It’s dull, expensive and
time-consuming, but regulation is only set to increase in the
coming years, meaning private banks need to adapt or suffer.
MaryRose Fison looks at the three regulations likely to have to
biggest impact on private banks.
If you know your enemy and you know
yourself, you will not be imperilled in 100 battles. But if you
don’t know your enemy and you don’t know yourself, you will lose
every single one”. So states the philosophy of Sun Tzu, the Chinese
general credited with writing The Art of War more than
2,000 years ago.
Go deeper with GlobalData
Though originally intended for
combat situations, the mantras espoused by Tzu are as relevant for
high-level business situations today as they were for face-to-face
conflicts in antiquity.
For, over the next nine years,
financial institutions across Europe will face their greatest
series of battles yet: regulatory reforms.
This Private Banker International feature analyses the
three key regulations that will shape the processes of private
banks over the next decade and highlights major changes that will
be needed.
(Click the image below to view as a large PDF)
How well do you really know your competitors?
Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.
Thank you!
Your download email will arrive shortly
Not ready to buy yet? Download a free sample
We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below form
By GlobalData
Basel III
Basel III, the successor to Basel II, is expected to
be the hardest-hitting piece of regulation for private banks over
the coming years as it will demand fundamental changes to the level
and quality of capital that institutions are allowed to hold.
The aim of the regulation is to
make banks more resistant to possible short- and long-term future
shocks and it will have a six-year phased implementation beginning
in 2013 and ending in 2019.
Raising
capital
At present, private banks must hold 8% of their risk-rated
assets as capital to comply with Basel II. Of this 8%, just over 2%
must be made up of shareholder equity.
But when Basel III comes into
place, both these figures will need to rise. The value of
shareholder equity will have to increase from just over 2% to 4.5%,
and the minimum capital requirement will also include a new
“capital conservation buffer” worth an additional 2.5% of
shareholder equity. This means that private banks will have to hold
10.5% of their risk-rated assets as capital, compared to the
present 8%.
Counter-cyclical
buffer
On top of this, individual national regulators will be given
disclosure to demand up to 2.5% more of capital from their banks in
what will be termed the counter-cyclical buffer. The overall result
will be that minimum capital requirements will rise from 8% to
potentially 13% should individual national regulators invoke the
counter-cyclical buffer.
Selwyn Blair-Ford, head of global
regulatory policy at FRS Global, says this will give jurisdictional
regulators flexibility but private banks more uncertainty.
“[The counter-cyclical buffer]
allows regulators to increase their capital locally by jurisdiction
by up to 2.5% according to the economic trends that they see… So
you could have a theoretical scenario where the Spanish national
regulator asks for 1%, Germany asks for 1.5%, Britain asks for
1.75% and the private banks have to reserve different amounts of
capital according to the jurisdiction.”
While the requirements will be
tougher for private banks to adhere to, Blair-Ford says complying
with the new standard ahead of the implementation deadline does
have clear benefits.
“The ability to say that you are
Basel III compliant is taken in the industry as a certification of
cleanliness and uprightness and solidity – so, even though we have
got a 2013 to 2019 transition period, any bank that intends to
follow that timeline tightly will find that they have a competitive
disadvantage to their peers.”
Liquidity
standards
Because of uncertainty over future financial shocks, Basel III
also introduces two new stress tests known simply as minimum
liquidity standards.
• Liquidity Coverage Ratio
The first new standard, the
liquidity coverage ratio, aims to ensure banks can stand up to a
maximum of one month’s acute liquidity stress. Specifically, this
requires banks to be able to demonstrate that they can maintain an
adequate level of high-quality assets capable of being converted to
cash to meet liquidity for a 30-day period.
• Net Stable Funding Ratio
The net stable funding ratio is a
longer-term stress test which aims to hold banks to a higher
standard, whereby they would be capable of withstanding market
shocks lasting up to one year. However, some professionals have
questioned the practical application of the ratio.
Marco Folpmers, principal
consultant at Capgemini and professor of financial risk management
at TiasNimbas Business School, says that if banks need to comply
with the net stable funding ratio it will be difficult for them to
profit from the maturity mismatch between assets and
liabilities.
“In order to profit from this
maturity mismatch, you have to be able to attract short-term
funding and to use it on the products for lending on a longer
basis, and this means that banks face interest rate risk.
“In Basel III, banks are forced to reduce their interest rate
risk and with the help of the net stable funding ratio they need to
align their funding and maturity, with the maturity of their
assets, and that means it will be more difficult to generate net
interest income.”
European Union Transparency Directive
The EU
transparency directive was implemented by private banks in January
2007 and applies to all EU member states.
It aims to prevent false markets
being created due to a lack of disclosure when majority
shareholdings in listed companies are increased or reduced.
The directive goes through periodic
revisions, the last being in 2009, and a consultation into
modernisation of the directive began last year. The results of the
consultation have yet to be published.
However, initial feedback suggested
that there are increased costs for crossborder investors resulting
from insufficiently harmonised regulations.
Fresh light has been cast on the
directive after a highly-publicised penalty was imposed on the
former head of one of the UK’s largest supermarket chains, after he
failed to report the sale of shares.
In August, Sir Ken Morrison,
formerly the head of Morrisons, was fined £210,000 ($328,401) after
the UK financial regulator, the Financial Services Authority, found
that he had reduced his shareholding in the company from 6.38% to
0.9% over a three-year period and had not reported this.
Morrison cooperated immediately
with the investigation and settled early, adding that he had not
been aware of his reporting obligation. The regulator acknowledged
that the reporting omission had not been deliberate but said the
result had “mislead the ownership of voting rights in WM
Morrison”.
Colin Smith, a solicitor in the
financial services group at London-based law firm Withers, says
this experience is a case in point for private banks as it
highlights the increased attention regulators are placing on share
disclosures.
“One of the services that you get
from a private bank on top of simply access to capital and
financing is the advice they give you on investment opportunities
and your wealth management portfolio,” he said.
“Where your portfolio includes shares in quoted companies,
private banks are going to have to make sure that those individuals
who are shareholders and who fall within the transparency directive
are aware of their reporting obligations.”
Foreign Account Tax Compliance Act (FATCA)
While the reasoning behind Basel III is largely economic,
and the EU transparency directive aims to present the most accurate
view of the market for investors, the motivation behind Foreign
Account Tax Compliance Act (FATCA) is ostensibly political.
FATCA came to life as a result of a
little-noticed provision in the US Hiring Incentives to Restore
Employment (HIRE) Act.
The legislation, which has been
prepared in the 
US and is due
to be phased in from 2014, is designed to curb the multi-billion
dollar losses to the US economy that arise each year from tax
evasion committed by American citizens.
Under the new regulation, private
banks across Europe will be obliged to enter into an agreement with
the US tax service – the Internal Revenue Service (IRS) – or face a
30% withholding tax on US source income and disposal proceeds.
Final guidance has yet to be
published, helping a number of myths surrounding FATCA legislation
to spring up.
The first myth is that banks can
avoid FATCA by getting rid of their US clients. The second myth is
that it is only going to apply to US direct investments.
“Private banks will have to set up
a whole series of new systems for reporting to the IRS and they
will also have to go through a verification process with their
clients as to their nationality,” George Hodgson, head of policy at
the UK-based Society of Trust and Estate Planners (STEP), says.
As well as identifying any clients
who are American citizens, banks will also have to report the size
of the account and, potentially, the source of the funds as
well.
If clients fail to provide
sufficient information to prove they are not US taxpayers, the IRS
will be allowed to withhold 30% of US tax from certain payments to
them.
Hodgson says this legislation is
likely to influence the way private banks view their clients.
“A lot of private
banks are basically saying we won’t have any US clients and are
getting rid of their US clients. But they will still have issues if
they have investors in the US,” he warns.
Meanwhile, Colin Smith says it will
have a wide-reaching impact on private banks’ approach to
developing new relationships.
“They are going to have to devote
significantly more resources to KYC [“Know Your Client” principles]
and to ensuring that their customers’ tax positions are properly
squared off from the outset which is something that hitherto they
have not really had to do.”
