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Raising the Practical Challenges of CEBS’ Risk Related Proposals

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Next month, industry practitioners will have four opportunities to provide feedback to the Committee of European Banking Supervisors (CEBS) on its risk related proposals, including those around concentration risk and stress testing. The regulatory body has organised four separate hearings at its London premises to garner feedback on a number of its recent consultation papers, all of which involve technology and systems considerations.

On 9 March, CEBS will be providing an opportunity for feedback on its draft guidelines on the management of operational risk in market related activities, enshrined in CP35. Within the guidelines CEBS introduces more specific principles and implementation measures for the identification, assessment, control and monitoring of operational risk in market related activities. These draft principles are divided into three different parts: governance mechanisms, internal controls and internal reporting systems.

CEBS is keen for firms to properly assess the operational risks that they face, including those related to rogue trading or the processing of complex instruments. “Institutions have focused their attention on market risk and, as a result, have overlooked the importance of operational risks,” warns CP35. To achieve this, the focus is on implementing “appropriate governance mechanisms and internal control systems” that must be monitored by a designated committee.

The CP includes specific requirements for greater integration between firms’ various “control functions”, comprising the back office, middle office, finance, risk management, compliance and internal audit. This suggests an investment in the technology architecture of a firm to enhance STP and data centralisation across these various functions. “The integration of key procedures related to the processing and accounting treatment of transactions and cross unit cooperation may increase the level of surveillance and control of the trading activities,” it suggests.

Furthermore, CEBS suggests various best practices should be adopted right from the front office pre-trade risk management space through to settlement in the back office, especially with regards to complex instruments. It also sets a basic standard for firms’ internal reporting systems, which it says should be designed to generate appropriate warnings and ensure the quality and consistency of internal reports.

CEBS will also be holding another hearing on 10 March to discuss its draft revised guidelines on stress testing in CP32. The guidelines aim to assist institutions in designing and implementing stress testing programmes with a robust governance structure, meaningful senior management engagement and an effective infrastructure, including information technology, data handling and skilled human resources.

The two most challenging aspects of the recommendations (in line with what A-Team Group has identified in other similar regulatory publications of late) will be drawing together the risk data from across the firm and having in place a platform in place that is sufficiently flexible to enable “modelling of a wide variety of stress tests across business lines and risk types as and when the senior management require”.

In addition to this and as part of the wider revision of the Capital Requirements Directive (CRD), CEBS will also be consulting with the industry on its CP34 on 11 March. This paper includes draft guidelines for the operational functioning of colleges as an instrument for stronger coordination and cooperation across Europe for key supervisory tasks. The colleges are expected to facilitate the handling of ongoing supervision and also to play a role in both the preparation for and handling of emergency situations.

The next day, 12 March, will see the last of these public hearings focus on the area of concentration risk and CP31. In the draft revised guidelines CEBS is taking a broader approach to concentration risk management and suggests that it is not sufficient to analyse concentration risk only within a risk type (intra-risk analysis), but that analysis of concentration risk across risk types (inter-risk analysis) is also necessary, including credit, market, operational and liquidity risks. This brings into the spotlight the idea of enterprise wide risk management (a goal that many firms claim they are striving to achieve, but remains out of reach for now).

The idea behind moving from credit risk assessment to concentration risk assessment is to better identify a firm’s risk exposures as a whole. CEBS directly states that firms need to ensure that their data management systems are up to the task: “an institution should have adequate data management systems to enable it to identify concentrations arising from different (types of) exposures”. This is a call for not just risk management technology investment, but also investment in the fundamental data infrastructure of the firm.

Given the scale of these challenges, these public hearings (at the CEBS London office in Tower 42) should be taken as a prime opportunity to raise these issues to the regulatory community before they are translated into European directives. If firms are in need of more guidance or wish revisions to be made, CEBS should be apprised of this now, before the regulatory axe swings…

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