Regulators aim to finalize rules

Toughening the basic capital requirements for the world’s big banks has been the primary task, but regulators also have finalized new measures to limit these banks’ leverage and ensure their liquidity. As a result, banks must begin to adopt new liquidity requirements and also start disclosing their leverage ratios this year.

New capital requirements also are being phased in, although full implementation isn’t required until Jan. 1, 2019 – and there are several details still to be hammered out.

In part, the drawn-out implementation is due to national regulators and lawmakers that must put those globally agreed principles into action. These authorities have a good deal of latitude in implementation, which may mean the actual rules facing financial services firms are tougher in some matters and weaker in others.

For example, the U.S. banking regulators’ proposed rules released in late 2014 to implement new capital buffer requirements for banks deemed “too big to fail” (the so-called “global systemically important banks”) are tougher than the measures agreed upon by global regulators.

Conversely, U.S. regulators also announced in late December that they will give further extensions to banks and various other firms to comply with the so-called “Volcker rule,” which requires affected firms to divest certain proprietary trading, private-equity and hedge fund businesses. Banks now will have until mid-2017 to adhere to restrictions that were supposed to take effect in mid-2014.

Authorities in different regions also are developing their own approaches to limiting the economic damage caused by the possible failure of banks deemed too big to fail. These efforts include requirements for banks to adopt resolution plans, develop bail-in mechanisms and adopt “living wills” designed to guide the winding down of failing banks in an orderly way. The final details of these rules shouldn’t affect the firms’ earnings directly but may affect banks’ capital structures, credit ratings and valuations.

There also still is work to do related to the so-called “shadow banking” sector to ensure the tougher rules for the regulated banking business don’t create new vulnerabilities by driving more business to less regulated financial services institutions.

In the year ahead, the FSB intends to finalize rules designed to prevent the buildup of excessive leverage in the shadow banking sector; the aim is to implement those rules by 2017. The group also is planning a peer review of the rules in the shadow banking sector this year that could lead to further reform recommendations.

Moreover, the process of adopting reforms is revealing areas in which further work is needed. For example, global banking regulators have found considerable variance in the way trading risk is measured and accounted for under the new capital rules. The regulators now are seeking ways to make those assessments less complex and more comparable from country to country and from bank to bank. The Basel Committee on Banking Supervision also is seeking clearer, more comparable standards in the way banks measure and provide for credit risk under the new rules.

Although banking has been the primary target of post-crisis reform efforts so far, other parts of the financial services sector aren’t escaping policy-makers’ attention. Last year, global insurance regulators proposed a new comprehensive capital standard for the world’s major insurance firms. Starting in 2015, insurance firms will be required to report their capital positions to insurance regulators on a confidential basis to help regulators refine those standards.

Insurance regulators also are seeking to prevent their own “too big to fail” scenario. In 2014, a preliminary list of systemically important insurers was compiled; this year, regulators will be working on their methodology for defining “systemic importance” in the insurance world. Regulators also are expected to come up with added capital requirements for these firms, which are expected to be implemented in 2019.

Policy-makers also are planning to create a list of other financial services institutions – including infrastructure firms, such as clearing and settlement companies; major brokerages; asset managers; and investment funds – that should also be considered systemically important.

The expectation is these firms also will face added regulation designed to limit the damage to the financial system and the broader economy if those companies were to collapse. As of early January, policy-makers had yet to release their methodology for identifying these firms; however, that is expected to happen early this year.

The other major area of reform is in over-the-counter (OTC) derivatives, in which progress has been slower than expected. As the FSB noted in its most recent report to the G20: “Implementation of OTC derivatives reforms is uneven and overdue.”

But, the FSB report says, progress is being made and more is expected in 2015 – including more comprehensive trade reporting and more mandatory central clearing.

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