29 Jul [EXPERT ANALYSIS] First Half of 2015: Franc Cap Scrap And CRD IV

An analysis from EIMF Trainer Mr Demetris Taxitaris

“In general, the financial services industry on a global scale is coming under increased scrutiny, tighter monitoring and closer supervision, highlighting the importance of compliance and risk management.”

Regulation and compliance issues are now having to be taken very seriously right across the retail FX brokerage industry and as a result trading firms need to come to terms with the latest developments in Global Financial Services legislation such as EMIR, Mifid II and CRD IV. At the same time brokers are having to navigate game-changing and disruptive market events including the recent SNB debacle, also known as January 2015’s Black Thursday.

• The impact of the Capital Requirements Directive (CRD) IV on firms?

Many factors stemming from CRD IV have to be incorporated somehow in the decision-making processes of each firm to ensure that at any point in time, irrespective whether reporting or not, firms comply with all their obligations.

CRD IV and its enhancements aim at making it less likely investment firms will fail, thereby improving stability in the financial sector.

On a corporate governance level, CRD IV strengthens the requirements with regard to corporate governance arrangements and processes and introduces new rules aimed at increasing the effectiveness of risk oversight by Boards, improving the status of the risk management function and ensuring effective monitoring by supervisors of risk governance. The measures adopted should help avoid excessive risk-taking by individual institutions and ultimately the accumulation of excessive risk in the financial system.

Another objective of CRD IV is increased transparency concerning the activities of institutions which operate on a multinational basis. Regulated firms are required to disclose annually information on a consolidated basis for the financial year such as name, nature of activities and geographical location, turnover, number of employees on a full-time equivalent basis, profit or loss before tax, tax on profit or loss and public subsidies received.On a corporate governance level, CRD IV strengthens the requirements with regard to corporate governance arrangements and processes and introduces new rules aimed at increasing the effectiveness of risk oversight by Boards, improving the status of the risk management function and ensuring effective monitoring by supervisors of risk governance. The measures adopted should help avoid excessive risk-taking by individual institutions and ultimately the accumulation of excessive risk in the financial system.

Employee remuneration is also affected. For variable elements of remuneration, the assessment of the performance shall be set in a multi-year framework and it shall not exceed 100% of the fixed component of the total remuneration for each individual.

CRD IV also sets capital adequacy on a different level than before. The minimum capital requirements are reduced and aligned to the ones for UCITS Management Companies and Alternative Investment Fund Managers.

The quality of capital is raised. A new capital conservation buffer will be introduced beginning in 2016; 2.5% of the Total Risk Exposures. Tier 3 capital is abolished, Common Equity Tier 1 is raised from 2% to 4.5% and Tier 1 capital is raised from 4% to 6%, implying that new regulations require firms to maintain higher quality capital instruments. The leverage ratio is introduced as Tier 1 Capital divided by Total Exposure. This ratio will follow an initial observation period that will run from 1st January 2015.

Based on this and the type and services of each firm, a number of reports are required to be submitted to regulators on a frequent basis, which are again accommodated by our team of experts.

[NDC: The EIMF is organising two separate CRD IV workshops, one aimed at the BoD level and the other for Risk Managers, COs, IAs, and CFOs, details for which can be found here and here respectively]

• SNB scrap on the franc cap

Despite the fact the dust has not fully settled yet, there are lessons to draw from the recent SNB decision and subsequent developments. First of all allow me to make clear that t Cyprus as a jurisdiction has not had a single case of significant impact to an FX firm due to that event. This highlights the importance of a healthy sector.

Having said that, the effects of this event on certain FX players globally may lead to a number of firms increasingly shifting their focus to risk management. The SNB event highlighted certain shortcomings in managing tail risk. A move towards revisiting risk management practices and closer control of risks at least by biggest players is expected. This may increase their operational cost base in the short term, hopefully compensating in the longer term through tighter risk control.

In response to this, the European Institute of Management and Finance (EIMF) took the initiative to organise a conference on risk management in the financial services sector in Limassol. The event reflects the need of the industry to look more closely at the various risks and their management techniques following the recent SNB-related events. Stress scenarios, what-if analysis and risk limits application are a sample of tools which may apply.

From a regulatory perspective, we observe certain moves towards a proactive risk-based supervisory approach across all investment firms. Inevitably, this will also affect the FX industry given its particular characteristics. Since all trades are reported nowadays to repositories, closer monitoring by regulators may be easier on an EU-wide basis. In other parts of the world, where reporting of FX derivatives is not as strong, we have had certain voices recently supporting tighter regulation for industry players.

It remains to be seen whether certain practices adopted during the SNB events would be deemed as acceptable by regulators. We should stress the importance of the experience built over the years for the industry by certain national regulators in their subsequent understanding of any risks involved and the measures to mitigate them.

This is an extremely dynamic industry which tends to be proactive rather than waiting for regulators to act, forcing things upon it. From our side, as leading consultants we play a role in this.

Demetris Taxitaris, General Manager of MAP S.Platis Group