Developing a new regulatory landscape

The rules that affect financial management are evolving and maturing, providing a substantial amount of work for financial consultancy practices, writes Jordan Bintcliffe


A troubled global market has seen the introduction of new regulations intended to better protect companies in the financial consultancy industry against the possibility of future downturns. The resulting changes are arguably the most substantial sinc

e the Great Depression of the 1930s, and they are changing the way that companies operate on a variety of levels.

There are a number of changes to regulation that have the industry abuzz; Solvency II; Basel III; and Dodd-Frank. Although it will take years before full implementation is achieved, their effective start dates are quickly approaching and many in the industry are unprepared for the changes they will bring. As the industry prepares itself, financial consultants are enjoying increased demand from financial institutions as they seek advice on implementing the changes.

Solvency II
Solvency II is set to harmonise European insurance firms by revising capital requirements and risk management standards. It involves increasing the amount of capital insurance firms must hold, improving consumer protection by reducing the risk of insolvency.

Solvency II takes a three-pillar approach. The first covers quantitative measures, setting out capital requirements for firms to meet. For instance, insurers must hold stricter reserves in proportion to the risks they underwrite − sufficient capital to give 99.5 percent confidence that assets can cover liabilities over the following 12 months. The second is qualitative, giving requirements for governance, risk management, and supervision of insurers. The final pillar regards supervisory reporting and reporting to stakeholders, to improve market transparency.The deadline for implementing Solvency II has been revised to January 1, 2014. Despite this, a Deloitte UK 2012 survey found the majority of insurers are growing uneasy about meeting the deadlines, and 37 percent of respondents were somewhat or very concerned that the rest of the industry might not implement the changes by the deadline – compared to 24 percent last year.

According to the survey, 73 percent of businesses believe they are seeing, or will see, tangible benefits from Solvency II, such as a better understanding of their business. Some also believe competitive advantage can be derived from successfully implementing the regulations. Jim Bichard, insurance regulatory Partner at PWC, says implementation of Solvency II has created a “skills crunch” whereby there is such demand for a finite number of actuaries throughout the UK that they have been able to almost double their salaries. Similar benefits may also be seen for the rest of the financial consultancy industry.

Basel III
Basel III is similar to Solvency II, but affects banking rather than insurance. It is one of the most substantial new regulations to affect financial sectors, and has a planned introduction spanning the next few years.

Building on previous versions of the protocol, Basel III will improve banks’ ability to deal with economic turbulence by requiring them to hold 4.5 percent common equity (up from two percent in Basel II) and six percent tier one capital of risk-weighted assets (up from four percent).

Basel III should start coming into effect from early 2013, with full implementation expected by 2019. With the deadline drawing close, late agreements on details has meant some countries are struggling to meet the new requirements. German banks have been given an extra six months to ready themselves in preparation for the new regulations’ capital requirements, although it is as yet unclear whether other countries will also be given additional time.

As with other regulations, the implementation of Basel III means that financial institutions are investing more resources into financial consultancy to ensure adequate liquidity planning, capital management, and portfolio management. The Management Consultancy Association found that the demand for advice from banks alone increased UK financial consultancy revenues by 35 percent last year to $1.15bn – just behind its record growth of 40 percent in 2006.

The Dodd-Frank Act was signed into law by President Obama in July 2010. At over 2,300 pages long, the industry is still trying to digest the potential longer-term affects of Dodd-Frank. Two years on, it continues to create waves in the industry as it makes sweeping changes to the financial system, aiming to improve transparency and thus prevent further
financial collapses. The Dodd-Frank Act sets out rules giving the federal government the power to liquidate failing financial companies that could pose a risk to the US economy if they fell. Banks are also required to create ‘funeral plans’ so that they can swiftly dismantle and shutdown if they run into severe financial trouble.

These measures are intended to protect the taxpayer by avoiding further bailouts. One recent effect of the Dodd-Frank is that large banks now have to carry out stress tests. The Federal Deposit Insurance Corporation (FDIC) said in a statement that all banks with more than $10bn in assets will, from October 2013, need to conduct one annual stress test. Those with assets over $50bn will have to conduct two tests annually, with the first tests to be carried out within the year.

Financial consultancy practices are urging financial institutions to be aggressive when it comes to approaching the new Dodd-Frank regulations. Deloitte suggests that companies focus on four key areas: strategic efficiency; treating risk management as an investment rather than an expense; competing for talented workers; and improving data transparency.

These involve improving strategic and operational efficiency by reassessing their portfolios and eliminating redundant operations, reassessing the way they hire talent, and taking an advanced approach to risk management.

Although financial consultancy practices won’t forever be able to ride the benefits that the implementation of new regulations bring, it seems they can expect something of a golden period over the coming years while the world’s institutions move to prepare themselves for the various regulation deadlines.