Australia plans first stress test of financial system in 2025

Chair of the Australian Prudential Regulatory Authority (APRA) John Lonsdale set out in speech the measures underway to ensure the financial stability of Australia’s banking system. 

The main takeaway: While APRA will continue to conduct industry-specific stress tests, it is now planning its first financial system stress test to ensure that banks are prepared to respond to financial or operational threats.

ADI stress test 2023: The 2023 authorized deposit-taking institution (ADI) stress test was the first exercise to test the resilience of banks under APRA’s new bank capital framework that came into effect last January, and which was designed to be stronger and more flexible than its predecessor in responding to stress scenarios. 

• While the APRA has observed ongoing improvement in banks’ internal stress testing capabilities there is still room for improvement in areas such as governance, modeling and data and stress test scenarios
• The APRA expects banks to do their own stress tests using their own scenarios to widen the lens on potential sources of future risks, such as commercial property and climate risk

System wide stress: The intention behind the new test is to sharpen APRA’s response to systemic risks by deepening their understanding of the transmission mechanisms of shocks across the financial system.

• APRA hopes to gain insight into the impacts of spillover and amplification risks between industries and identify possible “blind spots” in its supervisory regime
• The expectation is that the test would involve selected large entities and be conducted in stages, with a year for the design and a year for the exercise itself

International context: While the U.S. Federal Reserve has begun exploring broader market risk shocks as part of its bank stress testing program, the Bank of England has launched its first system-wide exploratory stress test exercise, including banks, insurers and pension funds, as well as other financial market participants. 

• APRA has had several meetings with the Bank to understand its approach to the exercise and how it went about designing it, which took them the best part of a year 
• Their thinking, successes and lessons learned will all contribute towards the approach APRA ultimately takes in designing its own system-wide stress test

Looking ahead: The APRA will be engaging with stakeholders throughout the financial system on the design of the test, focusing on exploring systemic risk hypotheses and potential scenarios.

• The APRA intends to provide an update before end-2024 ahead of rolling out the test in 2025
• Before that there will be the 2024 ADI stress test and APRA will continue to engage with participating banks on this year’s stress test, which will be conducted from mid-May to the end of July

Fed & OCC fine JP Morgan $348 million over trade surveillance gaps

JP Morgan was fined $348 million by U.S. regulators in two separate but coordinated enforcement actions relating to its trade monitoring practices. 

Specifically, the firm was fined $98.2 million by the Federal Reserve “for an inadequate program to monitor firm and client trading activities for market misconduct” and $250 million by the Office of the Comptroller of the Currency (OCC) for “gaps in trading venue coverage and [in]adequate data controls.” 

Swiss regulator calls for more supervisory and enforcement tools

The Swiss Financial Market Supervisory Authority (FINMA) published its Annual Report for the year 2023 and provided data on enforcement cases at its annual media conference. 

Strengthened legal basis: Following the collapse of Credit Suisse in March 2023, FINMA plans to adapt its supervisory approach in certain areas. 

In particular, FINMA believes that additional tools will enable it to fulfill its supervisory and enforcement duties more consistently, such as: a senior managers regime, the power to impose fines, and the possibility of communicating more actively about supervisory activities.

Adjusted organization of large bank supervision: Following the merger of UBS and the Credit Suisse Group, FINMA has amalgamated and expanded the former large bank supervision teams. 

• Thomas Hirschi, Head of the Banks’ Division, said that forty on-site supervisory reviews are planned at UBS in Switzerland and abroad, as well as two in-depth stress tests this year
• Supervision of UBS focuses on the risks arising from the integration process and operational stability due to the merger 
• FINMA is also focusing on the combined bank’s capital and liquidity planning as well as its conduct and the combined bank’s recovery and emergency planning will be critically reviewed 

Supervision of intermediaries: Supervision of insurance intermediaries in the year under review was shaped by the revised provisions of the Insurance Supervision Act and the Insurance Supervision Ordinance, which came into force on January 1, 2024. 

• Insurance intermediaries are now licensed and supervised by FINMA 
• By the end of 2023, 1,248 new registration applications had been successfully completed

Focus on new technologies and cyber risks: In 2023, FINMA also focused its supervisory activities on managing risks relating to cyber, artificial intelligence and sustainability. 

• FINMA also kept a close eye on the latest developments in cryptoassets, decentralized finance and DLT trading systems
• FINMA also set out its practice for staking services (custody of cryptoassets) in guidance

Enforcement: In the area of enforcement, FINMA carried out 732 investigations and concluded 27 proceedings against companies and individuals in the year under review. The courts upheld FINMA’s enforcement rulings in all contested cases concluded in 2023. 

Closely related: The Swiss National Bank (SNB) published its annual report for 2023. At national level, the SNB works closely with FINMA and the Federal Department of Finance (FDF) to create a regulatory framework that promotes stability. 

• In light of the Credit Suisse crisis the SNB considers that the current ‘too big to fail’ (TBTF) regulations should be reviewed to ensure that they take adequate account of the systemic importance of individual banks
• In particular, the SNB recognises a need for action in the areas of early intervention, capital and liquidity requirements, and resolution planning
  

EU Commission adopts draft rules on assessments of internal models for market risk

The EU Commission adopted technical rules on the assessment methodology under which competent authorities verify an institution’s compliance with the requirements to use an internal model approach (IMA) to compute the own funds requirements for market risk under the Capital Requirements Regulation (CRR). 

In more detail: The rules specify three main chapters:

1. Qualitative requirements
2. The internal risk-measurement model used to compute the expected shortfall measure and the stress scenario risk measure
3. The internal default risk model used to compute the additional own funds requirement for default risk

For each aspect for which the competent authority needs to perform an assessment of compliance, the technical standards specify concrete assessment techniques.

Wider context: The adoption of technical rules by the EU Commission comes as the implementation effort intensifies for the Fundamental Review of the Trading Book (FRTB) under the Basel banking standards. 

Next steps: The rules will now be subject to a scrutiny period by the European Parliament and Council, and if objections are raised they will be published in the Official Journal.

EIOPA publishes EU-wide strategic supervisory priorities for 2024-2026

The European Insurance and Occupational Pensions Authority (EIOPA) published its EU-wide strategic supervisory priorities for 2024-26. 

Strategic objectives: EIOPA outlines two main strategic objectives that will be pursued in collaboration with EU national competent authorities:

• Ensuring the financial robustness of insurance undertakings
• Protecting consumers in a disruptive environment

Supervisory priorities: EIOPA has highlighted three specific areas to be treated as supervisory priorities, which will undergo annual revisions over the three-year cycle to reflect recent developments and trends:

• Continuous monitoring of the impact of the macroeconomic environment

Risk transfers including the capacity and appropriateness of risk transfers

• Value for money including in relation to inflation and current macroeconomic trends

Reserve Bank of New Zealand publishes assessment of Capital Review implementation

The Reserve Bank of New Zealand (RBNZ) published an assessment of the first two years of the Capital Review implementation that phases in new higher capital requirements. 

In summary: Over the previous two years, the RBNZ found that all New Zealand banks have met the increasing capital requirements. 

• The central conclusions are that higher capital is helping to increase banks’ resilience to shocks, as well as their capacity to absorb losses, and lifting financial stability in New Zealand
• Banks have used a combination of retained earnings and issuances of new capital instruments to increase their capital
• The RBNZ has not found any evidence of financial market disruptions from changes to capital requirements
• The smaller banks have not yet faced any increases in capital requirements and are well-placed to meet the increases scheduled to affect them from July 2024 onwards

Looking ahead: The full impact of Capital Review decisions will not be clear until 2028, once all the changes are fully implemented. The next assessment is scheduled in two years.

Dubai regulator proposes changes to fund regime

The Dubai Financial Services Authority (DFSA) issued proposed changes to its regulatory regime for Credit Funds, Public Property Funds and Real Estate Investment Trusts (REITs). 

Credit funds: Current rules prohibit a DIFC based fund manager from managing a Credit Fund that is established or domiciled outside the DIFC. 

• However in light of experience and benchmarking against similar rules in comparable jurisdictions, the DFSA is now ready to remove this restriction
• The DFSA proposes to allow authorized fund managers to manage external funds that are credit funds subject to certain conditions

Public property funds and REITs: The proposals intend to modernize the frameworks for Public Property Funds and REITs through changes to corporate governance, fund manager remuneration, termination of fund management agreements, valuation of fund property, improving the quality of assets invested by REITs, minimum number of unitholders in public funds, and minimum size of REIT distributions. 

Next steps: 

• Respondents have until May 20, 2024 to submit feedback
• The DFSA plans to review the entire Credit Fund regime with regard to potential imbalances and will shortly initiate a call for evidence to gather market feedback

Australia consults on the design options for upcoming annual Superannuation Performance Test

The Australian Treasury launched a consultation on measures to improve the Superannuation Performance Test.

Context: The superannuation fund aims to deliver income for a dignified retirement, alongside government support, in an equitable and sustainable way, and therefore it is key that superannuation funds are managed efficiently and trustees are held to account. 

• With over three quarters (78%) of Australians having money in their superannuation accounts, the annual Superannuation Performance Test was introduced to protect Australians’ retirement savings by holding trustees to account for the investment performance they deliver and the fees they charge to members
• The test is conducted by the Australian Prudential Regulation Authority and assesses the performance of a superannuation product by comparing its historical investment performance against a benchmark return, based on the product’s strategic asset allocation and most recent administration fees against the median fees charged by their peer group 
• The test was designed to remove underperformers from the sector by setting an objective minimum standard with clear consequences for not meeting those benchmarks

Proposals in more detail: The Treasury is seeking industry feedback on ways to improve the performance test including whether to introduce new metrics and framework, in addition to the indices that are being used as policy benchmarks under the Superannuation Programme.  

The Government is giving increasing attention on the fund level liquidity, particularly on super assets, and impact on market stability. 

Looking ahead: The consultation closes on April 19, 2024 and the Government is open to alternative proposals from stakeholders that continue to hold trustees to account and improve member outcomes.