This week, the UK Financial Services Authority (FSA) has published its proposals for recovery and resolution planning requirements, which follow on from the Financial Stability Board’s (FSB) recommendations (see more on which here) and much regulatory discussion across the globe on the subject (see the FSA’s discussions from last year here). The regulator estimates that the direct costs of implementation will be between £4 million and £35 million for “high impact” firms, but does this take into account all of the indirect costs and items such as data infrastructure investment? A number of firms have already noted that these estimates may be conservative, especially with regards to producing the required “timely and accurate data.”
Tim Kirk, partner and head of financial services at accountancy and advisory firm BDO, for example, reckons that the costs will be far higher than the FSA’s estimates, given the need for restructuring that may result from the requirements. Andrew Shrimpton, member at financial advisory firm Kinetic Partners, also believes firms will be faced with a “considerable task, and expense, to prepare the necessary plans and structures” in order to meet the requirements.
As well as the initial implementation costs, the FSA estimates that the ongoing compliance costs to the industry will be between £150 million and £400 million, but are these estimates on the money?
Last year, the regulator asked the six largest banks in the UK to submit their preliminary draft recovery and resolution plans as part of the FSA’s pilot programme (see more on which here). However, this recent consultation paper extends the requirements beyond this initial group, which comprised of HSBC, Barclays, Royal Bank of Scotland (RBS), Standard Chartered, Lloyds Banking Group and Santander, to all banks and investment firms with more than £15 billion in assets.
To give the full background on the requirements (for those of you that may be unfamiliar with the developments over the last few years), the basic idea behind living wills is that financial institutions should be mandated to develop, and potentially to execute, their own resolution plans, should the worst happen. Recovery plans also call for the assessment of the systemic risk posed by individual financial institutions to the rest of the market in order for firms to be able to get out of a sticky situation without damaging the financial markets at large.
To this end, the FSA is asking firms to “identify options to recover financial strength and viability should a firm come under severe stress” and to “submit detailed information about their business and operational structure” for resolution purposes. The stress is on facilitating the retrieval of all of this data in a fast and efficient manner in order for actions to be taken quickly, for example over a “resolution weekend”.
The international nature of most of these financial institutions is recognised by the FSA paper, which indicates that groups need to consider “how all significant members of the group (both regulated and unregulated) could be resolved,” although it won’t require the submission of these living wills plans from UK branches of overseas entities. However, these overseas firms are likely to be facing similar requirements from their home regulators, provided that these regulators all end up on the same page as each other (which is by no means guaranteed).
While recovery plans will most certainly have a dramatic impact on capital planning and liquidity, both recovery and resolution planning will also require significant investment in data architecture. The capital and liquidity planning required for mandatory resolution plans will entail firms keeping a tight rein on where their liquidity is located and therefore the organisation of counterparty and instrument data will become paramount in a business sense. Unlike boom times, financial institutions now cannot afford to throw away opportunities due to bad data and may be severely penalised for such failures, but recovery plans take this one stage further: failure of the firm itself may be a result.
Furthermore, the FSA indicates that recovery plans must be fully integrated into firms’ existing governance frameworks and processes, including the addition of new “triggers” that will entail additional data checks being put in place within the risk function. Having all this data available on an on demand basis for senior management is much easier said than done, given that much of it will be stored in disparate systems across an organisation and even from external data sources (in the case of “negative market sentiment” about the firm – a particularly tricky item to measure).
The regulatory community at large has been well aware of the data impacts of this legislation for some time. Back in November 2009, Fed board governor Daniel Tarullo indicated that in order to meet living wills requirements firms will need sufficiently robust data management systems in place to track data quality and provide audit trails for regulators (see more on which here). He therefore noted that a “very significant upgrade of management information systems (MIS) may be the only way for the firm to satisfy living will requirements”.
To this end, the FSA paper states that the initial and subsequent annual provision of these plans will be made much easier if data infrastructure is put in place at the outset. “This will be a less onerous task than the initial preparation of the plans and, if systems for capturing and recording data are properly established, particularly for resolution information, this should help the firm to provide updated information quickly and efficiently when required,” it says.
Considering the lack of a standardised legal entity identification (LEI) standard in the market (although there is work going on to this end at the moment – see recent news on which here), the tracking of counterparty data and even internal hierarchical data will continue to be a challenge for these firms. After all, the FSA paper states: “alongside information and analysis on economic functions, the authorities will also need information on legal entities (for example, whether the entity has a deposit taking licence, what financial, operational and personnel interdependencies there are with other legal entities, and analysis of how the dependencies would be dealt with on separation).”
On the counterparty data side of things, the FSA paper notes: “Although it will clearly not be without cost, we expect that this kind of information on counterparty risk exposures should be easily extracted from firms’ risk management systems. However, we recognise that systems do differ across firms and that some will find it easier to provide the information in the templates than others.” It also states that these requirements will be reviewed once the “various relevant international data initiatives” are complete.
The FSA is also looking for an overview of firms’ positions with regards to counterparties in terms of derivatives trades and securities financing books. To clarify its aim, the paper says: “For the avoidance of doubt, this request is to enable the understanding of the location of trade data on the firm’s systems, rather than to obtain detailed IT infrastructure information.”
The UK regulator is asking for feedback from firms about whether this consultation paper provides enough detail on the requirements and whether there are any areas that need “further explanation”. Do you agree with the estimates? Are any changes needed to the data templates and individual fields?
In terms of next steps, the FSA is planning to publish the final rules in the first quarter of next year, at which point certain provisions will come into effect that will mean firms will be required to submit the first draft of their recovery and resolution plans in June 2012.
The FSA indicates it is taking what it believes is an “iterative and proportional approach” in that it will first be focused on firms’ critical economic functions, before it turns its attention to operational weaknesses that need to be addressed (one can expect data infrastructure to feature strongly in this particular equation). Moreover, the bigger and more complex the firm, the more the FSA will require, especially with regards to those that fall under the systemically important financial institution (SIFI) designation (more on which here).