Compliance Supplement: Staying liquid

Staying liquid and being able to prove it by complying with the new liquidity requirements that are now coming in post-crunch is a vital concern for banks, explains Liz Morrell, as she examines the readiness of the sector for the challenges ahead

The need to hoard money and repair battered capital bases has been a requirement for every bank since the dark days of the banking crisis in autumn 2008, but this economic necessity is now being hardened into a stronger regulatory requirement as financial watchdogs around the world seek to ensure the threat of collapse doesn't stalk the banking sector again anytime soon. The Financial Services Authority (FSA) published its final rules on the liquidity requirements expected of firms in the future during October 2009, when its document entitled Strengthening liquidity standards (PS09/16) came out after a six month consultation. The regulator also wrote to the 2,800 UK financial institutions in mid-January to ask them to clarify that they have all the technology systems and procedures in place to comply. Reassurance must be supplied by 12 February. The new rules aim to ensure banks reduce balance sheet risk through mandating increased holdings of low yield liquid assets, especially government bonds. Wide-ranging requirements for risk identification, measurement and monitoring are also included, alongside control measures, risk reporting and contingency planning to strengthen a firm's ability to withstand shocks. As a result, new technology systems and procedures will be needed by financial institutions across the country.

It's not just the FSA that is updating its rules post-crunch though. The EU and USA are also looking at changing their liquidity requirements, and the somewhat discredited Basel II capital adequacy requirements were revised last year by BIS to try and take account of the new environment in which banking now finds itself. In America, President Obama is seeking to ensure high liquidity and reduce risk by banning certain types of banking, such as proprietary trading with banks' own money (see page five for more), which contrasts with the UK approach of boosting capital ratios. For multi-national banks that span the globe, many of them based in London, these international changes will need to be taken into account when they are looking at the FSA requirements and how to met them - synergies will be keenly sought and potential disparities will have to be avoided if supra-national arbitrage is to be avoided.

UK liquidity requirements & timescale
The FSA is the first major national regulator so far to have introduced tighter, detailed liquidity requirements for financial institutions. Equally, the FSA's stipulation that banks must be self sufficient of their parent company means that global operators based here must also comply; no mere caveat for London, which is such an international financial centre, with many multi-national American banks basing their international operations here.

The changes have included both qualitative changes - such as introducing systems and control stress tests that had to be in place from the beginning of December 2009, and quantative changes such as how much liquidity banks will be required to hold - clearer details of which will be issued towards the end of Q1 2010. The actual need to start electronically reporting your liquidity status to the FSA will kick-in this June, with a phased approach that will rollout bank-by-bank throughout the year. Each institution will have a 'switch on' date.

Simon Hills, executive director of prudential capital and risk at the British Bankers Association (BBA), says banks are making the changes, although a little reluctantly. "They are doing it because banks haven't got any choice, but they're a little concerned they are doing it ahead of an international consensus being arrived at."

Hills argues that the cost of the new liquidity requirements to the industry will be high - with banks required to now create daily, weekly and monthly reporting systems that will need to collate data from a wide variety of sources. This will result in higher costs as banks make the necessary technological and procedural changes to do this.

It will necessitate new data mining and dashboard systems for those banks and investment houses that have not already invested enough in such reporting and risk management technologies. "Banks are spending a lot of time speaking to third party suppliers about the new regime," says Hills. "Some will buy in the technology and others will work hard to put in liquidity warehouses." [for Hills' initial reaction to the FSA rules click HERE]

According to Patrick Fell, director of regulatory practice at the PwC (PricewaterhouseCoopers) consultancy: "The new regime is about the immediacy of data and being able to look at liquidity on a much more real-time basis. The old regime didn't have nearly the same controls, and the failures of the likes of Northern Rock in 2007 and others in October 2008 pointed to the vital need for very rapid information [in a crisis]."

Although the banks may be reticent at the amount of information they must now provide, in reality the need has already been there. "We have required a lot of this data from some of the largest banks since 2007," says a spokeswoman for the FSA. "Indeed it says the under the existing banking handbook that every UK incorporated bank has long been expected to have the capability to report its liquidity position on a daily basis if so requested. For some firms this will be a cost but then the current climate has been expensive too."

Technology
One area that banks are already investing in is liquidity stress testing software as they seek to build models and scenarios that ensure we don't see a run on a bank again like with Northern Rock, or the fall of a behemoth like Lehman Brothers. Financial and compliance reporting vendor Fernbach launched its liquidity stress testing solution, part of its FlexFinance Analytix suite, last summer to help banks meet the compliance issues imposed by the new regulations, but also model future scenarios. This flexibility to model, and adapt installed software if so needed, is a vital consideration for multinational banks when other international liquidity regimes come on stream and if there are changes to the FSA's regime at a later date. The Fernbach Analytix tool includes a wizard-like data mapping interface that supposedly enables non-technical users to quickly and easily get data from existing systems, allowing users to source information from disparate sources, as required by regulators, while also enabling the data to be used for internal risk reporting.

S. Ramakrishnan, CEO of Reveleus and Mantas products, Oracle Financial Services Software, claims to offer a similar solution. "The regulators have said there should be a more scientific way of managing risk and reporting on it. It's about designing technology that prepares you for the worst case scenarios," he says. Under such stress scenario models, counterbalancing strategies can then be devised, ready in case the worst ever happens. Although this has always been done at some level, Ramakrishnan says that what is new now is the level of detail that is required. "The degree of rigour and thoroughness being demanded has changed dramatically," he adds.

Banks' readiness to comply varies dramatically. "There are pockets of capability around, but clearly no-one has had this level of oversight to contend with in the past," continues Ramakrishnan. "Banks are grappling with this. Many of them are putting in new systems or upgrading solutions, so the FSA's rules do certainly have major technology implications. They also force discipline in designing new procedures and methodologies."

According to the FSA no excuses will be accepted - even for those smaller banks who have complained their new liquidity systems will not be built in time. "We are expecting every firm to begin reporting to the timescale set out in the statutory instrument without exception," the FSA said in its Strengthening liquidity standards (PS09/16). The spokeswoman insists that with such a long consulting period the changes are not being made blind. "We have been discussing this with the banks since December 2007 and have had a tremendous amount of engagement on this issue. We are also offering training."

Although the biggest changes will undoubtedly have an effect, such as the increase in reporting regularity; the enhanced stringency of the reporting requirements; and the definition of liquid assets, including many more government bonds, the FSA's spokeswoman maintains that the other minor alterations - the vast majority of which administrators will have to pick through - have largely been based on previous rules and practise.

Is the industry ready?
While the banks analyse what changes to their systems and technologies are required, some are more prepared than others. "In the current crisis some firms weathered the storm better than others. These tended to be those that had policies that were similar to those we are introducing," said FSA director of prudential policy, Paul Sharma, upon the publication of the new rules last October.

PwC's Fell believes the challenge facing banks isn't so simple. "There is less than a year to comply if you're lucky, so do banks have time to upgrade fully or do they go for a quick fix to meet the liquidity requirements this summer or by year end? Alternatively, banks could introduce an interim solution that they then continue to upgrade," explains Fell. "Management and IT functions understand this is something that you cannot ignore and the realisation is growing that liquidity reporting is an issue that has to be dealt with; choosing one of these options is essential."

Many banks have already put new systems and procedures in place to meet the FSA's new liquidity requirements. For example, the FST Awards 2010 has already had two entrants this year into its compliance category that detail new technology that has been put in place to meet the FSA's rules and the expected deluge of other international requirements, while also enhancing internal risk management practices. The SMBC Europe and Credit Suisse liquidity projects can both be viewed online at www.fstech.co.uk/awards/shortlist10.htm.

In addition, the FSA says it has worked closely with external software vendors who have built specific applications to help banks comply with its liquidity requirements. The regulator believes that the work it has done in this area shows that the changes are capable of being introduced on time, and without the inflated costs that some predict.

The BBA's Hills also believes banks will comply with the deadlines they are given this year, but perhaps he isn't envisaging such a smooth transition. "This January's monitoring letter from the FSA, asking for evidence of firms' compliance plans, shows how strict the watchdog intends to be," he warns. "The FSA is definitely keeping the pressure up." You'd better stay liquid and be prepared to prove it at a moment's notice.


Boxout - The key elements of the FSA's new liquidity regime are:
• Over-arching principles of self sufficiency and adequacy of liquidity resources
• Enhanced systems and control requirements
• An updated quantative regime coupled with a narrow definition of liquid assets (mainly government bonds)
• Granular and frequent reporting requirements - a daily, weekly and monthly capability is essential
• Foreign-owned branches and divisions that operate in the UK are also covered.
[Source: FSA's Strengthening liquidity standards (PS09/16) document]

    Share Story:

Recent Stories


The Future of Intelligent Finance
FStech Group Editor Mark Evans sits down with Jason Cao, President of Global Financial Services Business Unit, Enterprise BG at Huawei ahead of its Intelligent Finance Summit which was held on 3rd and 4th of June in Shanghai. This Q&A delves into key trends in digital transformation of the financial services industry as well as a look at how data, robotic infrastructure, intelligent storage and innovative technologies are shaping the future for FSIs.

The Rise of Instant Payments
Instant payments are creating new business opportunities for banks by providing more touchpoints than ever. With these evolutions underway, Featurespace brought leading industry experts together to discuss how they are protecting customers from fraudsters in real time, utilizing innovative and disruptive solutions to reduce fraud. Click here to find out more.

Offloading Cyber Risk in the Cloud
As cyber attacks and data breaches are in the news on an increasingly regular basis - with regulatory penalties and customer trust on the line for financial services firms - it has never been more crucial to be compliant in the cloud.

This video, with Akamai’s EMEA director of security technology and strategy Richard Meeus, will help explain what your company can be doing to make sure it’s not embroiled in the next big fine or front-page scandal.