OpRisk Europe – April 2006

Compliance & Capital,or ‘MiFID and the CRD’

ISDAwww.isda.org

Copyright ® 2006 International Swaps and Derivatives Association, Inc.

Richard MetcalfeSenior Director, Policy

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MiFID and CRD

1) Market in Financial Instruments Directive

2) Capital Requirements Directive

3) CRD + MiFID = “CRMiFID”?

4) The bigger picture

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MiFID – translation

• Market in Financial Instruments Directive– Updates Investment Services Directives (1993)

– Implies capital requirements (CRD)

– Implementation in EU Member States – Nov 2007

• Transposition (into national law) – end-Jan 07

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MiFID – what?

• Governs investment business – Not just ‘investment firms’.

– common EU rules / ‘passport’

• Includes business on exchanges and Multilateral Trading Facilities (MTFs)

• Reflects growth in financial instruments (eg, credit derivatives; NB, commodity derivatives)

• Covers ‘advice’

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MiFID – How?

I. Definitions & ScopeII. Authorisation & Operating Conditions:

• Outsourcing/OpRisk (Article 13); Conflicts (Art. 18)• Best execution (Art. 21); Order handling (Art. 22)

III. Regulated MarketsIV. Competent Authorities

• Whistle-blowing obligation on auditors (Art 55)

V. Final Provisions

Annex I: Services & Activities Annex II: Professional Clients

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Article 13.5, MiFID

An investment firm shall ensure, when relying on a third party for the performance of operational functions which are critical for the provision of continuous and satisfactory service to clients and the performance of invesment activities on a continuous and satisfactory basis, that it takes reasonable steps to avoid undue additional operational risk. Outsourcing of important operational functions may not be undertaken in such a way as to impair materially the quality of its internal control and the ability of the supervisor to monitor the firm’s compliance with all obligations.

An investment firm shall have sound administrative and accounting procedures, internal control mechanisms, effective procedures for risk assessment, and effective control and safeguard arrangements for information processing systems.

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Organisational structure

HR

Marketing

Riskmanagement

Compliance

Trade execution Internal

audit

Legal

Branch structure

Data capture

Clientmanagement

Clientservices

IT

consider

Source: FSA, ‘Planning for MiFID’

Governance oversight

Policies and procedures

Trading & infrastructure

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EU & Financial Services

• EU ‘Financial Services Action Plan’– Market Abuse, Prospectus, Collateral

• ‘Lamfalussy’ Directive – 4 levels:1. Framework

2. Implementing Measures **

3. Co-ordination

4. Enforcement

** CESR. NB 1) Best execution 2) Advice

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2

CRD

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Capital Requirements Directive

• ‘Basel II’ Accord, translated into EU• ‘Recasts’ Directives on Capital Adequacy (1996)

+ Credit Institutions (2000)

• Basel I blocked ‘race to the bottom’– 8% * [Risk Weighting] * Asset/Exposure

• But…– Crude + vulnerable to arbitrage

– Basel II adds operational risk… and requirements

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Operational Requirements (eg, Credit Derivatives)

• Legally binding and enforceable contract• Procedures and processes for residual risks• Elgible providers:

– Low-weighted Sovereigns, Banks, Securities Firms

– Single-A entities, including related company weighted <obligor

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3

“CRMiFID”

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When Directives Collide

• FSA: SYSC pulled at last minute (Sept ’04)– “Need for consistency of approach”– FS05/1: ORM not required to manage systems and controls

• Brussels (?) – Compliance with CRD is satisfied by compliance with

requirements of MiFID… as far as they go• CRD Art 22 (governance, risk reporting, internal control)

• Basel– ‘Compliance… in banks’ (April 2005)’ - within OpRisk function?

• CEBS-CESR (-CEIOPS) co-operation– 2006 Cross-sectoral Work Programme

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OpRisk types – relevance of MiFID

• Fraud – internal• Fraud – external• Workplace• Clients…• Damage• Disruption• Delivery…

• People• PROCESS• SYSTEMS• Events

– Legal risk, including regulatory fines

REGULATORY FINES? CUSTOMER ACTION?

(REPUTATIONAL DAMAGE?)

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From Annex 7 Level 2 Level 3

Internal Fraud

External Fraud

Employment Practices and Workplace Safety

Clients, Products & Business Practices

• Suitability, Disclosure and Fiduciary

• Improper Trade Practices• Advisory Activities

• Aggressive sales• Account Churning• Disputes over performance

of advisory activities

Damage to Physical Assets

Business disruption and system failures

Execution, Delivery & Process

• Customer Intake (documentation)

• Client permissions / disclaimers

Source: Basel II

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Relevance of MiFID / Basel business line

• Corporate Finance

• Trading & Sales…• Retail Banking

• Commercial Banking

• Payment and Settlement

• Agency Services…• Retail Brokerage…• Asset Management

– Sales; Market Making

– Custody (MiFID 13.7)– MiFID passim

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MiFID and the 4 AMA elements

data data (external) scenariosbusiness environment and control factors

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H106 H206 H107 H207 H108

AMA FSA CP FSA reviews LIVE

‘SYSC’ CP*

MiFID Level 2 /EP CoB CP (Oct)

31 i 07: Transp.

LIVE (Nov)

Other “EU SarbOx”?

Timetables (UK)

* Delayed from Sept ’04

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‘Stable yet dynamic’ directives

• Lamfalussy Directive (MiFID)• Framework Directive (CRD)

• Developments in Basel– Especially likely on evolving discipline of OpRisk?

• CEBS *– April 6 2006: consulation on outsourcing: “the

management of risks related to [material activities]”; “any activities having a significant impact on its risk management”

* http://www.c-ebs.org/pdfs/CP02rev.pdf

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Other

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The broader environment

• Market Abuse Directive– Insider trading

• UCITS– Investor suitability

• Prospectus– Risk disclosure

• ‘[Complex Structured] Financing transactions’• Corporate Governance – unresolved EU debate…

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…Corporate governance

• (Unresolved EU debate)– Abortive attempts to

1) Launch Directive (2004)

2) ‘SarbOx’ Company Law Directives # 4 & 7 (Q205)

– Corporate Governance Forum set up – Oct 2004

– Dec 05-Mar 06 Consultation on ‘future priorities’

– Announced: Public Hearing, Brussels, 3rd May

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OpRisk Europe – April 2006

MiFID and the CRDor ‘2004/39/EC and Re-cast 2000/12/EC + 93/6/EEC’

ISDAwww.isda.org

Copyright ® 2006 International Swaps and Derivatives Association, Inc.

Richard MetcalfeSenior Director, Policy