demystifying the regulatory landscape basel iii / accounting johann kruger ca (sa), cfa ifrs and...

DEMYSTIFYING THE REGULATORY LANDSCAPE BASEL III / ACCOUNTING

Johann Kruger CA (SA), CFAIFRS and Financial Risk Management Consultant Lloyds Bank Corporate Markets

11th November 2011

STRICTLY PRIVATE AND CONFIDENTIAL

The Changing Regulatory Environment

Basel 2.5 (2011) and Basel III (2013)Basel 2.5 (2011) and Basel III (2013)

OTC derivatives, EMIR (2012/13)OTC derivatives, EMIR (2012/13)

Volcker Rule & Swaps push-outVolcker Rule & Swaps push-out

Securitisation controls: ‘skin in the game’Securitisation controls: ‘skin in the game’

MiFID II, Retail Distribution ReviewMiFID II, Retail Distribution Review

Solvency IISolvency II

Source: Oliver Wyman


BASEL III & BANK CAPITAL


Basel Committee BackgroundBasel Committee for Banking Supervision

Functions

• Basel Committee provides a forum for regular cooperation on banking supervisory matters.

• Over recent years, it has developed increasingly into a standard-setting body on all aspects of banking supervision.

Membership

• Senior officials responsible for banking supervision or financial stability issues in

• Central banks, and Authorities with formal responsibility for the prudential supervision of banking business where this is not the central bank (e.g. FSA in the UK).

Chairman

• Stefan Ingves, President of the Netherlands Sveriges Riksbank.

Secretariat

• Secretary General: Stefan Walter, supported by a staff of 14.

Source: Bank for International Settlements web site http://www.bis.org/about/factbcbs.htm

STRICTLY PRIVATE AND CONFIDENTIALSource: Bank for International Settlements web site http://www.bis.org/about/factbcbs.htm

• Argentina

• Australia

• Belgium

• Brazil

• Canada

• China

• France

• Germany

• Hong Kong SAR

• India

• Indonesia

• Italy

• Japan

• United States

Basel III – Committee Member Countries

• Korea

• Luxembourg

• Mexico

• Netherlands

• Russia

• Saudi Arabia

• Singapore

• South Africa

• Spain

• Sweden

• Switzerland

• Turkey

• United Kingdom

STRICTLY PRIVATE AND CONFIDENTIALSource: Bank for International Settlements web site http://www.bis.org/about/factbcbs.htm

• Standards Implementation Group

• Policy Development Group

• Accounting Task Force

• Basel Consultative Group

Basel III – Sub-Committees


Capital requirements

• Quality of capital

•definition – 14 criteria – mainly focusing on loss-absorbency

•proportion of common equity – from 3.5% to 4.5% by 2015

• Increase in % of capital – more for SIFIs

• RWA measurement

Basel III – Brief Summary


Liquidity and leverage

• Liquidity coverage ratio (Minimum std by 2015)

• Net Stable Funding ratio (Minimum std by 2018)

So what?

• Net effect: higher cost of doing business – not necessarily offset by lower cost of capital

• Impact of Solvency II on insurers: higher capital charge for holding equities and bank paper

• Impact of pension fund de-risking: lower demand for bank equities; higher demand for debt

securities

Basel III are only guidelines, local regulators may enforce higher requirements

However, draft EU legislation limits potential for higher requirements than Basel III

Basel III – Brief Summary


Phased Implementation – Market Response

2013 2014 2015 2016 2017 2018 2019

3.5% 4.0%

4.5%

4.5% 4.5%

1.0%

1.5%1.5%

3.5%

2.5% 2.0%

0.625%

0.625%

Minimum Common Equity

Capital Conservation Buffer

Countercyclical Buffer

Additional Tier 1 Capital

Tier 2 Capital

4.5%

1.5%

2.0%

4.5%

1.25%

1.25%

4.5%

1.5%

2.0%

4.5%

1.875%

4.5%

1.5%

2.0%

1.875%

4.5%

2.5%

4.5%

1.5%

2.0%

2.5%

9.5%

13.0%

20% 40% 60% 80% 100% 100% Phase-in of CET1 Deductions

Introduction of LCR Minimum Standard

Introduction of NSFR Minimum Standard

AND Pillar 1 Migration of Leverage Ratio

10 yr. transition period for capital

instruments starts

2013 2014 2015 2016 2017 2018 2019

3.5% 4.0%

4.5%

4.5% 4.5%

1.0%

1.5%1.5%

3.5%

2.5% 2.0%

0.625%

0.625%

Minimum Common Equity

Capital Conservation Buffer

Countercyclical Buffer

Additional Tier 1 Capital

Tier 2 Capital

4.5%

1.5%

2.0%

4.5%

1.25%

1.25%

4.5%

1.5%

2.0%

4.5%

1.875%

4.5%

1.5%

2.0%

1.875%

4.5%

2.5%

4.5%

1.5%

2.0%

2.5%

9.5%

13.0%

20% 40% 60% 80% 100% 100% Phase-in of CET1 Deductions

Introduction of LCR Minimum Standard

Introduction of NSFR Minimum Standard

AND Pillar 1 Migration of Leverage Ratio

10 yr. transition period for capital

instruments starts

• Phased regulatory transition is likely to be overtaken by market considerations

• Analysts and the market already differentiate the sector on a pro forma Basel III basis

• This will drive early implementation of measures to respond to new requirements


EBA Announcement : 26 October 2011

Term funding guarantee scheme• Banks’ access to term funding (ECB focuses on short term funding)

• EU Commission, ECB, EIB to “urgently explore options for achieving this objective”

New capital requirements• 9% CET minimum

• After deducting MTM on sovereign debt as at 30 September2011

• Note the French 10yr yield was 2.6% on 30 September, but is now above 3%

• Banks to submit plans by 2011

• Banks to meet requirement by 30 June 2012

• EBA estimates circa €106bn required

• Issues

• Lack of investor appetite for bank shares

• Significant shrinkage of bank balance sheets, possibly contributing to recession


Basel III – What Impact For Derivatives Pricing?

Key variables impacting the extent of the increase in RWA requirement in relation to

“unexpected losses”

• Counterparty credit quality

• Maturity

• Expected exposure (market movements and funding position)

• Type of instrument (Rates / FX / Commodities)

* Based on latest Basel Proposals (latest publication in June 2011) and, subject to change as the regulations are finalised for the EU and the Netherlands, and depending on expected exposure assumptions



Overall increase in charges at typically 2 x*, but could be several times for long dated credit

intensive trades

AA to A counterparties

• typically single digit basis points* on regular vanilla interest rate instruments and

• double digit increases in costs for XCCY swaps and commodity hedges

BB to BBB counterparties

• low double digit basis points* on vanilla interest rate instruments and

• possibly large double digit increases in costs for XCCY swaps and commodity hedges

General Increase in Capital Requirements Phased in From 2013

Increase in RWA for OTC Derivatives: Big Bang Effect on 1 Jan 2013 – inc Existing P’folio

* Based on latest Basel Proposals (latest publication in June 2011) and, subject to change as the regulations are finalised for the EU and the Netherlands, and depending on expected exposure assumptions


Our calculations show the following effect on some standard transactions in terms of multiples applied to credit spreads:

A BBB BB

Aggressive

Conservative

Aggressive

Conservative

Aggressive

Conservative

Receive fixed GBP, pay floating GBP 5yr

1.6x 2.3x 1.4x 1.7x 1.4x 2.3x

Receive fixed GBP, pay floating GBP 10yrReceive Fixed GBP, pay Fixed USD 5yr XCCY

2.4x

1.8x

3.0x

2.3x

1.8x

1.4x

2.1x

1.7x

2.0x

1.5x

2.5x

1.8x

Receive Fixed GBP, pay Fixed USD 10yr XCCY

2.5x 2.8x 1.9x 2.1x 2.1x 2.3x

Receive Fixed GBP, pay Floating USD 10yr XCCY

2.4x 2.8x 1.8x 2.0x 2.0x 2.3x

FX Fwd 1yr 100m Buy USD, sell GBP

1.8x 1.8x 1.3x 1.3x 1.3x 1.3x

For example, we recently looked at a 20-year cross currency swap for a good credit (single A) and the running cost was calculated as 50 basis points.


* Based on latest Basel Proposals (latest publication in June 2011) and, subject to change as the regulations are finalised for the UK, and depending on expected exposure assumptions


Unintended consequences• Costs for corporate hedgers could be prohibitive – especially accessing foreign capital markets

• Posting collateral and exposure to unacceptable levels of cash flow risk – putting the real economy at risk

• Discouraging hedging by corporates, who represent less than 15% of the market volume

What then shall we do?

• Cease to hedge

• Greater use of natural hedges

• Greater use of purchased options

• Credit breaks

• Deal with ignorant banks/Do as much as possible hedging while the market is behind the curve

• If all else fails, collateralise or clear centrally (if possible)

• Lobby the Basel Committee in relation to OCT derivatives used to manage corporate risk

What then shall we do? (1)


More Efficient Use of Capital by Banks

• RWA reporting

• Collateral management

• Counterparty risk exposure management

Product mix/innovation

• Caps/ Swaptions /LLS

• Margin funding

• Collateral transformation

• Synthetic margin swaps

• Borrow from the capital markets (insurance companies; pension funds)

• Securitisations: ratings for derivatives (especially useful if super-senior)

What then shall we do? (2)


Basel III – Recent Developments

• Basel guidance incorporated into proposed regulation and directive (CRD IV)

• Main capital requirements, including CVA RWA on OTC derivatives included as regulation –

therefore NO flexibility at national level

• Any lobbying by corporates must now be directed towards the European process and

timing is critical – CVA RWA is of particular concern

• Countercyclical buffer requirement included as directive

• Increasing media attention to conflicting requirements of Solvency II and Basel III , i.e.

• requirement for more capital and longer dated funding for banks vs

• higher capital charges for such instruments on insurance company balance sheets

• Australia to adopt 2 years early

• China to require higher than Basel III minimum for its banks


ACCOUNTING


• 74 jurisdictions have either adopted the IFRS or stated a plan to adopt within three years

• In Europe, reception has been cool

• Adopted: Bosnia; Macedonia

• Available for use: Switzerland

• Planned: UK, Ireland

• Others are studying it

• Netherlands: no plans to adopt

IFRS for SMEs

*Excluding charities and small companies as defined in company law, current proposed requirement is for years beginning on/after 1 July 2013.


IFRS 9: Overhaul of Financial Instruments Accounting (including derivatives)

• IAS 39 replacement – why?

• Three phases

• Classification

• General hedge accounting model + portfolio hedging of interest rate risk

• Impairment

• Convergence

IFRS 9 – Finally a principles based standard


The good news

• 80:125 corridor disappears

• Retrospective test disappears – continue to recognise all ineffectiveness

• Hedge accounting for option time value

• Rebalancing allowed

• Component hedging for non-financial items

• Derivative on derivative rule (NIH; interest rate hedging)

• Alignment with true risk management process



The bad news

• Voluntary de-designation possibly prohibited

• Delays

• EU endorsement process



Option time value behaviour – P&L behaviourExample: USD Revenue – buy GBP call vs. cylinder (add sold GBP put)Which causes most volatility?

Call strike (bought)

Loss

Gain

0

Put strike (sold)

Potential volatility of the call: A

Potential volatility of the cylinder: A+B

A

B

Time value behaviour at inception in relation to spot movement (assume static vega and theta)

If vega increases = expansion of peak/trough

As time passes (for constant vega) = contraction of peak/trough

X-axis: GBPUSD FX rate


• IFRS 13: Fair Value Measurement

• Single standard

• Similar to FAS 157 (and text currently in IAS 39 AG)

• Credit valuation adjustments for corporates

• IFRS 10, 11, 12: Consolidation, joint arrangements, disclosures of interests in other entities

• IAS 19: Post employment benefits

Accounting – Current Issues


• Exposure draft: Capitalisation of operating leases

• Increase in net debt

• Earlier recognition of expenses

• Impact on service contract

• Increased disclosures

• Onerous systems requirements

Exposure draft: Accounting for insurance activities

• IFRS and US GAAP conversion

Accounting – Current Issues


The analysis of financial reporting policies among FTSE 100 companies shows that they use non-IFRS profit numbers extensively to communicate performance to shareholders

FTSE 100 Financial Reporting Policies (% of total companies surveyed)

Financial reporting policy

% that use non-IFRS profit measures to communicate performance to shareholders

% that adjust for non-cash volatility from IAS 39

% that present the information on the face of the Income Statement

Results by accounting firm

BDO Stoy Hayward (1)

Deloitte (19)

Ernst & Young (12)

KPMG (17)

PwC (31)

0% 25% 50% 75% 100%1

2

Data gathered from a sampling of 80 FTSE 100 non-financial corporates; Data as of December 2010 based on latest published annual reports

84%

77%

83%

0%

40%

53%

79%

44%

58%33%

46%

57%

Strategic Financial Reporting Issues


QUESTIONS AND COMMENTS


Important NoticeThis presentation does not constitute or imply an offer or commitment whatsoever on the part of Lloyds TSB Bank plc (“Lloyds TSB”). Any such offer may only be made after the negotiation of satisfactory documentation and only after appropriate credit authority has been obtained. The pricing discussed herein is based on our view of current market conditions and is for discussion purposes only.

This presentation and all ancillary documents relating to it (together the "Presentation") was prepared by Lloyds TSB exclusively for you for the purpose of analysing certain potential transactions. The Presentation is being made available on a strictly confidential basis to you and is intended only for the internal use of authorised recipients (“Recipients”) and no part of it may be disclosed to any third party. This Presentation and the information contained herein are the property of Lloyds TSB. Recipients are hereby notified that photocopying, scanning, or any other form of reproduction, or distribution - in whole or in part - to any other person at any time is strictly prohibited without the prior written consent of Lloyds TSB.

The information in this Presentation reflects prevailing conditions and our judgment as of this date, all of which are subject to change or amendment without notice and the delivery of such amended information at any time does not imply that the information (whether amended or not) contained in this Presentation is correct as of any time subsequent to its date. Whilst Lloyds TSB have exercised reasonable care in preparing this presentation and any views or information expressed or presented are based on sources they believe to be accurate and reliable, neither Lloyds TSB, nor any of their officers, servants, agents, employees or advisors make any representation or warranty, express or implied, as to the fairness, accuracy, adequacy, completeness or correctness of such information, nor as to the achievement or reasonableness of any projections, targets, estimates, or forecasts and nothing in this Presentation should be relied upon as a promise or representation as to the future. Neither Lloyds TSB nor any of their officers, servants, agents, employees or advisors or any affiliate or any person connected with them accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this Presentation or its contents or otherwise arising in connection therewith. Lloyds TSB undertakes no obligation to update or correct any information contained herein or otherwise to advise as to any future changes to it. Applicable tax, accounting and legal considerations are subject to change and in all cases independent professional advice should be sought in those areas.

This Presentation is provided for information purposes only: there has been no independent verification of the contents of this Presentation. It does not constitute or contain investment advice. It is not and shall not be construed as an offer, invitation, recommendation or solicitation to sell, issue, purchase or subscribe for any securities in any jurisdiction or to enter into any transaction. It is not and shall not be construed as an offer to arrange, underwrite, finance, purchase or sell any security, financial instrument, assets, business, or otherwise provide monies to any party. Such offers may only be provided in writing after satisfactory legal, financial, tax, accounting and commercial due diligence, as well as approval from the relevant business and credit committees of Lloyds TSB and/or their affiliates. The information contained in this Presentation is in summary form for the convenience of presentation and may therefore not be complete.

Products and services that may be referenced in the Presentation may be provided through affiliates of Lloyds TSB or any person connected with them.

Lloyds TSB and their affiliates prohibits employees from offering a favourable research rating or specific price target or changing a rating or target to get a mandate and Lloyds TSB and their affiliates prohibit research analysts from being compensated for involvement in investment banking transactions, except to the extent that such participation is intended to benefit investor clients. Lloyds TSB, their affiliates, their respective directors or officers or persons connected with them may have an interest in any financial instrument mentioned in this Presentation.

Lloyds TSB Corporate Markets is a trading name of Lloyds TSB. Lloyds TSB’s registered office is 25 Gresham Street, London EC2V 7HN and it is registered in England and Wales under No. 2065.

Lloyds TSB is authorised and regulated in the United Kingdom by the Financial Services Authority.

LLOYDS CORPORATE MARKETS

Lloyds TSB Corporate Markets is a trading name of Lloyds TSB Bank plc, which is part of the Lloyds Banking Group. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and a signatory to the Banking Codes. Lloyds TSB Bank plc: Registered Office: 25 Gresham Street, London EC2V 7HN. Registered in England and Wales. Registered No. 2065.

BANK OF SCOTLAND

Bank of Scotland Treasury is a division of Bank of Scotland plc, which is part of the Lloyds Banking Group. Bank of Scotland plc is authorised and regulated by The Financial Services Authority and a signatory to the Banking Codes. Bank of Scotland plc: Registered Office: The Mound Edinburgh EH1 1YZ. Registered in Scotland. Registered No. SC 327000.

demystifying the regulatory landscape basel iii / accounting johann kruger ca (sa), cfa ifrs and...

Documents

bank capital slide

regulatory landscape

confidential source

debt securities basel

confidential liquidity

sifis rwa measurement

brief summary slide

bank equities higher