IOSCO Objectioves and Principles of Securities Regulation

Caribbean Group of Securities
Regulators 10th Annual Conference
and Workshop
Risk Based Capital Adequacy
Framework for Securities Regulators
Session 2
Richard Britton
Montego Bay, Jamaica
November 2013
Scope of the second session
• Risk-based on-site examinations to include
– A presentation by Shuchane Johnson of the FSC’s
– Joint inspections of banks
• Action in the event of financial failure of an
– The Australian approach
• Retail repo – liquidity risk in a shadow banking
• Regional issues - CXN
Risk-based on-site examinations
– better profiling of intermediary’s risk position and its
possible impact on the market
– adjust the scope and intensity of supervision in relation
to the level of risk exposed
– integrated supervisory regimes-efficient use/effective
allocation of scarce resources
– a more pro-active approach
– promote confidence in the system as a whole
Risk Faced by Market
Portfolio risk
Entity risks
Systemic risks
Interest rate risk.
Operational risk
Risk of negative spillover effects from other
Market risk
Management risk
Risk of economic downturn
Credit or counterparty risk
Compliance risk
Financial risk
Financial risk;
Liquidity risk
Legal and regulatory risk;
Mismatch risk etc
Strategic risk;
Contagion and related party risk etc
Tools of a risk-based regulatory
• Market entry controls
• Capital adequacy or solvency standards
• Close scrutiny of the quality and strategy of
• Requirements for risk management controls
• Reliance on professional experts such as external
• Regular reporting and disclosure requirements
• Better surveillance and enforcement powers
OR Principles - Role of
• Principle 8:The regulator should require that all licenseess,
regardless of size, have an effective framework in place to
identify, assess, monitor and control/mitigate material
operational risks as part of an overall approach to risk
• Principle 9:The regulator should conduct, directly or
indirectly, regular independent evaluation of a licensees’s
policies, procedures and practices related to operational
risks. The regulator should ensure that there are
appropriate mechanisms in place which allows it to remain
apprised of developments at licensees.
Liquidity Risk Management
Monitoring Processes
• Maturity gap analysis
• Cash flow forecasting
• Rollover rates
• Scenario planning
• Stress testing
Financial Ratio analysis
Liquid assets to total assets
Volatile liabilities to total assets
Liquid assets to volatile liabilities
Net liquid assets to total assets
Unpledged eligible collateral to total assets
Allocation of Scarce
Supervisory Resources
• Risk based assessments potentially maximise the
utility of resources
• Structured mechanism for determining frequency
and scope of inspections
• Prioritising intermediaries and markets that have
higher risk and higher impact
• Inspection “checklists” ensure consistency of the
areas inspected
– Must be capable of adaptation to suit the risks and
specific objectives of each inspection
• One size does not fit all
Intermediaries “buy in” is
• Boards and senior management need to fully engage in
the process
– Move away from a legally driven rules based compliance
– New focus on managing the delivery of defined outcomes in a
more flexible regulatory environment
• Firms must be prepared
– Data quality and reliability
– Demonstrable soundness of systems
– appropriateness of risk control mechanisms and supporting
human resources.
• Securities Commission supervision is risk based
– Risk profiling framework
• Quantitative and qualitative elements
• Frequency of inspections based on risk profile
• Supported by extensive off-site monitoring
• Bursa Malaysia fully engaged in supervising its
– Subject to Securities Commission oversight
• Collective investment scheme managers included
in the risk profiling framework
Jointly regulated entities (banks)
• A single risk based capital model is an advantage
• On-site inspections of risk management and internal
controls can still be problematic
• Who is the lead regulator?
• Scheduling – joint or separate?
• Process management
– Are the securities regulator’s priorities fully dealt with?
• Fair treatment of clients
• Client money
– Rectification and sanctions (if any)
The Bahamas
• Joint On-Site Examination Programme
• Joint Examinations Committee
– Senior on-site examinations staff of the Commission
and the Central Bank
• Objectives
– the planning, timing and scope of examinations of
these institutions;
– the reporting of examination findings and
– follow-up and enforcement actions, if any.
• Notification Letter
– Sent by Central Bank
– Includes Commission instructions on how to prepare
for the securities related elements
• Examiner in Charge (from Central Bank)
– Coordinates with the Senior Examiner of the
• Post examination
– Joint Report on Examination prepared and dispatched
Financial Services Commission
of Jamaica
Shuchane Johnson
Action in the event of financial
failure of an intermediary
Financial crises no longer just involve banks – and
banking supervisors
• Various securities market products are now
– Asset backed commercial paper
– Money market funds (especially those with a constant
– Repurchase agreements (repo)
– Structured finance (securitisation)
• A broker’s failure may not be a “quarantinable”
A crisis management plan is an
essential tool
• Components
– Research based – history does repeat itself
– Create a crisis handbook
• Responses to issues
• detailed actions
– taking control, reorganization, transferring client accounts
– interaction with other stakeholders
» CCP, central bank, government, foreign regulators, media
– Include the list of contacts and coordinates
– standard forms for court orders, account freezing actions etc
Update and test
• Assign responsibility for updating
• Conduct regular simulation
“War Games”
Identify the crisis team
Develop the scenario
discovery of massive fraud, political crisis, media
– Play the game
• Document and evaluate outcomes
• Improve systems
The Australian approach
• Twin peaks model - ASIC, APRA plus the exchanges and the
central bank
• Early warning system
• Risk Assessment Detection and Response (RADAR) system
• Risk profiles on larger Market Participants updated frequently while
a RADAR on smaller Market Participants may be conducted every
three years.
• This is not just a documents review off-site. To risk profile
effectively the analysts visit firm specifically for this purpose.
• The issues identified influence not just individual inspections but
also the thematic surveillance projects undertaken by Market and
Participants Supervision
Reporting obligations
• Monthly reporting to ASIC, ASX, ASX Clear or ASX Clear (Futures)
• More frequent reporting as follows:
– Weekly (or daily) reports where ASX/ASX Clear Participant’s capital has
dropped to less than 1.2 times the minimum required level
– A report (potentially daily) where ASX 24/ASX Clear (Futures) Participant’s
capital has dropped below 1.5 times the minimum required level;
– A report (potentially daily) where the ASX Clear (Futures) Participant’s capital
level falls by more than 20 percent since the previous report
– An ad hoc report where ASX Clear, ASX Clear (Futures) or ASIC (as
appropriate) so requests.
Failure to comply with any of its additional reporting requirements,
ASIC, ASX Clear or ASX Clear (Futures) results in sanctions including
Contingency Plans
• Financial Institution Response Plan (FIRP)
– Joint agency plan to deal with systemically important
• Significant Market Event Response Plan (SMERP)
– For ASIC licensees of little or no systemic importance
Both plans Includes public information dissemination
policy and procedures
Intervention powers
• Licensing restriction, suspension and revocation
– No need for a hearing if the licensee has become insolvent or
ceased to carry on financial services business
• Freezing of a licensee’s bank accounts
– Via court order
– In Australia or overseas
• Winding up
– Requires a court order
• Moving client accounts
– Use of direction powers under the Companies Act
Retail repo: overview of a
shadow banking product
• Client “purchases” government securities from a broker
• Client pays the broker
• Broker agrees to buy the securities back from the client in
30 days (or similar)
• Broker agrees to pay the client an agreed rate of interest
on the money he has “borrowed” for 30 days
• Broker retains ownership of the securities
• Broker commits to transferring ownership of the bonds to
the client should he be unable to repay the funds at 30
Success of the business relies
on confidence
• Brokers retaining the confidence of their customers
in their credit worthiness
• Customers having no reason to doubt that the
terms of their client agreements will be met in the
event of a default by a broker; ie the collateral will
become theirs to dispose of as they wish
• The Government maintaining the confidence of
their citizens and foreign bond holders in their
commitment and ability to meet its obligations as
they fall due.
Risks in the business model
• Brokers are generally undercapitalised for this business
• A retail repo contract (unlike a wholesale repo contract)
does not include a legal transfer of ownership of the
collateral at the time of “sale”
• In the event of a broker’s default transfers of collateral
may be challenged
• Risk management practices at broker dealers active in
this business vary and may not be sufficiently robust
• Clients using repo as a short term cash deposit do not
want to own long term and possibly illiquid bonds
• There is no insurance scheme for repo, whereas in many
jurisdictions retail bank deposits are protected
Regional issues - CXN
What is the current state of play?
Mr Marlon E. Yarde, C.E.O. & General Manager of the Barbados
Stock Exchange at the Fifth Annual CGSR Conference in 2008
raised several issues.
• The Barbados Securities Commission had told him that full
reciprocity of registration, reliance among regulators and fees would
• In the meantime brokers were to be limited to trading on behalf of
investors only in their domicile.
• Barbados Stock Exchange had to ensure that all brokers who
applied to trade on the exchange via CXN had appropriate
indemnity insurance coverage.
The current Caribbean Exchanges Network (CXN) Guidelines on the
web site of the Trinidad and Tobago Stock Exchange are detailed
and complex. Is this still work in progress?
Lessons from history
• If the stakes are high enough, someone will always break
the rules or go too far.
• Managements of firms will ignore danger signs if the
individuals or departments are producing high
• Firms are run by salesmen and traders not risk managers
• A firm’s management does not think in systemic risk
• So while regulators must know their firms individually they
must also place the firm within the bigger picture
Methodology for assessing implementation of the IOSCO Objectives and Principles of
Securities Regulation: IOSCO, 2011
Guidance to Emerging Market Regulators Regarding Capital Adequacy Requirements for
Financial Intermediaries: IOSCO EMC, December 2006
Amendment to the Capital Accord to Incorporate Market Risks: Basle Committee on
Banking Supervision, January 1996:
Sound Practices for the Management and Supervision of Operational Risk: BIS, February
Recognising the Risk-Mitigating Impact of Insurance in Operational Risk Modelling: BIS,
October 2010
International Convergence of Capital Measurement and Capital Standards - a Revised
Framework: BCBS: June 2004
Funding and Liquidity Risk Management Practices - Regulatory Notice 10-57: FINRA,
November 2010
International Framework for Liquidity Risk Measurement, Standards and Monitoring: BIS,
Dec 2009
Liquidity Management for Security Dealers that are not Licensed Deposit Takers: FSC
Jamaica, November, 2004
The Leverage Ratio: Policy Note Number 11 Katia D’Hulster, World Bank Group,
December 2009
Regulators are judged by their failures
and not by their successes
The End
Thank you very much

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