to CCR Net Stable Funding Ratio Securitisation Bail-in provisions Large exposures Fundamental Review of the Trading Book Interest Rate Risk in the Banking Book Funding Valuation Adjustment Data management Trader monitoring Resolution plans Conduct risk 5

6 Derivative reform is a core area where regulatory change is resulting in increasing complexity and cost. Shift from bilateral to central clearing Bank X Bank X Centrally cleared: Variation margin Initial margin Mandatory clearing for some instruments Lower capital requirements Direct membership / clearing agreements (pass-through risk) Non-centrally cleared: Variation margin Non-centrally cleared: Variation margin Initial margin 6

initial margin Regulatory capital requirements Collateral requirements Administration requirements Marginal contribution of a derivative trade Change in Credit Valuation Adjustment (CVA) Change in

7 Pricing systems need to be adapted to accommodate complex interactions and marginal impacts in real-time. Impact of collateral and central clearing on derivative pricing Normal bilateral (no CSA) Less frequent bilateral CSA Daily posting bilateral CSA Initial margin bilateral CSA Central clearing with initial margin Regulatory capital requirements Collateral requirements Administration requirements Marginal contribution of a derivative trade Change in Credit Valuation Adjustment (CVA) Change in CVA capital Change in Counterparty credit risk capital Change in margin Change in market risk capital Change in Funding Valuation Adjustment Marginal impacts of new trades will vary by bank in accordance with the composition of the portfolio at any given time. Customers may receive widely varying price quotes for the same transaction. 7

8 The Fundamental Review of the Trading Book (in consultation phase) is likely to be a game-changer. Capital based on stressed period (vs current + stressed period VaR) Market liquidity factored directly into the calculation through liquidity horizons Shift from Value-at-Risk to Expected Shortfall Revised standard method mandatory calculation, may be required to disclose publicly and may be treated as a floor on capital Diversification across risk factors constrained Model accreditation by trading desk, including desk-level back-testing Additional 'risk assessment tool' for desks with illiquid and/or complex products The standard method will be mandatory for securitisation positions Introduce a new default risk model consistent with the banking book Capital requirements likely to increase Significant additional computational and hardware requirements More onerous validation and accreditation process (by desk) May need to price market risk capital into some less liquid risks? CVA capital charge will move to expected shortfall and remain stand-alone Strengthened boundary between trading book and banking book to prevent arbitrage 8

9 Regulatory reforms are targeting to reduce risk but may also result in transferring or transforming risk. Regulatory change Potential impacts Derivative reform Initial margin Central clearing New processes Funding and liquidity risk Counterparty credit risk Collateral risk Operational risk Liquidity Coverage Ratio Liquidity risk Increase in liquid asset holdings Sovereign risk Credit and market risk Higher regulatory requirements Risks to financial system Increasing complexity Increasing operational costs Uneven implementation Smaller bank business models may become unviable Barriers to entry for new market participants Concentration risk Shift towards non-banks Arbitrage / inefficient liquidity and capital flows 9

10 The institutional banking business needs to respond to regulatory change dynamically Product design / offerings Does the risk/reward trade-off under new regulation require significant changes to product design? Are some product offerings now unviable? Pricing To what extent should higher capital / liquidity / implementation charges be reflected in customer pricing? Pricing per trade: dynamically assessing marginal contribution of a particular trade to the portfolio Balance sheet How do we optimise the asset / liability mix to go from the balance sheet we have to the one we want? How do we optimise balance sheet management strategies (e.g. where we book trades) Trader monitoring Implementing adequate monitoring systems and safeguards to mitigate market manipulation risk (eg LIBOR / FX / BBSW) and rogue trading Technology and data How can we leverage technology to stay ahead of the changes while getting the basics right? How can we use new technology to better serve customers? Customer relationships How do we keep our customers informed and prepared, partner with them and make it easy to do business with us? Responsiveness How do we make all of the above seamless and minimise disruption? 10

11 Keeping pace with (and ahead of) innovation requires a vigilant, flexible approach to anticipate trends and prioritise actions. Key drivers Key innovation trends Evolving customer needs Digital and real-time Easier, faster, simpler Regulatory reform and related market change Payments innovation New market entrants Disintermediation / disruptors Financial Markets e-facilitation Competitor investment Simplification Process efficiency / customer experience Internal demands Competitiveness / internal efficiency Big Data / Analytics 11

12 The mandate of Risk and Compliance is to steer the business through regulatory change, while avoiding over-reaction. Response Understand changes, implications and interactions Drive regulatory and industry responses to influence change Clarity in communication Risk / return Clearly define risk appetite with supporting limit structures Transparent allocation mechanisms to drive the right behaviours Constantly strive for process improvements and simplification Infrastructure and data Robust, integrated and real-time measurement systems Sustainable and adaptive systems and technology Commitment to data integrity Culture and conduct Risk as an integral part of business strategy: Risk is everyone s business Embedded processes for risk identification, control and escalation Increasing focus on conduct risk, litigation risk and reputation risk Governance Consistency and clarity in policy settings Effective monitoring mechanisms Well-defined roles & responsibilities for Board, senior management and lines of defence 12

13 To recap We are here primarily to serve customers and fulfil their needs The global and local environment in which we do that is undergoing massive change that will continue for the foreseeable future get used to it and treat it as a glass half full Competitive advantage for those who understand the implications better, generating substantial, sustainable financial outcomes Risk management plays a much more active role in strategy and achieving business outcomes but there is a risk of overkill 13

14 Thank you 14

15 Legal Disclaimer. This document is prepared by Westpac Institutional Bank, a division of Westpac Banking Corporation ABN AFSL ( Westpac ). This document has been provided to you in your capacity as a wholesale client under the Corporations Act 2001 (Cth). This document is not to be distributed to retail clients. The information in this presentation is (a) current as at the date shown on the front page; (b) contains general commentary only and does not constitute investment advice or financial advice; and (c) has been prepared without taking into account your objectives, financial situation or needs. Because of this, you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. The information contained in this presentation has been derived from sources believed to be accurate. Worked examples are included for illustrative purposes only and are not intended to be indicative of the likely performance of the underlying product. Past performance is not an indicator of future performance. This presentation does not constitute an offer, or a solicitation of an offer, to subscribe for or purchase any securities or other financial instrument; is not an invitation to invest; is not an offer for finance; does not constitute an offer, inducement or solicitation to enter a legally binding contract; and is not to be construed as an indication or prediction of future results. Any projections given in the presentation are predictive in character. While every effort has been taken to ensure that the assumptions on which the projections are based are reasonable, the projections may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ from these projections. This information should not be misconstrued as any opinion or recommendation in relation to the any product. While Westpac has made every effort to ensure the information is free from error, Westpac does not warrant the accuracy, adequacy or completeness of the information. This presentation may contain material provided by third parties. While such material is published with the necessary permission, Westpac does not accept responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, none of Westpac, their related entities, employees or directors gives any warranty of reliability or accuracy or accepts any responsibility or liability arising in any way in respect of such material. To the maximum extent permitted by law: (a) no guarantee, representation or warranty is given that any information in this presentation is complete, accurate, up to date, error or fault free or fit for any purpose; and (b) none of Westpac, any other company in the Westpac Group of companies or any of their employees or directors is in anyway liable or otherwise responsible to any person (including, without limitation, for negligence) or otherwise for any loss or damage arising as a result of or in connection with any reliance on this document or any information included in this document. This document was accompanied by an oral presentation and is not a complete record of the discussion held. No part of this presentation should be used elsewhere without prior written consent from Westpac. 15

16 Legal Disclaimer. Additional information if you are located outside of Australia New Zealand: The current disclosure statement for the New Zealand division of Westpac or Westpac New Zealand Limited can be obtained at the internet address Westpac Institutional Bank products and services are provided by either Westpac incorporated in Australia (New Zealand division) or Westpac New Zealand Limited. For further information please refer to the Product Disclosure Statement (available from your Relationship Manager) for any product for which a Product Disclosure Statement is required, or applicable customer agreement. Download the Westpac NZ QFE Group Financial Advisers Act 2008 Disclosure Statement at China, Hong Kong, Singapore and India: Westpac Singapore Branch holds a wholesale banking licence and is subject to supervision by the Monetary Authority of Singapore. Westpac Hong Kong Branch holds a banking license and is subject to supervision by the Hong Kong Monetary Authority. Westpac Hong Kong branch also holds a license issued by the Hong Kong Securities and Futures Commission for Type 1 and Type 4 regulated activity. Westpac Shanghai and Beijing Branches hold banking licenses and are subject to supervision by the China Banking Regulatory Commission. Westpac Mumbai Branch holds a banking license from Reserve Bank of India and subject to regulation and supervision by the RBI. U.K.: Westpac is registered in England as a branch (branch number BR000106) and is authorised and regulated by The Financial Services Authority. Westpac Europe Limited is a company registered in England (number ) and is authorised and regulated by The Financial Services Authority. This material and any information contained therein is directed at a) persons who have professional experience in matters relating to investments falling within Article 19(1) of the Financial Services Act 2000 (Financial Promotion) Order 2005 or (b) high net worth entities, and other persons to whom it may otherwise be lawfully communicated, falling within Article 49(1) of the Order (all such persons together being referred to as "relevant persons"). The investments to which this material relates are only available to and any invitation, offer or agreement to subscribe, purchase or otherwise acquire such investments will be engaged in only with, relevant persons. Any person who is not a relevant person should not act or rely upon this material or any of its contents. In the same way, the information contained in this material is intended for "eligible counterparties" and "professional clients" as defined by the rules of the Financial Services Authority and is not intended for retail clients. With this in mind, Westpac expressly prohibits you from passing on the information on this material to any third party. In particular this material, and, in each case, any copies thereof may not be taken, transmitted or distributed, directly or indirectly into any restricted jurisdiction. 16

17 Legal Disclaimer. Additional information if you are located outside of Australia U.S.: Westpac operates in the United States of America as a federally licensed branch, regulated by the Office of the Comptroller of the Currency. Westpac is also registered with the US Commodity Futures Trading Commission ( CFTC ) as a Swap Dealer, but is neither registered as, or affiliated with, a Futures Commission Merchant registered with the US CFTC. Westpac Capital Markets, LLC ( WCM ), a wholly-owned subsidiary of Westpac, is a broker-dealer registered under the U.S. Securities Exchange Act of 1934 ( the Exchange Act ) and member of the Financial Industry Regulatory Authority ( FINRA ). This communication is provided for distribution to U.S. institutional investors in reliance on the exemption from registration provided by Rule 15a-6 under the Exchange Act and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors in the United States. WCM is the U.S. distributor of this communication and accepts responsibility for the contents of this communication. All disclaimers set out with respect to Westpac apply equally to WCM. If you would like to speak to someone regarding any security mentioned herein, please contact WCM on All disclaimers set out with respect to Westpac apply equally to WCM. Investing in any non-u.s. securities or related financial instruments mentioned in this communication may present certain risks. The securities of non-u.s. issuers may not be registered with, or be subject to the regulations of, the SEC in the United States. Information on such non-u.s. securities or related financial instruments may be limited. Non-U.S. companies may not subject to audit and reporting standards and regulatory requirements comparable to those in effect in the United States. The value of any investment or income from any securities or related derivative instruments denominated in a currency other than U.S. dollars is subject to exchange rate fluctuations that may have a positive or adverse effect on the value of or income from such securities or related derivative instruments. The author of this communication is employed by Westpac and is not registered or qualified as a research analyst, representative, or associated person under the rules of FINRA, any other U.S. self-regulatory organisation, or the laws, rules or regulations of any State. Unless otherwise specifically stated, the views expressed herein are solely those of the author and may differ from the information, views or analysis expressed by Westpac and/or its affiliates. For the purposes of Regulation AC only: Each analyst whose name appears in this report certifies that (1) the views expressed in this report accurately reflect the personal views of the analyst about any and all of the subject companies and their securities and (2) no part of the compensation of the analyst was, is, or will be, directly or indirectly related to the specific views or recommendations in this report. 17

Winter is coming June 2016 quarter Westpac McDermott Miller Consumer Confidence Index: 106.0

Winter is coming June 2016 quarter Westpac McDermott Miller Consumer Confidence Index: 106.0 June 16 Winter is coming June 16 quarter Westpac McDermott Miller Consumer Confidence : 6. Consumer confidence has fallen for a second quarter. Confidence is now well below the peak reached in 14, and