Monday October 1, 2012 - Top 10 Risk Management News

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International Association of Risk and Compliance
Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.risk-compliance-association.com

Top 10 risk and compliance management related news stories
and world events that (for better or for worse) shaped the week's
agenda, and what is next

George Lekatis
President of the IARCP
Dear Member,
There are some interesting job openings and descriptions:

Vice President - Bank Regulatory Policy / Basel
Manhattan, NY, Salary $120,000-$180,000 / yr., Full -Time
“This individual will assist in interpreting and developing firm policy for
U.S. and international banking regulations related to capital and and
other regulatory reporting matters. They are seeking individuals with
prior Basel II and III and bank capital regulations experience.”

Finance and Risk Solution Architect
London, Salary £80,000 - £115,000 + Bonus
“We are currently looking for profiles with a consulting or business
stream background in the following areas for a new business practice in
the finance sector: we are looking for individuals with the following
background or experience: Risk Management in Capital or Liquidity
requirements, Financial Industry Regulatory Reporting such as FSA,
Dodd Frank, Basel II/III & Industry Best Practice, reporting strategies
& Global Transactions. Individuals will have a Business/Technical
Architectural Background ideally with some Business Analysis &
Consulting background.”

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International Association of Risk and Compliance Professionals (IARCP)
www.risk-compliance-association.com

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Business Analyst with Basel III Job
“We are actively seeking a contractor to lead a team in documentation,
design, and traceability of requirements in support of Basel III
implementation. This includes defining solutions to business/systems
problems and ensuring the integrity of delivery through customer
acceptance and final disposition of solution for the Basel III project.
This is a minimum 6-8 month project with strong possibility of extension
or conversion to full time” employment.”

Very interesting job descriptions…
… and very interesting salary.

The same time, banks try hard to understand what to do with the new
Basel III requirements (Number 1 of our list) and to find more investors
(Tier 1 capital).

Welcome to the Top 10 list.

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BIS, Results of the Basel III monitoring
exercise as of 31 December 2011

This report presents the results of the Basel
Committee's Basel III monitoring exercise.

The study is based on rigorous reporting
processes set up by the Committee to
periodically review the implications of the
Basel III standards for financial markets; the
first results of the exercise based on June 2011
data had been published in April 2012.

Financial Services Agency, The
Japanese Government

Recent Trend of Financial and Capital Markets,
Regulatory and Supervisory Challenges
Ryutaro Hatanaka

Investor Protection through Audit Oversight
Lewis H. Ferguson, Board Member
California State University 11th Annual SEC Financial Reporting
Conference, Irvine, CA

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Annual public hearing of the chairpersons
of the three European Supervisory Authorities (EBA, ESMA and EIOPA).
Initial statement by Andrea Enria Chairperson of the EBA, in front of the
Economic and Monetary affairs committee of the European Parliament

Challenges to the single monetary policy and
the European Central Bank’s response

Speech by Mr Benoît Coeuré, Member of the
Executive Board of the European Central
Bank, at the Institut d’études politiques, Paris,
20 September 2012.

EIOPA and FINMA
Sign a Memorandum of
Understanding

The European Insurance and Occupational Pensions Authority (EIOPA)
and the Swiss Financial Market Supervisory Authority (FINMA) have
signed a Memorandum of Understanding (MoU) in Bern.

The main objective of the MoU is to ensure optimal cooperation in
supervision, in particular for insurance groups with international
activities in the European economic area (EEA) and Switzerland.

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European Systemic Risk Board
ESRB Risk Dashboard

Simon Kwan, vice
president at the
Federal Reserve Bank
of San Francisco, states his views on the current economy and the
outlook.

Maximum Employment and

Monetary Policy"
Jeffrey M. Lacker, President Federal Reserve Bank of
Richmond
Money Marketeers of New York University, Down Town
Association, New York City, N.Y.

Basel iii in Singapore
Response to the feedback
received

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NUMBER 1

BIS, Results of the Basel III monitoring
exercise as of 31 December 2011

Important parts

This report presents the results of the Basel
Committee's Basel III monitoring exercise.

The study is based on rigorous reporting
processes set up by the Committee to
periodically review the implications of the
Basel III standards for financial markets; the
first results of the exercise based on June 2011
data had been published in April 2012.

A total of 209 banks participated in the study, including 102 Group 1
banks (ie those that have Tier 1 capital in excess of €3 billion and are
internationally active) and 107 Group 2 banks (ie all other banks).

While the Basel III framework sets out transitional arrangements to
implement the new standards, the monitoring exercise results assume full
implementation of the final Basel III package based on data as of 31
December 2011 (ie they do not take account of the transitional
arrangements such as the phase in of deductions).

No assumptions were made about bank profitability or behavioural
responses, such as changes in bank capital or balance sheet composition.
For that reason the results of the study are not comparable to industry
estimates.

The study finds that based on data as of 31 December 2011 and applying
the changes to the definition of capital and risk-weighted assets, the
average common equity Tier 1 capital ratio (CET1) of Group 1 banks was
7.7%, as compared with the Basel III minimum requirement of 4.5%.

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In order for all Group 1 banks to reach the 4.5% minimum, an increase of
€11.9 billion CET1 would be required.

The overall shortfall increases to €374.1 billion to achieve a CET1 target
level of 7.0% (ie including the capital conservation buffer); this amount
includes the surcharge for global systemically important banks where
applicable.

As a point of reference, the sum of profits after tax and prior to
distributions across the same sample of Group 1 banks in 2011 was €356
billion.

Compared to the June 2011 exercise, the aggregate CET1 shortfall with
respect to the 4.5% minimum for Group 1 banks has reduced by €26.9
billion.

At the CET1 target level of 7.0%, the aggregate CET1 shortfall for Group 1
banks has reduced by €111.5 billion.

For Group 2 banks, the average CET1 ratio stood at 8.8%.

In order for all Group 2 banks in the sample to meet the new 4.5% CET1
ratio, the additional capital needed is estimated to be €7.6 billion.

They would have required an additional €21.7 billion to reach a CET1
target 7.0%; the sum of these banks' profits after tax and prior to
distributions in 2011 was €24 billion.

Executive summary
In 2010, the Basel Committee on Banking Supervision1 conducted a
comprehensive quantitative impact study (C-QIS) using data as of 31
December 2009 to ascertain the impact on banks of the Basel III
framework that was published in December 2010 and revised in
June 2011.

The Committee intends to continue monitoring the impact of the Basel
III framework in order to gather full evidence on its dynamics.
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For this purpose, a semi-annual monitoring framework has been set up
on the risk-based capital ratio, the leverage ratio, and the liquidity metrics
using data collected by national supervisors on a representative sample of
institutions in each jurisdiction.

This report is the second publication of results of the Basel III monitoring
exercise and summarises the aggregate results using data as of 31
December 2011.

The Committee believes that the information contained in the report will
provide the relevant stakeholders with a useful benchmark for analysis.

Information considered for this report was obtained by data submissions
of individual banks to their national supervisors on a voluntary and
confidential basis.

banks and 107 Group 2 banks.

Members’ coverage of their banking sector is very high for Group 1 banks,
reaching 100% coverage for some jurisdictions, while coverage is
comparatively lower for Group 2 banks and varied across jurisdictions.

The Committee appreciates the significant efforts contributed by both
banks and national supervisors to this ongoing data collection exercise.

The report focuses on the following items:

- Changes to bank capital ratios under the new requirements, and
estimates of any capital deficiencies relative to fully phased-in
minimum and target capital requirements (to include capital charges
for global systemically important banks – G-SIBs);

- Changes to the definition of capital that result from the new capital
standard, referred to as common equity Tier 1 (CET1), including a
reallocation of deductions to CET1, and changes to the eligibility
criteria for Additional Tier 1 and Tier 2 capital;

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- Increases in risk-weighted assets resulting from changes to the
definition of capital, securitisation, trading book, and counterparty
credit risk requirements;

- The Basel III leverage ratio; and

- Two Basel III liquidity standards – the liquidity coverage ratio (LCR)
and the net stable funding ratio (NSFR).

With the exception of the transitional arrangements for non-correlation
trading securitization positions in the trading book, this report does not
take into account any transitional arrangements such as phase-in of
deductions and grandfathering arrangements.

Rather, the estimates presented assume full implementation of the final
Basel III requirements based on data as of 31 December 2011.

No assumptions have been made about banks’ profitability or
behavioural responses, such as changes in bank capital or balance sheet
composition, since this date or in the future.

For this reason, the results are not comparable to current industry
estimates, which tend to be based on forecasts and consider management
actions to mitigate the impact, and incorporate estimates where
information is not publicly available.

The results presented in this report are also not comparable to the C-QIS
that was prepared using end-December 2009 data because that report
evaluated the impact of policy questions that differ in certain key respects
from the finalised Basel III framework.

As one significant example, the C-QIS did not consider the impact of
capital surcharges for global systemically important banks.

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Key results
Capital shortfalls

Assuming full implementation of the Basel III requirements as of 31
December 2011, including changes to the definition of capital and
risk-weighted assets, and ignoring phase-in arrangements, Group 1 banks
would have an overall shortfall of €11.9 billion for the CET1 minimum
capital requirement of 4.5%, which rises to €374.1 billion for a CET1 target
level of 7.0% (ie including the capital conservation buffer); the latter
shortfall also includes the G-SIB surcharge where applicable.

As a point of reference, the sum of profits after tax prior to distributions
across the same sample of Group 1 banks in 2011 was €356 billion.

respect to the 4.5% minimum for Group 1 banks has improved by €26.9
billion or 69.3%.

banks has improved by €111.5 billion or 23.0%.

Under the same assumptions, the capital shortfall for Group 2 banks
included in the Basel III monitoring sample is estimated at €7.6 billion for
the CET1 minimum of 4.5% and €21.7 billion for a CET1 target level of
7.0%.

The sum of Group 2 bank profits after tax prior to distributions in 2011
was €24 billion.

Further details on additional capital needs to meet the Basel III
requirements are included in Section 2.

Capital ratios

The average CET1 ratio under the Basel III framework would decline
from 10.4% to 7.7% for Group 1 banks and from 10.4% to 8.8% for Group 2
banks.
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The Tier 1 capital ratios of Group 1 banks would decline, on average from
11.7% to 8.0% and total capital ratios would decline from 14.2% to 9.2%.

As with the CET1 ratios, the decline in other capital ratios is
comparatively less pronounced for Group 2 banks; Tier 1 capital ratios
would decline on average from 11.0% to 9.2% and total capital ratios
would decline on average from 14.3% to 11.0%.

Changes in risk-weighted assets

As compared to current risk-weighted assets, total risk-weighted assets
increase on average by 18.1% for Group 1 banks under the Basel III
framework.

This increase is driven largely by charges against counterparty credit risk,
trading book exposures, and securitization exposures (principally those
risk-weighted at 1250% under the Basel III framework that were
previously 50/50 deductions under Basel II).

Banks that have significant exposures in these areas influence the average
increase in risk-weighted assets heavily.

As Group 2 banks are less affected by the revised counterparty credit risk
and trading book rules, these banks experience a comparatively smaller
increase in risk-weighted assets of only 7.5%.

Even within this sample, higher risk-weighted assets are attributed
largely to Group 2 banks with counterparty and securitisation exposures
(ie those subject to a 1250% risk weighting).

As discussed in Section 4.1, the increase in risk-weighted assets contains
certain estimates pertaining to trading book exposures for banks that
have already adopted the Basel 2.5 enhancements.

Leverage ratio
The average Basel III Tier 1 leverage ratio for all banks is 3.6%. The Basel
III average for Group 1 banks is 3.5%, and the average for Group 2 banks
is 4.2%.
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Liquidity standards

Both liquidity standards are currently subject to an observation period
which includes a review clause to address any unintended consequences
prior to their respective implementation dates of 1 January 2015 for the
LCR and 1 January 2018 for the NSFR.

Basel III monitoring results for the end-December 2011 reporting period
give an indication of the impact of the calibration of the standards based
on the December 2010 rules text and highlight several key observations:

- A total of 102 Group 1 and 107 Group 2 banks participated in the
liquidity monitoring exercise for the end-December 2011 reference
period.

- The weighted average LCR for Group 1 banks is 91%, compared to
90% for 30 June 2011, while the weighted average LCR for Group 2
banks is 98%.

The aggregate LCR shortfall is €1.8 trillion which represents
approximately 3% of the €61.4 trillion total assets of the aggregate
sample.

- The weighted average NSFR is 98% for Group 1 banks and 95% for
Group 2 banks, compared to 94% for each of the Group 1 and Group 2
samples as at 30 June 2011.

The aggregate shortfall of required stable funding is €2.5 trillion.

Sample of participating banks

banks and 107 Group 2 banks.

Group 1 banks are those that have Tier 1 capital in excess of €3 billion and
are internationally active.

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All other banks are considered Group 2 banks.

Banks were asked to provide data as of 31 December 2011 at the
consolidated level.

Subsidiaries are not included in the analyses to avoid double counting.

Table 1 shows the distribution of participation by jurisdiction.

For Group 1 banks members’ coverage of their banking sector was very
high reaching 100% coverage for some jurisdictions.

Coverage for Group 2 banks was comparatively lower and varied across
jurisdictions.

Not all banks provided data relating to all parts of the Basel III
framework.

Accordingly, a small number of banks are excluded from individual
sections of the Basel III monitoring analysis due to incomplete data.

In certain sections, data are based on a consistent sample of banks.

This consistent sample represents only those banks that reported
necessary data at both the June 2011 and December 2011 reporting dates,
in order to make more meaningful period-to-period comparisons.

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Capital shortfalls

Chart 5 and Table 2 provide estimates of the amount of capital that Group
1 and Group 2 banks would need based on data as of 31 December 2011 in
addition to capital already held at the reporting date, in order to meet the
target CET1, Tier 1, and total capital ratios under Basel III assuming fully
phased-in target requirements and deductions.

Under these assumptions, the CET1 capital shortfall for Group 1 banks
with respect to the 4.5% CET1 minimum requirement is €11.9 billion.

The CET1 shortfall with respect to the 4.5% requirement for Group 2
banks, where coverage of the sector is considerably smaller, is estimated
at €7.6 billion.

For a CET1 target of 7.0% (ie the 4.5% CET1 minimum plus the 2.5%
capital conservation buffer, plus any capital surcharge for Group 1 G-SIBs
as applicable), Group 1 banks’ shortfall is €374.1 billion and Group 2
banks’ shortfall is €21.7 billion.

The surcharges for G-SIBs are a binding constraint on 21 of the 27 G-SIBs
included in this Basel III monitoring exercise.

As a point of reference, the aggregate sum of after-tax profits prior to
distributions for Group 1 and Group 2 banks in the same sample was €356
billion and €24 billion, respectively in 2011.

respect to the 4.5% minimum for Group 1 banks has improved by €26.9
billion or 69.3% (see Chart 5).

banks has improved by €111.5 billion or 23.0%.

Assuming the 4.5% CET1 minimum capital requirements were fully met
(ie, there were no CET1 shortfalls), Group 1 banks would need an
additional €32.5 billion of additional Tier 1 or CET1 capital to meet the
minimum Tier 1 capital ratio requirement of 6.0%.
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Assuming banks already hold 7.0% CET1 capital, Group 1 banks would
need an additional €219.3 billion of additional Tier 1 or CET1 capital to
meet the Tier 1 capital target ratio of 8.5% (ie the 6.0% Tier 1 minimum
plus the 2.5% CET1 capital conservation buffer), respectively.

Group 2 banks would need an additional €2.1 billion and an additional
€11.9 billion to meet these respective Tier 1 capital minimum and target
ratio requirements.

Assuming CET1 and Tier 1 capital requirements were fully met (ie, there
were no shortfalls in either CET1 or Tier 1 capital), Group 1 banks would
need an additional €100.2 billion of Tier 2 or higher quality capital to meet
the minimum total capital ratio requirement of 8.0% and an additional
€224.3 billion of Tier 2 or higher quality capital to meet the total capital
target ratio of 10.5% (ie the 8.0% Tier 1 minimum plus the 2.5% CET1
capital conservation buffer).

Group 2 banks would need an additional €4.1 billion and an additional
€8.6 billion to meet these respective total capital minimum and target
ratio requirements.

As indicated above, no assumptions have been made about bank profits
or behavioural responses, such as changes balance sheet composition,
that will serve to ameliorate the impact of capital shortfalls over time.

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Impact of the definition of capital on Common Equity Tier 1
capital

As noted above, reductions in capital ratios under the Basel III
framework are attributed in part to capital deductions not previously
applied at the common equity level of Tier 1 capital in most jurisdictions.

Table 3 shows the impact of various regulatory adjustment categories
on the gross CET1 capital (ie, CET1 before adjustments) of Group 1 and
Group 2 banks.

In the aggregate, regulatory adjustments reduce the gross CET1 of Group
1 banks under the Basel III framework by 29.0%.

The largest driver of Group 1 bank deductions is goodwill, followed by
combined deferred tax assets (DTAs) deductions, and intangibles other
than mortgage servicing rights.

These deductions reduce Group 1 bank gross CET1 by 14.0%, 4.3%, and
3.5%, respectively.

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The category described as other adjustments reduces Group 1 bank gross
CET1 by 3.8% and pertain mainly to deductions for provision shortfalls
relative to expected credit losses and deductions related to defined benefit
pension fund schemes.

Holdings of capital of other financial companies reduce the CET1 of
Group 1 banks by 1.9%.

The category “Excess above 15%” refers to the deduction of the amount
by which the aggregate of the three items subject to the 10% limit for
inclusion in CET1 capital exceeds 15% of a bank’s CET1, calculated after
all deductions from CET1.

These 15% threshold bucket deductions reduce Group 1 bank gross CET1
by 1.6%.

Deductions for MSRs exceeding the 10% limit have no impact on Group 1
CET1 in the aggregate.

Table 3 also compares regulatory adjustments for Group 1 banks with the
results of the previous period for those banks which participated in both
exercises.

Overall, deductions have been reduced by 2.6 percentage points, mainly
driven by lower deductions for goodwill and financials.

Regulatory adjustments reduce the CET1 of Group 2 banks by 20.4%.
Goodwill is the largest driver of deductions for Group 2 banks, followed
by holdings of the capital of other financial companies, deductions for
intangibles other than mortgage servicing rights, and combined DTAs
deductions.

These deductions reduce Group 2 bank CET1 by 7.5%, 2.3%, 2.3% and
1.9%, respectively.

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Other adjustments, which are driven significantly by deductions for
provision shortfalls relative to expected credit losses, result in a 3.1%
reduction in Group 2 bank gross CET1.

Deductions for items in excess of the aggregate 15% threshold basket
reduce Group 2 bank gross CET1 by 1.2%.

Deductions for mortgage servicing rights above the 10% limit have no
impact on Group 2 banks.

Changes in risk-weighted assets
4.1 Overall results

Reductions in capital ratios under the Basel III framework are also
attributed to increases in risk-weighted assets.

Table 4 provides additional detail on the contributors to these increases,
to include the following categories:

Definition of capital:

These columns measure the change in risk-weighted assets as a result of
proposed changes to the definition of capital.

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The column heading “other” includes the effects of lower risk-weighted
assets for exposures that are currently included in risk-weighted assets
but receive a deduction treatment under Basel III.

The column heading “50/50” measures the increase in risk-weighted
assets applied to securitisation exposures currently deducted under the
Basel II framework that are risk-weighted at 1250% under Basel III.

The column heading “threshold” measures the increase in risk-weighted
assets for exposures that fall below the 10% and 15% limits for CET1
deduction;

Counterparty credit risk (CCR):
This column measures the new capital charge for credit valuation
adjustments (CVA risk) and the higher capital charge that results from
applying a higher asset value correlation parameter against exposures to
financial institutions under the IRB approaches to credit risk.

Banks have not been asked to provide data on the risk-weighted asset
effects of capital charges for exposures to central counterparties (CCPs)
or on any impact of incorporating stressed parameters for effective
expected positive exposure (EEPE);

Trading book:

As data from most countries already include the RWA impact of the
Basel 2.5 market risk rules, the incremental impact for changes in market
RWA shown in these tables has been estimated using the sum of the
following elements relative to elements in place under Basel II: the
proportion of internally modeled general and specific risk that is
attributable to stress value-at-risk, the incremental risk capital charge
(IRC), capital charges for the correlation trading portfolio, and capital
charges under the standardised measurement method (SMM) for other
securitisation exposures and nth-to-default credit derivatives.

The effect of higher capital charges for re-securitisation exposures in the
banking book and increased conversion factors for short-term liquidity
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facilities to off-balance sheet conduits are not considered in these tables
given the data are no longer available for all countries.

However, prior reports have shown the impact of these charges to be
generally small for both Group 1 and Group 2 banks.

Risk-weighted assets for Group 1 banks increase overall by 18.1% for
Group 1 banks.

This increase is to a large extent attributed to higher risk-weighted assets
for counterparty credit risk exposures, which result in an overall increase
in total Group 1 bank risk-weighted assets of 7.9%.

The predominant drivers behind this figure are capital charges for CVA
risk and the higher asset value correlation parameter, which is included in
the column labelled “CCR”.

Trading book exposures and securitisation exposures currently subject to
deduction under Basel II, also contribute significantly to higher
risk-weighted assets at Group 1 banks at 4.9% and 4.2%, respectively.

Risk-weighted assets of Group 2 banks increase overall by 7.5%.

Banks in this group tend to have smaller counterparty credit risk and
trading book exposures, which explains the lower increase risk-weighted
assets for Group 2 banks as compared to Group 1 banks.

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Securitisation exposures currently subject to deduction, CCR exposures,
and exposures that fall below the 10% and 15% CET1 eligibility limits are
significant contributors to changes in risk-weighted assets for Group 2
banks.

Changes in risk-weighted assets show significant variation across banks
as shown in Chart 6.

Again, these differences are explained in large part by the extent of banks’
counterparty credit risk and trading book exposures, which attract
significantly higher capital charges under Basel III as compared to
current rules.

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Liquidity
6.1 Liquidity coverage ratio

One of the two standards introduced by the Committee is a 30-day
liquidity coverage ratio (LCR) which is intended to promote short-term
resilience to potential liquidity disruptions.

The LCR has been designed to require global banks to have sufficient
high-quality liquid assets to withstand a stressed 30-day funding scenario
specified by supervisors.

The LCR numerator consists of a stock of unencumbered, high-quality
liquid assets that must be available to cover any net outflow, while the
denominator is comprised of cash outflows less cash inflows (subject to a
cap at 75% of outflows) that are expected to occur in a severe stress
scenario.

102 Group 1 and 107 Group 2 banks provided sufficient data in the 31
December 2011 Basel III monitoring exercise to calculate the LCR
according to the Basel III liquidity framework.

The weighted average LCR was 91% for Group 1 banks, compared to 90%
for 30 June 2011, and 98% for Group 2 banks.

These aggregate numbers do not speak to the range of results across the
banks.

Chart 8 below gives an indication of the distribution of bank results; the
thick red line indicates the 100% minimum requirement, the thin red
horizontal lines indicate the median for the respective bank group.

47% of the banks in the Basel III monitoring sample already meet or
exceed the minimum LCR requirement, an increase from 45% at the end
of June 2011, and 62% have LCRs that are at or above 75%.

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For the banks in the sample, Basel III monitoring results show a shortfall
(ie the difference between high-quality liquid assets and net cash
outflows) of €1.8 trillion (which represents approximately 3% of the €61.4
trillion total assets of the aggregate sample) as of 31 December 2011, if
banks were to make no changes whatsoever to their liquidity risk profile.

This number is only reflective of the aggregate shortfall for banks that are
below the 100% requirement and does not reflect surplus liquid assets at
banks above the 100% requirement.

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Banks that are below the 100% required minimum have until 2015 to meet
the standard by scaling back business activities which are most
vulnerable to a significant short term liquidity shock or by lengthening
the term of their funding beyond 30 days.

Banks may also increase their holdings of liquid assets.

The key components of outflows and inflows are shown in Table 7.

Group 1 banks show a notably larger percentage of total outflows, when
compared to balance sheet liabilities, than Group 2 banks.

This can be explained by the relatively greater contribution of wholesale
funding activities and commitments within the Group 1 sample, whereas
Group 2 banks, as a whole, are less reliant on these types of activities.

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75% cap on total inflows

As at 31 December 2011, no Group 1 and 16 Group 2 banks reported
inflows that exceeded the cap, compared to 19 Group 2 banks as at 30
June 2011.

Of the 16 Group 2 banks, three fail to meet the LCR, so the cap is binding
on them.

Of the banks impacted by the cap on inflows, 12 have inflows from other
financial institutions that are in excess of the excluded portion of inflows.

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Composition of high-quality liquid assets

The composition of high-quality liquid assets currently held at banks is
depicted in Chart 9.

The majority of Group 1 and Group 2 banks’ holdings, in aggregate, are
comprised of Level 1 assets; however the sample, on whole, shows
diversity in their holdings of eligible liquid assets.

Within Level 1 assets, 0% risk-weighted securities issued or guaranteed
by sovereigns, central banks and PSEs, and cash and central bank
reserves comprise the most significant portions of the qualifying pool,
with the latter increasing its contribution to the overall composition to
31.4% as at the end of December 2011 from 27.6% as at the end of
June 2011.

Comparatively, within the Level 2 asset class, the majority of holdings are
comprised of 20% risk-weighted securities issued or guaranteed by
sovereigns, central banks or PSEs, and qualifying covered bonds.

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Cap on Level 2 assets

€117 billion of Level 2 liquid assets were excluded because reported Level
2 assets were in excess of the 40% cap as currently operationalised.

23 banks currently reported assets excluded, of which 16 (8% of the total
sample) had LCRs below 100%.

These results compare to €121 billion of Level 2 liquid assets excluded by
34 banks as at 30 June 2011, of which 24% (11% of the sample) had LCRs
below 100%.

Chart 10 combines the above LCR components by comparing liquidity
resources (buffer assets and inflows) to outflows.

Note that the €710 billion difference between the amount of liquid assets
and inflows and the amount of outflows and impact of the cap displayed
in the chart is smaller than the €1.8 trillion gross shortfall noted above as it
is assumed here that surpluses at one bank can offset shortfalls at other
banks.

In practice the aggregate shortfall in the industry is likely to lie
somewhere between these two numbers depending on how efficiently
banks redistribute liquidity around the system.

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Net stable funding ratio

The second standard is the net stable funding ratio (NSFR), a
longer-term structural ratio to address liquidity mismatches and provide
incentives for banks to use stable sources to fund their activities.

102 Group 1 and 107 Group 2 banks provided sufficient data in the 31
December 2011 Basel III monitoring exercise to calculate the NSFR
according to the Basel III liquidity framework.

51% of these banks already meet or exceed the minimum NSFR
requirement, compared to 46% at the end of June 2011, with 92% at an
NSFR of 75% or higher as at 31 December 2011.

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The weighted average NSFR for the Group 1 bank sample is 98% while it
is 95% for the Group 2 sample, compared to 94% for each of the Group 1
and Group 2 samples as at 30 June 2011.

Chart 11 shows the distribution of results for Group 1 and Group 2 banks;
the thick red line indicates the 100% minimum requirement, the thin red
horizontal lines indicate the median for the respective bank group.

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The results show that banks in the sample had a shortfall of stable
funding of €2.5 trillion at the end of December 2011, a decrease from €2.8
trillion at the end of June 2011, if banks were to make no changes
whatsoever to their funding structure.

This number is only reflective of the aggregate shortfall for banks that are
below the 100% NSFR requirement and does not reflect any surplus stable
funding at banks above the 100% requirement.

Banks that are below the 100% required minimum have until 2018 to meet
the standard and can take a number of measures to do so, including by
lengthening the term of their funding or reducing maturity mismatch.

It should be noted that the shortfalls in the LCR and the NSFR are not
necessarily additive, as decreasing the shortfall in one standard may result
in a similar decrease in the shortfall of the other standard, depending on
the steps taken to decrease the shortfall.

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NUMBER 2

Financial Services Agency, The
Japanese Government

Recent Trend of Financial and Capital Markets,
Regulatory and Supervisory Challenges
Ryutaro Hatanaka

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NUMBER 3

Investor Protection through Audit
Oversight
Lewis H. Ferguson, Board Member
California State University 11th Annual SEC Financial Reporting
Conference, Irvine, CA
Thank you for inviting me to speak today. I am delighted to be here in
sunny Southern California to share some thoughts with you about
developments in auditor oversight, the part of the financial reporting
universe in which I now spend my time.
Before I begin, I must tell you that the views I express today are my own
and do not necessarily reflect the views of the Public Company
Accounting Oversight Board, any other Board member, or the staff of the
PCAOB.
Anyone involved in the financial reporting process deals daily with the
hard realities of complexity and rapid change -- whether you are a
preparer of financial statements, a board or audit committee member, an
investor, an independent or internal auditor, a counselor, or a regulator.
Commercial activity is increasingly global.
Some financial instruments and transactions are bafflingly complex with
values that can only be estimated.
Standard setters in the United States and abroad are moving away from
historical cost accounting toward fair value accounting, requiring difficult
estimates.
There is a plethora of new rules and requirements growing out of the
Dodd-Frank and JOBS acts in the United States, and all of this is
happening in what since 2008 has been the most difficult global economic
environment since the Great Depression of the 1930s.

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Much as we struggle with these rapid changes and their complexity,
regulators also struggle to see around the curve, to be prepared for what is
coming tomorrow, and to have tools in their toolbox that will be
appropriate for those challenges.
In the next session of today’s conference, I will discuss a number of
specific initiatives the PCAOB is undertaking to deal with some of these
challenges, but in this address I want to focus on one specific area, the
challenge of globalization and cross-border financial reporting, auditing
and audit oversight.
A bit of background may be useful here.
The PCAOB was created by the U.S. Congress in 2002, in response to a
crisis stemming from the failures of enterprises like Enron, WorldCom,
Adelphia and others.
These cases all involved systemic and undetected financial and
accounting fraud.
Congress concluded that these cases demonstrated that the long
established system of auditor quality oversight by the auditing profession
itself, known as peer review, was irretrievably broken.
Accordingly, Congress created the PCAOB as an independent,
not-for-profit body, whose five members are appointed by the United
States Securities and Exchange Commission, to “oversee the audit of
public companies that are subject to the securities laws.”
The Board’s mission is “protect the interest of investors and further the
public interest in the preparation of informative, accurate, and
independent audit reports” for U.S. public companies.
From its establishment in 2002, the PCAOB has grown to be an
organization with a projected 800 employees by the end of this year
located in 16 offices throughout the United States, including in Irvine and
Los Angeles.
To prevent capture by the accounting profession, Congress provided that
while two of the five PCAOB board members had to be CPAs, no more
than two could be.
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That leaves two of my fellow board members and me, including the
PCAOB’s chairman, who are lawyers by training and profession.
The PCAOB was assigned four principal functions by the statute:
1. The first is to oversee and maintain the registration of all auditing firms
whether they are located here or abroad that file audit reports with the
SEC or participate substantially in the audit of companies that file such
reports.
In 2010, the Dodd-Frank Act also gave the PCAOB jurisdiction over
auditors of registered brokers and dealers and required all such firms to
be registered.
Today, 2,380 auditing firms are registered with the PCAOB including 570
firms that audit brokers and dealers.
Of the total, 1,465 firms are located in the United States and 915 firms
outside the United States in 85 jurisdictions.
The largest number of foreign registered firms are in China with 100
firms, including 52 in Hong Kong and 48 in the People’s Republic of
China, 66 in India, 64 in the U.K., 48 in Canada and 41 in Australia.
2. The second principal function of the PCAOB is periodically to inspect
registered firms that file or participate in the preparation of audit reports
of public companies and securities brokers and dealers.
Any audit firm with more than 100 issuer audit clients must be inspected
annually and at least triennially if they regularly provide audit reports for
100 or fewer issuers.
In 2012, there are currently 9 annually inspected auditing firms.
Our inspections are not randomly selected but are selected on the basis of
audit risk, focusing on issues, industries, or firms where we believe the
greatest risk of audit failure may lie.
Since its inception, the PCAOB has conducted more than 1,950
inspections and examined portions of over 8,200 individual audits.

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In 2011, for example, for the 10 firms subject to annual inspection in that
year, the PCAOB inspectors looked at portions of approximately 340
audits.
For the 203 firms inspected on a three-year cycle in 2011, portions of
approximately 485 audits were examined, including 42 non-U.S. audit
firms located in 15 jurisdictions.
We are scheduled to inspect approximately 80 non-U.S. firms in 2012.
As part of an interim program for the inspection of brokers and dealers, in
2011 and early 2012, we inspected 10 audit firms, examining portions of 23
separate audits and issued a public interim report on those inspections in
August of this year.
3. Our third function is to set auditing and other professional standards.
We have an ambitious standard-setting agenda that tackles old and new
issues in auditing, particularly issues that surfaced after the recent
financial crisis – from improving communications with audit committees
to reforming the auditor’s reporting model.
In the next session of this conference, I will discuss in more detail the
PCAOB’s standard-setting projects.
4. Our fourth and last principal function is to conduct investigations and
enforcement proceedings.
The Board has the authority to impose disciplinary sanctions, including
barring auditors from public company auditing and imposing substantial
monetary penalties.
Since 2003, the PCAOB has taken 55 disciplinary actions against 42
registered accounting firms and 56 persons associated with registered
firms.
As part of these enforcement actions, the Board has revoked the
registration of 27 firms, barred 43 individuals, and suspended the
registration of five individuals and one firm.
These are our four core functions: registration, inspections, standard
setting, and investigation and enforcement.
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Everything the Board does is in support of these functions.
Other offices, particularly the Office of Research and Analysis, provides
valuable input.
ORA’s staff of more than 30 economists and analysts study economic
trends and the large bodies of confidential data we collect as part of our
inspection process.
The broad reach of our activities gives us a unique perspective on the
state of audit practice in the United States and abroad, and on the
operations of major auditing firms.
When the PCAOB was created in 2002, the United States was essentially
alone in the world in having comprehensive regulation of the auditors of
public companies that was independent of the profession itself.
Initially, Sarbanes-Oxley was seen by many, particularly outside the
United States, as an effort to address something that was strictly an
American problem.
But shortly after the failures of Enron and WorldCom, a series of major
accounting failures were uncovered at non-U.S. companies, such as
Parmalat, Vivendi, Hollinger, Ahold, Royal Dutch Shell, China Aviation
and others.
As a result, many other countries began to adopt independent audit
supervisory regimes.
Today, just 10 years after the creation of the PCAOB, almost all advanced
or emerging market countries have an independent audit regulator.
These regimes differ. Some like the PCAOB are independent agencies;
others are housed in the local securities regulator.
But they share certain common attributes: they are either government
agencies or bodies that are independent of the audit profession; they
conduct regular inspections of audit firms; and they possess disciplinary
and sometimes licensing and standard-setting powers.

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We are grateful that the example of the PCAOB has encouraged the
creation of similar, independent audit oversight in other
countries—oversight that can only benefit the investors in our national
and global markets.
International Cooperation
IFIAR
It is not surprising that these new regulators soon decided that they
should form an organization for sharing views and helping each other
improve their work.
In September 2006, a group of 18 independent audit regulators formed the
International Forum of Independent Audit Regulators, to provide a forum
for regulators to share knowledge of the audit market environment and
the practical experience gained from their independent audit regulatory
activity.
Only regulators that are truly independent of the auditing profession are
eligible for membership which has grown steadily to 43 members today
with another 13 candidate members in various stages of the application
process.
In addition to the United States, Canada and one South American
regulator, most European regulators are members as well as several
regulators in the Middle East, and a number of Asian regulators,
including those in Japan, Korea, Taiwan, Thailand, Malaysia, Singapore,
Sri Lanka, and Australia.
The United States has come to play a leadership role in IFIAR and I was
honored recently to be elected Vice-Chair of the organization.
IFIAR holds annual plenary meetings at which regulators from around
the world meet to exchange information on a variety of topics including
general inspection and enforcement findings, standard-setting initiatives
and cross-border cooperation.
The next such meeting will be in London at the beginning of October.

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In addition, there are five working groups that meet more frequently and
focus on specific issues like standard setting, international cooperation,
investor concerns, inspection training and public policy.
One of the most important is the last, the Global Public Policy Committee
Working Group, that meets three times each year with the leadership of
the six global network audit firms to discuss issues of concern to the
regulators and the firms.
IFIAR also conducts an annual inspection training workshop for audit
inspectors from around the world.
For the first time this year, IFIAR has surveyed its members about their
audit inspection findings.
Thirty-seven of the 43 IFIAR members responded to the survey and while
the results are presently confidential, I can tell you that a striking result of
the survey is that other regulators around the world seem to be finding the
same types of defects in their inspections that the PCAOB is finding,
particularly deficiencies in auditing fair value measurements, testing
internal controls, revenue recognition and engagement quality control
reviews.
The Global Environment
You might ask why an organization like IFIAR is important.
The short answer is that it enables individual regulators to get a better
window on the global landscape of audit practice and financial reporting.
This is important because the world’s largest enterprises -- those that
represent the largest share of global economic activity and shareholder
wealth -- operate globally.
Not only do they sell products globally, but increasingly they purchase
raw and component materials, manufacture, distribute, and do research
and development globally.
One only needs to look at some of the latest signature industrial products,
like new automobiles, computer and smartphone products, or the Boeing
787 airliner to realize that these products are produced from designs and
components sourced and manufactured in many different countries.
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A global company, perhaps operating in more than 100 countries, also has
financial reporting activities in many, if not all, of those countries.
Any regulator, confined to a view within its own borders, can only see a
portion, and often a small portion, of the activities and risks of such an
enterprise.
Cross-border regulatory cooperation, working together and sharing
information, is vital to our common mission to improve the protection of
investors who rely on auditors to assure that the financial reports of
publicly traded companies are transparent, complete and fairly stated.
Just as the largest corporations in the world have become increasingly
global in their operations, their auditors must be able to conduct audits
on a global basis.
The largest audit firms have grown globally along with their clients.
But unlike their corporate clients, which usually operate globally through
a centrally controlled structure of parent and subsidiary entities, the
global audit firms operate as an affiliation of individual audit firms.
They are organized and operating under the laws of different political and
regulatory jurisdictions joined together in networks where they share
clients, training, audit methodologies, and quality assurance practices. T
hey operate under a common name such as Deloitte Touche Tohmatsu,
Ernst & Young, PricewaterhouseCoopers, KPMG, Grant Thornton and
others.
There are a number of reasons for such structures: local licensing and
ownership requirements; different traditions of training and practice; and
not least, concern about cross border liability exposure.
The global organization of these networks provides common audit
methodologies, conducts quality assurance examinations and provides
other services.
But in the final analysis, the only real power the global leadership has over
its individual members is the power to remove a member from the
network.

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This is a very different power from that of the chief executive officer of a
global corporation over his or her far flung subsidiaries.
In the audit of a major global corporation, a number of different auditing
firms, operating under a single trade name, will cooperate to perform the
audit of the corporation’s global operations.
Today, the auditor’s report on such a corporation is signed by only one
firm in the network and does not reveal whether other affiliated firms
participated in the audit or the extent of their participation.
The reality of today’s global business environment means that regulators
around the world must do the same thing. We must cooperate effectively
with each other if we are to ensure that audit quality remains high and
that investors are protected.
Details of the PCAOB’s Cooperative Arrangements with Other
Regulators
The PCAOB cooperates closely with audit regulators outside the United
States, and the scope of that cooperation is extensive.
Since 2005, we have conducted 338 inspections of PCAOB registered
firms in 38 different countries.
We have cooperative agreements with 14 foreign regulators in Australia,
Canada, Dubai, the U.K., Germany, Israel, Japan, the Netherlands,
Norway, Korea, Singapore, Spain, Switzerland, and Taiwan as a result of
which we either conduct joint inspections or share inspection findings
with regulators in those jurisdictions.
We are also actively negotiating such agreements with regulators in a
number of other European countries.
We have conducted international inspections, both alone and jointly, with
the local regulator.
We have found that joint inspections are particularly useful and have
conducted them with regulators in Canada, Switzerland, the United
Kingdom, Germany, Norway and the Netherlands.

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We will shortly conduct joint inspections with the Spanish and Korean
audit regulators.
In these inspections, we have faced and resolved difficult data protection
issues that are of great concern to regulators in the European Union.
We have also resolved confidentiality concerns that Swiss regulators have
raised.
The joint inspections have demonstrated that with a cooperative
approach many obstacles can be overcome.
In joint inspections each regulator learns from the other and we are
convinced that these inspections have improved regulatory oversight both
by the PCAOB and by our foreign counterparts.
Limits on PCAOB Inspections and their Effects on Investors
I want to talk now about some of the limits to the PCAOB’s ability to
inspect non-U.S. audit firms registered with us and the potential risks this
poses to U.S. investors.
The PCAOB currently is prevented from inspecting the U.S.-company
related audit work and practices of PCAOB-registered firms in certain
European countries, China, and – to the extent their audit clients have
operations in China – Hong Kong.
In Europe, the obstacles to inspection center around the requirement to
satisfy the individual country’s data protection requirements under
European Union law.
After some delay, we are now making progress and have cooperative
agreements with several European Union regulators.
We continue to negotiate with others.
Where the PCAOB is not able to conduct inspections, investors in
U.S.-traded companies who rely on the audit reports of firms' in those
countries are deprived of the potential benefits of PCAOB inspections of
those firms.

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To better inform investors about our inspections, the PCAOB publishes
on its website a list of more than 400 companies whose auditors are
located in jurisdictions where obstacles to PCAOB inspections exist.
The list is derived from annual reports filed with the PCAOB by
registered public accounting firms.
China
Now, let me turn to China. As you are probably aware, in the past year or
so, alleged serious financial frauds and attendant accounting problems
have been disclosed involving a number of China-based companies
whose securities are registered outside of China, particularly in the
United States, Singapore and, to a lesser extent, Europe.
Not more than a decade ago, Chinese firms began to access foreign
capital markets.
Two types of Chinese companies sought access to U.S. capital markets,
smaller enterprises that had difficulty accessing the very restricted
Chinese domestic capital markets and some of the largest state-owned
enterprises in industries such as petroleum and telecommunications.
At the same time some of the largest global companies, including U.S
companies, began to engage in extensive operations in China.
The smaller companies most commonly sought access to U.S. markets by
merging with existing, registered U.S. shell companies in reverse
mergers.
The larger companies filed initial public offerings.
A PCAOB Research Note showed that, in the United States alone,
between January 1, 2007 and March 31, 2010, 159 Chinese companies
entered the U.S. securities markets using reverse mergers and generated
market capitalization of $12.8 billion.
These transactions represented the largest share of the reverse merger
market during that period.

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In the same period, 56 Chinese companies, including a number of very
large state-owned enterprises completed U.S. IPOs and had an aggregate
market capitalization of $27.2 billion.
Seventy-four percent of these reverse merger companies were audited by
U.S.-based audit firms and China-based audit firms audited the balance,
but all of these firms were registered with the PCAOB.
As major U.S. companies like General Motors, IBM, Microsoft, Apple
Computer, Proctor & Gamble, General Electric and Walmart began to
build extensive operations in China, the China and Hong Kong based
affiliates of the global network audit firms began to play an increasing
role in the consolidated audits of those companies.
Beginning in the latter part of 2010, alleged financial frauds and serious
accounting issues were revealed at a number of the smaller Chinese
reverse merger companies.
To date, 67 of these China-based issuers have had their auditor resign,
and 126 issuers have either been delisted from U.S. securities exchanges
or “gone dark” – meaning that they are no longer filing current reports
with the SEC.
Billions of dollars of market capitalization of such companies have been
lost in U.S. securities markets and it is fair to say that all of these smaller
China-based companies listed on U.S. securities exchanges have suffered
serious losses of both market value and investor confidence as a result of
the problems of other companies.
The number of China-based companies that have successfully filed an
initial public offering in the United States in the past year has slowed to a
trickle.
We understand that smaller Chinese companies have also suffered similar
adverse consequences in other non-U.S. and non-Chinese markets.
At present, the PCAOB does not have cooperative agreements with either
the China Securities Regulatory Commission or China’s Ministry of
Finance which share jurisdiction over Chinese accountants.

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The CSRC has jurisdiction over the 53 accounting firms, including the
affiliates of the global network firms that are authorized to file audit
reports with respect to companies listing securities on the Chinese
domestic securities markets in Shanghai and Shenzhen.
The MOF licenses all accountants in China and has jurisdiction over
more than 7,000 accounting firms in China, including some of the firms
registered with the PCAOB.
Under Chinese law, it is illegal to remove audit work papers from China.
At the present time, Chinese authorities will also not permit any
non-Chinese regulator to conduct inspections on Chinese soil.
As a result, it is impossible for the PCAOB or other regulators to inspect
China-based audit firms or to assess the quality of such firms registered
with it.
This limitation also applies to the affiliates of the global network firms
that perform audit work on the audits of the Chinese operations of the
large global companies operating in China.
In an attempt to address these problems, the PCAOB has intensified its
dialogue with both the China Securities Regulatory Commission and the
MOF over the past year.
Both we and the Chinese regulators recognize the importance of
improving audit quality and investor protection.
For the PCAOB, an agreement with China is important not only because
of the risks investors face, but because of the size and rapid growth of the
Chinese economy.
Almost 5 percent of PCAOB registered firms are based either in China or
Hong Kong, the largest group of non-U.S. firms.
Chinese authorities say that we should rely on their oversight of auditors.
They have two principal concerns.
The first is that any action by a foreign regulator on Chinese soil, even a
mere inspection, could violate Chinese sovereignty.

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This concern has deep historical roots, specifically relating to the
humiliations that China suffered at the hands of Western powers in the
nineteenth and early twentieth centuries.
The second concern grows out of China’s very expansive state secrecy
laws.
There has been a concern expressed that inspection of audit work papers,
particularly work papers from the audits of state-owned enterprises, could
lead to disclosures of state secrets.
The question for both countries is how to conduct inspections in ways
that respect national sovereignty and the legitimate regulatory goals of
both countries.
As mentioned earlier, we have been able successfully to navigate or
balance these seemingly competing interests in a number of countries
around the globe.
As a first step toward further cooperation, we are working toward and
have tentatively agreed on observational visits where PCAOB inspectors
would observe the Chinese authorities conducting their own audit
oversight activities and the Chinese could observe the PCAOB at work.
This would not be a substitute for a PCAOB inspection but would be a
trust building exercise between regulators.
Initially, such observations would focus on quality control examinations
of the audit firm being examined rather than a substantive review of a
specific audit.
We hope such exercises will build trust and lead to further cooperation.
The ultimate goal for the PCAOB is to achieve a level of cooperation with
the Chinese authorities that will enable us to have enough information
and confidence that we could issue inspection reports on those
China-based audit firms that prepare or participate substantially in the
preparation of audit reports filed in the United States.
There is, however, a second and complicating issue with China and Hong
Kong.

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Both the PCAOB and the SEC are in discussion with Chinese authorities
about cooperation in connection with investigative activities.
Both agencies are seeking the cooperation of the Chinese authorities in
obtaining documents in appropriate investigations.
Although we remain hopeful that breakthroughs will be achieved, to date
difficulties remain.
Despite our hopes, the question arises as to what happens if we are not
able to achieve an agreement on regulatory cooperation with the Chinese.
Any firm that registers with the PCAOB is legally obligated to cooperate
with us and provide documents and potentially testimony if requested in
connection with an inspection or investigation.
A refusal to cooperate, either in an inspection or an investigation, could
subject the firm to PCAOB sanctions even if motivated by compliance
with local laws that restrict such cooperation.
One possible sanction could be revocation of a firm’s PCAOB
registration.
Any company audited by such a firm would either have to get a new audit
opinion signed by a firm registered with the PCAOB or risk being in
violation of SEC and stock exchange rules.
The stakes in this matter are very high.
But U.S. financial authorities have a primary responsibility to protect the
integrity of our capital markets and the interests of U.S. investors.
We believe the Chinese authorities are aware of the seriousness of this
matter and we are hopeful that we will be able to work out satisfactory
arrangements.
We continue to engage in dialogue with the Chinese authorities, but at
this time it remains uncertain where this dialogue will ultimately lead.

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Other Steps to Improve Transparency in Audit Reports
Affecting Global Enterprises
The PCAOB has also proposed another step to increase the transparency
of the audits of global enterprises.
Today, the typical audit report for a U.S-listed company is a one-page
document.
It provides general information about how every audit must be conducted
and states that the audit complied with applicable standards.
It gives the firm’s opinion on the company’s financial statements,
including internal controls over financial reporting where appropriate,
and concludes with the signature of the firm that issued it.
In this era of global networks firms, that signature does not tell the full
story.
An audit report on a multi-national company may carry the signature of
one audit firm, but gives the reader no hint about the key participants in
the audit, including whether portions of the audit were conducted by an
affiliated firm in the global network or by another auditor.
The audit report also gives no information about how the audit work was
allocated among firms.
In October 2011, the Board proposed amendments to PCAOB auditing
standards that would require audit reports to disclose the name of the
audit engagement partner as well as the identity of other independent
audit firms or persons that provided 3 percent or more of the total hours in
the most recent audit.
These amendments, if approved by the Board and the SEC, would serve
two purposes.
First, they would give investors more information about which firms are
actually performing work in the audit which many investors have told us
they want; and second, they would make publicly available the names of
firms that have provided more than 3 percent of the total audit hours but

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are located in jurisdictions where the PCAOB cannot yet conduct
inspections.
Investors can then make a more informed decision about the quality of
the firms participating in a company’s audit.
Some Issues in International Registrations and Inspections
Finally, I want to address an issue we have faced in connection with the
registration of certain non-U.S. audit firms as well as certain findings in
international inspections.
As mentioned above, U.S. securities laws require that any company with
securities traded in U.S. markets be audited by an accounting firm
registered with the PCAOB.
Registration subjects each firm to the oversight activities assigned to the
PCAOB for the protection of investors including inspections and
enforcement.
In 2010, the PCAOB began to request additional information from certain
firms applying for registration.
Essentially, we asked the firm to provide assurance -- including written
confirmation from its national regulatory authority -- that the PCAOB
would be able to inspect the firm.
We have requested such information from applicants from China, Hong
Kong and certain European countries.
To date, one firm’s registration has been rejected by the Board because it
could not offer that assurance, and several other firms’ applications were,
at the firms’ request, essentially put on hold until they are able to provide
this assurance.
Some of those applications have since been approved as the Board
reached agreements with the regulators.
Since 2005, the PCAOB has inspected portions of more than 825 audits
performed by 213 registered firms based outside the United States.

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Seven years of international inspections have revealed that too often
auditors are missing some basic things and making troubling errors,
including errors in the timing and documentation of a company’s revenue
recognition; overreliance on managements’ estimates of such things as
contingency and warranty reserves, allowances for doubtful accounts in
financial institutions, hard to value financial instruments, and obsolete or
overvalued inventory.
These problems are not confined to inspections of non-U.S. firms and we
have seen similar deficiencies in the audits of U.S.-based auditors.
Many of these problems could be solved if auditors approached their jobs
with a higher degree of independence, objectivity and, perhaps most
important, professional skepticism.
Auditors are supposed to challenge management, and the PCAOB would
like to see more auditors do so.
In the same vein, PCAOB inspections continue to find that firms are
deficient in aspects of their internal governance.
More specifically, in an international context, our inspectors have found
deficiencies in the quality control mechanisms within the global network
firms, in the supervision by the principal auditor of work performed by
affiliated firms and in their referral of work to non-affiliated firms or
specialists.
We continue to pursue these issues actively directly with individual firms,
with the leadership of the global auditing network firms, and through our
role as a member of the Global Public Policy Committee Working Group
of IFIAR which meets with the leadership of the global practice firms
three times each year.
That Working Group has concentrated on questions around professional
skepticism, engagement quality control review, group audits, revenue
recognition, sovereign debt issues, the role of the audit committee and
the auditor’s reporting model.

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Conclusion
In the economic crisis that reached its nadir in 2008 we saw well-known
companies—notably Lehman Brothers—whose bankruptcies eclipsed
the failures of Enron and WorldCom in 2002.
What is more sobering is that the economic climate remains uncertain,
with weak job growth in the United States, uncertainty inside the
European Community and a slowing of business growth in China.
Despite these uncertainties globalization of the world economy continues
apace.
This is just the time that investors most need protection.
We may claim a large company as our own because its headquarters is
within our national borders, but, more likely than not, the company is
doing business globally and seeking capital in markets in other countries.
As a consequence, it is the duty of all of us involved in the financial
reporting process, whether as preparer, manager, audit committee
member, auditor, counselor or regulator to work to ensure that financial
reports are complete, transparent, and fairly stated, wherever the
operations they reflect are located.
We owe that to investors who are, after all, our fellow citizens.
Thank you for your attention.

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NUMBER 4

Annual public hearing of the chairpersons
of the three European Supervisory
Authorities (EBA, ESMA and EIOPA).
Initial statement by Andrea Enria Chairperson of the EBA, in
front of the Economic and Monetary affairs committee of the
European Parliament

Dear Madame Chair, Honourable Members of this Committee,
The sovereign debt crisis has had serious adverse consequences on the
banking sector in the euro area and the Single Market.
The interconnection between banks and their sovereigns deepened,
leading to a segmentation of the Single Market along national lines and to
a dangerous volatility of deposits in some Member States.
The concerns of investors translated into a freeze in bank funding,
especially on the longer maturities, which could have triggered a massive
and disordered deleveraging process, with potentially large effects on
growth and employment. Since the second half of 2011, the EBA argued
for a three-pronged approach to address this situation:
(i) Strengthening banks’ capital, to put them on a stronger footing to
finance the real economy and limit deleveraging;
(ii) European interventions to support bank funding and break the link
with the sovereigns; and
(iii) Actions directly remedying the sovereign debt crisis, thus taking
redenomination risk off the table.
As supervisors, we tackled head on the first line of intervention, which
falls directly in our remit.
If we consider the capital injected in the system, for achieving the
threshold set in the 2011 stress test, and the adjustment in capital
positions triggered by our Recommendation, which asked banks to set up
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a Core Tier 1 buffer equal to 9% of risk weighted assets, with a prudent
valuation of sovereign exposures, the overall strengthening already
realised is above € 190 bn – an amount very close to the recommendation
issued by the IMF in the Autumn of 2011.
The support measures already approved for Greek and Spanish banks will
bring the final figure further up, to a significant amount.
We managed this complex process ensuring that banks did not achieve
the capital target by cutting back on lending to households and
corporates, especially small and medium enterprises (SMEs).
We also fostered close cooperation between home and host authorities
within supervisory colleges, to avoid that the possible capital adjustment
was affected by a home bias.
The EBA is committed to pursuing its efforts to ensure that the action of
balance sheet repair continues.
In this respect, supervisory coordination should take place to ensure that
banks apply conservative and consistent valuation of assets and take
actions to gradually restore the smooth funding of their activities in
private markets.
The unlimited supply of term liquidity by the ECB and by other
European central banks, and the decision to move towards a Banking
Union, which we strongly support, are other key components of the policy
package to restore stability in the European banking sector.
The Banking Union will have an impact on the responsibilities of the
EBA as it will call on the whole Union for an even stronger commitment
to the Single Rulebook and for a leap towards truly unified supervisory
methodologies - a Single Supervisory Handbook - to assess the risks at
banks and to trigger corrective actions.
Without such an effort, we risk a polarisation of the Single Market
between the euro area, with single rules and supervisory practices, and
the rest of the Union, which would operate with a still wide degree of
national discretion in implementing and applying the Single Rulebook.

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The EBA has put a lot of effort in contributing to the action of regulatory
repair and the establishment of the Single Rulebook, by preparing draft
standards in a number of areas defined by the proposed CRD4-CRR.
At the request of the Commission, we also finalised a report on the capital
requirements for SME lending, a topic that is receiving great attention
also in your discussions.
I believe we established a good working method, with open channels of
communication with this Committee and due process of open
consultation and impact assessment.
This should allow us to promptly finalise our draft standards once the
legislative texts are approved.
In the final stage of the negotiations, it is essential that all policy makers
maintain a strong commitment to rigorous and consistent rules, in line
with international standards.
In the EU, these rules will be applied to all banks and should therefore
acknowledge the variety of business models and cultures.
Proportionality will be a key concept in this respect.
But in a large number of areas, it is essential that the yardsticks to assess
the solvency and liquidity of banks are effectively the same for all banks in
the Single Market.
The strong pressure we faced to address the difficult situation in banking
markets and in contributing to the reform of banking rules determined a
slower start in the accomplishment of our tasks in the area of consumer
protection.
I am aware that the Parliament attaches great importance to these tasks.
The urgency of making progress in this area is confirmed by the recent
episodes of mis-selling, poor compliance with anti-money laundering
rules and manipulation of market benchmarks.
We are now working at a much higher speed in these areas and envisage
issuing important guidelines in the area of mortgage lending - on
responsible lending and on arrears management.

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Reviews of the risks for consumers and banks from financial innovations
such as Exchange Traded Funds, Contacts for Differences and structured
products are also being finalised.
Further work is taking place under the aegis of the Joint Committee.
In conclusion, let me touch on the delicate issue of resources.
We really appreciate the efforts made by the Parliament to strengthen our
resources.
Notwithstanding the generous support provided by national supervisory
authorities, which have seconded a significant number of staff at our
premises during the periods of our most intense workload, it remains
difficult for us to fulfil our tasks under such stringent resource
constraints.
While the amount of staff envisaged in the steady state situation, to be
reached around 2015, is still commensurate to our tasks, there is an urgent
need to accelerate the process, as the difficult challenges we are facing
require that the resources are available as soon as possible.
Thank you for your attention.

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NUMBER 5

Benoît Coeuré: Challenges to the single
monetary policy and the
European Central Bank’s response
Speech by Mr Benoît Coeuré, Member of the
Executive Board of the European Central
Bank, at the Institut d’études politiques, Paris,
20 September 2012.

Ladies and gentlemen, It is a great pleasure for
me to speak here today at Sciences Po Paris.

9 August this year was the fifth anniversary of the start of the financial
crisis.

The past few years have been times of hardship, financial turbulence and
risks.

At the same time, the crisis has exposed weaknesses in the framework of
the economic and monetary union and provided an impetus to strengthen
its foundations and to begin the process of bringing all euro area
countries back to a more sustainable fiscal and macroeconomic path.

The crisis has also brought challenges and opportunities for monetary
policy, which is going to be the focus of my remarks today.

Let me elaborate on two of them.

The first challenge I will describe is that after Lehman’s collapse central
banks had to combat exceptional threats to price stability arising from
financial instability and recessionary forces.

At that time their standard tool of monetary policy – changes to the
short-term interest rate – was losing traction due to the dislocation in the
financial system.
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Central banks had to quickly learn that this situation required switching
from normal operating mode, based simply on setting short-term interest
rates, to crisis mode, aimed at sidestepping the obstacles to the standard
channels of monetary policy transmission.

This experience has given us an opportunity to deepen our understanding
of monetary policy and, in particular, to reject the textbook dichotomy
that either the central bank is able to rely on the “interest rate channel” for
the transmission of its intentions, or else the economy is condemned to
lasting instability.

It is now clear that additional channels and conduits are available.

The second challenge I want to discuss is the sovereign debt crisis and
the associated fragmentation of credit markets across national borders.

Starting in 2010, the financial crisis began to unfold in the euro area by
turning into a debt crisis for some sovereign issuers.

This quickly spilled across markets and countries.

And more recently, it was exacerbated by investors’ fears of the
reversibility of the euro.

The challenge faced by monetary policy in this environment is enormous
and is testing the ability of the ECB to act as the central bank of a single
monetary area with 17 fiscal jurisdictions.

It has been increasingly challenging to preserve the singleness of the
monetary policy and to ensure the proper transmission of the policy
stance to the real economy throughout the currency area.

To address this situation, the ECB has taken a number of non-standard
measures, and two weeks ago it announced the modalities for
undertaking Outright Monetary Transactions in secondary markets for
sovereign bonds in the euro area.

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I will describe the rationale for this decision and argue that it is a key
element to ensure a lasting “monetary dominance” in the euro area,
compliant with the Treaties.

Channels of monetary policy in normal times and crisis times

In normal times, monetary policy works primarily through inter-temporal
financial arbitrage.

In the Eurosystem, this arbitrage covers two different time dimensions.

There is the weekly arbitrage cycle, through which the volume of central
bank liquidity is reallocated across banks trading in the money market in
the period between two consecutive weekly Eurosystem main refinancing
operations (MROs).

The reason for this reallocation is that – as a matter of routine, at least –
the Eurosystem provides reserves at weekly intervals.

While the banking sector’s need for reserves in the aggregate may not
change significantly within a week, the cash needs of individual banks do
fluctuate at higher frequencies, probably daily.

So banks with liquidity deficits in the infra-weekly period need to borrow
from banks with liquidity surpluses.

The price at which these trades of liquid reserves between banks occur,
i.e. the overnight interest rate (of which a euro area average, the EONIA,
is computed and published every day by the ECB), is influenced by
expectations of the cost of Eurosystem credit – the so-called MRO rate –
at the next weekly monetary policy operation.

A short-term inter-temporal arbitrage calculus anchors the overnight
interest rate applied on the credit transaction between banks that need
liquidity and banks that have a liquidity surplus.

The second dimension of the inter-temporal calculus has a longer horizon
and a wider scope of application across asset classes.
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Banks can borrow short in the money market or from the Eurosystem and
decide to engage in term lending to other banks or to their customers.

Bank customers, in turn, can use bank liquidity to finance consumption
or the acquisition of capital.

It is important to note that all of these money transactions in the broader
economy involve traders weighing the costs of their borrowing against the
return opportunities on their asset acquisition at different points in time,
where the horizon is typically longer than a week.

But, again, as banks borrowing from the Eurosystem are the source of
this liquidity propagation pattern, and banks’ financial calculus is based
on their anticipations of the interest rate settings by the Eurosystem in the
future, such anticipations anchor the pricing of credit in the broader
economy.

We call this “the interest rate channel” of monetary policy decisions.

In normal times, when risk factors are contained and can be diversified
away, the interest rate channel, working through inter-temporal arbitrage,
is the prime conduit of monetary policy (see slide 2).

It sets the floor for term borrowing costs.

Parsing longer-term yields into two components – the average level of the
short-term policy interest rate expected over the term to maturity of the
asset, and the risk premia – expectations of monetary policy pin down the
first component.

The mechanism through which this occurs is the inter-temporal financial
arbitrage I just described.

Term and liquidity premia are the additional returns that investors
demand as a compensation for their reluctance to bear interest rate risk
over long-duration assets, and for their decision to forgo liquidity services
– I am abstracting here from credit risk, to which I will return later.

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