A vision of the future - and it has to be near term if you want to compete

Immediately following the 2008 crash we should have been at the peak of regulatory change. Indeed, there were some very rapid responses, such as the 2009/2010 UK liquidity regime.  The mountain of reform needed was far greater than initially understood, ranging from structural change to Basel III.

As a result of the size of the change needed, it has been slower. Bank business model changes have arisen as a result of the redefinition of capital, the meaning of high quality and, of course liquidity. In addition, the amount of capital reserves and liquidity have increased.  But now that Basel III is largely in place, is the avalanche over? 

 My sense is that we have not dug ourselves out as yet; there is more to come and it is different in nature, mainly because of technological advances.  The change to what it means to be regulated now follows more predictable lines: stringent ratios, a mass of reporting to illustrate adherence to these calculations and more supervisory muscle.  The latter has shown up in the form of changes in the roles and liabilities of directors, and more recently of new language - “I Attest That This Report Is True” having new meaning now.  Fundamentally, these are enlargements to the pre-crisis operational response to being regulated. 

So as we gradually move towards a new peak, I am now expecting firms to:

·        Move from tactical to strategic action in terms of how they respond to being regulated

·        Embrace being regulated as being a competitive advantage

·        Shift from seeing data quality and data confidence as blocking issues, to an enabling force for positive change

·        Crystallise the business case for building a responsive, agile, future-change friendly operating environment

·        Evolve to exception-based processing for regulatory obligations as a goal and to do all these things whilst continuing to respond to the on-going shift in the landscape. There are more changes to regulatory requirements which are coming down the pipe now that the legislative framework looks beyond Basel III.

Ongoing changes to regulatory requirements

To achieve all the above it is probably best to start with the last, as the evolving regulations are mandatory and they drive requirements.  The remainder of the list is about how firms deal with these, and where they will win or lose. 

Upcoming changes start firstly with the rest of Basel III, or Basel IV.  Firms must take action on these right now for January 2017 for the Standardised Approach to Counterparty Credit Risk (SA-CCR) and the Standardised Approach to Central Counterparty exposures (SA-CCP).  These are the two core changes to credit risk which already challenge the data quality and granularity firms need.  There is more over the medium term, in particular FRTB (Fundamental Review of the Trading Book) and its impact on market risk.  As internal models are side-lined and more fine-tuned, standardised approaches take their place and firms have ongoing work to do to re-engineer their process related to these risks. 

Finally, firms need to plan around data reporting; this is accelerated already with transaction reporting demanded by Dodd Frank and EMIR to obtain transparency in the OTC market, turning  data lakes into a reality.  The US Federal Reserve has been collecting granular data for capital adequacy purposes for the past four years, and has now added granular cash flow data with the implementation of LCR (Liquidity Coverage Ratio requirement).  In Europe, following an XBRL data model, vast quantities of data has already been gathered as well.  Going forward, with incoming regulations such as AnaCredit, reform of Money Market Statistical Reporting requirements (MMSR), MiFID/R and new requirements under the Securities Financing Transaction Regulation (SFTR) the march to detailed data reporting has no stop.

In the face of these macro statements around regulatory change, the first set of bullets listed above are those which outline where firms can win as they gradually move towards the larger new peak post-Basel III.

The move from the tactical to the strategic

In our industry, we strive to help firms met their regulatory requirements.  In order to compete and be future proofed, major firms are now exploring strategic ways on how to model the operational side of their business in order to reduce the costs of merely being allowed to exist, and to restructure how they hold and report data. The pace of regulatory change is not slowing down; firms cannot just keep adding people, local processes, or yet another automation solution at the business unit.  They are called to look at the bigger picture. 

There are specific areas where firms can make material savings, for example preparing and managing data, information transformation, meeting target regulator’s data labelling requirements, and internal approvals and workflow.  To compete, firms need to look at all areas where costs can be reduced, regulatory risks can be managed, and operational efficiencies can be increased.  Doing so, they can achieve a competitive advantage and ensure a better position with regulators, whilst dealing with costs and achieving scalability.

Being in control of regulatory demands – today and tomorrow –  is a significant competitive advantage

To be regulated well and benefit from this is a competitive advantage. Senior management can be proactive, has the time to think and is positively informed about trends, outliers and ratios and is reusing regulatory data to good effect.  It is not distracted by a sequence of audit interventions, Matters Requiring Attention or other costly remediations. 

Firms need to move from a tactical to a strategic response in terms of how they respond to being regulated, and the faster and more efficiently they do so, the better their competitive position will be.  Firms have to deal with this by going upstream to ensure data quality and availability. They need to have confidence in the accuracy of the information flowing through the firm and to the regulator, with only exceptions requiring human intervention.  Data lakes will arise as technology ensures that generating and using them is not a problem for regulators.  Firms need to support the straight through flow of ‘clean’ data to regulators, which will allow them to manage their time more effectively rather than worrying about the next report that has to be sent to one or multiple regulators.  This end game crystallises the business case for building an agile, future-proof operating environment with exception-based processes as a central goal.

James Phillips

Regulatory Strategy Director

Lombard Risk