The biggest accomplishment in global financial regulation reform in 2011 was the creation of tougher rules for “too big to fail” financial services institutions whose collapse could threaten the entire financial system. But there is still plenty of work to be done on new rules for the financial services sector in general.
Global policy-makers have agreed that financial services institutions deemed “systemically important” will be required to hold additional capital cushions of 1%-2.5% of risk-weighted assets, depending on their degree of systemic importance, with an additional 1% surcharge possible for the very biggest firms.
The list of “too big to fail” institutions — drawn up by the global Financial Stability Board, now under the leadership of Bank of Canada governor Mark Carney — will be updated annually. The additional capital requirements won’t take effect until 2016 and will apply to institutions that appear on the list in 2014.
As for the institutions named to the initial list, which was published in November 2011, they are required to develop recovery and resolution plans — setting out how they would be wound down if they fail — by the end of this year. This initial list is confined to banks (17 European institutions, eight U.S. firms and four Asian banks), but other financial services institutions, such as insurers, could be included in the future.
In the meantime, policy-makers continue to refine the new capital requirements that will affect all global banks with the introduction of the Basel III capital regime, which will start taking effect in 2013 and be fully implemented by 2019. Basel III will both raise the capital requirements and tighten the definition of what counts as capital for banks.
Although the basic changes to increase the quantity and quality of bank capital have been agreed on, policy-makers are still working out certain details, such as defining the capital charges that should apply to trading activities to ensure they properly reflect the risks that banks are taking in their trading books. A consultation paper on this matter is scheduled for release early this year.
As the BofC notes in its December 2011 Financial System Review, the results of this consultation will be important for the Canadian banks, which all have significant trading operations and allocate a substantial amount of capital to their trading books.
Policy-makers are also working on the details of the liquidity and leverage limits they will impose on big banks as part of the Basel III regime, but these aren’t due to be finalized until mid-2013.
In addition, increased regulation of the “shadow banking” sector (such as the investment funds and structured investment vehicles that facilitate banking activities but don’t reside on regulated banks’ balance sheets) and the introduction of a new framework for the supervision of over-the-counter derivatives markets are also high on the global regulators’ agenda.
The G20 leaders have singled out enhanced regulation of shadow banking activities as their top priority for the year ahead. Their fear is that the efforts to increase regulation in the traditional sector will push more banking activity into the shadows and thus outside of regulatory oversight, thereby leaving the financial system as risky as it was before.
Regulators are also seeking much greater oversight of the OTC derivatives markets, including central clearing of standardized OTC derivatives contracts, which would require reporting of all trades to trade repositories and impose higher capital requirements for contracts that aren’t centrally cleared.
The G20 leaders have committed to completing globally harmonized reforms by the end of 2012, but this deadline looks optimistic. In Canada, for example, the provincial securities commissions have published only two of eight planned consultation papers on various aspects of the OTC markets, with the rest due this year.
The past year had seen divergent local initiatives. Generally, the countries that suffered worst during the financial crisis are considering extraordinary reforms to ensure the stability of their financial systems. It’s unlikely more radical reforms will be taken in countries in which the crisis wasn’t as severe, such as Canada. However, these reforms will affect firms doing business in these places.
In Britain, for example, a commission on banking reforms has recommended that traditional deposit-taking functions should be kept legally, economically and operationally separate so that riskier businesses, such as investment banking, can’t take down the entire bank. The commission also has called for much higher capital requirements than are being adopted globally.
Meanwhile, European policy-makers have agreed to impose a new tax on financial transactions and are pushing for this initiative to be adopted worldwide. So far, policy-makers in other jurisdictions — most notably, Canada and the U.S. — have resisted.
In the U.S., increased regulation of banking fees, along with other reforms — such as the so-called “Volcker rule,” which aims to separate proprietary trading and private-equity investing businesses from traditional investment banking — are starting to take effect, resulting in either increased regulatory costs or reduced revenue for affected companies. IE