Series 5 Episode 3: The Transatlantic perspective - exploring the regulatory agenda in the US and UK

Transcript

Tessa Norman: Hi everyone, and welcome to the latest episode of Risk and Regulation Rundown. The podcast where we share our views and insights on the latest hot topics in financial services, risk and regulation. My name is Tessa Norman. I'm a Senior Manager in PwC's Financial Services Regulatory Insights team and I'm your regular host for this podcast. In today's episode we're joined by a special guest dialing in from the US to talk about the regulatory landscape in the US and how that compares to policymakers' and regulators' priorities here in the UK, covering everything from Basel 3.1 to risk management, consumer protection and ESG, and unpacking how all of that impacts firms with a global footprint. I'm delighted to be joined by two experts to help explain how firms would navigate what's a very complex and busy regulatory agenda on both sides of the Atlantic. So, I'm joined by Adam Gilbert, PwC’s Global Senior Regulatory Advisor on financial services risk and regulation, and he's joining us from the US, and Conor MacManus, a Director in our Financial Services Regulatory Insights team in the UK and who's a returning guest to the podcast. Welcome to you both.

Conor MacManus: Great to be here. Thanks, Tessa.

Adam Gilbert: Thank you for having me.

Tessa: Adam, I'll start with a bit of an understatement. It's been a busy few months in the US and a lot of that recent activity that we've seen from government, congress and regulators has been driven by the reaction to the market disruption and some of the bank failures that we saw earlier this year. And we've also had the final Basel 3 Endgame proposals published very recently. Do you want to kick us off by setting the scene and sharing your thoughts on some of those major themes and initiatives which are really shaping regulatory priorities in the US at the moment?

Adam: Yes, sure. Thanks, Tessa. I think it would be helpful to set up two parts to that discussion. The first is the supervisory side and then the second is the regulatory side. And it's important to make those distinctions because a lot of what's been happening in the regulatory space generally relates to the examiners on the ground in the US at the banks, following on to the events of SVB's failure, and the analysis and concerns that came out of the Silicon Valley Bank failure. There's been a lot of activity that the supervisors have pursued at individual bank level and also horizontally across the industry following that. In addition, there have been a number of important rule makings and you mentioned Basel 3, the so-called Basel 3 Endgame in the United States as it's taken on that name, so there's been a lot of regulatory activity as well. On the supervisory side, concerns coming out of the SVB failure and the other two bank failures as well, relate to concerns about liquidity risk management and interest rate risk management. And the examiners have come out in force to review the practices of banks in those areas, and as a result banks have had to take a step back and look at their practices around liquidity risk management, the same as following on with interest rate risk management as well. So, there's been a lot of activity there.

That's in addition to the normal supervisory review process to begin with, so you've had these special focused exams that have come on top of what was probably on the schedule already for any individual banks review. In addition, a few other areas of note. There have been those rule makings around consumer protection and fair lending which is an important area in the United States. A very important focus, especially for the Biden administration. So there are parts of Dodd-Frank still being implemented by the CFPB around small business lending data as well as regulation around consumers' control of their data and providing access to third parties. As well as focus on fees, late fees and other fees that banks charge for customers being late with payments and so forth. So that's been important. If you think about the full range of financial resource management and operational resiliency, all of that has been in play in the United States over the last several months.

Tessa: Great, thank you. That’s a really wide-ranging agenda that you've spoken to there and a lot of those themes and issues that you've mentioned really speak to some of the priorities here in the UK as well. Conor, it would be great if you could give us a comparative high-level view in terms of the UK's regulatory agenda and priorities and what's really driving those at the moment?

Conor: Yes, if you listen to Adam, you can see the scale of the activity over in the US and I think it's equally busy here in the UK. I think there's a number of things driving that. The Financial Services and Markets Act passed parliament in July and that's a really important milestone for the UK's post-Brexit regulatory framework. It really sets out the way in which we're going to regulate our financial services sector but it's also going to be a trigger for a lot of activity. I think what the Act does is, in essence, give the regulators the powers to make a suite of changes to EU onshored regulation, MiFID, PRIIPs, UCITS, all of those acronyms that we're so familiar with from looking at financial services regulation, all of these dossiers to be looked at, reviewed and amendments made. I think that's a process which is really kicking off at the moment. We're really starting, in earnest in the Autumn, so we're going to see a huge amount of activity in that space. We've also got the regulators really responding to technology and innovation. Some of the topics that Adam mentioned, so crypto is clearly on that list, regulation of AI, an incredibly important priority for the government here in the UK and regulators really responding to technological innovation and change in the sector. ESG clearly a big priority here in the UK, both from a climate risk perspective for the PRA, but the FCA being much more assertive with firms in saying, 'We really want you to embed this into your business model, your operating model.' That's an agenda which continues to grow. And then consumer duty came into force at the end of July, we can talk about that in a bit more detail, but clearly a lot of activity and a lot of work being driven off that. I think headline message is the regulatory agenda here in the UK is probably as busy as it's ever been.

Tessa: Yes, absolutely. And, of course, Adam talked about the regulatory and supervisory response to the bank failures over in the US that we've seen so far. What are we seeing on that in the UK, Conor? How have we seen that the PRA responding to that market disruption?

Conor: Yes, there's some commonalities and there's some differences with the US. The differences are the starting point of the prudential framework that UK banks have faced. You know, clearly in the US, there was an initiative in 2019, I think it was, to, in effect, reduce the prudential requirements on banks which were not the largest banks in the US but were still relatively significant, so SVB clearly fell into that category. We haven't had that process in the UK, so interest rate risk in the banking book was capitalised, we have liquidity standards which were applied to all organisations, all banks in the UK, but clearly the PRA is going through a lessons learned exercise and I think one of the things which is different, again in the UK is deposit protection. I believe it's $250,000 in the US, significantly lower here in the UK, £85,000. The experience of SVB and all those huge outflows that we saw because of digital banking, some messages we saw being shared around social media, clearly regulators across the world but also here in the UK are looking at that and thinking about what are the implications of that and how do you respond from a policy perspective? And one of the things that they are clearly looking at and have said so publicly, is this point around how can you ensure continuity of access to deposits when a bank gets into trouble? And I think that's something we'll see more details from the Bank of England and HMT in the coming period.

Tessa: And Adam, you spoke insightfully about the immediate supervisory response that we've had in the US. How do you see the medium to longer term response and impact? How do you see things evolving from here?

Adam: I think they will continue to go through these exercises at the banks, the examinations on liquidity risk management and interest rate risk management. I'm sure there'll be additional guidance that comes out of that process, in addition to the findings for individual firms that they will have to address. And one of the things that we observe here is that, and it's not just related to SVB but there are other enforcement actions out there that indicate this as well, that patience has worn thin with recidivism, or the inability to address supervisory findings in a timely and importantly sustainable way. And I think a lot of the focus over the ensuing months is going to be on delivering clear messages to the banks that, 'Hey, when we come up with these findings we expect you to address them in a timely way. In a way that's going to get you validated and that is sustainable.' So, we see that examiners are reopening issues or leaving them open because they're not convinced the bank may have addressed the issue in a timely or thorough way. And we see a very big emphasis on testing of controls and data quality, lineage, to make sure that the information that the bank is using for its risk management and control purposes is sound and be validated and provides a strong basis for the risk and control environment.

Tessa: Okay, thank you. And you also talked earlier Adam, about the Basel 3 Endgame proposals that were published at the end of July. It would be great to delve into that in a bit more detail really, in terms of for anyone who's maybe not had the time to dive through quite all the 1000 plus pages. What are the really headline messages from that and how do you see this impacting the banking sector when it comes into force?

Adam: Well, it's significant and you have to divide up the banking sector into tiers to understand the impacts. For the largest, for the G-SIBs, there's clearly a significant impact in the proposal around the trading book, FRTB as it's known, Fundamental Review of the Trading Book, and the proposal suggests very significant increases in capital related to trading book activity. They're also affected by the elimination of the advanced measurement approach for operational risk. So, we have a new standardised operational risk approach that will be incorporated here and that's also very impactful to the largest banks. The new thing is the application of these rules to banks $100 billion and above and that is a clear outcome of the SVB failure. It is a rollback of the so-called tailoring rule that was implemented previously, and this is a significant impact to banks in that tier because they're going to have to do things that they've not had to do before, at least as proposed in the rule. We'll see when the final rule comes out, but they will have to incorporate AOCI into their capital as a matter of course, it's not an opt-out anymore. They will have to do the market risk rule, even if they don't have a lot of activity relative to the largest dealers, so they will have to do that as well, so that's a new lift for them, as well as the operational risk component which under US rules today is not explicit for that tier of banks in the current standardised approach so that's a new thing as well. In 1100 pages there's a lot of detail and we and our clients are going through all of that now. There's also the operational side. So, implementing this rule is going to be a big challenge. You will have to have strong governance, documentation, especially around interpretations of the rules, even though there's a move more towards the standardised approaches, which in the market risk rule for the G-SIBs is important so there's going to be a requirement to get your models validated. So, at the desk level, that is a very big burden in terms of documentation and an approval process. This is one example of many, of where you're going to have to do a lot more work just to implement something which feels like a pretty simple, standardised approach but comes with operational requirements that are significant.

Tessa: So certainly, lots for firms to both digest and then to work through in terms of the implementation.

Adam: Exactly.

Tessa: So Conor, here in the UK firms have had a bit more time to digest the PRA's Basel 3 implementation proposals that came out in November 2022, I mean, do you think there will be an impact now we've seen the Fed's approach, you know, might that influence the final outcome we see here in the UK?

Conor: Potentially, clearly the impacts that Adam has just outlined will be pertinent here in the UK, so there's definitely a lot of work to be done here as well. I mean, I think there's an interesting dynamic here which is that the EU went first with its CRR3 proposals which have recently been agreed, took them a while to get political agreement on that, as it usually does because of the process they have to go through. The outcome of that in some areas is quite different from what the Basel committee agreed on. And I think the fact that the EU has diverged in some areas has caused some people to question the PRA's approach which was quite consistent with Basel.

I think the fact that the US, obviously another major jurisdiction, is taking a pretty robust approach to implementation of Basel 3.1 as we describe it here in the UK, will strengthen the hand of the PRA in sticking quite closely to Basel. So, I think they will be quite pleased to see the Fed taking a robust stance. I mean, I think as Adam mentioned, there's a question of implementing Basel requirements for those firms that didn't necessarily have to meet all of them before. In the UK we have a slightly different thing which is the Strong and Simple regime which the PRA is developing for non-internationally active banks which would take them out of the Basel requirements. I think that it would be interesting to see how recent events and the steps that the Fed are taking in the US influences the development of that regime. Now, I don't think there was ever an intention in the PRA to create a regime which was weak, that's just not the way in which the PRA regulates. The idea was to create something which was simpler and didn't have the complexity that is inherent in the Basel standard. But I think that will be an interesting dynamic to look at as the PRA develops its framework over the coming months.

Tessa: Absolutely, thank you. So, as we've touched on, there's clearly a really busy agenda on the Prudential side but I think you've also both referenced some of the developments that we're seeing on the retail conduct agenda, which I think is worth just spending a bit more time talking about. So, Conor in the UK you mentioned earlier the FCA consumer duty, so we've just had the first implementation deadline for that, which applies to open retail products and services that came into force at the end of July. And there's also the broader consumer protection and financial inclusion part of the UK government's agenda. Do you want to just tell us a bit more about how we're seeing that impacting UK firms?

Conor: Yes, certainly, consumer duty is a very ambitious piece of regulation, it's designed to be a paradigm shift, I think the FCA describes it as transformational. So it's understandable that there's a lot of work to be done and as you say, the initial deadline has passed and firms have got over that hurdle but there's still a lot of work to be done. And I think really what it's about now is embedding it throughout the organisation and that's something the FCA is asking firms to do, so culture, the way in which you design your products, the way in which you interact with your customer base, all of these things, you need to think about the consumer duty in those contexts.

I think one of the things that firms will have to focus on is data. Data availability to be able to understand their customer base, their needs, the way in which they're interacting with them to make sure that they are delivering good outcomes for their customers, which is at the heart of the proposal. So, I think there's clearly a lot of work to be done in that space and I think it’s clearly is a big, big priority for the FCA. It's really their iconic piece of regulation so I'd expect that they will be, as part of their supervisory approach to firms looking very closely at how firms are embedding it and taking action if they see concerns, have been very clear that they will do that.

And then there's the broader agenda that you talk to, you know, clearly the macroeconomic environment is very challenging at the moment, that's putting pressure on consumers. The way in which financial services is structured and interacts with its customer base is changing, much more focus on digital which is something the regulators are encouraging but they're also thinking about the implications of this change, particularly for more vulnerable customers. So, you have things like the access to cash agenda, which is included in the Financial Services and Market Act, this is for the payment system regulator to take forward but we'll put an obligation on large banks to ensure that customers have fair access to cash. So there's a lot of stuff going on in this space and clearly it's a priority for the FCA and for parliament in particular.

Tessa: And Adam, I know you listed consumer protection as one of your, kind of, top agenda items in the US as well in the priorities you set at the beginning. Is that being driven by similar factors to those that Conor outlined and is it having a similarly large impact on firms? How does it compare?

Adam: Yes, I think it is and it's clearly a priority of this administration. I think we're seeing a high degree of activity, especially now given, as you know, we have a presidential election in '24 in the United States, I think some of the agencies, in particular CFPB and SEC look at that election and say, 'We don't know the outcome and so we ought to get busy on the agenda because we don't know if we'll still be in seat, in 18 months time. And so we're going to put the pedal to the metal, if you will, to accelerate the policy-making process.' And you can see that in the agendas of both those agencies in particular which are very assertive and have a lot on the docket. So very much so concerned in a larger sense for the administration and that's flowing down into the regulatory agencies.

Tessa: Yes, absolutely. And that brings us quite nicely to ESG and climate risk which you've both mentioned, and it's another kind of theme and issue where the, sort of, political policy-making agenda clearly has a big impact, and I think it's one of those areas where although there's lots of commonalities in approach between the UK and US as we've talked about, I think ESG and climate is one where we're seeing a bit more divergence. You know, in the UK and the EU there's a significant drive towards greater disclosure, greater reporting, and transparency. Whereas in the US the picture is somewhat different. Adam, do you want to just, kind of, characterise for us how the US is currently approaching ESG regulation and how that might differ to the UK and EU?

Adam: Yes, in the US I think it's more cautious, there's been a lot of information gathering by the Fed, a lot of learning about how banks are incorporating ESG into their business, risk management and operations, and there's a desire not to be too prescriptive at this stage as it's still relatively early in the whole ESG discussion and process. So the US is taking a bit of a more of a principled-type approach, we want to see you incorporate this into your broader framework. They're doing a pilot scenario exercise with a small set of large banks. But they've made it clear that they're not going to incorporate any prescription into, say, capital rules at this time, or require ESG to be a formal component of the formal stress testing process that they run every year. So it's, kind of, an on-the-side, if you will, a little bit. And I think that reflects in some respects the politics in the country around this topic where interestingly you have politicians pushing back on corporate leaders for their efforts to try to move towards various net-zero targets and incorporate ESG-type investments into the portfolios of their customers. And they're getting pushback from politicians on that, which is a very interesting dynamic, you don't see that type of political pushback from Republicans in particular in this country on corporate leaders like that. So it's quite an interesting dynamic and we'll see how that plays out over the months and years ahead. But we haven't really seen that too much before.

Tessa: Yes, and Conor for the firms that have got a global footprint, you know, that kind of approach that we've just heard about in the US does feel, you know, notably different to what we see in the UK where ESG is becoming, sort of, increasingly central to the regulatory agenda and to firm strategy. So, how much of a challenge does that create for firms which are operating in jurisdictions that might be taking different approaches?

Conor: Yes, it's very challenging and there's an example where, you know, major jurisdictions have gone ahead and done their own thing without, you know, an international standard setter taking the lead in the way that we've seen, for example, on bank prudential requirements. And there's the political dynamic that you have to navigate that Adam alluded to. But there's also just the operational side of having, you know, different, similar regulatory requirements particularly on disclosure, which is what we're seeing between the UK and the EU, for example. What they're trying to achieve is the same outcome but they're doing it in a slightly different way. That brings a lot of challenges in terms of, you know, data availability, definitions, and, you know, there's a lot of emphasis on at least having inter-operable regimes that reduce that challenge, but a the moment it looks like quite a fragmented global landscape.

Tessa: We talked quite a lot about the live regulatory issues that are impacting firms in the here and now, but I think to finish up our discussion it would be great to also get your views on some of the forward-looking issues on the regulatory agenda, I think you both referenced some of those themes in your opening viewpoints. So, in the UK we've heard a lot from the government, as you've said Conor, that they want to be really supportive of innovation and emerging technology. How are you, kind of, seeing that starting to manifest in terms of the UK's priorities? And how should firms be preparing to respond, particularly, you know, when they're trying to, kind of, plan ahead for the next six months, next few years in terms of their strategy?

Conor: Yes, there are two drivers here. There's the regulators and the government trying to keep pace with innovation and change in the sector. And then there's also the government and regulators trying to encourage innovation and change across the sector, and particularly I think here in the UK a focus on trying to be as tech-enabled in terms of our capital markets as possible. So you talked about AI, clearly that's an area where there's both, you know, potential risks around, you know, discrimination, bias, and decision making but also huge potential in opportunity for the financial services sector, and I think that's recognised by the regulators and is clearly a big priority for the government. Similarly with crypto we had proposals from HMT around the UK's regulatory framework for that a few months ago, we'll have to see how that progresses. And then in the capital markets space, as I said, there's a number of different initiatives which are being taken forward as part of the Edinburgh reform package. One of them is around how we can make the assessment system more efficient using technology, also things like the use of sandboxes to really encourage firms to deploy technology like distributed ledger technology where they can in a safe space.

I think, what's really important for firms is just to take a step back and look at all of these trends, you know, not just from a regulatory perspective but also from a business perspective, and try and ensure that they're keeping pace with the innovation and change that we're seeing across the sector. But doing it in a way which is cognisant of the regulatory priorities that policymakers here are articulating, because if you don't do either of those things you're going to find in five years' time that you're in a difficult position.

Tessa: Absolutely, and Adam how does that picture compare in the US? How are we seeing both firms and regulators trying to keep pace with that change and managing those risks and opportunities?

Adam: I think it's a somewhat similar picture. Obviously, technology goes at a pace that neither the banks nor the regulators control, but have to adapt to, and they're all doing that to varying degrees. But I see AI in particular as a very promising, exciting, but also to some extent scary, at least if you're a regulatory seat development that has to be very well understood, and any policy-making around that has to be done very carefully because you could easily stifle innovation by making things too prescriptive too soon. Or if you have very loose regulation, it may unleash some activity or behaviour that you might find hard to reverse. So that's a very important space. We see a lot of great use cases, we're working with clients on that today, their myriad of use cases is, in particular, in risk and regulatory management, so that's very exciting. I don't think the regulators are yet at the stage of trying to make policy around it, kind of like climate and crypto they've been trying to understand it much better; this is in the bank regulatory side. And I think that they will watch and learn for quite a while as banks develop their own approach to how they use AI to improve their operations and improve their efficiency while also keeping an eye on things like how does AI work in the context of model risk management, where you would be concerned about bias and things like that, and how do you do model validation in the context of something like a generative AI.

I think that's an exciting area but also one I think there's some caution on the part of the regulators, and they'll watch and learn for a while before being prescriptive in any way. On crypto, in the United States, I think we really have to play this out in Congress in order to get clarity. Right now regulations are essentially happening through enforcement by the SEC and CFTC mostly, and to some extent at the state level as well. But that creates a very uncertain environment and I think, you know, Congress has to weigh in here to determine who, you know, what regulatory body is to make the rules around this, what are the contours of that, do they distinguish between stablecoins and other types of digital assets for this purpose? So there's a lot more to play out there, it's not clear when that happens. There is definitely legislation that's moving through the process but it's hard to see the end game on that one right now.

Tessa: Thank you, and I think it just shows in terms of those emerging areas that level of uncertainty as that regulation developed, it certainly creates challenges for firms as they're trying to, kind of, work through some of those use cases without having that, kind of, regulatory clarity.

Thank you both for your time and your insights, it's been great to get that from you across both jurisdictions in terms of the regulatory and supervisory priorities in both the UK and EU. We've talked about a really broad range of issues which shows just how wide-ranging that agenda is at the moment. And as we've discussed, there's a lot of convergence and similarities, but also some divergence too, for instance, on ESG. It's been really helpful to hear about how firms can navigate some of those challenges, particularly in a market which is evolving and changing so quickly.

To our listeners, I hope you've enjoyed this episode, and thank you very much for listening. As always, if you found this conversation helpful, please subscribe to future episodes, and rate and review this series as it helps other listeners to find us. If you'd like to hear more from us on risk and regulation please look out for our regular publications on our website, which we'll link to in the show notes. And we'll be back next month with our next episode, which is going to be focused on a deep dive into consumer duty.