Basel II delay would threaten EU timetable, UK says
LONDON, January 21 - Any delay in reaching final agreement on the Basel II accord upgrade of international rules for bank safety would threaten the already tight timetable for bringing the European version into law, the UK Financial Services Authority (FSA) said this week.
The Basel process appears to be `back on track' following the successful October meeting in Madrid of the Basel Committee on Banking Supervision, the architect of Basel II, the FSA notes. But "some commentators remain sceptical about the Committee's ability to deliver a final accord by the middle of 2004," the FSA says in its "Financial Risk Outlook 2004" issued yesterday.
The annual outlook - on which the FSA, the UK's chief financial services watchdog, invites comments - reviews the range of shorter and longer term risks confronting both consumers and providers of financial products.
The FSA says that while much of Basel II has been agreed, there are still European Union-specific issues that need to be resolved before the EU version is formally proposed.
The controversial, risk-focused Basel II rules are intended to come into force in the UK via the EU's risk-based capital directive, generally known as Cad 3, by the end of 2006. Cad 3 will apply to all banks and investment firms in the EU.
Last week the Basel Committee, which comprises senior banking supervisors from the world's leading economies, including the UK, said it was confident of finalising Basel II by the middle of this year. The committee had met at its headquarters in Basel, Switzerland to review industry comments on the Madrid proposals to drop expected losses from the more sophisticated ways of calculating the minimum capital banks need to absorb credit risk losses. The proposal was a response to last-minute protests, mainly from US banks and their regulators, at the inclusion of expected losses. The protests seemed at one stage to threaten a major upset of the Basel II timetable.
But US regulators are now indicating that any agreement by the end of June will be far less definitive than previously expected (see the current, January issue of Global Risk Regulator newsletter). European regulators insist that the June document must essentially represent the final package.
Meanwhile, the FSA notes in its outlook that financial firms will have to contend with an unusually high volume of regulatory and legal reform over the next two to three years. The EU is the largest single source of the changes.
The Basel II/Cad 3 rules and the introduction of new international accounting standards (IAS) across the EU are key elements of the process, as is the nearly complete Financial Services Action Plan to create a single European market in financial services. Other efforts include the Solvency II project aimed at bringing EU insurance companies under a three-pillar safety regime of capital charges, supervisory review and market discipline similar to the Basel-II structure.
The FSA says there's a risk that one or more planned directives will not be agreed before the end of the current period of office of the European Commission and the European Parliament, for which elections are due in mid-2004. If this happens, negotiations on the directives might have to restart, changing the timescale and possibly the impact of the measure from that currently expected.
The FSA says the Solvency II project provides an opportunity to achieve a more coherent risk-based approach to insurance supervision. It should encourage better internal risk management and reduce opportunities for regulatory arbitrage between banks and insurance companies.
But the Solvency II negotiations could result in a regime that is not compatible with the UK's own risk-based approach and could create inappropriately prescriptive rules.
In turn, the EU's plans to bring all EU reinsurance firms into the regulatory net might prejudice Solvency II proposals by introducing inappropriate solvency requirements or creating an uneven playing field, the FSA says.
The European Commission plans to issue a draft Solvency II directive in early 2005, but has not named a date for bringing it into law.
The FSA notes there's likely to be more volatility in financial accounts with the EU's adoption next year of the new IAS accounting rules based on fair value principles, in which most liabilities and assets will be measured at current or marked-to-market values rather than at cost.
The agency says financial firms will need to take account of the interaction of this volatility with changes to regulatory reporting, where the capital requirements under Basel II and Solvency II could be materially different to those under current capital rules.
There's a potential that the capital requirements for some banks and investment firms could rise during a slowdown in economic activity, at the same time that asset values are reduced and mark-to-market losses are incurred.
The FSA says firms can contain such pressures by using stress tests and managing their overall capital with reference to cyclical conditions.
("Financial Risk Outlook 2004" is available on the FSA's website: www.fsa.gov.uk)
David Keefe (dkeefe@globalriskregulator.com)
